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JOINT C O M M I T T E E PRINT

MONETARY, CREDIT, AND FISCAL POLICIES

A

COLLECTION

T O

T H E

CREDIT,
M E N T

OF

STATEMENTS

S U B C O M M I T T E E
A N D

FISCAL

OFFICIALS,

O N

POLICIES

BANKERS,

A N D

SUBMITTED
M O N E T A R Y ,
BY

GOVERN-

ECONOMISTS,

OTHERS

JOINT C O M M I T T E E ON T H E ECONOMIC

Printed for the use of the
Joint Committee on the Economic Report

UNITED STATES
GOVERNMENT PRINTING OFFICE
98257




WASHINGTON : 1949

REPORT

JOINT

C O M M I T T E E

O N

T H E

E C O N O M I C

R E P O R T

(Created pursuant to sec. 5 (a) of Public Law 304, 79th Cong.)
UNITED

STATES

SENATE

HOUSE

JOSEPH C. O'MAHONEY, Wyoming,
Chairman
FRANCIS J. MYERS, Pennsylvania
JOHN J. SPARKMAN, Alabama
PAUL H. DOUGLAS, Illinois
ROBERT A. TAFT, Ohio
RALPH E. FLANDERS, Vermont
ARTHUR V. WATKINS, Utah

THEODORE J . KREPS, Staff

REPRESENTATIVES

Director

GROVER W . ENSLEY 1 , Associate

Staff

JOHN W .

Clerk

SUBCOMMITTEE
UNITED

OF

EDWARD J. HART, New Jersey,
Vice Chairman
WRIGHT PATMAN, Texas
WALTER B. HUBER, Ohio
FRANK BUCHANAN, Pennsylvania
JESSE P. WOLCOTT, Michigan
ROBERT F. RICH, Pennsylvania
CHRISTIAN A. HERTER, Massachusetts

STATES

ON M O N E T A R Y ,

CREDIT,

SENATE

PAUL H. DOUGLAS, Illinois, Chairman
RALPH E. FLANDERS, Vermont




LEHMAN,

Director

AND FISCAL

HOUSE

OF

POLICIES

REPRESENTATIVES

WRIGHT PATMAN, Texas
FRANK BUCHANAN, Pennsylvania
JESSE P. WOLCOTT, Michigan

LESTER V . CHANDLER,

Economist

L E T T E R

OF

TRANSMITTAL

NOVEMBER 7 , 1 9 4 9 .
H o n . JOSEPH C . O ' M A H O N E Y ,

Chairman, Joint Committee on the Economic Report,
United States Senate, Washington, D. (7.
D E A R SENATOR O ' M A H O N E Y : Transmitted herewith is a collection
of statements on monetary, credit, and fiscal policies that have been
submitted to the subcommittee by Government officials, bankers,
economists, and others. The publication of these statements before
the opening of public hearings will serve several purposes: First, it will
make available to the committee in usable form a large amount of
information on these subjects; second, it will point up issues that
require further study and discussion; and, third, it will apprise every
witness, even the first ones to appear, of the points of view expressed
by others, thereby adding to the value of the testimony at the hearings.
The materials presented here do not necessarily represent the views
of the subcommittee, of its individual members, or of its staff.
Sincerely,




Chairman, Subcommittee on Monetary,
Credit, and Fiscal Policies.
HI

CONTENTS
Introduction
Chapter
I. Reply by John W. Snyder, Secretary of the Treasury
II. Reply by Thomas B. McCabe, Chairman, Board of Governors of the Federal Reserve System
III. Replies by the presidents of the Federal Reserve banks
IV. Reply by Preston Delano, Comptroller of the Currency
V. Reply by Maple T. Harl, Chairman, Federal Deposit Insurance Corporation
VI. Reply by Harley Hise, Chairman, Board of Directors,
Reconstruction Finance Corporation
VII. Reply by Raymond G. Foley, Administrator, Housing and
Home Finance Agency
VIII. Reply by I. W. Duggan, Governor, Farm Credit Administration
I X . Reply by Frank Pace, Jr., Director, Bureau of the Budget. _
X . Replies by bankers, economists, and others to a general
questionnaire
X I . Economists' statements on Federal expenditure and revenue policies




Y

Page
1
3

21
91
199
207
218
226
247
281
289
435

MONETARY, CREDIT, AND FISCAL POLICIES
INTRODUCTION

In its report to the Congress on March 1 of this year, the joint
committee pointed to the need for a study of monetary, credit, and
fiscal policies, stating "It is the plan of this committee to appoint a
subcommittee to make a thorough study and report on our monetary
policy, on the machinery for monetary policy formulation and execution, and in general on the problem of coordinating monetary,
credit, and fiscal policies with general economic policy.' (S. Rept.
No. 88, p. 16.) The authority and means for this study, as well as
for three others, were provided by Senate Concurrent Resolution 26,
which was approved in May. This resolution authorized and directed
the Joint Committee on the Economic Report, or any duly authorized
subcommittee of it, "to conduct 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." A subcommittee to conduct the study was appointed
in early July and soon thereafter began its work.
This volume contains most of the statements that have been submitted to the subcommittee up to this time. Its contents fall into
three general parts: (1) Replies to questionnaires sent to officials occupying responsible positions in governmental and quasi-governmental agencies; (2) replies to a general questionnaire sent to a
large number of bankers, economists and others; and (3) two statements that deal with Federal expenditure and revenue policies which
were drawn up and unanimously approved by a group of the country's leading university economists. A few words about each of
these sections will clarify its purpose and content.
As noted above, the first general part is made up of responses
by governmental and quasi-governmental officials to the questionnaire
sent to them in August by the subcommittee. It includes statements
by the Secretary of the Treasury, the Chairman of the Board of
Governors of the Federal Reserve System, the presidents of the 12
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 second part includes replies and digests of replies to a general
questionnaire which was sent out in August to more than 450 people,
including about 150 bankers, 150 economists, the 48 State bank supervisors, officials of a number of insurance companies and other
financial institutions, and representatives of business, agricultural,




1

2

MONETARY, CREDIT, AND FISCAL POLICIES

and labor organizations. The number of questionnaires sent out
had to be limited in order to hold down to a reasonable level the
work of compiling and analyzing the replies, but the sample covered
a broad area. For example, questionnaires were sent to banks in
every geographic region, to National and State banks, to member
and nonmember banks, to insured and noninsured banks, and to
banks of many sizes. Similarly, the list of economists receiving the
questionnaire included individuals in every section of the country,
both older and younger persons, economists with widely differing
shades of opinion, general economists, and specialists in a number
of fields, such as money, banking, Government finance, and business
finance. A few replies had to be omitted from this volume either
because they were received so long after the dead line (September 15)
that it was impossible to process them in time, or because they were
much too long for inclusion even after being digested. But the
number of replies omitted is quite small; most of the replies received
are included here in either complete or digest form.
The third part includes two statements on Federal expenditure
and revenue policies that were drawn up and unanimously approved
by a group of outstanding economists meeting in Princeton, N. J.
under the auspices of the National Planning Association. The statements were prepared during the period September 16 to 18 and presented to the subcommittee on September 23.
It is believed that the publication of these materials in advance
of the opening of public hearings will serve a number of highly useful
purposes. In the first place, it will make available to the committee
and to others in a convenient form a large amount of information
on subjects in the field of money, credit, and fiscal operations. In
the second place, it will bring out widely varying points of view and
indicate areas requiring further discussion and investigation. And
in the third place, it will enable every witness, before his appearance
at the hearings, to become thoroughly familiar with the information
and points of view presented by others. This should add to the
fruitfulness of the hearings.




CHAPTER I
REPLY

BY

JOHN

W.

SNYDER,

SECRETARY

OF

THE

TREASURY
M Y D E A R M R . C H A I R M A N : This is in reply to your letter dated
August 22, 1949, in which you enclosed a questionnaire which you
asked me to answer in connection with a comprehensive study relating
to the effectiveness and coordination of monetary, credit, and fiscal
policies, which has been undertaken by the Joint Committee on the
Economic Report, by direction of CongressThe subject matter of the questions falls into several main categories.
All of the questions are answered; but, since much of the material
would be repetitive if each question were answered separately, I have
taken the liberty of answering the questions by groups rather than
question by question.
The first eight questions relate to the monetary and debt-management policies of the Treasury and their coordination with the policies
of the Federal Reserve System. The questions are as follows:
1. What are the principal guides and objectives of the Treasury in formulating its monetary and debt-management policies ?
What attention is paid to the interest costs on the Federal debt;
to the prices of outstanding Government obligations; to the state
of employment and production; to the behavior of price levels in
general; to other factors ?
2. To what extent and by what means are the monetary and
debt-management policies of the Treasury coordinated with those
of the Federal Reserve? Describe in detail the procedures followed for these purposes.
3. What were the principal reasons for the particular structure
of interest rates maintained during the war and the early postwar
period ?
4. To what extent, if at all, would a monetary and debt-management policy which would have produced higher interest rates
during the period from January 1946 to late 1948 have lessened
inflationary pressures ?
5. When there are differences of opinion between the Secretary of the Treasury and the Federal Reserve authorities as
to desirable support prices and yields on Government securities,
whose judgment generally prevails?
6. What, if anything, should be done to increase the degree
of coordination of Federal Reserve and Treasury policies in the
field of money, credit, and debt management?
7. What would be the advantages and disadvantages of providing that the Secretary of the Treasury should be a member
of the Federal Reserve Board? On balance, would you favor
such a provision?




3

4

MONETARY, CREDIT, AND FISCAL POLICIES

8. What are the advantages and disadvantages of offering for
continuous sale savings bonds of the E, F, and G series with
their present yields, maturities, and limitations on the annual
amount to be purchased by each buyer? Does this policy lessen
the supply of private savings for equity capital and riskier private
loans? What are the advantages and disadvantages of promoting the sale of these securities during periods of recession?
Should the terms of these securities and the amount that each
buyer may purchase be varied with changes in economic conditions?
The primary concern of the Treasury in formulating its monetary
and debt-management policies is to promote sound economic conditions in the country. When I took office as Secretary of the Treasury,
the country had only started the tremendous task of converting the
economy from a wartime to a peacetime basis. Federal expenditures,
which had raised the output of the United States to the highest levels
on record during the war years, had been cut back sharply as soon as
the war ended. In the fiscal year 1945, Federal expenditures had been
just under $100,000,000,000, and had accounted for nearly one-half of
the gross national product; in the fiscal year ending June 30, 1946,
they dropped to a little over $60,000,000,000. This prompt cut in
Federal expenditures after the close of the war was necessary and
desirable; but it left the Nation facing the problem of replacing the
production which had gone for war purposes with civilian production
as rapidly as possible. There were many who felt that the reconversion could be achieved only after the country had experienced serious
unemployment and severe economic dislocation. Government and
business, farmers and labor, were all worried about many factors on
the economic scene.
Not the least of the economic factors which were causing concern
was the size of the public debt—which had increased more than fivefold during the war years. It was difficult at the time to forecast how
so large a debt might be handled. The size was unprecedented, both
in terms of the dollar amount involved and of the debt's relation to
the economy of the country. On February 28, 1946, at its post-war
peak, the Federal public debt stood at nearly $280,000,000,000. It
constituted over 60 percent of all outstanding debt, public and private.
At the end of 1939, before the United States started its defense and
war finance program, the total public debt had stood at $48,000,000,000.
This was only 23 percent of the entire debt of the country.
At the end of the war. the public debt was widely held. This broad
ownership made it possible for the debt to play its part in the flexible
fiscal policy which was necessary to promote economic stability in the
post-war period. The particular composition of the debt was the
result of conscious planning by the Treasury as a part of its policy of
fitting Government securities to the needs of various types of investors.
Practically all of the securities sold to commercial banks, for example,
have been short term, in order that the portfolios of banks would be
kept highly liquid. This was essential if banks were to be in a position
to finance reconversion needs. Business corporations likewise have
been provided with short-term securities for the temporary investment
of their reserve funds. Insurance companies and savings banks, on
the other hand, have held longer-term securities, largely with maturi-




5 MONETARY, CREDIT, AND FISCAL POLICIES

ties over 10 years. Savings bonds have been, of course, the principal
type of Government security held by individuals. At the same time,
however, that broad ownership of the debt contributed to easing the
problems of post-war debt management, it made good debt management particularly vital, since every segment of the economy was
affected.
When I became Secretary of the Treasury, total Government security holdings of individuals, including marketable as well as nonmarketable issues, amounted to $64,000,000,000—a significant change from
the situation prior to the war, when they owned only about $10,000,000,000 of Government securities. Over $43,000,000,000 of the Government securities held by individuals were savings bonds. Other
nonbank investors also held large amounts of Government securities.
Financial institutions had a substantial proportion of their assets invested in the public debt issues of the Federal Government. For
mutual savings banks, it amounted to 11% billion dollars—about 64
percent of their total assets. All insurance companies—life, fire,
casualty, and marine—held 25% billion dollars of Government securities. Life insurance companies alone had holdings of $22,000,000,000—over 46 percent of their total assets. Federal agencies and trust
funds, which are by law required to invest their accumulated funds in
Government securities, held $29,000,000,000. Other nonbank investors,
which include business corporations, State and local governments,
and other small groups of investors, held $32,000,000,000.
The commercial banking system held $108,000,000,000 of Government securities. Commercial banks held 84y2 billion dollars of the
total. This comprised 71 percent of their earning assets. The balance,
23y2 billion dollars, was held by the Federal Reserve banks.
It was obvious that the decisions which had to be made with respect
to a public debt which was so large, and which was interwoven in the
financial structure of the entire economy, would significantly affect
the economic and financial welfare of the country. It was essential,
under these circumstances, that debt management be directed toward
promoting and maintaining a stable and smoothly functioning economy. In the nature of things, the Federal Government must exercise
firm control of debt management as long as the debt remains so large
and so important. In the course of formulating debt-management
policies, I have consulted with advisory committees representing a
cross section of American business, for an exchange of views and information. These consultations have been helpful in determining the
soundest possible debt-management policies; but, in the final analysis,
the responsibility for these policies belongs to the Secretary of the
Treasury and under the law cannot be delegated.
As I have said, the overriding consideration in debt-management
policy is the economic welfare of the country. The Secretary of the
Treasury has many responsibilities; but his primary one is that of
maintaining confidence in the credit of the United States Government.
In addition, in prosperous years such as we have enjoyed since the
end of the war, it is important to reduce the total amount of the public
debt and to reduce bank ownership of Federal securities and widen the
distribution of the debt. Accordingly, these have been the principal
objectives of the Treasury's debt-management program during the
post-war period.




6

MONETARY, CREDIT, AND FISCAL POLICIES

1. To maintain confidence in the credit of the United States Government.—It is for this reason that stability in the Government bond
market has been a continuing policy during the postwar period. Stability in the Government bond market during the transition period
has been of tremendous importance to the country. It contributed to
the underlying strength of the country's financial system and eased
reconversion, not only for the Government but also for industrial and
business enterprises. This is in marked contrast to the situation after
the First World War, when the severe decline in the prices of Government securities contributed to the business collapse that occurred
within 2 years after the war's end.
The particular structure of interest rates maintained during World
War II was, with only minor variations, the one which existed at the
time we began our defense and war finance program. It was apparent
almost from the beginning of this program that it would require a
large increase in the public debt; and an important consideration was
the cost of the borrowed funds. It was especially fortunate, therefore,
that interest rates were at a relatively low level. It made it possible
to finance the war cheaply without disrupting the financial structure
of the country.
Stability in the Government bond market since the end of the war
has been achieved through the cooperative efforts of the Federal Reserve System and the Treasury Department. Some of the stabilizing
measures—notably, of course, the operations of the Federal Open
Market Committee—have been primarily the responsibility of the
Federal Reserve System. Others have been primarily the responsibility of the Treasury Department.
In maintaining stability in the Government bond market, flexibility
in adapting policies to changing economic conditions has been essential. It has been necessary at times to take steps to prevent too sharp a
rise in Government security prices; and, at other times, declining
prices have been halted.
Beginning in the spring of 1947, the Federal Reserve and the Treasury took action to control an incipient boom in the Government bond
market. Long-term bonds were sold from some of the Government
investment accounts, the investment series of bonds was offered to
institutional investors, and interest rates on short-term Government
securities were increased. All of these operations combined to take
upward pressure off the market. When conditions changed, and a
downward pressure on bond prices developed, the market was stabilized through purchases of long-term bonds. Short-term interest
rates—which had been permitted to rise beginning in mid-1947—were
held steady from the fall of 1948 until this summer. Then, in midSeptember of this year, they were reduced.
All of these actions have been taken with a view toward promoting
confidence in the Nation's business and financial structure and the
attainment of a high level of employment and production in the
economy.
2. To reduce the amowit of the debt.—In the statement which I made
when I took office as Secretary of the Treasury in June 1946,1 said:
* * * It is the responsibility of the Government to reduce its expenditures
ill every possible way, to maintain adequate tax rates during this transition
period, and to achieve a balanced budget—or better—for 1947.




7 MONETARY, CREDIT, AND FISCAL POLICIES

During the first two fiscal years after I took office, the Federal Government operated with a budget surplus. In the fiscal year 1948, the
surplus wras, in fact, the largest in the history of the country. Starting
in March 1946, the large cash balances that had remained at the end
of the Victory loan were applied to the reduction of the public debt.
These balances were largely expended during the calendar year 1946,
and subsequent debt reduction was effected through pay-offs from the
budget surpluses of the fiscal years 1947 and 1948. At its postwar
peak on February 28,1946, the public debt stood at 279.8 billion dollars;
on June 27 of this year, it reached a postwar low of 251.3 billion dollars.
There is no longer a budget surplus, however, largely because of the
tax reductions enacted by Congress in 1948, over the President's veto.
As a result, the debt has been rising steadily in recent months; and at
the end of September, it stood at 256.7 bilion dollars. Both President
Truman and I have stressed the importance of continuing debt reduction in years of prosperity such as we have enjoyed since the end of
the war. This was one of the reasons why the President on three occasions vetoed measures reducing taxes at a time when the economic
condition of the country permitted continued retirement of the debt.
3. To reduce bank ownership of Federal securities and widen the
distribution of the debt,—Strong inflationary pressures existed during
most of the postwar period. In order that debt reduction would have
the greatest possible anti-inflationary effect, under these circumstances,
it was concentrated on debt held by the commercial banking system*
The concentration of debt reduction in bank holdings was facilitated
by the Treasury's policy of fitting the debt to the needs of investors,
which had placed a large volume of short-term debt in the hands of
the banking system. The reduction in the public debt held by the
commercial banking system has actually been greater than the reduction in the total debt.
The total public debt was reduced 28.5 billion dollars from its
postwar peak of 279.8 billion dollars to the postwar low of 251.3
billion dollars. During the same period, bank-held debt was reduced
by approximately $34,000,000,000. This came about because the
Treasury was able to increase the Government security holdings of
nonbank investors. Funds from the sale of savings bonds and other
nonmarketable issues to nonbank investors were available for the
retirement of maturing issues of bank-held debt, in addition to the
budget surpluses of the fiscal years 1947-48. There has been an
increase of 5.4 billion dollars in the debt, however, since the low
point was reached in June of this year; and at the end of September,
the total amount of debt outstanding was 256.7 billion dollars. Bank
holdings have increased approximately $2,000,000,000 since the end
of June, so that the net reduction in these holdings from February
1946 to the end of September totals $32,000,000,000.
Because of the social and economic benefits of broad ownership of
public debt securities, the maintenance of the widespread distribution
of the debt has been an essential part of the Treasury's postwar debtmanagement policies. It has been one of the principal objectives in
the continued promotion of savings bond sales. Broad ownership
of the public debt is good for the purchasers of Government securities and it is good for the country. It gives to the people a greater




8

MONETARY, CREDIT, AND FISCAL POLICIES

sense of economic security and an enhanced feeling of personal dignity. It causes them to take an increased interest in national issues.
It gives them a direct stake in the finances of the United States.
Another postwar objective of savings bond sales was to combat
inflationary pressures. The sale of savings bonds was a two-edged
weapon against inflation. It took purchasing power directly out of
the hands of consumers; and the funds obtained from the sale of
savings bonds were available for the retirement of the bank-held debt,
thereby reducing the money supply to that extent.
We have continued actively to promote the sale of savings bonds
to encourage thrift on the part of Americans. Thrift is a vital factor
in our present-day life.
The total amount of savings bonds outstanding at the end of September was over 56% billion dollars, an increase of nearly 8y2 billion
dollars since the end of 1945. The success of the postwar savings bond
program is especially notable since it was generally expected that a
flood of savings bond redemptions would be one of the major debtmanagement problems as soon as the war ended.
Actually, the savings bond redemption experience has been better
than the turn-over rate on other comparable forms of savings. For
example, during 1949, average monthly redemptions of series E bonds
have amounted to 0.91 percent of the total of series E bonds outstanding. For other forms of savings the ratios of withdrawals to total
deposits have been as follows: Postal-savings accounts, 3.57 percent;
savings banks (in New York State), 2.32 percent; insured savings
and loan associations, 2.30 percent; savings accounts in commercial
banks, 4.86 percent (1948 figure). Moreover, the trend of savings
bond redemptions when related to the total amount outstanding has
been downward since the end of the war, whereas the percentage trend
of withdrawals in most other forms of savings has been upward.
The sale of savings bonds has not, however, been at the expense of
other types of savings. During the period in which we were using
the savings bond program as an anti-inflationary weapon, the whole
tone of our advertising was to encourage personal savings in any
practical form—not just to encourage the sale of savings bonds.
Individuals have increased their holdings of savings bonds by 13
percent since the end of 1945. But, in this same period, individuals
increased their shareholdings in savings and loan associations by over
60 percent; their life insurance by 30 percent; their deposits in mutual
savings banks by 25 percent; tneir savings accounts in commercial
banks by 15 percent; their checking accounts by about 10 percent;
and their postal-savings accounts by about 10 percent. Of the various
forms of liquid savings, only currency holdings in the hands of individuals declined.
The reasons for offering series E savings bonds are, of course, not
the same as those for offering series F and G bonds. A small savings
bond program was instituted in 1935 for the purpose of providing a
risk-free investment for small investors. When it was decided early
in the war to sell as large a portion as possible of the wartime security
offerings of the Federal Government to nonbank investors, and especially to individuals, series E savings bonds became the keystone of
that policy. This was done in order to prevent a repetition of the
post-World War I experience. After the war, the prices of Government bonds dropped precipitously—one of the Liberty bond issues



9 MONETARY, CREDIT, AND FISCAL POLICIES

sold below 82—and small investors, inexperienced in the operations of
security markets, were the greatest losers. Series F and G bonds,
which are intended for larger investors than those reached by the
series E bonds, were introduced early in 1941 as a part of the Treasury
policy of shaping offerings of Government securities to meet the needs
of various investor classes.
The savings bond program, like other parts of the debt-management
policies of the Treasury Department, has been adapted to changing
conditions in the economy. You asked whether the terms of savings
bonds and limitations on purchases should be varied with economic
conditions. We have done this to the extent that seemed necessary.
On March 18,1948, the limitation on holdings of series E savings bonds
purchased in any one calendar year was raised from $5,000 (maturity
value) for each individual to $10,000 (maturity value), effective beginning in the calendar year 1948. In the fall of 1947, the Treasury
offered the investment series bond—a savings bond type of issue—to
certain institutional investors. Again in order to meet the needs of
these investors, we raised the limitation on purchases of series F and
G bonds, for the period from July 1 through July 15, 1948.
Achievement of the debt-management objectives of the Treasury
Department requires day-to-day attention to debt operations. Decisions are made continuously.
There is, for example, the matter of refunding maturing issues.
This is one of the constantly recurring duties of the Department.
There is a Treasury bill maturity each week. There are frequent
maturities of certificates of indebtedness; and, in the postwar years,
there have been several note and bond maturities each year. In addition, there are savings bond and savings note maturities—and
redemptions of these issues before maturity. The volume of refunding, carried through each year has amounted to approximately $50,000,000,000—in itself a task of considerable magnitude. It exceeds
the total of all security refunding engaged in by all other borrowers
in the country during the past 25 years.
The interest cost of the debt to taxpayers is another of the many
considerations which must be taken into account in debt-management
policies. It is estimated that the interest charge on the public debt
during the fiscal year 1950 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 onehalf 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 fiiiance
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 taxpayers' money is a highly important factor in the budget picture of the Federal Government.




10

MONETARY, CREDIT, AND FISCAL POLICIES

It has been argued that if the Government had permitted higher
interest rates on its long-term securities at the end of the war—that
is, had permitted Government bond prices to drop below par—inflationary pressures would have been lessened.
Fiscal-monetary weapons have only limited effectiveness in combating inflationary pressures. They operate against inflation in an overall fashion. They can be used to cut down the total spending power
of the economy and so are effective—and, in fact, indispensable—in
periods of general price rise. Any curtailment of general spending
power drastic enough, however, to bring special price situations into
line, might set off a severe deflationary spiral. High prices in special
areas are most effectively dealt with by specific measures applied
directly to those areas; and it was with this in mind that President
Truman repeatedly asked Congress to enact appropriate legislation to
deal with special areas of inflationary pressures.
The Government's fiscal policy from January 1946 to late 1948 did^
however, have a direct counterinflationary effect. Federal Government expenditures were cut rapidly and sharply from their wartime
peak, while revenues were maintained at high levels. I have mentioned that President Truman on three occasions vetoed tax measures
designed to cut revenues because he recognized the urgency of reducing the debt during this period. Debt reduction by the use of a surplus of receipts over expenditures was, in fact, the most potent antiinflationary fiscal measure available to the Government. A surplus
of Federal receipts over expenditures takes purchasing power directly
out of the hands of consumers; and by using this surplus to reduce
bank-held debt, the Treasury to a large extent offset the increase in
the money supply due to other factors. I have already noted also the
promotion of savings bond sales as an anti-inflationary measure; and
that short-term interest rates were permitted to rise, starting in the
summer of 1947.
The policy of stabilizing the Government bond market in itself
made a substantial contribution to economic stability. I do not agree
with those who believe that if the support prices of Government
securities had been lowered below par, sales of these securities to
the Federal Reserve would have been stopped and inflationary pressures would have been lessened. It seemed to me that, under the
circumstances which existed, we would have taken the risk of impairing confidence in the Government's credit if the prices of Government bonds had been permitted to go below par; and that as a
result the Federal Reserve might have had to purchase more bonds
below par than at a par-support level. This, of course, would have
increased bank reserves and to that extent would have been inflationary rather than anti-inflationary.
During the postwar period, the country has enjoyed a level of
prosperity never before achieved in peacetime. Personal income
has reached the highest level on record, and has remained near that
level. Civilian employment likewise attained the highest peak in our
history, and today there are nearly 60,000,000 persons employed.
There is no doubt that the successful management of the public debt
and the maintenance of a continued period of stability in the Government bond market have contributed materially to the economic wellbeing of the country during this period.




11 MONETARY, CREDIT, AND FISCAL POLICIES

In the execution of its monetary and debt-management policies,
the Treasury consults with the Federal Reserve. The Chairman of
the Board of Governors of the Federal Reserve System and I discuss
policy matters thoroughly and arrive at decisions which are mutually
satisfactory. It does not seem to me that statutory directives to increase the degree of coordination of Federal Reserve and Treasury
policies are needed. In my opinion, such policies can best be coordinated as they are at the present time, by discussions between the
Secretary of the Treasury and the Chairman of the Board of Governors
of the Federal Reserve System.
Neither would there be any particular advantage in providing that
the Secretary of the Treasury should be a member of the Federal
Reserve Board. The Secretary of the Treasury did serve as a member
of the Federal Reserve Board from its inception until February 1,
1936. There is no evidence that the coordination of Federal Reserve
and Treasury policies was carried out any more effectively during
that period than it has been subsequently.
The Secretary of the Treasury is the chief fiscal officer of the
Government. It seems to me that any proposal to make him a member
of the Board of Governors of the Federal Reserve System for the
express purpose of bringing about better coordination of Federal
Reserve and Treasury policies would appear to subordinate the responsibility of the Treasury Department infiscal-monetarymatters. In the
final analysis, the principal responsibility in the fiscal-monetary area
must rest with the President and his fiscal officers, who are accountable to the electorate for their actions.
Questions 9, 10, and 11 are concerned with the monetary system of
the United States. The questions are as follows:
9. What would be the principal advantages and disadvantages
of reestablishing a gold-coin standard in this country? Do you
believe that such a standard should be reestablished?
10. Under what conditions and for what purposes, if any,
should the price of gold be altered? What consideration should
be given to the volume of gold production and the profits of gold
mining? What effects would an increkse in the price of gold have
on the effectiveness of general monetary and credit policies ? On
the division of powTer over monetary and credit conditions between the Federal Reserve and the Treasury ?
11. What changes, if any, should be made in our monetary
policy relative to silver ? What would be the advantages of any
such changes ?
I do not think that conditions require an alteration in the monetary
system. As the committee undoubtedly knows, I am on record as
being opposed to any change in the price of gold; and the Treasury
Department is firmly of the view that a gold-coin standard should
not be reestablished in the United States.
The Department has considered the latter proposal in connection
with a number of bills which have been introduced in the Congress.
For example, in the last session of Congress, we submitted a report
to the Senate Banking and Currency Committee on bills S. 13 and
S. 286. A copy of our report on those bills is attached.
98257—49

2




12

MONETARY, CREDIT, AND FISCAL POLICIES

The present monetary policy of the United States relative to silver
is laid down in three acts of Congress; namely, the Silver Purchase
Act of 1934, section 4 of the act of July 6, 1939, and the act of July
31,1946, which has largely superseded the 1939 act. Under the third
act, domestic silver mined since July 1, 1946, may be delivered, at
the owner's option, to United States mints for a return of 90.5 cents
per ounce. The Treasury has no discretion under this legislative provision. Since this price is considerably higher than the open market
price (now between 73 and 74 cents per ounce), the effect of this act
is to divert to the United States Treasury at the 90.5-cent price substantially all of the current production of silver in the United States.
On previous occasions, the Treasury has stated that it would interpose no objection if Congress wished to repeal all the provisions
relating to acquisitions of silver in the above-named acts.
Question 12 relates to the coordination of the lending and loan
insuring and guaranteeing policies of the various Government agencies. The question is as follows:
12. To what extent and by what methods does the Treasury
coordinate the activities of the various Government agencies that
lend and insure loans to private borrowers ? In what ways, if at
all, should the Treasury's powers in this field be altered?
The Treasury does not, of course, have statutory authority to coordinate the activities of the various Government agencies that lend and
insure loans to private borrowers. The Department has been instrumental, however, in furthering consultations between the heads of
these agencies, with a view to coordinating lending, insuring, and
guaranteeing policies. In the final analysis, it seems to me that this
voluntary type of consultation is perhaps the best method of coordinating these policies. The heads of the lending, insuring, and guaranteeing agencies are responsible to the President; and the decisions
which they make must be made in accordance with his policies. Furthermore, the policies and operations of these agencies are subject
to annual review by the Congress in connection with their annual
budgets.
Such limited authority as the Treasury has with respect to the
lending, insuring, and guaranteeing policies of Government agencies
is restricted almost entirely to the methods employed by the agencies
in borrowing funds which they, in turn, are authorized to lend to
private borrowers. For example, under the Government Corporation
Control Act, "All bonds, notes, debentures, and other similar obligations which are * * * issued by any wholly owned or mixedownership Government corporation and offered to the public shall be
in such forms and denominations, shall have such maturities, shall
bear such rates of interest, shall be subject to such terms and conditions,
shall be issued in such manner and at such times and sold at such
prices as have been or as may be approved by the Secretary of the
Treasury" except that any mixed-ownership Government corporation
from which Government capital has been entirely withdrawn is exempt
from this provision during the period it remains without Government
capital. In addition, the Federal intermediate credit banks, the production credit corporations, the Central Bank for Cooperatives, the
regional banks for cooperatives, and the Federal land banks are specifically exempted from this provision, but are required to consult with




13

MONETARY, CREDIT, AND FISCAL POLICIES

the Secretary of the Treasury prior to issuing securities; and, in the
event an agreement is not reached on the terms of the securities, the
Secretary of the Treasury may make a report in writing to the corporation involved, to the President, and to the Congress, stating the
grounds for his disagreement.
There are only a few cases in which the Treasury has any direct
control over lending operations of Government agencies. Reconstruction Finance Corporation loans on the nonassessable preferred stock
of insurance companies can be made only upon certification by the
Secretary of the Treasury of the necessity for such loans to increase
the capital funds of the companies concerned. Also, under section 103
of Public Law 901, Eightieth Congress, the Administrator of Veterans' Affairs has the authority, with the approval of the Secretary of the
Treasury, to raise the permissible rate of interest on loans guaranteed
or insured under title III of the Servicemen's Readjustment Act of
1944, from the rate specified in the law, namely, 4 percent, to a maximum of 414 percent. In addition, the Secretary of the Treasury, or
an officer of the Treasury designated by him, is a member of the Board
of Directors of the Federal Farm Mortgage Corporation.
In the field of foreign loans, there is in existence a coordinating
and policy-determining agency. The Secretary of the Treasury is
Chairman of the National Advisory Council on International Monetary
and Financial Problems, established by the Congress in the Bretton
Woods Agreements Act, approved July 31,1945. Among other things,
the statute directs the Council to coordinate the policies and operations
of the representatives of the United States on the International
Monetary Fund and the International Bank for Reconstruction and
Development, the Export-Import Bank of Washington, and all other
agencies of the Government "to the extent that they make or participate in the making of foreign loans or engage in foreign financial,
exchange, or monetary transactions."
Question 13 asks my opinion on the Hoover Commission proposal
that supervision of the Federal Deposit Insurance Corporation be
vested in the Secretary of the Treasury. The question is as follows:
13. What would be the advantages and disadvantages of adopting the Hoover Commission proposal that supervision of the
operations of the FDIC be vested in the Secretary of the Treasury ?
On balance, do you favor this proposal ?
The recommendation that the supervision of the operations of the
FDIC be vested in the Secretary of the Treasury has been carefully
considered. There is much to be said for the independent status which
this agency now enjoys. Its policies are, in many cases, governmental
policies which have been set after consultation with the President and
other Cabinet members; and the agency can, therefore, function independently. However, it could also function as a part of the Treasury.
Question 14 asks my opinion with respect to the establishment of a
National Monetary and Credit Council of the type proposed by the
Hoover Commission. The question is as follows:
14. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by the Hoover Commission ? On balance, do you favor the
establishment of such a body ? If such a council were established,




14

MONETARY, CREDIT, AND FISCAL POLICIES

what provisions relative to its composition, powers, and procedures would make it function most satisfactorily ?
I am not opposed to the establishment of a National Monetary and
Credit Council of the type proposed by the Hoover Commission. The
establishment of such a council would not of itself, however, solve any
fundamental problem. But if such a council were established, the
Treasury Department would be happy to contribute the accumulated
knowledge and earnest efforts of its various staff groups.
Questions 15 and 16 relate to Federal budget policy. The questions
are as follows:
15. What, in your opinion, should be the guiding principles in
determining, for any given period, whether the Federal budget
should be balanced, should show a surplus, or should show a
deficit? What principles should guide in determining the size
of any surplus or deficit ?
16. Do you believe it is possible and desirable to formulate
automatic guides for the Government's over-all taxing-spending
policy? If so, what types of guides would you recommend?
What are the principal obstacles to the successful formulation and
use of such guides ?
The general economic welfare of the country should be the guiding
principle in determining for any given period whether the Federal
budget should be balanced, should show a surplus, or should show a
deficit, and in determining the size of any surplus or deficit.
Since I took office as Secretary of the Treasury in June 1946 I have
continuously urged a Federal budget that would permit debt retirement. Both President Truman and I have stated on a number of occasions that it is essential to reduce the public debt in years of prosperity,
such as we have enjoyed since the end of the war. This was one of
the reasons why the President on three occasions vetoed tax-reduction
measures. This has also been a major reason why the President has
constantly limited budget expenditures to the minimum amount necessary to carry out the defense program and other essential domestic
and international programs.
I do not believe that it is feasible to attempt to formulate automatic
guides for the Government's over-all taxing-spending policy. The
economic and social variants which should determine the policy in any
given period are so numerous and for different periods are present in
such different combinations that taxing-spending policy can be determined only after the most careful consideration of the situation existing at any given time. Budget receipts and expenditures for each
fiscal period must be examined item by item with due regard to their
relative need and public service. This is a responsibility which can
be discharged properly only by Congress.
One of the most frequently mentioned possibilities along these
lines is that automatic guides can be established based on levels of
national income. It obviously is not possible to say that under all
circumstances the budget should be balanced when the national income is at any particular level; and it is not possible to provide by
statute exemptions to cover all, the cases when, exemptions would be
necessary. In my opinion, policy formulation and action must, of
necessity, be left to the responsible authorities to be made in accord-




15 MONETARY, CREDIT, AND FISCAL POLICIES

ance with their best judgment in view of economic developments as
they occur.
Questions 17, 18, and 19 are concerned with the commercial banking system. The questions are as follows:
17. What were the aggregate amounts of interest payments by
the Treasury to the commercial banking system during each year
since 1940?
18. What changes, if any, should be made in the ownership of
the Federal Reserve banks ? In the dividend rates on the stocks
of the Federal Reserve banks?
19. What changes, if any, should be made in the laws relating
to the disposal of Federal Reserve profits in excess of their dividend requirements ?
The following table shows the estimated distribution of interest
payments on the public debt, by class of recipient, for the calendar
years 1940 through 1948:
[Billions of dollars]

Nonbank investors

Banks
Total
interest1

Calendar year

1940
1941
1942
1943
1944
1945
1946.
1947
1948

_

1.1
1.1
1.5
. 2.2
3.0
4.1
5.0
5.0
5.4

Total

0.3
.3
.5
.8
1.1
1.4
1.5
1.4
1.4

Commercial
banks

0.3
.3
.4
.7
1.0
1.3
1.4
1.2
1.1

Federal
Reserve
banks

Total

2
(2)
()

0.1
.1
.1
.1
.1
.2
.3

0.8
.8
1.0
1.4
1.9
2.7
3.5
3.6
3.9

Individuals

U. S.
Government
investment
accounts

Other
investors

0.3
.3
.4
.5
.7
1.1
1.4
1.5
1.6

0.2
.2
.3
.3
.4
.5
.7
.7
1.0

0.3
.3
.3
.6
.8
1.1
1.5
1.4
1.4

1 Actual payments on the basis of daily Treasury statements.
2 Less than $50,000,000.
NOTE—Figures will not necessarily add to totals, due to rounding.

Interest payments to commercial banks amounted to approximately
27 percent of the total interest paid on the debt in 1940, but amounted
to only 20 percent in 1948. Payments to the entire commercial banking system, that is, to commercial banks and Federal Reserve banks—
which amounted to about $350,000,000 in 1940 and $1,450,000,000 in
1948—similarly showed a decline as a percentage of total interest
payments during this period.
Interest earnings on Federal Reserve bank holdings of Government securities increased from $42,000,000 in 1940 to $299,000,000 in
1948, as a result of the wartime credit and currency needs of the
country. The Board of Governors of the Federal Reserve System
took the initiative in turning over a part of the Reserve banks' relatively high earnings to the Federal Government, by invoking its
authority to levy an interest charge on Federal Reserve notes issued
by the banks. In its announcement on April 24, 1947, the Board
stated that the purpose of the charge was to pay into the Treasury
approximately 90 percent of the net earnings of the Federal Reserve
banks in excess of their dividend requirements. Payments to the




16

MONETARY,

CREDIT, AND FISCAL POLICIES

Treasury as a result of this action amounted to $75,000,000 in 194T
and $167,000,000 in 1948.
If Congress wishes, it can, of course, set forth specific statutory
directives for the disposal of Federal Reserve bank profits in excess
of their dividend requirements.
With respect to the matter of stock ownership of the Federal
Reserve banks and the dividend rate on this stock, I do not believe
that there is any urgent need to deal with these questions at this;
time.
Very truly yours,
J O H N W . SNYDER,

Attachment:
H o n . BURNET R . MAYBANK,

Secretary of the Treasury.
MAY 4,1949.

Chairman, Committee on Banking and Currency,
United States Senate, Washington, D. C.
M Y D E A R M R . C H A I R M A N : This is in further reply to your letters of
April 25, 1949, stating that your committee intends to begin hearings
on S. 13 and S. 286 on May 5 and requesting the report of the Department on these bills prior to the date of the hearing.
Both bills specifically authorize the acquisition, trading, and export
by members of the public of any gold mined in the United States or
imported into the United States after their enactment. S. 286 would
also repeal sections 3 and 4 of the Gold Reserve Act of 1934. Since
these sections contain the authority to regulate transactions in gold
in the United States, their repeal would permit a free market for all
gold. In substance, S. 13 would also result in a free market for all
gold since it would not be possible to distinguish newly mined or
imported gold from other gold.
The Treasury is strongly opposed to the enactment of these bills.
They would create serious risks to our national monetary and banking
structure and would result in a weakening of the present strong and
stable position of the dollar in its relation to gold. At the same time,
the advantages expected by their advocates appear to be based on
misunderstandings and illusory hopes.
1. Enactment of either S. 13 or S. 286 would amount to a reversal
of the decision made by the Congress in the Gold Reserve Act of 1934,
that gold should be held by the Government as a monetary reserve and
that it should not be available for private use for other than legitimate
industrial, professional, or artistic purposes. We believe that the
United States should continue to follow the principle that the most
important use of gold is for the domestic and international monetary
functions of the Government and that gold should not be held by
private individuals as a store of wealth.
2. The existence of a free market for gold in the United States with
a fluctuating price determined by private demand and supply would
have exceedingly unfortunate consequences for our domestic economy.
In fact, the Secretary of the Treasury is required by statute to maintain all forms of United States money at a parity with the gold
dollar. Since the gold dollar contains one-thirty-fifth of an ounce
of gold, this means that the Treasury should maintain the price of gold
at $35 an ounce in legal gold markets in the United States. Therefore, the Treasury would hardly have any alternative if the proposed




17 MONETARY, CREDIT, AND FISCAL POLICIES

bills were enacted other than to sell gold to the extent necessary to
maintain the market price at $35 an ounce. Thus, the rise in the price
of gold which appears to be contemplated by the proponents of these
bills would not take place.
If the Treasury did not take measures to stabilize the market at
$35, the shifting of the price of gold could not fail to confuse and
disturb the public. The common interpretation of such fluctuations
would be that something was wrong with the dollar and that the value
of the dollar and all savings stated in dollars were going up and down
with each fluctuation.
Such prices for gold, however, would probably be the result of a
relatively trifling volume of transactions. No significant determination of the value of the whole world supply of gold could be made
with the United States Treasury, which is the main factor in the gold
market, left out of the balance. Because of popular misconceptions,
prices determined by an insignificant volume of transactions would
be interpreted as applying to all gold, including the $24,300,000,000
in gold held by the United States Treasury. Thus, the public misinterpretation of the quotations in the so-called free market might
cause a loss of confidence in the dollar and be extremely damaging to
our economic welfare.
If the Treasury let the price of gold in the United Statesfluctuate,it
would be defeating the very purposes which have led us to acquire over
$24,000,000,000 worth of gold. The Treasury has paid out those billions of dollars for gold in order to keep stable the relation between
gold and the dollar. There would be no clear reason why we should
have bought this gold in the past or should continue in the future to
buy gold at $35 an ounce if we were not also to be ready to sell it at
the same price for any legitimate purpose in order to maintain that
stability.
It would be exceedingly improvident for the United States to sell
gold at $35 an ounce to foreign governments if such gold or other
gold could be resold in the United States at premium prices. On the
other hand, the Treasury believes it to be of the highest monetary importance to the United States that it continue to sell gold to foreign
governments and central banks at $35 an ounce whenever the balance
of international payments turns in their favor and they ask for settlement in gold. To refuse to make such sales at $35 would be equivalent
to a devaluation of the dollar and an abandonment of our adherence
to a gold standard. Moreover, if the United States should not continue
to buy and sell gold freely for international settlements at $35 an
ounce, we could not meet our obligations to the International Monetary
Fund without adopting a system of exchange controls to prevent
transactions in foreign currencies in the United States at other than
official rates.
It should not be assumed, however, that it is at all certain that the
proposed free market in gold would result in a marked rise in the
price of gold for any extended period even if the Treasury should not
stabilize the market at $35. Expectations of substantial increases in
price are based on widespread exaggeration of the significance of
various premium quotations abroad and inadequate appreciation of
the degree to which prices of go]d everywhere depend on the readiness
of the United States to buy at $35 virtually all gold which is offered
to the Treasury. There is also inadequate appreciation of the extent




18

MONETARY, CREDIT, AND FISCAL POLICIES

to which gold imports and trading are restricted in every important
country in the world and the valid reasons for such restrictions.
3. The international monetary relations and obligations of the
United States would also be prejudiced if gold were authorized to be
exported and imported freely. One of the dangers of permitting
exportations of gold from the United States without restriction is that
much of the gold would flow to black markets abroad. In some countries the gold markets are illegal; in others, gold imports or dollar
payments for gold are prohibited. These restrictions are designed to
conserve urgently needed dollars to finance essential imports. Permitting gold exports to these markets would work directly against
our efforts to restore Europe to financial solvency through the European recovery program.
In this connection, the International Monetary Fund has expressed
its concern that international gold transactions at premium prices tend
to divert gold from central reserves into private hoards. The fund has
asked its members to take effective action to prevent premium price
transactions in gold with other countries or with the nationals of other
countries. The existence of a free market in the United States with
a fluctuating price for gold, coupled with the repeal of authority to
control the export of gold would make it impossible for the United
States to cooperate with the fund in achieving this objective.
4. Treasury sales of gold to the extent necessary to maintain a $35
price in a free market created by the enactment of either of these bills
would in effect mean that any holder of dollars or dollar obligations
would be able to convert them into gold. While this would be preferable to an erratic movement in gold prices in the United States, it
would force this Government to a course of action which might have
extremely serious consequences.
Internal gold convertibility is likely to exert critical pressure at
the most dangerous and damaging times and to do little good at other
times. It threatened the foundations of our financial structure during the depression and it might have done so again during the last war,
yet it has proven of no use either to prevent inflationary booms or serve
other desirable purposes at other times. When left in a centralized
reserve, our gold stock gives impregnable international strength to
the dollar. If our gold stock, on the other hand, were dissipated into
immobilized private holdings, our power to maintain the position of
the dollar might be critically weakened.
The problems of financing the last war would have been tremendously magnified if private citizens had been free to draw down our
gold reserves. The prosecution of the war, for example, would have
been critically hampered if Government and business borrowing had
been limited because gold hoarders had left no excess reserves in the
banking system.
Even our $24,000,000,000 of gold holdings would be completely
inadequate to meet a serious run on gold from the $27,000,000,000 of
United States currency in circulation, over $140,000,000,000 of bank
deposits, and scores of billions of dollars of Government securities, not
to mention other relatively liquid assets. Conversion of around 5 or 6
percent of these Government and bank obligations would be enough
to bring the Federal Reserve banks below their legal minimum gold
reserve.




19 MONETARY,

CREDIT, AND FISCAL POLICIES

Even in a letter of this length it is not possible to state all the considerations which cause the Treasury to oppose these bills. We believe,
however, that the foregoing will give you a general indication of the
difficulties and problems which the Treasury considers would arise
from the enactment of either of them.
The Bureau of the Budget has advised that there would be no
objection to the submission of this report to your committee since the
proposed legislation is not in accord with the program of the President.
Very truly yours,
WILLIAM M C C . MARTIN, J r . ,

Acting Secretary.

A P P E N D I X TO CHAPTER

I
AUGUST 1949.

QUESTIONNAIRE ADDRESSED TO THE SECRETARY OF THE TREASURY

1. What are the principal guides and objectives of the Treasury in
formulating its monetary and debt management policies ? What attention is paid to the interest costs on the Federal debt ? To the prices
of outstanding Government obligations? To the state of employment and production? To the behavior of price levels in general?
To other factors ?
2. To what extent and by what means are the monetary and debt
management policies of the Treasury coordinated with those of the
Federal Reserve ? Describe in detail the procedures followed for these
purposes.
3. What were the principal reasons for the particular structure of
interest rates maintained during the war and the early postwar period?
4. To what extent, if at all, would a monetary and debt management
policy which would have produced higher interest rates during the
period from January 1946 to late 1948 have lessened inflationary pressures ?
5. When there are differences of opinion between the Secretary of
the Treasury and the Federal Reserve authorities as to desirable support prices and yields on Government securities, whose judgment generally prevails?
6. What, if anything, should be done to increase the degree of coordination of Federal Reserve and Treasury policies in the field of
money, credit, and debt management?
7. What would be the advantages and disadvantages of providing
that the Secretary of the Treasury should be a member of the Federal
Reserve Board ? On balance, would you favor such a provision ?
8. What are the advantages and disadvantages of offering for continuous sale savings bonds of the E, F, and G series with their present
yields, maturities, and limitations on the annual amount to be purchased by each buyer ? Does this policy lessen the supply of private
savings for equity capital and riskier private loans? What are the
advantages and disadvantages of promoting the sale of these securities
during periods of recession ? Should the terms of these securities and




20

MONETARY, CREDIT, AND FISCAL POLICIES

the amount that each buyer may purchase be varied with changes in
economic conditions?
9. What would be the principal advantages and disadvantages of
reestablishing a gold-coin standard in this country ? Do you believe
that such a standard should be reestablished?
10. Under what conditions and for what purposes, if any, should
the price of gold be altered? What consideration should be given
to the volume of gold production and the profits of gold mining?
What effects would an increase in the price of gold have on the effectiveness of general monetary and credit policies ? On the division of
power over monetary and credit conditions between the Federal Reserve and the Treasury?
11. What changes, if any, should be made in our monetary policy
relative to silver? What would be the advantages of any such
changes ?
12. To what extent and by what methods does the Treasury coordinate the activities of the various Government agencies that lend and
insure loans to private borrowers? In what ways, if at all, should
the Treasury's powers in this field be altered?
13. What would be the advantages and disadvantages of adopting
the Hoover Commission proposal that supervision of the operations
of the FDIC be vested in the Secretary of the Treasury ? On balance,
do you favor this proposal ?
14. What would be the advantages and disadvantages of establishing a national monetary and credit council of the type proposed by the
Hoover Commission ? On balance, do you favor the establishment of
such a body? If such a council were established, what provisions
relative to its composition, powers, and procedures would make it
function most satisfactorily?
15. What, in your opinion, should be the guiding principles in determining, for any given period, whether the Federal budget should be
balanced, should show a surplus, or should show a deficit? What
principles should guide in determining the size of any surplus or
deficit?
16. Do you believe it is possible and desirable to formulate automatic guides for the Government's over-all taxing-spending policy?
If so, what types of guides would you recommend? What are the
principal obstacles to the successful formulation and use of such
guides ?
17. What were the aggregate amounts of interest payments by the
Treasury to the commercial banking system during each year since
1940?
18. What changes, if any, should be made in the ownership of the
Federal Reserve banks? In the dividend rates on the stocks of the
Federal Reserve banks?
19. What changes, if any, should be made in the laws relating to
the disposal of Federal Reserve profits in excess of their dividend
requirements ?




CHAPTERII
REPLY BY THOMAS B. McCABE, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
H o n . P A U L H . DOUGLAS,

Chairman, Subcommittee on Monetary, Credit, and Fiscal Policies,
Senate Office Building, Washington, Z>. C.
D E A R SENATOR DOUGLAS : In submitting these answers to your questionnaire of August 22 on monetary, credit, and fiscal policies, I
would like to express my sincere appreciation of your consideration
in granting me the few days of extra time to prepare them.
I had no idea of the magnitude of the task involved until I sat down
with our staff and began to analyze the length and breadth of these
most penetrating questions. In my judgment, if everyone to whom
these questions have been addressed catches the constructive spirit
of the inquiry and frames answers in a spirit of objectivity, you
will have in your possession a most significant contribution to better
understanding of this vital subject.
Although I had the benefit of the wealth of experience of the other
members of the Board of Governors and of our very able staff, the
final answers are my own. I have not asked the Board to share the
responsibility of any of the conclusions.
With warmest regards,
Sincerely,
T H O M A S B . M C C A B E , Chairman.
I.

OBJECTIVES OF FEDERAL RESERVE P O L I C Y

1. What do you consider to be the more important purposes
and functions of the Federal monetary and credit agencies?
Which of these should be performed by the Federal Reserve ?
The principal purposes and functions of the various Federal monetary and credit agencies, taken collectively, may be stated broadly as
follows:
(1) To accommodate commerce, industry, and agriculture by
assuring an adequate but not excessive volume of money and
credit at rates of interest appropriate to the general welfare of
the economy.
(2) To preserve confidence, so far as these agencies can contribute to that end, in the country's money and in the financial
institutions in which the savings of the people are invested.
(3) To maintain a valid rate of foreign exchange appropriate
to the position of the American economy in the world economy.
(4) To foster continued strengthening of the democratic system and its related economic institutions by encouraging maximum reliance on private banking and other lending institutions.




21

22

MONETARY, CREDIT, AND FISCAL POLICIES

(5) To promote active and effective competition among lenders.
(6) To assist in formulating and carrying out Government
economic policies which are consistent with the Employment
Act of 1946.
(7) To contribute, through participating in the formulation of
international economic policies, to the solution of international
monetary and economic problems.
The Federal Reserve
Among the various Federal monetary and credit agencies the only
one whose primary purpose is monetary is the Federal Reserve; the
others (see final section of this answer) are not charged with statutory
responsibility for general monetary policy, althought some of them
have functions of a monetary nature.
Monetary functions are those concerned directly with regulating
the supply, availability, and cost of money. The most important responsibility of the Federal Reserve is that of determining policies with
respect to these functions in accordance with the broad objectives' of
public policy, notably that of contributing to sustained progress of this
economy (except in time of war, when other objectives supervene)
toward the accepted goals of high employment and rising standards
of living. Though not always stated by responsible authorities in just
these terms, this purpose has been dominant throughout the life of
the Federal Reserve. A recent statement of it appears in the 1946
annual report of the Board of Governors of the Federal Reserve
System [italics supplied] :
It is the Board's belief that the implicit, predominant purpose of Federal
Reserve policy is to contribute, insofar as the limitations of monetary and
credit policy permit, to an economic environment favorable to the highest
possible degree of sustained production and employment.

A similar statement, indicating that the same concept was held by
the founders of the System, was made in 1913 by the chairman of the
Senate Committee on Banking and Currency in discussing the bill to
establish the Federal Reserve System [italics supplied] :
Senate bill No. 2639 is intended to establish an auxiliary system of banking,
upon principles well understood and approved by the banking community, in
its broad essentials, and which, it is confidently believed, will tend to stabilize
commerce and finance, to prevent future panics, and place the Nation upon an
era of enduring prosperity.

The Federal Reserve banks hold the reserve balances that member
banks are required by law to maintain against their deposits, and
issue most of the currency that is put into circulation in response to
the public's demand for cash money. Federal Reserve policies influence the supply, availability, and cost of money by adding to or
subtracting from the supply of funds available to banks for extending
credit or for meeting currency needs without depleting their reserves
below the required level. The principal instruments employed by the
Federal Reserve for this purpose are:
(1) Open market and discount operations, which—
(a) add to or subtract from the supply of available funds',
and
(5) establish rates of interest at which such funds may be
obtained; and




23 MONETARY, CREDIT, AND FISCAL POLICIES

(2) The raising or lowering of the reserve requirements of
member banks.
The System also has certain selective instruments which may be
said to influence the availability of credit in particular sectors of the
economy. The various instruments of policy used by the System are
discussed further in answers to the questions in part IV.
The Federal Reserve has a responsibility for adjusting the money
market effects of international movements of funds and for helping
to maintain the foreign exchange position of the dollar.
Monetary management in the public interest is the cardinal concern of the Federal Reserve System. It has the responsibility of advising the Government as a whole with respect to monetary matters,
particularly as to the contributions of monetary and credit policy
to general economic policy. It has an obligation through educational
work to foster public understanding of monetary policies and the
relation of money and credit to economic conditions and development.
It collects and analyzes economic information to facilitate the attainment of the System's objectives. Together with the Treasury and
the Government generally, the Federal Reserve System shares responsibility for maintaining universal confidence in our money and
in our financial and economic institutions.
The System also has (or shares with other agencies) certain supervisory functions, including supervision not only of many banks but
also affiliates and holding company affiliates of banks. It also performs certain important service functions such as supplying currency,
facilitating the clearance of checks, and performing fiscal agency
services for the United States Government. These functions are
essential to the operation of the economy and require large staffs at
the Federal Reserve banks. The System also makes or guarantees
loans to businesses in certain limited circumstances, as brought out
elsewhere in this set of answers.
As I have indicated, the responsibilities of the Federal Reserve
are not exclusively domestic. Movements of money into and out of
this country affect, and in turn may be affected by, the operations of
the Federal Reserve. This was notably true in the period when
capital movements were not restricted by official controls. Federal
Reserve policies influence the availability of funds for international
loans and they may also offset or absorb the effects of international
movements of funds on domestic money markets. The Federal Reserve System also has certain nondomestic operational functions, such
as holding balances and acting as correspondent for foreign central
banks and governments, making advances to foreign central banks,
and passing judgment on applications by member banks and certain
banking corporations to establish foreign branches and regulating
their activities in foreign countries. In addition, as more fully
described in the answer to question I I I - l , the Federal Reserve System
performs important advisory functions in the international field, both
with respect to United States foreign financial policy and to financial
problems arising in foreign countries.
As a general principle, I think that the Federal Reserve should
perform those functions which are of a strictly monetary nature. How
far functions which are not altogether of this nature should be confided to the Federal Reserve is discussed in the answers to other




24

MONETARY, CREDIT, AND FISCAL POLICIES

questions in this questionnaire, particularly to some of those in parts
I I and III and to questions VI-2 and VI-5.
Other Federal agencies
Other Federal agencies whose primary spheres of activity affect
monetary and credit policy are of a different category from the Federal Reserve. They include the Department of the Treasury and, in
addition, a number of more specialized agencies of which the principal
ones are the Reconstruction Finance Corporation, the Federal Deposit
Insurance Corporation, the Comptroller of the Currency, the Housing
and Home Finance Agency, the Farm Credit Administration (each
of the last two embraces a group of agencies) the Rural Electrification
Administration, the Veterans' Administration, the Export-Import
Bank, and the Economic Cooperation Administration.
The Treasury has important monetary powers, such as those to purchase and sell gold and silver, to regulate the holding and the export
of gold, and to mint coins and issue certain types of currency. In addition, it has important responsibilities for the international monetary
and financial operations of this country.
Other Treasury functions have an important influence upon monetary developments, particularly the handling of its cash balance and
public-debt management. These relations are discussed in answer to
the questions in part II.
The other agencies are charged with responsibility for dealing with
specific aspects of the credit situation; the operations of many of them
take the form of granting credit to the public directly or of facilitating
through guarantee and similar procedures, credit extension by others
(as is brought out in the answers to question VI-4 and VI-5). In
some cases, their use of the credit mechanism is incidental to their primary purpose, which may be to aid agriculture, veterans, home owners,
etc. Since the operations of all the specialized agenices have an influence on the general monetary and credit situation, even though none
of these agencies is charged with responsibility for general monetary
policy, there is need for some means (consistent with the responsibility
of each agency) of bringing about a closer relationship between these
operations and general monetary and credit policies. This problem is
discussed elsewhere in this set of answers, particularly in the answers
to questions 1-4, II-6, VI-4, VI-5, and VI-6.
2. What have been the guiding objectives of Federal Reserve
credit policies since 1935 ? Are they in any way inconsistent with
the objectives set forth in the Employment Act of 1946?
For the period since 1935, to which this question specifically relates,
the credit policies of the Federal Reserve can best be described by dividing the period into four parts—before the war, during the war, the
period of postwar inflation, and the recent period of abatement of inflationary pressures.
For the period from 1935 to the outbreak of the war in 1939, when
the country was still in process of recovering from a deep depression,
the Federal Reserve maintained a policy of monetary ease. The heavy
gold inflow created a very large volume of bank reserves especially
excess reserves, and led to the lowest interest rates in history. The
Federal Reserve recognized that under conditions of the period an
abundant supply of money at low rates was fully justified but at the
same time was aware that the available supply of bank reserves was far



25 MONETARY, CREDIT, AND FISCAL POLICIES

in excess of any foreseeable needs in a peacetime economy. Accordingly steps were taken in 1936 and early 1937 to absorb some of the
redundant reserves in order to forestall their subsequent use for excessive or unsound credit expansion. The over-all policy of monetary
ease, however, was maintained.
During the war period, including for this country the period of defense preparation, Federal Reserve credit policies were in keeping with
the Nation's war requirements and at the same time wTere designed to
help (along with more direct measures such as price regulation) to
restrain inflation. During this period the objectives of Federal Reserve policy were: (1) To assure at all times an ample supply of funds
available for financing whatever part of the defense and war effort
was not financed through taxes and through the sale of Government
securities to nonbank investors; (2) to maintain orderly conditions
in the Government security market; and (3) to help maintain, in
close collaboration with the Treasury, a structure of interest rates at
approximately the levels existing at the beginning of the war—which
had an anti-inflationary purpose to the extent that it would tend to
induce nonbank investors to put money into Government securities
instead of holding off in the expectation of higher rates. Anti-inflationary pressures were also exerted by the Board's regulation of consumer credit and stock-market credit.
The war left the country with an unprecedented inflation potential
which became active as reconversion proceeded, and continued until
the end of 1948. In this period the objective of Federal Reserve
policy was to apply as much restraint to inflation as could be applied
without occasioning or risking so sharp a decline in the market for
Government securities as might disorganize the capital markets. Pursuit of the second element of this composite objective involved providing support for the Government securities market so as to maintain
relatively stable prices and yields. Pursuit of the first element included at one stage or another raising margin requirements to a
maximum, elimination of a wartime preferential discount rate on
short-term Government securities, discontinuance of a very low buying rate on Treasury bills and other measures conducive to increasing
interest rates on Treasury bills and certificates, absorption of some
bank reserves by open market operations, such as permitting maturing
holdings to be retired for cash, some lowering of support prices on
Treasury bonds, reimposition of consumer credit regulation, and some
increases in member bank reserve requirements.
More recently, as inflation began to abate and signs of some slackening in business began to appear, the policy of restraint was promptly
moderated—initially by relaxation of restraint on consumer credit and
stock-market credit—and then, during the second quarter of 1949, replaced by a policy of monetary ease, exemplified in particular by several successive reductions in member bank reserve requirements. The
flexibility that is inherent in the structure and organization of the
Federal Reserve System was never better demonstrated than in this
most recent period.
Federal Reserve credit policies for all these periods—and related
policies—are discussed more fully (and in broader context) in the
answers to questions in part II. It will be evident from this brief
review, however, that for the entire period since 1935 Federal Reserve
credit policies have been altogether in conformity with the objectives




26

MONETARY, CREDIT, AND FISCAL POLICIES

stated in the Employment Act of 1946.1 Review of a longer period
would show that throughout the System's existence Federal Reserve
objectives have been in harmony with these broad purposes.
3. Cite the more important occasions when the powers and policies of the System have been inadequate or inappropriate to
accomplish the purposes of the System.
It is well recognized that the policies pursued by the Federal Reserve System, over the 35 years of its existence, have not always been
adequate or appropriate to accomplish fully the purposes which such
an agency is designed to serve. How far this has been a result of inadequate or inappropriate legal powers, however, is a matter on which
competent students of the subject do not seem to have come into general agreement. Remedial legislation has been enacted to take care of
many of the problems which have arisen. The more important cases
where it has not are treated in other sections of these answers, particularly in parts II, IV, and V.
4. Would it be desirable for the Congress to provide more specific legislative guides as to the objectives of Federal Reserve
policy ? If so, what should the nature of these guides be ?
Whether Congress should provide more specific legislative guides
as to the objectives of Federal Reserve policy is a question that has
taken different forms at different times. Before the adoption of the
Employment Act of 1946, with its declaration of a national policy to
govern all Federal agencies, there were recurrent proposals that the
Federal Reserve be given some very specific legislative mandate (such
as one that would require the System to maintain a constant general
price level). To these proposals the Board made vigorous objection,
but on grounds which do not apply at all to the policy declaration
set forth in the Employment Act of 1946. That declaration recognizes, as the Board had long maintained, that sustained national prosperity is not something that can be achieved by any single Government agency or by monetary means alone, or through using any narrowly defined guides to policy.
The carefully considered statement of objectives which is set forth
in the Employment Act of 1946, since it applies to the Federal Reserve
as well as to other Federal agencies, seems to be specific enough to
serve the needs' of the country in the monetary field. With that statement the directives to the Federal Reserve that are contained in
existing legislation, though adopted earlier and sometimes in less specific terms, are entirely consistent.
This question is not taken to suggest that the Federal Reserve in
pursuing the objectives of the Employment Act of 1946, should be
specifically required to base policy decisions on some particular formula or some particular statistical guide (such as an index of general
prices or the level of employment). Such a guide would not only
1 The Congress hereby declares that 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.




27 MONETARY, CREDIT, AND FISCAL POLICIES

traverse the principle recognized in the Employment Act of 1946 but
would be likely to be so rigid as to defeat its purpose, since the making
of decisions on monetary policy calls at all times for the weighing of
a great many different factors and for the attaching of different
weights to the same factor at different times. Such decisions must
always be a matter of judgment, based on the fullest and widest information respecting all phases of the national economy.
I I . RELATION OF FEDERAL RESERVE POLICIES TO FISCAL POLICIES
AND D E B T MANAGEMENT

Monetary and credit policies are closely interwoven with fiscal and
debt-management policies. These interrelationships have become increasingly important and binding as a result of the tremendous wartime expansion of the public debt to a dominant position in the over-all
financial structure. It is essential that there be a high degree of coordination of decisions and actions and close cooperation on the part
of the authorities operating in these fields.
Fiscal policies are in the final analysis determined by Congress in
authorizing appropriations and legislating taxes, although the President and the various executive agencies of the Government have a
major influence upon these policies in their recommendations for
legislation and in carrying out the measures voted by the Congress.
The Treasury has a primary responsibility for recommendations as to
tax policy, as well as for the collection of taxes, and it has important
discretionary authority with reference to the management of the public debt, which includes decisions as to the timing and nature of borrowing and of debt retirement. The Treasury possesses certain monetary powers. Among these are the holding of monetary gold and silver stocks, the issuance of currency against them, and the minting
of coins. The Treasury also has important responsibility with reference to the international financial operations of the Government.
These various Treasury operations have a direct bearing on and are
affected by conditions in the money market, with which the Federal
Reserve is concerned.
The functions of the Federal Reserve are primarily monetary. As
explained in answers to questions in part I, most of the country's circulating currency is issued by the Federal Reserve banks, and the System
has primary responsibility for influencing the supply, availability, and
cost of bank reserves, which provide the basis for the bulk of the country's supply of money and credit. Federal Reserve authorities, by
exercising an influence on the cost and availability of reserves, can
affect not only the level of interest rates but also the ability and willingness of banks to lend and invest. These policies necessarily impinge upon public-debt operations. The Treasury can affect the supply of bank reserves to a limited extent through the exercise of its
powers with reference to gold or currency or through the handling of
its cash balances. Moreover, the magnitude of public debt offerings
(or retirements), the rates of interest paid by the Treasury, and the
maturities and other features of the various issues are reflected in the
demands for credit and can thereby influence the supply of money and
the demands upon the Federal Reserve.
98257—49

3




28

MONETARY, CREDIT, AND FISCAL POLICIES

The rates of interest which the Treasury finds it necessary to offer
on new issues of securities are to a substantial degree affected by the
Federal Reserve's influence on the money market. Obviously if the
Treasury and the Federal Reserve were preoccupied solely with the
question of rates, they would sacrifice all other considerations to this
end. Both of course must take account of the many broad aspects of
their respective policies and the effects upon the entire economic structure. Because measures adopted by either agency must be taken into
consideration by the other in determining its policies, it is most essential that the Federal Reserve and the Treasury cooperate in the effort
to direct their respective policies toward common broad objectives of
national policy. It is my view, as pointed out in answers to specific
questions, that a splendid degree of cooperation now exists between the
Treasury and the Federal Reserve.
1. To what extent and by what means are the monetary policies
of the Federal Reserve and the fiscal, debt management, and
monetary powers of the Treasury coordinated ?
Coordination of Treasury and Federal Reserve policies is effected
by frequent consultation between policy-making and operating officials of the two agencies. It is customary for Treasury and Federal
Reserve officials to consult before decisions are made by the Treasury
with respect to (1) the day-to-day variations in the Treasury's balance at the Federal Reserve banks and calls on balances with other
depositaries (these transactions temporarily affect the supply of bank
reserves) ; (2) any changes in the usual amounts or terms of weekly
offerings of Treasury bills; (3) periodic offerings of new issues of
other marketable securities and refunding or retirement of maturing
securities, with reference to amounts, rates, and terms; and (4)
changes from time to time in the nature of offerings of nonmarketable
securities. Purchases and sales of marketable securities by the Treasury for the account of Government agencies and trust funds are handled through the Federal Reserve banks, acting as fiscal agents for
the Treasury, and Federal Reserve officials are consulted as to monetary effects of such operations.
In connection with the consultations of the Secretary of the Treasury with Federal Reserve officials prior to the adoption of financing
programs, the System's representatives have taken the opportunity
to give the Secretary their best judgment about market conditions
and about the preference of banks and other investors for particular
kinds of securities. In this way representatives of the Federal Reserve
System have made, available the benefit of their close contacts with
the market and have endeavored to be helpful in the1 solution of the
technical market problems of financing the Government.
Beyond giving advice and assistance as to the details of financing,
the Federal Reserve System has a vital interest from the point of view
of its own responsibilities in the broader economic and financial consequences and implications of Treasury financing. The securities
offered, particularly to banks, have aft important bearing upon the
maintenance of an effectively operating money market, of sound
banking conditions, and of freedom to pursue flexible monetary and
credit policies appropriate to changing conditions.
Because of the economic effects of fiscal and debt-management operations and policies, Federal Reserve officials frequently offer sug-




29 MONETARY, CREDIT, AND FISCAL POLICIES

gestions to the Treasury regarding various aspects of these policies,
either those of a current nature or longer-term programs. Likewise
the Secretary of the Treasury is customarily asked by the Federal
Reserve for his views with respect to action contemplated by the
System to effectuate its monetary and credit policies.
2. Cite the more important occasions since 1935 when Federal
Reserve policies have been adjusted to the policies and needs of
the Treasury.
(a) What were the principal areas of agreement and what
were those of conflict between the two agencies ?
(b) In wThat way were the differences adjusted?
(c) When there were differences of opinion between the
Secretary of the Treasury and the Federal Reserve authorities as to desirable support prices and yields on Government securities, whose judgment generally prevailed?
3. What were the principal reasons for the particular structure of interest rates maintained during the war and the early
postwar period ?
4. Would a monetary and debt-management policy which
would have produced higher interest rates during the period
from January 1946 to late 1948 have lessened inflationary
pressures ?
These questions can best be answered as a group by describing the
principal developments with respect to Federal Reserve policies and
operations that were particularly influenced by, or had a bearing
upon, Treasury policies and needs during the period. I want to point
out in advance that I was not directly connected with the determination of these policies until the last 18 months of this period and, therefore, the discussion of events before that is based upon the available,
record.
In the 15 years since 1935, the growth of the public debt and its*
management have been dominant elements in financial developments
in the United States. During the early years of this period Government deficits resulted from expenditures to counteract depression
and unemployment; later, financing of the war required unprecedented borrowings; and, finally, the problem of refunding and retiring parts of the vast public debt were of prime importance. Treasury needs were largely the result of taxation-and-expenditure policies
determined by Congress and the executive authorities, first to combat depression and later to conduct a wTar. These situations required
close contact between the Treasury and the Federal Reserve System.
It may be said that in general during this entire period the Treasury and the Federal Reserve were guided by the same broad objectives and there was a reasonable degree of consultation and coordination, with consideration on the part of each agency of the views and
interests of the other. Such differences of opinion as appeared between the Treasury and the Federal Reserve were chiefly with reference to procedures to carry out common broad objectives. They reflected principally differences of judgment of the kind that might
reasonably be expected. Even now when they can be viewed in retrospect, it is frequently difficult to judge as between them.




30

MONETARY, CREDIT, AND FISCAL POLICIES

INTEREST-BEARING DEBT OF THE U.S. GOVERNMENT
BY T Y P E S OF ISSUES

T O T A L OUTSTANDING

CALL REPORT DATES

Growing importance of public debt in prewar period
During the period from 1935 to 1940 continued budget deficits and
the consequent growth in the public debt accompanied a relatively
small amount of private credit demands and an expansion in the supply of bank reserves resulting from gold inflows. This combination
of developments caused banks to expand greatly their holdings of
Government securities and gave increased importance to market
fluctuations in prices and yields of Government securities. The expansion in the public debt took the form mainly of bonds. As shown
in the chart, the volume of short-term Government securities outstanding actually decreased from 1936 to 1941 while bonds increased.
These movements were reflected in bank portfolios where holdings of
United States Government bonds increased while those of short-term
securities declined. Treasury financing needs and operations, as well






YIELDS ON U. S. GOVERNMENT SECURITIES

t

BREAKS IN LINES REPRESENT CHANGES IN ISSUES INCLUDED.
98257—49

( F a c i n g p. 3 0 )

31 MONETARY, CREDIT, AND FISCAL POLICIES

as market transactions in Government securities, thus became important money-market factors and had to be taken into account in
formulating Federal Eeserve policies.
Term structwe of interest rates.—During the 1935-40 period, as
shown on the next chart, interest rates gradually declined. By the
latter part of the period, rates on short-term Treasury bills were close
to zero; yields on high-grade long-term bonds, Government and corporate, were at record low levels. The low interest rates then prevailing
reflected the effect of a huge supply of loanable funds in relation to the
demand for such funds. The supply had been greatly expanded by
the heavy gold inflow which gave unprecedentedly large excess reserves
to banks; it also included a substantial volume of savings held by investment institutions seeking investments of relatively low risk.
Demand for loans by borrowers, other than the United States Government, was small because of depressed conditions in the economy, as well
as because of the large amount of liquid funds already held by nonfinancial businesses and by individuals.
The particular term structure or pattern of rates prevailing prior
to the war reflected in large part the strong preference of lenders, and
particularly of banks, for liquidity, together with a reduced supply
of short-term assets which could be easily turned into cash. Such
assets were in very large demand and commanded a substantial rate
advantage over long-term securities. This desire for liquidity was a
product of the rapid increase in available funds as well as of the
experience of banks and other lenders in the early thirties when bond
prices declined sharply.
Orderly market operations.—It was during this 1935-40 period that
the Federal Eeserve System accepted the responsibility for maintaining orderly conditions in the market for United States securities. In
particular, the System gradually found it necessary to give more consideration to the bond market rather than to confine its operations
largely to the short-term money market. When a sudden decline developed in the bond market in March and April 1937, it became quickly
apparent that large-scale, and particularly disorderly, liquidation of
bonds by banks could cause repercussions not simply in the Government
bond market but also in capital markets in general, and possibly in
the business situation. The Board of Governors in its 1937 annual
report, after describing developments in the bond market in March
and April 1937, made the following statement:
Intervention by the Federal Reserve System in the bond market in March
and April, therefore, helped to stabilize that market. In recent years the bond
market has become a much more important segment of the open money market,
and banks, particularly money-market banks, to an increasing extent use their
bond portfolios as a means of adjusting their cash position to meet demands
made upon them. At times when the demands increase they tend to reduce their
bond portfolios and at times when surplus funds are large they are likely to expand
them. Since prices of long-term bonds are subject to wider fluctuations than
those of short-term obligations, the increased importance of bonds as a medium
of investment for idle bank funds makes the maintenance of stable conditions
in the bond market an important concern of banking administration.

A second comparable occasion arose at the outset of the war and the
Board in its 1939 annual report explained its position as follows:
In undertaking large-scale open-market operations in September 1939, the
System was guided principally by the following considerations:
(1) By helping to maintain orderly conditions in the market for United States
Government securities the System can exert a steadying influence on the entire




32

MONETARY, CREDIT, AND FISCAL POLICIES

capital market, which is an essential part of the country's economic machinery,
and disorganization in which would be a serious obstacle to the progress of economic recovery. The market for United States Government securities is the
only part of the capital market in which the System is authorized by law to
operate, and Government securities occupy a vital place in that market.
(2) The System also has a measure of responsibility for safeguarding the
large United States Government portfolio of the member banks from unnecessarily
wide and violent fluctuations in price. The System cannot and does not guarantee any current prices of Government obligations, nor does it undertake to
preserve for member banks such profits as they may have on their Government
securities, or to protect them against losses in this account. The Government
security market, however, has become in recent years the principal part of the
money market, and member banks are in the habit of adjusting their cash positions through sales and purchases of United States Government securities. This
practice has arisen partly because of a shrinkage in the availability of other liquid
assets, such as street loans and bankers' acceptances, which in earlier years w7ere
in much larger volume and were the medium through which banks were likely to
adjust their positions. In the enhanced importance of the Government portfolio
to member banks, the System sees an additional reason for exerting its influence
against undue disturbances in Government security prices.

Bank examination policies.—During this same period official policies
with regard to bank examinations were also revised in recognition of
the growing importance of bonds in bank portfolios. The policy of
not requiring deduction from capital of paper losses on highest grade
bonds encouraged the banks to appraise their investment portfolios on
a basis of longer range or intrinsic worth rather than by the precarious
yardstick of current market quotations. Where declines in market
prices of bonds reflect only changes in the level of long-term interest
rates and not impairment of the credit position of the issuer, the position of investors holding the bonds is not materially affected unless
they wish to sell them. For banks to sell bonds should be unnecessary
when they have adequate secondary reserves in the form of short-term
assets and when the Federal Reserve can make advances to meet any
temporary needs.
Financing the war
During the period of financing the earlier defense program and more
particularly in that of heavy wartime expenditures, Treasury and
Federal Reserve operations and policies were closely related. Treasury
and Federal Reserve officials had frequent conferences and in other
ways interchanged views with respect to plans for financing the war,
organizing machinery for marketing United States Government securities, and developing and putting into effect credit policies that would
meet the Nation's war requirements while minimizing the inflationary
effects.
At the beginning of the defense program banks had abundant excess
reserves and the problem was in part one of preventing undue expansion of private credit under the stimulus of growing demands. With
this situation in mind, various groups of Federal Reserve officials (the
Board of Governors, the 12 presidents of the Federal Reserve banks,
and the Federal Advisory Council) issued a joint report to Congress
in December 1940, presenting a program of measures designed to provide the means for more effective restriction of possible inflationary
developments.
As a part of the Government's program to combat inflation and
for the purpose of reducing the large volume of excess reserves and
thus establishing better contact between the Federal Reserve banks
and the money market, the Board in the autumn of 1941, after con


33 MONETARY, CREDIT, AND FISCAL POLICIES

sultation with the Secretary of the Treasury, increased reserve requirements of member banks to the limit of its statutory power. At the
time the Secretary of the Treasury and the Chairman of the Board
issued the following statement:
The Treasury and the Board of Governors will continue to watch the economic
situation and to cooperate with other agencies of the Government in their efforts,
through priorities, allocations, price regulation, and otherwise, to fight inflation.
Recommendations on the question of what additional powers, if any, over bank
reserves the Board should have during the present emergency and what form
these powers should take will be made whenever the Treasury and the Board,
after further consultation, determine that such action is necessary to help in
combating inflationary developments.

When the United States entered the war in December 1941, the
Board issued the following statement with respect to war finance:
The financial and banking mechanism of the country is today in a stronger
position to meet any emergency than ever before.
The existing supply of funds and of bank reserves is fully adequate to meet
all present and prospective needs of the Government and of private activity.
The Federal Reserve System has powers to add to these resources to whatever
extent may be required in the future.
The System is prepared to use its powers to assure that an ample supply
of funds is available at all times for financing the war effort and to exert its
influence toward maintaining conditions in the United States Government
security market that are satisfactory from the standpoint of the Government's
requirements.
Continuing the policy which was announced following the outbreak of war
in Europe, Federal Reserve banks stand ready to advance funds on United
States Government securities at par to all banks.

Objectives of war finance.—During the war period the Federal Reserve System and the Treasury endeavored to coordinate their respective policies and actions toward common objectives. The major objective, as stated in the Board's annual report for 1942 and in other
connections, was to derive the largest possible amount of war funds
from current income and from savings and to depend as little as possible on the creation of bank credit. This objective was fully shared
by the Treasury. It was recognized, however, that all Government
expenditures could not be raised by taxation and borrowing from nonbank investors and that some borrowing from banks would be necessary to supply funds for an expanding war economy with its abnormal
demands for money. Another important objective of the Federal
Reserve as well as the Treasury in connection with war finance was
the maintenance of the structure of interest rates at approximately the
levels existing at the beginning of the war.
In furtherance of these aims, the Federal Reserve undertook to
supply banks with additional reserve funds after those available at the
beginning had been utilized. The large-scale purchases of Government securities by the Federal Reserve needed to keep short-term
interest rates from rising fully supplied banks with all the reserves
they needed to do their share in financing the war.
Discussions between the Treasury and the Federal Reserve during
the war and postwar periods related particularly to the specific means
of carrying out their common broad objectives in a manner that
would augment to the smallest possible extent inflationary pressures,
both immediately and in the future. It was recognized that the poli*
cies being followed were necessary in view of the exigencies of war
finance and that inevitable inflationary developments would have to be
restrained largely by use of other measures of control such as rationing



34

MONETARY,

CREDIT,

A N D FISCAL

POLICIES

and price fixing. It was acknowledged that, although the war might
be financed at even lower rates of interest through the Federal Reserve
and the banks, such policies would make more difficult the control
of inflation through other measures and would also intensify postwar
difficulties. Thus, a difficult combination of measures was needed—
ready availability of additional reserves required for war finance but
at the same time all feasible attempts to limit bank participation, which
would unduly inflate the supply of money.
Any differences in point of view between the two agencies reflected
their respective areas of operations and the policies adopted were determined after consideration of the various views. The Treasury had
the direct responsibility for marketing an unprecedented volume of
new issues, while it was the responsibility of the Federal Reserve to
safeguard the credit structure as much as possible from current and
prospective inflationary effects of these issues, particularly issues that
were absorbed into the banking mechanism. The chief concern of the
Federal Reserve was to place greater limitations on purchases by
banks, actual or potential, of long-term, higher-interest bearing securities. The Treasury was conscious of this problem and devised special
securities, noneligible for bank holding, tailored to tap specialized
sources of savings funds. It also increased greatly the volume of shortterm issues outstanding., Discussions between the agencies when
differences of emphasis emerged related largely to the level and structure of short-term interest rates and the amounts and types of longerterm issues that were available for purchase by banks.
The results of war-financing policies are illustrated in the chart
previously presented showing yields on United States Government
securities and that on the distribution of the public debt by types of
issues which follows this page. The interest-rate structure showed
little change until 1945 when longer-term rates declined. All types
of Government securities showed substantial increases. Commercial
banks added large amounts to their holdings of bonds, as well as to
holdings of notes and certificates, but after 1942 reduced their buying
of bills. Bills and other short-term securities were purchased in
substantial amounts by the Federal Reserve throughout the war.
Level and structure of interest rate.2—The wide spread between
short- and long-term interest rates, inherited from the prewar period
of easy money, created some difficult problems under conditions of
war finance in which funds had to be raised in unprecedented volume.
Both the Treasury and the Federal Reserve were in full agreement
that, for purposes of war financing, it would be desirable to finance
the war at relatively stable interest rates. This conclusion was reached
on the basis of the experience gained in financing World War I and
was designed to eliminate the incentive to defer subscriptions in expectation of progressively rising interest rates. The decision to maintain a stable structure of interest rates was made to serve the following
purposes:
(1) To encourage prompt buying of securities by investors,
who might otherwise have awaited higher rates;
(2) To assure a strong and steady market for outstanding
securities ;
(3) To keep down the interest cost on the war debt; and
2

This part of the discussion relates in particular to question 3 in this group.




35

MONETARY, CREDIT, AND FISCAL POLICIES

INTEREST-BEARING DEBT OF THE U. S. GOVERNMENT
BY T Y P E S OF ISSUES

T O T A L OUTSTANDING

HELD BY REPORTING COMMERCIAL BANKS
T R E A S U R Y SURVEY
END OF MONTH

(4) To limit the growth in bank and other investors' earnings
from their public debt holdings'.
It became the responsibility of the Federal Reserve authorities consequently to see to it that sufficient reserves were made available to
maintain a stable interest rate level.
Both the Treasury and Federal Reserve were also in full agreement
that, if war financing was to be rapidly launched with a minimum of
difficulties, it would not be desirable to make any substantial adjustment in the pattern of short- and long-term rates that prevailed at
the time. Maintenance of a fixed structure of rates, however, gave a
strong incentive to investors "to play the pattern of rates," i. e., to
purchase longer-term securities not to hold to maturity but for resale
at higher prices as maturity approached. With the low level of
short-term rates stabilized by action of the Federal Reserve, there




36

MONETARY, CREDIT, AND FISCAL POLICIES

was no possibility that corrective market forces would eliminate the
incentives that encouraged the practice.
These related decisions were shared by the Treasury and the Federal Reserve. As events developed and it became evident that the
financing of the war was involving ultimately much larger amounts
than were generally expected at the time these basic decisions had
to be made the task of stabilizing an abnormal rate pattern created
serious problems for the Federal Reserve. These problems led to a
variety of suggestions for modifications in the war-finance program.
They became much more serious under conditions of reconversion
after the war. The System suggestions in general fell under three
heads: moderate adjustments in short-term rates to narrow the spread,
further measures to limit purchases of securities by banks particularly
the longer-term issues, and more offerings to nonbank investors of
long-term bonds with restricted marketability. Some of these suggestions were adopted or led to modifications or changes in programs.
At the time, and even now from the vantage point of retrospect,
one cannot be categorical about these suggestions or about their results. The money market is a complex structure and the needs of
war finance were without precedent. Looking backward, it still
seems that the decision not to let interest rates rise during the war
was right in that the war was financed at an exceptionally low interest
cost, the Treasury had no difficulty in obtaining all the funds it needed,
and there was no lack of confidence in Government securities. The
most important lesson of the war-financing experience is that it was
desirable to have a stabilized level of rates during the war, but not
necessarily the particular highly -abnormal structure of rates which
happened to exist at the beginning of the war.
In looking back on these problems, which antedate my coming to
the Board, as well as in discussing those with which I have had to deal,
I have sought to review the entire period covered by the questionnaire,
not as the advocate, but in a more judicial spirit, mindful of the end
result which was a truly splendid achievement in financing the most
devastating and costly war of all time and in restoring the country
to full peacetime production and employment.
Problems of postwar inflation
In the transition period from a war to a peacetime economy the inflationary problem became more acute, notwithstanding the termination of heavy Government deficits. The development of inflation
was made possible primarily by the large volume of liquid assets built
up during the period of war finance, accompanying shortages of goods
and deferred demands, but it was augmented by postwar expansion
of credit to private borrowers. Liquidation of Government securities was an important source of funds for current spending and for
credit expansion, and the Federal Reserve found it necessary to purchase securities in order to maintain a stable and orderly market for
Government securities. These purchases supplied additional bank
reserves. Under the circumstances action for counteracting inflationary developments had to be limited to relatively moderate measures.
Federal Reserve officials were thoroughly aw^are of the dilemma presented by the conflicting problems of debt management and monetary
policy in the postwar period and endeavored by various means to restrict credit expansion while at the same time stablizing the market




37 MONETARY, CREDIT, AND FISCAL POLICIES

for Government securities. The Treasury also endeavored through
fiscal and debt retirement operations and the use of its deposit balance
to exert an anti-inflationary influence. Proposals were made by the
Federal Reserve for legislation to provide additional powers needed
to deal more effectively with the situation, but none of these was
adopted until the summer of 1948.
Following is a summary of developments and of measures adopted
or considered by the Treasury and the System with respect to debt
management and monetary policy in the postwar period.
Playing the pattern of rates.—The practice of playing the pattern
of rates increased considerably in 1945 and became most prevalent
early in 1946. It resulted in such a rise in bond prices that market
yields on long-term restricted bonds declined to a little over 2 percent,
while those on medium-term bank eligible bonds declined below 1 y2
percent, as shown in the chart previously presented. The short-term
securities sold were largely purchased by the Federal Reserve, and the
bank reserves thus created were pyramided into a larger volume of
bank credit expansion and consequently a further rapid growth of
bank deposits.
One remedy for this situation would have been to permit short-term
rates to rise to a point at which such shifts were not sufficiently profitable. The System, however, recognized the disadvantage to the Treasury, as well as the possible disturbance in the Government securities
market, of any marked advance in short-term rates. Attempts were
made to solve the problem by other means, while moderate adjustments in some rates most out of line were recommended by the Federal
Reserve.
Preferential discount rate.—In 1945, the System came to the conclusion that it should discontinue a preferential discount rate of onehalf of 1 percent on 15-day advances to member banks secured by shortterm Government securities established early in the war to encourage
banks to purchase and hold such Government securities. Banks were
using this facility at times to hold Government securities when faced
with a loss of reserves, and this use served to create additional reserves.
The Treasury opposed the proposed elimination of this rate, but the
change was finally made in April 1946.
Elimination of bill-buying rate.—Federal Reserve authorities in
1945 and 1946 considered the discontinuance of the bill-buying rate
of three-eights of 1 percent and the repurchase option established early
in the war. It was proposed that the rate on bills be permitted to approach the %-percent rate on 1-year certificates, with support of the
latter rate continued at that level. The purpose of these steps was to
reduce the abnormal spread in the pattern of rates and to encourage
banks to hold more bills. In 1947, the Treasury concurred in the discontinuance of the buying rate on bills and the repurchase option as a
part of a program in which an increase was permitted also in the rate on
certificates. This action is discussed below.
Special reserve requirement.—In order to place limitations on bankcredit expansion on the basis of reserves created by purchases of Government securities by the Federal Reserve and at the same time avoid a
substantial rise in interest rates, the Board of Governors proposed
various special measures of legislation for consideration by Congress.
These proposals were first presented in the Board's annual report for
1945 and more definitely recommended in modified form on various




38

MONETARY, CREDIT, AND FISCAL POLICIES

subsequent occasions. The principal proposal was for the System
to be granted authority to require that banks hold, in addition to other
required reserves, special reserves in the form of Treasury bills or
Treasury certificates of indebtedness, balances with Federal Reserve
banks, or other cash assets.
This proposal was designed to give the Federal Reserve means of
further restricting bank-credit expansion, without raising interest
rates on Treasury obligations, but it was not enacted by Congress.
In August 1948, Congress gave the Board emergency authority to
raise reserve requirements for member banks by limited amounts.
This authority, which is discussed in a later section, was used in part
and served some of the purposes aimed at by the other proposals.
Treasury debt retirement.—Use by the Treasury of surplus cash to
retire bank-held securities became the dominant anti-inflationary
factor of the postwar period. This action served to diminish the
practice by banks of shifting from short-term to long-term securities,
which during 1945 and 1946 provided the basis for expanding bank
reserves. In 1946, the Treasury offered new issues in exchange for
only a portion of maturing securities, and the remainder were redeemed for cash, drawing upon a large Treasury cash balance in excess
of needs built up in the Victory-loan drive at the end of 1945. This
policy brought about some decline in the volume of bank credit to
the extent that commercial banks held the redeemed securities and
of bank reserves in the case of securities held by the Reserve banks. In
this way, the liquidity position and also the reserves of banks were
reduced. As a consequence, banks were less willing to dispose of
additional amounts of short-term securities in order to purchase
longer-term issues.
Beginning in 1947, the Treasury confined its retirements largely to
Federal Reserve holdings of maturing certificates and to Treasury
bills, of which the Federal Reserve held the major portion. Substantial retirements of maturing securities were made from the proceeds
of a budgetary surplus and also by use of funds obtained through
sales of savings bonds to the public. This policy, which resulted in
a direct drain on bank reserves and on bank-liquidity positions, was
continued into early 1949 and was by far the most important and effective measure of restriction on inflationary credit expansion.
Increase in bank loans.—Another development which brought to an
end bank purchases of long-term securities, but not their selling of
short-term securities, was the growing demand for bank loans. Loans
to businesses, consumers, and property owners increased sharply during 1946 and 1947. In order to meet these demands, banks sold securities to the Federal Reserve. These sales created reserves which
supplied the basis for multiple credit expansion.
Rise in short-term rates.3—In the middle of 1947, the Federal Reserve and the Treasury agreed upon a policy of permitting rates on
short-term securities to rise. This policy and its purposes were described in the Board's annual report for 1947 as follows:
Beginning in July, the Federal Reserve System and the Treasury adopted
measures to permit some rise in interest rates on short-term Government securities in order to increase their attractiveness to banks and other investors and
to place an additional restraint on further monetary expansion. The System
3

The discussion in this section relates particularly to question 4 in this group.




39 MONETARY, CREDIT, AND FISCAL POLICIES
discontinued its buying rate on Treasury bills, which had been
percent since 1942. The rate on bills rose during the remainder
to nearly 1 percent, as is shown in the chart. The length of term
of newly offered Treasury certificates was shortened in August and
and, subsequently, higher issuing rates were placed on new issues.
rose from % percent to 1 % percent by the end of the year.4

fixed at %
of the year
to maturity
September;
These rates

The policy, which continued until the rate on certificates had reached
I14 percent in October 1948, was effective in reducing the shifting of
short-term securities to the Federal Reserve and in encouraging banks
to increase their holdings of such securities. There developed a
tendency on the part of banks to reduce holdings of long-term securities and to buy short-term securities, as well as to expand their loans*
This tendency reflected in large part the gradual retirement of maturing bonds and their refunding into short-term securities. It showed
a willingness on the part of banks, for liquidity reasons, to hold shortterm securities at moderately lower rates than bond yields, whereas
they would not do so at very low short-term rates. The profits of
playing the pattern of rates were substantially reduced. Another
factor in this change probably was a feeling that the rise in shortterm rates might lead to a reduction in premiums on bonds.
In any event, during 1947 and part of 1948 banks in general reduced
their holdings of Treasury bonds and increased somewhat their holdings of bills. The higher short-term rates, therefore, had the desired
effect of encouraging banks, as well as others, to hold short-term
securities. As a consequence, the Reserve System was enabled to
reduce its holdings and thereby absorb bank reserves. To some extent
the reserves absorbed were supplied by System purchases in supporting the bond market, as explained below.
While the Treasury and the Federal Reserve were in general agreement on the policy of higher short-term rates, Federal Reserve authorities favored somewhat more frequent increases in rates. It was hoped
that the rise in short-term rates would permit a somewhat more flexible policy in open-market operations. Since a rigid pegging of all
rates prevents money-market forces from developing their own correctives, the change in policy was looked upon as a step toward reducing the ready availability of bank reserves provided by rigidly maintaining short-term rates at low levels.
Nonbank sales of securities and Federal Reserve support of bond
friees.5—In the latter part of 1947 investment institutions and other
nonbank holders of securities began to sell Treasury bonds in substantial amounts. This movement reflected primarily growing demands for investment funds on the part of the borrowers, particularly corporations, State and local governments, and property owners.
Partly because of these demands and partly because of credit-restriction measures, money rates and bond yields generally rose during the
last half of 1947. This movement began to be reflected in the Government bond market and caused a sharp decline in the prices of
these bonds from the high premiums at which they had been selling.
As a result the nature of the problem changed from one in which the
Federal Reserve was buying short-term securities, w^hile the market
4 Thirty-fourth Annual Report of the Board of Governors of the Federal Reserve
System, p. 5.
,
6 The discussion in this section relates in particular to question 4 in this group.




40

MONETARY, CREDIT, AND FISCAL POLICIES

bought bonds, to one in which the Federal Reserve was called upon
to purchase large amounts of bonds.
A considerable degree of uncertainty developed as to the maintenance of support buying by the Federal Reserve or as to the prices
at wiiich support would be supplied. A broad wave of bond selling
ensued. The System maintained its purchases, but late in December
1947 support prices were lowered to a level which would keep all
bonds at par or slightly above. Widespread selling of bonds by nonJbank investors slackened somewhat in the spring of 1948, but was
resumed in the summer. Finally, in November 1948, selling definitely
slackened. Subsequently the Federal Reserve was able to reduce its
holdings, and did so after consultation wTith the Treasury.
During the period of support operations questions arose as to the
advisability of the Federal Reserve continuing to supply inflationary
funds through purchasing at par or higher prices Government boixds
being sold by investors to shift funds to other uses. It was suggested
that an effective means of restraining inflation would be not to provide funds for these purposes so readily and to permit higher longterm interest rates to operate as a restraining influence. The largescale purchase of bonds by the Federal Reserve accentuated inflationary developments, and presumably a contrary policy would have
exerted a strong anti-inflationary influence, since increasing longterm interest rates has generally been a more effective deterrent on
business commitments and plans than increasing short-term rates.
The Federal Reserve, however, was in entire accord with the Treasury that maintenance of a stable and orderly market for Government
bonds was an overriding objective under conditions prevailing at
that time. It was agreed that the longest-term bond should not be
permitted to decline below par. Considerations entering into this
decision included the unprecedented volume of Government bonds
outstanding, the large refunding problem of the Treasury, the possibility that fear of declining bond prices would lead to much more
liquidation, and concern that a decline in bond prices might cause
a deterioration in the position of many financial institutions holding
large amounts of bonds. As I stated before the Senate Banking and
Currency Committee on May 11,1949:
In retrospect, I am certain that our action in support of the Government securities market was the right one. That program was a gigantic operation. In
the 2 years 1947 and 1948, the System's total transactions in Government securities amounted to almost $80,000,000,000. Despite this huge volume of activity,
the net change in our total portfolio was relatively small. I am convinced that
we could not have abandoned our support position during this period without
damaging repercussions on our entire financial mechanism as well as seriously
adverse effects on the economy generally.

It needs to be recognized in the long run, however, that interest
rates perform an economic function and should reflect the relation
between the supply of savings and the needs for capital formation.
To keep down the rate of interest by making credit freely available
at a time when capital demands exceed current savings has an inflationary result. Conversely, to increase rates of interest and thereby
discourage borrowing at a time when business activity is low, is conducive to further contraction. Monetary policies should be flexibly
adapted to the changing needs of the economy. However, in view of
the large outstanding public debt and its widespread distribution, the
Federal Reserve faces the dilemma of endeavoring to follow flexible



41 MONETARY, CREDIT, AND FISCAL POLICIES

monetary policies without detracting from the willingness of investors
to be firm holders of Government securities.
Increase in reserve requirements.—While the System could not stop
purchase of Government securities and still maintain a stable bond
market, it had some power to limit the effect of such sales upon bank
credit expansion. As pointed out, higher short-term interest rates
operated toward this end by encouraging banks and others to buy
short-term securities from the Federal Reserve. Increases in bank
reserve requirements also provided a means of immobilizing the additional reserves created by Federal Reserve purchases of securities
from nonbank investors, so that they would not give the basis for a
further multiple credit expansion.
During the first half of 1948, the Board exercised virtually all the
remaining authority it had to increase reserve requirements. The
authority it had not exercised was limited to central reserve city banks.
Requirements against demand deposits of these banks were raised by
two points in February and again in June, and these increases added
about a billion dollars to required reserves.
In August 1948, Congress granted the Board emergency powers
to increase reserve requirements for all member banks, and increases
made under this authority in September absorbed about $2,000,000,000 of reserve funds. These increases in reserve requirements just
about offset additional reserves supplied during the previous 10 months
by net purchases of securities from nonbank investors. They served
to reduce the liquidity positions of banks and thereby to discourage
further extensions of credit.
Abatement of inflationary pressures
In view of the changed economic situation that became apparent
early in 1949, the Board took action in May and June to reduce reserve requirements of member banks. The emergency power to raise
reserve requirements expired June 30, 1949. On June 28, the Federal
Open Market Committee issued the following statement:
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 investors in the
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.

In August 1949, after further consultation with the Treasury, additional reductions in reserve requirements were made on the basis of
permanent statutory authority to release about 1.8 billion dollars of
reserves. This series of reductions in reserve requirements resulted
in a substantial demand by banks for Government securities. Bond
prices rose sharply, and yields on short-term securities declined. For
the purpose of maintaining orderly conditions in the money market,
the Federal Reserve met the demand for short-term securities by selling a part of the System portfolio, and thus moderated the decline in
money rates.
At the same time, the System discontinued the practice of freely
selling Government bonds. With the adoption of this policy, pressure



42

MONETARY, CREDIT, AND FISCAL POLICIES

of market forces brought about a decline in yields on medium- and
long-term Government securities. This had the effect of encouraging
investors to seek corporate and municipal securities and mortgage
loans as outlets for the funds they had available for investment.
This greater flexibility in open-market policy places the System in a
better position to carry out its functions in adjusting to changed
economic conditions.
5. In what way might Treasury policies with respect to debt
management seriously interfere with Federal Reserve policies
directed toward the latter's broad objective?
(NOTE.—The following also provides an answer to question
6 (a), which reads: "What changes in the objectives and policies
relating to the management of the Federal debt would contribute
to the effectiveness of Federal Eeserve policies in maintaining
general economic stability?")
As explained in the answer to the preceding questions, because of
the great importance of the public debt in the present financial structure of the country, Treasury policies with respect to new borrowing,
retirement, and refunding of the debt unavoidably affect credit and
money-market developments and influence Federal Reserve operations.
Likewise, Federal Reserve policies can have an important influence
upon management of the debt by the Treasury. For these reasons,
the Treasury and the Federal Reserve must be constantly mindful of
each other's needs in determining their policies.
The importance of the problem of debt management is indicated
not merely by the size of the present Federal debt, in excess of 250
billion dollars, but by its proportion to the total of all debt, the impact
of its management on all interest rates, the cost of servicing the debt,
and proper provision for its retirement. The total Federal Government debt is now almost exactly the same as the gross national product
valued at the current postwar price level, whereas in 1939, for example,
it was little over one-half of the gross national product. The Federal
debt is now over half of all public and private debt in this country,
compared with less than one-fourth of the total in 1939 and less than a
tenth in 1929.
While these comparisons are not intended to suggest that there are
certain normal relationships that should be maintained, the broad
changes that have occurred do indicate that the public debt has become
a far more important element in the economy than formerly. They
also suggest that changes in the holdings of the debt might have farreaching effects on the economy. It seems essential that debt management be directed not merely to the financial considerations of Government itself, as important as they may be, but to the effect of such
management on our entire economy.
The present distribution of the Federal Government debt by types
of issues and by broad groups of holders is shown on the attached
table. The bulk of the debt is in marketable issues held by banks, other
investment institutions, business corporations, and individuals.
Ninety billion dollars of Government securities are due or callable
within about 3 years, and over two-thirds of these are held by the
banking system, including the Federal Reserve banks.




43

MONETARY, CREDIT, AND FISCAL POLICIES

Estimated ownership of U. 8. Government securities1 Aug. 31,1949
[Par values, in billions of dollars]
Investor classes
Total all Federal
investors agencies Federal Commer- Mutual
cial
savings
and trust Reserve
banks
banks
banks
funds

Type of security

Marketable securities:
Treasury bills
Certificates of indebtedness and Treasury notes. _
Bonds:
Bank-eligible, total
Due or callable:
Within 5 years
5 to 10 years
After 10 years
Bank-restricted
Total marketable securities
Nonmarketable securities:
Savings bonds
Savings notes
Special issues to Government agencies and trust
funds
Other, including noninterest-bearing securities

Insurance
companies

(2)

All other
investors

12.1

0.1

3.5

4.5

32.8

.1

6.3

14.4

0.2

0.8

61.0

.7

2.9

44.6

1.8

3.6

7.5

46.9
9.8
4.3
49.6

.3
.3
.1
4.6

2.7
.1

4.9

34.2
6.9
3.4
1.0

1.5
.2
.1
8.9

2.4
.9
.2
15.0

5.8
1.3
.4
15.2

155.6

5.4

17.5

64.4

11.0

19.4

37.9

.5

.7
.1

53.8
6.6

.1

.3

2.5

56.5
6.8

(2)

(2)
(2)

1.5
.1

33.4

.1

(2)

4.1
11.1

33.4

3.7

(2)

Total nonmarketable securities

100.3

33.5

Total, all securities

255.9

38.8

.6
2.2
17.5

.6

1.2

62.8

66.7

11.6

20.6

4 100. 7

1 Total gross public debt and guaranteed securities.
2 Less than $50,000,000.
s Includes Treasury bonds and minor amounts of other bonds.
4 Consists of 69.1 billion dollars held by individuals, 8.3 billion held by State and local governments,
and 23.3 billion held by "other corporations and associations."

For the Treasury the immediate problem of debt management is
concerned primarily with refunding maturing issues. The nature of
these refundings has an important bearing upon the problems that the
Federal Reserve may need to face to assure an orderly market and at
the same time to be in a position to follow flexible monetary policies.
There is an annual turn-over of some $45,000,000,000 a year in shortterm securities and in addition bond issues that become callable or
mature amount to from 11 to 17 billion dollars in each of the next three
calendar years. The types of securities offered to refund these maturities will have a bearing upon the demands for bank credit and thus
upon the Federal Reserve System.
Manifestly, policies with respect to interest terms, maturities, and
types of securities to be offered for the purpose of obtaining new
money or for refunding or retiring maturing issues all have a bearing
on current as well as possible future problems and policies of the
Federal Reserve. Debt management policies and Federal Reserve
policies must therefore be harmonized basically with a view to maintaining economic stability at high levels.
6. What, if anything, should be done to increase the degree of
coordination of Federal Reserve and Treasury objectives and
policies in the field of money, credit, and debt management ?
98257—49

4




44

MONETARY,

CREDIT, AND FISCAL POLICIES

The close relationship of monetary policy and debt management
will continue to require constant cooperation and coordination between
the Treasury and the Federal Eeserve.
As I have stated in answer to question II-6 (b), close cooperation
now exists between the Treasury and the Federal Eeserve in all matters
of mutual concern. Cooperation and coordination between responsible heads of governmental agencies depend upon the individuals
concerned and their grasp of mutual problems and responsibilities.
The present method of consultation between policymaking and operating officials of the two agencies is on a voluntary basis. I can conceive of no formalized action that would add to the satisfactory
relationships that prevail.
(For answer to question 6 (a), see II-5.)
6 (5) What would be the advantages and disadvantages of
providing that the Secretary of the Treasury should be a member
of the Federal Eeserve Board? Would you favor such a provision ?
For many years prior to the enactment of the Banking Act of 1935
the Secretary of the Treasury was an ex-officio member of the Federal
Eeserve Board. Experience demonstrated, however, that this arrangement had serious disadvantages. Being fully occupied with the
extensive duties of his own Department for which he was primarily
responsible, the Secretary was unable to devote adequate attention to
the problems of the Board or to attend its meetings with regularity.
Today the burden of official responsibilities borne by the Secretary
is even greater.
In the course of hearings on the Banking Act of 1935, both Senator
Glass and Senator McAdoo, each of whom had previously occupied
the office of Secretary of the Treasury at a time when the Secretary
was also ex-officio Chairman of the Eeserve Board, expressed the
opinion that the Secretary should not be a member of the Board.
During the.same hearings, Secretary of the Treasury Morgenthau,
who wras at the time ex-officio Chairman of the Board, indicated that
he believed the various controls of credit should be centered in a
Government agency which should be as independent as possible in
its determinations of credit policies.
The closest working arrangement now exists between the Treasury
and the Federal Eeserve, with constant consultation in all matters of
mutual concern and a full appreciation of the responsibilities placed
upon both. There is therefore no need for restoring the ex-officio
status of the Secretary on the Eeserve Board.
I I I . INTERNATIONAL P A Y M E N T S , GOLD, SILVER

1. What effect do Federal Eeserve policies have on the international position of the country ? To what extent is the effectiveness of Federal Eeserve policy influenced by the international
financial position and policies of this country? What role does
the Federal Eeserve play in determining these policies ? In what
respects, if any, should this role be changed ?
During the period since the passage of the Federal Eeserve Act,
the international financial position of this country has undergone
profound changes incident to two world wars and the world-wide



45 MONETARY, CREDIT, AND FISCAL POLICIES

depression in the early thirties. The country, transformed from a
debtor to a creditor Nation, has not been adequately prepared to cope
with the resultant new problems. The changed international situation brought to the United States a heavy inflow of gold, which greatly
expanded the reserves and lending power of the banking system; it
also presented this country with' strong demands from abroad for
financial and other economic assistance through investment, extension
of credits, grants, and other means. These various developments
deeply affected the domestic economy and the value of the currencies
of other countries relative to the dollar.
Traditional functions of central (or reserve) banking organizations
include the two tasks of helping to maintain domestic economic activity at the highest sustainable levels and also of aiding in keeping
international financial payments and receipts currently in balance.
Broadly speaking, free-enterprise countries look to their central banking institutions for performance of functions that relate to current
movements of foreign exchange and of gold. In most of these countries, the international exchange of goods and services is greater relative to aggregate internal economic activity than it is in the case of
the United States. In most of these countries the central bank participates directly in the management of foreign exchange operations.
In the United States the Federal Eeserve System has not customarily participated directly in foreign exchange operations, except
in the sense that imports and exports of gold directly affect the availability of dollar exchange in the world market. The strength of the
dollar has been of such a nature and our gold reserves have been so
large that any direct intervention in foreign exchange markets has not
been necessary. The Federal Eeserve System, however, also provides
services as correspondent for foreign central banks and monetary
authorities. This function includes foreign exchange operations for
foreign central banks, and also the making of advances to them, as
well as the holding of dollar balances of foreign correspondents.
In the experience of the Federal Eeserve System, from its inception
to date, movements of gold have constituted a factor of the first importance in determining the magnitude of its operations in the domestic
markets, since gold imports and exports have a direct effect upon
the reserves of member banks and, therefore, upon the demand for
credit at Federal Eeserve banks. Throughout most of the history
of the Federal Eeserve System, the international financial position of
the country has been strong and the Federal Eeserve System has not
had to fear excessive gold withdrawals. Its problem rather has frequently been to prevent the gold that has flowed to this country from
inflating the economy of the United States. The Federal Eeserve
System must always take account of the fact, however, that its policies
directed toward the supply, availability, and cost of money within the
United States directly affect the balance of international payments of
this country. Because of the important position of this country in the
world economy, there are likely to be accentuated world-wide effects
from domestic developments. These effects are sometimes amplified
by the psychological repercussions which fluctuations in the United
States may have in foreign countries.
In turn, the maintenance of international stability, economic and
political, has become of critical importance to the internal stability
and security of the United States. In a longer view, any contribution



46

MONETARY, CREDIT, AND FISCAL POLICIES

which Federal Reserve policies may make to this country's economic
well-being may well be lost unless economic and political stability is
achieved in the rest of the world. Even though foreign trade forms
in absolute volume a small percentage of our total trade, the fluctuations both of prices abroad and of export and import volume have
wide effects on our whole economy. A steady expansion of mutually
beneficial trade between the United States and other countries can
take place only if prices remain tolerably stable throughout the trading area, if exchange rates are appropriate and also reasonably stable,
and if the balances of international payments are consistent wdth the
resources of the main debtor and creditor countries. To establish
and maintain such conditions is beyond the power of any single country acting alone. Similarly, the achievement of enduring peace requires economic progress throughout the world. Progress toward
economic prosperity and political stability depends in great measure
on the wisdom of governmental economic and financial policies in each
country.
Domestic monetary and credit policies and the international financial position and policies of the United States are thus inextricably
linked together. In addition to the tasks in foreign financial operations of the United States which it now performs, the Federal Reserve
System is equipped to do more in this field. The System has a direct
interest in United States foreign financial policy not only because of
its immediate relation to the domestic monetary situation but also because of the general interest of the United States in the achievement
and maintenance of monetary and financial stability abroad.
The role of the Federal Reserve with respect to international financial policies is at present most directly performed through membership on the National Advisory Council on International Monetary
and Financial Problems. The Chairman of the Board of Governors
is by law a member of this Council, and members of the Board's staff
participate in the Council's well-organized staff work. This Advisory
Council is responsible for coordinating the policies and operations of
all United States Government agencies which Congress authorizes to
engage in foreign financial, exchange, or monetary transactions.
Apart from the work of the Federal Reserve in connection with the
National Advisory Council, the System is frequently called upon for
advice and counsel to Congress and to Government agencies dealing
with international monetary problems. The System also functions
operationally* in the foreign field, as mentioned in question 1-1, by
holding balances and acting as correspondent for foreign central banks
and governments, making advances to foreign central banks, and passing judgment on applications by member banks and certain banking
corporations to establish foreign branches and regulating their activities in foreign countries.
In postwar years, the United States has had a vital interest in the
achievement of internal stability in many foreign countries, and in
their making the best possible use of their own resources and of the aid
they are receiving from the United States. In the cases of Germany
and Japan, where the United States has had a direct responsibility as
an occupying power, the occupying agencies have on occasion consulted the Federal Reserve with respect to monetary policies to be
followed. There have also been frequent occasions when foreign countries have sought the technical advice and assistance of the Federal



47 MONETARY, CREDIT, AND FISCAL POLICIES

Reserve or when a United States Government agency (such as the
Economic Cooperation Administration), having responsibilities that
directly concern a foreign country's monetary and financial policies,
has requested special help from the System. By providing technical
missions to help foreign countries in the development of appropriate
policies, the Federal Reserve System has contributed to achieving more
fully the basic objectives of United States policies.
The principal problems which arise for consideration in the National Advisory Council are those which are intimately connected
with the restoration of stability in the world economy through providing an adequate supply of dollars. These problems are therefore
closely interrelated with Federal Reserve policies in the domestic
field. During recent years, the most important problems coming to
the Council's attention have related to giving aid to foreign countries
in the form of loans and grants. There have also been important
problems of exchange rates and exchange controls in other countries.
Also related to these problems has been the question of United States
policies with respect to the purchase and sale of gold. The National
Advisory Council has proved to be an efficient and desirable medium
for bringing together representatives of the Federal Reserve System
and representatives of other Government agencies whose responsibilities bear on foreign financial policies.
Although, in recent abnormal circumstances of international imbalance, the Reserve System's operating functions in the foreign field
have been of limited scope, its representatives have generally been
able to play an important part in the Council's activities because of
their familiarity with the kinds of analysis that are involved.
Strengthening of the Reserve System's operating collaboration in the
field of international finance may be expected as further progress
is made toward the reestablishment of more normal international
financial relationships and mechanisms.
2. Under what conditions and for what purposes should the
price of gold be altered? What consideration should be given
to the volume of gold production and the profits of gold mining ? What effect would an increase in the price of gold have on
the effectiveness of Federal Reserve policy and on the division
of power over monetary and credit conditions between the Federal Reserve and the Treasury ?
An increase in the price that the United States pays for gold would
have two major monetary results aside from dangerous psychological
repercussions : (1) The amount of the increase with respect to any
gold purchased would provide monetary aid from the American
economy as a whole to producers of gold (largely foreign) and to
foreign countries selling gold from accumulated stocks. (2) A corresponding addition (again with respect to gold purchases) would
be made to bank reserves, which would provide the basis for a manifold expansion of credit that might be highly inflationary.
As to the first result, an increase in the price of gold would provide additional dollars to foreign countries without reference to the
needs of the recipients. The extending of grants or credits, in such
amounts as are in conformity with the real needs of the countries
receiving them and are in the interest of the United States, is far better than increasing the price of gold as a means of providing any




48

MONETARY, CREDIT, AND FISCAL POLICIES

additional dollars needed. The United States is thus able to select
the countries and the periods of time for which such aid would be
given.
Concerning the second result, this country has no shortage of money.
In fact, there is an abundance of gold reserves, on the basis of which
additional money could be readily created by monetary and fiscal
action. Increasing the price of gold is a deceptively easy, as well as
potentially dangerous, way for the Treasury to provide more dollars
for foreign aid (by buying foreign gold) or for domestic purposes
(by buying domestic gold or by revaluing its existing stock) without
having to raise taxes or to borrow. Such an arbitrary creation of more
dollars is as inflationary as would be the arbitarary creation of an
equal amount of "greenbacks" and more inflationary than Treasury
borrowing of a corresponding amount from the banking system. This
country should not resort to such potentially harmful means of raising
funds.
Any change in the dollar price of gold, either up or down, would
have the following important effects: (1) Unless accompanied by a
proportionate change in the price of gold in terms of all other currencies, it would dislocate the entire pattern of foreign-exchange rates;
(2) it would change the dollar value of existing gold reserves, both
at home and abroad; (3) it would alter the profitability, and thus the
level of production, of the gold-mining industry; (4) it would change
the dollar value of this country's gold stock and all future additions
to it, and thus be a basis for monetary expansion or contraction; and
(5) it would constitute a major change in United States monetary
policy, with unforseeable psychological effects. In what follows each
of these effects is discussed.
1. Unilateral changes in a country's price of gold have in the past
been a means of altering exchange rates, and thus have served to adjust
disparities between commodity price levels in that country and in the
outside world. For example, if commodity prices and costs in a given
country are too high in relation to those in the outside world, it might
help to restore equilibrium by raising the price of gold in that country's
currency, i. e., by depreciating its currency in terms of gold and also
of such foreign currencies as remain unchanged in terms of gold. Conversely, if prices in the outside world were higher than in the given
country, the country might reduce its price of gold in order to help
bring about a better relationship.
During the spring and summer of 1949 price levels in many foreign
countries were too high in relation to prices in the United States. To
attempt to correct the disparity by a change in our price of gold
(assuming that other countries made no change) would have called for
a reduction in the gold price from $35 to some lower figure, that is, by
an upward valuation of the dollar in terms of gold and of other
currencies. This, however, would have caused serious dislocations in
many foreign countries and would have had severe psychological consequences domestically. The needed adjustments were brought about
in September by devaluations (in terms both of dollars and of gold) of
a number of foreign currencies.
2. A change in the dollar price of gold would alter the dollar value
of all existing gold reserves in direct proportion to the change in
price. Thus a 50 percent increase in the price of gold would result in




49 MONETARY, CREDIT, AND FISCAL POLICIES

a 50 percent increase in the dollar value of gold reserves, both in the
United States and throughout the world.
In the case of the United States, it is clear that a rise in the price
of gold is not needed to augment the value of domestic gold reserves,
since these are more than adequate for present and foreeable monetary
•needs. Under present legislation, the Federal Reserve System is required to maintain a reserve of 25 percent against Federal Reserve
notes and deposits, but the present ratio is actually about 55 percent.
Even if the latter ratio were to fall to the legal minimum, an increase
in the gold price would not be an appropriate means of correction.
In the case of fpreign countries, the situation varies. Many countries, because of postwar dislocations, are seriously handicapped at the
present time by a domestic shortage of gold and dollar reserves. But
a rise in the price of gold would help most those countries which already have large reserves. Every country which holds gold would
automatically receive an increase in the number of dollars available
to it, so that the largest increases would go to the largest holders, which
are the Soviet Union and Switzerland as well as the United Kingdom.
Under present and prospective circumstances, if the United States
wished to make more dollars available for foreign reserves, it would
be preferable to do so by extending stabilization credits to those countries whose reserves we wish to increase. Making dollars available to
selected countries by means of credits would cost the United States
less, in real terms, than trying to help these countries by making
dollars available indiscriminately in exchange for gold.
3. A change in the dollar price of gold would alter the profitability
of gold mining, and thus the level of gold production. Following the
increase in the dollar price of gold in 1933-34 (from $20.67 to $35
per ounce), gold production, both in physical volume and even more
in dollar value, was greatly stimulated all over the world. Because
of the world-wide rise in costs of labor and materials which occurred
as a result of World War II, the profitability of gold mining has
sharply fallen, and production has contracted considerably from the
peak level of 1940. Accordingly, proposals have been freely forthcoming from wwld gold-producing interests to raise the dollar price
of gold. The dollar price of gold, however, is still higher relative to
the general level of commodity prices than it was in the 1920's, and
gold production remains above the level of that period.
An increase in the price of gold would no doubt stimulate gold
production. As for the United States, however, there is clearly no
need for an increase in domestic gold production, since gold reserves
in this country are far in excess of minimum requirements. An increase in the dollar price of gold obviously cannot be justified on the
sole ground that it would increase the profits of gold mining.
In the case of foreign countries, those producing gold—which would
be the immediate beneficiaries of a rise in the gold price—are not the
ones whose need for assistance is greatest. While they might use the
augmented value of their gold to pay for imports from western Europe and thus enable western Europe to do more toward balancing
her trade with the United States, it would be much more to the advantage of the United States to accomplish this end by extending grants
or loans.




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MONETARY, CREDIT, AND FISCAL POLICIES

4. As to the effects that an increase in the price of gold might have
on our domestic monetary system, it is important to emphasize that
this country's existing gold holdings, valued at the present price of
gold, would support a far greater volume of money than needed for
any likely future contingency.
The immediate monetary effect of an increase in the price of gold •
would be a "profit" from the revaluation of our existing gold stock.
Expenditure of this "profit," which presumably would be within the
discretion of the Treasury, would increase commercial bank reserves,
and thereby foster a multiple expansion of bank credit, subject to the
reserve requirements of banks in effect at the time. Increased bank
reserves and resulting multiple expansion of bank credit would also
be fostered by accelerated inflow of gold from foreign sources and
domestic output. These developments would expose the economy to
great inflationary dangers.
The Federal Reserve has no means adequate to cope with such a
danger. In the absence of greatly expanded authority to absorb or
immobilize the inflationary reserves thus created, the Federal Reserve
would be incapable of performing its function of adjusting the credit
supply to the needs of a stable economy.
Increasing the price of gold would be an awkward and dangerous
instrument for this country to use, particularly in view of the fact that
other more effective and far less risky means are available or could
readily be found to accomplish anything constructive that would be
accomplished by changing the price of gold.
5. Lastly, it should be emphasized that any change in the price of
gold would constitute a major change in the foreign economic policy
of the United States. Since January 1934 the price of gold in terms
of the dollar has remained unchanged at $35 per ounce. Thus, for
over 15 years there has been a fixed relationship between gold and the
dollar—one of the few elements of stability in an international economic situation that is only slowly recovering from the ravages and
disruptions of extended world war. Changing the dollar price of
gold would inevitably weaken the high confidence that this country's
currency universally enjoys.
3. What would be the principal advantages and disadvantages
of restoring circulation of gold coin in this country? Do you
believe this should be done ?
The advantages which might be gained by restoring the circulation of gold coin in this country are negligible and serious disadvantages would be incurred. None of the important domestic or international monetary problems now facing us would be appreciably
helped toward solution.
Confidence in money, in our day, is based upon its internal purchasing power and the ability of a country to meet its external obligations, not upon internal convertibility of the money into gold. The
currency of the United States is the most generally acceptable currency in the world today. Confidence in it is assured by the productive power of the United States economy. Gold is readily available
and existing reserves are more than adequate to meet any conceivable
international drain of funds. Since the chief argument for institut-




51 MONETARY, CREDIT, AND FISCAL POLICIES

ing a gold-coin circulation would be the strengthening of confidence
in the currency, it is clear that on these grounds no need for taking
such a step exists today.
The argument that a return of gold-coin circulation would bring
about a desirable and automatic regulation of the domestic money
supply and would assure the country a "sound" monetary system—
in the sense that such a system would be "sounder" than the present
one—is not valid. On the contrary, the adoption of a gold-coin standard might actually hinder the maintenance of a stable and prosperous economy, since there is no automatic relation between the demand
for gold coin and the economy's need for money. The demand for
gold for individual use, as contrasted with its use to balance international payments, reflects various speculative and capricious influences which should not affect monetary policy, and fails to indicate
other conditions which ought to guide monetary policy. Thus a
strong public demand for gold coin might arise in time of depression,
as occurred in 1931-33, imposing a restrictive monetary policy at the
very time when the opposite policy is necessary. In time of rising
prices, when shifts from money to commodities are likely, demand for
gold might be small, so that the necessary restrictive action would
not automatically occur. If during wartime, moreover, heavy demands for gold should appear, free sales of gold would reduce our
gold stock, stimulate speculation against the currency, and hinder the
financing of the war. Furthermore, depletion of gold reserves resulting from private hoarding could conceivably impair our ability to
meet extraordinary wartime expenditures abroad.
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 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 our 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 at times of high speculative demand
for gold for hoarding, or else the Government would have to 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.
In regard to the international effects, it is often contended that if
gold were made freely available by the United States, whether in the
form of coin or otherwise, one effect would be to eliminate the premium
at which gold is quoted, in relation to the United States dollar, in black
or free markets abroad. However, the present premium of gold over
the dollar in foreign markets is a matter of very limited importance.




52

MONETARY,

CREDIT, AND FISCAL POLICIES

It reflects chiefly the special suitability of gold for hoarding, its great
familiarity, and its anonymous nature. It cannot even remotely affect
the stability of the United States dollar.
4. What changes, if any, should be made in our monetary
policy relative to silver ? What would be the advantages of any
such changes ?
In considering the role of silver in our currency system the pertinent
facts may be summarized as follows:
Of the total paper money and coin in circulation amounting to 27.5
billion dollars at the end of June 1949, there were 2.1 billion dollars
of silver certificates and 1.1 billion dollars of silver dollars and subsidiary coin containing silver. The Treasury purchases newly mined
domestic silver at a price fixed by law in 1946 of 90.5 cents per ounce.
The Treasury may also purchase other silver at whatever price it
deems appropriate. Because of the fact that the New York freemarket price of silver is currently around 73 cents an ounce, all
domestic production is sold to the Treasury.
The silver thus acquired by the Treasury may be monetized at any
time, either through coinage or through issuance of silver certificates
at the statutory price of $1.29 per ounce. The silver received by mints
and assay offices in 1948 totaled about 37,000,000 ounces, costing the
Treasury about 33 million dollars. Since the end of 1934 silver acquired by the Treasury has cost 1.4 billion dollars and silver certificates
and coin issued have aggregated 1.7 billion dollars.
To the extent that silver purchases increase the country's money
supply, there is a resulting increase in bank reserves and thus in the
base for credit expansion. These arbitrary additions to bank reserves
have no relation to the need for reserves and, so long as the supply of
gold and Federal Reserve credit continues ample, are unnecessary. So
long as additions to reserves through silver monetization remain relatively small, their monetary effects can be offset whenever desirable.
In regard to the international monetary aspects of silver, these are
of secondary significance in the present-day world, since no important
country is on a silver standard, although several countries use silver
for coinage and a few (chiefly Mexico and the Netherlands) maintain part of their currency reserves in silver. The vital problem of
the stabilization of foreign currencies today involves their relation to
gold and the dollar, and the carrying out of necessary internal adjustments, rather than their relation to silver which has practically no
status today as a means of settlement of international balances.
Accordingly, in the light of the aims and present operation of our
monetary system, no extension of the role of silver in the monetary
system would be desirable.
IY.

INSTRUMENTS OF FEDERAL RESERVE POLICY

Introduction
Purposes and functions of the Federal Reserve System, as indicated
in the answers to the questions in section I, are primarily concerned
with regulating the supply, availability, and cost of money with a
view to the basic objective of promoting economic stability at high
levels of employment and production. This broad objective coincides
with the guiding principles set forth in the Employment Act of 1946



53 MONETARY, CREDIT, AND FISCAL POLICIES

as the continuing policy and responsibility of the entire Federal Government. The instruments which the different branches of Government may use in furthering this objective vary in accordance with the
functions of the respective agencies. In a private-enterprise society
such as ours, Government action to promote stability should be as much
as possible of a type that will operate in a general manner, while specific decisions as to what shall be produced and bought should be left
largely to the free choice of individuals in the market.
The Committee for Economic Development, in its statement Monetary and Fiscal Policy for Greater Economic Stability, set out the
principles of Government action best suited to our system as follows:
The appropriate powers of government in a free society are powers that can
be democratically exercised without arbitrary discrimination among and coercion of individuals. This consideration does not debar the people from establishing through their government the general framework, equally applicable to all,
within which the members of the society shall operate. The government must,
for example, establish the terms on which individuals must contribute to the
support of the government through taxation ; it must establish the general conditions under which money can be created. If certain basic rules of nondiscrimination are observed, the power to levy a tax or to limit the creation of money
can be used without coercion of individuals. But the exercise of these powers
does have a great effect upon the stability of the economy. The important distinction is between power to coerce individuals and power to affect the general
behavior of the economy.

Monetary policies of government are particularly adapted to this
objective. They are designed to help stabilize the economy and at
the same time leave specific decisions of lending and borrowing to individual bankers, businessmen, and others. Instruments which the
Federal Reserve may use to influence the credit situation and the
money supply fall into two major groups—general instruments which
affect the total volume, availability, and cost of bank reserves, and
selective instruments which supplement general instruments in particular sectors without directly influencing other areas of the market.
General instruments include those which affect primarily the volume
of member bank reserves, such as open market operations and discounts ; those whose major influence is upon the availability of reserves,
such as changes in reserve requirements and policies and regulations
regarding the eligibility or acceptability of bank assets as a means of
obtaining access to Federal Reserve credit; and those which affect primarily the cost of bank reserves, such as discount rates and buying and
selling rates on Government securities and on acceptances.
The principal selective instrument which the Federal Reserve is empowered to use at this time is the authority to establish and change
margin requirements on listed securities. For limited periods in the
past the System has been authorized to regulate consumer installment
credit.
Appraisal of the effectiveness or the adequacy of instruments of
Federal Reserve policy must take into consideration the surrounding
circumstances in each case, and the interrelation of different instruments. Each instrument is important to the extent that it helps to
round out the entire framework designed to achieve the objectives of
Federal Reserve policy. Thus, authority to change reserve requirements is needed and justifiable only because without it the System
would be severely handicapped in efforts to maintain an effective influence over the money supply.




54

MONETARY, CREDIT, AND FISCAL POLICIES

It is also necessary in appraising the adequacy of instruments used
by the Federal Reserve to give proper weight to all of the accompanying economic conditions and factors. Monetary policy alone cannot
assure economic stability. Fiscal and other policies of Government or
business may at times make positive action in the monetary field unnecessary or prevent such action from being effective. The instruments used by the Federal Reserve should not, strictly speaking, be
referred to as "controls"; they generally do not control in a direct
manner, but only influence the course of economic developments. Under some conditions, mild measures may be sufficient to exert considerable influence, while under other conditions more vigorous measures
may be essential to affect economic forces. Changes occur, moreover,
which reduce the effectiveness of instruments as compared with what
they had been or call for the application of new instruments.
1. What changes, if any, should be made in the law governing
the reserve requirements of member banks ? In the authority of
the Federal Reserve to alter member bank reserve requirements?
Under what condition and for what purposes should the Federal
Reserve use this power? What power, if any, should the Federal
Reserve have relative to the reserve requirements of nonmember
banks ?
Banks as a group need to hold reserves to promote monetary and general economic stability. From the standpoint of the individual bank,
its required reserves are assets that cannot be loaned or invested to
earn an income and, accordingly, represent a contribution which that
bank makes to effective national monetary policy. It is important
that the basis used for allocating among different banks the total
burden of holding required reserves be as fair and equitable as it can
be made. ^
The existing statutory basis for member bank reserve requirements
tends to be inequitable in important respects as among banks. The
present system of classifying banks for reserve purposes on the basis
of geographic location dates back to the establishment of the national
banking system over 85 years ago. A member bank's designation for
reserve-requirement purposes depends on whether it is located in a
central Reserve city or in a Reserve city, or whether it is outside of
these cities—a so-called country bank. A member bank located in a
central Reserve or Reserve city must hold reserves at the higher percentages designated for such a center, irrespective of whether it is doing the correspondent banking type of business (holding of interbank
balances and nonmember bank reserves, which is associated with the
designation of a Reserve city and initially was the justification for the
higher requirements for banks in Reserve cities). On the other hand,
another member bank holding an important volume of deposits of
banks, but located outside the Reserve city areas, need maintain only
the reserve percentages required of country member banks. Some inequities of this kind have been relieved by the Board's discretionary
authority relating to outlying areas of Reserve cities, but many cases
of inequity cannot be solved in this way and a basic problem of equity
of treatment as among member banks still remains.
In order that the necessary burden on banks of holding reserves in
the public interest may be as fairly distributed as possible, consideration should be given to a fundamental revision in the basis for estab-




55 MONETARY, CREDIT, AND FISCAL POLICIES

lishing bank-reserve requirements. Differences in reserve requirements should be based more largely on the nature of deposits than on
the location of banks. Higher requirements might be set against
interbank deposits than against other types of demand deposits-and
lower requirements, as at present, against time deposits, strictly
defined.
A second problem of fairness in connection with member bank
reserve requirements arises in connection with the treatment of vault
cash. At present, member banks may count as legal reserves only
funds on deposit at the Federal Eeserve banks. Some banks, because
of location or the particular needs of their customers, need to hold
substantially larger amounts of vault cash than others. From the
standpoint of its contribution to the effectiveness of monetary controls,
however, the vault cash which banks need for operating purposes is
the equivalent of deposits at the Eeserve banks; both are in effect
liabilities of the Federal Eeserve banks. When banks obtain currency
they must draw on their reserve balances or obtain equivalent reserve
funds, and they can obtain reserve deposits in exchange for currency.
If a basic revision in bank reserve requirements is made, provision
should be made to permit banks to count vault cash as reserves.
Banks should probably also be permitted to count as part of their
reserves that part of their interbank balances which the correspondent bank in turn must hold as reserves with the Federal Eeserve. Under a revised system of requirements, such balances might require
more reserves than other types of deposits.
The staff of the Federal Eeserve has studied for some time the
matter of a fundamental change in the basis for reserve requirements.
A preliminary report by a staff group was made to the Joint Committee on the Economic Eeport, at its request, on May 27, 1948. The
staff is still studying this question, and when Congress may wish to
consider specific proposals we shall be glad to make available the
results of this work.
The authority to change reserve requirements is an important instrument for generally contracting or expanding the liquidity position of the banking system and for making other credit instruments
effective. It may be needed particularly to absorb excessive reserve
funds of banks obtained from large gold inflows or return of currency
from circulation, and perhaps also from Federal Eeserve purchases
of Government securities in maintaining orderly markets. Although
the Federal Eeserve now holds about $17,000,000,000 of Government
securities which might be sold to absorb reserves arising from inflows
of gold or currency, these inflows could over a period of years be so
large as to deplete the System's resources to below a reasonable operating level. Moreover, it would be disruptive for the System to endeavor to sell Government securities at a time when other holders
would be selling on balance.
The Federal Eeserve should have authority broad enough to meet
its responsibilities under different situations. The Federal Eeserve
cannot function properly if it must go to Congress for adequate authority after an emergency has arisen. Monetary and credit actions
work best when they can be applied in time to prevent a crisis from
arising.
Eeserve requirements are imposed on banks in the national interest
and in the interest of the entire banking system. They are part of




56

MONETARY, CREDIT, AND FISCAL POLICIES

the necessary mechanism by which the supply of money and credit may
be influenced to promote economic stability. To the extent that banks
do not bear their fair share in what is a national responsibility, the
effectiveness of monetary policy is weakened, to the detriment of all
banks. It is clearly unfair and inequitable to ask member banks
alone to bear the burden. This aspect of the question is discussed ii>
the answer to question V - l .
2. Should the Federal Reserve have the permanent power to
regulate consumer credit? If so, for what purposes and under
wiiat conditions should this power be used ? What is the relationship between this instrument and the other Federal Reserve instruments of control ?
The Board has heretofore proposed that the authority to regulate
consumer credit—or rather, consumer installment credit—be made permanent. It is unquestionably a useful tool, supplementary to reserve
requirements and other available instruments, to influence credit conditions in the interest of economic stability. The arguments for the proposal have been so extensively presented in the Board's annual reports
and elsewhere that I shall not undertake to review them here, but
I shall, of course, be glad to discuss this subject before the committee
if you should so desire.
3. What, if any, changes should be made in the power of the
Federal Reserve to regulate margin requirements on security
loans ?
A few minor changes in the margin provision of the Securities
Exchange Act of 1934 might be desirable. These provisions have
worked reasonably well as they stand.
The statutory objectives for which the power is to be used are
in line with those set forth in the Employment Act of 1946, and, taking
the Securities Exchange Act as a whole, are set forth with sufficient
precision to serve the desired purpose.
A possible change, in a liberalizing direction, would be one clarifying and extending the Board's power to make rules to permit brokers
to extend credit on unregistered (i. e., unlisted) securities, when this
would serve the public interest and not be inconsistent with the purposes of the act.
There is a possibility that need for a provision permitting regulation of bank loans for the purchase or carrying of unregistered securities might develop at some time in the future, but up to the present
there has been ^ O evidence of the necessity for such authority.
L
4. Should selective control be applied to any other type or types
of credit ? If so, what principles should determine the types of
credit to be brought under selective control ?
As of the present time, we do not advocate that selective control be
applied to other types of credit.
Persuasive argument can be made for selective regulation of realestate credit, since it can exert an unstabilizing influence on the course
of business in much the same way as consumer credit does. However,
the administrative difficulties of regulation in the real-estate field are
formidable. It is possible that similar objectives can be achieved by




57 MONETARY, CREDIT, AND FISCAL POLICIES

closer coordination between Federal Reserve monetary policies and the
policies of Government agencies which make, guarantee, or encourage
real-estate loans. Reference here is to a domestic advisory council,
referred to elsewhere. Since real-estate credit activities of Government agencies exert a strong influence on monetary and credit conditions, further exploration of this problem is very desirable. With
abatement of abnormal demand for housing, it should be possible to
bring about more coordination of policies in the interest of better
stabilization in this area.
5. In what respects does the Federal Reserve lack the legal
power needed to accomplish its objectives? What legislative
changes would you recommend to correct any such deficiencies ?
By far the most important deficiency in the System's legal powers is
found in the field of bank reserves. The desirability of correcting these
deficiencies and rationalizing the basis for determining reserve requirements is discussed more fully in the answers to questions IV-1
and V-l.
Although of somewhat less significance, there are a number of deficiencies in other areas that deserve mention. Some of these are
discussed in the answers to other questions as follows:
Consumer credit, discussed in the answer to question IV-2;
Capital requirements for admission to the Federal Reserve
System, discussed in the answer to question V-2; and
Financing of small businesses, discussed in the answer to question VI-5.
In an effort to prevent abuses which had developed in connection
with the operation of bank holding companies, the Banking Act of
1933 authorized the Board to impose certain restrictions on such holding companies as a condition to their right to vote stock controlled
by them in member banks. Subsequent experience, however, has demonstrated that the 1933 legislation is inadequate for effective regulation of bank holding companies.
Almost every one of the Board's annual reports since 1943 has recommended legislation to improve the situation, and S. 829, a measure
for that purpose in the Eightieth Congress, was favorably reported by
unanimous action of the Senate Banking and Currency Committee.
Currently, S. 2318 and H. R. 5744 have been introduced in the Eightyfirst Congress on the subject.
Except between 1935 and 1942, the Federal Reserve banks throughout their 35-year history have always had authority to purchase Government obligations directly from the Treasury: Since 1942, however,
the authority for such direct purchases has been limited to an aggregate maximum of $5,000,000,000 at any one time, and the authority has
been in temporary form. The time limit has been extended from time
to time, but under present law the authority will expire on June 30,
1950.
The provision for the Reserve banks to make such direct purchases
provides a flexible method of easing the money market in occasional
brief periods of heavy drain, as, for example, around tax-payment
dates. It affords the Treasury a source from which it may obtain
funds to meet temporary contingencies, making it possible for the




58

MONETARY,

CREDIT, AND FISCAL POLICIES

Treasury to operate with a smaller cash balance than might otherwise
be necessary. This mechanism has been used from time to time for
short periods. It should be extended beyond the present deadline of
June 30, 1950, and preferably made permanent.
In addition to the matters mentioned above, there are certain features of the law which, although not of vital importance, may deserve
reference here. These are requirements which are impracticable or
unnecessary and impair to some extent the efficient functioning of the
Federal Reserve System. Some examples of such requirements may
be mentioned:
The requirement of section 16 of the Federal Reserve Act for the
segregation of collateral against Federal Reserve notes in the form
of eligible paper, gold certificates, or Government obligations is cumbersome and yet adds nothing to the quality of such notes since they
are a prior lien on all the assets of the Federal Reserve banks and are
obligations of the United States. There could be written into the law
a formula which would accomplish the same purpose without the procedural requirements of this provision.
The provision of section 16 prohibiting any Federal Reserve bank
from paying out Federal Reserve notes issued by another Federal
Reserve bank, except under penalty of a 10-percent tax, serves no
useful purpose and the cost of sorting and returning such notes results in at least $350,000 a year of unnecessary expense to the Federal
Reserve banks.
The requirement of section 14 (d) of the Federal Reserve Act that
each Federal Reserve bank must establish discount rates every 14
days has entailed unnecessary inconvenience and might well be modified so that at least in the ordinary cases such rates could be established
less frequently, say, once during each month.
The provision of section 10 (b) which requires an interest rate
higher by at least one-half percent per annum than the highest discount rate of the Federal Reserve Bank for advances to member banks
secured by any satisfactory collateral other than eligible paper should
be eliminated.
Y.

ORGANIZATION AND STRUCTURE OF THE FEDERAL RESERVE SYSTEM

1. In what respects, if at all, is the effectiveness of Federal
Reserve policy reduced by the presence of nonmember banks ?
The effectiveness of Federal Reserve policies is reduced by the
fact that nonmember commercial banks, some 7,250 in number, are
not subject to the same reserve requirements as the 6,900 member
banks, and that they do not have the same direct access as member
banks to the credit facilities of the Reserve banks. This is true even
though the lending power of nonmember banks is indirectly affected
by changes in the total volume of reserves available to the banking
system and they share indirectly in the benefits growing out of the
existence of the Federal Reserve System. The table below shows the
composition of the commercial banking system by class of banks as
of June 30,1949.




59 M O N E T A R Y ,
Number

and deposits

CREDIT, A N D FISCAL

of aVl commercial
June

banks in United States,
30,1949

Number

Total
Insured nonmember
Noninsured
All commercial

by class of

hank,

Total deposits

Number of banks

Member banks:
National,
State

POLICIES

Percentage
of total

Millions of
dollars

Percentage
of total

4,987
1,913

35.3
13.5

78,219
38,745

56.8
28.2

6,900
6,517
733
14,150

48.8
46.0
5.2
100.0

116,964
18,410
2,146
137,520

85.0
13.4
1.6
100.0

I wish at the outset to indicate my general position on the problem
Raised by this question, mainly with respect to the implications of a
divided banking structure.
There is no simple answer to the problem presented by a divided
banking structure. It must be considered from many angles, historic
and institutional as well as political and economic. If it is the purpose of this inquiry to point out a constructive course of future action,
little would be gained by a simple reiteration at this point of the many
problems presented to those charged with the administration of
national policies by the existence of thousands of nonmember banks.
The dangers inherent in a divided banking system such as ours have
been repeatedly considered by the Congress, and on various occasions
legislation has been enacted looking toward eventual integration of
our thousands of individual banks into a more logical banking structure. In each instance, however, forces have arisen of sufficient
strength to nullify the action or to prevent such integration before
the deadline date.
It seems fairly clear to me that these forces are no less powerful
today than they have been in the past and that, in the absence of a
major banking catastrophe, it would be futile to premise a course
of constructive action upon the promotion of legislation requiring all
commercial banks, or even all of those that enjoy the benefits of Federal deposit insurance, to undertake all of the responsibilities that
are carried by members of the Federal Reserve System. If we are
to be realistic as well as conscientious, I would prefer rather to have
us bend our efforts toward measures sufficient to buttress the most
glaring weaknesses in our present structure. This, it seems to me,
is the path of wisdom if we are to avoid the widespread calamities that
might yield us in the end a more logical and integrated structure of
banking but only after and at the expense of another banking collapse.
I want to make my own position clear. I have always supported
the dual banking system. I welcome it as a source of flexibility and
decentralization in our banking supervisory structure. Our thousands of individual unit banks established in our separate communities,
chartered and supervised in some cases by Federal and in other cases
by State authorities, have made a distinct contribution to our free
enterprise society, a contribution that finds little parallel in the more
centralized banking systems of other countries. They are in intimate
contact with their local customers. They are sensitive to local needs.
98257—49 5




60

MONETARY, CREDIT, AND FISCAL POLICIES

They have helped build and maintain the vitality of small and
medium-sized business in this country and they have contributed to
the spirit of competition and initiative that is characteristically
American.
The term "dual banking" should not be confused with "the divided
banking system"; i. e., the division of banks into members of the
Federal Reserve System and nonmembers. The Federal Reserve
System was created originally to preserve our unit banking system
and our dual banking system and to protect it from its one fatal
weakness; namely, the recurrence at relatively frequent intervals of
devastating money panics. It was established with full recognition
of the desirability of continuing dual banking and membership in
the System has not destroyed it. The Federal Reserve System itself
is vulnerable, however, to the extent that it lacks direct contact with
half of the banks of the country; mainly, the smaller banks. We need
direct contact with these banks and there are times, particularly times
of strain, when they vitally need contact with us. That contact, of
course, would be provided if they all took out membership in the
System, but it seems to me that universal membership is not a feasible
solution of the problem. I want naturally a membership that is as
large as possible and I would recommend changes in the Federal
Reserve Act to make it easier for nonmember banks to ioin the System.
I am not in favor of compulsory membership in the Federal Reserve
System. I think it is important that our membership remain on a
voluntary basis.
While I personally favor the preservation of dual banking and voluntary membership as the basis of our Federal structure of reserve
banking, I do not wish to minimize the fact that this lack of integration presents a very serious problem.
What does it mean to have a commercial banking structure that consists of over 14,000 individual banks, of which fewer than 5,000 hold
national charters while the remaining operate under the differing
charter provisions of the 48 separate States? Does the existence
among all these banks of a small number of large correspondent banks,
as well as a few branch and group banking systems, provide sufficient
interconnection to assure an adequate flow of loanable funds from
regions where financial resources are ample to regions in need of outside financial assistance? What are the limitations imposed on national monetary policies by the fact that less than 2,000 of the 9,000
State-chartered institutions have chosen to take out membership in
the Federal Reserve System? To what extent are these limitations
offset by the fact that most of the larger banks, including most of the
correspondent bank and branch banking systems, are members of the
Federal Reserve System so that it includes 85 percent of the total deposits of the commercial banking system ? Does the fact that the
Federal deposit insurance system covers all but a handful of our banks
provide indirectly that hard central minimum core of essential unity
which first the national banking system and later the Federal Reserve
System failed to achieve ?
There are many, particularly among the commercial bankers, who
feel that the division in our banking structure, and even in the authority of the Federal Government to supervise banks, is no longer a danger. They believe, in fact, that this division has become an asset in
that it diffuses governmental power and responsibility arid, eonse-




61 MONETARY, CREDIT, AND FISCAL POLICIES

quently, safeguards the banks from capricious and arbitrary acts on
the part of the public authorities. This consideration, however, runs
both ways. If the minimum unification essential to survival has not,
in fact, been achieved, the present division of powers between the various authorities may very well turn into competition in laxity in
periods of prosperity as well as into impotence in times of stress.
Something of this sort happened in the early 1930's when the problem
of bank failures was acute. Difficulty again threatened in 1947 and
1948 when the efforts of the Federal Eeserve System to temper the
postwar inflation, through increases in reserve requirements, brought
into sharp focus the competitive situation between member and nonmember banks. As the Federal Eeserve System raised the reserve requirements of member banks, these member banks became increasingly
aware of the competitive advantages with respect to reserve requirements held by nonmember banks, and correspondingly restive. Had
the conditions of 1948 persisted much longer the ability of the System
to meet its responsibilities might have been seriously impaired by withdrawals among its members.
The acute phase of the postwar inflation, fortunately, seems now to
be in the past, and the particular circumstances that complicated central banking administration in that period have abated. We must,
however, take counsel to forestall a comparable episode from arising
in the future. We cannot rest content with a situation in which those
charged by Congress with the administration of the Federal Eeserve
System may be prevented from discharging their responsibilities because of the competitive situation created by the inadequate reserve
requirements of nonmember banks.
I feel that we may reach a constructive and practical solution of
this problem if we concentrate on the two aspects of the situation
where mandatory legislation is not only justified but essential to
the Nation's welfare. One is that the legal reserve requirements
which all banks must observe to retain their charters, whether they
be State or Federal, be so drawn that the monetary strength of this
country is not affected by a bank's voluntary decision to enter or
withdraw from the Federal Eeserve System. The other is that access
to the Federal Eeserve System—that is, to the ultimate source of
financial liquidity in times of strain—be open to every commercial
bank whether or not it is a member of the Federal Eeserve System.
These two changes are not separable. They must be linked together.
The legislation that would most directly accomplish these results
would provide, first, that all commercial banks—that is, all banks
carrying deposits subject to check—or at least all insured commercial
banks, observe the same reserve requirements irrespective of whether
they are member banks or nonmember banks. Such legislation would
not affect the authority of the State supervisors over nonmember banks
but it would remove once and for all the danger that the relative competitive advantages of membership, as compared with nonmembership,
in the Federal Eeserve System would affect the aggregate money supply of this country and inhibit the power of the Federal governmental authorities to deal effectively with problems of inflation.
If such legislation were enacted, it should provide for a revision of
the reserve requirements now applicable to member banks, which contain many anomalies inherited from the past. The uniform reserve




62

MONETARY, CREDIT, AND FISCAL POLICIES

plan outlined to your Committee last year contains many features that
merit consideration. It is discussed in the answer to question IV-1.
This proposed uniform reserve plan would provide for a fairer distribution of reserves among member banks, and the requirements
could be met by many nonmember banks with little change in their
operations.
Should Congress be disposed to meet the problem presented by the
continued existence of nonmember banks in this forthright fashion,
I would recommend that direct access to the discount and loan facilities of the Federal Reserve banks be extended to all commercial banks
without distinction as to whether or not they were members of the
Federal Reserve System. Such a move would make generally available the most important present material advantage of membership
in the Federal Reserve System. It might result in some losses in our
membership, and, therefore, in the applicability of some of the supervisory safeguards that Congress has written into the Federal Reserve
Act as a condition of membership, and perhaps in a decreased coverage
of the par collection system. Much as I would deplore this weakening
in System membership, I would prefer such a solution to a continuance
of the present position. We would at least be sure that the aggregate
volume of effective commercial bank reserves of the country would
no longer be threatened by competition between member and nonmember banks. I would, of course, welcome the fact that all commercial banks would have direct access to the credit facilities of the
Federal Reserve banks. It might well rescue many nonmember banks
from trouble in times of strain.
A somewhat similar, but much less effective, suggestion has recently
been advanced to deal with this same situation; namely, that Congress
require all commercial banks to hold the same percentage of reserve
against their deposits but that nonmember banks be permitted to
count their balances held with correspondent banks as part of the
assets available to meet the requirement to a much greater degree than
would be permitted to member banks. This suggestion would not
meet the basic logic of the situation since it would not provide assurance that the aggregate volume of effective bank reserves would be adequate to permit the central banking authorities to meet their responsibilities. It would go part of the way, however, toward minimizing
the dangerous effects of a competitive situation, such as developed last
year, in that the percentages of reserves which nonmember banks were
required to carry would have changed parallel to changes in the percentages of the reserves which member banks were required to carry.
If this improvement were all that could be achieved, it would not be
safe to give direct access to the credit facilities of the Federal Reserve
Banks to all nonmembers banks. It should be feasible, however, to
provide direct access to the credit facilities of the Federal Reserve
banks to all nonmember banks that chose of their own volition to
carry their reserves in the Federal Reserve banks.
In considering any such legislation, Congress should review the
other requirements now imposed on member banks.
My support of the dual banking system and my feeling that problems which need to be dealt with should be solved within this framework, even though it entails continued existence of a considerable
number of nonmember banks, rests largely on my reading of the basic
philosophy of the people of this country. We have here a most




63 MONETARY, CREDIT, AND FISCAL POLICIES

elaborate body of law, State and Federal, that deals with the financial
structure. The American people have shown no reluctance to enact
legislation to safeguard the soundness of banks, their safety, and their
liquidity, although sometimes the need for such legislation was learned
only through disaster. These purposes are common to the banking
legislation of the 48 States and of the Federal Government, including
the legislation creating the Federal Reserve System and the Federal
Deposit Insurance Corporation. At the same time, the history of our
banking legislation has shown definitely that the American people
not only want banks and a central banking system that are simply
sound, safe, and liquid, but they insist also on the preservation of
banking institutions that are locally owned and locally managed. It
is this insistence that explains the continued existence of our unit
banking system, the preservation of our dual banking system, our
separate regional Federal Reserve banks, and the unwillingness to
unify our banking structure compulsorily under the Federal Reserve
System. I, for one, am content as a realist to accept that insistence.
Even more, I find myself in accord with it. Possibly, students of the
problem in the past have been mistaken in seeking to safeguard our
monetary structure by advocating universal membership in the Federal Reserve System, for that membership involves conformity with
national standards with respect to a great many of a bank's activities.
It is not solely confined to conformity with respect to reserves.
I suggest that instead of pushing for compulsory universal membership in the Federal Reserve System it would be better if we all were
to concentrate on the elimination of competition in laxity with respect
to reserve requirements. If we can gain that one objective, we can
then direct access to the credit facilities of the Federal Reserve System and we will have dealt with the most serious threat to our ability
to safeguard the monetary structure of this country.
The foregoing suggestions are based on the fact that Federal Reserve
policies are accomplished in the main through expanding or contracting the amount of reserves available to banks. In the monetary system
of the United States today, balances with the Federal Reserve banks
and vault cash supply the basic reserves of the entire banking system;
increases in the amount of these reserves make possible expansion in
the supply of money while decreases are likely to necessitate contraction. The amount of these basic reserves that banks are required to
hold against their deposits determines the volume of credit that can
be extended by the banking system on the basis of any given total
volume of such reserves. Under existing conditions the total volume of
deposits in all commercial banks is approximately 7y2 times the aggregate of reserve balances with Federal Reserve banks and vault cash
held by commercial banks.
Member banks are required to hold balances with Federal Reserve
banks as reserves against their deposits. Nonmember banks, on the
other hand, may hold their reserves in the form of vault cash, balances
due from other commercial banks, and, in some States, certain amounts
of securities of the United States, States, and political subdivisions.
Only the vault cash, which must be obtained indirectly from the Federal Reserve, will be reflected dollar for dollar in the demand for
Reserve bank credit. Vault cash, however, constitutes only a very
small portion of required reserves of nonmember banks; their reserves
consist largely of balances due from other banks. Balances due from



64

MONETARY,

CREDIT,

AND

FISCAL

POLICIES

other banks, since the banks with which the funds are deposited can
lend or invest them, do not restrict credit expansion except to the small
extent that reserves are held against these deposits in the form of vault
cash or of balances at the Federal Reserve banks. Balances deposited
with correspondent banks are in large part available for lending by
correspondent banks and thus may contribute to the process of multiple
credit expansion on the basis of a given amount of basic reserves.
Reserves consisting of securities are not effective as reserves in a
monetary sense—i. e., as a means of regulating the total amount of
credit that can be supplied by the banking system—because they are
not immobilized assets but rather are assets which reflect credit expansion. A reserve requirement in the form of specified securities—
e. g., United States Government securities—is, however, a limitation
on the proportion of bank funds which can be invested in other loans
and securities.
With reference to required reserves, it should be pointed out that
member banks in practice hold as working balances certain amounts
of vault cash and deposits with correspondents, in addition to their
required reserves with Federal Reserve banks, whereas nonmember
banks can count their minimum working balances as required reserves.
Thus, the differences in percentages of deposits required to be held as
reserves do not accurately reflect the actual differences in effective
reserves that must be held by the member and nonmember banks.
Although member banks hold about 85 percent of total deposits of all
commercial banks, it must be remembered that the effectiveness of
reserve requirements lies not only in the aggregate volume of dollars
required to be held as reserves; to a very considerable extent it lies in
the direct impact of those requirements upon the loan and investment
policies of the thousands of individual banks and the influence those
policies exert upon the myriad users of bank credit. Accordingly, the
fact that more than one-half of all commercial banks are not members
of the Federal Reserve System and are not subject to Federal reserve
requirements can seriously weaken the effectiveness of these requirements. Moreover, the geographical distribution of the nonmember
banks is not uniform throughout the country but varies widely, ranging
from approximately 15 percent of all commercial banks in the Federal
Reserve District of New York to approximately 71 percent in the
Federal Reserve District of Atlanta. As a result, the impact of Federal
Reserve policies and the possibility of rendering assistance and support
in time of need varies widely in different areas of the country.
,Number of all commercial

banks and percent which are nonmembers,
reserve districts, June
30,1949

Number

Boston
New York
Philadelphia
Cleveland
Richmond
A " QTifo
H
Ohicago




498
909
843
1,128
1,026
1,195
2,498

Percent
which are
nonmember
banks
33.1
14.5
23.8
37.9
53.3
70.9
59.8

Federal

All commercial banks

All commercial banks
Federal Reserve district

by

Federal Reserve district
Number

St. Louis.
Minneapolis
Kansas City
Dallas
San Francisco
Total

Percent
which are
nonmember
banks

1,473
1,281
1,768
1,019
512

66.4
62.8
57.1
39.1
48.0

14,150

51.2

65 MONETARY, CREDIT, AND FISCAL POLICIES

2. What changes, if any, should be made in the standards that
banks must meet in order to qualify for membership in the Federal Eeserve System? What would be the advantages of such
changes ?
The present statutory requirements with respect to the amount of
capital necessary for admission of a State bank to membership in
the System are arbitrary, unrealistic, and have little relationship to
the capital needed by the banks. They should be substantially modified. For the same reason, specific provisions regarding the minimum
amount of capital stock required for the admission to membership
of a State bank operating an out-of-town branch or branches, or for
the establishment of an out-of-town branch by a State bank, should
be eliminated.
As a result of present capital requirements, sound banks which are
otherwise entitled to membership, and most of which are insured
banks, are prevented from becoming members of the Federal Eeserve
System or from establishing branches as member banks. A recent
survey indicates that there are approximately 2,000 State banks which
were not eligible for membership because of the present capital
requirements.
Furthermore, present capital requirements have caused some State
member banks to withdraw from membership in order to establish or
continue out-of-town branches, which they can do as insured nonmember banks but cannot do as member banks. Since January 1,
1946, 11 State member banks have withdrawn from membership for
this reason. In each case, after considering all of the factors prescribed by law, including the adequacy of capital structure, the Federal Deposit Insurance Corporation approved the bank's application
for continuance of insurance as a nonmember bank and establishment
or continuance of the branch. In each case, the bank's capital stock
was less than the amount required for the operation of branches as a
member bank.
As a general rule, banks which are eligible for Federal deposit
insurance should not be barred from membership in the Federal
Eeserve System by arbitrary capital requirements. The following
proposed changes are desirable in and of themselves and necessary in
order to eliminate unwarranted discrimination against membership in
the Federal Eeserve System.
Instead of the present capital requirements, which relate only to
the amount of capital stock and are based upon population, there
should be only one specific capital requirement for admission to membership: a minimum of $50,000 paid-up capital stock, with the exception that a bank organized prior to the enactment of the proposed
legislation might be admitted with paid-up capital of $25,000. The
adequacy of a bank's capital structure should continue to be included
among the factors to be considered by the Board of Governors in
passing upon the application of a State bank for membership.
The Board has recommended such changes, and bills incorporating
the recommendations have been introduced in the present Congress
as S. 2494 and H. E. 5749.
Except for the suggested minimum capital stock, the discretionary
authority proposed would be similar to that now prescribed for the
Federal Deposit Insurance Corporation in passing upon applications




66

MONETARY, CREDIT, AND FISCAL POLICIES

for insurance and for the establishment of branches by insured nonmember banks.
Provisions of existing lam
The existing law provides, in general, that no State bank shall be
admitted to membership in the Federal Reserve System unless it possesses a paid-up unimpaired capital stock of at least $50,000 if in a
place of not over 6,000 population ; $100,000 if in a place of over 6,000
but not exceeding 50,000 population; $200,000 if in a place of over
50,000 population. Exceptions permit, in certain circumstances, the
admission of State banks with a minimum capital stock of $25,000 if
located in a place of not over 3,000 population, and with a minimum
capital stock of $100,000 if located in an outlying district in a city with
a population of over 50,000.
If a bank with an out-of-town branch established after February
25, 1927, wishes to become a member, or a State bank which is a member wishes to establish an out-of-town branch, it is required by law to
have a capital stock of at least $500,000, except in a few States with
relatively small population. A minimum of $250,000 is applicable in a
State with a population of less than 1,000,000 and in which there is no
city with a population exceeding 100,000; a minimum of $100,000 is
applicable in a State with a population of less than 500,000 and in
which there is no city with a population exceeding 50,000. In addition, the bank must have capital stock not less than the aggregate required for the establishment of national banks in the various places
where the bank and its branches are located. In many cases, the capital
requirements for the establishment of branches by State member
banks (which are the same as for national banks) are much more
stringent than those under the State law.
3. What changes, if any, should be made in the division of
authority within the Federal Reserve System and in the composition and method of selection of the System's governing bodies?
In the size, terms, and method of selection of the Board of
Governors? In the Open Market Committee? In the boards
of directors and officers of the Federal Reserve banks? What
would be the advantages and disadvantages of the changes that
you suggest ?
Board of Governors
Before the recent debates on the executive salary bill (H. R. 1689),
I would have answered the question with respect to changes in the sizer
terms, and methods of selection of the Board of Governors by recommending that no change be made, or at most that the membership of
the Board be reduced from seven to five. However, these discussions
reflected a widespread misunderstanding of the Reserve System's responsibilities for monetary and credit policies and of the need for
salaries for members of the Board commensurate with their responsibilities. As I am in no way dependent upon my salary as a member
of the Board, my comments on the question of salaries are actuated
only by a desire to increase the effectiveness and prestige of the Federal Reserve System.
The executive salary bill as passed by the Congress increases the
salaries of the Board from $15,000 to $16,000. The salaries of members of the Cabinet were increased from $15,000 to $22,500, under
secretaries formerly receiving $10,000, $10,330, or $12,000 were in


67 MONETARY, CREDIT, AND FISCAL POLICIES

creased to $17,500, and a number of other official salaries, ranging from
$10,330 to $15,000, were increased to $16,000 and more. When the
System was first organized, the salaries of the members of the Board
were the same as those of members of the Cabinet, and they have been
at that level for many years past. The fact that the Congress did not
maintain in the executive salary bill the salary status of the members
of the Board has disturbed me greatly, because it reflects either a misunderstanding as to the Board's responsibilities or a feeling that they
are no longer as important as they have been in the past. Since the
Board's responsibilities have increased over the years, particularly
during and since the war and because of the great growth in the public
debt, I am convinced that the action of the Congress is the result of
a misunderstanding.
The availability of credit for the financing of business is the lifeblood of a dynamic society. When an agency is given the responsibility—as the Federal Reserve System has been—for increasing or
decreasing the amount of credit available and the cost of such credit,
its decisions and policies have a profound effect on all segments of the
economy. Failure to meet that responsibility wisely in the public
interest could do untold damage to business, industry, and agriculture.
Sound national monetary conditions are essential to achievement of
the objectives of the Employment Act of 1946. Primary responsibility in this field is vested in the Board of Governors. It would be
difficult to exaggerate the importance of this responsibility, and hence
the need for confiding it to men of wide experience who have great
breadth of vision and understanding. In my opinion, this duty alone
justifies a salary level for Board members that is substantially above
the limitation set by the current legislation. In addition, the Board
has other important duties. It has general and other major supervisory functions in connection with the operations of the 12 Federal
Reserve banks and their 24 branches which perform central banking
functions in the public interest and, therefore, are entirely different
in their purposes and functions from the commercial banks which are
private institutions. The Board also exercises special supervision over
the relations of the Reserve banks with foreign banks and bankers. Its
duties include the supervision and examination of banks. Additional
responsibilities among others, include the issuance and retirement of
Federal Reserve notes, which is the major portion of our currency, and
the issuance of regulations relating to the many subjects to which the
jurisdiction of the Board extends.
In the light of the above, I am satisfied that it is essential to the
•effective discharge of the Board's functions that the prestige of the position of a member of the Board and the salary for the position be
such as to attract the best-qualified men available. Whether the Board
consists of three, five, or seven members is not as important as to have
the positions filled with men of the highest qualifications and competence who will be induced by the nature and standing of the position
to accept and remain in office. There is no question in my mind that
if the subordinate salary relationship established by H. R. 1689 is
continued it will be most difficult, if not impossible, to attract to the
Board men of the caliber I have indicated. After serving for a period
of 18 months as Chairman, I feel that the salary relationship which
existed in the past should be maintained; and, if the only way to restore that relationship is to reduce the number of members of the




68

MONETARY, CREDIT, AND FISCAL POLICIES

Board, I would strongly recommend that step. In this connection^
it should be borne in mind that salaries and expenses of the Board
and its staff are not paid from appropriated funds or governmental
revenues or from assessments upon member banks but from earnings
of the Federal Reserve banks in the normal course of their operations,
particularly open-market operations.
If the Congress should reduce the present Board to five members
and retain the present Open Market Committee, it would be my suggestion that the representative membership on the Committee be reduced
to three or four instead of five as at present.
The present law requires that from the membership of the Board
the President shall designate one member as Chairman and one member as Vice Chairman to serve as such for a term of 4 years. The purpose of this provision of the law was to afford a new President an
opportunity to designate a Chairman and Vice Chairman of the Board.
In practice, this provision has not worked out satisfactorily because it
has not been possible to make appointments so that they would coincide with the term for which the President is elected. It would be
preferable if the law were changed to provide that the President
shall designate the Chairman and Vice Chairman for terms expiring
on March 31,1953, and March 31 of every 4 years thereafter.
Federal open-rnMrhet committee
Differences of opinion have always existed as to the most desirable
distribution of functions within the various parts of the Federal
Reserve System and particularly as to where responsibility for the
instruments of credit policy should be placed. One view expressed
in answers to questions of the subcommittee is that authority with
respect to more of these instruments should be lodged with the Federal
open-market committee. It is my considered opinion that the present
arrangement works very well. It has been my experience that the
Board is constantly seeking and benefiting from the advice on System
policies generally as provided not only through the open market
committee but also through consultation with all of the presidents
and the chairmen of the Federal Reserve banks and the Federal
Advisory Council. A splendid spirit of cooperation and understanding on policy and procedure exists throughout the System, and my
chief interest is to preserve and improve it.
If any change were to be made in this regard, I would prefer to
consider an amendment to the law to place authority over open-market
operations, and of all powers and authorities vested in the Board of
Governors, in a reconstituted Board (w7hich would be known as the
Federal Reserve Board) consisting of three members appointed by
the President with the advice and consent of the Senate, and the
presidents of two of the Federal Reserve banks, making a Board of five
full-time members. The terms of the three members appointed by
the President would be 12 years, so arranged that one term would
expire every 4 years. The present requirement that a member shall
be ineligible after the completion of a full term should be eliminated,
except that no one should be eligible for appointment for a term or
the unexpired portion thereof if he would reach 70 years of age
before the end of the term.
The two members chosen from the presidents of the Federal Reserve
banks would each serve for a period of 1 year in accordance with a




69 MONETARY, CREDIT, AND FISCAL POLICIES

system of rotation among the 12 Federal Reserve bank presidents
which would be written into the law. The two president members
of the Board would be required to give their full time to the work
of the Board. To be eligible for service as a member of the Board,
a president of a Federal Reserve bank should have served as an officer
of the bank for at least 2 years.
Such a proposal would terminate the existing arrangement under
which authority over instruments of credit policy are divided between
the Board of Governors and the Federal open-market committee.
It would preserve the present advantages of having presidents serve
on the open-market committee, and would be in harmony with the
regional character of the Federal Reserve System, which contemplates
that the coordination, supervision, and final determination of national
credit and other major policies would be in the hands of a supervisory
governmental body located in Washington. Because of the importance
of the New York money market, provision should be made for participation of the president of the New York Federal Reserve Bank
in the consideration of open-market policies and operations.
However, unless future experience should reveal a greater need than
now exists for changing the duties or composition of the Federal-openmarket committee, I would not recommend a change.
Directors of Federal Reserve banks
One of the major advantages of having a board of directors at each
of the Federal Reserve banks is that it brings to bear on the problems
of the System the wide range of training and experience possessed by
the directors. This advantage can be most effectively utilized, however, if there be injected regularly into the membership of the board
of directors fresh points of view. This can best be accomplished by
a system of rotation of membership on the bank boards. Another
advantage of such a system would be that a more frequent turn-over
of directors would result in more of the outstanding businessmen in
the various Federal Reserve districts having close contact with and
understanding of monetary and credit policies. These problems are
complex. They are not generalty understood by the public. Men
who serve as directors of the Federal Reserve banks or as members
of the Federal Advisory Council gain a much better understanding
of national monetary and credit problems and of policies designed to
meet such problems, and they are thus able to inform other businessmen and bankers on these subjects. This results in a far wider understanding and acceptance of S}rstem policies.
In 1935 the Board adopted a policy under which class C directors of
Federal Reserve banks (who are appointed by the Board) who had
served six or more consecutive years (except in the case of the chairman of the board of directors) would not be reappointed. It was the
hope of the Board that the same policy would be followed in the election by the member banks of class A and B directors of the Reserve
banks but that course was followed only to a limited extent. Accordingly, in 1942, the Board announced that it had abandoned any fixed
rule as to the length of service of class C directors but that it would
adhere generally to a policy of rotation. Since it has not been possible to bring about a system-wide policy in this regard, it would be
my recommendation that the law be changed to provide that directors
of Federal Reserve banks (perhaps with the exception of the chairman




70

MONETARY,

CREDIT, AND FISCAL POLICIES

of the board of directors) shall be ineligible for service as directors
after the completion of two consecutive full terms of 3 years each.
Officers of Federal Reserve banks
The Banking Act of 1935 required that the chief executive officer
of a Federal Eeserve bank be a president, appointed by the directors
with the approval of the Board of Governors for a term of 5 years,
and all other executive officers and employees of the bank are directly
responsible to him. Provision was also made for the appointment of
a first vice president in the same manner and for the same term as the
president and he serves as the chief executive officer in the absence or
disability of the president.
For a variety of reasons relating to the freedom to assign responsibilites to officers and the selection of men to fill the second position on
the executive staffs of the Federal Eeserve banks, it would be preferable if the position of first vice president were eliminated. If that
were done, the directors would be free to shift the more important
duties and responsibilities among the vice presidents and make changes
in the official line-up of officers without the difficulties sometimes
encountered under the present arrangement.
Federal Advisory Council
There is no formal limitation on the length of time that a member
of the Federal Advisory Council may serve. For the same reasons as
are given above for the adoption of a system of rotating membership
on the boards of directors of the Federal Eeserve banks, I believe it
would be desirable to provide for rotation in the membership of the
Federal Advisory Council. The desirability of such rotation has been
recognized in resolutions adopted by the chairmen of the Federal Eeserve banks as well as by the Federal Advisory Council itself, but the
directors of some of the Federal Eeserve banks have not acted to put
the suggestion into effect. Accordingly, I would favor a change in the
law to provide that an individual shall not be eligible to serve as a
member of the Council for more than three full consecutive calendar
years.
Other changes
There are other changes of lesser importance in the organization of
the System which I shall not undertake to detail in this reply but
which would be desirable in the event a general revision of the Federal
Eeserve Act were undertaken.
VI.

EELATION

OF THE FEDERAL EESERVE TO O T H E R B A N K I N G
CREDIT AGENCIES

AND

1. What are the principal differences, if any, between the bank
examination policies of the Federal Eeserve System and those
of the FDIC and the Comptroller of the Currency ?
At the present time, the differences between the examination policies
of the Federal Eeserve, the FDIC, and the Comptroller of the Currency are not of material consequence. Such variations as formerly
existed related mainly to the appraisal of assets held by the examined
bank, and these appear to have been largely eliminated by an agreement on appraisal standards—more fully described iii the answer to
question VI-2—which was worked out among the three agencies in



71 MONETARY, CREDIT, AND FISCAL POLICIES

1938 and revised by them in 1949. The differences might be greater
and of more significance in periods when inflationary and deflationary
pressures are less evenly balanced and one or the other is tending to
unstabilize the economy.
It is only natural that there should be some differences among the
supervisory policies of the three agencies (as implemented by bank
examinations and otherwise), in view of the fact that the responsibilities and principal functions of the respective agencies are not
the same, but the differences in policies are on the whole less important
than the similarities. General statements respecting their varying
responsibilities, if made by any one of the three agencies, would perhaps be unacceptable to both the others. By reason of their institutional connection the examiners of the Federal Reserve System are
particularly attentive, in appraising a bank's assets and the character
of a bank's management, to taking into account the general business
and credit conditions and the current monetary and credit policy of
the Federal Reserve authorities.
2. To what extent and by what means have the policies of
the Federal Reserve been coordinated with those of the FDIC
and the Comptroller of the Currency where the functions of these
agencies are closely related? What changes, if any, would you
recommend to increase the extent of coordination? To what
extent would you alter the division among the Federal agencies
of the authority to supervise and examine banks ?
3. What would be the advantages and disadvantages of providing that a member of the Federal Reserve Board should be
a member of the Board of Directors of the Federal Deposit
Insurance Corporation? Would you recommend that this be
done ? Should the Comptroller of the Currency be a member of
the Federal Reserve Board ?
These questions relate in reality to a single problem—one of long
standing and great complexity. It grows out of the fact that Federal
supervision and regulation of banks are divided among three agencies
set up by Congress for different purposes and at widely separated
times in our banking history. The Comptroller of the Currency over
85 years ago was charged with the responsibility of chartering and
examining national banks. As passed in 1913 and with later amendments, one of the purposes of the Federal Reserve Act stated in its
preamble was "to establish a more effective supervision of banking
in the United States," and the act places upon the Federal Reserve
Board and the Federal Reserve banks, among other responsibilities,
supervisory and examining functions with respect to all member banks.
In the depression period of the early 1930's, the Federal Deposit
Insurance Corporation was created to administer a bank deposit insurance fund, and was given certain limited powers over all insured
banks, including national banks and State member banks, and special
powers of supervision and regulation with respect to nonmember insured banks. As a result, each of the three agencies is primarily concerned with a certain class of banks; but each also has regulatory
functions in specific areas which affect banks primarily under the*
jurisdiction of one or both of the other agencies. In addition, Congress has placed upon the Board of Governors important responsi-




72

MONETARY, CREDIT, AND FISCAL POLICIES

bilities in the field of credit and monetary policy with which bank
supervisory and regulatory policies have a definite relationship.
In the circumstances, a layman examining an organization chart
of the three agencies or a description of their functions would expect
to find little evidence of coordination in their supervisory policies
and wrould probably expect them to be working completely at cross
purposes. There has been no specific directive from Congress requiring cooperation between them and, except that the Comptroller of the
Currency is an ex officio member of the Board of Directors of the
FDIC, each of the agencies is quite independent of the others. Actually, however, the agencies have accepted the need for cooperation
as a practical matter and each of them has made its own contribution
to this end.
In the field of bank supervision, which has to do with individual
banks and is implemented by bank examinations, the three supervisory
agencies appear to have achieved reasonably uniform standards for
the appraisal of bank assets by bank examiners. This has resulted
chiefly from the adoption of a written agreement between the three
agencies and the National Association of Supervisors of State Banks,
first in 1938 and revised, in detail but not in principle, in 1949. In
such matters as the chartering of banks, admissions to deposit insurance or to membership in the Federal Reserve System, and grants
of permission to establish branches, a great deal of coordination has
been likewise attained.
Serious problems of coordination have arisen from the fact that
the three agencies are authorized under the law to issue and interpret
regulations applicable to the classes of banks under their respective
jurisdictions which relate to the same general subject matter and also
from the fact that as to certain matters one of the agencies may possess
regulatory authority with respect to a class of banks primarily under
the jurisdiction of another agency. Even here, however, a considerable degree of uniformity has been accomplished.
Both in connection with supervisory and examination policies and
the issuance and interpretation of regulations, coordination has resulted from constant efforts to foster discussions and consultations
between the agencies both at top level and at the staff level. The 1938
agreement with respect to banK examination policies is an excellent
example of the cooperation that may be accomplished through such
methods.
A common understanding of mutual problems at the staff level
has been substantially aided by the fact that in several districts the
Federal Reserve banks have provided office accommodations for the
chief national bank examiners of the Comptroller's office and also
for the corresponding field representatives of the FDIC. In the case
of the FDIC, however, differences in areas covered by the various
districts from those in Federal Reserve districts made more cooperation difficult in some regions.
There are, of course, certain particulars in which complete coordination and uniformity with respect to examination policies as well
as regulatory functions have not yet been achieved. That all reasonable steps should be taken to increase cooperation in these areas is
obviously desirable. However, in proposing additional means of
achieving closer cooperation, each of the three agencies would natu-




73 M O N E T A R Y ,

CREDIT,

A N D FISCAL

POLICIES

rally be influenced by the special functions and objectives which
have been assigned to it by the Congress.
While it is natural to consider the possibility of ex officio relationships between the agencies concerned as a means of encouraging increased coordination of policies, such relationships are subject to certain inherent disadvantages. An officer attached to a particular
agency is unlikely to devote adequate attention to all of the problems
of another agency served by him in an ex officio capacity; and he is
often unable to attend meetings of the other agency with regularity
or to participate as fully as would be desirable in its deliberations.
4. In what cases, if any, have the policies of other Government
agencies that lend and insure loans to private borrowers not
been appropriately coordinated with general monetary and credit
policies ?
A large number of Federal corporations and agencies have independent responsibilities for making credit available to private borrowers. Congress has given some agencies certain powers to make
loans and other agencies powers to insure or guarantee loans made by
banks and other private financing institutions. (A few have authority
both to lend and to guarantee loans.) In some cases the lending or
loan-insuring functions are related primarily to specific purposes such
as aid to agriculture, homeowners, and veterans, and in other cases
they are intended primarily to make credit available on risks and
terms not ordinarily accepted by private lenders.
Altogether the operations of these agencies play an important role
in influencing the supply, availability, and cost of credit to private
borrowers and consequently in the effectiveness of national credit
policy. The aggregate volume of credit obtained by private borrowers
in domestic fields through the aid of Federal financing agencies more
than doubled in the 3 years 1946-48, and totaled more than $20,000,000,000, at the end of 1948, as shown in the attached table. About threefourths of the outstanding credit was home mortgage loans, most of
which had been extended by private lenders under guarantees or insurance of the Federal Housing Administration and the Veterans'
Administration. Nearly one-fifth of the total represented various
types of credit to farmers, a substantial part of which had been extended by the Rural Electrification Administration, the Commodity
Credit Corporation, and the Farmers' Home Administration. A small
remaining amount consisted largely of Reconstruction Finance Corporation loans to businesses. Most of the credit reflected the financing
operations of the 13 agencies listed in the table, but some 13 other
agencies also made or insured loans.
Domestic

loans and loan guaranties and insurance
credit agencies

by Federal

corporations

and

[In millions of dollars]

Outstanding
Dec. 31,1948

Total.
Loans
Loan guaranties and insurance.




Change during:
1948

1947

20,520

+5,553

+4,553

+1,805

5,286
15.234

+949
+4,603

+592
+3,962

-278
+2,083

1946

74

MONETARY, CREDIT, AND FISCAL POLICIES

Domestic loans and loan guaranties and insurance by Federal corporations and
credit agencies—Continued
[In millions of dollars]

Outstanding
Dec. 31,1948

To aid homeowners and housing, total __
Loans:
Reconstruction Finance Corporation
Federal National Mortgage Association
Home Owners' Loan Corporation
Federal home loan banks
Public Housing Authority.
Other
__
Loan guaranties and insurance:
Federal Housing Administration
Veterans' Administration..
To aid agriculture, total

..

1948

1947

15,860

+4,171

+4,024

+1, 778

184
199
369
515
295
22

+51
+195
-117
+79
+17
-43

+110
-1
-151
+142
-1
+39

-26
-2
-216
+99
-7
+6

7, 276
7,000

i +2, 489
+1, 500

i -886
+3,000

i -379
+2,300

3, 792

+1, 368

80
426
305
620
999
523
6

To States and Territories:
RFC
Other agencies
Other:
RFC 7
Other agencies

+469~

+159

-30
+89
+30
+439
+265
-32
-2

-40
+63
+44
+173
+206
-32
-1

-93
+42
+35
2 -i
+120
3 -10
-6

+574
+35

-14
+70

2+22
+50

575

To aid industry, total

Loans for other purposes, total

1946

673
160

Loans:
Federal Farm Mortgage Corporation
Federal intermediate credit banks
Banks for cooperatives
Commodity Credit Corporation
Rural Electrification Administration
Farmers' Home Administration
Other
Loan guaranties:4
Commodity Credit Corporation
Veterans' Administration

Loans:
Railroads (RFC)
Other industry:
RFC
Other agencies
Loan guaranties:
RFC
Veterans' Administration

Change during:

+36

+78

-11

140

(5)

-7

-23

-53

272
38

+31
+7

+91
-10

+2
-43

125

+5

(5)
+20

293

-22

-18

-125

137
86

+14
+11

+14

-10
-5

47
23

-39
-9

-29
-2

-59
-49

<6)

(5)

+90

1 Excludes loans insured under Title I of National Housing Act.
2 Estimated.
Includes emergency crop and feed loans, which were handled by the Farm Credit Administration until
Oct. 31, 1946.
4 Excludes a small amount of loans insured by the Farmers' Home Administration.
6 Not available.
e Less than $500,000.
7 Reflects largely loans to businesses for nonwar purposes.
3

NOTE—Loans outstanding represent gross amounts and are based onfigurespublished by the U. S. Treasury Department; groupings of agencies are by Federal Reserve. Loan guaranties and insurance represent
principal amount of loans outstanding and are based on reports and information from the respective agencies.
The number of agencies included in " Other" and not already listed in the table is as follows: To aid agriculture, 4; to aid homeowners, 2; to aid industry, 3; and other purposes, 4.

The powers given by Congress in connection with the activities of
these Federal agencies are primarily to meet special problems. No
general provision has been made to coordinate the numerous credit
activities with over-all credit policy of the Government.
In approaching this aspect of Federal credit agencies we should
take into account the important nonmonetary purposes that are served
by the lending activities of these agencies and the fact that nonmonetary considerations may be compelling in determining the policies of individual agencies. At the same time it should be borne




75 MONETARY, CREDIT, AND FISCAL POLICIES

in mind that the credit extended does become a part of the country's
money supply and can interfere with or facilitate the effectiveness
of national credit policy. At times, moreover, monetary effects of
the credit activities of Federal agencies may be a major consideration of the Government in determining the over-all contribution of
its numerous and varied activities to accomplishing the objectives
of the Employment Act of 1946.
For such reasons, considerations of the bearing of the lending and
loan-insuring policies of Federal agencies on general credit policy
should not be ignored. These agencies have varying degrees of discretionary authority which can be used to influence the volume of
credit extended. It would be desirable, moreover, that those responsible for general credit policy be fully informed at all times
as to the probable effects of various loan or loan-insuring programs
on the supply of credit, so that general credit policy could be formulated in the light of these prospective developments.
For a number of years there has been increasing recognition of
the desirability of bringing the policies of the various lending and
loan-insuring agencies into closer relation with each other and with
general credit policy. In testifying before the Senate Banking and
Currency Committee on May 11, 1949, I emphasized "* * * the
need for some mechanism of policy coordination on the domestic
financial front as we have available through the NAC on the international financial front."
Such a mechanism would permit consideration of those policies
of the agencies that affect the extension of credit to private borrowers
with a view to bringing about a greater consistency among the agencies and a greater consistency with over-all credit policy. It could
also inform the President and the Congress as to the extent to which
lending and loan-insuring policies of Federal agencies are compatible
with each other and with the objectives of the Employment Act of
1946. Other aspects of a domestic financial advisory body are discussed in the reply to question VI-6.
5. What changes, if any, should be made in the powers of the\
Federal Reserve to lend and guarantee loans to nonbank borrowers ? Should either or both of these powers be possessed by
both the Federal Reserve and the Reconstruction Finance Corporation ? If so, why ? If not, why not ?
Small business is of vital importance to the maintenance of a flourishing national economy under our system of competitive private
enterprise. It is essential, therefore, that all credit-worthy small
businesses should have access to adequate sources of financing.
In general, current working capital requirements of small businesses are met by their local banks. However, the usual sources of
short-term credit may not be adequate in times of financial depression
or in abnormal times such as occurred during the defense and war
periods. Moreover, an important need of the smaller independently
owned business enterprises in normal times is for longer term funds
for such purposes as plant modernization and the purchase of machinery and equipment. As a rule, the owners of small enterprises
prefer to obtain such funds on a loan rather than on an equity basis.
98257—49

6




76

MONETARY, CREDIT, AND FISCAL POLICIES

Whether the need is for current working capital or for longer term
funds, the use of the private banking system should be encouraged in
the financing of small business enterprises. It is obviously desirable
that loans to businesses should be made as far as possible by local banks
dealing with local concerns with whose problems they are familiar.
Governmental agencies should function in this field only when adequate financing is not available from the customary private sources of
credit, and then chiefly with a view toward helping to restore and
maintain normal credit relationships between business concerns and
their local banks.
It was on this basis that Congress in 1934, during a depression
period, in the same statute authorized both the Federal Eeserve banks
and the Reconstruction Finance Corporation to assist in the financing
of business enterprises.
The 12 Federal Reserve banks, as permanent credit institutions, are
especially qualified to provide financial assistance to business enterprises through the regular banking channels. With their 24 branches,
the Reserve banks constitute a regional organization to which financing
institutions and businesses in all parts of the country have convenient
access. Because of their long experience in the credit field and their
daily relationships with banking institutions, they are thoroughly
familiar with credit needs and problems of both banks and businesses.
For these reasons, the Reserve banks are especially fitted to assist local
banks in making credit available to borrowers who, though otherwise
meritorious, may present credit risks of a character which banks will
not ordinarily accept; and, by such aid, the Reserve banks can help
to restore and maintain normal credit relationships between such
borrowers and the banks. The Reserve banks gained additional valuable experience in the field of business loans as the result of their active
participation in the wartime V-loan program under which guaranties
of war production loans aggregating nearly 10y2 billion dollars were
processed.
Notwithstanding their qualifications for the task, the Reserve banks
have been handicapped in carrying out their industrial-loan function
by the restrictive provisions of section 13b of the Federal Reserve Act.
Under present law, they may make commitments and loans only for
w^orking-capital purposes, only to "established" business, and only
with maturities not exceeding 5 years. These are severe limitations
upon the ability of the Reserve banks to render effective assistance in
meeting the requirements of smaller businesses.
Unless appropriate changes are made in the law to place the authority of the Reserve banks in this field on a more effective basis, I believe
that it would be preferable to repeal the present limited authority
of the Reserve banks in its entirety.
If it is the desire of Congress to utilize effectively the services of the
Federal Reserve System in the extension of financial assistance to small
business in time of need, the Reserve banks should be authorized to
enter into participations and commitments with financing institutions
with respect to loans made to business enterprises, on a basis under
which a Reserve bank might assume not more than 90 percent of the
risk involved and under which loans would not be limited solely to
working-capital purposes or restricted to established businesses. The
maximum maturity on any such loan should be fixed at 10 instead of
5 years. It would be the policy of the Federal Reserve to have the




77 MONETARY, CREDIT, AND FISCAL POLICIES

local bankers assume as much of the risk as possible. The Eeserve
banks would be prepared to release to the banks at any time within
the life of the loan any part of their participation.
Without entering into details, there are certain other changes in
the law which would be desirable. Thus, the aggregate amount of
participations and commitments by all the Federal Eeserve banks outstanding at any one time might be appropriately limited to, say
$500,000,000; and, in order to assure the availability of credit to the
smaller businesses, it might be provided that the aggregate amount
of participations and commitments individually in excess of $100,000
could not exceed $250,000,000. Also, the existing appropriation of
approximately $139,000,000 for the industrial loan operations of the
Eeserve banks should be repealed and amounts heretofore received
by the Eeserve banks for such operations should be returned to the
Treasury, so that henceforth the Eeserve banks would utilize only
their own funds in providing assistance to business enterprises.
It is my view that both the Federal Eeserve banks and the Eeconstruction Finance Corporation may, without inconsistency, operate together in providing financial assistance for business enterprises, provided, however, that there is written into the law a provision which
would require the Eeconstruction Finance Corporation, before it extends financial assistance to a business enterprise, to consider whether
such assistance is available, not only from commercial banks, but
through the Eeserve banks. This would be in the nature of a clarification of the present statutory requirement that the Corporation shall
render financial assistance only if it is "not otherwise available on reasonable terms."
As a source of extraordinary financial assistance, it is appropriate
that the Eeconstruction Finance Corporation should make loans of a
kind, which, because of the size of the loan or the type of operation
involved, are not ordinarily suitable for banks and which are not participated in by the Eeserve banks. Examples are to be found in the
financing of railroads, air carriers and large public projects, and in the
loans made by the Corporation for disaster relief. Aside from loans
of this type, the Corporation's principal objective should be to provide needed financial assistance to small businesses in those exceptional
circumstances in which regular credit facilities, including those of the
Eeserve banks, are inadequate.
With the qualification mentioned above, there is ample room for the
functioning of both the Federal Eeserve banks and the Eeconstruction
Finance Corporation in providing credit assistance to business, pro*
vided, of course, that their functions in this field are coordinated with
national credit policies and are not exercised in competition with pri-/
vate financing institutions.
^
6. What would be the advantages and disadvantages of establishing a national monetary and credit council of the type proposed by the Hoover Commission? On balance, do you favor the
establishment of such a body ? If so, what should be its composition?
In view of the large role which Government financial agencies have
come to play in influencing the supply, availability, and cost of credit
to private borrowers; as discussed in the answer to question VI-4, I
am sure that some mechanism for effecting a closer harmony between




78

MONETARY, CREDIT, AND FISCAL POLICIES

them would serve a constructive purpose. The specific objectives of
an appropriate council, in my opinion, should be to promote consistency in the policies of Federal agencies extending loans, loan insurance, and loan guaranties, and consistency of such policies with the
general stabilization program of the Government in accordance with
the objectives of the Employment Act of 1946. Such a council should
have only consultative and advisory functions. It would serve in some
respects as a domestic counterpart of the National Advisory Council
on International Monetary and Financial Problems. However, there
are important differences in the problems to be considered by the two
agencies and there would necessarily be significant differences in organization and operation.
With the existence of such a council, each of the present Federal
credit agencies would continue to exercise the authority and discharge
the responsibilities which have been especially delegated to it by the
Congress, but its policies and operations would have the benefit of
joint study in the light of national monetary and credit needs and overall stabilization policies. Furthermore, over-all monetary and credit
policy could be formulated in the light of a clearer current picture of
the various Federal financing programs and the prospective effects of
such programs on the supply of credit.
A council such as I have in mind could help to achieve a more harmonious domestic financial program within the existing framework
and without impairing the essential operating flexibility of the various
agencies. In fact, it seems reasonable to expect that each of the
agencies would gain greater long-run effectiveness as a result of a more
definite and systematic mechanism for interagency discussion relating
to the appropriateness of policies (from the standpoint of general
economic stability) and the coordination of credit functions.
Such a council might be established by statute, as in the case of the
National Advisory Council on International Monetary and Financial
Problems, or it might perhaps be established on a less formal basis by
executive action of the President. A statutory provision for the
council would have the advantage of definite recognition by the Congress but would have the disadvantage of making it more difficult for
the council to evolve gradually in working out an effective advisory
and coordinating mechanism in the domestic field.
Because of the diverse interests and difficult problems involved, it
would be desirable to provide ample flexibility for the functional
evolution of the proposed council. In addition some problems of
integrating the council's activities with those of the NAC would doubtless arise and these would need to be resolved on an empirical basis.
It is entirely possible that considerable experience would be needed
before such a council could be given its most effective form and function. Therefore, it would be well to test out the operation of a
domestic lending advisory council under executive authority before
attempting to make it the subject of specific statutory definition. If
it should be covered by statute at this time, it would be desirable to
limit the statute to broad outline, leaving ample room for adaptation
in organization and operation. In general, it would seem undesirable
to attempt at this time any close integration of activities of the proposed council with those of the already successfully operating National
Advisory Council. Such integration in time might prove to be a




79 MONETARY, CREDIT, AND FISCAL POLICIES

constructive step, but some period of operation in the domestic field
should be allowed to determine the wisdom of that course.
The council, in my opinion, should comprise the top officials of
Federal departments or other agencies having recognized interests or
responsibilities in the credit field. Membership should not be too
large. Agencies not regularly members would be expected to participate in the consideration of matters relating to their responsibilities.
V I I . DEPOSIT INSURANCE

1. What changes, if any, in the laws and policies relating to
Federal insurance of bank deposits would contribute to the
effectiveness of general monetary and credit policies?
As the agency primarily responsible for monetary policy, the Federal Reserve System is vitallv interested in the functioning of the
deposit-insurance program, wJiich has as a primary objective the removal of one of the major threats to public confidence in monetary
institutions and hence to general monetary stability. Deposit insurance is one of the important reforms intended to improve monetary
stability by the banking legislation of the 1930's. Many of these were
aimed at preventing another drastic shrinkage in the money supply
such as occurred between 1929-33.
To that end the Board of Governors was authorized, among other
things, to vary reserve requirements within certain limits, the Federal Reserve banks were authorized to grant credit on any sound bank
asset, and provisions for the issuance of Federal Reserve notes were
liberalized. These changes in System authority, while providing
necessary capacity in the banking system to cope with adverse conditions, deal only indirectly with one factor which in the past has
greatly aggravated cyclical developments on the downward side,
namely, panic conditions among depositors. Deposit insurance is the
instrument which Congress set up to prevent that considerable part
of a liquidating process which is due to panic withdrawal of funds by
the general public.
When the insurance program was established there was little experience and information on which to develop a genuine basis for insuring bank depositors against loss. At that time, consequently, insurance coverage, rates of assessment, and the assessment bases all had to
be set more or less arbitrarily. We now have more than 15 years of
successful experience in operating a national deposit-insurance program. During this period our economy and our banking structure
have undergone great changes. In view of our experience with deposit
insurance and the important changes that have occurred over the past
decade and a half, it seems appropriate to review and perhaps to revise
certain of the judgments that were originally made with respect to
deposit insurance.
There are several points at issue which might be considered in
connection with such a reappraisal. The $5,000 limit of depositinsurance coverage which was established when the program was
set up has not been revised, but in the interim the price level has
doubled, the average deposit account has more than doubled, and total
bank deposits and average per capita income have nearly quadrupled.




80

MONETARY,

CREDIT, AND FISCAL POLICIES

The rate of assessment burden on banks for deposit insurance has not
been changed since 1935, although subsequent changes in the bankingsystem have tremendously reduced the possibility of another major
banking crisis and in every year of operation assessment receipts of the
F D I C have dwarfed its nominal losses. If the deposit-insurance
reserve is not to be increased indefinitely, the insurance assessment
rate should be geared to actual loss experience.
Some months ago the Board was asked by Congress for an expression
of views concerning proposed legislation regarding the deposit insurance program, and accordingly the Board asked its staff to undertake a
study of certain aspects of the program. This study has been circulated for comment to persons throughout the Federal Eeserve System
and now incorporates many of their suggestions. A copy was also
sent several weeks ago to the Federal Deposit Insurance Corporation.
In view of that agency's primary responsibility, I am naturally hesitant about offering a more specific answer to the committee's question
regarding deposit insurance until I have had the benefit of their
review.
VIII.

EARNINGS OF THE FEDERAL EESERVE B A N K S AND T H E I R
UTILIZATION

1. Describe briefly the process by which the Federal Eeserve
banks create money, the kinds of money created, and the amount
of outstanding money on June 30 of the various years since 1935
that owed its existence to its creation by the Federal Eeserve.
Include a description of the process and the extent of money
creation by the Federal Eeserve—(a) by dealing in Government
debt; (b) by dealing in private debt of various kinds.
For the purpose of replying to this question, money will be defined
as bank deposits, both demand and time at commercial and savings
banks, and currency in circulation outside banks. The amounts of
these money components or kinds of money which were outstanding on June 30 dates, 1935-49, are shown in the attached consolidated
condition statement for banks and the monetary system. It will be
noted from the consolidated statement (third line from the bottom)
that on June 30, 1949, total deposits and currency amounted to approximately $172,000,000,000, compared with 53 billion in 1935 and
nearly 80 billion in 1941. (For references to discussions of the definition of money, to more complete analyses of the sources and processes
of monetary expansion and contraction, and to explanations of the
figures referred to in this answer, see note attached to this answer and
entitled "Technical Beferences.'5)
In analyzing the sources of this money supply and its expansion,,
it is necessary to distinguish between those sources which supply reserve funds to banks and those which are extensions of credit by
banks to the public. The first group includes monetary gold stock,
Treasury silver purchases and other Treasury currency, and Federal
Eeserve bank credit. These elements may also be a direct source of
money for the nonbanking public, but their principal significance
is that they supply funds to banks, which may be used either to build
up basic reserves or to obtain additional currency without depleting
reserves. These basic reserves in turn provide the means for extensions of credit to the public through loans or the purchase of invest-




81

MONETARY, CREDIT, AND FISCAL POLICIES

ment securities by banks. Under a fractional system of reserves the
amount of credit eventually extended by the banking system as a
whole can be many times the amount of reserves added. This process
is briefly explained below.
On June 30, 1949, as may be noted from the attached consolidated
statement for banks and the monetary system, the total amount of
deposits and currency was $172,000,000,000, or $119,000,000,000 more
than on June 30, 1935. Of this increase nearly $20,000,000,000 was
in the form of currency and nearly 100 billion in demand and time
deposits. Specific items on the asset side of the statement, which
portray in a sense the way in which the money supply has been
created, cannot be directly related to those specific items on the
liability side which represent the money supply; there are other socalled liability items representing principally the capital funds of
the banking system. However, an examination of the consolidated
statements over the period since 1935 provides a reasonably clear picture of the extent to which credit extension and other factors have
been responsible for the expansion of the money supply.
The various asset items showed the following approximate
increases:

Billion
dollars

Gold and Treasury currency
Holdings of "United States Government securities:
Federal Reserve banks
Other banking institutions
Bank loans and other securities

17
17
63
29

Thus it is evident that the principal source of monetary expansion
in this period was purchases of Government securities by the banking system. The Federal Reserve purchased part of these securities
directly and, thereby, along with the gold inflow, made it possible
for banks to meet the heavy wartime demand for currency and at the
same time purchase additional amounts of securities and expand their
loans. To a large extent this monetary expansion was essential to
finance the war and the postwar readjustment. It could have been
diminished (1) through increased taxes to meet the Government's
war cost; (2) through larger sales of securities to nonbank investors
rather than to banks; or (3) to a small extent by more restraint in
lending by banks, particularly in the postwar period.
The process by which Federal Reserve operations increase total
deposits or currency outstanding and thereby create money may follow a variety of alternative courses at various stages. Hence any
brief description must necessarily be illustrative rather than definitive.
A typical sequence of events might arise where a nonbank holder of
Government securities wishes to sell such securities and the Federal
Reserve System in carrying out monetary and credit policy purchases
the securities. Utilizing the established broker merchanism, the manager of the system open market account would purchase the securities for the account of the System. These securities would be paid
for by the Federal Reserve Bank of New York by a Federal Reserve
check, which the broker would deposit in his account at a commercial
bank. That bank in turn would deposit this money in its reserve account at the Reserve bank. The effect of such a transaction is to
create an additional deposit to the credit of the seller of the securities
and also a corresponding increase in a member bank's reserve balance




82

MONETARY, CREDIT, AND FISCAL POLICIES

at the Reserve bank. Thus, not only is the total money supply increased but also the total of bank reserves, thereby providing the
basis for a further multiple expansion of deposits. The process and
the final effect, while varying in details, would be broadly similar in
the case of any other payment by the Federal Reserve to a bank
depositor.
In the case of an advance by the Federal Reserve to a bank or the
purchase of securities by the Federal Reserve from a bank, the result
would be an increase in member bank reserve balances, but no direct
or immediate increase in a depositor's balance at a commercial bank.
The additional reserves would, however, as in the other cases, supply
the basis for a multiple expansion of credit.
The ability of the banking system as a whole to create money arises
from the fact that when an individual bank using funds deposited
with it expands loans or investments, an additional deposit is thereby
created. This deposit is likely to be transferred from one depositorto another and from one bank to another without generally being
withdrawn from the banking system. If the initial deposit is in the
form of new reserve funds, as in the example given above, the bank
retains the portion of reserves required to be kept against the additional deposits and lends or invests the remainder. These proceeds
are then deposited either in another bank or in the same bank and
carry with them reserves that become the basis for a further extension
of credit. The extent of the potential multiple expansion that may
result through this process from any increment of new reserves is
determined by the amount of such new reserves available to banks,
by the ratio of reserves to deposits which banks are required to maintain by law or by practices which they may observe as a matter of
custom or judgment, and the forms in which the money is held. In
the United States at present the ratio averages between 7 and 8 to 1.
Whether the potential expansion takes place also depends on the
availability of loans and investments which the banks regard as acceptable. Receipts also have an influence on the result in that they may
choose to hold their funds as deposits or take them in the form of
currency, or to pay off a loan at (or buy securities from) a bank. In
the last case, the banks would continue to have capacity to expand
credit. During the 1930's banks had large excess reserves which were
not used as a basis for further credit expansion because of the absence
of demand for loans or of satisfactory investments.
It should be kept in mind that no individual bank can take a given
amount of reserve funds and extend 5 to 10 times as much credit.
This would be possible only in the unlikely case that the new credits
remained indefinitely on deposit in that bank. As pointed out above,
it is because the credits advanced are generally kept on deposit in
some bank that the banking system as a whole can bring about a
multiple expansion of credit and of money on the basis of a given
amount of reserves.
Although it is incidental to the specific question, it may be relevant
to point out that an important role of the Federal Reserve System




83 MONETARY, CREDIT, AND FISCAL POLICIES

is that of giving elasticity to the currency component in the money
supply. The public may elect to hold its money either as deposits in
banks or in the form of currency, and the relative amounts held in
deposits and in currency are entirely determined by the preferences
of the public. As public need or preference for currency increases
and depositors withdraw cash banks are able to supply the demand
by drawing upon their balances at the Reserve banks in exchange
for currency, which the Federal Reserve can provide, if necessary,
by issuing Federal Reserve notes. Banks replenish reserve balances,
if necessary, by borrowing from, or selling securities to, the Federal
Reserve. Before the establishment of the Federal Reserve System
the supply of currency was limited and any increase in circulation
caused a corresponding reduction in the basic reserves of the banking
system, thus leading to forced liquidation and frequent monetary
crises. Since the establishment of the System, a desire of the public
to have more of its money in the form of cash rather than of bank
deposits can be satisfied through Federal Reserve action without contraction in the volume of money or in the adequacy of bank reserves.
An increase in the demand for currency can be met, without decreasing bank reserves, by discounting with a Federal Reserve bank or by
the sale of a security to such a bank; and a return flow of currency
can be used to liquidate a discount at or to purchase a security from
a Federal Reserve bank and thus not add to bank reserves. This is
the basis of currency elasticity in our banking system.
TECHNICAL REFERENCES

The composition and derivation of the figures given in the table is
described in detail in Banking and Monetary Statistics, Board of
Governors of the Federal Reserve System, Washington, D. C., 1943,
pages 11-12, and in Morris A. Copeland and Daniel H. Brill, Banking Assets and the Money Supply Since 1929, Federal Reserve Bulletin, January 1948, pages 24-32.
It should be particularly noted that the figures include data for
mutual savings banks and the Postal Savings System, as well as for
the commercial banking system. This is because of the difficulty of
drawing a precise line between savings deposits in these various
groups and between savings deposits and demand deposits. The bulk
of the process of money creation through credit expansion takes place
through commercial banks. For a discussion of the problem of defining money see Woodlief Thomas, Money System of the United States,
in Banking Studies, Board of Governors of the Federal Reserve
System, Washington, D. C., 1941, pages 295-305.
For further discussion of the sources of bank reserves and for the
process of credit expansion, see The Federal Reserve System, Its
Purposes and Functions, chapters II and VIII, Board of Governors
of the Federal Reserve System, Washington, D. C., 1947, and also the
above-cited chapter on Money System of the United States in Banking Studies.




Consolidated condition statement for banks and the monetary system, end of June dates, 1985-49—All
banksj the Postal Savings System, and Treasury currency funds

commercial, savings, and Federal Reserve
1

[In millions of dollars]
End of June dates

Item
1935

1936

1937

1938

1939

1940

1941

1942

1943

Gold stock
Treasury currency.
Bank credit.
Loans, net
U. S. Government obligations..
Commercial and savings banks..
Federal Reserve Banks
Other
Other securities
Total assets, net...

14, 868 15,676

18,991

22, 976 25, 773 26,050

9,116 10,608
2, 506 2,498

12,318
2,550

12,963
2,713

16,110
2,881

19, 963 22, 624 22, 737 22,388
4,077
3,013
3,313
3,149

47, 565 51,823

Monetary reserve.

53,197

50, 877 53,325

11, 622 13,106

1944

1945

1947

1948

1949

28,097

29,063

20, 213 20, 270 21, 266 23, 532
4,145
4, 539 4, 552 4, 565

24,466
4, 597

26, 465 25, 277 24,358
21,173
4,104

1946

24, 809 25,818

55,050

61,387

67, 932 96, 563 125,517 153, 992 163, 485 156, 297 157, 958 156,491

20,191 20, 627 22, 391 20, 965 21, 310 22,346
17, 498 20, 743 20, 605 20, 409 22,483 23,389

25,305
26,984

25, 080 22, 234 25, 361 27,948 31, 570 38,373 45, 299
34, 226 66,434 92,609 118,041 122, 740 107, 873 101,451

47,148
97,428

76, 774
21,366
3,311

74,877
19,343
3,208

14, 258 17, 323 16, 954 16. 727 18. 770 19, 689 23, 539 30, 299 57, 740 75, 737 93, 655 95, 911 82,679
2,645
7,202 14,901 21, 792 23, 783 21,872
2, 526 2, 564 2, 551 2, 466 2,184
2, 433 2,430
3,322
2, 594 3,046
1,118
1,162
1, 234 1,261
1,282
1, 492 1,971
1,125
807
990
9, 876 10, 453 10, 201
59,187

64, 929 68,065

9,315

9,098

11, 208

11, 915

66, 553 72, 316 78,026

87,160

93,982 123,028 150, 794 178,350 188, 294 182,115 186,055

185, 554

73,400

80,126 102,113 116,666 138, 403 157, 821 164,140 165, 695 165,626

9, 503

9, 532

8,626

7,895

7, 547

8,003

9,175

10,051

LIABILITIES AND CAPITAL

Total adjusted deposits and currencyCurrency outside banks
Demand deposits adjusted 2..
Time deposits adjusted 3
Postal savings deposits
U. S. Government balances.
Treasury cash
At commercial and savings banks.
At Federal Reserve banks
Foreign bank deposits, net.
Total deposits and currency
Capital and miscellaneous accounts, netTotal liabilities and capital, net

49, 070 53, 910 56, 592 55, 966 60,151

66,124

6,699
5, 417 6,005
4, 783 5, 222 5,489
20, 433 23, 780 25,198 24,313 27,355 31,962
25, 530 26,171
22, 650 23,677 24, 638 24,985
1,204
1, 231 1, 267 1, 251 1, 261 1,292

8,204 10, 936 15, 814 20,881 25, 097 26, 516 26, 299 25, 638
37,317 41, 870 56,039 60, 065 69,053 79, 476 82,186 82, 697
26, 576 26,005 28, 684 33, 688 41, 596 48, 710 52, 263 53, 982
3,119
2,657
3,378
3,392
1, 303 1,315
1, 576 2,032

25,266
81,877
55, 224
3,259

10, 771 22, 452 27,259

16,500

3, 437

5,435

4,049

2,279
2,296
19, 506 24,381
599
650

2,251
13,416
833

1,314
1,367
756

1,327
2,180
1, 928

1,307
2,304
438

1,894

1,657

1,727

1,927

3, 779

4,329

4,204

3, 762

4, 299

3,248

4,008

4,314

2,866
811
102

2,497
1,142
690

3,445
666
93

2,303
599
860

2,563
792
944

2,186
828
234

2,275
753
980

2,187
1,837
290

2,268
8,048
455

473

731

301

991

1,375

1, 949

1,624

1,928

230
53,079
6,108

58, 712 61, 527 60.029
6,217
6,524
6,538

59,187

64,929

68,065

65. 441 70, 747 79,357
7, 279 7,803
6,875

66, 553 72,316

78,026

87,160

2,433

93,982 123,028 150,794 j 178,350 188,294 182,115 186,055

1 Treasury funds included are the gold account, Treasury currency account, and exchange stabilization fund.
2 Demand deposits, other than interbank and U. S. Government, less cash items reported as in process of collection.
a Excludes interbank time deposits; U. S. Treasurer's time deposits, open account; and deposits of Postal Savings System in banks.




2,378

86,064 114, 812 141,551 168,040 176, 215 169, 234 172, 857 171,602
8,216
7,918
9,243 10,310 12,079 12,882 13, 200 13,952
185, 554

(X)

85 MONETARY, CREDIT, AND FISCAL POLICIES

2. Prepare a statement showing the earnings of the Federal Reserve banks as a group and the utilization of those earnings for
each year since 1939. Show separately the earnings on United
States Government securities and on other credit, dividends to
member banks, payments to the Treasury, and additions to
surplus.
Current earnings of Federal Reserve banks, 1939-48
Discounts
and advances

Purchased
bills

$36,903,367
$60,898
42,174,224
51,188
55, 934
40,151,501
64, 521
51,404,012
151,915
68,089,456
724,113
102,809, 518
1,977,081
139, 552,881
. _ 147,124,827 2,497,339
155, 563,861 2,194, 546
298,903,034 4,370,951

$2,323

U. S. Government
securities

Year

1939
1940
1941
1942
1943
1944
1945
1946.
1947
1948

_

110
42,872
3,890

Industrial
loans

Commitments to
make in- All other
dustrial
loans

$615,169 $128, 577
97, 672
451, 501
90, 270
399,319
101,050
474,370
48,904
414,281
22,045
302,980
12, 533
100, 755
15,298
37, 676
19.205
60,438
14,385
42,099

$790, 331
763,220
683,071
618, 751
601,159
533,173
566,186
667,021
813,626
830,349

Total

$38, 500, 665
43, 537,805
41,380,095
52,662,704
69,305, 715
104,391,829
142,209, 546
150,385,033
158, 655, 566
304,160,818

Earnings and expenses of Federal Reserve banks, 1939-48

Year

Current
earnings

Current
expenses

1939
1940-.-.
1941-.._
1942..„.
1943..-1944.
1945
1946
1947-...
1948

$38, 500,665
43, 537,805
41,380,095
52,662, 704
69,305,715
104,391,829
142,209, 546
150,385, 033
158, 655, 566
304,160,818

$28,646,855
29,165,477
32,963,150
38,624,044
43,545, 564
49,175,921
48, 717, 271
57, 235,107
65, 392, 975
72, 710,188

Paid to U.
Net earnPaid to S. Treasury
ings before
U. S.
payments Dividends
(interest
paid
Treasury on Federal
to U. S.
(sec. 13b) Reserve
Treasury 1
notes)
$12, 243,365
25,860,025
9,137, 581
12,470,451
49, 528,433
58,437, 788
92,662,268
92, 523, 935
95, 235, 592
197,132,683

$8,110,462
8, 214, 971
8,429,936
8,669,076
8,911,342
9, 500,126
10,182,851
10.962,160
11,523,047
11,919,809

$24, 579
82,152
141,465
197,672
244,726
326, 717
247,659
67,054
35,605

Transferred to
surplus
(sec. 13b)

-$425,653
-54,456
-4,333
49,602
135,003
201,150
262,133
27, 708
86, 772
$75, 223,818
166,690,356

Transferred to
surplus
(sec. 7)

$4,533,977
17, 617,358
570,513
3, 554,101
40,237,362
48,409, 795
81,969,625
81,467,013
8,366,350
18,522,518

1 Current earnings less current expenses, plus profits on sales of U. S. Government securities and other
additions to current net earnings, and less transfers to reserves for losses and contingencies and other deductions from current net earnings.

NOTE.—Each annual report of the Board of Governors contains a detailed statement of earnings and expenses of the Federal Reserve banks for the year.

3. What changes, if any, should be made in the ownership of
the Federal Reserve banks? In the dividend rates of Federal
Reserve stock?
This question is understood to refer to the ownership of the capital
:stock of the Federal Reserve banks. While this stock is owned by
the member banks and they receive a 6-percent statutory dividend
thereon, the Federal Reserve Act prescribes the ownership of this
stock and the organization and operation of the Reserve banks in
such manner that the relationship of the stockholders to the banks
is quite different from that ordinarily existing between a corporation
and its stockholders. Furthermore, in the event of liquidation of a
Federal Reserve bank, any surplus remaining after the payment of
all debts becomes the property of the United States.




86

MONETARY, CREDIT, AND FISCAL POLICIES

The basic provisions of law with respect to the ownership of Federal
Reserve bank stock and dividends on such stock have remained unchanged since the Federal Reserve Act was originally passed in 1913.
These provisions have worked reasonably satisfactorily and I would
not recommend that they be changed at this time.
4. What changes, if any, should be made in the legislative provisions relative to the disposal of Federal Reserve earnings in
excess of expenses?
Federal Reserve banks are essentially public-service institutions.
They are operated for the benefit of commerce, industry, and agriculture—for the general economy of the country—and not for the
purpose of making a profit.
The creation of Federal Reserve bank credit through lending and
through purchases of securities incidentally yields an income to the
Reserve banks. Ordinarily this income is sufficient to cover the general expenses and statutory dividend requirements of the Reserve
banks and leave a balance, although some of the Reserve banks in certain years have operated at a loss. Such earnings as may accrue are
an incidental result of monetary and credit policies which are designed, first and last, to serve the general public interest.
Because of their special character, the earnings of the Reserve banks
are, and should be, treated differently from those of ordinary institutions. When the Reserve banks have a reasonable cushion of capital and surplus to protect their operations, as they now have, a large
percentage of their earnings above expenses and statutory dividend
requirements should be paid into the United States Treasury.
That is now being done under existing law. Therefore, I do not
believe any change is needed at the present time in the provisions regarding the disposition of such earnings.
However, it may be of interest to review some of the background
of the present procedure and explain some of the details of how it
works.
The Federal Reserve Act as originally enacted in 1913 provided
for the payment by the Federal Reserve banks of a portion of their
net earnings to the United States as a franchise tax. As amended
in 1919 the act provided that all net earnings should be paid into a
surplus fund until it was equal to the subscribed capital of the Reserve
bank, which is twice the amount of its paid-in capital, and thereafter
10 percent of net earnings should be paid into the surplus and the
remaining 90 percent should be paid in to the United States as a
franchise tax.
Under these provisions of law the Federal Reserve banks, to the
end of 1932, paid franchise taxes to the United States Treasury
amounting to $149,000,000, and at that time they had accumulated
surplus accounts of $278,000,000, as compared with subscribed capital
aggregating $302,000,000. By the Banking Act of 1933, which established the Federal Deposit Insurance Corporation, Congress required
each Federal Reserve bank to pay an amount equal to one-half of its
surplus on January 1, 1933, as a subscription to the capital stock of
the FDIC (the stock provided for no dividend and was later retired
by the FDIC paying the amount to the Treasury). These stock subscriptions amounted to $139,000,000 and reduced the surplus of the
Federal Reserve banks to an equivalent figure, or considerably less




87 MONETARY,

CREDIT, AND FISCAL POLICIES

than one-half of their subscribed capital. Congress, therefore, ineluded a provision in the Banking Act of 1933 which eliminated the
franchise tax of the Federal Eeserve banks in order to permit them
to restore their surplus accounts from future earnings.
Net earnings for the next 10 years were relatively small, and at the
end of 1944 the combined surplus accounts of the Federal Eeserve
banks were less than 80 percent of their subscribed capital. During the
next 2 years, however, net earnings increased substantially, due primarily to large holdings of Government securities accumulated
through open market operations which were necessary to carry out
System policies in the public interest. At the end of 1946 the subscribed capital of the Federal Eeserve banks was about $374,000,000,
of which half was paid in, and their combined surplus was about
$467,000,000.
Under the circumstances the Board concluded in 1947 that it would
be appropriate for the Federal Eeserve banks to pay into the United
States Treasury the bulk of their net earnings after providing for
necessary expenses and the statutory dividend. For this purpose the
Board invoked the authority granted to it by section 16 of the Federal Eeserve Act to levy an interest charge on Federal Eeserve notes
issued to the Federal Eeserve banks and not covered by gold certificate
collateral. The Board established on such Federal Eeserve notes interest charges equal to approximately 90 percent of the net earnings
after dividends of each of the Eeserve banks, and consequently the
Eeserve banks have been paying into the Treasury approximately 90
percent of their net earnings since January 1,1947.
Under this procedure, which is still in effect, Federal Eeserve banks
have paid approximately the following amounts into the Treasury
from their net earnings: For the year 1947, $75,000,000; for the year
1948, $167,000,000; and for the year 1949 to September 30, $147,000,000;
the aggregate for this period being $389,000,000. On September 30,
1949, the subscribed capital of the Federal Eeserve banks was about
$414,000,000, of which half was paid in, and the aggregate surplus was
about $494,000,000.
As stated before, I believe that a large percentage of the earnings
of the Federal Eeserve banks above expenses and statutory dividend
requirements should be paid into the United States Treasury in present
circumstances. Since this is now being done under existing law, I see
nothing to be gained by amending the statutory provisions on the
subject.
APPENDIX TO CHAPTER I I
AUGUST 1 9 4 9 .
QUESTIONNAIRE ADDRESSED TO THE FEDERAL RESERVE BOARD

/. Objectives of Federal Reserve policy
1. What do you consider to be the more important purposes and
functions of the Federal monetary and credit agencies? Which oi
these should be performed by the Federal Eeserve ?
2. What have been the guiding objectives of Federal Eeserve credit
policies since 1935 ? Are they in any way inconsistent with the objectives set forth in the Employment Act of i946 ?



88

MONETARY, CREDIT, AND FISCAL POLICIES

3. Cite the more important occasions when the powers and policies
of the System have been inadequate or inappropriate to accomplish
the purposes of the System.
4. Would it be desirable for the Congress to provide more specific
legislative guides as to the objectives of Federal Eeserve policy? I f
so, what should the nature of these guides be?
II. Relation of Federal Reserve policies to fiscal policies and debt
management
1. To what extent and by what means are the monetary policies o f
the Federal Eeserve and the fiscal, debt management, and monetary"
powers of the Treasury coordinated?
2. Cite the more important occasions since 1935 when Federal Eeserve policies have been adjusted to the policies and needs of the
Treasury.
(a) What were the principal areas of agreement and what were
those of conflict between the two agencies?
(~b) In what way were the differences adjusted ?
(c) When there were differences of opinion between the Secretary of the Treasury and the Federal Eeserve authorities as to
desirable support prices and yields on Government securities,whose judgment generally prevailed?
3. What were the principal reasons for the particular structure of
interest rates maintained during the war and the early postwar
period ?
4. Would a monetary and debt management policy which would
have produced higher interest rates during the period from January
1946 to late 1948 have lessened inflationary pressures?
5. In what way might Treasury policies with respect to debt management seriously interfere with Federal Eeserve policies directed
toward the latter's broad objectives?
6. What, if anything, should be done to increase the degree of coordination of Federal Eeserve and Treasury objectives and policies
in the field of money, credit, and debt management?
(a) What changes in the objectives and policies relating to the
management of the Federal debt would contribute to the effectiveness of Federal Eeserve policies in maintaining general economic stability ?
(b) What would be the advantages and disadvantages of
providing that the Secretary of the Treasury should be a member
of the Federal Eeserve Board ? Would you favor such a
provision ?
III. International payments, gold, silver
1. What effect do Federal Eeserve policies have on the international
position of the country ? To what extent is the effectiveness of Federal Eeserve policy influenced by the international financial position
and policies of this country? What role does the Federal Eeserve
play in determining these policies? In what respects, if any, should
this role be changed ?
2. Under what conditions and for what purposes should the price
of gold be altered ? What consideration should be given to the volume
of gold production and the profits of gold mining ? What effect would
an increase in the price of gold have on the effectiveness of Federal



89 MONETARY, CREDIT, AND FISCAL POLICIES

Eeserve policy and on the division of power over monetary and credit
conditions between the Federal Eeserve and the Treasury ?
3. What would be the principal advantages and disadvantages of
restoring circulation of gold coin in this country ? Do you believe this
should be done ?
4. What changes, if any, should be made in our monetary policy
relative to silver? What would be the advantages of any such
changes ?
IV. Instruments of Federal Reserve policy
1. What changes, if any, should be made in the law governing thereserve requirements of member banks ? In the authority of the Federal Eeserve to alter member bank reserve requirements? Under
what conditions and for what purposes should the Federal Eeserve
use this power? What power, if any, should the Federal Eeserve
have relative to the reserve requirements of nonmember banks ?
2. Should the Federal Eeserve have the permanent power to regulate consumer credit ? If so, for what purposes and under what conditions should this power be used ? What is the relationship between
this instrument and the other Federal Eeserve instruments of control?
3. What, if any, changes should be made in the power of the
Federal Eeserve to regulate margin requirements on security loans ?
4. Should selective control be applied to any other type or types
of credit ? If so, what principles should determine the types of credit
to be brought under selective control ?
5. In what respects does the Federal Eeserve lack the legal power
needed to accomplish its objectives? What legislative changes would
you recommend to correct any such deficiencies ?
V. Organization and structure of the Federal Reserve System
1. In what respects, if at all, is the effectiveness of Federal Eeserve
policies reduced by the presence of nonmember banks ?
2. What changes, if any, should be made in the standards that
banks must meet in order to qualify for membership in the Federal
Eeserve System ? What would be the advantages of such changes ?
3. What changes, if any, should be made in the di vision of authority
within the Federal Eeserve System and in the composition and method
of selection of the System's governing bodies? In the size, terms,
and method of selection of the Board of Governors? In the Open
Market Committee? In the Boards of Directors and officers of the
Federal Eeserve banks? What would be the advantages and disadvantages of the changes that you suggest ?
VI. Relation of the Federal Reserve to other hanking and credit
agencies
1. What are the principal differences, if any, between the bank
examination policies of the Federal Eeserve and those of the FDIC
and the Comptroller of the Currency ?
2. To what extent and by what means have the policies of the
Federal Eeserve been coordinated with those of the FDIC and the
Comptroller of the Currency where the functions of these agencies
are closely related? What changes, if any, would you recommend to
increase the extent of coordination ? To what extent would you alter
the division among the Federal agencies of the authority to supervise
and examine banks ?




90

MONETARY, CREDIT, AND FISCAL POLICIES

3. What would be the advantages and disadvantages of providing
that a member of the Federal Eeserve Board should be a member of
the Board of Directors of the Federal Deposit Insurance Corporation?
Would you recommend that this be done? Should the Comptroller of
the Currency be a member of the Federal Eeserve Board ?
4. In what cases, if any, have the policies of other Government
agencies that lend and insure loans to private borrowers not been appropriately coordinated with general monetary and credit policies?
5. What changes, if any, should be made in the powers of the Federal Eeserve to lend and guarantee loans to nonbank borrowers?
Should either or both of these powers be possessed by both the Federal
Eeserve and the Eeconstruction Finance Corporation? If so, wThy?
If not, why not?
6. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by
the Hoover Commission? On balance, do you favor the establishment of such a body ? If so, what should be its composition ?
VII. Deposit insurance
1. What changes, if any, in the laws and policies relating to Federal
insurance of bank deposits would contribute to the effectiveness of
general monetary and credit policies ?
VIII. Earnings of the Federal Eeserve banks and their utilization,
mo1. Describe briefly the process by which the Federal Eeserve banks
create money, the kinds of money created, and the amount of outstanding money on June 30 of the various years since 1935 that owed its
existence to its creation by the Federal Eeserve. Include a description of the process and extent of money creation b}^ the Federal
Eeserve—
(a) By dealing in Government debt;
(&) By dealing in private debt of various kinds.
2. Prepare a statement showing the earnings of the Federal Eeserve
banks as a group and the utilization of those earnings for each year
since 1939. Show separately the earnings on United States Government securities and on other credit, dividends to member banks, payments to the Treasury, and additions to surplus.
3. What changes, if any, should be made in the ownership of the
Federal Eeserve banks? In the dividend rates on the Federal Eeserve stock ?
4. What changes, if any, should be made in the legislative provisions relative to the disposal of Federal Eeserve earnings in excess
of expenses?




CHAPTER III
REPLIES

BY

THE

PRESIDENTS

RESERVE

OF

THE

FEDERAL

BANKS

INTRODUCTION

Copies of the questionnaire appearing as an appendix to this chapter
were sent to the presidents of all 12 Federal Reserve banks in
order to give each a chance to register his ideas, and every president
did submit his own reply to the subcommittee. But in order to conserve time and effort the Reserve banks appointed a special research
committee made up of their own personnel to draw up a set of draft
replies. As it turned out, most of the Reserve bank presidents agreed
substantially with the System answers. It has therefore been possible to conserve space and publishing costs without undue sacrifice
of content by reproducing the System answer to each question, and
by including the replies of the individual Reserve bank presidents
only where they differ substantially from the System answer or add
significantly to it. Mere differences in phraseology and minor differences in content and emphasis have not been included.
I . OBJECTIVES OF FEDERAL RESERVE POLICY

The System answer
The basic continuing objective of Federal Reserve policy has been
to promote economic stability at high levels of employment and production. This general objective underlies the wide variety of phrases
that have been used in the past four decades to describe the System's
purposes in general and enumerate them in detail.
Agreement on this basic objective is clear, for example, in the following statements, even though the first was made in 1913 by the chairman of the Senate Committee on Banking and Currency and the
second in 1946 by the Board of Governors:
Senate bill No. 2639 is intended to establish an auxiliary system of banking,
upon principles well understood and approved by the banking community, in its
broad essentials, and which, it is confidently believed, will tend to stabilize commerce and finance, to prevent future panics, and place the Nation upon an era
of enduring
prosperity.1
It is the Board's belief that the implicit, predominant purpose of Federal
Reserve policy is to contribute, insofar as the limitations of monetary and credit
policy permit, to an economic environment favorable to the highest possible degree
of sustained production and
employment?

This broad objective on which there is agreement covers a number
of intermediary and more detailed objectives. It is with respect to
1 Statement of Robert L. Owen, chairman of the Committee on Banking and Currency
of the U. S. Senate, appearing at p. 1 in Sen. Doc. No. 117 of the 63d Cong., 1st sess.
(The strategic words have been italicized.) See also p. 3 of S. Rept. No. 133 of the same
session.
2 Thirty-second Annual Report of the Board of Governors of the Federal Reserve System,
p. 1. (The strategic words have been italicized.)
98257—49
7
91




92

MONETARY, CREDIT, AND FISCAL POLICIES

these intermediary objectives and their relative importance that there
will always be significant differences of opinion. Judgment with
respect to guiding objectives of policy is necessarily based on the
experience of the System in developing such guides to meet widely
different conditions and developments. A brief review of some of
the significant aspects of this experience is a suitable background to
consideration of specific questions concerning objectives.
Initially it was believed that the System would make the greatest
contribution toward stable prosperity if the Federal Reserve banks
limited their discounting to self-liquidating paper "arising out of
actual commercial transactions." The Federal Eeserve Act was based
on the so-called real-bills doctrine. The Federal Eeserve Board was
given power to define paper eligible for discount. The importance
of this power arose from the belief that the proper definition of
"eligibility" was fundamental to achieving the objectives of the System. The regulations, and particularly the elaborate rulings, with
respect to eligibility reflect this belief that proper administration
of Federal Eeserve credit depended on the characteristics of the paper
accepted for discount.
Experience did not bear out these sanguine hopes and beliefs. The
First World War could not have beenfinancedon the basis of the realbills doctrine. The act in fact was amended in 1916 to authorize the
Eeserve banks to make advances to member banks upon notes secured
by Government securities as well as eligible paper. Developments
after the First World War demonstrated that eligible paper itself can
be issued in amounts sufficient to finance a boom, that self-liquidating
paper is not liquid in an emergency, and that its liquidation in large
amounts can accentuate a depression.
This experience did not result in basic changes in the law concerning eligibility, but it did confirm the inadequacy of eligibility rules
as a means of promoting economic stability. During the decade of
the twenties, the System authorities developed open-market operations
and changes in discount rates as coordinate instruments of monetary
policy. They sold securities and increased rates when business and
speculative activity appeared excessive; they bought securities and
reduced rates in times of business depression. The powers of the Eeserve banks to discount and make advances were not enlarged substantially until the depression of the early 1930's, when experience demonstrated that eligibility rules were a positive deterrent to aiding banks
suffering from large losses of deposits. The initial enlargements were
on an emergency basis only. The orginal principle of regulating
credit through eligibility rules was not abandoned in the law until
1935, when it was provided that—
Any Federal Reserve bank * * * may make advances to any member
bank on its time or demand notes * * * which are secured to the satisfaction of such Federal Reserve bank.

Experience with the real-bills doctrine adds important support to
the conclusion of the System that the law should specify only general
objectives. To establish intermediate objectives as final goals' is likely
in practice to produce unforeseen and undesirable results. Automatic, specific legal directives on credit policy are inappropriate and
inadequate alternatives to judgment based on experience. Some observers, of course, take a different view on the ground that the particular doctrine was poorly chosen and that another specific intermediary



93 MONETARY, CREDIT, AND FISCAL POLICIES

objective would produce the best results. They minimize the importance of the fact that the real-bills doctrine had widespread support,
Its inclusion in the law seriously limited the ability of the System
to act appropriately in a critical period. In view of this experience,
it does not appear appropriate to give absolute priority to any single
intermediary objective, however cogent the arguments that may
presently be made in its support.
A large number of specific criteria have been suggested from time
to time, either singly or in specific combination, as a means of achieving appropriate monetary policy without the use of judgment by the
authorities. Thirteen such possible criteria were listed in a questionnaire prepared by the Senate Committee on Banking and Currency in
1939.
Most of these criteria have been found useful by the System authorities from time to time in indicating conditions calling for action. But
none of them, singly or in specific exclusive combination, has been found
adequate to serve as an unerring guide to policy. It is frequently
true, of course, that developments in one or more of these guides to
policy, however unwelcome, are beyond the scope of powers now
vested in the Federal Eeserve System or likely to be vested in any
central banking organization.
Reply of Allan Sprout, Federal Reserve Bank, New York
In any general statement outlining the principal objective of Federal
Eeserve policy, namely, the promotion of economic activity at high
levels of production and employment, stress must be placed on the twoway aspect of monetary controls. At times monetary ease will be
appropriate, and, at other times, monetary restraint. Some of the
enthusiasts for a "full-employment policy" have occasionally implied
a need for continuous stimulation of the economy from the monetary
sector. This would probably mean the use of monetary powers to
promote a state of perpetual inflation; a self-defeating policy. The
objective of stable economic progress is best pursued by checking the
stimulating influence of new money creation in the face of inflationary
tendencies, whatever their cause, and bringing about some restraint,
insofar as this can be done by monetary action, before the danger
point has been reached. The general answer to your first question
was deficient, perhaps, in not making this point.
Your first question under subsection 1 of section I was also deficient in that it seemed to recognize a number of Federal monetary
and credit agencies with coequal powers. The development of a national monetary and credit policy is the responsibility of the Federal
Eeserve System, given to it by the Congress. This is not a function
which can be split up and passed around. Many of the activities
of other Government agencies engaged in making particular types of
loans, or guaranteeing loans, or conducting bank examinations, or
"insuring" bank deposits, have a bearing on the way this policy actually works out; but monetary control, as such, is the System's responsibility. It is only the service functions performed by the Federal Eeserve System which are comparable to the operations of these
other agencies. The distribution of these incidental servicing duties
among governmental agencies can be largely determined by administrative convenience, and historical precedent, so long as there are arrangements for consultation to avoid undesirable differences in policies




94

MONETARY, CREDIT, AND FISCAL POLICIES

and practices. But over-all responsibility for holding the reserves
of the banking system, and for influencing the creation of credit by
varying the cost and availability of those reserves according to the
monetary and credit requirements of the economy, can only reside in
the one agency designated by Congress as the national monetary
authority. The Federal Reserve System is not just one of a number
of Federal agencies; its duties and responsibilities range over the
whole of our economy and touch the lives of all of our people.
Reply of Alfred II. Williams, Federal Reserve Bank, Philadelphia
The basic continuing purpose of the Federal Reserve System has
been to promote economic stability at high levels of employment and
production. The future of our free competitive economic organization depends on the degree to which this goal is achieved. The problems of economic stability, however, are complex. Despite centuries
of intense effort and study, we have not yet found satisfying solutions.
Experience should warn us that expectations that the Federal Reserve
System or any other agency can produce stability in some simple, easy
way wTill be doomed to disappointment.
Experience demonstrates that no single individual or institution
holds a magic key to sustained prosperity. If our search for solutions
is to be successful, all agencies must understand how the parts of our
economy fit together and how they may be made to work together
most effectively. It is not even possible to separate the parts with
precision; they mesh so intimately that it is impossible to say, except
arbitrarily, where one leaves off and another begins. Stability is inherently a collective responsibility.
It is not feasible to describe the role of all segments in promoting
stability, but it is worth while to mention and describe a few to illustrate the nature of our problem. Since we have a money and credit
economy, a heavy share of responsibility rests on those who determine
fiscal and monetary policies. The three major agencies in these fields
are the Congress, the Treasury, and the Federal Reserve System.
The Congress is responsible for expenditures and receipts and therefore for the cash surplus or deficit of the Federal Government. The
Members of Congress are subjected to continuous pressures to increase
expenditures for particular purposes and to reduce or eliminate particular taxes. Many individual decisions to tax and spend are made
with reference to merits other than their contribution to stability.
Obviously there are other merits of varying importance, including
some that may be considered compelling. At the same time, however,
if too many important decisions are based on other considerations,
economic stability may inadvertently be sacrificed in the process. In
that event, expenditures and receipts, and therefore deficits and surpluses, are likely to be merely the sums of items that have been determined with little reference to the totals. Yet the totals as well as the
individual items have widespread repercussions on economic stability.
The Treasury takes up where the Congress leaves off. Decisions of
earlier Congresses largely determine the magnitude of the debt, and
decisions of the current Congress largely determine the rate of increase
or decrease in the debt. A basic responsibility of the Treasury is the
management of the public debt and the cash balance. The Treasury
is naturally interested in maintaining public confidence in Government securities and in financing them as cheaply as possible. The rate




95 MONETARY, CREDIT, AND FISCAL POLICIES

paid on Government securities, however, affects much more than the
cost of servicing the debt. It influences also the willingness of investors to hold the securities and the flow of expenditures throughout the
whole economy. Too low a rate stimulates expenditures and exerts an
upward pressure on prices of goods and services, including those purchased by the Government. The debt-management policies of the
Treasury, therefore, have important influences on economic stability.
The Federal Reserve System has primary responsibility for monetary policy. It influences the flow of expenditures in the economy
primarily through use of instruments which affect the supply, availability, and cost of money. A program of monetary ease—increasing
the supply and availability and reducing the cost—tends to encourage
expenditures, and a program of monetary restraint tends to discourage
expenditures. Federal Reserve policy, therefore, is an extremely important but by no means the only force influencing the flow of
expenditures.
The policy of each of these major fiscal, debt management, and
monetary agencies influences and, in turn, is influenced by those of the
others. It may either reinforce or impair their effectiveness. At the
over-all level, in a period of inflation, for example, congressional
action which produces a surplus w^ould make easier both the Treasury's
problem of managing the debt and the System's task of restricting
credit. A deficit, on the other hand, would aggravate the problems or
both the Treasury and the System.
The full network of relationships between the three agencies is not
limited to aggregates, such as the size of the surplus or deficit. For
example, the maturity distribution of outstanding Government securities as well as the size of the debt conditions monetary policy. There
are circumstances, of course, such as deficits arising from wartime
finance, under which the public interest prevents the activities of one
agency from reinforcing those of the others. Nevertheless, promotion
of economic stability depends on pursuit of coordinated and complementary policies on the part of the three agencies.
There is a tendency to focus almost exclusive attention onfiscal,debt
management, and monetary policies as unique ways in which to achieve
economic stability. It is therefore particularly important to recognize
the inevitable relationship to this problem of actions by others. This
inherent relationship may be illustrated with an example chosen from
the field of labor-management relations. Negotiations in a basic industry that result not in a new contract but in a work stoppage clearly
jeopardize the stability of the whole economy. An actual work stoppage affords a clear-cut demonstration that monetary and fiscal policy
alone cannot assure stability. Such policies cannot make up the loss
in output.
Labor-management negotiations affect economic stability even when
they result in new contracts without work stoppage. Such contracts
affect not only the distribution of income between the contracting
parties but also the amount of income to be distributed and ultimately
the flow of expenditure through the entire economy. If, for example,
the rates generally are set too high, the monetary and fiscal authorities
are likely to be confronted with choosing between permitting an expansion in the money supply to support higher costs and rising prices
on the one hand and unemployment on the other. If, on the other
hand, rates generally are set too low, the monetary and fiscal authori


96

MONETARY, CREDIT, AND FISCAL POLICIES

ties may be faced with choosing between equally undesirable alternatives. The important point is not the exact alternatives confronting
the monetary and fiscal agencies but that no monetary and fiscal policy,
however well conceived and executed, can achieve economic stability
in the face of inappropriate contracts.
Pricing policies of corporations also have an important bearing on
economic stability. The effects of maintaining prices by reducing output and employment in the face of declining markets are very different
from those resulting from reductions in prices. Similarly, decisions
of business with respect to investment in plant, equipment, and inventory influence the flow of expenditures and the level as well as the
character of economic activity.
Decisions of individuals anect economic stability. Federal Eeserve
policies affect the amount available for expenditure. Individuals
decide whether and for what they will spend. In the aggregate, personal income accounts for roughly four-fifths of gross national product, so that the total of individual decisions with respect to consumption, saving, and investing exerts a powerful influence not only on
the distribution of our productive resources but also on the general
level of economic activity. If, when resources are fully employed,
people generally spend and invest more than their income—by borrowing and perhaps calling on past savings to do so—they will enlarge
the flow of spending without enlarging correspondingly the flow of
goods and services. The effect is inflationary.
These few illustrations from fields outside the fiscal, debt management, and monetary areas have been analyzed in order to emphasize
the comprehensive nature of the responsibility for economic stability.
One may view the role of the private, nonfinancial sector of our economy as a whole. This sector, like the governmental sector, may
operate with a cash surplus or a cash deficit. The net effect will be
reflected in changes in the indebtedness of the private sector to the
banking system. An excess of receipts over expenditures exerts a
depressing effect and an excess of expenditures over receipts exerts
an inflationary effect. It is possible, of course, to construct so-called
models of our economic system, which make it appear that appropriate
fiscal and monetary policy would exactly offset the net results of all
nonmonetary decisions and thus produce economic stability at a high
and continuously rising level of employment and production. The
basic weakness of such models is that they omit many of the fundamental characteristics of the human world in which we live.
It is clear also that the very essence of stability lies in timing. An
act that contributes to stability under one set of conditions will aggravate instability under another set. Thus a governmental, or a private,
cash surplus contributes to stability when we are threatened by excess
expenditures; but such surpluses add to depression when we are already threatened by inadequate demand. Proper timing, in turn,
presupposes flexibility or the ability and willingness to change a program of action to suit conditions as they develop.
A direct responsibility for promoting economic stability rests on
those who determine fiscal, debt management, and monetary policies.
It is important, however, to comprehend that these agencies cannot
separately or collectively do the whole job.




97 MONETARY, CREDIT, AND FISCAL POLICIES

1 (&). What do you consider to be the more important purposes and functions of the Federal monetary and credit agencies?
The System answer
The broad over-all purpose of Federal monetary and credit agencies
is to assure that money and credit will contribute as much as possible
to an economic environment favorable to the highest possible degree
of sustained production and employment. The general policies and
programs directed toward this purpose are described in answers to
other questions. Basically, they are concerned with adjusting the supply, availability, and cost of money to the changing needs of the
economy.
In addition to this general purpose, these agencies perform specific
functions with respect to credit aspects of particular segments of the
economy and also provide many related services indispensable to efficient operation of a money and credit economy. Any attempt to
give in abbreviated form these specific functions and related services
is bound to be inadequate. Several major groups of them, however,
may be described.
One important group consists of those services that are needed to
assure that the public may at all times exchange freely the various
types of money (deposits, currency, coin). This service involves a
large number of functions, such as coinage, printing and engraving,
issuance, redemption, deposit insurance, bank supervision, provision
of reserves.
Another group of services is provision for an efficient means of effecting payments and settling balances—machinery for clearing and
collecting checks and noncash items, such as maturing obligations.
Yet another necessary service is providing the Government with an
efficient means of handling its vast financial operations.
Among the specific functions with respect to credit aspects of particular segments of the economy is that of assuring the availability
of funds to qualified borrowers for designated purposes on reasonable
terms.
1 ( i ) . Which of these should be performed by the Federal
Reserve ?
The System answer
Determination of which of these functions should be performed by
the Federal Reserve, as the agency charged with paramount responsibility for the national monetary and credit policy, is a matter not
only of logical nicety but also of conditions as they have developed
in the United States. For example, a strong logical case can be made
for having only one type of currency and having that currency issued
by the Federal Reserve. However, so long as other types of currency
are strictly limited to an amount far below the minimum total currency
requirements of the country, they create no serious difficulties, although
they are an unnecessary complexity in our monetary system.
Assignment of particularly important functions that are performed
by more than one Federal agency is discussed in answers to the relevant questions below.
With these qualifications in mind, the major functions that should
be performed by the Federal Reserve are:
Determination and administration of the over-all monetary and
credit policy of the country.



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MONETARY, CREDIT, AND FISCAL POLICIES

Participation in operations and decisions relative to the international position of the country and the international value of the
currency.
Holding the legal reserves of commercial banks.
Issuing and redeeming currency.
Providing facilities for the collection and clearance of checks
and other items incidental to the flow of payments.
Supervision of member banks.
Service as fiscal agents of the United States Government.
2 (a). What have been the guiding objectives of Federal Reserve credit policies since 1935?
The System answer
In 1935 the Nation was still short of full recovery and the System
continued the policy of monetary ease which it had been following
since the beginning of the depression. By 1935 this policy was being
implemented not by positive action of the System but by allowing
imports of gold to have an easing effect. In 1936 and 1937, while continuing the general program of monetary ease, the System increased
reserve requirements to avoid the likelihood of future injurious credit
expansion based on the large excess reserves accruing from continued
gold imports. In 1938 the System participated in the general program
for economic recovery by reducing Reserve requirements.
In the interval between the outbreak of war in Europe and the
attack on Pearl Harbor, the principal objective of System policy was,
first to exert a stabilizing influence against the uncertainties of the
early war period, and then in 1941 to restrain the gradually developing
inflationary pressures.
After 1941, the emphasis shifted to assuring the Government that
it would be able to raise the funds it needed to finance the war effort
with a minimum of disturbance to economic stability. Developments
during this period are given in more detail in the answers to the questions in section II below. The more specific guiding objectives were
to secure as much of the needed funds as possible outside the banking
system, to provide the banking system with the reserves needed to
acquire the residual amount of securities, and to avoid the necessity of
financing the war at progressively rising interest rates.
After the war the System continued to pursue the general objective
of restraining monetary expansion to the extent this could be done
without creating unstable conditions in the market for Government
securities. Restraint in the postwar period was exercised by the
System not only directly but also in cooperation with the Treasury,
especially in the administration of the large cash surplus. The collection of the funds by the Treasury reduced the privately owned money
supply. The transfer of these funds from commercial banks to the
Federal Reserve banks absorbed reserves. Since the funds were used
primarily to redeem maturing issues held by the System, the banks
were put under pressure in order to replenish their reserves. Increases
in Reserve requirements on several occasions in 1948 put banks under
similar pressure. Other measures of credit restraint taken by the
System were discontinuance of a preferential rate on discounts secured
by short-term Government securities in April 1946, gradual increases
in yields on short-term Government securities and in discount rates




99 MONETARY, CREDIT, AND FISCAL POLICIES

beginning in July 1947, reduction in the support prices of longer-term
Government securities in December 1947, and reimposition of the
regulation of consumer installment credit.
Early in 1949, when evidence accumulated that inflationary pressures had been checked, the System inaugurated a program of relaxing
the restraints on credit. The first steps were relaxation in restrictions
on consumer credit and stock-market credit. These were followed by
successive reductions in member bank Reserve requirements. On June
28,1949, the Federal Open Market Committee announced that it would
thereafter "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."
2 (&). Are they in any way inconsistent with the objectives
set forth in the Employment Act of 1946 ?
The System answer
The guiding objectives of Federal Reserve credit policy are thoroughly consistent with the objectives set forth in the Employment
Act of 1946. Section 2 of this act provides:
The Congress hereby declares that 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.

In addition, section 4 (c), which defines the duty and function of
the Council of Economic Advisers to the President, includes the following provision:
to develop and recommend to the President national economic policies, to foster
and promote free competitive enterprise, to avoid economic fluctuations or to
diminish the effects thereof, and to maintain employment, production, and
purchasing power.

Federal Reserve policy has generally been directed to these same
objectives throughout the life of the System. Thus, during both the
First and the Second World Wars the objective of national policy
was to achieve victory and the essential consideration of the System
was to assure war financing with a minimum of disturbance to economic stability. In the interval between the two wars, the System
tried to mitigate economic fluctuations by easing credit when employment, production, prices, and purchasing power were declining, and
by firming credit when the economy was experiencing inflationary
tendencies which threatened subsequent collapse.
For 3 years after the termination of the Second World War the
System exercised such restraint on inflationary expansion as it could
without, however, risking the disruptive effects on the economy that
might have followed had serious disorder been permitted to develop
in the Government securities market. Finally, as evidences of recession appeared early in 1949, it relaxed restraint on credit to help
maintain production and purchasing power.




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MONETARY, CREDIT, AND FISCAL POLICIES

3. Cite the more important occasions when the powers and
policies of the System have been inadequate or inappropriate
to accomplish the purposes of the System.
The System answer
Adaptation of the Federal Eeserve System to changing conditions
is frequently reflected in amendments to the law. An indication of
the frequent need for adjustment is the fact that the Federal Reserve
Act has been amended in 27 of the 35 years that the System has been
in existence. Many of the changes, of course, have been relatively
minor in character; but some of them have been fundamental.
Early illustrations of inadequate authority occurred during the inflationary boom and subsequent depression that followed the First
World War. In the fall of 1919, the Reserve System was deterred
from adopting a policy of restraint for several months because of
Treasury opposition to any action that might interfere with the "digestion" of the Victory loan. After the collapse of the inflation, it
would appear (with the benefit of hindsight) that a more appropriate
policy would have been to ease credit sooner and more vigorously.
At the time, however, the gold holdings of the Reserve banks were
near the legal minimum. Without a change in the law or a suspension
of reserve requirements, therefore, the System was not in position to
expand.
In an effort to promote general stability, the System in 1928 and
1929 described its twofold objective in these words:
The problem was to find suitable means by which the growing volume of security credit could be brought under orderly restraint without occasioning avoidable
pressure on commercial credit and business.

Its powers, however, were inappropriate to accomplish this dual
objective. This defect was ameliorated by authorizing the Board to
prescribe margin requirements with respect to loans on securities and
to prohibit certain types of financing of security trading.
The powers of the System were inadequate and to some extent inappropriate to deal with the depression that began in 1929. In large
part the legal limitations were based on the real bills doctrine, described above. The eligibility provisions of the Federal Reserve Act
limited unduly the amount of credit the Reserve System could extend.
Such limitations, after numerous modifications, were finally removed
in 1935. Similarly, the collateral requirements for Federal Reserve
notes severely restricted the extent to which the System could engage
in open-market operations. These limitations were alleviated in 1932
for a temporary period. After several extensions of time, the provision allowing Government securities to serve as collateral was made
permanent in 1945.
At various times, as described in section IV below, the power of the
System to absorb actual or potential excess reserves has been inadequate because of the magnitude of additions to reserves arising from
sources such as gold inflows, because the Board's authority over reserve
requirements applies only to member banks, and because use of openmarket operations and discount rates was inhibited by a desire to avoid
interference with the management of the public debt and adverse
effects on the public's appraisal of Government obligations.
There are also a number of existing legal impediments to effective
and efficient operation of the System. Although none of these is as
serious in itself as the limitations that have been described, collectively



101 MONETARY, CREDIT, AND FISCAL POLICIES

they add to a considerable total. Among these limtations are: Inadequate legal authority to regulate bank holding companies effectively;
too rigid capital requirements for membership and for member banks
with branches; unnecessary requirements concerning segregation of
collateral against Federal Eeserve notes; unnecessary prohibition
against a Federal Reserve bank paying out notes of another Federal
Reserve bank; and expiration on June 30, 1950, of authority of the
Federal Eeserve banks to purchase Government obligations directly
from the Treasury.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
On the whole, I agree with the draft reply and even with the statement that—
the power of the System to absorb actual or potential excess reserves has been
inadequate because * * * use of open-market operations and discount rates
was inhibited by a desire to avoid interference with the management of the public
debt and adverse effects on the public's appraisal of Government obligations.

I believe the statement to be a correct representation of the facts
with regard to the attitude of a majority of those in the System charged
with responsibility for policy but I am not fully in sympathy with that
position because, as I indicate in my reply to question I I - l , below, I
believe more determined steps could and should have been taken to
absorb some of the excess reserves through use of open-market operations and a more flexible policy as to support prices of governments.
4. Would it be desirable for the Congress to provide more
specific legislative guides as to the objectives of Federal Eeserve
policy ? If so, what should the nature of these guides be ?
The System answer
The way in which our economy actually operates and the role of
money and credit in those operations are extremely complex. The
relative importance of specific objectives will vary, depending on
actual developments.
It is almost certain that no single specific objective of Federal Eeserve policy would prove equally appropriate for prosperity and depression, for defense, war, reconstruction, and peace. An alternative
to the single specific objective is a list which enumerates a number of
specific objectives. Such a list may be either illustrative or inclusive.
If it is illustrative only, it accomplishes nothing that would not be
accomplished by a statement of more general objectives. If such a
list is meant to be inclusive, however, it may either be made so extensive—to cover all foreseeable circumstances—as to be in effect a general
direction, or it may be so short as to omit desirable objectives.
Such considerations bolster the conclusion based on the actual operation of the System under widely changing conditions over a long
period of time that legal directions as to objectives will accomplish
most in the long run if they are general in character. Experience has
demonstrated that enactment of permanent detailed rules does not
prevent undesirable developments, but it may and almost certainly will
hinder, as it has in the past, the handling of critical conditions that
were not anticipated at the time the legislation was enacted.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
Experience has demonstrated that enactment of permanent detailed
rules does not prevent undesirable developments, but it may and almost
certainly will hinder, as it has in the past, the handling of critical



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MONETARY,

CREDIT, AND FISCAL POLICIES

conditions that were not anticipated at the time the legislation was
enacted. Yet another danger is that detailed legislative rules encourage the public to expect more than can in fact be accomplished.
The inevitable disappointment creates new problems.
The congressional declaration of national economic policy in the
Employment Act of 1946 is general rather than specific. It would be
desirable, as is indicated in the answer to question VI-6, to direct all fiscal, monetary, and credit agencies to promote these same objectives.
II.

RELATION OF FEDERAL RESERVE POLICIES TO F I S C A L POLICIES AND
D E B T MANAGEMENT

The System answer
Federal Reserve policies are carried out through the System's
influence upon the cost and availability of credit. Government securities now account for more than one-half the dollar volume of credit
instruments outstanding in the economy. Clearly, any congressional
action which results in increasing or reducing the volume of Government debt, or any Treasury decisions concerning the management of
that debt, will necessarily condition the effectiveness of the general
credit policies undertaken by the Federal Reserve System. Furthermore, since direct action in the money market by the Federal Reserve
System is mainly exercised through purchases and sales of Government securities, and since Reserve System action to influence the availability of credit affects interest rates, the Federal Reserve System is
at all times affecting the environment in which Treasury financing
activities take place.
Moreover, System influence upon the cost and availability of credit
is, in turn, significant as an influence upon the flow of expenditures in
the economy. Government has become an increasingly important
contributor to aggregate expenditures in recent years, and rising taxes
have caused major shifts within the spending stream. Government
expenditures and taxes, therefore, exert influences upon the flow of
money and income which may, at times, run parallel to those exerted
by monetary and credit policy, and which may at other times have
contrary effects—thereby increasing those disturbances to economic
stability which monetary policy attempts, within modest limits, to
offset.
Broadly speaking, while the fiscal policy which emerges from the
grand aggregate of all congressional decisions on expenditures and
taxes should be roughly consistent with the general aim of restraining
inflation, or moderating deflation, no precise and flexible use of fiscal
policy is practicable. Treasury financing of the deficits which result
from congressional action, or the Treasury's use of surpluses as they
arise, can always, however, be conducted in ways which are more or
less consistent with general credit policy.
The same is true for the Treasury's management of the outstanding
Government debt. In its decision on the types of securities to be
offered, their term, and their yield, the Treasury exerts a direct influence upon conditions in the money market. It is in this sector, probably to a much greater extent than in that of congressional action concerning expenditures and taxes, that fruitful possibilities exist for
coordination between Treasury policy and the national monetary and
credit policy. Even with full and harmonious coordination, however,




103 MONETARY, CREDIT, AND FISCAL POLICIES

it must be recognized that these form but one of the many complexes
of influences acting upon the money market, and through that market
upon the general state of inflation, deflation, or sustained prosperity
in the economy. Neither the Treasury nor the Federal Reserve System can ever assume responsibility for guaranteeing the maintenance
of economic stability at high levels of employment and production;
their influence, however, should be coordinated toward promoting
achievement of that objective.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
Government securities now account for more than one-half of the
dollar volume of credit instruments outstanding in the economy.
Clearly, any congressional action which results in increasing or reducing the volume of Government debt, or any Treasury decisions concerning the management of that debt, will necessarily affect the results
of credit policies undertaken by the Federal Reserve System. Furthermore, since the Federal Reserve System operates mainly through
purchases and sales of Government securities, its actions are at all
times affecting the environment in which Treasury financing activities
take place.
Both System and Treasury policies affect the flow of expenditures in
the economy. Government, because of the sharp rise in its receipts
and expenditures in recent years, has direct influence over a major
segment of the spending stream. Through its control over expenditures and taxes, the Government affects both the amount and the direction of the income-expenditure flow. Fiscal actions of the Government may run parallel to the actions of the monetary authorities, thus
tending to supplement monetary policy, or they may tend to counteract the effects of money and credit policy.
Management of the outstanding Government debt is an important
force in the money market, which may affect reserves and the money
supply. Treasury decisions as to the types, maturities, and rates on
securities to be offered exert a direct influence on conditions in the
money market. The Federal Reserve actions affecting the supply and
cost of credit influence the rate of interest and terms the Treasury
must offer on new security issues. Debt management may affect the
volume of bank reserves and the money supply. If new issues are
offered on terms which are attractive mostly to banks, the tendency
is to increase bank holdings and the money supply and vice versa.
Federal Reserve policies and fiscal and debt-management policies
are closely interrelated. Either agency is in a position to influence
the success of the policies of the other. While neither the Treasury
nor the Federal Reserve System can assume full responsibility for
guaranteeing the maintenance of economic stability at high levels of
employment and production, their policies should be directed toward
the achievement of this basic objective.
1. Would a monetary and debt management policy which would
have produced higher interest rates during the period from January 1946 to late 1948 have lessened inflationary pressures ?
The System answer
A policy of permitting higher interest rates during the period from
January 1946 to late 1948 would have enabled the Treasury and the
Federal Reserve System to pursue an even more restrictive monetary
and debt-management policy than that which was actually undertaken.



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MONETARY, CREDIT, AND FISCAL POLICIES

The objective of such a policy would have been a more effective restraint upon the supply and availability of borrowed funds in an
effort to restrain certain expenditures in our economy financed by
funds obtained in the credit and capital markets; a rise in interest
rates would have been the concomitant (and not the precise objective)
of such a policy. An appraisal of monetary and debt-management
policies which would have produced higher interest rates must consider not only the more obvious direct effects upon inflationary pressures, but also the costs, uncertainties, and possible adverse effects of
such alternative policies.
A more restrictive monetary and debt-management policy in the
postwar period would have included higher rates on short-term Government securities, higher yields on Government bonds (with some
prices probably below par), and lessened purchases of Government
securities in the open market on behalf of the Federal Open Market
Committee. The supply of reserve funds available to commercial
banks as the basis for loan expansion would have been reduced. Lifeinsurance companies and other institutional investors would have had
to accept capital losses in attempting to sell Government securities,
and this might have discouraged transfer of some of their investments
into corporate bonds, State and local government obligations, and
mortgages.
The effectiveness of such a restrictive policy in restraining inflation must be appraised in terms of the many strong factors giving
rise to the underlying inflationary condition. During the war individuals and businesses accumulated large holdings of money and Government securities as a result of the wartime deficits and the increase
in the public debt. Heavy deferred demands and acute needs for
many goods gave rise to tremendous expenditures. A rising spiral
of costs and prices was supported by use of past savings and high
incomes as well as by credit expansion. All these factors together
gave rise to a situation in which total demand by consumers, businesses, and governments exceeded the capacity of the economy to supply goods and services. A restrictive monetary and debt-management
policy resulting in higher interest rates would have restrained more
effectively those expenditures which depended upon the use of borrowed funds. Total demands for goods and services might well have
remained high, however, and some degree of inflation was inevitable
as a result of the war.
The widespread repercussions throughout the economy in other
directions, apart from lessening the contribution of new credit toward
inflationary pressures, must also receive attention in considering a
policy of higher interest rates. Such an alternative monetary and
debt-management policy might have brought about grave disturbances
in the market for Government securities, with damaging repercussions
on our entire financial mechanism, as well as seriously adverse effects
upon public confidence in the Government's credit. The interest cost
on the public debt would have been increased, and the Treasury's
refunding operations made more difficult. A policy of higher interest
rates might have led to panic selling of marketable obligations, loss
of confidence in financial institutions, and perhaps large redemptions
of savings bonds. Moreover, a policy of higher interest rates might
have had such restrictive effects on private financing as to bring about
a sharp down-turn in business rather than merely to restrain infla


105 MONETARY, CREDIT, AND FISCAL POLICIES

tion. Thus while greater freedom of action with respect to interest
rates might have permitted some desirable further restraint, the Federal Eeserve System would, nonetheless, have been compelled to proceed cautiously, reversing itself if other dangers became important.
While it is unfortunate that further tightening of rates was not permitted, no categorical answer can be given as to how much that approach could have accomplished in lessening inflationary pressures
during thefirstthree postwar years. A greater effort should, how ever,
have been attempted.
Reply of Alfred H\ 'Williams, Federal Reserve, Bank, Philadelphia
The answer to the question as phrased is "Yes," but equally pertinent is the question: "At what cost?" The period January 1946 to
late 1948 was characterized by a plethora of money and liquid assets
and a scarcity of goods. Bestrictions on civilian production during
the war created both a large backlog of demand for goods and a large
accumulation of money and Government security holdings with which
to buy them. The tremendous flow of expenditures reflected not only
a high level of incomes, but also the conversion of Government securities and other liquid assets into cash and an expansion of credit which
was facilitated by large bank holdings of Government securities which
could be sold to the Federal Reserve at approximately fixed prices.
The result was a rising spiral of prices, costs, and profits.
The problem confronting Federal Reserve authorities was not only
one of checking inflation. It was one of checking inflation without
precipitating a depression. The objective was clear, but how it could
best be achieved in the face of a huge and unstable Federal debt, a
tense international situation, and a shortage of goods was not so clear.
Basically, there were two courses of action which the Federal
Reserve authorities could have taken. They could have used open market operations and other available instruments primarily to limit the
supply of bank reserves and check credit expansion, leaving the price
of Government securities and interest rates free to seek their own
level. The other alternative was to have pursued a twofold objective
of maintaining a stable market for Government securities, limiting
credit expansion insofar as this policy permitted.
The first program of action would have permitted the full use of
open market operations and other instruments of Federal Reserve
policy to limit the supply and availability of bank reserves. The
primary restraint on inflation would have been exerted by a more
effective limitation of the supply of bank reserves. A secondary
restraint would have been a rise in interest rates, reflecting the shortage of funds, which might have tended to restrict the private demand
for credit, especially for uses in which interest was an important part
of total cost.
The greater freedom of action in checking inflation would have
been gained, however, only by sacrifices in other directions. Sales
of Government securities in an unsupported market by lending
agencies shifting to loans and other investments would have resulted
in a decline in the price of securities and a rise in interest rates. Fear
of further declines might have started a wave of liquidation of marketable obligations and of redemptions of savings bonds. Once started
such repercussions would have been difficult to stop, and a serious
deflation might have been precipitated. The decline would have made




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MONETARY, CREDIT, AND FISCAL POLICIES

more difficult the Treasury's large refunding operations, and any tendency to undermine confidence in Government credit would have been
serious because of the tense international situation. The lowering or
withdrawal of support prices would not have been a method by which
anti-inflationary pressure could have been applied or released flexibly
and gradually as desired.
An alternative course of action was to restrict credit expansion
within the limits made possible by maintaining a stable market for
Government securities. This alternative, the one chosen, interfered
with actions to check inflation because Federal Eeserve purchases in
supporting the bond market were the major factor increasing bank
reserves. Increases in reserves were counteracted by the cash redemption of Treasury securities held by the Federal Reserve System,
by System sales of short-term securities, and by increases in reserve
requirements. Permitting a somewhat flexible pattern of interest
rates to develop enabled more effective action in checking inflation than
would have been possible under a fixed pattern. A rise in short-term
rates, even with the long-term rate pegged, enabled the Federal
Reserve to sell short-term securities and absorb some of the reserves
being created by purchases of bonds. Flexible short-term rates, therefore, tended to minimize the inflationary effects of the support program. Under either a fixed or flexible support policy, however,
maintaining a stable market for Government securities resulted in
sacrificing some control over the money supply and the ability of the
authorities to check inflation.
The essential problem was one of choosing between alternatives.
The advantages of a more effective anti-inflationary action were
weighed against the dangers of a disorderly Government securities
market. The System decided to avoid the latter.
Reply of Hugh Leach, Federal Reserve Bank, Richmond
Theoretically, higher interest rates represent an increase in the
cost and a reduction in the availability of credit and therefore could
have lessened inflationary pressures during this period. In practice,
however, a higher interest rate policy would have been ineffective and
inadvisable. In view of Treasury considerations of continued public
confidence and low service cost relative to refunding, there was no
possibility of marked changes in interest rates or of lessened purchases
of Government securities by the System. As long as the System stood
ready to purchase Government securities, reserves were available to
the banking system and a higher interest rate policy in and of itself
could not have been effective.
In addition, even assuming a policy designed to bring about increases in interest rates in both sectors of the market (with the System
lessening purchases and with some bond prices going below par),
there is a real question as to whether this would have been a major
anti-inflationary factor. During this period it is obvious that the
two primary causes of inflationary pressures were the volume of
money already created and in the hands of business and individuals
and the insufficient quantity of goods in relation to this existing money
supply. Higher interest rate policy could hardly have reduced the
volume of money already created and might possibly have had adverse
effects upon increased production. Furthermore, any resultant tight-




107 MONETARY, CREDIT, AND FISCAL POLICIES

ening of reserves and bank lending might have been offset by an
expansion in other types of credit reflecting a huge volume of liquid
assets in the hands of nonbank investors. In retrospect, it appears
that the intense demand for goods and services during this period relative to the existent shortages indicates that interest rate policy could
not have substantially lessened these inflationary pressures.
With more specific reference to the policy followed, a review of the
record as to the interest rate changes during this period reveals that
System policy succeeded in bringing about an increase in the short-term
rate within the practicable limits dictated by Treasury considerations.
As to the long-term rate, however, it is believed that the maintenance
of the 2y2 percent rate was fully justified by the public interest. Longterm rates were not, and should not have been, permitted to rise and
bond prices to have been driven below par. Certainly, the unstabilizing effect on the market for Government securities, the possible upset
to public confidence, the question of just how much selling would
have occurred in the market, represented sufficient considerations outweighing the advantages from the standpoint of the anti-inflationary
effect of such action. Thus, in view of the nature of the inflationary
pressures during this period (which conceivably would have made
any higher interest rate policy relatively ineffective) and the overwhelming necessity of considering market stability (which militated
against any change in the long-term sector), a monetary and debt management policy producing higher interest rates would not have been
effective or advisable from the standpoint of inflationary pressures.
Reply of 'William S. McLarin, Jr.. Federal Reserve Bank, Atlanta
A restrictive monetary and debt-management policy resulting in
higher interest rates would have restrained more effectively those
expenditures which depended upon the use of borrowed funds, but
the total demands for goods and services might nevertheless well have
remained high, and some degree of inflation was certainly inevitable
as a result of the w ar. On the other hand, such a monetary and debtmanagement policy might have brought about grave disturbances in
the market for Government securities; the interest cost on the public
debt would have been increased, and the Treasury's refunding operations made more difficult; it might have led to panic selling of marketable obligations, loss of confidence in financial institutions, and perhaps large redemptions of savings bonds and might have had such
restrictive effects on private financing as to bring about a sharp
downturn in business rather than merely to restrain inflation.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
Probably a monetary and debt-management policy which would
have produced higher interest rates in 1946-48 would have lessened
inflationary pressures. It should be pointed out, however, that the
total demand for goods and services (including current demand as a
result of high income, past savings, and credit, as well as deferred
demand as a result of wartime restrictions) might have been almost
as large even had credit been restricted more strongly. Credit restriction presumably would have curtailed demand which was dependent upon credit, but greater activation of the money supply already in
existence (more rapid use of relatively idle balances) was possible.
98257—49

8




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MONETARY, CREDIT, AND FISCAL POLICIES

Thus no firm answer to the question is possible. Furthermore, the
alternative to the policy pursued might have led to consequences more
dangerous for the economy than the inflation which took place. This
point is covered more fully in the answer submitted in the special
System study.
Nevertheless, I believe that more rapid and stronger action with
respect to short-term rates might have relieved the inflationary situation to some extent. Greater effort should have been made in this
direction. My own feeling is that the open market committee's suggestions for quicker action on this front would have led to a more
sound situation than actually existed under the policies pursued.
Reply of t/. N. Peyton, Federal Reserve Bank, Minneapolis
This question can, of course, only be answered in the affirmative.
The real issue is how much additional restraint would have been
exercised by a monetary policy somewhat more restrictive in character. The at-one-time popular tendency to dismiss changes in interest rates as unimportant in influencing business activity is unrealistic.
Interest rate changes are merely symptomatic or symbolic of the
changed terms of availability of credit and funds, and the latter is
important in a substantial way in the general business situation.
In view of the bond price-support commitment, monetary policy
even so exercised a considerable degree of restraint during the postwar boom years. Through a judicious policy of periodically raising
short-term rates, combined with an expert use of Treasury surpluses,
considerable and continuous pressure was exerted on the money market. The former effect should, however, not be overgeneralized. A
substantial part of its effectiveness is undoubtedly to be explained by
the fact that changes in short-term rates injected considerable uncertainty about long-term rates. The longer and the more tenaciously
the long yield rate is held, the less effective obviously is this uncertainty in exercising monetary restraint.
Reply of H. G. Leedy, Federal Reserve Bank, Kansas City
A policy of permitting higher interest rates during the period from
January 1946 to late 1948 would have enabled the Treasury and the
Federal Reserve System to pursue an even more restrictive monetary
and debt-management policy than that which was actually undertaken.
The objective of such a policy would have been a more effective restraint upon the supply and availability of borrowed funds in an
effort to restrain certain expenditures in our economy financed by
funds obtained in the credit and capital markets; a rise in interest
rates would have been the concomitant (and not the precise objective) of such a policy. An appraisal of monetary and debt-management policies which would have produced higher interest rates must
consider not only the more obvious direct effects upon inflationary
pressures, but also the costs, uncertainties, and possible adverse effects
of such alternative policies.
A more restrictive monetary and debt-management policy in the
postwar period would have included higher rates on short-term Government securities, higher yields on Government bonds (with some
prices probably below par), and lessened purchases of Government
securities in the open market on behalf of the Federal Open Market
Committee. The supply of reserve funds available to commercial
banks as the basis for loan expansion would have been reduced. Life


109 MONETARY, CREDIT, AND FISCAL POLICIES

insurance companies and other institutional investors would have had
to accept capital losses in attempting to sell Government securities,
and this might have discouraged transfer of some of their investments into corporate bonds, State and local government obligations,
and mortgages.
The effectiveness of such a restrictive policy in restraining inflation
must be appraised in terms of the many strong factors giving rise
to the underlying inflationary condition. During the war individuals
and businesses accumulated large holdings of money and Government
securities as a result of the wartime deficits and the increase in the
public debt. Heavy deferred demands and acute needs for many
goods gave rise to tremendous expenditures. A rising spiral of costs
and prices was supported by use of past savings and high incomes
as well as by credit expansion. All these factors together gave rise
to a situation in which total demand by consumers, businesses, and
governments exceeded the capacity of the economy to supply goods
and services. A restrictive monetary and debt-management policy
resulting in higher interest rates would have restrained more effectively those expenditures which depended upon the use of borrowed
funds. Total demands for goods and services might well have remained
high, however, and some degree of inflation was inevitable as a result
of the war.
The widespread repercussions throughout the economy in other
directions, apart from lessening the contribution of new credit toward
inflationary pressures, must also receive attention in considering a
policy of higher interest rates. Such an alternative monetary and
debt-management policy might have brought about grave disturbances
in the market for Government securities, with damaging repercussions
on our entire financial mechanism, as well as seriously adverse effects
upon public confidence in the Government's credit. The interest cost
on the public debt would have been increased, and the Treasury's
refunding operations made more difficult. A policy of higher interest rates might have led to panic-selling of marketable obligationsv
loss of confidence in financial institutions, and perhaps large redemptions of savings bonds. Moreover, a policy of higher interest rates
might have had such restrictive effects on private financing as to bring
about a sharp downturn in business rather than merely to restrain
inflation. Thus while greater freedom of action with respect to
interest rates might have permitted some desirable further restraint,
the Federal Reserve System would, nonetheless, have been compelled to proceed cautiously, reversing itself if other dangers became
important.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I am in agreement with the draft reply which states that such a
policy would have enabled the Treasury and the Federal Reserve
System to pursue a more restrictive monetary and debt-management
policy than that which was actually undertaken. I also agree with
the concluding sentences that it is difficult to conjecture how effective a policy of further tightness would have been during the three
postwar years. In my opinion, some of the steps finally taken by
the System should have been taken sooner. How far we could have
gone without precipitating the undesirable consequences in the markets that some feared, no one knows. I have been disturbed by the




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MONETARY, CREDIT, AND FISCAL POLICIES

extent to which people in key managerial positions in banks, insurance companies, trust companies, and elsewhere in the financial and
business world, to say nothing of the lay public, appear to have
accepted the doctrine that an invariable maintenance of Government
bond prices at or above par is essential to the financial soundness of
the country. To me, this is a doctrine out of keeping with the history
of our financial past and unfortunate in the restrictions that it puts
on the functioning of ourfinancialmachinery. I believe that a tighter
policy could have been followed which w^ould have permitted some
issues to go moderately below par so that the country could have
adjusted its thinking on the matter of money rates, security prices,
and financial soundness to changing conditions. I recognize that such
a program would have involved certain risks, but I believe they should
have been taken.
While believing that a tighter policy should have been followed,
I am by no means confident that it would have had any materially
different effects than did the policy that was actually followed during
the first three postwar years. As the draft reply states * '* *
a more restrictive policy would have restrained more effectively those
expenditures which depended upon the use of borrowed funds. The
most important of these expenditures were in construction and real
estate and in business itself. Liberality in the use of credit in construction and real estate was fostered by congressional policy, and
more restrictive Federal Reserve action might have resulted in a
direct countermandate of the Congress or in congressional action to
provide special governmental financing facilities, thus nullifying, at
least in part, Federal Reserve action. Business demand for credit
grew out of the need for inventories and additional or renovated
plant and equipment. While some speculation in inventories may
have occurred, most of the increase in the postwar period appeared
to be necessary in order to permit industry and trade to function
more efficiently. The expansion or renovation of plant and equipment reflected the need of business to expand capacity to meet the
large postwar demand for goods and services, and we have a record
of accomplishment in catching up with these demands which is highly
praiseworthy.
A more restrictive monetary and credit policy might have led to
a moderation in the rate of capital expenditures. A reduction in
the rate of capital expenditures might have resulted in their being
spread out over a longer period of time, so that they might not have
reached such a high peak in 1948 and might not have declined so
much in 1949. Had such been the case, inflationary pressures from
this source might have been reduced and a more stable employment
situation might have occurred. On the other hand, capacity would
not have been increased so much, and thus the inflationary pressures
resulting from consumer demand might have been maintained over
a longer period and have been reflected in higher prices. Criticism
of our business leadership might also have been more severe because
of an alleged slowness in expanding capacity to a point adequate
to serve the needs of the Nation. Only a few months ago the steel
industry was under such attack.




111 MONETARY, CREDIT, AND FISCAL POLICIES

2. In what way might Treasury policies with respect to debt
management seriously interfere with Federal Eeserve policies
directed toward the latter's broad objectives?
The System answer
Treasury determination of rates of interest on Government securities and Federal Eeserve policies which influence the money market
are necessarily very closely related. Federal Eeserve policies designed
to encourage credit expansion would make it possible for the Treasury
to offer lower rates of interest on new issues of Government securities. On the other hand, Federal Eeserve policies designed to restrain credit expansion might make it necessary for the Treasury to
offer higher rates of interest on new issues.
Federal Eeserve policies are likewise affected by Treasury determination of the rates of interest on new issues of Government securities and a necessity of avoiding action which might impair public
confidence in Government securities. Heavy private demands for
credit and capital funds might bring about selling of Government
securities by banks, life-insurance companies, and other institutional
investors in order to obtain funds to meet such demands. In these
circumstances, the Federal Eeserve would have to buy Government
securities in the market if Treasury rates of interest on new securities were to be supported and if prices and yields on outstanding
issues were to be maintained within a narrow range. Federal Eeserve purchases of Government securities from commercial banks
create new reserve balances, and Federal Eeserve purchases of Government securities from nonbank investors create both new reserve
balances and new deposits as well. Such additions to reserve funds
and the money supply might be inflationary, unless offset by other
actions, such as increases in reserve requirements or use of a Treasury
cash surplus to retire Federal Eeserve holdings of Government
securities.
The choice of securities offered by the Treasury may likewise interfere with Federal Eeserve policies. For example, the supply of Treasury bills at a given rate might be increased in circumstances where
commercial banks and nonbank investors were not willing to acquire
a corresponding additional amount of Treasury bills. This situation
would necessitate either higher bill rates or Federal Eeserve acquisition of Treasury bills in the market, bringing about expansion in
member-bank reserve balances (whether or not such an expansion
should be consistent with the current phase of Federal Eeserve policy).
3 (a). What, if anything, should be done to increase the degree
of coordination of Federal Eeserve and Treasury objectives and
policies in the field of money, credit, and debt management?
The System answer
The close relationship of monetary policy and debt management
will continue to require a high degree of cooperation and coordination between the Treasury and the Federal Eeserve. The problem
of coordination involves much more than administrative coordination
of two agencies with different areas of operation and responsibilities.
Coordination necessarily involves decisions as to alternative objectives
and degrees of emphasis in policies. Attention is directed to three
alternative ways of achieving close coordination of Federal Eeserve
and Treasury objectives and policies in the field of money, credit,
and debt management, in addition to the fourth possibility discussed
below in parts (&) and (c) of the present question.



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MONETARY, CREDIT, AND FISCAL POLICIES

The present method of coordination of Treasury and Federal Reserve policies is that of consultation between policy-making and operating officials of the two agencies, largely upon a voluntary basis.
This method of coordination rests upon recognition by the Treasury
and the Federal Reserve of their mutual responsibilities in a cooperative effort to direct their respective policies toward common, broad
objectives of national economic policy. It assumes that ocasional informal conferences and discussions can bring about adequate recognition of the objective of promoting economic stability at high levels of
employment and production through monetary policy, as well as
that of facilitating Treasury financing operations in public-debt
management.
An alternative method of coordination of objectives and policies
would be through congressional directive. Congress might require
by legislation that the Treasury, in consultation with the Federal
Open Market Committee, shall give due consideration to the effects
of debt-management policies upon bank reserves and the money supply, in a manner consistent with the objectives set forth in the Employment Act of 1946.
A third method of coordination would be the establishment of a
National Monetary and Credit Council somewhat along the lines proposed by the Hoover Commission. This proposal is discussed below
in the answer to question VI-6, concerning the relation of the Federal Reserve to other banking and credit agencies. Such a council
would have as members the Secretary of the Treasury, the Chairman
of the Federal Open Market Committee, and representatives of the
agencies engaged in domestic lending or loan-guaranty activities.
The council would provide, among other things, for regular consultations within the council among the Treasury, the Federal Reserve, and
other affected agencies concerning the Treasury's fiscal and debtmanagement policies and the Federal Reserve's monetary and credit
policies.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
The problem of coordination is not primarily one of setting UD some
formal mechanism for consultation between policy-making officials;
rather, it is one of establishing a common set of values and purposes.
Coordination is unlikely if the two agencies are working toward different objectives. In former years, low interest cost and technical
efficiency in handling the debt were the major objectives of management. Economic effects were largely ignored. Today, debt-management operations are so vast and their economic effects so great that
economic stability must be given primary consideration if debt-management policies are to assist rather than obstruct monetary and
credit policies.
We already have, in the Employment Act of 1946, a general congressional directive establishing economic stability as the common
objective of national economic policy. It is our conviction that coordination of fiscal, debt-management, and monetary policies would
be promoted by specific congressional directive to those responsible
for policies in these areas.
Reply of W. S. McLarin, Jr., Federal Reserve Bank, Atlanta
One method of coordination would be the establishment of a National Monetary and Credit Council somewhat along the lines proposed



113 MONETARY, CREDIT, AND FISCAL POLICIES

by the Hoover Commission, having as members the Secretary of the
Treasury, the Chairman of the Federal Open Market Committee, and
representatives of the agencies engaged in domestic lending or loanguaranty activities. The council would provide, among other things,
for regular consultations within the council among the Treasury, the
Federal Reserve, and other affected agencies concerning the Treasury's
fiscal and debt-management policies and the Federal Reserve's monetary and credit policies.
3 ( i ) . What would be the advantages and disadvantages of
providing that the Secretary of the Treasury should be a member
of the Federal Reserve Board ?
The System answer
The principal advantage of providing that the Secretary of the
Treasury should be a member of the Board presumably would be that
it might facilitate coordination of debt-management policy with
monetary or credit policy. It would provide an opportunity for the
Secretary of the Treasury to hear and participate in discussions of
credit policies by the Board of Governors of the Federal Reserve System, and the Federal Open Market Committee and to discuss with
other members of the Board and the Committee the Treasury financing
and debt-management policies that would be most appropriate in the
light of Federal Reserve credit policies.
The principal disadvantage would be that it would tend to strengthen
the suspicion that Federal Reserve policies were being influenced
unduly by consideration of facilitating Treasury financing and the
management of the public debt. It would probably be suspected,
rightly or wrongly, that the influence of the Secretary of the Treasury
would be exerted in the direction of low interest rates to hold down the
interest cost on the debt, even at times when the appropriate credit
policy would be one of restraining credit expansion with the probable
accompanying result of raising interest rates.
Reply of W. S. McLarin, Jr., Federal Reserve Bank, Atlanta
The principal disadvantage, not offset by any corresponding advantage, would be that it would tend to strengthen the suspicion that
Federal Reserve policies wTere being influenced unduly by considerations of facilitating Treasury financing and the management of the
public debt. It would probably be suspected, rightly or wrongly,
that the influence of the Secretary of the Treasury would be exerted
in the direction of low interest rates to hold down the interest cost
on the debt, even at times when the appropriate credit policy would
be one of restraining credit expansion, with the probable accompanying result of raising interest rates.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
The principal advantage of placing the Secretary of the Treasury on
the Board would be the theoretical gain in mutual understanding.
Actually the Secretary, when he was on the Board, found little time
to attend Board meetings; and, consequently, the presumed advantage
was minimized. However, new problems arising from the magnitude
of the public debt make Federal Reserve policy and action much more
important to the Secretary than was the case when he was a member
of the Board.




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MONETARY, CREDIT, AND FISCAL POLICIES

3 (c). Would you favor such a provision ?
The System answer
While we do not believe that membership of the Secretary of the
Treasury in the Board of Governors would, in fact, mean undue
emphasis in the determination of Federal Reserve policies on Treasury
financing considerations, we are inclined to believe that establishment
of a national credit advisory council of the sort suggested in the reply
to question VI (6) would be a better method of promoting greater
coordination of monetary and debt-management policies. Past experience suggests that the many demands on the time of the Secretary
of the Treasury are likely to prevent his regular, or even frequent,
attendance at the meetings of the Board. Furthermore, the Secretary
could hardly be expected to devote the considerable amount of time
to meetings of the Board that is taken up by discussion of the internal
affairs of the Federal Reserve System. Consequently, it is questionable whether the presumed advantage of the Sacretary's membership
on the Board would, in fact, be realized. Two prominent former
Secretaries of the Treasury, who served also as members of the Federal
Reserve Board, Carter Glass and William McAdoo, later took the
position that the Secretary of the Treasury should not be ex officio
a member of the Board.
Reply of W. S. McLarin, Jr., Federal Reserve Bank, Atlanta
No. Some better method of coordination should be found.
Reply of J. N. Peyton, Federal Reserve Bank, Minneapolis
The major problem of coordination between the Federal Reserve
and the Treasury is that it be on a basis where neither has the dominant, overriding influence. The verdict of history may be that in
the postwar years inflation control was more important than maintaining Government bond prices. In that case it may seem that
Treasury influence in monetary affairs during this period has been
excessive even in view of the legacy of war financing problems. While
much can and has been done through informal consultation, the almost
inevitable result has been that Treasury preferences have been accorded excessive weight. Having the Secretary of the Treasury as
a Board member does not seem to be the answer to this problem. Here
the Secretary of the Treasury tends to be in the status of a "poor relation" since, in any formal sense, the Board could always outvote the
Treasury. It is not surprising, therefore, that this device, during its
period of existence, was not found to be particularly useful. The Secretary's chronic absence from Board meetings can be presumed to be
circumstantial evidence of this unbalanced relationship.
This problem might be met by the establishment of a National
Monetary Council somewhat along the lines of the Hoover Commission recommendation. Through this device not only potential conflicts between the Federal Reserve and the Treasury policies but also
divergent policies between the Federal Reserve and lending agencies
can be aired and minimized. This has the considerable advantage that
all agencies meet on roughly equal terms, and a formalized clearing
arrangement is thereby provided.
This is not, however, a panacea. It does not guarantee the elimination of policy conflicts. Its greatest weakness, in fact, might be the
illusion of having come to grips with hard decisions through the




115 MONETARY, CREDIT, AND FISCAL POLICIES

mirage of a new organizational set-up. The basic question is one
on which public opinion must make up its mind. There are times
when easy money and credit and stable prices cannot both be had.
It is essential not to lose sight of the fact that what are often called
Treasury-System conflicts are really the periodic incompatibility of
these conflicting objectives. And these conflicts are not automatically
eliminated by putting the contending parties on a new commission.
It must, of course, be emphasized that a great deal can be accomplished
through continuous and informal consultation at the top level if there
is a genuine will to keep in mind the whole public interest.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
A congressional directive setting up a common objective for Federal
Reserve and Treasury policies is proposed above as a means of achieving a better coordination of monetary and debt-management policies.
If this were done, it would not be necessary to make the Secretary of
the Treasury an ex officio member of the Federal Reserve Board to
accomplish the same purpose. Two former Secretaries of the Treasury, Carter Glass and William G. McAdoo, after having served as ex
officio members, expressed the opinion that the Secretary of the Treasury should not be a member of the Federal Reserve Board.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
On balance, I would not favor placing the Secretary on the Board.
The anticipated greater coordination of policy would not necessarily
take place. I believe a small National Monetary and Credit Council
would be a preferable step.
4. What changes in the objectives and policies relating to the
management of the Federal debt would contribute to the effectiveness of Federal Reserve policies in maintaining general economic
stability ?
The System answer
The Federal Reserve System has a vital interest from the point of
view of its responsibilities for monetary and credit policy in the
broader consequences and implications of Treasury financing. The
objectives and policies relating to the management of the Federal debt
should give due emphasis and consideration to the effects of debt management on bank reserves and the money supply, both directly and
indirectly through restraints upon the exercise of Federal Reserve
policies.
The following aspects of debt management are of importance in
this respect:
(1) Freedom to permit adequate flexibility in interest rates and
prices of Government securities in response to changing economic
conditions would definitely contribute to the effectiveness of the
Federal Reserve policies directed toward the objective of maintaining general economic stability. Adherence to a rigid pattern
of rates and prices in times of large private demands for credit
and capital funds may require Federal Reserve purchases (in
maintaining orderly markets for Government securities) in an
amount which lessens the effectiveness of Federal Reserve policies
aimed at restraining the supply and availability of bank reserves
and the money supply. Again, maintenance of a wide margin
between short-term and long-term rates on marketable securities



116

MONETARY, CREDIT, AND FISCAL POLICIES

through Federal Reserve intervention encourages "playing the
pattern" and results in undesirable monetization of the Federal
debt through sale of short-term securities to the Federal Reserve
in order to purchase longer-term higher-rate issues.
(2) The choice of types of securities in new money or refunding operations must be such as to appeal appropriately and at
the right time to bank and nonbank investors. For instance,
offering of a particular type of security might necessitate Federal
Reserve support and bring about undesirable extension of Federal Reserve bank credit. In inflationary periods, particular
emphasis is needed upon the offering of securities which will appeal to nonbank investors, thereby minimizing the transference of
public debt to the Federal Reserve System. In periods of business recession, the Treasury should offer types of securities mainly
appropriate for banks. It would be undesirable to offer long-term
securities at higher interest rates instead of short-term securities
at lower interest rates at a time when the Federal Reserve System
was endeavoring to introduce easy money policies in an effort to
combat recession.
(3) Consideration should be given to the offering of securities
which will encourage stable holdings by nonbank investors. For
example, it has been suggested that attention be given to the issuance of long-term bonds in a nonmarketable form, redeemable
on demand prior to maturity at a discount so as to give a lower
yield if not held until maturity. Through these issues an appropriate rate could be paid for genuine long-term savings, but the
Treasury would not have to pay a high coupon rate to purchasers
who hold for a short period only. Successful use of such issues
would also permit a reduction in the amount of long-term marketable securities outstanding. It is the marketable issues which
necessitate Federal Reserve support in maintaining orderly conditions in the Government securities market.
Reply of J. N. Peyton, Federal Reserve Bank, Minneapolis
The major peril here to avoid is that debt management policies
inadvertently sterilize monetary policy—a major problem in the immediate postwar years. This has in fact emerged as the major postwar monetary-fiscal problem. While our experience with this problem
at its present magnitude is still brief, some conclusions do seem to
emerge.
(a) Appropriate variations in interest rates (particularly shortterm rates) can be an instrument of monetary policy without saddling
the Treasury with excessive additions to debt service charges. Much
was done along this line in the immediate postwar years. It seems
clear, however, that more could have been accomplished had the Treasury not been reluctant so long to adopt this policy.
(b) Some greater degree of flexibility in the price of marketable
securities can help to minimize the conflict of debt management and
monetary policy. Our experience with this problem during the postwar period clearly suggests that a great deal might have been gained
by some greater downward flexibility in the price of marketable securities even to a level but slightly below par.




117 MONETARY, CREDIT, AND FISCAL POLICIES

(c) The less willingness there is to pursue the policies mentioned
above, the more will the conflict between debt management and monetary policy have to be minimized through some sort of a variant of the
certificate reserve proposal.
The reason for this is clear. The requirements of Government bond
price stabilization policy and monetary policy directed toward highlevel economic and price stability are inconsistent during periods of
inflationary pressure. During such periods the demand for credit
will presumably be relatively heavy. To restrain undue credit expansion and, therefore, inflationary tendencies, restrictive monetary
policy is required. This means putting enough pressure on the money
and capital markets to make funds less readily available. Here the
dilemira becomes evident. If such pressure should become really
restrictive, banks and financial institutions will tend to unload Government securities in favor of higher yielding private loans, debentures, and securities. The prices of Government securities will accordingly tend to fall and yield rates rise or the Federal Reserve must
come to their rescue with necessary purchases. This creates excess
reserves and, therefore, an easy monetary policy, a result which is
precisely at variance with what would be appropriate for the inflationary situation. The inevitable result, therefore, will be some added
creation of bank reserves, some further credit expansion, some added
inflationary pressure generally and some further deterioration in the
real value of the bonds.
To minimize this problem and still adhere to the policy of supporting the price of Government securities, some procedure to "pin down"
holdings of these securities will be required. The secondary or certificate reserve proposals, as proposed during the postwar boom by
the System, constitute a partial method of dealing with the solution.
Through this plan banks would be required to hold Government securities up to a certain proportion of their deposits. On the other hand,
this is not the whole solution since banks are not the only holders of
marketable securities. In fact, it is well to remember that from June
1947 to December 1948 holdings of Government securities by insurance companies wrere reduced by 3.5 billion dollars, as insurance companies were shifting out of governments in favor of more attractive
yield rates on private securities. This forced the Federal Open Market Committee to purchase large quantities of bonds in order to support the bond price level. Therefore, it seems clear that such a plan
must envisage the inclusion of other financial institutions such as life
insurance companies also, as well as banks or other remedies must be
found.
The real policy issue here must presumably be settled by Congress
and public opinion rather than by the monetary authorities in a restricted sense. It is important for the public to realize that adherence
to the policy of supporting the price of Government securities leads
toward some such program of pinning down the Government debt
unless it is preferred to allow the inflation to run unchecked—or allow
some greater downward flexibility in the price of Government
securities.




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MONETARY, CREDIT, AND FISCAL POLICIES

(d) The important thing is that the usefulness of the monetary
policy not be sold short through belief in the inevitable transcendency
of debt management policy.
Reply of W. S. McLarin, e/>., Federal Reserve Bank, Atlanta
The objectives and policies relating to the management of the Federal debt should give due emphasis and consideration to the effects
of debt management on bank reserves and the money supply, both
directly and indirectly through restraints upon the exercise of Federal Reserve policies, in accordance with the objectives of the Employment Act.
The following aspects of debt management are of importance in
this respect: Freedom to permit adequate flexibility in interest rates
and prices of Government securities in response to changing economic
conditions would definitely contribute to the effectiveness of the Federal Reserve policies directed toward the objective of maintaining general economic stability.
The choice of types of securities in new money or refunding operations must be such as to appeal appropriately and at the right time
to bank and nonbank investors.
Consideration should be given to the offering of securities which will
encourage stable holdings by nonbank investors.
5 (a). On what occasions, if any, since 1929 have the Government's fiscal policies militated against the success of the Federal
Reserve in attaining its objectives ?
The System answer
The years since 1929 have seen a succession of depression, inadequate
recovery, defense and war, postwar boom, and abatement of inflationary pressures. By and large, the Government's fiscal policies during these years have been in the same direction as Federal Reserve
policies. Frequently, however, the Government's fiscal policies have
been inadequate in extent or have not comprised an entirely consistent
program from the standpoint of stability and growth in the economy.
In retrospect, the depression of 1929-33 probably should have been
met by a more vigorous fiscal program, involving greater increases
in emergency Government expenditures. Again, efforts to balance
the budget through increases in tax rates and the imposition of new
taxes were futile and unsound at a time of severely depressed business
conditions.
The financing of the war provided another example of inadequate
fiscal action. Particularly during the first years of the war, Federal
tax receipts were below the levels urgently needed from the standpoint
of more effective wartime economic policy, as well as for restraint of
postwar inflationary tendencies. Higher wartime levels of taxation
would have lessened wartime deficits and would have eased to some
extent, therefore, the present dilemmas in Federal Reserve policy
resulting from the size and nature of the wartime increase in the
public debt. Moreover, a greater share of that debt probably should
have been placed outside the banking system.
The achievement of substantial cash surpluses in fiscal 1947 and
1948 and their use to retire bank-held debt provided an example of
effective fiscal action which greatly aided the Federal Reserve in seek-




119 MONETARY, CREDIT, AND FISCAL POLICIES

ing to attain its objectives. However, the very high level of Federal
expenditures itself provided a substantial inflationary stimulus.
Moreover, the anti-inflationary effect of budget policy in the postwar
boom would have been heightened by exclusive use of cash surpluses
in retirement of Federal Reserve holdings of Government securities.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
The period since 1929 included a depression, a war, a postwar inflation and, more recently, an abatement of inflationary pressures. In
general, Government fiscal policies did not seriously interfere with
the success of Federal Reserve policies during this period. In retrospect, of course, instances may be cited in which fiscal policy could
have been more effective in contributing to their success.
The financing of World War II provides one illustration. It was
important from the standpoint of preventing inflation that Treasury
expenditures be financed as far as possible out of current income. If
taxes had been increased sooner and a larger proportion of war expenditures had been financed by taxation, the wartime deficit would
have been less, the Federal debt would not have been as large, and the
problem of restraining postwar inflation would have been lessened.
In the postwar period certain governmental fiscal policies conflicted
with Federal Reserve action to check inflation. For example, taxes
were reduced and large cash payments were made to veterans at a time
when total spending was already too large in relation to the available
supply of goods. The Government's program of very easy credit for
housing tended to accelerate credit expansion at a time when Federal
Reserve authorities were trying to restrict it.
From the standpoint of avoiding war and postwar inflation, Federal
tax policy during the war could have been more effective. From the
standpoint of civilian morale and incentives for maximum production,
however, there were dangers in raising the level of taxation too high.
Viewed as a means of helping the veterans who sacrificed much during
the war, the cash payments and very easy home-purchase credit may
seem justified. But when judged in relation to existing inflationary
pressures, they were ill-timed.
Reply of W. S. McLarin, Jr., Federal Reserve Bank, Atlanta
The depression of 1929-33 probably should have been met by a
more vigorous fiscal program, involving greater increases in emergency Government expenditures. Efforts to balance the budget
through increases in tax rates and the imposition of new taxes were
futile and unsound at a time of severely depressed business conditions.
On the other hand, during the first years of the war, Federal tax
receipts were far below the levels urgently needed from the standpoint of more effective wartime economic policy, as well as for restraint of postwar inflationary tendencies. Higher wartime taxation
would have lessened wartime deficits and would have eased to some
extent, therefore, the present dilemmas in Federal Reserve policy
resulting from the size and nature of the wartime increase in the
public debt. An example of effective fiscal action which greatly aided
the Federal Reserve in seeking to attain its objectives was the achievement of substantial cash surpluses in fiscal 1947 and 1948 and their
use to retire bank-held debt.




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MONETARY, CREDIT, AND FISCAL POLICIES

5. (b) What type of fiscal policy would best supplement monetary policies in promoting the purposes of the Employment Act?
The System answer
The high level of Federal expenditures and taxes and their importance in the economy make appropriate fiscal policies of substantial
importance in promoting the purposes of the Employment Act. Much
more is involved than the dollar amounts of cash surpluses or deficits.
Consideration must also be given to the absolute levels of Federal
expenditures (both in terms of purchases of goods and services and
transfer payments), to the types of taxes imposed, and to Government
loan guaranties.
The fiscal policies of the Government are affected by developments
in the economy and in turn will influence the level of economic
activity. Fiscal policies therefore should be in the right direction as
must monetary policies, which are more flexible, in promoting the
purposes of the Employment Act. In good times and especially in
periods of inflationary pressures, surpluses should be achieved and
used for retirement of bank-held Federal debt. High levels of income
and profits provide an opportunity for scaling down the public debt
which should be utilized. There should be restraint in periods of
high employment upon Government expenditure programs which
can be deferred.
In bad times there will be necessitous increases in expenditures,
such as constructive public works programs deferred in periods of
prosperity. Tax rates should clearly not be raised in periods of
business recession, because such action would accentuate the problem
of unemployment and low production. Tax revenues under the existing tax rates will decline in bad times, of course, as incomes and profit
levels decline.
Attention must be given to certain undoubted dangers and limitations which are attached to the growing reliance upon fiscal policies.
There are strong pressures on behalf of higher governmental expenditures and lower taxes, irrespective of the current economic situation.
A difficult but vital distinction must be made between short-run
increases in Government expenditures to combat recession and longrange decisions as to continuing programs of Government action.
The incentive impact of taxation upon the attractiveness of increased
income, and hence upon private expenditures, demands greater attention. Uncertainties of economic analysis and economic forecasting
limit the possibilities of appropriately adjusting fiscal policies to each
current short-run economic situation. There is need alike for sharpened tools of fiscal management both in the executive branch and in
Congress, and for greater public understanding of the fiscal process.
Above all, care must always be exercised to avoid exaggerating the
usefulness of fiscal policies alone. If stability is to be achieved at a
high level in a private enterprise economy, there must be emphasis
as well upon price and wage policies, and upon monetary policies.
Reply of Joseph A. Erickson, Federal Reserve Bank, Boston
The high level of Federal expenditures and taxes and their importance in the economy make appropriate fiscal policies of substantial
importance in promoting the purposes of the Employment Act. Much




121 MONETARY, CREDIT, AND FISCAL POLICIES

more is involved than the dollar amounts of cash surpluses or deficits.
Consideration must also be given to the absolute levels of Federal
expenditures (both in terms of purchases of goods and services and
transfer payments), to the types of taxes imposed, and to Government
loan guaranties.
The fiscal policies of the Government are affected by developments
in the economy and in turn will influence the level of economic activity.
Fiscal policies therefore should be in the right direction as must monetary policies, which are more flexible, in promoting the purposes of
the Employment Act. In periods of inflationary pressures, surpluses
should be achieved and used for retirement of Federal debt held by
the Federal Reserve banks and the commercial banks. In good times,
some reduction of the Federal debt held by individuals, insurance and
savings institutions might be achieved. High levels of income and
profits provide an opportunity for scaling down the public debt which
should be utilized. There should be restraint in periods of high employment upon Government expenditure programs which can be
deferred.
In bad times there will be necessitous increases in expenditures, such
as constructive public works programs deferred in periods of prosperity. Tax rates should clearly not be raised in periods of business
recession, because such action would accentuate the problem of unemployment and low production. Tax revenues under the existing tax
rates will decline in bad times, of course, as incomes and profit levels
decline.
Attention must be given to certain undoubted dangers and limitations which are attached to the growing reliance upon fiscal policies.
There are strong pressures on behalf of higher governmental expenditures and lower taxes, irrespective of the current economic situation.
A difficult but vital distinction must be made between short-run increases in Government expenditures to combat recession and longrange decisions as to continuing programs of Government action. The
incentive impact of taxation upon the attractiveness of increased income, and hence upon private expenditures, and investments demands
greater attention. Uncertainties of economic analysis and economic
forecasting limit the possibilities of appropriately adjusting fiscal
policies to each current short-run economic situation. There is need
alike for sharpened tools of fiscal management both in the executive
branch and in Congress, and for greater public understanding of the
fiscal process. Above all, care must always be exercised to avoid exaggerating the usefulness of fiscal policies alone. If stability is to be
achieved at a high level in a private enterprise economy, there must
be emphasis as well upon price and wage policies, and upon monetary
policies.
Reply of Allan Sprout, Federal Reserve Bank, New York
Fiscal policies, as has been indicated in the introduction to section II
of the accompanying research study, are the result of the many individual decisions taken by Congress concerning governmental expenditures and taxes. With governmental expenditures now accounting for
more than one-sixth of the gross national product, it is obvious that
these congressional decisions will inevitably affect the volume and composition of total output. That is not to say, however, that expenditures




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MONETARY, CREDIT, AND FISCAL POLICIES

and taxes can be rapidly increased or reduced in response to every
change in the business outlook, with Government receipts and disbursements providing the balance needed for holding the economy at high
and stable levels of employment and income. Even if Congress could
ignore the special considerations giving rise to each major tax and
expenditure item, adjustments would necessarily be slow moving and
blunt in their effects.
What can be expected, probably, is that in periods of inflation Congress will be reluctant to increase any expenditures that would contribute further to inflationary pressures, and that most taxes would
be held at relatively high levels. Conversely, in depressed periods
Congress might emphasize expenditures for worth-while public projects and avoid the imposition of new taxes or tax rates that would
seriously interfere with economic recovery. It seems highly impracticable to suppose, however, that taxes and expenditures already
scheduled and in effect can be rapidly and substantially altered to
offset changes in the general economic situation. Certainly such
action would imply a swiftness of response, and an accuracy in forecasting, for which American experience has not yet furnished a promising precedent.
There is grave danger in any case in relying upon even a combination of fiscal policy, monetary policy, and debt management to cure
instability in our economy. The stabilizing powers of monetary
measures were exaggerated two decades ago. There has been some
tendency to make the same mistake with respect to fiscal policies in
recent years. While the fullest practicable coordination among fiscal,
debt management, and monetary policies is desirable, and while such
coordination can do much to promote economic stability, we should
avoid deceiving ourselves or the public in the belief that all major
economic disturbances can be corrected by these measures.
Granting the limitations then, what can be done? The field for
administrative coordination is in the relations between the Treasury
and the Federal Reserve System, and cannot readily include those
major aspects of fiscal policy determined by congressional decisions.
Each step taken by the Treasury in disposing of a current surplus,
in financing a current deficit, or in replacing matured issues of Government obligations with new issues, has a direct influence on the
money market—the same money market through which Federal Reserve credit policies are also being carried out. Generally speaking,
there is a wide range of alternatives open to the Treasury when any
of these steps is taken, and some of these alternatives will always be
more nearly consistent with the current phase of credit policy than
others.
For example, a cash surplus arising in a period when monetary
policy is aimed at restraint might best be devoted (subject to the special technical factors which differ from case to case) to retiring Government securities held by the Federal Reserve banks because the
transfer of funds will correspondingly reduce the reserves of the
banking system. A cash deficit occurring in such a period (which
would probably represent a failure of adjustment of fiscal policy to
the economic situation) might best be met by the sale of new Government securities to the public, thereby absorbing funds from the inflated income stream, rather than by sale to the banks, which would
enlarge the money supply, or indirect sale to the Federal Reserve



123 MONETARY, CREDIT, AND FISCAL POLICIES

banks, which would enlarge both the money supply and the reserves
of the banking system (permitting a further multiple expansion of
money and credit). The replacement of maturing issues at a time of
monetary restraint also offers possibilities for greater or lesser consistency between debt management and monetary policy. Treasury
insistence, for example, on adding to the supply of issues no longer
attractive to the public, or even to the commercial banks, might force
the Federal Reserve System to choose between its general policy of
restraint and the apparent necessity of releasing additional reserve
funds to create buyers for the new issue and protect the Government
credit.
These are but three abbreviated illustrations of the inevitable connection between Treasury debt management and Federal Reserve action. Many more could be suggested. But it is clear even from these
few hypothetical cases that the interrelationships are much too variable and complex to be suitable subjects for precise legislation. What
the Treasury does in any of these situations is within the scope of its
powers as defined by Congress; the indicated Federal Reserve policy
would also be formulated consistently with the System's broad directives from Congress. The problem is one of administrative coordination within the framework of delegated powers. It may not always be possible fully to reconcile the aims of debt management
and monetary policy, but every effort should be made to assure mutual
consideration of problems and policies; and to avoid the sometimes
easy assumption that one takes precedence over the other—that a
Cabinet officer outranks the head of an independent agency and that
Treasury views, therefore, should prevail.
While I agree with the skepticism expressed in the accompanying
study over the practical usefulness of making the Secretary of the
Treasury an ex officio member of the Board of Governors, I do feel
that something might be done to give status to consultations between
the Secretary of the Treasury and the representatives of the Federal
Open Market Committee who discuss related debt management and
credit problems. For that reason, I am inclined to endorse the proposal for a congressional directive on this matter, or for a national
advisory council on domestic financial policy. Within such a group,
not only debt management and monetary policy could be discussed,
but also the experience of those Federal agencies which make credit
directly available to agricultural, financial and business borrowers.
Through the joint review of common policy issues it should be possible to achieve a degree of coordination, without suffering the grave
disadvantages that would arise from subordinating any one of these
agencies to the others.
Reply of Alfred II. 'Williams, Federal Reserve Bank, Philadelphia
The most important step in making fiscal policy an effective supplement to monetary policies in promoting the purposes of the Employment Act is to establish these purposes as the common objective. Those
primarily responsible for fiscal and debt management policies—Congress and the Treasury—must accept economic stability at high levels
of employment as their basic primary objective. Policies designed to
promote narrower, secondary objectives, even though desirable in themselves, must be pursued only within the limits imposed by an over-all
98257—49

9




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MONETARY,

CREDIT, AND FISCAL POLICIES

policy directed toward maintaining stability and a full utilization of
resources.
Once this basic objective is accepted, the formulation of specific
policies designed to achieve it will be greatly facilitated. In periods
of depression fiscal policy can be a valuable supplement to monetary
policy. Monetary policy can make funds available on easy terms, but
business firms will not invest unless they think there is a good chance
to make a profit. Fiscal policy can help get the economy off dead center
if it results in the Treasury paying out more than it takes in and
financing the deficit through the banking system. This not only increases the money supply but puts it into circulation via Government
expenditures, thus tending to increase the total flow of expenditures
and the demand for goods and services. On the other hand, in periods
of inflation, fiscal policy, by effecting a Treasury cash surplus and
using it to retire Treasury securities held mainly by the Federal Reserve System, can reduce bank reserves and the money supply available
for expenditure. This also concentrates debt repayment in periods
of high income when the public is best able to bear the additional
burden. Thus,fiscalpolicies aimed at stimulating the flow of spending
in periods of slack demand and restricting it during inflation, rather
than always aimed at low carrying costs, would contribute materially
to the success of Federal Reserve policies directed toward maintaining
economic stability.
Monetary, fiscal, and debt management policies are only one sector
of the front in the battle to maintain stability at high levels of income
and employment. The policies in all of the major sectors of the
economy should be coordinated toward our No. 1 problem of winning
the battle against business fluctuations and of maintaining production,
employment, and incomes at high levels. Success requires that we
move ahead on all fronts.
I I I . INTERNATIONAL P A Y M E N T S , GOLD, SILVER

1 (a). What effect do Federal Reserve policies have on the
international position of the country ?
The System answer
To the extent that the Federal Reserve System is successful in exerting a stabilizing influence on the economy of the United States, it contributes also to the success of the international policies of this country
and hence to a strengthening of its international position. Owing to
the industrial predominance of the United States and its importance
as an importer of raw materials (and also as a consumer of some types
of imported finished goods), economic conditions here have far-reaching effects on economic conditions throughout a large part of the world,
and hence upon the success of this country's efforts to promote world
economic and political stability. An unrestrained boom here followed
by a collapse and severe depression would have disastrous economic
effects abroad which would involve the risk of political developments
unfavorable to the United States. On the other hand, to the extent
that Federal Reserve policies contribute to expansion of industrial
activity in a situation such as the present one, the international trade of
the United States will be stimulated, with beneficial effects abroad—
on the British dollar problem, for example.




125 MONETARY, CREDIT, AND FISCAL POLICIES

In earlier days of unrestricted capital movements, speculative booms
here, especially in the security markets, attracted foreign capital to this
country to the detriment of the economies of foreign countries. In
recent years, however, restrictions on capital movements by foreign
countries, together with the use of powers granted the Reserve System
to restrain the use of credit in such speculative waves, have minimized
the danger of such disruptive developments.
Finally, Federal Reserve policies, through their effects on money
market conditions, affect the terms of Treasury financing of Government expenditures, including expenditures for foreign aid and other
aspects of this country's international policies. They also affect the
ability of foreign countries and international institutions to borrow
capital in the United States, and the terms of such borrowing, as well
as the financing of private investments abroad by United States
nationals.
1 (&). To what extent is the effectiveness of Federal Reserve
policy influenced by the international financial position and policies of this country ?
The System answer
The international financial position and policies of this country,
through their effects on the demand from abroad for the products of
our industries and agriculture and on the volume of purchasing power
in the United States, may have an important influence on the effectiveness of Federal Reserve policy. To the extent that the international
position of this country involves heavy gold inflows from abroad in
payment for United States products, the effect is to add to the money
supply and also to volume of purchasing power in the United States
(wages, farm and other entrepreneurial income, and profits) at the
same time that part of this country's production is being diverted to
foreign use. Furthermore, gold inflows add to the volume of bank
reserves and thus provide the basis for a secondary expansion of the
money supply through credit expansion. Thus the tendency is to
create or add to inflationary pressures here. A situation of this kind
creates a problem for the Reserve System in its efforts to prevent an
expansion of the money supply which is not paralleled by a growth in
the supply of goods for domestic consumption. At the same time the
Reserve System feels a responsibility for avoiding policies which
might have restrictive effects on production and hence on the ability
of this country to support the international economic and political
policies of the Government.
The opposite type of situation may also arise—one in which there is
a gold outflow which tends to reduce the money supply and bank reserves at a time when a shrinkage in the money supply (or even
inability to extend it) may seriously hamper the financing of essential
production and Government expenditures. For example, in the recent
war period, when a moderate outflow of gold coincided with needs
for the utmost utilization of the country's productive capacity and
manpower and with a heavy drain on bank reserves caused by a rapid
increase in currency circulation, it was necessary for the Reserve
System to supply very large amounts of Federal Reserve credit to
the banking system to prevent serious interference with the financing
of the war effort.




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MONETARY, CREDIT, AND FISCAL POLICIES

The ability of the Federal Reserve Svstem to carry out effective
credit policies is also greatly affected by Government policies relating
to gold and (to a much smaller extent) by policies relating to silver.
For example, the rise in the United States gold price in January 1934
from approximately $20.67 an ounce to $35 an ounce, was followed by
a huge gold inflow and a correspondingly great expansion of bank
reserves. This gold inflow was attributable only in part to the direct
effects of the advance in the gold price in inducing a speculative inflow
of capital to take advantage of an expected inflation here or the ultimate devaluation of the "gold bloc" currencies in Europe, and was
more largely attributable to a flight of capital from Europe in fear
of the Hitler regime and eventual war, and later to payments for war
supplies by the countries at war with Germany. Nevertheless, the
rise in the gold price greatly increased the dollar value of the possible
gold inflow, first by stimulating greatly gold production throughout
the world, and second, by increasing the unit value in dollars of existing gold stocks. The growth of bank reserves resulting from the
gold inflow was so large and so rapid, that the Federal Reserve System
would have been quite unable to exert any effective influence on the
volume of credit and the money supply, but for the authority granted
it by the Congress to increase member bank reserve requirements up
to double the statutory requirements. And despite this authority,
member banks at the end of 1940 held nearly $7,000,000,000 of excess
reserves, an amount substantially greater than the System could have
absorbed by the maximum use of its authority over reserve requirements and by the sale of all of its security holdings. It was only the
huge financial requirements incident to this country's participation
in the war that resulted in the regaining by the Reserve System of a
position in which it could again exert an effective influence over the
banking and credit situation in this country.
Meanwhile, the gold inflow and the resulting accumulation of bank
reserves at a rate faster than the banks were able to use them had
effects on the interest-rate structure in this country which have constituted a major source of difficulty for the Federal Reserve System
in recent years. The shortest-term interest rates declined almost to
zero, and long-term rates had a smaller proportionate reduction before
the war. After a slight rise early in the war period, a structure of
rates was fixed for the war financing which encouraged "playing the
pattern of rates" and was a serious obstacle to the System's efforts to
restrain further expansion of the volume of bank credit and the money
supply in the postwar period.
1 (<?). What role does the Federal Reserve play in determining
these policies?
The System answer
The System plays an important role in the determination of the
international financial policies of this country through the representation of the Board of Governors on the National Advisory Council.
Advisory relations of the Board and the Reserve banks with the
Treasury and the ECA, and occasional testimony before Congressional committees are other means by which it is able to exert some
influence upon such policies. The System has also supplied trained
men for various foreign missions to aid in carrying out the international economic policies of the United States.



127 MONETARY, CREDIT, AND FISCAL POLICIES

1 (d). In what respects, if any, should this role be changed?
The System answer
In view of the great effect on the System's position of policies such
as that relating to the price of gold, it seems appropriate to emphasize
the necessity of continued Federal Reserve participation in the determination of such policies if the System is to be able to carry out effectively the responsibilites placed upon it by Congress. However, no
specific changes in the System's role are suggested at this time.
2 (a). Under what conditions and for what purposes should the
price of gold be altered ?
The System answer
Criteria for altering the gold price must depend upon the type of
monetary standard in existence in the United States, and the standards
prevailing in the rest of the world. Given a fractional reserve banking
system, which supplies a dominant share of the total quantity of
money, and given responsible control over the banking system by the
Federal Reserve System (to provide the fullest practicable adaptation
of the money and credit supply to the requirements of economic
stability)—there are no apparent domestic "conditions or purposes"
under which the price of gold need be altered. However, so long as
the United States continues to rely upon gold as one medium for
settling its balances on foreign account, a change in the gold price may
be necessary on rare occasions as an adjustment to fundamental structural changes in the network of international trade and monetary
relationships.
As a domestic consideration, it has been suggested that the gold
price should be raised at present to correspond with the rise in the
general level of commodity prices over the past decade. That is not a
valid reason for raising the gold price. A rise in the gold price would
be likely to result in a substantial increase in the reserve base of the
banking system. And there is no reason why a sustained rise in the
price level should be followed by an arbitrary increase in the reserve
base, permitting additional deposit expansion and a further upward
spiraling of prices. The rise in the United States gold price in 1934
brought it 69 percent above the previous level; United States wholesale prices have now reached a point 60 percent above the 1927-29
level. Moreover, the present United States gold stock is sufficiently
large to support such further growth in the money supply of the
country as may be needed for many years ahead.
So far as international factors are concerned, it is impossible to
formulate in advance precise criteria for altering the gold price in
response to structural changes which are, by their nature, unpredictable. In general, a persistent inflow of gold would, if there were
no extenuating circumstances, suggest a need for lowering the dollar
price of gold, since the self-correcting mechanism of a world-wide gold
standard is not in operation. Conversely, given the monetary standards which appear likely to exist throughout the world, a long continued outflow of gold would suggest a basis for raising the dollar
price of gold. In appraising the significance of those gold movements
which do occur, however, a distinction must be made between gold
movements resulting from underlying trade factors, or capital movements, and the gold flow which can be directly attributed to the level
of the dollar price of gold.



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MONETARY, CREDIT, AND FISCAL POLICIES

E^en if evidence were to suggest that the gold price itself had been
responsible for persistent one-way gold flows, no change in the gold
price should be undertaken as a result of these international considerations until provision had been made to offset the possible harmful
effects of the change upon the reserve base of the domestic monetary
system. It would certainly be unwise to consider raising the gold price
for such nonmonetary reasons as a desire to extend additional foreign
aid to those countries which possess or produce substantial amounts of
gold. Foreign aid should continue to be administered by Congress,
with due regard for the legitimate needs of the recipient countries,
rather than extended according to the more or less accidental distribution of existing gold stocks, or of gold-producing capacity. The fixed
relation between gold and the dollar has become over the past 15
years the one firm element in a world of unstable currencies; that
relationship should not be altered for transitory considerations.
2 (6). What consideration should be given to the volume of
gold production and the profits of gold mining ?
The System answer
There is no reason for the United States to give consideration to the
volume of gold production, or the profits of the gold-mining industry,
in reaching a decision concerning its gold price. Since gold is relied
upon primarily as a convenient medium for settling differences on
international account, rather than as the ultimate reserve base for
most existing monetary systems, there is no special reason to regard
the encouragement of gold production as a concomitant of monetary
policy. Gold-producing countries which rely upon exports of gold
for a significant portion of their foreign exchange earnings, rather
than directing their resources more largely to the production of other
export commodities, would undoubtedly take a different view of this
question.
2 (c). What effect would an increase in the price of gold have
on the effectiveness of Federal Reserve policy and on the division
of power over monetary and credit conditions between the Federal
Reserve and the Treasury?
The System answer
As noted above, the principal domestic consequence of an increase in
the price of gold is an arbitrary increase in the potential reserve base
of the banking system. An increase in the gold price to $50, for
example, would increase the dollar value of the present United States
gold stock by about 10 billion and give a "profit" to the Government
of a like amount. Use of this profit by the Treasury in meeting Government expenditures would increase the money supply and add a
corresponding amount to bank reserves, thereby providing the basis for
a further large expansion of credit and of the money supply. If the
Treasury were to hold idle its proceeds from the rise in the gold price,
in deference to Federal Reserve policy, one of the major benefits
claimed for a rise in the gold price would not be realized. In any
event, the Treasury would be placed in a position to exert great influence upon the volume of bank reserves and thus (if there were not
full cooperation between the Treasury and the Reserve System) to
interfere seriously with the efforts of the System to maintain an effective credit policy.



129 MONETARY, CREDIT, AND FISCAL POLICIES

Furthermore, reserves would also be swelled as the regular gold
inflow from abroad, recently at a rate of roughly $1,000,000,000 a year,
would be valued upward by more than 40 percent. In addition, gold
production throughout the world would be greatly stimulated and the
additional output would, in all probability, flow largely to the United
States. Thus, unless the System's authority over reserve requirements
were further increased, permitting it to absorb the resulting additions
to bank reserves by raising these requirements, the System would soon
exhaust its power to exert an effective influence upon the expansion of
credit and the money supply, even if it were to sell all of its earning
assets through open-market operations aimed at absorbing the new
reserves (thereby also losing its ability to earn an income sufficient to
cover its expenses).
3 (a). What would be the principal advantages and disadvantages of restoring circulation of gold coin in this country ?
The System answer
Several advantages of restoring gold coin circulation in this country
have been suggested. The principal argument is that by opening this
country's gold reserves to public withdrawal a certain discipline will
be imposed upon Government spending and upon bank-credit expansion. It is said that whenever the public might sense dangerous developments, the reactions of many individuals would be to demand gold.
With the monetary reserve being depleted, the Government would be
restrained from deficit financing through drawing upon new bank
credit; banks would likewise become reluctant to expand credit to the
private sector because of the drain on their reserves; and the Federal
Eeserve would have been given a signal to exert a restraining influence
upon the money supply. In this way, Congress, the Treasury, and the
Federal Eeserve System would be forced by indirection to accept policies which they would not otherwise adopt. It is also claimed that
convertibility into gold would increase public confidence in the currency and have a stabilizing effect on the economy.
In effect, under a gold-coin standard the initiative for over-all monetary control would, through the device of free withdrawal of gold
from the monetary reserve base, be lodged in the instinctive or speculative reactions of the public. Some segment of the public would, no
doubt, take advantage of the accessibility of gold for many reasons.
Conscientious resistance to large Government spending, or fear of inflation, may well be among these reasons. But speculative motives, a
desire for hoards (however motivated), and such panic reactions as
those set off by unsettled international conditions or monetary fright
concerning the business outlook—all of these, and more, will be among
the other reasons. The mechanism will not distinguish among motives. Whenever, for any reason, a few wealthy concerns or individuals, or a group of speculators, or the public at large, demand more gold,
the reserve base of the monetary system will be reduced. Moreover,
if only the dollar were convertible into gold while practically all other
currencies were not, hoarding demands from all over the world would
tend to converge upon this country's monetary reserves. Circumvention of the exchange controls of other countries would be stimulated,
and dollar supplies which they badly need for essential supplies or
for developmental investments would be diverted to the selfish interests
of the hoarders.




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MONETARY, CREDIT, AND FISCAL POLICIES

Even if a particular reduction should occur for desirable "disciplining" reasons, rather than for any of the others which will be continually affecting the reserve base, the impact of such gold withdrawals
upon the credit mechanism is likely to be crude and harsh. Since the
present ratio between gold reserves and the money supply is less than
1 to 5, and since a roughly similar ratio will be in effect so long as this
country retains a fractional reserve banking system, any withdrawal
of gold coins will tend to be multiplied many times over in its contractive effect on bank credit and the money supply. In a business
recession, the Reserve System might undertake to offset this effect
by adding to its holdings of Government securities, but, if the gold
withdrawals attained sufficiently large volume, the shrinking reserve
position of the Federal Reserve banks might eventually prevent them
from continuing such operations.
It was in large measure to offset such arbitrary and extreme influences upon the volume of credit, and to make up for the inflexibility
of a money supply based on gold coins (in responding to the fluctuating seasonal, regional, and growth requirements of the economy), that
the Federal Reserve System was initially established. During the first
two decades of its existence, the System devoted much of its attention
to offsetting the capricious or exaggerated effects of the gold movements associated with continuance of a gold-coin standard, and as a
consequence was handicapped severely in attempting to deal with the
crises of 1920 and 1931. The System relied upon its rediscount rate
and other limited operations to accomplish what it could. But when
the gold-coin standard was eventually abandoned, it was because
experience had shown that, at best, internal covertibility of the currency into gold was no help to the Federal Reserve System in its
efforts to exert a stabilizing influence on the economy and, at worst,
gold convertibility could at times actually prevent effective System
operation. The occurrence of two of the worst depressions in the
history of this country during the period when the United States was
on the gold-coin standard (in the 1890?s and the early 1930's) casts
serious doubt on the claim that return to such a standard would have a
stabilizing effect on the economy.
The high confidence in the currency of the United States today is a
result primarily of the great productive power of the American
economy and public confidence in this country's fiscal and monetary
policies; our gold reserves have grown steadily as a counterpart of
that superiority in production and that confidence in our national
policies. Those reserves are readily available to meet any outward
drain of funds to other countries, and are more than adequate to
satisfy any outflow that could conceivably develop. Confidence in
our currency is unquestioned. Only by undertaking to pay out gold
coins to everyone, and subjecting our gold reserves to the inroads of
speculation or whims of fancy, could we possibly create a danger of
depleting our gold reserves to the point where general confidence in
the currency might be jeopardized.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I am not in full apreement with the draft reply to this question.
While I realize that it may not be practicable to restore circulation of
gold coin in this country immediately when the rest of the world is
not on the gold standard and when political and economic uncertainties throughout the world would be conducive to the hoarding of gold



131 MONETARY, CREDIT, AND FISCAL POLICIES

coin, I do believe that we could and should liberalize the provisions of
law and regulation with respect to the ownership of gold by our citizens. I believe that steps could be taken to permit people to buy, hold,
and sell gold more freely in this country without endangering our
financial soundness.
3 (&). Do you believe this should be done?
The System answer
Because the discipline claimed for the gold-coin standard must necessarily be exerted with extreme harshness under a fractional reserve
deposit system; because the mechanical arrangements which would
permit such discipline would also necessarily open the way to a host of
capricious influences upon the supply of money and credit; because
ultimate responsibility for determining the amount of Government
expenditures must rest with Congress and the electorate, rather than
with any particular group of individuals; and because in the last
analysis the responsibility for deciding to what extent credit expansion or contraction should be encouraged, in the light of any set of
economic circumstances, ought to rest with the Federal Reserve System (as designated by Congress)—it would appear unwise to take
any steps toward the restoration of gold-coin payments in this country.
4. What changes, if any, should be made in our monetary policy
relative to silver? What would be the advantages of any such
changes ?
The System answer
United States policy with respect to the purchase of silver for the
monetary base is at present of minor significance. The policy does,
however, rest upon an unsound principle. In effect, in order to subsidize silver producers, the Treasury is directed to buy silver at a price
substantially above that on the world market, and in turn to issue
small denomination paper notes at a rate which provides a profit to
the Government. The silver subsidy differs, therefore, from other
subsidy programs of the Government in that payments automatically
increase the supply of currency (unless offset by Federal Reserve
action) instead of being met out of the Treasury's general revenues.
The issues of public policy involved in the granting of subsidies to
producers of silver, or of any other commodity, are properly considered
by Congress, not by the Federal Reserve System. While it may
be argued that an artificially high price for silver is a deterrent to the
silverware, jewelry, and related trades, perhaps offsetting any gains
which might flow to the silver producers, that is not a question of importance for monetary policy. The influence of the Federal Reserve
System upon the money supply is disturbed, however, by the fact
that the subsidy payments result in regular increases in the reserve
base of the banking system. The annual increase is not large, to be
sure; it has recently been less than $50,000,000 per year. Nonetheless, the Treasury's silver purchases do cause a continual increase
in the reserve base, year by year, regardless of whether monetary policy
is currently aimed at contracting or expanding that base.
So long as silver production is to be subsidized, Government purchases of silver should be handled in a manner comparable to that
now followed for the stock piling of strategic materials, or to that
used in crop support, and divorced from a direct relation to monetary




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MONETARY, CREDIT, AND FISCAL POLICIES

reserves. Silver can, of course, continue to be used in the manufacture
of metallic coins, just as many other metals are used today.
The monetary needs of the United States are served primarily by
bank deposits and printed notes. The Federal Reserve System is
charged with the responsibility of adjusting the money supply to the
requirements of the economy, in accordance with general objectives
such as those contained in the Employment Act of 1946. It is anomalous to continue automatically relating any segment of this money
supply, however small, to the subsidy payments made for encouraging
the production of silver metal.
Comments of Allan Sproul, Federal Reserve Bank, New York, on
III as a whole
Until roughly two decades ago it was expected that the Federal
Reserve System, as the Nation's central banking system, would exercise leadership in determination of international financial policies.
That responsibility has largely shifted, in recent years, to the Treasury
Department. It was expected that establishment of the International
Monetary Fund would constitute another step in this trend toward
direct governmental responsibility, by providing for a limited pooling
of responsibilities among countries. The shift away from central bank
responsibility has gone further in this country than in England or
Canada, for example, or in any other leading country in which the
central banks still retain appreciable autonomy in domestic matters.
It is within this narrowed framework that the Federal Reserve
System exercises its responsibilities in the foreign or international
field. It is represented in policy formation through the membership of
the Chairman of the Board of Governors on the present National
Advisory Council on International Financial Policy. That Council
provides a meeting ground where international financial issues can be
jointly reviewed, as they arise, by all of the affected agencies of Government. It has apparently enjoyed a considerable success in policy
coordination during the 5 years of its existence.
There may be a question, however, as to whether the experience
gained in conducting international financial transactions, which (so
far as the Federal Reserve System is concerned) are largely carried
out by the Federal Reserve Bank of New York, is given sufficient
representation in this development of a coordinated approach to policy
questions. My own feeling is that the aim of curbing the early dominance of the Federal Reserve Bank of New York in international
financial matters, through the changes introduced in the Federal
Reserve Act by the Banking Act of 1935, carried the reaction further
than was necessary. That act, while open to various interpretations,
has generally been construed by the Board of Governors as lodging full
responsibility for policy formulation in the hands of the Board itself.
There is little opportunity for the Federal Reserve banks (the Federal Reserve Bank of New York particularly) to have a voice in formulating the System's position on questions considered by the
National Advisory Council on International Financial Policy.
It has seemed to me for some time that one major change in the
locus of responsibility within the Federal Reserve System would overcome much of this and other difficulties. In line with recommendations below concerning domestic matters, the ultimate responsibility
for the System's share in international financial policy might be placed
in the Federal open market committee (or a similar group with a more



133 MONETARY, CREDIT, AND FISCAL POLICIES

appropriate name, representing botli the Board of Governors of the
Federal Eeserve System and the Federal Eeserve banks). This committee makes possible a unique blend between policy formation and
the experience gained through translating policy into practical operation. The committee consists of the members of the Board of Governors (appointed directly by the President and serving full time in
Washington) and the presidents of the various Federal Eeserve banks,
serving (with the exception of New York) in rotation. Thus, through
the Federal open market committee each Federal Eeserve bank would
have a ready avenue for bringing into policy considerations the understanding and analytical competence which are acquired through intimate contact with the implementation of these policies. (And the
vice chairman of the Federal open market committee or its equivalent, who has always been the president of the Federal Eeserve Bank
of New York, could be an alternate of the Chairman on the National
Advisory Council.)
Question 3 of this section on international financial matters concerns
the gold-coin standard. My 30 years of exposure to the problems of
monetary control, as they present themselves to the Federal Eeserve
System, have been split about evenly between a period in which this
country was operating with, and without, such a standard. From that
experience I can confirm what is said in the attached document on the
manner in which a gold-coin standard acts as a more or less automatic control over the reserve base of the monetary system, competing
with the discretionary control which the Federal Eeserve is expected
to exercise. It seems to me that reliance upon two independent, and
frequently incompatible, types of control over the reserves of our banking system is undesirable. If there is to be regulatory discretion to
offset the automatic action from time to time, the automatic action
cannot be relied upon to exert that type of dominant control which, so
it is argued, would supersede decisions now made by Congress and the
Federal Eeserve System with respect to fiscal and monetary policies.
Moreover, it is important to recognize that the automatic discipline
of a gold-coin standard is likely to be perverse, rather than consistent
with the objective of economic stability. Discipline is necessary in
these matters, but it should be the applied discipline of competent
men, not the automatic discipline of self-interest on the part of a
limited segment of the public applied to the monetary metal that constitutes the base of our entire monetary system. In the exuberance
characteristic of inflation up to its final stages, for example, gold coins
are likely to flow steadily into the monetary reserves of the country—
providing a base for more and more credit expansion. Only when the
crisis stage has been reached is a reversal likely. Thus, at a time when
discretionary controls could begin restraint, the impetus of a goldcoin standard would be toward further expansion. When a delicate
adjustment is necessary to moderate the shock of a collapse of inflation, the control exerted by a gold-coin standard would express itself
through a great drain on the reserves of the banking system, tending
to force hasty and chaotic liquidation of credit. A drain on gold
reserves is likely to continue, moreover, throughout a period of depression, forcing a tightness in the availability of bank funds for lending,
instead of permitting the monetary ease appropriate for such a period.
Having seen the distressing periods of 1920-21 and 1931-33, when
deflation was aggravated by this perverse discipline of the gold-coin




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MONETARY,

CREDIT, AND FISCAL POLICIES

standard—despite the limited offsetting measures which the System
was able to undertake under then existing legislation—I cannot be impressed by arguments (many of them of a most extravagant character) for restoration of a gold-coin standard in this country. Gold
has a useful purpose to serve as a medium for balancing international
accounts among nations, and perhaps as a guide to the necessary discipline required in the international field. It has no useful purpose
to serve in the pockets or hoards of the people. The present large
official holdings of the United States are a symbol of our towering
international strength. To open our gold reserves to the drains of
speculative and hoarding demands strikes me as both unwise and
improvident.
I V . INSTRUMENTS OF FEDERAL RESERVE POLICY

The System answer
The instruments of Federal Reserve policy fall into two major
groups, those quantitative instruments which are designed to give the
System a satisfactory degree of general control over the total volume,
availability, and cost of bank reserves and those selective controls
which are designed to supplement the various quantitative controls in
such a way as to enable the Federal Reserve to operate in a particular
sector of the market without direct influence upon other areas of the
market when conditions develop that cannot be reached by the general
or quantitative methods.
Instruments of quantitative control include those which affect
primarily the volume of member bank reserves, such as open market
operations and policies affecting the volume of Federal Reserve float;
those whose major influence is upon the availability of reserves, such
as changes in reserve requirements and policies and regulations regarding the eligibility or acceptability of bank assets as a means of obtaining access to Federal Reserve credit; and those which affect primarily
the cost of bank reserves, such as discount rates and buying and selling
rates on Government securities and on acceptances.
The only instrument of qualitative or selective control which the
Federal Reserve can use at this time is the authority to establish and
change margin requirements on listed securities. In the past, of course,
the System has exercised control over consumer credit, and from time
to time other selective instruments of control, such as controls on realestate financing and on trading in the commodity markets, have been
suggested.
An appraisal of the effectiveness or the adequacy of instruments of
Federal Reserve policy must take into consideration the particular circumstances in which the use of each instrument is most effective, and
the interrelation of the different instruments. Each instrument is
important to the extent that it is essential in rounding out the entire
framework of control in such a way as to contribute to the achievement
of the objectives of Federal Reserve policy. For instance, the authority to change reserve requirements is an instrument needed only be
cause, under conditions which have been experienced and which may
reoccur in similar or different form, the absence of such authority
would tend to prevent the System from maintaining effective control




135 MONETARY, CREDIT, AND FISCAL POLICIES

over the money supply. The power to change reserve requirements—
or the use of any other instrument of control—should be considered
as a tool which, when used with other appropriate instruments, tends
to make Federal Reserve policy more effective.
It is also important in appraising the adequacy of instruments of
control to give proper weight to the whole broad set of economic conditions and factors which establish the framework within which the
instruments of control must be used.
Developments during the late twenties led to a condition in the
securities market that was beyond the effective control of the traditional instruments of the time. The subsequent grant of authority
over margins was important only in that it tended to provide the
System with an instrument of control to reach this particular sector of
the market which the traditional general instruments were not effectively reaching.
Again, following the dollar devaluation in the mid-thirties large
and continuing gold imports so increased the supply of available
reserves as to place control over the volume of reserves beyond the
limits of effectiveness of the instruments at the System's disposal.
Authority to change reserve requirements became essential to restore
a satisfactory degree of control to the System and to enable the System
to use other more or less orthodox general instruments more effectively
Also, following the war, developments growing out of the magnitude of the public debt and the problems of debt management as
they related to interest rates led to a set of conditions which tended
to prevent the use of the System's instruments of control to such a
degree and in such a manner as to assure Federal Reserve control over
the volume of bank reserves. Additional power at that time was
sought in the form of authority to raise reserve requirements beyond
the limits in existing legislation. During this postwar period, largely
as a result of the problems involved in dealing with the huge public
debt, it has not been possible for the System to operate freely in the
money market with traditional instruments of control because of the
effect upon the rate structure and the Government securities market.
Until recent months, System policy involved to a considerable extent
the use of major instruments of control to maintain stability in the
Government securities market, with a consequent marked loss of control over the volume of bank reserves. An alternative to this policy
would have been use of instruments to attempt primarily to control
the volume of bank reserves, even though such a policy might have
involved a substantial decline of prices of Government bonds. It
was this situation which led the Board of Governors to seek additional
direct authority over reserve requirements to be in a position to
absorb reserve funds arising out of the support program or from other
sources, such as gold inflows. In other words, it has not been the
policy of the System with respect to instruments of control to obtain
additional authority merely for the sake of having that authority, but
it has been the objective of the Federal Reserve to attempt to obtain
such instruments of control as have appeared to be necessary in order
for the System to exert an effective influence on the money market
and to achieve its recognized objectives.




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MONETARY, CREDIT, AND FISCAL POLICIES

1 (a). What changes, if any, should be made in the reserve
requirements of member banks %
The System answer
The principal purpose of the requirement that member banks hold
legal reserves is to enable the central bank to exercise an effective
influence over the total volume of bank credit and the money supply.
The central bank can limit credit expansion only if it has control of
the amount of the required reserves and of the amount of assets available as acceptable reserves. Therefore, if the central bank is to discharge effectively its responsibility with respect to the control of
bank credit and the money supply, it must have authority to fix within
reasonably broad limits the reserve requirements of member banks and
to require that they hold as legal reserves only those assets which are
liabilities of the central bank. The requirement imposed upon member banks to hold a legal reserve of nonearning assets is, in a sense, a
price that they must pay as their contribution toward the achievement of a satisfactory degree of national economic stability; in view
of this fact, it is very important that reserve requirements be equitable
as between different banks and as between different groups of banks,
e. g., member banks and nonmember banks. In addition, reserve requirements should be founded on a sound economic basis and should
be administratively feasible and simple.
The present system of member bank reserve requirements, based
upon geographic location of banks with different reserve requirements against net demand deposits of banks located in central Reserve cities, Reserve cities, and other towns and cities, is a carry-over
from the national banking legislation which was in effect when the
Federal Reserve System was established. Higher reserve requirements for banks in Reserve cities and central Reserve cities were considered essential because of the substantial amounts of interbank
deposits which tended to concentrate in those cities.
With the passage of time, however, it has become evident that mere
geographic location does not determine the character of a bank's business. For instance, studies have shown that there are many so-called
country banks which hold a substantial amount of interbank deposits
and carry on a banking business similar to that done by some banks
located in Reserve cities or central Reserve cities. On the other hand,
there are Reserve city and central Reserve city banks which hold no
substantial amount of interbank deposits but simply provide banking
service for business and individuals in their localities. As a result, the
present system of reserves frequently involves indefensible inequities
and raises very difficult administrative problems.
Inasmuch as the purpose of reserve requirements is to enable the
central bank to control the volume of bank credit, it can be contended
with some basis that a single reserve requirement subject to variation
within reasonable limits without differentiation as to bank or type
of deposit might be effective in enabling the central bank to discharge
its responsibility. However, a change from the present system of
reserves to a system involving a single reserve requirement would be too
disruptive, as large excess reserves would be created in central Reserve
city banks, while huge deficiencies would appear at country banks. In
addition, to a considerable extent, interbank deposits have some of the
characteristics of bank reserves. While many fine shadings regarding
different types of deposits might be made, from an administrative point
of view it is desirable to classify deposits for reserve purposes as inter


137 MONETARY, CREDIT, AND FISCAL POLICIES

bank deposits, other demand deposits, and time deposits. Such a deposit classification is readily understandable in the banking system,
has the value of traditional acceptance, would provide the basis for
an equitable system of reserves and, assuming appropriate discretionary authority to the central bank, would enable effective control over
the limits within which expansion of the volume of bank credit could
occur.
A system of uniform reserve requirements based upon the three
major classes of deposits and involving the specific features outlined
below is recommended to enable the Federal Reserve System to discharge its objectives more effectively, to eliminate inequities existing
under the present reserve structure, to facilitate administrative control, and to conform to sound economic principles with respect to the
control of bank credit in a dual system of private banking such as exists
in this country.
1. Abolish central Eeserve city and Eeserve city designations of
banks.
2. Establish reserve requirements uniform for all banks accepting deposits on the basis of type of deposits classified as interbank,
other demand, and time deposits. Initial reserve requirements
should be established at differential levels that would permit the
transition to the new system to be made with a minimum unfavorable impact on individual banks and which would result in an aggregate volume of required reserves approximately equal to the
amount required under the present system at the time of change.
3. The Federal Eeserve should be authorized to change reserve
requirements on any or all of the three classes of deposits within
reasonably broad statutory limits.
4. Banks should be allowed to consider vault cash as required reserves. Since the purpose of required reserves is to influence the
volume of bank credit, it is a matter of indifference to the central
bank whether banks hold reserves in the form of central bank
currency or reserve deposits with the central bank.
5. Banks should be allowed to consider as reserve that part of
their balances due from other banks wThich those latter banks are
required to hold as reserves against such balances. This provision
would recognize the correspondent bank relationship as an established part of our banking system but would relate correspondent balances to reserves in such a way that a shift of funds by
banks into or out of "due from banks" would not affect the total
volume of the banking system's excess reserves.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
The major reason for reserve requirements, as we see it today, is to
give the central bank influence over the total money supply. In exercising this influence, the central bank needs powers which enable it
to vary the total amount of reserves available to the banking system
and power to vary the legal relationship between the volume of reserves and the volume of deposits.
In a very real sense, the legal requirement to hold reserves may be
viewed as a price paid, a contribution made, by the banks for greater
economic stability. Consequently, reserve requirements should be set
so that they do not bear more harshly upon certain groups of banks
than upon others. In other words, the reserve burden should be shared
equitably by all banks.



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MONETARY, CREDIT, AND FISCAL POLICIES

The present method of fixing reserve requirements does not meet
this test of equity and in addition has certain other disadvantages,
both administrative and technical. A plan has been proposed (and is
given in some detail in the special System study reply to this question)
which would establish uniform reserve requirements for the banking
system with different reserve requirements for the three major classes
of deposits—interbank, demand, and time. This plan would seem to
have administrative feasibility, and would eliminate inequities as
between banks, many of which, solely because of geographic location,
now have reserve requirements which do not match their actual operations. In addition, it would eliminate some of the technical difficulties in our present system of reserve requirements.
In May 1948 a joint meeting of the Board of Governors and the
Conference of Presidents reviewed a staff report of a similar program
which would change the method of assessing reserve requirements
from a geographical to a "type of deposit" basis, and recommended
it be given continuing study by all elements in the System (including
the Conference of Chairmen and the Federal Advisory Council), and
of consultation with commercial bankers and other interested parties.
Thus, I would recommend consideration of a change in the manner of
assessing reserve requirements, but not necessarily the specific plan as
outlined in the special System study.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I am not in agreement with the recommendation contained in the
draft reply. The present system of reserve requirements is by no
means perfect, and from time to time the Federal Reserve System
has had committees study this question. However, sufficient agreement
to justify change has never been secured on any proposal for determining reserve requirements. Recently, a technical staff System
committee submitted a proposal for a new system of reserve requirements based on type of deposits rather than on location of bank, as at
present. The recommendation in the draft reply to your questionnaire is essentially that proposal. I do not believe that the particular
proposal has been given enough study by the banking system and particularly by parties other than those directly connected with the
Federal Reserve System to warrant its consideration at this time. The
banking system has adapted itself to the existing method of reserve
requirements, and banking relationships have developed around them.
The advantages claimed for the proposal do not appear to me to be
sufficient either in character or in probability of achievement to warrant the disturbance to the banks that would result in making the
change. I would favor legislation permitting member banks to count
vault cash as a part of their reserves. This would help to remove
some of the present inequities claimed in the system of requirements.
Otherwise, I am in favor of letting the entire question of reserve
requirements rest unless there can be an approach made to the subject
in a manner which would give opportunity for participation by a
wide group of interested parties such as bankers' associations, State
bank supervisors and others.




139 M O N E T A R Y ,

CREDIT,

AND FISCAL

POLICIES

1 (&). What changes, if any, should be made in the authority
of the Federal Reserve to alter member-bank reserve requirements ?
The System answer
As stated in the answer to the preceding question, the Federal
Reserve should have authority to change reserve requirements within
reasonably broad statutory limits. The limits within which such
changes should be permitted would need to be changed from those
existing in present legislation to limits consistent with the uniform
reserve plan and the basic purposes underlying changes in reserve
requirements. The upper limit of authority to fix reserve requirements on each of the different classes of deposits should not be so high
as to destroy the advantages of a proportional system of reserve requirements, although the range of change above and below the initially
established basic levels of reserves should be wide enough to assure
the System of the ability to absorb or release reserves in sufficient
amounts when necessary to prevent injurious credit expansion or
contraction.
Although the following is not in the nature of a recommendation,
it involves a proposal which may deserve consideration. In view of
the desirability of retaining the advantages of the proportional system
of reserves and because of the fact that increases in reserve requirements strike all banks equally, regardless of reserve position or their
rate of credit expansion, it has been suggested that, to prevent an
increase in bank credit beyond the amount outstanding on a given
date, a reserve requirement somewhat, perhaps even substantially,
higher than the reserve requirement on existing deposits be applicable
to new deposits. This type of reserve requirement, which could be
supplementary to the uniform reserve plan, would be more selective
in nature than a general increase in reserve requirements and would
avoid the unfavorable impact of a general increase in reserve requirements on banks not engaging actively in the expansionary development. This instrument might serve valuably under special circumstances, existing for comparatively short periods, when it might be
desirable to restrict the expansive effects of bank reserves by reducing
or conceivably even eliminating the multiple-expansion potential.3
1 (e). Under what conditions and for what purposes should the
Federal Reserve use this power (to change reserve requirements) ?'
The System answer
The principal purpose for which the Federal Reserve should use
the power to change reserve requirements is to adjust the total reserve
requirements of the banking system in order to prevent serious credit
expansion or contraction, control of which for one reason or another
is beyond the limiting influence of other instruments. The power to
change reserve requirements is a broadside weapon which reacts uniformly throughout the banking system, although its impact upon individual banks will vary, depending upon the reserve position of such
banks at the time of change. It is an instrument that is well adapted
to those occasions when, because of excessive banking liquidity (or
tightness), it becomes necessary to absorb (or release) a comparatively
3 The recommendation in this paragraph was no* included in the statements made by the
presidents of the Boston, New York, Philadelphia, Richmond, and St. Louis Federal
Reserve Banks.

98257—49

10




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MONETARY, CREDIT, AND FISCAL POLICIES

substantial amount of reserve funds from (or into) the market. It
provides a direct and positive means by which the availability of banking reserves for credit expansion by the banking system may be adjusted and other instruments made more effective than otherwise
would be the case.
Any set of conditions which would result in an excessive flow of
reserve funds into or out of the banking system beyond the control of
the Federal Reserve through the use of other instruments of control
might give rise to a situation calling for the use of the authority to
change reserve requirements. For example, continuing gold movements in substantial amounts could lead to a condition of excessive
liquidity or tightness in the banking system such as to require the use
of this authority. A substantial return flow of currency to banks or
a persistent currency drain from the banks might lead to similar situations. Developments during the postwar years, when a large volume
of gold imports and sales of Government securities by banks and nonbanking investors added large amounts to available reserves, also
gave rise to conditions calling for an increase in reserve requirements.
It is possible that at times the magnitude of operations required to
achieve an objective through open-market operations might be such
as to be unduly disturbing to the money market or to threaten the
Reserve System's capacity to continue them. Under such circumstances, a change in reserve requirements might absorb sufficient reserves to aid in making the more traditional instruments more readily
effective. In general, as long as the Federal Reserve through the use
of its other instruments of control is able to control the volume of reserves available to the banking system, it should not need to use the
authority to change reserve requirements; but, when conditions develop causing the Federal Reserve to lose effective control over the
volume of reserve funds, then it might become necessary to resort to
changes in reserve requirements.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia,
It is impossible to foresee precisely all the conditions under which
changes in reserve requirements, either separately or in conjunction
with other instruments, would be the most appropriate tool. Experience with this instrument is limited, and we still have a lot to learn
about its operation. We have, however, sufficient experience to correct
one misconception. Changes in reserve requirements have been opposed by some because they assumed that the alternatives are a change
in requirements and no other action by the System at all. The relevant
comparison is that between the efficiency and effectiveness of changes
in reserve requirements and of use of other instruments to achieve
similar over-all results.
We have had sufficient experience to indicate some of the unique
characteristics of the instrument which influence its peculiar appropriateness to certain developments. The following analysis should
be viewed as illustrative of such developments rather than as a complete catalog.
A unique characteristic of changes in reserve requirements is that
they affect all member banks directly and immediately. This is not
true of either changes in discount rates or open-market operations.
Individual banks may be wholly unaware that these instruments have
been used, even when they feel the effects in the course of regular




141 MONETARY, CREDIT, AND FISCAL POLICIES

operations. They cannot remain unaware of changes in reserve requirements. Such changes are uniquely suitable when it is desired
to influence the availability of funds at all banks.
Changes in reserve requirements are also particularly adapted to
conditions in which the earning assets of the Federal Reserve banks
are inadequate to absorb excess reserves. There are differences of
opinion as to the wisdom of increasing reserve requirements in 1937.
The differences, however, rest on the differences in judgment as to
timing and the probability of an eventual undesirable expansion of
credit. No one questions that the System had no other instrument
adequate to halt undesirable credit expansion had it been a reality at
the time.
Changes in reserve requirements also make possible a more flexible
program of action when used in conjunction with other instruments.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
The authority to alter member-bank reserve requirements is a clumsy
and unsatisfactory instrument of credit control. It affects all banks
and requires or permits adjustments which may have unhealthy general effects and be harmful in many individual instances. The use of
this authority, therefore, can be justified only in exceptional cases
and calls for a degree of discrimination difficult of attainment. As
the draft reply indicates, requirements should be altered only to take
care of those situations in which excessive liquidity or tightness could
not be compensated for by open-market operations without engaging
in purchases and sales of such magnitude as to have seriously detrimental effects on money markets, security markets, and business and
Government finance. Such situations would include unusually heavy
and sustained imports or exports of gold. I believe, therefore, that
the power itself should be used rarely and not as a substitute for
ordinary open-market operations. On that basis I do not believe that
additional powers or changes in existing powers are necessary. Bankers generally would appreciate our giving the matter a rest cure and
letting them feel that they have a stable basis of reserves on which to
operate.
1 (d). What power, if any, should the Federal Reserve banks
have relative to the reserve requirements of nonmember banks ?
The System answer
The Federal Reserve System should have the same authority over
the reserves of nonmember banks as it has with respect to the reserves
of member banks if it is to be able to carry out its responsibilities
effectively. While it is recognized that this question is a highly controversial one, the several reasons in support of the answer given above
are compelling.
The Federal Reserve System, as an agent of Congress, has the
responsibility of controlling the volume of bank credit and the money
supply in the national economic interest. That control can be achieved
only if the Federal Reserve System has control over reserve requirements of the Nation's banks and the amount of reserves available to
those banks. To subject only the member banks to Federal Reserve
System control not only imposes inequitable restrictions on those banks
relative to nonmember banks but also restricts the System's use of its
authority due to the very real danger of loss of membership when-




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MONETARY, CREDIT, AND FISCAL POLICIES

ever member-bank requirements become much more onerous than
non-member-bank requirements.
It is virtually universally recognized and has been established in
law that Congress should have the ultimate control over the money
supply of the country. As far back as 1865 that power was demonstrated with the imposition of the 10-percent tax on the note issues
of State banks. At that time, bank notes represented a substantial
bulk of the money supply, and the Congress undertook a drastic step
to bring within the scope of its control the power of money creation
of the State banks. Today, by far the largest part of the Nation's
money supply is the deposit currency created by the Nation's banks.
Through the Federal Reserve System the Congress has ultimate control over that part of the money supply created by the central bank
and the member banks, but it does not have control over that part of
the money supply created by nonmember State banks. This defect
in the system of control of the Nation's money supply reflects such
an inconsistency with the generally accepted responsibility of the
Congress as to make the need for its correction apparent.
It is sometimes contended that if nonmember banks were subject to
the reserve requirements of the Federal Reserve System it would mean
a step in the direction of breaking down the dual system of State and
national banking that is firmly established in the banking tradition
of this country. Such a position, however, is untenable. The very
essence of the dual system of banking in this country lies in the recognized authority of the State and Federal governments to {a) charter
banking organizations and (&) supervise those banks of their respective creation toward the end of assuring sound, safe, banking institutions. These vital aspects of the dual banking system would not
be threatened if nonmember banks were subject to the reserve requirements of the Federal Reserve System.
Reply of C. E. Earhart, Federal Reserve Bank, San Francisco
It would be desirable for the Federal Reserve System to have the
same authority over the reserves of insured nonmember banks as it
has with respect to the reserves of member banks. It should be made
clear that this authority would not impair minimum State requirements when they exceed System requirements. While it is recognized
that this question is highly controversial, the several reasons in support of the answer given above are compelling. (The reason for suggesting insured nonmember banks instead of all nonmember banks
rests primarily on legal, not economic, considerations.)
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I am in agreement with the draft reply to this question. However,
I reiterate the position taken in my immediately preceding replies
that the whole subject of reserves should be given a rest cure. If legislation should be considered, such legislation should include application of the same general type of reserve requirements to all banks.
2 (a). Should the Federal Reserve have the permanent power
to regulate consumer credit?
The System answer
The Federal Reserve System should have the permanent authority
to regulate consumer credit arising out of personal installment loans




143 MONETARY, CREDIT, AND FISCAL POLICIES

und installment sales of various types of consumers' durable goods.
Such authority should be broad enough to provide discretionary power
to the System in order to make possible the administration of the
regulation with the needed flexibility. Experience during the past 8
years has proved that consumer installment credit control is administratively practical and is comparatiyely simple. Moreover, while in
effect, the regulation received a high degree of compliance and, in
general, was a factor in helping to hold the forces of economic instability in check.
The volume of consumer credit has grown tremendously since the
early twenties, reflecting largely the increased demand for a steadily
growing volume of durable goods and the increasing number of wage
and salary earners who resorted to this type of credit as they became
familiar with its advantages. The total amount of consumer credit
outstanding and the amount of consumer installment credit in force
have now reached such proportions as to hold potential danger of
contributing to general economic instability if uncontrolled; moreover, the behavior of consumer installment credit at times in the
past—the fluctuation in its outstanding volume—has been a factor
in accentuating business-cycle fluctuations. During periods of rising
and high business activity consumers have tended to supplement
current income by an expanding use of consumer credit, thus exerting
increased inflationary pressures. On the other hand, during periods
of declining business activity, developments in the consumer-credit
field have had the effect of aggravating the decline in effective consumer purchasing power, since consumers have been compelled to use
current income to repay installment credits created during the preceding period of prosperity and high prices. Variations in the volume
of consumer credit have been sizable in relation to total variations
in national income and at times have corresponded roughly with
fluctuations in industrial production.
Since consumer installment credit is so intimately related to the
purchase, distribution, and production of durable goods, its trend and
volume influence actively a very strategic sector of the economy.
The automobile industry, producers of the various other major durable goods, and those producing a miscellany of so-called minor durables have become a very important direct factor in influencing
employment, incomes, and national prosperity. Furthermore, the
indirect influence of these consumers' durable goods industries is also
notable as a result of the relations of these industries with a myriad
of other large and small businesses which serve as their suppliers.
On the basis of past experience and with regard to the place of
durable goods in the American scheme of things, it is reasonable to
believe that the volume of consumer installment credit will continue
its upward trend at a fairly substantial rate and that significant
fluctuations in the outstanding volume of such credit will continue
to occur around the growth trend. The growth of consumer credit
can be a very constructive force in our economy, provided undesirable
fluctuations are restrained and excesses are prevented; uncontrolled,
however, it could conceivably become a very damaging force to the
economy. As a solution, at least in part, to some of the problems
involved in the extension and use of consumer credit, this form of
credit should be subject to the control of the central bank.




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MONETARY, CREDIT, AND FISCAL POLICIES

Reply of Joseph A. Erickson, Federal Reserve Bank, Boston
We prefer that a time limit of, say, 5 years be placed on this authority to permit review of the operation of this program under ordinary
peacetime conditions.
Reply of Alfred B. 'Williams, Federal Reserve Bank, Philadelphia
The Federal Reserve System should have the permanent authority
to regulate consumer installment credit because of the contribution
which the exercise of that authority would make to the basic objective
of economic stability.
The extent to which the regulation of this credit has helped to mitigate economic fluctuations since it was inaugurated in 1941 cannot be
fully demonstrated. During the war such credit declined sharply
while the regulation was in effect, but the extreme shortage of the
durable goods customarily purchased on the installment plan was the
principal factor in this decline. Up until the past year, the postwar
period has been characterized by large current and accumulated demand, large reserves of liquid assets making liberal credit terms less
necessary, and a general concern with respect to the future based on
recollections of the post-World War I period which was conducive to
conservatism on the part of both the grantors and the seekers of credit.
Accordingly, credit expanded substantially during the period despite
restrictions on terms so that the effectiveness of such restrictions has
been widely challenged by interested groups.
It has been demonstrated that, in the absence of regulation, competitive influences drive down-payment requirements toward the minimum and maturities toward the maximum when business is expanding—as happened when the regulation was dropped in 1947—and that
this tendency is reversed as business activity declines and creditors
become cautious. This has the effect of increasing the funds available
for spending when purchases generally are increasing toward the point
when capacities may be strained and further spending power wasted
in rising prices. Conversely, when buying declines, the amount of
consumer income available for current purchases is further reduced by
the payments on past debt, and with strict terms on new credits the
money supply tends to shrink further.
The economic significance of these fluctuations is partly reflected
in the amount of credit involved—$10,000,000,000—which is almost
as much as the total real estate loans outstanding at all insured commercial banks and nearly two-thirds as much as the total of all such
banks' commercial, industrial, and agricultural loans. Their impact
on general stability, however, is greater than the dollar figures alone
would suggest. This spending power represented by net additions to
outstanding consumer installment credit is heavily concentrated in
the field of automobiles and other durable goods. Such items by their
nature involve large unit costs, are deferrable purchases, and come at
the end of relatively long production cycles so that fluctuations in production and sales are greater than is true in the nondurable goods.
Furthermore, the impact of changes in the market for the durable
goods spreads widely through the long and complex chain of suppliers, with a substantial total effect upon business activity and
employment.
Expansion in buying power through liberal terms on consumer installment credit has been regarded a factor in the excesses of 1929 and




145 MONETARY, CREDIT, AND FISCAL POLICIES

1937, with their subsequent recessions, even though the volume of
credit involved was smaller and the variety and scope of the industries
affected were not as great as is now the case. The importance of the
durable goods industries and accordingly of the credit going into the
market for these products may be expected to increase further as our
economy develops and the benefits of our productive system spread
over a wider range of income groups. As these cyclically responsive
elements of the economy develop, the national objective of orderly expanding business and consumption becomes more and more important
to society.
Reply of J.N. Peyton, Federal Reserve Bank, Minneapolis
The answer to this question is not clear-cut. There are two powerful
arguments in favor of permanent power to regulate consumer credit.
Such types of credit are not susceptible to general measures of monetary control. The alternate expansion and contraction of consumer
credit has furthermore augmented the cyclical swing of business
activity.
On the other hand it is not clear that the alternate contraction and
expansion of consumer credit (over and above what a reasonable administration of consumer credit regulation would permit in any case)
has been a material factor in booms and busts. Because of the large
number of organizations which directly or indirectly participate in
the extension of consumer credit, an effective permanent administration poses formidable problems and would require a substantial staff.
These considerations, together with the fact that selective controls in
principle come close to being inconsistent with the democratic concept
of freedom of choice, make it doubtful if such a permanent power can
be justified even though there is a modest case for it on purely theoretical grounds.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I do not believe that the Federal Reserve should have permanent
power to regulate consumer credit as I am not at all convinced that it
is necessary, wise, or practicable thus to police this field of human activity. I am not satisfied that there are advantages to be derived from
use of the power sufficient to offset the disadvantages inherent in an
irritating interference with normal business transactions.
2 (h). If so, for what purposes and under what conditions
should this power be used ?
The System answer
The power to regulate consumer credit should be used for the purpose of maintaining a credit situation in that particular area which
will contribute as much as possible to general economic stability.
Power to control consumer credit should not be used in such a way as
to prevent a normal, steady growth in the use of this type of credit
consistent with a sound growth in the durable goods industries and
in the economy as a whole. It should be used, however, to prevent an
excessive use of credit in the consumer goods field, especially during
periods of sharply increasing demand when the use of such credit tends
to stimulate rising prices more markedly than it does the increase in the
production of goods.
Looking back upon our experience with the use of consumer credit
controls, it seems that such controls were needed and effective during




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MONETARY, CREDIT, AND FISCAL POLICIES

the last quarter of 1941. During the war years, when the production
of most consumer durable goods was discontinued for civilian consumption and when cash incomes were rising sharply, conditions were such
that it is not possible to draw clear conclusions as to the usefulness
or effectiveness of consumer credit regulation. With the end of the
war, however, and the removal of various other wartime controls at
a time when consumer demand for durable goods was very intense and
the supply of such goods very meager, the use of consumer credit
controls was important and effective.
These developments of the past several years show that there may
be alternately occurring periods of a need for or a lack of need to exercise consumer credit controls, but in view of the probability that conditions will arise again in the future when consumer credit control
would be desirable, the Federal Reserve should have the authority, in
order to be in a position to exercise control promptly when it is needed.
Further discussion of the use of selective credit controls, including
control over consumer installment credit, is presented in question 4,
below.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
The power should be used to minimize the extent to which fluctuations in consumer installment credit and the industries affected accentuate inflationary and deflationary excesses.
The questions of trade practices and charges and the problems of
liberal terms per se we do not regard as matters of concern to central
banking authorities. The importance of consumer credit to a highly
industrialized economy with large productive capacity is such that it
should be allowed to develop soundly as the industries which depend
extensively upon it grow. Only as the volume expands unduly in relation to current conditions and specifically the capacities of the affected industries to meet demand or as the volume unduly contracts
with waves of pessimism and excess caution should the central banking authorities take action.
The complex institutional structure in the area of consumer credit
and the low cost of money relatively to the income from it make it
impracticable to attempt by some simple, general instrument, such
as a special discount rate, to control the flow of funds into the hands
of credit grantors. The means must instead be directed at the flow
out from credit grantors, which involves the setting of standard
terms on individual transactions. The experience of the Federal
Reserve System under Regulation W indicates that there is an exceptionally high degree of understanding and compliance with the
basic terms of a consumer credit regulation, but the fact that more
than 100,000 business establishments are directly affected in their
millions of transactions suggests that the substantive provisions of
any consumer installment credit regulation should be applied only
on a so-called emergency and not a continuing basis.
Reply of C. JS. Young, Federal Reserve Bank, Chicago
At best, consumer credit regulation can be most effective under
conditions of inflationary pressures, and hence is not needed on a continuing basis. Since consumer credit control is discriminatory against
persons with low incomes and limited cash resources, it is fitting
that it be employed only in the most urgent instances. Moreover,




147 MONETARY, CREDIT, AND FISCAL POLICIES

competition through extension of credit is unduly limited by consumer
credit control.
2 (c). What is the relationship between this instrument and the
other Federal Reserve instruments of control ?
The System answer
The authority to regulate consumer credit is not a substitute for the
use of other instruments of Federal Reserve policy, nor should it be
considered as minimizing in any degree the importance of continuing
effective use of general controls. The authority to control consumer
credit is in the nature of a supplementary type of control instrument,
which, when used as needed as an adjunct to general controls, enables
the System to achieve a more satisfactory control over the volume
and use of credit.
If the general instruments of Federal Reserve policy can be used
in such a manner as to result in a balanced credit situation not only
from the standpoint of the economy as a whole but also from the
standpoint of the particular area of the economy in which consumer
credit is so important, then it would not be necessary to make use of
this supplementary authority. There have been occasions, however,
in the past—and it is only reasonable to assume that such occasions
will arise in the future—when, despite the use of general instruments
of control, unsound credit developments have occurred in the consumer durable goods area. Under such circumstances, when the general controls are not completely effective, it would be advantageous
for the System to be in a position to use a supplementary control
which would enable it to create a balanced credit situation in the
particular area which, for one reason or another, may not be responsive to the effects of general control and in which the volume of credit
is subject to wide fluctuations.
Reply of Alfred II. Williams, Federal Reserve Bank, Philadelphia
This instrument should serve as a supplement to the other general
or selective instruments of credit control to be aimed at a sector of
the economy which either is not affected by the more general instruments or is out of balance with other sectors of the economy so that
application of a general instrument affecting all is not appropriate.
3. What, if any, changes should be made in the power of the
Federal Reserve System to regulate margin requirements on
security loans ?
The System answer
The authority of the Federal Reserve System to regulate margin
requirements on loans for the purpose of purchasing securities registered on a national securities exchange has proved to be an administratively feasible and valuable selective instrument of Federal Reserve
policy. This instrument of control has especially proved its value since
the end of the war when, during a period of very strong inflationary
forces which exerted their influence not only in the general money
market but also in other sections of the economy, an excessive use of
credit has been prevented in the security markets, with the result that
the impact of inflationary forces in this particular area of the economy has been kept to a minimum. Looking back upon the monetary
and credit conditions of the past 4 years, characterized as they have




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MONETARY, CREDIT, AND FISCAL POLICIES

been by comparatively low and stable levels of interest rates, an abnormal condition of liquidity in the banking system, and, at best, an
imperfect control by the central bank over the volume of bank reserves,
it is very probable that the use of this direct authority to regulate the
volume of credit flowing into the security markets averted a greater
degree of inflation in those markets and a more severe liquidation,
which might have had serious repercussions on the economy.
A favorable feature of the existing legislation on margin requirements is that the Board of Governors is given discretionary authority
to prescribe lower or higher margin requirements as it deems necessary
or appropriate for the accommodation of commerce and industry, with
due regard to the credit situation, or to prevent the excessive use of
credit in the securities markets. Such discretionary authority, which
permits the Board to establish a flat margin requirement which in its
judgment is appropriate under the economic conditions prevailing at
the time, is not only administratively more feasible, but it is likely to
be more effective in enabling the Board to achieve its objective than if
the Board were limited to the dictates of an arbitrary, automatic
formula. Policy decisions with respect to economic matters cannot
safely be entrusted to the workings of an automatic mathematical
formula.
It has been contended in some quarters that a weakness of the present
authority is its failure to include, within its coverage, unregistered
securities. While this factor deserves study, experience of the past 15
years does not seem to indicate that it has appreciably weakened the
effectiveness of the Board's authority and control over the flow of
credit into the security markets. In fact, it appears that changes in
margin requirements applicable to registered securities have extended
their influence in a general way to the markets for unregistered securities, thus accomplishing the desired objective without the burden of
the administrative difficulty which might be associated with the attempt to extend legal control to unregistered securities. In addition,
there are obviously opportunities under the regulations to evade established margins, but these represent fringe cases and have not prevented
or impeded effective administration of the Federal Reserve authority.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
The authority of the Federal Reserve System to regulate margin
requirements on loans for the purpose of purchasing securities registered on a national securities exchange has proved to be an administratively feasible and valuable selective instrument of Federal Reserve
policy. This instrument of control has especially proved its value
since the end of the war when, during a period of very strong inflationary forces which exerted their influence not only in the general
money market but also in other sections of the economy, an excessive
use of credit has been prevented in the security markets, with the result
that the impact of inflationary forces in this particular area of the
economy has been kept to a minimum. Looking back upon the monetary and credit conditions of the past 4 years, characterized as they
have been by comparatively low and stable levels of interest rates, an
abnormal condition of liquidity in the banking system, and, at best,
an imperfect control by the central bank over the volume of bank
reserves, it seems clear that this direct authority to regulate the volume
of credit flowing into the security markets was the principal factor in




149 MONETARY, CREDIT, AND FISCAL POLICIES

preventing a degree of inflation in those markets somewhat comparable
to that which appeared in other markets,
A favorable feature of the existing legislation on margin requirements is that the Board of Governors is given discretionary authority
to prescribe lower or higher margin requirements as it deems necessary
or appropriate for the accommodation of commerce and industry, with
due regard to the credit situation, or to prevent the excessive use of
credit in the securities markets. Such discretionary authority, which
permits the Board to establish a flat margin requirement which in its
judgment is appropriate under the economic conditions prevailing at
the time, is not only administratively more feasible, but it is likely
to be more effective in enabling the Board to achieve its objective than
if the Board were limited to the dictates of an arbitrary, automatic
formula. Policy decisions with respect to economic matters cannot
safely be entrusted to the workings of an automatic mathematical
formula.
It has been contended in some quarters that a weakness of the present
authority is its failure to include within its coverage "unregistered
securities." While this factor deserves study, experience of the past
15 years does not seem to indicate that it has appreciably weakened
the effectiveness of the Board's authority and control over the flow of
credit into the security markets. In fact, it appears that changes in
margin requirements applicable to registered securities have extended
their influence in a general way to the markets for unregistered securities, thus accomplishing the desired objective without the burden of
the administrative difficulty which might be associated with the
attempt to extend legal control to unregistered securities. In addition, there are obviously opportunities under the regulations to evade
established margins, but these represent fringe cases and have not
prevented or impeded effective administration of the Federal Eeserve
authority in influencing the aggregate volume of credit in the securities
markets.
4. Should selective control be applied to any other type or types
of credit ? If so, what principles should determine the types of
credit to be brought under selective control ?
The System answer
As pointed out in the introductory statement to this group of questions dealing with instruments of Federal Eeserve policy, selective
credit controls are intended to enable the central bank to operate in a
particular sector of the market that is not, for one reason or another,
capable of being effectively reached at the time by the more orthodox
general controls. It should be emphasized that the use of selective
control is not a substitute for the use of general controls but instead
should be considered as a supplementary type of control which, together with reasonably effective general controls, enables the Federal
Eeserve to fulfill its objectives and responsibilities with regard to the
volume and use of credit more completely. Moreover, selective controls represent a means by which the central bank can influence, at
least in some degree, the problem of velocity, for they enable the
monetary and credit authority to exercise more effective control over
the use of funds in a particular sector of the market than can be accomDlished, as a rule, through the medium of general controls.




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MONETARY, CREDIT, AND FISCAL POLICIES

An increase in the authority and use of selective credit controls
appears to be more important under conditions when general controls
are used in a manner to promote a comparatively stable, low interest
rate structure. If the authority of the central bank from a practical
point of view is to be restricted in any appreciable degree with respect
to its freedom to use general controls to influence the availability and
cost of credit, then the case for selective controls as supplementary
instruments becomes more compelling. A comparatively low and
stable interest rate structure induces expansionary tendencies and,
in fact, poses a more or less continuous inflationary threat, and therefore under those circumstances it may be necessary for the central
bank to be in a position to check promptly the danger of credit excesses
in certain important segments of the economy.
Certain basic principles may be relied upon to determine whether a
particular type of credit should be brought under selective control.
First, how strategic and important to the stability of the general
economy are the developments which might occur in the particular
sector ? Second, how extensive is the use of credit in that area of the
economy and how widely does its volume fluctuate? Third, is it
administratively feasible to exercise effective selective control in the
particular area ? Selective control in the regulation of consumer credit
and in authority over margin requirements on registered securities can
be strongly supported in terms of each of the three basic principles
listed above. Other areas for which selective control has been suggested from time to time include real-estate financing and the commodity markets. In addition, of course, one might add selective control over such types of lending activity as farm loans and loans to
business to finance inventories, but support for such control in either
of these areas has not been extensive.
It is undoubtedly true that developments in the field of real estate
and in commodity markets do have an important bearing and influence
upon the course of the business cycle. From the standpoint of the first
objective, one might conclude that these areas should be subject to
selective control. Turning to the second objective, the very extensive
use of credit in connection with real-estate financing and the fact that
on numerous occasions in the past credit in that sector has been relatively free of control, with the consequence that serious excesses have
developed and have caused marked instability in the real-estate markets, it would appear that the case for selective control is well established in terms of this second principle. In the organized commodity
markets, however, credit is not used extensively in future trading. Inasmuch as the Commodity Exchange Commission already has rather
extensive authority over speculative commodity trading and since additional authority over margins may be granted to the Secretary of
Agriculture, it would not appear desirable for the Federal Eeserve
to have authority in this area.
From the standpoint of administrative feasibility, selective control
over real-estate financing might pose serious difficulties. Of course,
one approach to the problem would be through control over the amount
of down payment required for the purchase of a piece of property.
Control also might be extended to cover the period of amortization
of the mortgage. There are certain obstacles under existing circumstances, however, which would tend to complicate effective System
administration of real-estate credit. In the first place, there is a




151 MONETARY, CREDIT, AND FISCAL POLICIES

multiplicity of Federal agencies which are active in the housing field
which do exert a considerable influence on real-estate developments.
Secondly, the Congress has shown during the postwar years a strong
desire to make credit available on very lenient terms for the purchase
of certain classes of real estate. The trend toward Government housing subsidies—in fact, the entire program with respect to adequate
housing, with public assistance if necessary—would militate against
effective discharge of credit control responsibility.
If it were believed possible to administer selective control of realestate financing in an objective manner as it may be administered in
other areas, the case for including control in this area might be very
strong. It is weakened considerably, however, by the problems mentioned above. Perhaps an alternative to selective control in this area
would be a continuous and very close policy coordination between the
various agencies having responsibilities in the field of housing and
the monetary and credit authorities, so that the objectives of both
groups would be coordinated and within reasonable limits pointed
toward the same end. Although control of margins in the commodity
markets would be administratively simple, the inconsequential use
of credit in those markets does not justify Federal Reserve control.
For the various reasons indicated above, it is not recommended that
selective control be extended at this time to types of credit other than
consumer credit as developed in question 2.
Reply of J. N. Peyton,, Federal Reserve Bank, Minneapolis
In the immediate postwar period the ballooning of urban mortgage
credit may prove to have provided the largest legacy of troubles in
the period ahead. Whether this, however, could be corrected by
some sort of selective credit control should be given careful consideration. The magnitude of this problem is indicated by the $13,000,000,000 rise in home mortgage debt from 1945 to 1948 and the $8,000,000,000 rise in Government-guaranteed mortgages.
Selective credit controls should meet three fundamental requirements :
(a) The type of credit should be considered not to be susceptible
to general monetary policy.
(b) It must be administratively feasible.
(c) The potential gains in economic stability must be of such
overriding significance as to outweigh the inconsistencies in principle with the democratic concept of the right of the individual
to choose within the framework of general rules.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
As pointed out in the introductory statement to this group of questions dealing with instruments of Federal Reserve policy, selective
credit controls are intended to enable the central bank to operate in
a particular sector of the market that is not, for one reason or another,
capable of being effectively reached at the time by the more orthodox
general controls. It should be emphasized that the use of selective
tools is not a substitute for the use of general instruments but instead
shouW be considered as a supplementary means which, together with
reasonably effective general controls, enable the Federal Reserve to
fulfill more completely its objectives and responsibilities with regard
to the volume and use of credit. Moreover, selective controls represent
a means by which the central bank can influence, at least in some de


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MONETARY, CREDIT, AND FISCAL POLICIES

gree, the velocity of circulation, for they enable the monetary and
credit authority to exercise more effective control over the use of
funds in a particular sector of the market than can be accomplished,,
as a rule, through the medium of general controls.
Certain basic principles should govern the types of credit that
should be brought under control. First, how strategic and important to the stability of the general economy are the developments
which might occur in the particular sector? Second, how extensive
is the use of credit in that area and how widely does the amount
fluctuate ? Third, is it administratively feasible to exercise effective
control in the particular area? Selective control in the regulation
of consumer credit and in authority over margin requirements on
registered securities can be strongly supported in terms of each of
these three basic principles. Other areas for which selective credit
controls have been suggested from time to time include real estate
and the commodity markets. One might add such types of lending
activity as farm loans and loans to business to finance inventories,
but support for control in either of these areas has not been extensive.
It is undoubtedly true that developments in the field of real estate
and in commodity markets do have an important bearing and influence upon the course of the business cycle. From the standpoint of
the first objective, one might conclude that these areas should be subject to selective control. Turning to the second objective, the very
extensive use of credit in connection with real-estate financing and the
fact that on numerous occasions in the past credit in that sector has
developed serious excesses causing marked instability in the realestate markets would make it appear that the case for selective control
is well established in terms of this second principle. In the organized
commodity markets, however, credit is not used extensively in future
trading. Moreover, legislation recently has been introduced in the
Congress to grant to the Secretary of Agriculture authority to regulate margin requirements with respect to speculative transactions
in commodity futures on commodity exchanges. Inasmuch as the
Commodity Exchange Commission already has rather extensive authority over speculative commodity trading and since additional
authority over margins may be granted to the Secretary of Agriculture, it would not appear desirable for the Federal Reserve to have
authority in this area.
From the standpoint of administrative feasibility, selective control
over real-estate financing might pose serious difficulties. Of course,
one approach to the problem would be through control over the
amount of down payment required for the purchase of a piece of
property. Control also might be extended to cover the period of
amortization of the mortgage. There are certain obstacles under
existing circumstances, however, which would tend to complicate
effective System administration of real-estate credit. In the first
place, there is a multiplicity of Federal agencies which are active in
the housing field which do exert a considerable influence on realestate developments. Secondly, the Congress has shown during the
postwar years a strong desire to make credit available on very lenient
terms for the purchase of certain classes of real estate. The trend
toward Government housing subsidies—in fact, the entire program
with respect to adequate housing, with public assistance if necessary—




153 MONETARY, CREDIT, AND FISCAL POLICIES

would militate against effective discharge of credit-control
responsibility.
If it were believed possible to administer selective control of realestate financing in an objective manner as it may be administered in
other areas, the case for including control in this area might be very
strong. It is weakened considerably, however, by the problems mentioned above. Perhaps an alternative to selective control in this
area would be a continuous and very close policy coordination between
the various agencies having responsibilities in the field of housing and
the monetary and credit authorities, so that the objectives of both
groups would be coordinated and within reasonable limits pointed
toward the same end. Although control of margins in the commodity
markets would be administratively simple, the inconsequential use of
credit in those markets does not justify Federal Reserve control.
For the various reasons indicated above, it is not recommended that
selective control be extended at this time to types of credit other
than consumer credit as developed in question 2.
5. In what respects does the Federal Eeserve lack legal power
needed to accomplish its objectives?
The System answer
The respects in which the Federal Eeserve lacks legal power necessary for it to accomplish its objectives have been indicated in the statements presented in the discussion of questions IV-1, 2, and 4; they
relate to bank reserves and to uses of credit in major special fields that
are presently beyond the Eeserve System's effective sphere of influence. Although, in the final analysis, the extension of credit rests with
the individual commercial banks, insofar as the availability of central
bank credit is concerned the System is in a position to create conditions
which would make an undesirably restrictive credit situation unnecessary ; on the other hand, the System is not always in a position to
absorb bank reserves to the extent that might be necessary to prevent
an unwarranted expansion in credit.
In addition, the System, at least under conceivable conditions,
might not be in a position to control the volume of credit in certain
important sectors of the economy. For example, there might be a
recurrence of inflationary developments in the consumer-credit area
which would require the use of a selective instrument to supplement
the effects of the more general quantitative instruments. System control of credit in the real-estate field, while desirable from the standpoint of preventing credit excesses in that very important area, poses
such problems at this time as to lead to the conclusion that the desired
result perhaps should be sought, first, through a better coordination
of the policies of the Federal Eeserve and those agencies involved
in the regulation and financing of real-estate activities.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
The Federal Eeserve System at present lacks adequate powers to
deal with bank reserves. On the upswing of the cycle its powers to
absorb bank reserves and to curtail credit expansion are severely
limited by the existing circumstances of a large Federal debt and the
necessity to preserve reasonable order in the Government securities
market. On the downswing its powers over bank reserves are not
limited in anything like as great a degree. However, due to certain




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MONETARY, CREDIT, AND FISCAL POLICIES

restrictions in the present legislation the System does not have adequate power to supplement credit granted by the banks with a system
of guaranteed or direct loans to business.
The Federal Eeserve System also lacks power to control credit
volume in certain strategic areas of the economy. These are discussed
in detail in the System-wide study answers to questions IV-2, 3, and 4.
Finally, there are a number of minor restrictions existing under
present legislation which tend to hamper efficient operations of the
Federal Eeserve banks. For example, there is the provision in the
present law which forbids a particular Eeserve bank from paying out
any notes but its own. No one of these minor restrictions is of any
particular significance. Taken together, as noted, they tend to hamper
efficient operations and thus to lessen the effectiveness of System
action.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
Promotion of economic stability at high levels is the basic objective
of the Federal Eeserve System. Achievement of that objective, however, does not depend primarily on the legal powers of the System.
A nation of free people can achieve stability only through self-discipline based on able leadership and widespread understanding of how
our system actually operates and can be made to operate better. We
cannot legislate ourselves into continuous prosperity. Inappropriate
laws, however, hinder and appropriate laws promote achievement of
stability.
The principal inadequacies of the Federal Eeserve System are those
with respect to reserve requirements of commercial banks as discussed
in the answer to IV-1, and with respect to consumer credit as discussed in IV-2. It should be repeated, however, that mere increase
of the authority of the System in these particulars will not produce,
though it will assist in promoting economic stability.
6. What legislative changes would you recommend to correct
any such deficiencies ?
The System answer
Legislation should be enacted establishing the uniform reserve requirements for all commercial banks, including authority to change
reserve requirements, as outlined in detail in question IV-1.
In addition, the Congress should grant authority to the Federal
Eeserve to exercise control over the volume of consumer installment
credit by permitting the System to establish from time to time as
needed minimum down payments and maximum maturity periods for
installment credit transactions involved in the sale of durable goods
and maximum maturity periods involved in credit transactions arising out of personal installment loans.
Finally, if a national credit council is established, it should be clear
in the establishing legislation that it is the intent of Congress that
the policies of the various lending and credit agencies involved in
housing and real-estate financing—in fact, all lending and credit agencies—be coordinated reasonably well with the basic monetary and
credit policies of the Federal Eeserve.
Moreover, legislation creating such a council also should express
clearly the intent and desire of the Congress with regard to the necessity of coordinating the monetary and credit policies and objectives




155 MONETARY, CREDIT, AND FISCAL POLICIES

of the Federal Reserve and the fiscal and debt management^ policies
and objectives of the Treasury. If a national credit council is not
established, the intent of the Congress regarding these particular problems which have become of first-rank importance should be expressed
in connection with legislation relating to the general instruments of
control of the Federal Reserve System or, if that is not appropriate,
in any event in a general congressional statement of policy and intent.
Reply of Chester Davis, Federal Reserve Bank, St. Louis
I would favor consideration of a system of uniform reserve requirements on banks and legislation to make nonmember banks subject to
the same reserve requirements as member banks; which would grant
the System control over consumer credit; which would eliminate certain restrictions in guaranteeing credit granted to business; and which
would eliminate the minor restrictions that hamper efficient operations
throughout the System.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
Legislation should be enacted establishing uniform reserve requirements for all commercial banks, including authority to change reserve
requirements, as outlined in detail in question IV-1.
In addition, the Congress should grant authority to the Federal
lieserve to exercise control over the volume of consumer installment
credit by permitting the System to establish from time to time as
needed minimum down payments and maximum maturity periods for
installment credit transactions involved in the sale of durable goods
and maximum maturity periods involved in credit transactions arising
out of personal installment loans.
Finally, it would be desirable for the Congress to direct the Treasury and all lending and credit agencies, as well as the Federal Reserve,
to promote the objectives of the Employment Act of 1946.
Comments of Allan Sproul, Federal Reserve Bank, New York, on IV
as a whole
Any economy, however organized, appears to need some degree of
guidance, but a central problem in our country, and in all countries
but Russia and its satellites, in fact, is how far such guidance or control can go without destroying the effective functioning of a private
economy. In this country, with our traditions of individual enterprise, we seem to have preferred to keep such guidance to the practicable minimum, and to have it exercised largely through broad and
impersonal controls—controls which affect the general environment,
but do not extend to the regulation of individual transactions. One
cornerstone of such a philosophy is an effective monetary policy. In
making monetary policy work, to the full limits of its potentialities,
we prepare one of the best possible defenses against the growth of
control by intrusion.
But even in trying to make monetary policy work, there are dangers. Ends have a deceptive way of justifying means. The goal of
making monetary policy work may present itself as the need for just
one more power. The tests of such requests for further powers should
always be: Are they really needed and will they, in operation, still
leave a reasonably free functioning private economy ? It is this latter
test which sets the final limit on additions to the instruments of Fed98257—49

11




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MONETARY, CREDIT, AND FISCAL POLICIES

eral Eeserve policy. But the first test is important as well: Is the
proposed control really necessary, or is it perhaps a way of camouflaging either an unwillingness to take the action permitted by existing
powers or an attempt to achieve varied, and possibly conflicting,
objectives ?
This test forms the basis for my one substantial disagreement with
the views expressed in the accompanying treatment of section IY in
the questionnaire. Under question IV-5, the document says " * * *
the System is not in a position to absorb bank reserves to the extent
that might be necessary to prevent an unwarranted expansion in
credit." For a period of runaway inflation, that statement is probably
correct, and perhaps, as I tentatively indicated at one time in testimony
before the Senate Banking Committee, a provision allowing temporarily higher reserves against deposit increases (new deposits)
might prove helpful in such circumstances. But for the type of inflationary situation through which we have just passed, I should think
our present powers are adequate, provided they are used to the necessary extent.
What the drafting committee no doubt had in mind was the period
of 1947 and 1948, when a conflict developed between system support of
the Government security markets (which necessitated frequent purchases, and a corresponding release of reserves to the banking system)
and the System's desire to put pressure on bank reserves in order to
check credit expansion. This posed a difficult problem, but in my
view a request for more powers was sidestepping the real issue, an
issue which would have remained, and reemerged, once any new powers
had been granted and put in operation. To have raised reserve requirements in an effort to lock up the new reserves created by support
purchases would have been only the first step in a chain reaction.
Banks would have sold more securities to the Federal Eeserve in order
to meet the higher requirements, while the attendant loss of earning
assets (and other considerations) might have caused them to go on
selling Governments in order to obtain funds for use in making profitable loans or purchasing non-Government securities. A further rise in
reserve requirements would probably then have led to even more sales
of securities to the Federal Eeserve. Meanwhile, member banks alone
would have carried the brunt of the attempted restraint, while many
nonmember banks and all other financial institutions could have gone
on selling Government securities to the Federal Eeserve (thereby
adding, as well, to bank reserves) and making new loans and investments as long as they were available and attractive.
The real problem lay in the System's acceptance of a degree of responsibility toward the prices of Government securities, which, however compelling in the early years of postwar transition, could not be
continued indefinitely if credit policy was to assume its former role.
As events transpired, Treasury surpluses and System redemptions of
maturing securities, together with open-market sales of short-term
securities, accomplished within the general framework of prices acceptable to the Treasury, reabsorbed most or all of the bank reserves
created by System support purchases of other Government securities.
As a result, apart from gold inflows which were only partially offset,
member-bank reserves did not rise throughout these years by any more
than the amount of those increases in reserve requirements which did
occur. It is doubtful, moreover, whether the increases in reserve




157 MONETARY, CREDIT, AND FISCAL POLICIES

requirements in 1948 did any more than cause the sale to the Federal
Eeserve banks of an equivalent amount of Government securities—
sales which presumably would not have occurred if it had not been for
the increase in reserve requirements themselves.
For the future, it is even more important to point out that a flexible
monetary policy, geared to the requirements of economic stability,
must be permitted to reflect itself in changes in interest rates. If rates
on Government securities are kept rigid, then all rates must be relatively rigid, because Government debt now constitutes more than
one-half the total of all debt in the economy, and its behavior tends
to dominate the structure of interest rates. So long as the System
cannot allow moderate changes in rates to occur, as a result of its
decisions to ease or tighten credit, then it cannot in fact accomplish an
easing or a tightening of credit. The real decision must be made in
terms of how far such fluctuation can be permitted. A resort to
special powers to increase reserve requirements would, in my opinion,
only conceal or delay recognition of this central fact.
I am not arguing, of course, for abandonment of System concern
over the Government's credit. I do say, however, that it will be the
compromises achieved between extreme forms of this concern, and
concern over the other credit measures appropriate to sustained economic stability, which will determine the effectiveness of general
credit controls in the future; not a reliance upon roundabout new
powers which, in the end, will lead us back to recognition of the inherent need to compromise between two desirable, and sometimes
inherently conflicting, objectives. This is not to say, however, that
the Eeserve System should not have authority to change the reserve
requirements of the banks in order to meet fundamental changes
in our banking system or in the reserve position of the banks. For
example, long-continued gold inflows on a large scale, or a major
reduction in the use of circulating currency, might be among the
factors justifying a rise in requirements. Conversely, a substantial
gold outflow, or a rise in currency circulation, may make a reduction
of reserve requirements necessary.
On the other suggestions advanced in this section of the research
study I have only passing comments. The recommendation under
question IY-1 (a) for legislation permitting the establishment of
uniform reserve requirements based on a type of deposit, rather than
on a geographical location, is one which I assume the Federal Eeserve
bank presidents will wish to submit to the consideration of their
directors, the Federal Advisory Council, the banks concerned, and
others, perhaps, before taking a definite and final stand. My own
view has been and still is that the uniform reserve proposal offers
considerable promise as a measure of eliminating inequities in the
present system, and should have your earnest consideration.
To the remarks on question IY-1 (c) I would add the amplifying
footnote that changes in reserve requirements should be made only
to meet fundamental changes in the reserve position of the banks, or
to accomplish a major structural adjustment in the expansion potential of our fractional reserve banking system. I would not endorse
the use of changes in reserve requirements to carry out short-term
shifts in policy. Constant jiggling of reserve requirements is not
the way to run a banking system. Open-market and discount operations are much better suited, as I see it, to the sensitive adjustments



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MONETARY, CREDIT, AND FISCAL POLICIES

called for in effecting ordinary variations in bank reserve positions,
and thus influencing the cost and availability of credit.
I would reinforce the conclusion that nonmember banks should
be subject to the same reserve requirements as member banks (question
IV-1 (d)) by asking why, as a matter of equity, should a free-riding
group of banks be permitted to avoid the responsibility of contributing
to national monetary policy, leaving the impact of such policy to be
borne only by banks which are members of the Federal Reserve
System ? It is no answer, in my opinion, to say that only a small proportion of the bank deposits of the country are free of member-bank
reserve requirements, and that the effectiveness of monetary policy is
not at stake. Any institution which has been given the power to add
to or subtract from the money supply of the Nation (as have the
banks) should be subject to the monetary policies of the Nation. I
would not emphasize the concern, expressed by the report, over the
threat of withdrawal from membership because of differences in
reserve requirements between member and nonmember banks; and,
by the same reasoning, I would emphasize the view that no threat to
the dual banking system is involved. Member State banks have lived
within the System for years and have submitted to its reserve requirements without loss of identity.
As for the statement on margin requirements (question IV-3), I
would merely add that one additional point of policy needs legislative
clarification. That is whether or not imposition of a full 100-percent
margin requirement is a violation of the principle Congress intended.
Is it correct, in other words, to consider an administrative elimination
of margins altogether as consistent with the setting of margin requirements ? I present no opinion either way, at this time, but I do suggest
that Congress might wish to remove a possible ambiguity concerning
the uses to which this power should be extended.
In keeping with the first of the two tests outlined earlier in my
remarks in this section, I am concerned over the dangers in any further
significant extension of selective controls (such as those reviewed
without endorsement under question IV-4). Whether the proposal
is for special controls over the credit used in the commodity markets,
in real-estate transactions, in inventory accumulation, or in other
forms of business credit, the test must be the same: can the control
be effectively administered through general regulations, without delving into the affairs of particular individuals? So far as loans for
commodity trading are concerned, there is the additional consideration that these perform a unique economic function. They permit
those hedging transactions and those truly speculative (as distinguished from gambling) transactions which are indispensable for
modifying swings in the prices of basic commodities, as demand and
supply factors fluctuate.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
As indicated in any replies to questions IV-1 and IV-2, I am opposed to the recommendations in the draft replies for legislation
changing the method of determining reserve requirements and granting authority to the Federal Reserve to exercise control over the volume
of installment credit. While a number of other changes could be
suggested which would be conducive to more efficient and more economical operations, they are of minor significance to the achievement




159 MONETARY,

CREDIT, AND FISCAL POLICIES

of Federal Reserve policy objectives. I believe that the System can
do a good job under existing authority.
V.

ORGANIZATION AND STRUCTURE OF THE FEDERAL EESERVE SYSTEM

1. In what respects, if at all, is the effectiveness of Federal
Eeserve policies reduced by the presence of nonmember banks?
The System answer
The effectiveness of Federal Eeserve policies is reduced by the
presence of nonmember banks as a result of the fact (1) that those
banks are subject to different reserve requirements than member banks
and are subject only indirectly, if at all, to the influence of Federal
Eeserve policies, and (2) that nonmember banks do not have full
access to Eeserve-bank lending facilities.
As the Federal Eeserve System, in exercising its general credit
powers, influences the volume, availability, and cost of bank credit
chiefly through the reserves maintained at the Eeserve banks, the
larger the coverage the more effective the policies and actions of the
system. Thus, the effectiveness of the credit policies of the Federal
Eeserve System is increased with the increase in the number of banks
that carry reserve balances with the Federal Eeserve banks. However,
the great disparity which generally exists between member- and nonmember-bank reserve requirements tends to discourage membership
in the Federal Eeserve System, and it must be recognized that this
disparity could lead to termination of membership through shifts
from national to State charters and withdrawal. Nonmember banks
usually are subject to lower reserve requirements than member banks.
They are permitted to hold their reserves at correspondent banks,
those balances serving both as legal reserves and as correspondent balances, while member banks must maintain reserves with the Federal
Eeserve banks and, except for the largest city banks, generally also
carry balances at correspondent banks. Moreover, in some States,
nonmember banks are permitted to invest a portion of their reserves
in interest-bearing public securities. The wider the spread between
member- and non-member-bank reserve requirements, the greater the
deterrent to membership and the danger of withdrawal become. The
possibility of withdrawal from membership has to be taken into account by the Federal Eeserve in considering increases in memberbank reserve requirements and tends to inhibit the System in making
such increases.
The fact that nonmember banks have only limited access to Eeservebank lending facilities could seriously interfere with the effectiveness
of Federal Eeserve policies in time of monetary crisis. One of the
prime objectives in such a period is the maintenance of the liquidity
of the commercial banks' earning assets and in turn the availability
to the public of the funds that they have on deposit with the banks,
so that the flow of payments in the economy will not be interrupted.
The basic source of that liquidity is the lending power of the Federal
Eeserve banks. Nonmember banks have only limited access to those
lending facilities and are largely dependent upon the lending facilities of the correspondent banks, which are inadequate in time of
monetary crisis.




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MONETARY, CREDIT, AND FISCAL POLICIES

Reply of J. N. Peyton,, Federal Reserve Bank, Minneapolis
The presence of nonmember banks and the possibility of becoming
a nonmember bank constitute the principal safety valve through
which State banks can escape if Federal Reserve pressure becomes
too heavy. This is both good and bad. It is good in that an additional check is thereby placed on the possibility of arbitrary and excessive exercise of power by a policy agency. It is bad in that a policy
of restraint, if such should become socially desirable as in 1946 and
1947, becomes accordingly more difficult because of the discrimination
thereby imposed against State member banks. There is also the possibility that a sufficient number of member banks would become nonmembers, so that bank-credit pyramiding would occur in undesirable
amounts. (Non-member-bank reserves are a portion of the deposits
of member banks which are subject to the fractional reserve requirements set by the Board of Governors of the Federal Reserve System.)
There is no easy way out of this dilemma. A suggestion along the
lines of that given in l V - 1 (b) might provide the basis for a working
compromise.
2. What changes, if any, should be made in the standards that
banks must meet in order to qualify for membership in the Federal
Reserve System ? What would be the advantages of such
changes ?
The System answer
The present statutory requirements with respect to the capital stock
required for the admission of State banks to membership should be
eliminated. Instead, the adequacy of the bank's capital structure
should be specified as one of the factors that the Board of Governors
would be required to consider before giving its approval of the application of a State bank for membership, but there should be no specific
capital requirements except a minimum of $50,000 paid-up capital
stock subject to the exception that a bank organized prior to the time
of the enactment of the proposed legislation might be admitted with
a minimum of $25,000 paid-up capital stock. Under this proposal,
the Board of Governors would exercise discretion with respect to the
adequacy of the bank's capital structure in relation to the character
and condition of the bank's assets and to its deposit liabilities and
other corporate responsibilities.
Specific capital requirements also should be eliminated from the
statutes with respect to the establishment or operation of domestic
branches of State member banks. The establishment and operation
of a domestic branch (where permitted by State law) should require
the consent of the Board of Governors, which consent should be given
only after consideration of the financial history and condition of the
bank, the adequacy of the bank's capital structure, its future earnings
prospects, the general character of its management, and the convenience and needs of the community to be served by the branch.
These factors are the same as those which the Federal Deposit Insurance Corporation is required to consider before permitting the establishment of branches by nonmember insured banks.
The suggested change in the requirements for admission of State
banks to membership would eliminate the present capital requirements
based on the population of the town in which the bank is located,
these requirements being generally the same as those required for




161 MONETARY, CREDIT, AND FISCAL POLICIES

chartering a national bank in the same location. Requirements based
on population of the place in which a bank is located are not a reasonable measure of the bank's capital needs. In practice, such requirements prevent sound banks entitled to membership by other criteria
from becoming members of the Federal Reserve System. The recommendation of a $50,000 minimum capital-stock requirement is made
with a view to avoiding discrimination against the chartering of
national banks. The provisions for an exception whereby banks
organized prior to the enactment of the proposed legislation might be
admitted with a minimum of $25,000 paid-up capital stock would not
interfere with the chartering of national banks and would permit the
admission of sound banks which otherwise would be denied membership.
Present capital requirements specify only capital stock and fail to
take into consideration surplus and other accounts, which are part of
the capital structure of a bank. In this way, a bank with a substantial
and well-balanced capital structure may be ineligible for membership
even though its capital structure is stronger than that of some bank
that has the required amount of capital stock. A bank should have a
reasonable amount of capital stock to be eligible for membership, but
consideration also should be given to other capital accounts. If a
nonmember bank has a sound investment and lending policy and its
management is capable, it should not be denied membership in the
Federal Reserve System if the only reason involved is lack of capital
sufficient for it to become a national bank.
The suggested changes in requirements for the establishment or
operation of domestic branches by State member banks also are made
with a view to removing arbitrary capital requirements. At present,
the law provides that a State member bank wishing to establish domestic out-of-town branches must have a minimum capital stock of
$500,000, except for a smaller minimum in a few States of smaller
population. In addition, the bank must have a capital at least equal to
the minimum aggregate capital for establishing national banks in the
various locations of the bank and its branches. The same requirements
are applicable for the admission to membership of a State bank operating out-of-town branches, if such branches were established subsequent
to February 25,1927.
These legal provisions do not establish a proper measure of the
capital needs of a bank, and in many cases they result in capital
requirements not only in excess of the requirements under the laws
of the State where the bank is located but also in excess of reasonable
capital needs. In some instances, State banks with out-of-town
branches have refrained from joining the Federal Reserve System,
as it would have been necessary either to give up their branches or to
increase their capital stock in excess of capital needs. In other instances State banks have withdrawn from membership when they
wished to establish out-of-town branches and the statutory capital
requirements were unreasonably large.
3. What changes, if any, should be made in the division of
authority within the Federal Reserve System and in the composition and method of selection of the System's governing bodies ?
In the size, terms, and method of selection of the Board of Governors? In the open market committee? In the boards of
directors and officers of the Federal Reserve banks ? What would




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MONETARY, CREDIT, AND FISCAL POLICIES

be the advantages and disadvantages of the changes that you
suggest ?
The System answer
The power to change member-bank reserve requirements within the
limits provided by law and the power to approve rediscount rates
established by the Federal Reserve banks should be transferred from
the Board of Governors to the Federal open market committee. The
transfer of the power to change member-bank reserve requirements
to the open market committee was recommended to the Congress
jointly by the Board of Governors, the presidents of the 12 Federal
Reserve banks, and the members of the Federal Advisory Council on
December 31, 1940.
The credit powers of the Federal Reserve System are not isolated
or unrelated powers, and the decisions made and the actions taken
with respect to these powers need to be properly coordinated if they
are to be consistent and effective. Accordingly, the power to approve
rediscount rates established by the Federal Reserve banks, the power
to change member-bank reserve requirements, and the power to conduct open-market operations should be lodged in a single body rather
than divided as at present between the Board of Governors and the
Open Market Committee.
In placing such authority and responsibility in a single body the
Open Market Committee becomes the logical choice by the nature of
its membership, which includes both the entire Board of Governors
and five Reserve bank presidents. The composition of this committee
gives assurance of proper coordination of national and regional considerations. Moreover, Reserve bank representation on this committee gives added assurance that the practical experience of the Reserve
banks in carrying out central banking operations will be given consideration in the determination and execution of Federal Reserve
credit policies.
No changes appear to be necessary with respect to the size, terms,
and method of selection of the Board of Governors. Moreover, no
changes are recommended in connection with the boards of directors
and officers of the Federal Reserve banks, as the present legal provisions appear to be satisfactory. It is important that men of outstanding ability should be interested in serving on the Reserve banks' boards
of directors, and it is firmly believed that the continued service of such
men is largely dependent upon the retention of sufficient autonomy in
Reserve bank administration and sufficient participation in the consideration of System policies to make Reserve bank directorships challenging assignments to capable men.
Reply of Hugh Leach, Federal Reserve Bank, Richmond
No changes are recommended with respect to the size, terms, and
method of selection of the Board of Governors, or the boards of directors of Federal Reserve banks as the present legal provisions appear
to be satisfactory. It is believed, however, that the provision of law
with respect to the first vice presidents of Federal Reserve banks should
be eliminated. A more flexible organization would result if all senior
officers under the president were designated as vice presidents. The
directors would then be free to shift duties and responsibilities without the difficulties that might now arise because of the public recog-




163 MONETARY, CREDIT, AND FISCAL POLICIES

nition of one of the senior officers as the chief executive in absence of
the president.
Reply of J. N. Peyton, Federal Reserve Bank, Minneapolis
Experience of the last three decades has confirmed the wisdom of
the initial decision to set up a regional system of central banking
rather than a centralized bank as such. Accordingly the System should
continue to be organized on a basis which can to a maximum extent
cash in on the advantages of this regional set-up. The American
economy is exceedingly diversified. Monetary policy must be attained
to take cognizance of this diversity. Greater familiarity with problems of the area, less hostility because of seeming remoteness and autocracy—these are important in the American setting. It would seem
wise, therefore, to accord to the boards of directors of the regional
banks as much power and responsibility for the operation of the Federal Reserve banks as is consistent with the requirements of a general
national monetary policy. Within this framework certain specific
questions can be raised.
(a) The Hoover Commission report for reducing the number
of governors and delegating more of the routine activities to staff
members deserves serious consideration.
(b) The terms of the members should continue to be long in
order to provide some measure of System autonomy and independence, an independence which the whole history of central
banking has clearly demonstrated to be in accord with social and
economic welfare.
(c) Currently the Federal Reserve Act provides for boards
of directors of the branches and at the same time makes the head
office responsible for the operation of the branches. This leaves
the branch boards of directors duly constituted and with no operational function or responsibility to perform. Accordingly it
would seem desirable to reconstitute these branch boards as advisory committees which can serve as a desirable liaison with the
public. This in fact is about the only function that they can perform currently. The alternative, changing the law to make,
branch boards responsible for the operation of branches, would
virtually convert the branches into separate Federal Reserve
banks.
Comments of Allan Sproul, Federal Reserve Bank, New York, on V
as a whole
My comments on this section all relate to question Y 3. I have previously urged upon the Joint Committee on the Economic Report
that responsibility for all major credit policies should be in one body,
and that the Federal Open Market Committee most nearly meets the
requirements of our national plus regional central banking system.
In this Committee, the Federal Reserve System has evolved a method
for conducting policy deliberations that is uniquely in tune with our
political and economic institutions. Government is directly represented through the Presidential appointees to the Board of Governors.
Regional interests, and the lessons of experience "in the field," are
represented through the rotating membership of the Federal Reserve
bank presidents. (The president of the Federal Reserve Bank of
New York is continuously a member, Congress having recognized the




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MONETARY, CREDIT, AND FISCAL POLICIES

importance of the continuous participation of the head of the Federal
Reserve bank, located in the principal national and international
money market, in the proceedings of the Committee.) National
policies are formulated without complete centralization of authority.
The Federal Open Market Committee evolved out of experience and,
in its present form, has survived the tests of nearly 15 years; it has
worked well. It already has been given (by the Banking Act of
1935) statutory responsibility for open-market operations, the most
important single instrument of Federal Reserve policy. Personally,
I continue to believe we should recognize the full potentialities of
what is, actually, an extraordinarily successful innovation in the
methods of democratic administration and policy formation. The
practicality of a policy-making group including representatives of the
Board of Governors and of the Federal Reserve Banks has proved
itself. Such a body should have not only the powers mentioned in
the attached document, but also ultimate responsibility over margin
requirements and all other general aspects of credit policy, including
the System's role in international financial policy. The regulatory
duties under these various powers would continue with the staff of
the Board of Governors and the Federal Reserve banks. The major
gain would lie in bringing together in one group representative of
the whole System, all significant policy formation; in bringing together authority for the exercise of powers which must be exercised
in concert, which cannot be exercised in isolation.
Whether or not this major chang;e in the organization of the System
is accepted, I would endorse certain minor changes. The size of the
Board of Governors, for example, could well be lowered to five members, with some increase in efficiency and an increased likelihood of
being able to attract outstanding men to this service. Consistent with
this change, the terms of members could be shortened to 10 years,
with members eligible for reappointment. It would also be desirable
to eliminate the present regional and vocational requirements for the
selection of members, requiring only experience and competence for
the job. So far as the structure of membership in the Federal Open
Market Committee is concerned, it need not be altered by such a
change in the size of the Board. The number of Federal Reserve bank
presidents in the Committee could be reduced to four, or the possibility of parliamentary difficulties arising from the membership of
five members of the Board and five Federal Reserve bank presidents
could be resolved by providing that the Chairman of the Board and
of the Committee cast a second vote if an even split should occur on
any question. Based on past experience with a 12-member Committee,
such an eventuality seems unlikely. As a general rule, votes indicating
an even split would result in no action being taken. The Open Market
Committee has rarely acted without the agreement of all but two or
three members; usually action is unanimous.
One final observation on another aspect of question V3. While I
see no need for change in the size, terms, and methods of selection of
the boards of directors of the Federal Reserve banks, I would like to
stress the very real contribution which these Boards make to the
success of Federal Reserve operations and policy. The directors
provide the Federal Reserve banks with a cross section of public sentiment in their regions. They furnish advice that reflects a wider range
of experience than could practicably be assembled on the staffs of the



165 MONETARY,

CREDIT, AND FISCAL POLICIES

Federal Reserve banks themselves. They provide the judgment of
experienced management in passing upon the internal operating performance of the Federal Reserve banks. Nor is the relationship between the Federal Reserve banks and their directors all one way.
The directors also gain an acquaintance with the purposes and the
practical details of credit policy, which they in turn can pass on to
their own communities and associates. In helping to create an awareness of the goals of monetary and credit controls, the directors can do
much toward broadening the general understanding of Federal Reserve operations and toward the effectiveness of credit policy. Such
intangible results cannot be measured, but they are of the greatest
importance.
VI.

RELATION OF THE FEDERAL RESERVE TO O T H E R B A N K I N G AND
CREDIT AGENCIES

The System answer
Questions under this heading cover three aspects of Federal Reserve
policy and operations:
(1) The Federal Reserve System has a major responsibility for
national monetary and credit policy.
(2) The System has supplementary duties and authority with
regard to the extension of credit to business.
(3) The System exercises limited supervisory powers over
banks.
All of these activities bring it into contact with other banking, credit,
and lending agencies of Federal and State Governments.
In a broad sense, all of the activities of the Federal Reserve System
have been developed with a view to their contribution to national
monetary and credit policy. While the authority to make direct loans
to business (or to participate with other lending institutions in loans
to business, to provide, in effect, guaranties on loans through agreements to purchase parts of those loans) was undoubtedly established
by Congress to provide business with access to funds when ordinary
sources were not available, the delegation of the authority to the Federal Reserve System is appropriate for two reasons. Practical lending
skills and machinery already exist at the Federal Reserve banks, and
further, the System is concerned over the effective functioning of our
credit system so as to assure the availability of credit to accommodate
commerce, industry, and agriculture, during periods in which breakdowns of normal credit arrangements may serve to defeat the objectives of a monetary policy designed to secure an optimum use of our
economic resources.
From the viewpoint of the Federal Reserve System, therefore, the
problems of relationships with other agencies should be viewed primarily on the basis of the System's major responsibilities for the determination of national monetary and credit policy and secondarily in
terms of the details of operation of the various duties and tasks assigned to the System. From this dual viewpoint the System is concerned with coordination between the lending activities of Government
and national monetary and credit policy. It is important that other
agencies should not embark on unduly liberal lending policies at a time
when the long-run economic welfare of the country calls for credit
restraints. Conversely it would be unfortunate if the other lending



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MONETARY, CREDIT, AND FISCAL POLICIES

agencies were to follow a policy of restriction at times when a policy
of ease and expansion was desired. Experience indicates that this
latter conflict is much less apt to occur than is the former.
The System is also concerned over the necessity of devising and
maintaining bank supervisory policies of a type which will seek the
proper objectives of supervision—maintenance of sound banks which
can meet their obligations to depositors and provide the credit facilities essential to the most effective use of our economic resources—
without, at the same time, exerting an influence in opposition to national monetary and credit policy, whether that policy calls for ease or
restraint.
1. What are the principal differences, if any, between the bank
examination policies of the Federal Reserve System and those
of the FDIC and the Comptroller of the Currency ?
The System answer
At present, there are no significant differences between the bank
examination policies of the Federal Reserve System and those of
other Federal supervisory agencies. As noted below, important differences do arise among the three agencies in the exercise of the supervisory function; that is, in the critical appraisal of the results revealed
by bank examinations. To the extent that differences do exist among
examination practices as such, we believe them to be primarily the
result of differences in individual interpretations throughout the field,
and differences in the attitudes and viewpoints of individuals or of
supervisors in particular circumstances. All three agencies are concerned with the preservation of soundness of banks. They emphasize
the maintenance of quality of assets and the conduct of the bank in
accordance with practices which through years of banking experience
have proved to be sound. They also emphasize the maintenance of
adequate cushions of capital and valuation allowances to protect the
bank. While differences in approach to the problem of adequate
capital may exist, it is by no means certain that the differences are not
due as much to personal attitudes and predilections as to differences
in the interests of the agencies. Even here, however, the difficulties of
determining adequacy of capital are stressed so frequently by each of
the agencies that it is not too easy to ascribe to any one agency a particular approach to the problem. We believe it correct, however, to
point out that the Comptroller of the Currency tends to emphasize
the ratio of capital to risk assets, the FDIC tends to emphasize the
relation of capital to total assets, while the Federal Reserve System
tends to follow a more flexible policy in relating capital to the general
character of the bank and the business which the bank is conducting.
Considerable differences of opinion, however, would probably be found
among the agencies as to the accuracy of this description of differences
m attitude toward bank capital requirements.
In general, bank supervision and bank examination seek to protect
the public interest in the banking system as a whole.
Primary consideration is given to protecting the customers of the
banks, primarily the depositors. Some consideration is also given to
the protection of (or rather the availability of services to) borrowers,
but individual differences are more pronounced in this matter.




1

167 MONETARY, CREDIT, AND FISCAL POLICIES

Secondary consideration is given to the preservation of shareholders' equity, and the encouragement of its growth especially by the
retention of a portion of earnings in the capital structure of each bank.
The accomplishment of these objectives is approached through periodic examinations of banks. An examination includes the following steps:
An analysis, appraisal, and classification of all the bank's assets
according to their apparent soundness. This includes: Investments, loans, and other assets.
Study of each bank's practices with reference to its compliance
with statutory requirements: Federal laws and regulations that
are applicable; and State laws and regulations of State supervisory authorities that are applicable.
Verification of assets and liabilities to the bank's statement.
Consideration of methods and operating practices under use by
the bank including: The making of tests, the conduct of which is
designed to forestall and discourage the beginning peculations by
officers and employees; and the holding of meetings or conferences
when necessary with officers and directors to review and consider
bank policies, indicated trends, and the responsibilities assumed
by bank management.
Review and appraisal of apparent abilities of the bank's management.
While significant differences do not now exist in examination policies and practices, differences in viewpoint with regard to supervision
do exist and these differences have given rise to conflicts and may
continue to do so in the future.
The Federal Reserve System has a broad responsibility and interest not only in the soundness of the banks themselves but also in
the proper functioning of the monetary and financial system so as
to maintain the flow of funds and contribute to an allocation of resources conducive to the most effective use of our economic resources.
The Comptroller of the Currency, on the other hand, is interested in
the chartering and supervision of national banks in order to maintain
the strength and prestige of the national banking system and the
strength and soundness of the individual national banks themselves.
The FDIC as insurer has the responsibility of protecting its insurance risks in the individual banks. As a consequence, during periods
of strain or crisis, policies and actions of these agencies in seeking to
protect the immediate interests of the individual banks could run
counter to those of the Federal Reserve System concerned with the
preservation of the entire monetary and financial system including
the satisfactory functioning of the money markets.
The System is concerned over the possibility of supervisory policies
being so devised as to complicate the establishment of national monetary and credit policy, and, through conflicting objectives, to reduce
the effectiveness of such policies. The monetary authorities affect the
credit situation through influencing the availability and cost of money.
Its actions, therefore, are reflected in money rates. Among the important series of rates are those shown by the yields on securities,
chiefly bonds. Yields on bonds are in effect the reciprocal of the




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MONETARY, CREDIT, AND FISCAL POLICIES

prices paid for those bonds. Any action by the national monetary
authority, therefore, affecting interest rates is bound to have an effect
on bond prices or bond values as reflected in the market. Actions of
the supervisory authorities in determining eligibility of securities
for bank investment and the values at which securities would be
appraised also affect bond prices, money rates, and bank investment
policies. As a consequence, their actions can reduce the effectiveness
of policies and actions taken by the monetary and credit agency or
even restrain that agency from adopting policies or taking actions
which it would consider to be desirable in pursuit of the objectives
enumerated in section I above.
During periods of deflation and business decline, monetary policy
would ordinarily call for easing action. As economic uncertainties
develop, holders of investment securities attempt to dispose of some
of their investments, depressing prices of securities generally. At such
times in the past, bank supervisors have sometimes required banks
to write down the values of (or to liquidate) assets as market prices
have declined. Particularly has this been true of the obligations of
concerns which appeared to be more susceptible than others to adverse
business developments. This practice, if followed again at some time
in the future by bank supervisors, would intensify the pressures for
liquidation and would lessen the availability of money at the very
time that monetary policy would be attempting to arrest or at least
slow down the forces of liquidation and deflation.
It is also possible in periods of inflation for supervisors to adopt
policies with respect to the valuation of bank assets which would embarrass or interfere with monetary policy. A monetary policy of
restraint to combat a speculative growth in credit and speculative and
unwise investments in business might not be adopted or pursued with
sufficient vigor if there were reason to believe that the supervisors of
banks would require the banks to write down the values of their assets
to conform to the lower prices which will result temporarily from the
increases in money rates and bond yields accompanying the policy
of restraint. A situation could be precipitated in which investors
would seek to liquidate their holdings in such large volume as to demoralize the market. The financial repercussions of such actions might
compel the substitution for a policy of monetary restraint of one of
emergency support of demoralized markets, necessitating large purchases of securities by the Federal Eeserve with corresponding increases in bank reserves which, when the market crisis was surmounted,
would contribute further to the inflation against which national monetary policy was supposed to be contending.
One conspicuous difference in policy between the Federal Eeserve
and the FDIC has to do with the question of payment of interest on
demand deposits. The Federal Eeserve System has ruled that the
absorption of exchange charges by a bank constitutes payment of interest in violation of Eegulation Q of the Board of Governors of the
Federal Eeserve System and section 19 of the Federal Eeserve Act.
The FDIC, on the other hand, contends that the absorption of exchange is not a payment of interest on demand deposits in violation of
Eegulation IV of the Corporation and of section 12-B of the Federal
Eeserve Act. These conflicting interpretations have given rise to
controversy and confusion.




169 MONETARY, CREDIT, AND FISCAL POLICIES

Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
In general, bank supervision and bank examination seek to protect
the public interest in the banking system as a whole. Primary consideration is given to protecting the customers of the bank, particularly
the depositors and the beneficiaries of trusts being administered by
the bank. Secondary consideration is given to the preservation and
growth of the shareholders' equity.
The accomplishment of these objectives is approached through
periodic examinations of banks. An examination includes the verification of assets and a determination of the nature and extent of liabilities ; an analysis, appraisal, and classification of all of the bank's
assets according to their soundness; an investigation to ascertain
whether the bank is complying with applicable Federal and State laws
and regulations; consideration of the methods and operating practices
in use by the bank, including certain tests designed to detect, forestall,
and discourage peculations by officers and employees; and an appraisal of the character and ability of the bank's management.
The Comptroller of the Currency is concerned primarily with the
soundness of individual national banks and the competence of their
managements. The Federal Deposit Insurance Corporation is concerned primarily with the degree of risk in individual bank assets
and in the aggregate of those risks as related to the insurance fund.
Under the law the Federal Reserve System is required to be cognizant not only of the soundness of banks, the character of their managements, and the degree of risk in bank assets but also the credit
policies of the banking system and their relation to basic monetary
and credit conditions.
Out of these differences in basic objectives some differences in
policies do develop, but they are currently not regarded as of a critical
nature. For example, there are differences in the policies of the three
supervisory organizations with respect to the thoroughness and frequency of individual examinations. There are differences in policies
with respect to the extent to which examiners enforce compliance
with regulations which are not directly concerned with the primary
functions of their own agencies. Examples of such regulations are
Regulations Q affecting payment of interest on demand deposits, U
affecting credit to purchase and carry securities, and W, which affected
terms on consumer credits. Finally, and perhaps more basically, the
differences in institutional objectives, organizations, and procedures
lead the examiners of the Federal Reserve System to be particularly
aware of current monetary and credit conditions and policies in their
appraisal of bank assets and the management of loans and investments.
2 (a). To what extent, and by what means have the policies
of the Federal Reserve been coordinated with those of the FDIC
and the Comptroller of the Currency where the functions of these
agencies are closely related ?
The System answer
For the most part coordination is achieved at both the top policy
levels and at the top technical and administrative levels through conferences and exchanges of viewpoints in Washington. We understand that the Board of Governors of the Federal Reserve System is




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MONETARY, CREDIT, AND FISCAL POLICIES

preparing an answer to a somewhat similar question, and we believe
that the details of the Washington procedures could more appropriately come from that source.
At the district level, coordination is obtained through informal conferences and through exchange of ideas and information. Each of
the supervisory authorities holds conferences of its examiners in each
of its districts. It has been the practice of each agency to invite representatives of the other agencies to attend its conferences and to
participate in discussions regarding policy and procedures, and in
discussions of sample cases illustrating existing policies.
2 (S). What changes, if any, would you recommend to increase
the extent of coordination ?
The System answer
While differences in viewpoint and approach exist, particularly with
regard to some of the broader aspects of supervisory policy, and while
conflicts are possible, existing policies and procedures are not so
badly coordinated in actual practice as to be a matter of serious concern! The necessity for, and problems of, coordination among Government agencies with respect to other matters are of greater concern
to the Federal Reserve System and the reply to this question is dictated
in considerable measure by considerations raised in the answers to
other questions, particularly II-3, IV-4, and IV-6.
A variety of suggestions could be made. Among them are:
Consolidation of all Federal supervisory agencies into one;
Designation of the Comptroller of the Currency as an ex officio
member of the Board of Governors of the Federal Reserve System,
and a member of that Board as an ex officio member of the Board
of Directors of the FDIC; or
Creation of a national credit advisory council.
These alternatives are discussed more fully below.
On logical grounds the consolidation of all Federal bank supervisory agencies would appear to be the best solution, and if one were
to start with a clean sheet this might be recommended. However, we
have an existing system with three Federal agencies which has developed out of the experience and traditions of the country. The
problem, therefore, is not what would be done if a fresh start were to
be made, but what is to be done with what we now have.
The advantages of consolidation would be: Policy determination
would rest in a single source. Consolidation in the Federal Reserve
System would provide unified administrative control which could compel coordination not only with regard to bank supervision but also
with regard to monetary and credit policy. Consolidation in an independent agency other than the Federal Reserve System would provide administrative control which could compel coordination in bank
supervision. Coordination with monetary policy would not be assured but its achievement presumably would not be made more difficult and might be made easier. Some reduction in cost of administering the examination function would probably result from elimination
of overlapping supervisory offices. There is little actual duplication,
however, among the three Federal agencies.
The disadvantage of consolidation is: A single agency would be
supervising three groups of banks to which it would stand in different




171 MONETARY, CREDIT, AND FISCAL POLICIES

sets of legal relationships—national banks, chartered by the Federal
Government, State member banks, and State nonmember insured
banks. Suggestions and recommendations made in other answers, if
put into effect, would lessen the significance of these differences without lessening in any way the independence of the State banking systems, except on those matters of broad national monetary and credit
policy which are properly the concern of the Federal establishment,
to be dealt with in such manner as the Congress might direct.
The proposal for designation of ex officio members of the Federal
Reserve and FDIC Boards is more fully discussed in the answer to
question VI-3 below. As indicated in that answer, it is by no means
clear that use of this device in the past has resulted in improved
coordination. It is doubtful that future experience would be materially different.
Increased coordination might also be secured through the creation
of a national credit advisory council, such as is discussed in the
answer to question VI-6. In any case, consideration might be given
to amendment of the provisions of the Federal Reserve Act dealing
with bank examinations by the three Federal bank supervisory agencies to require regular consultation between these agencies. (See also
answer to question VII-1.)
2 (<?). To what extent would you alter the division among the
Federal agencies of the authority to supervise and examine banks ?
The System answer
As indicated in the answers above, the need for changes in the division among Federal agencies of the authority to supervise and examine
banks does not appear to be vital.
Consideration might be given to the desirability of transferring
from the Office of the Comptroller of the Currency to the Federal
Reserve Board responsibility for determining eligibility of securities
for investment by member banks of the Federal Reserve System (both
National and State). As indicated earlier, use of this authority has
repercussions on the money markets which could reduce the effectiveness of monetary and credit policy.
Consideration might also be given to the transfer from the Federal
Reserve Board to the Office of the Comptroller of the Currency of
the authority to grant trust powers to national banks. This authority
would appear more appropriately to belong with that now possessed
by the Comptroller of the Currency.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
While differences in viewpoint and approach exist, particularly
with regard to some of the broader aspects of supervisory policy, and
while conflicts are possible, existing policies and procedures are so
coordinated in actual practice as not to represent a matter of serious
concern. However, it is believed that coordination would be facilitated if the FDIC districts were made to coincide with those of the
Federal Reserve districts and the headquarters of the supervising
examiners were located in Reserve cities. At the present that portion
of the Third Federal Reserve District represented by New Jersey
and Delaware is in the Second FDIC District with headquarters
at New York City, and all of Pennsylvania is included in the Third
98257—49

12




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MONETARY, CREDIT, AND FISCAL POLICIES

FDIC District with headquarters at Columbus, Ohio. As a result,
our contacts with either of the two FDIC supervising examiners are
infrequent and the free discussion of our mutual problems is complicated. (See also answer to question 3 (a).
3 (a). What would be the advantages and disadvantages of
providing that a member of the Federal Reserve Board should
be a member of the Board of Directors of the Federal Deposit
Insurance Corporation?
The System answer
Advantages.—The chief advantage would lie in the possibility of
greater coordination of policy.
FDIC could have a better knowledge of and insight into monetary
and credit policies of the Federal Reserve System.
The Board of Governors of the Federal Reserve System could
have a better understanding of policies and practices of the FDIC.
Channels for the exchange ox information would exist as a matter
of law and administrative routine rather than, as at present, through
personal relationships and cooperative good will.
Disadvantages.—Experience has shown that ex officio members of
boards frequently do not give proper attention to affairs of the board
or organization of which they are ex officio members.
It has also shown that hopes for increased coordination are not
necessarily realized by use of ex officio members.
3 (b). Would you recommend that this be done?
The System answer
We have no recommendation to make. Members of the Board of
Governors of the Federal Reserve System who would be most concerned with the problem of serving in a dual capacity are probably
better able than we to answer this question. From the viewpoint of a
Federal Reserve bank the problem is one of coordination of policies
and practices. As indicated in the answer to question 2 of this section,
a substantial degree of practical coordination now obtains. Should
greater coordination be sought, there would appear to be as good a
chance of achieving it through the device discussed in the answer to
question VI-6 as through any other means short of actual consolidation.
3 (c). Should the Comptroller of the Currency be a member
of the Federal Reserve Board?
The System answer
We consider this matter to be relatively unimportant and have no
recommendation to make. Historical precedents do not support the
proposal. The Comptroller of the Currency was an ex officio member
of the Federal Reserve Board from 1913 to 1935, at which time he
was removed from the Board by the Banking Act of 1935 along with
the Secretary of the Treasury of whom the Comptroller of the Currency is a subordinate.
The Comptroller of the Currency is concerned with the task of
chartering national banks and supervising the approximately 5,000
national banks now in existence. It is doubtful that he would give
the time necessary to the consideration of those broad problems of




173 MONETARY, CREDIT, AND FISCAL POLICIES

national monetary and credit policy to which the Board members devote their major attention and that he would contribute any more in
the future to the establishment of Federal Reserve policy than he did
prior to 1935.
Reply of J. N. Peyton, Federal Reserve Banky Minneapolis
Unquestionably the presence of multiple monetary and banking
agencies has created some overlapping of jurisdictions, duplications
of function, and, therefore, waste. How sweeping would be the changes
required to correct this situation is perhaps debatable. Consideration
might be given to the following lines of action:
(а) The various bank supervisory agencies might set up a single examination agency jointly operated by all and with all
agencies having access to the examination reports.
(б) The FDIC would then become more strictly an insurance
organization.
(c) A more extreme suggestion would be to give the Federal Reserve power to charter and supervise national banks.
(d) The various suggestions contained in the Hoover report
on these matters should be studied very carefully.
4. In what cases, if any, have the policies of other Government
agencies that lend and insure loans to private borrowers not been
appropriately coordinated with general monetary and credit policies ?
The System answer
Appropriate coordination between the policies of Government lending (or loan-insuring) agencies and general monetary and credit policies would consist in frequent consultation between these agencies and
the Federal Reserve System. Coordination would not necessarily
imply uniformity of action, since an agency might well find at any
particular time, upon reviewing the prevailing national monetary
policy, that its own actions should be governed instead by other special considerations. Coordination would mean, however, that decisions would be made by the agencies with full awareness that they
conformed to (or deviated from) the general credit policies being applied nationally to the banking system. It would imply that a decision
to differ, or to take action which might appear to differ, from general
monetary and credit policy should be reached after the factors
influencing the determination of general policy had been carefully
reviewed.
Such coordination through consultation has not been achieved.
Policies of the Government lending (or loan-insuring) agencies have
commonly been consistent with over-all credit policy, but this result
has been more or less accidental. At times, particularly during the
postwar period, there has been an apparent inconsistency, especially
in the rapid growth of real-estate credit. It might have proved, if
thorough studies had been undertaken, that unusual considerations
required a discrepancy between general policy and that aspect of
Government loan policy directed to the stimulation of housing construction. But the national interest presumably would have been
better served if such a decision had been reached after deliberative
review of all relevant considerations by the several agencies engaged
in housing finance, in consultation with the Federal Reserve System.



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MONETARY, CREDIT, AND FISCAL POLICIES

Moreover, there has not been comparable coordination among the
various Government lending (or loan-insuring) agencies themselves.
It has appeared during the recent postwar period, for example, that
several of the agencies engaged in agricultural finance were engaged
in a policy of mild restraint, while some of the other agricultural
agencies were encouraging credit expansion. Similarly, at least one
of the housing agencies has at times imposed relatively strict standards
when inflationary pressures were mounting, while another Government program for insuring the mortgage loans of home purchasers
was offering considerably easier terms.
In the aggregate, home-mortgage debt experienced an increase of
unprecedented rapidity in the years 1945-48, rising by about $13,000,000,000 to a record total of $33,000,000,000. The amount of Government-guaranteed mortgage debt rose from $4,000,000,000 to $12,000,000,000, not counting debt indirectly encouraged or underwritten by
the Federal Government because of the existence of such facilities as
the Federal home-loan banks and the secondary market for mortgages
provided by the Federal National Mortgage Association (a division
of the Reconstruction Finance Corporation). A large proportion of
loans was made on an installment basis at 4 percent for periods of
20 and 25 years. Many were made at a high percentage of current
sale prices which were greatly inflated.
Agricultural credit supplied by Federal agencies or by those under
Government sponsorship in some instances was made available in large
amounts at relatively low rates and on easy terms. Loans made by
the Commodity Credit Corporation increased sharply in 1948. Likewise short-term production loans to farmers, made principally by production credit associations and banks for cooperatives and financed
through the Federal Intermediate Credit Banks, increased substantially in 1948.
Not all of the credit expansion provided by the several Government
agencies was inflationary. Much of it was necessary. It is probable,
however, that some part was excessive for a period when Government
programs were generally oriented toward an anti-inflationary policy.
The Government agencies concerned have not in any instance willfully
disregarded this over-all policy, but have considered themselves bound
(by the mandate setting up their special activity) to pursue their own
programs vigorously. No doubt if Congress were to direct each
agency to vary its program in accordance with the objectives of the
Employment Act of 1946, any future recurrence of such apparent inconsistencies between particular loan programs and general policy
could be either avoided, or explicitly reconciled through consultation
among the various affected agencies.
Reply of J. N. Peyton, Federal Reserve Bank, Minneapolis
This hiatus in monetary and credit policy was particularly serious
in the immediate postwar inflation and is apt to be increasingly critical
in the future whenever a stiff monetary policy is presumably desirable.
During the immediate postwar period boom conditions called for a
policy of monetary restraint which the Federal Reserve was trying
to pursue. In view of the serious limitations to a policy of restraint
imposed by the bond-support policy, the results were on the whole
fairly effective.




175 MONETARY, CREDIT, AND FISCAL POLICIES

Unfortunately during the time when public opinion was calling for
something to be done about high prices, Congress was also voting a
very liberal GI loan program and substantially liberalized mortgage
credit, at the same time that the RFC and others were making Federal
funds available on relatively easy terms to private borrowers. The
results were, on the whole, impressive. Government guaranteed mortgages jumped from $4,000,000,000 to $12,000,000,000 in the first three
postwar years. During the same period home-mortgage debt jumped
from $20,000,000,000 to $33,000,000,000, a rise of 65 percent. Thus
the effect was to encourage credit expansion in a substantial way at
the same time Federal Reserve policy was rightly trying to discourage it.
If monetary policy is to serve the social interest, such divergencies
and conflicts must be minimized. In view of the inflationary biases
increasingly prevalent in the economy this might well become an increasingly serious matter.
Reply of Alfred II. Williams Federal Reserve bank, Philadelphia
The rapid and substantial expansion of credit extended by Government agencies directly or through guaranties in the 3-year period
of inflationary developments following the war did not appear to
be coordinated with the national monetary and credit policy as reflected
in Federal Reserve statements and actions seeking to restrain excessive use of private credit in the face of continued limitations on
supplies of goods.
It is recognized that special considerations govern the extension
of various types of Government credit and that these may be compelling in many cases when the policies run counter to the national
monetary and credit policy. Appraisal of these considerations is not
believed to be within the purview of this inquiry.
The importance of credit extensions by Government agencies in
relation to national credit policy is not only in the amount of the
funds added to the flow of private credit even though this is substantial in the case of home-mortgage credit and to a lesser extent
farm credit. The principal feature of concern to monetary authorities is the impact of Government credit agency policies on the
grantors of private credit.
In this Federal Reserve district, in each of the 4 years since the
war, the officers and staff have held from 25 to 40 meetings throughout the district with representatives of all the commercial banks,
including a director as well as the principal officer in each bank.
During most of this period the discussion at these meetings centered
around the desirability of restraint in the granting of private credit
and explanation of Federal Reserve policies which sought to produce such restraint. Almost without exception the expansive credit
policies of "the Government"—without distinguishing one part of
the Government from another—have been cited in each of these meetings as (1) evidence of divided counsel within the Government,
and (2) reason for continuing expansive lending policies in the
private banks. This, of course, seriously complicated the task of
the Federal Reserve authorities.
Without commenting on the individual cases or the special considerations underlying these policies, attention was called principally
to rapidly expanding credit and reportedly liberal policies in ap-




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MONETARY, CREDIT, AND FISCAL POLICIES

praisals and granting of credit or guaranties by the Federal Housing
Administration, the Veterans' Administration, and savings and loan
associations operating under the Federal Home Loan Bank Board.
In certain agricultural communities the aggressive lending programs
of production-credit associations were cited. In the field of indus*
trial and commercial credit the so-called blanket-participation agreement, promulgated by the Reconstruction Finance Corporation and
since discontinued, was referred to as a stimulant to lowered credit
standards and loose credit practices. Similarly, the price-support
program carried out through Commodity Credit Corporation loans
was often referred to as evidence that the left hand of the Government was expanding credit aggressively while the right hand sought
to restrain such expansion as an anti-inflationary measure.
It would appear from this experience that much of the difficulty
could have been eliminated even though many of the policies were
unchanged had there been clear evidence that the credit policies of
the agencies were adopted in the light of and reconciled with accepted
national monetary and credit policy.
5 (a). What changes, if any, should be made in the powers of
the Federal Reserve to lend and guarantee loans to nonbank
borrowers ?
The System answer
In the light of over 15 years' experience in making and servicing
industrial loans, it now appears that the law granting this authority
should be revised because it is unduly complex and in part outmoded.
Only two basic provisions of the law, however, materially impede
operations.
(1) The limitation requiring proceeds of industrial loans to be used
only for working-capital purposes should be eliminated. Extensive
technological changes in many instances require concerns to purchase
new equipment to strengthen or maintain competitive positions. At
the same time, there is an active need for funds to pay high costs,
operate at high price levels, and sustain profits through large volumes,
while the tax structure tends to restrict the acquisition or accumulation
of surplus. In meeting these needs many concerns must frequently
borrow for mixed purposes which cannot always be correctly classified
as wholly "working capital" requirements.
(2) Full consideration of the basic nature of current requirements
for funds growing out of changed financial, technological, and competitive conditions may indicate the desirability of extending the
maximum maturity from the present 5-year limit to, perhaps, 10 years,
in order to provide for longer-term needs if they should become apparent.
Another (minor) suggested change relates to the industrial advisory committees. These committees have contributed valuably to the
development of the work of the Reserve banks in this field, but are no
longer required. The directors of the Reserve banks represent broad
segments of industry and finance and provide informed judgment on
loan applications, in addition, the wide acquaintance of the directors,
officers, and staffs of the banks in their respective districts provides
direct access to specialized information when it is needed. It would
be sufficient to provide that such committees could be formed by the
individual Reserve banks whenever needed.




177 MONETARY, CREDIT, AND FISCAL POLICIES

It would seem desirable to retain the authority to guarantee credits
through a commitment procedure, as provided in the present Federal
Reserve Act. By means of commitments and participations, the Federal Reserve banks are enabled to assist banks in developing new
credit techniques, in appraising particularly complex loan applications, and in carrying loans that exceed the statutory limits of smaller
banks (and for which these banks have been unable to obtain the
assistance of their correspondent banks). Such a program also provides for the possibility that in the unforeseeable future another period
of credit stringency and excessive caution among lenders might lead
to cumulative liquidation pressure which might be alleviated by extensive guaranties of local business loans.
It should be noted, howTever, that the guaranty principle has possible undersirable aspects when applied to the area of commercial or
industrial loans, where credit factors are highly individualized and
frequently complex. The opportunity to pass credit risks to another
institution may be conducive to loose or unduly expansive lending
practices, principally because of the desire to receive interest income
on amounts which (in the absence of guaranty) would be in excess
of legal or prudent limits. For these reasons, the responsibility for
a guaranty (commitment or participation) program in commercial or
industrial loans should probably be placed in the Federal Reserve
System, which has staffs trained both in bank supervision and in loan
techniques and appraisals.
5 ( i ) . Should either or both of these powers be possessed by both
the Federal Reserve and the Reconstruction Finance Corporation ? If so, why ? If not, why not ?
The System answer
There is an appropriate place in the economy for a Government lending agency such as the Reconstruction Finance Corporation, in addition to the industrial loan operations of the Federal Reserve banks. A
Government agency should make loans to promote public policies
which by nature and, in some cases because of large volume, would
be inappropriate assets for a central bank holding the reserves of the
banking system. Loans of this nature include:
Home mortgage financing;
Loans to public utilities where the services are necessary to the
communities but the credits have subsidy aspects (example—
railroads) ;
Loans to industries whose prospects are peculiarly dependent
upon administrative regulation and action by the Government
(examples—air lines subject to CAB and aircraft production dependent upon military purchase allocations) ;
Loans to industries subsidized in accordance with public policy
(examples—prefabricated housing, synthetic rubber production,
tin smelting and refining) ;
Loans to municipal instrumentalities;
Loans to stock pile strategic materials; and
Disaster loans.
It is probably unwise, however, for the Reconstruction Finance
Corporation and the Federal Reserve banks to be engaged in making
or guaranteeing loans of essentially the same character. The Re


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MONETARY, CREDIT, AND FISCAL POLICIES

construction Finance Corporation should undoubtedly have full jurisdiction over any loans (or guaranties) included in the above list that
are not specifically delegated to other Government lending agencies.
As to business loans, however, such as provided by section 5d of the
Eeconstruction Finance Corporation statute, and by section 18b of
the Federal Eeserve Act, there is need for a clear separation of
functions.
As noted earlier, a loan-guaranty program for commercial or industrial loans is subject to particular hazards, requiring for effective
administration a combination of close operating relations with the
banks and the skills of highly developed credit analysis (and experience with marginal cases). The Federal Eeserve banks do possess
both of these qualifications, while the Eeconstruction Finance Corporation possesses only the latter. Moreover, the Federal Eeserve
banks gained extensive experience with the procedures of loan guaranties when they were charged with administration of the program for
guaranteeing war production loans (regulation V loans). For these
reasons, it would appear desirable to place full responsibility in the
Federal Eeserve for any loan guaranties that are to be extended to
the banking system for industrial or commercial loans (except for
those related to foreign trade, which are handled by the Export-Import
Bank).
So far as direct business loans are concerned the appropriate choice
of agency is not as clear, nor is the need to eliminate duplication as
great. Perhaps a dividing line can be drawn between industrial or
commercial loans arising in the normal course of business, and those
arising for developmental purposes which have been designated by
Congress for special assistance in the public interest. The latter would
obviously be handled by the Eeconstruction Finance Corporation; the
former might better be delegated to the Federal Eeserve banks.
Reply of Alfred H. Williams, Federal Reserve Bank, Philadelphia
There is an appropriate place in the economy for a Government
lending agency such as the Eeconstruction Finance Corporation in
addition to the industrial loan operations of the Federal Eeserve
banks. When the Congress decides, as a matter of public policy and
not simply to promote sound competition in the regular course of
business, that certain areas should be stimulated by loans, credit
guaranties, or agreements to purchase loans, it seems proper that the
stimulus be administered through a public credit agency. A central
banking system does not seem to be the proper agency to administer
these credits involving special policies. The credits might include
guaranties of home mortgage loans; loans to public utilities where the
services are necessary to the communities but the credits have subsidy
aspects (example—certain railroads) ; loans to activities whose prospects are peculiarly dependent upon administrative regulation and
action by the Government (example—air lines subject to CAB) ; loans
to activities subsidized in accordance with public policy (examples—
synthetic rubber production, wartime tin smelting and refining); loans
to municipal instrumentalities; loans to stock-pile strategic materials;
and disaster loans.
The Federal Eeserve banks are peculiarly well adapted to participating with banks or extending commitments or guaranties to them
on commercial or industrial loans arising through the banking sys-




179 MONETARY, CREDIT, AND FISCAL POLICIES

tem in the ordinary course of business, when banks seek such assistance
because of the unusual character or degree of risk in the loans requested. The Federal Eeserve banks are an integral part of the banking system, working closely with banks in their daily operations. In
the course of 35 years the boards of directors, officers, and staffs have
become closely associated with local commerce and industry, its credit
requirements, the quality of management, and economic forces affecting them. In addition to carrying on the industrial loan program
since 1934, the System gained valuable experience in financing Government contracts during the war through its administration of the
guaranteed war production loan program. This experience has proved
particularly helpful in serving recent credit needs.
The effective operation of the industrial loan program of the Federal Eeserve banks is of mutual benefit to the Eeserve banks, the local
banks, and the borrowers. Active day-to-day contacts in credits keep
the Eeserve banks in intimate association with the basic operations of
their members and establish a common ground promoting mutual
understanding which is vital to effective banking and credit policies.
The local banks are provided assistance in meeting the requirements
of their borrowers and their communities through a noncompetitive
source familiar with such requirements and actively interested in
promoting sound bank credit policies and practices.
For borrowers, in times of general economic stress the industrial
loan program provides a source of funds to prevent cumulative and
destructive credit liquidation. In the regular course of business it
makes funds available with a minimum of procedural difficulty to
individual applicants having a justified need for credit, which credit
for a wide variety of reasons experience has shown is not always
supplied through regular channels.
Providing credit by means of guaranties or agreements to purchase is particularly applicable to loans which can most effectively
be made and serviced by local institutions. Such loans would include
those which are made in large numbers over wide geographic areas,
or for other reasons cannot effectively be serviced by the guarantor,
and those in which there is a substantial degree of uniformity as to
credit standards and procedures. Home-mortgage loans, for example, or other loans of an essentially collateral nature would fall
into these categories.
In the case of commercial and industrial loans, where credit factors
are highly individualized and frequently complex, the guaranty principle has undesirable aspects. Special problems require special analysis, borrowing conditions, and servicing often not available at
local institutions. At the same time, the opportunity to pass credit
risks to another institution while retaining most of the interest income is conducive to loose or unduly expansive lending practices.
Accordingly, it is believed that the activities of Government agencies, such as the EFC, in making, guaranteeing, or agreeing to purchase loans, should be confined to those credits extended primarily
as an instrument of public policy. The area of commercial and industrial credits arising in the ordinary course through the banking
system should be served by the Federal Eeserve banks which work
closely with their members and seek to promote sound credits as one
aspect to credit policy.




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MONETARY, CREDIT, AND FISCAL POLICIES

Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I am in disagreement with the position taken in the draft reply to
the first question. I do not believe that our present authority to lend,
or, in effect, guarantee loans to nonbank borrowers needs change at
this time. At the Federal Eeserve Bank of Cleveland we have been
able to operate effectively under the provisions of the act and do not
feel that it is unduly restrictive. Eather, we feel that the restrictions now in section 13b of the Federal Eeserve Act are wise and
desirable.
6 (a). What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type
proposed by the Hoover Commission ?
The System answer
The principle of orderly consultation among the Federal agencies
engaged in direct lending or loan guaranty programs within the
United States, as suggested by the Hoover Commission in Eecommendation No. 9 of its report on the Treasury Department, is a desirable extension of the cooperation now attained, through the National Advisory Council on International Monetary and Financial
Problems, by Federal agencies engaged in extending foreign credits.
The present NAC, moreover, in addition to its studies of the factors
relevant to particular loan (or guaranty) applications, also attempts
to attain consistency by mutual agreement on all principal aspects
of United States international financial policy. Although the specific intention of the Commission's recommendation is not clear, it
would seem desirable to interpret the proposal as favoring a comparable scope for the domestic agency, including not only the analysis
of problems related to Federal granting or guaranteeing of domestic
credits, but also the relations among Federal loan policy, the Treasury's fiscal and debt management policy, and the over-all monetary
and credit policy of the Federal Eeserve System. Consequently the
following discussion of advantages and disadvantages, and of suggestions as to the composition of a national advisory council on domestic financial policy, will relate to a recommendation of this broad
type.
The major advantage of the recommendation lies in the fact that
some coordination of policy objectives is desirable to minimize inconsistencies among the influences exerted upon the economy by the many
agencies now engaged in financial (i. e., monetary or credit) activities.
First, as indicated in the reply to question VI-4 above, there is a great
need for closer coordination among the lending, and loan guarantee
activities themselves. Second, with greater consistency among these
various agencies achieved, there still remains a need to coordinate the
broad policy aspects of any unified loan program with the objectives
of the Employment Act of 1946, and with the policies pursued by the
Treasury and the Federal Eeserve System in conformity with those objectives. Third, it would be desirable to provide for regular periodic
consultations among the Treasury, the Federal Eeserve, and other affected agencies concerning the underlying principles common to debt
management,fiscalaffairs, and national monetary and credit policy. It
should not be expected that such a council would be a policy-making
body; its function would be to promote understanding and cooperation
between the agencies represented.




181 MONETARY, CREDIT, AND FISCAL POLICIES

Administratively, and in terms of the fundamental safeguards of
democratic government, there is also great advantage in providing
for consultation on an equal plane among agencies experienced in
each phase of these common problems, rather than attempting to
achieve an apparent but deceptive efficiency by concentrating all
directing authority in one of the agencies.
There is the further advantage, in an advisory or consultative relationship, that responsibility for all administration, and for formulating specific regulations interpreting policy, will reside solely in the
hands of the agency experienced in the intimate operating details of
each field—whether lending, or over-all credit control, or debt management—and will not be subject to mandatory over-ruling by a body
composed largely, in each specific instance, of persons representing
other fields. Full reliance will thus be placed on the "separation ox
power," while each agency will benefit from the experience of the
others in reaching those fundamental policy decisions which may now,
oftentimes, be reached without conscious recognition of their full im<
plications. A forum will also have been created to which inconsistencies arising in the field may be referred for review, while at present
only unusually outstanding "differences reach the top levels for discussion, and then only through unsatisfactory ad hoc arrangements.
The disadvantages of the Hoover Commission recommendation all
arise from the danger that such a council, once established, might not
function in the manner just described. Should the Council take upon
itself de facto status as the source of all policy, the degree of independence necessary for the formulation, particularly, of over-all monetary and credit policy by the Federal Eeserve might be jeopardized.
There is the associated risk that the Treasury might tend to dominate
the group out of concern for the day-to-day requirements of fiscal and
debt-management operations, to the detriment of broader policy objectives. Perhaps, too, if the Council attempted to consider the detailed application of broad policy, it might' become an undesirable
superimposed administration, hampering the decisive action frequently
needed in swift response to changing economic conditions.
The Hoover Commission also mentioned the possibility of combining
both foreign and domestic policy formation in one group. At least in
the early stages, this might involve the difficulty that studies would be
spread too thin over a wider range of subjects than most of the participants could handle effectively. The result might be a haphazard,
rather than thorough, analysis of the relatively few deeper, fundamental issues which should occupy such an advisory body. No doubt
the question of amalgamating the international and domestic councils
could be deferred for several years, while the domestic agency was
establishing its procedures and reaching agreement on initial guiding
principles.
6 (J). On balance, do you favor the establishment of such a
body?
The System answer
For the purposes outlined above, and subject to the qualifications
expressed below concerning the organization and composition of such
a body, it would seem highly desirable to provide for a consultative
council of the principal Federal agencies engaged in domestic financial
affairs.




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MONETARY, CREDIT, AND FISCAL POLICIES

6 (<?). If so, what should be its composition?
The System cmswer
For the broader purposes suggested above, the Secretary of the
Treasury and the chairman of the Federal open market committee,
or in their absence the Under Secretary and vice chairman, respectively, are two obvious members of such a group. Presumably the
Secretary of the Treasury should serve as Chairman of the Council;
the chairman of the Federal open market committee, as vice chairman. Since the duties of the secretariat for the present National Advisory Council on International Financial Policy are undertaken by
the Treasury staff, comparable duties for the domestic advisory council
should be carried out by the staff of the Board of Governors of the
Federal Reserve System, serving under the direction of the Board
Chairman (who is also chairman of the Federal open market committee, and would be vice chairman of the Advisory Council).
To avoid a large unwieldy membership and unduly heavy representation of' the diverse agencies engaged in domestic lending or loan
guaranty activities, and to give emphasis to the need for administrative consolidation among these latter agencies, they should be represented in rotation by the chief official of each of the three principal
agencies, i. e., the Reconstruction Finance Corporation, the Federal
Housing and Home Finance Agency, and the Farm Credit Administration. (It would not be a matter of grave consequence, however,
if all three were to sit regularly on the council; this matter can be
decided either way without disturbing the major conclusions of the
present suggestion.) The chief policy officer of all other lending, loan
guaranty, and related agencies (including the two not currently
serving on the council under the rotation arrangement) should be
permitted to attend all meetings of the council, and should be specifically invited to attend and participate in meetings of direct concern
to their own agencies. The staffs of all such agencies should also be
invited to participate in the staff working groups, at the discretion
of the council. The rotating membership, if accepted as a workable
arrangement, might be changed each year, to assure a close and continuous relationship of all three of the principal loan agencies with
the work of the council. The list of other agencies permitted to attend might be specified by Congress, and might include the following:
The Securities and Exchange Commission; the Federal Deposit Insurance Corporation; the Comptroller of the Currency; the Veterans'
Administration, presumably the Administrator or the deputy charged
with responsibility for the loan insurance program; the Farmers*
Home Administration; the Commodity Credit Corporation; and the
Rural Electrification Administration. Others might also be invited
by the council itself. The basis for omitting these listed agencies
from direct membership on the council, apart from the desire to limit
membership in the interest of efficiency, would be that their duties
are either primarily administrative or relatively small in volume, or
that they do not relate as intimately to the current implementation of
monetary or credit policy.
In keeping with the over-all principle that domestic financial activities should be conducted in conformity with the objectives of the Employment Act of 1946, the Chairman of the President's Council of
Economic Advisors should also serve as a regular member of the




183 MONETARY, CREDIT, AND FISCAL POLICIES

Council. If it should be desirable for the Council to prepare regular
reports on its deliberations (summarizing activities and perhaps pointing out needs for legislation) these could be sent to Congress through
the Joint Committee on the Economic Report.
Owing to the desirability of limiting the Council to an advisory
and consultative capacity, formal votes would presumably only be
taken on procedural matters, such as invitations to attend, the composition of staff committees or study groups, and so on. The Council
could work out its own voting procedure for such cases. The important achievement of such a council would lie in providing a regular
meeting place for an exchange of views among the leading officials
charged with formulating and carrying out the many different aspects
of the domestic financial policies of the United States.
Reply of Alfred H. Williamis, Federal Reserve Bank, Philadelphia
If stability is to be achieved, it is imperative that all agencies pursue
it as a common purpose. It is the concern of the Congress that this
be the common purpose. The law can make a substantive contribution
by directing each agency to direct its policies and activities to that
objective. If all agencies are motivated by a real unity of purpose,
they will devise effective procedures—whether through formal or informal organizations or without organization—to achieve that purpose. On the other hand, if the agencies are motivated by diverse and
conflicting purposes, statutory organizations and procedures, no matter how effective they may be made to appear on paper, will not
reconcile those differences.
The proposal to establish a National Monetary and Credit Council
appears to be based on the assumption that coordination can be
achieved by establishing a legal organization and procedure. While
agreeing thoroughly with the purpose to be achieved by creation of
such a council, experience does not afford convincing evidence that
the method will be effective.
Reply of J. N. Peyton, Federal Reserve Bank, Minneapolis
The problem mentioned in No. 4 primarily requires consistency of
policy. This may be secured by a revised organizational set-up, but it
is by no means automatic. The most forthright method of assuring
consistency of policy would be for the Federal Reserve to assume direct charge of these Government credit programs through some sort
of an appropriate extension (e. g. sec. 13b) of Federal Reserve powers to take over the lending agencies' operations. If this suggestion
seems to clutter the Federal Reserve System with activities of a somewhat remote or political character, and there are substantial reasons
for thinking it may, then the credit agencies themselves should perhaps continue to be the operating organizations through which the
credit is extended. In this case some top level monetary policy council such as recommended by the Hoover Commission should be formed
to develop the general monetary and credit policy within which all
money and credit agencies will operate.
Even this poses questions. Should the council be merely advisory,
or should its recommendations be mandatory? If the former, how
much of a real contribution to consistency of policy would be made ?
Is the latter feasible ?
This council should presumably be composed of representatives for
the Federal Reserve, the Treasury, the Comptroller of the Currency,



184

MONETARY, CREDIT, AND FISCAL POLICIES

the FDIC, and some representation from the lending agencies themselves.
The Hoover Commission recommendation on this matter should
receive particularly serious consideration.
Comments of Allan Sproul, Federal Reserve Bank, New York, on VI
as a whole
The first three questions in this section concern Federal Reserve
relations with the two other Federal agencies which perform bank
examinations. The examination function is important as an audit
of the operations of commercial banks, helping to protect depositors
and the deposit insurance fund against the risks of unwise or improper
conduct of banking operations. The supervision extended to the
banks through the examination process may also at times exert some
influence on the loan or investment policies of the banks. But, by and
large, bank examination and supervision is not an important aspect
of the credit control functions vested in the Federal Reserve System.
Insofar as the existence of three different supervisory agencies permits the banking community to attempt to "play one off against the
other," there is some danger that a uniform and effective system of
examinations may be weakened, particularly in critical periods. There
may also be a loss of efficiency, and certainly an additional expense,
involved in maintaining three overlapping jurisdictions for bank examination and supervision, even though duplication of supervisory
activities has been largely avoided. But these are problems which
have not been significant in recent years. Consequently, although it
might be a more satisfactory administrative arrangement to place all
responsibilities for bank examination in one agency, there is no pressing need to do so. What is important is that a full degree of cooperation among the three agencies be attained.
Question V I (3) mentions two possibilities for making this integration somewhat closer: To place a member of the Board of Governors
on the Board of the Federal Deposit Insurance Corporation, and to
place the Comptroller of the Currency on the Board of Governors.
One other possibility, not specifically mentioned in the questionnaire
(but suggested in one of the Hoover Commission task force reports),
wmild be to place the Federal Deposit Insurance Corporation within
the Federal Reserve System, providing for administration of the insurance fund as a trust, under regulations to be formulated by the
Board of Governors or the Federal open market committee. I think
this proposal deserves further study.
I would favor, now, the intermediate step of placing a member of
the Board of Governors on the Board of the Federal Deposit Insurance Corporation. Certainly the fact that the Comptroller of the
Currency already serves as one of the three members of the Federal
Deposit Insurance Corporation Board makes this a logical proposal.
If the Board member charged with special responsibility for the examination functions exercised by the Federal Reserve System were
to occupy the dual position, it would not be open to the usual difficulties of ex officio membership. That member of the Board of Governors could undoubtedly serve as an active responsible director of the
Federal Deposit Insurance Corporation, since many of his duties at
both agencies would cover the same ground.




185 MONETARY, CREDIT, AND FISCAL POLICIES

So far as coordination with the Comptroller of the Currency is concerned, I would oppose making him a member of the Board of Governors of the Federal Reserve System. His responsibilities are largely of
a supervisory nature, and he is not primarily concerned with the broad
matters of credit policy which should mainly occupy the attention of
the Board of Governors. The Comptroller is, of course, a subordinate official of the Treasury, even though the Office has independent
status, and I should think any necessary extension of coordination
between the national bank examiners and the examination staff of the
Federal Reserve System could be accomplished through arrangement
between the Secretary of the Treasury and the Chairman of the Board
of Governors.
With respect to question VI (6), I am favorably disposed, in general, toward the idea of a National Credit Council. Such a council, if
established, however, should confine itself to the broad policy problems of common interest to the Treasury, the Federal Reserve, and
the Federal agencies engaged in making credit available to various
types of borrowers through loan insurance or direct lending. The
council should not be expected or permitted to assume the function
of making and enforcing policy decisions. It should serve as a
clearing house for the different points of view inherently associated
with the three types of agencies. Any attempt to make the council
into a superstructure for final policy determination would result in
placing responsibility over the affairs of one type of agency in a group
composed largely of individuals who are not experienced in the detailed
problems peculiar to that agency.
No doubt the deliberations of such a council would be simplified if
there were better administrative integration of the many Federal
lending agencies now in existence. There would be fewer instances
of apparently divergent policies among these agencies; and the membership of the council could be smaller. (The possibilities for merger
and unified direction of the lending and loan guaranteeing activities
is discussed in the report of the task force on lending agencies of the
Hoover Commission.) Meanwhile, I would favor representation of
all three of the principal lending agencies in regular membership on
any national credit council which might be created, that is the Reconstruction Finance Corporation, the Federal Housing and Home Finance Agency, and the Farm Credit Administration. Until there is
some form of coordination between these three principal lending
agencies and the many others which are not now affiliated with them,
the chief officers of these other agencies could be invited to attend
meetings of the national credit council whenever topics of concern
to them are included on the agenda for discussion.
I do not think that the chairman of the President's Council of Economic Advisers would be a suitable member of such a council. He is
not charged with the administration of policy, and serves solely as an
adviser to the President on general economic questions, without any
direct responsibility to Congress. All of the other agencies suggested
for membership on such a council actually have a relationship both
with Congress and the Executive.
Reply of Ray M. Gidney, Federal Reserve Bank, Cleveland
I have reservations about the value, effectiveness or desirability of
stich a council and, on the whole, would be inclined to oppose its crea-




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MONETARY, CREDIT, AND FISCAL POLICIES

tion. Should one be established, however, I believe it should be purely
advisory and reportoriaL For this reason its membership should be
inclusive of all Federal lending and supervisory agencies and not restricted to just a few as suggested in the draft reply.
V I I . DEPOSIT INSURANCE

1. What changes, if any, in the laws and policies relating to
Federal insurance of bank deposits would contribute to the effectiveness of general monetary and credit policies ?
The System answer
The crisis of the thirties demonstrated that the powers of the Federal
Reserve System to provide a flexible currency and to introduce,
through its lending powers, greater liquidity into the banking system
were not sufficient in a period of serious depression and deflation to
provide full assurance of the safe and continuous operations of the
banking system. Efforts to correct this situation included the establishment of emergency lending institutions such as the National Credit
Corporation and the Reconstruction Finance Corporation, and the
broadening of the lending authority of the Federal Reserve banks to
permit them to make advances to member banks against any sound
assets, regardless of whether or not they met previous eligibility rules.
Another major step was the creation of the Federal Deposit Insurance
Corporation with a view to strengthening the confidence of depositors
in the banking system and thus removing an immediate cause of banking crises. From the viewpoint of the Federal Reserve System, the
insurance of deposits affects monetary and credit policies in three
ways:
(1) By contributing toward a feeling of general confidence in
the banking system;
(2) By contributing to the liquidity of bank assets and to the
T stability and availability of bank deposits for monetary purposes;
and
(3) By contributing to orderly markets and stable values for
bank assets through reducing the likelihood of large-scale
liquidation.
Although deposit insurance on the basis of the experience thus far
has been very successful, there are several ways in which the laws and
policies relating to Federal insurance of deposits could be strengthened
to contribute further toward the effectiveness of general monetary and
credit policies. Since the primary objective of general monetary and
credit policies is to promote economic stability at optimum levels, any
changes in the arrangements concerning deposit insurance that will
contribute to the effectiveness of monetary and credit policies will also
contribute to the success of Federal insurance of deposits by reducing
the incidence of failures.
General confidence in the banking system.—Confidence in the banking system is aided by Federal insurance of deposits primarily through
guaranteeing depositors against loss (up to a specified amount), and
through widening the scope of Federal supervision of banks to provide
increased general protection for all depositors in insured banks.
As to the guaranty against loss, there would seem now to be good reasons for broadening the scope of insurance coverage. No doubt con-




187 MONETARY, CREDIT, AND FISCAL POLICIES

fidence would be ideally served by a 100 percent guaranty of all
deposits, but several possible disadvantages in a major change of this
character have been suggested: full coverage might remove the incentive for large depositors to keep informed as to the soundness of the
banking institutions in which their accounts are kept; the feeling that,
since all deposits were guaranteed, there would be no threat of transfers of large accounts to other institutions might be conducive to less
conservative banking practices; and such an extension of insurance
coverage might unduly increase the risks and costs of the FDIC. On
the other hand, the self-interest of bankers and bank stockholders
themselves may well provide a strong inducement to sound and conservative banking practices and greater costs may be justified if confidence is increased and the likelihood of failures is correspondingly
reduced. The debatability of these considerations suggests, however,
that the question of full coverage be deferred, and that Congress give
immediate consideration instead to raising the limit of insured deposits
at least to $10,000. A change of this magnitude would be in keeping
with the substantial growth in the total volume of deposits and in the
average size of accounts since 1935, and with the decline in the purchasing power of the dollar.
A second major FDIC contribution toward confidence in the banking
system is provided by the widening of the range of Federal supervision
of banks. Previously such supervision was limited to national banks
and to the State chartered banks that chose voluntarily to become members of the Federal Reserve System. It has now been extended to most
of the banks throughout the Nation through Federal supervision of
insured nonmember State banks. The fact that the legal provisions
concerning the examination functions of the Comptroller, the FDIC,
and the Federal Reserve are included in the Federal Reserve Act
apparently indicates congressional recognition of the close relationship among their operations. But there is not, at the present time, any
express legal requirement for consultation among these agencies, nor
any implied legal basis for any one of the agencies to bring its problems
to the others; the law probably should contain specific provision for
consultation among the three agencies.
Liquidity of bank assets and stability of the monetary system.—
Federal deposit insurance has contributed to the liquidity of the banking system and to the stability of the money supply by providing
liquid funds against unliquid assets in cases where individual banks
have gotten into difficulties and their closing either became necessary,
or was averted only by action of the FDIC in arranging bank mergers
with its support. As was pointed out in the answer to question 1 of
section V of the questionnaire, however, the effectiveness of Federal
Reserve monetary and credit policies is reduced by the presence of
nonmember banks because such banks are not subject to the responsibilities of membership in the Federal Reserve System (especially that
of maintaining reserve requirements equal to those that member banks
are required to maintain) and because nonmember banks do not have
full access to the lending facilities of the Federal Reserve banks. Consequently, further measures to increase the liquidity of the banking
system and to promote a more effective control over the money supply
would appear to be desirable. Presumably it was with a view to these
considerations that the original FDIC legislation in 1933 provided
1)8257—49

13




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MONETARY, CREDIT, AND FISCAL POLICIES

for the insurance of deposits of nonmember banks only for a limited
period. In effect, this would have required all banks desiring to obtain the benefits of deposit insurance to become members of the Federal
Reserve System, and thus to obtain access to its lending facilities and
become subject directly to national monetary and credit policy within
a few years after the establishment of the FDIC. This provision was
omitted from the permanent FDIC legislation of 1935, and the result
has been an element of weakness in the banking system and in the implementation of monetary and credit policies.
As was suggested in the reply to question 2 of part V, modifications
of the present capital requirements for membership in the Federal
Reserve System would make it possible for many more nonmember
banks to become members. But in all probability many nonmember
banks would still choose to remain outside the Federal Reserve System for one reason or another. Membership of all insured banks in
the Federal Reserve System would serve both (1) to increase the
liquidity of the banking system by making available to all such banks
the lending facilities of the Federal Reserve banks, and (2) to
strengthen the effectiveness of Federal Reserve monetary and credit
policies by bringing all such banks within the responsibilities as well
as the privileges of membership. An alternative would be to require
the Federal Reserve banks to offer the same lending facilities to nonmember banks as to member banks on the condition that nonmember
banks be required to maintain the same reserve requirements as those
in force for member banks. A change in the character of reserve requirements of the sort suggested in the answer to the first part of
question IV-1 might go far toward making an adjustment to member
bank reserve requirements somewhat less difficult for the nonmember
banks.
As a further measure to assure that bank deposits will be as fully
available as possible for monetary purposes, consideration might be
given to a broadening of the powers of the FDIC to determine the
appropriate course of action with respect to banks on the verge of
insolvency, and to make deposits in closed banks more quickly available to the depositors. At present only the State banking supervisors
and the Comptroller of the Currency can place, respectively, State
and National banks in receivership. The FDIC only has powers to
facilitate a merger, and these powers are useless if there is not another
sound bank in the community which is willing to cooperate. In addition, consideration might be given to authorizing the Federal Reserve
banks to lend to the FDIC against the assets of closed banks if, in
emergencies, its available resources for releasing deposits in such banks
should be inadequate.
So far as the size of the insurance fund is concerned, no attempt
should be made to provide a fund large enough to assure liquidity
to the entire banking system in the event of a catastrophic situation
such as occurred in the early thirties; to a large extent reliance would
have to be placed on the Federal Reserve System to supply such
liquidity if a similar situation should ever again occur. The fund,
however, should be large enough to cover all probable losses over the
business cycle. The aggregate amount of the insurance fund should
be related to the total volume of deposits and the Corporation should
be given the power to vary assessment rates within prescribed limits,
once an appropriate relationship between the fund and total deposits




189 MONETARY, CREDIT, AND FISCAL POLICIES

had been achieved. The Corporation could thus maintain the fund
at the desired level, while limiting as far as possible any disturbing
cyclical effects of insurance assessments on the banks.
Orderly markets and stable values for bank assets.—Another aspect
of Federal insurance of deposits of concern to the Federal Reserve
System is the extent to which operations of the insurance system affect
the orderliness and stability of markets and values for bank assets.
To the extent that deposit insurance promotes public confidence in
the banking system and prevents unusual withdrawals of deposits,
the danger of forced liquidation of assets to meet such withdrawals is
eliminated and with it the depressing influence on the values of all
similar assets held by the banking system. To the extent that deposit
insurance does not prevent silent runs or mass transfers of funds,
however, banks may be compelled to liquidate large blocks of assets
under adverse conditions. To the extent that banks can borrow
against these assets at the Federal Reserve banks, pending their orderly liquidation, the disruptive effects upon market values and upon
the affairs of debtors can be minimized. Even under the most favorable circumstances, however, mass conversion of assets creates serious
problems and hazards and has an upsetting effect on markets and
also on the attitudes of managers of banks. It is desirable, therefore,
that the banking system and the deposit insurance structure be
strengthened so as to reduce the possibility of such a development.
The orderliness and stability of markets are affected also by the
manner in which the FDIC handles assets in the liquidation of closed
banks. To date the method of handling such assets by the FDIC
has contributed to stability, and the experience and tradition of the
Corporation suggest that its policies and practices will continue to
do so in the future. However, the volume of operations involved
thus far has been small. Should the volume of assets required to be
assumed by the FDIC become significantly large at any time, the
Corporation might find itself under some pressure to liquidate largt>
blocks of bank assets. The pressures thus generated would in all
probability reduce the effectiveness of monetary and credit policy
which would be seeking to reduce pressures on markets during such
periods.
The law should provide a basis for resolving such an apparent conflict between public policies at any time in the future. One method
would be to permit emergency borrowing by the FDIC, at the Federal
Reserve banks, against assets that are to be liquidated, subject to Federal Reserve regulations and approval. In all likelihood a bunching of liquidations could thereby be avoided; and the decision upon
when liquidation should be attempted could be determined in consultation with the Federal Reserve System. Any possible conflict
between asset liquidation and credit policy could thereby be avoided.
In summary, the measures needed to increase the contribution of
Federal insurance of bank deposits toward effective monetary and
credit policies are all extensions of principles which have, at one time
or another, been included in the banking laws. Primarily, the need
is to strengthen the banking system further against the impact of
economic crises. As a corollary, any measures answering this need
will protect the dual-system characteristic of American banking.
Pursuance of these objectives leads necessarily to consideration of the
following suggestions. Should these suggestions be accepted in prin-




190

MONETARY, CREDIT, AND FISCAL POLICIES

ciple, precise details can be worked out in subsequent consultation with
the FDIC and the Federal Reserve System.
(1) The coverage of deposit insurance should be widened.
(2) Provision should be made for increased consultation among
the three Federal agencies charged with bank examination and
supervision.
(3) The lending facilities of the Federal Reserve banks should
be extended to banks now outside the Federal Reserve System,
concomitantly requiring all such banks to become members, or
to hold reserve balances comparable to those of member banks.
(4) The FDIC should be given broader powers with respect
to receivership, the appointment of conservators, and borrowing at the Reserve banks against the assets of closed banks in
emergencies.
(5) General criteria should be established for determining the
adequacy of the insurance fund; and the FDIC should be permitted to vary assessment rates within prescribed limits.
Reply of Allan Sproul, Federal Reserve Bank, New York
I have very little to add to the accompanying statement on this question, but would like to emphasize again that deposit insurance alone
cannot assure the uninterrupted availability of deposits for meeting
the monetary requirements of the economy. The insurance fund provides protection against ultimate loss, but liquidity in the event of
a serious crisis can only be provided through cash reserves supplied
the banks (or the Federal Deposit Insurance Corporation) by the
Federal Reserve System.
I would agree that the Federal Deposit Insurance Corporation
should have a wider range of powers over alternative methods of protecting the depositors in failing banks. The power to facilitate
mergers with open institutions is not enough. I would also recommend consideration of legislative provision for permitting the Federal Deposit Insurance Corporation, in emergencies, to borrow directly at the Federal Reserve banks for the account of insured banks
in distress, subject to the regulations of the Federal Reserve banks.
Both of these suggestions bring attention again to the fact that nonmember banks constitute a peculiar problem for the banking system.
Of course, under paragraph 13 of section 13 of the Federal Reserve Act,
the Federal Reserve banks may make advances secured by direct obligations of the United States, for periods not exceeding 90 days, to
any individual, partnership, or corporation. As interpreted by the
Board of Governors, this paragraph permits such advances to nonmember banks, but an even greater access to the facilities of the Federal Reserve banks might be necessary if full assurance of liquidity is
to be provided through any period of grave crisis.
Two other aspects of Federal Deposit Insurance Corporation operations deserve mention, although they are not intimately related to the
effectiveness of general monetary and credit policies. One is the extent of deposit coverage under the insurance plan; the other is the
assessment rate at which insured banks contribute to the fund. In
my view an increase in insurance coverage can be justified at this time,
as an adjustment to the changes which have occurred in the volume
of deposits and the price level since 1933, when deposit insurance was
inaugurated. I do not believe, however, that the limit should be




191 MONETARY, CREDIT, AND FISCAL POLICIES

raised above $10,000. The assessment rate was set at a time when it
was necessary to provide for the rapid accumulation of a substantial reserve fund. That fund now exceeds a billion dollars, and I
believe criteria should be devised and put into effect promptly for setting some limit on the accumulation of reserves, and for providing
flexibility in assessment rates.
Once the criteria for determining adequacy have been devised satisfactorily, consideration can also be given to the development of an
assessment formula. While that formula must bear a relation to thq
liabilities incurred by the Federal Deposit Insurance Corporation year
by year, it should be so constructed, or so subject to administrative
discretion, as to avoid the possibility of a sharp rise in rates at time
of depression and heavy losses to banks. It is at just such periods that
the banks which remain open can least afford to bear the burden of
insurance assessments.
Reply of Alfred H. 'Williams, Federal Reserve Bank, Philadelphia
The insurance of bank deposits primarily affects monetary and
credit policies by contributing to a feeling of public confidence in the
banking system. We see no changes in the law or policies with respect to the insurance itself which would contribute substantially to
more effective monetary and credit policy. Changes might be appropriate in connection with the administration of deposit insurance,
such as the method of calculating the assessment base and the rate of
assessment, but these do not seem to be within the scope of the
question.
A change in the law which would increase the effectiveness of
monetary and credit policies would be to require that all insured
banks be members of the Federal Eeserve System as essentially provided in the original legislation. As an alternative, the law might
be amended so that insured banks would be required to observe the
same reserve requirements as those in force for member banks.
Reply of Hugh Leach, Federal Reserve Bank, Richmond
While there has been no widespread demand for 100 percent insurance of all deposits, many think the limit of insured deposits should
be increased from $5,000 to at least $10,000. It appears doubtful,
however, that such a change would materially enhance public confi«
dence and the stability of the money supply. It has been argued that
an increase in coverage would not in practice cause an increase in liability because when trouble materializes, the Federal Deposit Insurance Corporation customarily protects all deposits through purchase
of assets, but this overlooks the possibility that in the future the Corporation may find it advisable to elect to liquidate banks and pay off
deposits only to the extent insured.
Reply of J.N. Peyton, Federal Reserve Bank, Minneapolis
The current laws and policies relating to insurance of bank deposits
as such do not constitute any great deterrent to the effectiveness of
eneral monetary and credit policy. Accordingly no change seems to
e necessary for these reasons.
Reply of O. S. Young, Federal Reserve Bank, Chicago
The present limit of insured deposits of $5,000 covers the great majority of depositors and should not be increased at this time.

f




192

MONETARY,

CREDIT, AND FISCAL POLICIES

Reply of Chester Davis, Federal Reserve Bank, St. Louis
Insurance of bank deposits has aided general monetary and credit
policy by contributing to (1) greater confidence in the banking system, (2) greater liquidity of bank assets and greater stability of bank
deposits, and (3) more orderly markets and more stable values.
At the same time, changes in banking law have permitted more flexible monetary and credit policies to deal with problems in an economic
downswing. This has resulted in less exposure of the banking system
fo distress liquidation of assets to meet large-scale withdrawals of
funds.
A study of the record of bank failures in the past demonstrates that
large depositors, who are relatively better informed than small depositors, have withdrawn funds from banks as they seemed to weaken,
and thus have precipitated liquidations of assets. In many cases this
action may have made the difference between the continuation of the
bank and its failure.
Because of this past history it would seem desirable to increase the
coverage of deposit insurance. Since the banks have more liquidity
by reason of greater freedom of central bank action, and by reason of
other institutional changes, exposure to failure resulting from distress
liquidations is not as great as it was prior to 1935.
Theoretically, if the major purpose of deposit insurance is viewed
as maintaining confidence and preventing withdrawals of deposits
leading to forced liquidations, full coverage insurance would seem to
be logical. This question should be given extensive study. For the
present, however, I believe that more limited extension of coverage,
perhaps to as high a figure as $25,000, would be a desirable step toward
greater stability of deposits and consequently a greater contribution
toward effective monetary and credit policy.
Some formula should be devised for relating the total amount of
the insurance fund to the total amount of deposits, and permission
should be granted to the FDIC to vary the assessment rate so as to keep
a fund of proportionate size.
Finally, it would seem desirable to require that all insured banks
be members of the Federal Reserve System. In addition to the considerations which have been advanced in answers to previous questions
with respect to membership in the Federal Reserve System, membership of all insured banks in the System would provide for equal access
of such banks to Federal Reserve credit and thus reduce the potential
amount of liquidation facing the FDIC in case of adverse economic
conditions.
VIII.

EARNINGS OF THE FEDERAL RESERVE B A N K S AND T H E I R
UTILIZATION

1 (a). What changes, if any, should be made in the ownership
of the Federal Reserve banks ?
The System answer
It is assumed that this question refers to the ownership of the stock
of the Federal Reserve banks. No change in the ownership of the
stock is suggested. It may be appropriate to point out that the required holding of Federal Reserve bank stock by member banks in proportion to their own capital and surplus does not mean ownership by
member banks of the Federal Reserve banks in the usual meaning of



193 MONETARY, CREDIT, AND FISCAL POLICIES

the term "ownership." Member banks are more in the position of
owners of preferred stock with limited voting rights. They are entitled to a cumulative dividend at a specified rate on the Reserve bank
stock they hold, but most of the net earnings of the Reserve banks,
after payment of the fixed dividend, are paid to the United States
Treasury. In the event of liquidation of the Reserve banks, the residual assets remaining after payment of all obligations and the par value
of the stock are payable to the United States. The stock is not transferable ; it cannot be sold or assigned. The stockholding member banks
may elect six of the nine directors of a Federal Reserve bank, but only
three directors may be bankers, and each member bank has only one
vote, regardless of the number of shares it holds. Three directors,
including the Chairman, are appointed by the Board of Governors of
the Federal Reserve System, a Government body. The stockholding
member banks have only a very limited—and, in general, remote—
voice in the determination of the policies of the Federal Reserve
System.
The Federal Reserve System has achieved much of its effectiveness
because of its regional organization and of its internal freedom from
domination by any particular group. The individual banks are operated by men trained in banking and, to an increasing extent, by men
with long years of central banking experience. In each bank, a board
of directors oversees the administration by the bank's officers. The
directors are generally well known and highly regarded in their communities and represent banking, business, agriculture, and the public.
They are elected or appointed because of qualities which have been evidenced by success in their respective fields. Besides providing direction of the operations of the Reserve banks, these men furnish valuable
sources of information as to the economic conditions within each
district, help to widen public understanding of the policies and operations of the Reserve System, and provide local support for the Federal Reserve banks through their connection with them.
The directors administer the affairs of the Reserve banks, subject to
the general supervision and regulations of the Board of Governors of
the Federal Reserve System. Expenses, including salaries, are subject
to the Board's approval, as are appointments of the two chief executive
officers of each bank by its board of directors. Thus, in the actual
administration of the 12 banks, a unique combination is obtained
through the positive contributions of able directors and experienced
officers combined with the safeguard of effective supervision by a public body.
The System has been able to secure men of ability to serve as officers
and directors only because operations have been directed to the public
interest and have not served the objectives of special groups. Directors are willing to serve because they feel that they are elected or appointed on the basis of ability and reputation; officers who have made
a career of central banking have done so because they are attracted to
a public-service institution and feel that advancement for merit and
security from arbitrary selection are available in the Federal Reserve
banks.
The present organization of the Federal Reserve System exemplifies the principle of checks and balances traditional in American Government. Some powers have been given to the central agency, the
Board of Governors; some to the regional banks; and some to a com-




194

MONETARY, CREDIT, AND FISCAL POLICIES

bination of the two. Group judgments provide variation in emphasis,
and this is a source of strength. Member-bank ownership of the stock
of the Reserve banks was not intended to place control of the System's
policies in the hands of the member banks, and has not in fact done so.
1 (&). What changes, if any, should be made in the dividend
rates on Federal Reserve stock ?
The System answer
Dividends are paid on Federal Reserve bank stock at the rate of 6
percent per annum as required by section 7, paragraph 1, of the Federal Reserve Act. This rate was set during a period when interest
rates were substantially above their present levels, and the proposal is
sometimes made that it should now be reduced to conform to present
low rates.
There are several possible considerations involved; the most important one is the question of equity as regards the member banks. The
stock of the Reserve banks is noncallable; holdings of the individual
member bank are redemable only to the extent that they must be surrendered in the event of a reduction in the capital and surplus of
the member bank or in the event of the liquidation of the member bank
or its withdrawal from membership. The stock of a Reserve bank,
as a whole, is redeemable only in the event of the liquidation of the
Reserve bank. Member banks have been required to hold stock of
the Reserve banks through periods when the prospects for Reservebank earnings were uncertain and through periods when prevailing
open-market interest rates were higher than the dividend rate on
the stock, as well as in periods when open-market rates were lower.
The payment of dividends has never presented any serious problem to the Federal Reserve banks, nor has it influenced Federal Reserve
policies with a view to increasing or maintaining Reserve-bank earnings. Since 1925, there have been only 3 years in which dividends were
not fully paid out of current earnings.
There is no apparent necessity of a reduction of the dividend rate,
and there is a good reason, in equity, for maintaining the present rate
on outstanding stock. Furthermore, the current rate, in present circumstances, offers a minor attraction to membership in the Federal
Reserve System. It is recommended that the present dividend rate
be maintained.
2. What changes, if any, should be made in the legislative provisions relative to the disposal of Federal Reserve earnings in
excess of expenses ?
The System answer
It is recommended that no action be taken with respect to the disposition of the earnings of the Federal Reserve banks.
The original Federal Reserve Act contained provision (sec. 7) for
the payment by the Federal Reserve banks of a franchise tax based
upon earnings after dividends. Although this provision was modified in 1919 to provide for the accumulation of larger surplus funds
by the banks, the principle remained in force until 1933, when the
Banking Act of 1933 removed all requirement of franchise-tax payments becaues the Reserve banks were required to place amounts equal
to one-half of their surplus accounts in subscriptions to the capital
stock of the Federal Deposit Insurance Corporation.



195 MONETARY, CREDIT, AND FISCAL POLICIES

From 1933 through 1942, earnings were not large enough to present
any problems about their disposition. Net additions to surplus
amounted to $37,000,000, only a fraction of the $139,000,000 which had
been utilized in 1933, for the purchase of FDIC stock.
Beginning in 1943, however, earnings after dividends were substantial in amount. In that year $40,000,000 was carried to surplus,
followed by $48,000,000 in 1944, $82,000,000 in 1945, and $81,000,000
in 1946. By the end of 1946, the capital accounts of all Reserve banks
were equal to or exceeded the total of their subscribed capital, the
level set in the act prior to 1933 as the point at which the payment of
the franchise tax should begin.
In view of this fact and because earnings of the banks were expected
to continue at high levels, the Board of Governors invoked the authority granted them by section 16, paragraph 4, of the Federal
Reserve Act to impose an interest charge upon the Federal Reserve
notes of each bank. As stated in the Board's announcement of April
24,1947, "The purpose of this interest charge is to pay into the Treasury approximately 90 percent of the net earnings of the Federal Reserve banks for 1947."
So long as the franchise tax was in effect, there was little reason for
imposing the interest charge, since excess earnings of the banks were
transferred to the Treasury through the tax mechanism. Similarly,
following the removal of the franchise tax in 1933, no interest charge
was called for, since it had been the obvious intent of the Banking
Act of 1933 that earnings should be used to restore surplus funds
depleted by the subscription to the capital stock of the FDIC.
The imposition of the charge upon Federal Reserve notes was thus
in accord with the original intent of the Federal Reserve Act: that
excess earnings of the Reserve banks, after provision for the building
up of adequate surplus accounts, be paid to the Government. This
action, in a positive sense, recognizes the public character of the Reserve banks. This device is at present transferring the excess earnings
of the Reserve banks to the Treasury just as effectively as the earlier
franchise tax.
Reply of Allan Sproul, Federal Reserve Bank, New York
I do not believe that any change should be made in the ownership
of the Federal Reserve banks. Stock ownership by the member banks
is an important, if intangible, link between the Reserve banks charged
with the execution of over-all monetary policy and the member banks
which experience the direct effects of that policy. The stock does not,
of course, carry the powers of control normally associated with stock
ownership in private corporations. However, through their election
of six of the nine directors, the member banks do have an opportunity
to gain some sense of participation in the chain of responsibilities
through which over-all credit policy is evolved.
It is also significant that the member banks do not have a right to
share proportionately in the earnings of the Federal Reserve banks.
These earnings, over and above all operating expenses, and the payment of a fixed cumulative dividend on stock shares, are now returned
to the Treasury, with the exception that some allowance may be made
for further additions to the surplus accounts of the individual Reserve banks. The device now used for accomplishing the payment
to the Treasury is a self-imposed tax related to the volume of Federal




196

MONETARY, CREDIT, AND FISCAL POLICIES

Reserve notes outstanding and uncovered by gold-certificate reserves.
I regard this as an inappropriate method, because it involves distortion of the purpose of the tax. The original purpose of placing an
interest charge on such Federal Reserve notes was to prevent any
tendency for the Federal Reserve banks to overissue their notes. That
danger has never arisen, as the Federal Reserve banks have never made
any effort to keep more of their notes in circulation than have been
required to meet the demands of the public. It seems to me quite
anomalous, therefore, to use techniques intended for an altogether
unrelated purpose to accomplish the transfer of Federal Reserve bank
earnings to the Treasury.
To accomplish the purpose and overcome the objection, I would
favor reimposition of the franchise tax on Federal Reserve banks provided for in section 7 of the original Federal Reserve Act as amended
March 1919. This tax implicitly recognized the mixed status of Federal Reserve banks, and the fact that their "profits" arise from the
earning assets acquired in carrying out over-all credit policy. The
earnings subject to the tax should be determined by the Federal
Reserve banks in accordance with regulations of the Board of Gov •
ernors.
APPENDIX TO CHAPTER

III
AUGUST 1949.

QUESTIONNAIRE ADDRESSED TO THE PRESIDENTS OF THE FEDERAL RESERVE
BANKS

/. Objectives of Federal Reserve policy
1. What do you consider to be the more important purposes and
functions of the Federal monetary and credit agencies? Which of
these should be performed by the Federal Reserve ?
2. What have been the guiding objectives of Federal Reserve credit
policies since 1935 ? Are they in any way inconsistent with the objectives set forth in the Employment Act of 1946 ?
3. Cite the more important occasions when the powers and policies
of the System have been inadequate or inappropriate to accomplish
the purposes of the System.
4. Would it be desirable for the Congress to provide more specific
legislative guides as to the objectives of Federal Reserve policy? If
so, what should the nature of these guides be ?
II. Relation of Federal Reserve policies to fiscal policies and debt
management
1. Would a monetary and debt-management policy which would
have produced higher interest rates during the period from January
1946 to late 1948 have lessened inflationary pressures?
2. In what way might Treasury policies with respect to debt management seriously interfere with Federal Reserve policies directed
toward the latter's broad objectives?
3. What, if anything, should be done to increase the degree of coordination of Federal Reserve and Treasury objectives and policies
in the field of money, credit, and debt management? What would be




197 MONETARY, CREDIT, AND FISCAL POLICIES

the advantages and disadvantages of providing that the Secretary
of the Treasury should be a member of the Federal Reserve Board?
Would you favor such a provision ?
4. What changes in the objectives and policies relating to the management of the Federal debt would contribute to the effectiveness of
Federal Reserve policies in maintaining general economic stability?
5. On what occasions, if any, since 1929 have the Government's fiscal
policies militated against the success of the Federal Reserve in attaining its objectives? What type of fiscal policy would best supplement
monetary policies in promoting the purposes of the Employment Act ?
III. International payments, gold, silver
1. What effect do Federal Reserve policies have on the international
position of the country ? To what extent is the effectiveness of Federal Reserve policy influenced by the international financial position
and policies of this country? What role does the Federal Reserve
play in determining these policies ? In what respects, if any, should
this role be changed ?
2. Under what conditions and for what purposes should the price
of gold be altered ? What consideration should be given to the volume
of gold production and the profits of gold mining ? What effect would
an increase in the price of gold have on the effectiveness of Federal
Reserve policy and on the division of power over monetary and credit
conditions between the Federal Reserve and the Treasury ?
3. What would be the principal advantages and disadvantages of
restoring circulation of gold coin in this country? Do you believe this
should be done ?
4. What changes, if any, should be made in our monetary policy
relative to silver? What would be the advantages of any such
changes?
IV. Instruments of Federal Reserve policy
1. What changes, if any, should be made in the reserve requirements
of member banks? In the authority of the Federal Reserve to alter
member-bank reserve requirements ? Under what conditions and for
what purposes should the Federal Reserve use this power? What
power, if any, should the Federal Reserve have relative to the reserve
requirements of nonmember banks ?
2. Should the Federal Reserve have the permanent power to regulate consumer credit ? If so, for what purposes and under what conditions should this power be used? What is the relationship between
this instrument and the other Federal Reserve instruments of control ?
3. What, if any, changes should be made in the power of the Federal Reserve to regulate margin requirements on security loans ?
4. Should selective control be applied to any other type or types
of credit ? If so, what principles should determine the types of credit
to be brought under selective control ?
5. In what respects does the Federal Reserve lack the legal power
needed to accomplish its objectives?
6. What legislative changes would you recommend to correct any
such deficiencies ?
V. Organization and structure of the Federal Reserve System
1. In what respects, if at all, is the effectiveness of Federal Reserve
policies reduced by the presence of nonmember banks ?




198

MONETARY, CREDIT, AND FISCAL POLICIES

2. What changes, if any, should be made in the standards that banks
must meet in order to qualify for membership in the Federal Reserve
System ? What would be the advantage of such changes ?
3. What changes, if any, should be made in the division of authority
within the Federal Reserve System and in the composition and method
of selection of the System's governing bodies ? In the size, terms, and
method of selection of the Board of Governors ? In the Open Market
Committee? In the boards of directors and officers of the Federal
Reserve banks ? What would be the advantages and disadvantages of
the changes that you suggest?
VI. Relation of the Federal Reserve to other banking and credit
agencies
1. What are the principal differences, if any, between the bankexamination policies of the Federal Reserve and those of the FDIC
and the Comptroller of the Currency?
2. To what extent and by what means have the policies of the Federal Reserve been coordinated with those of the FDIC and the Compf
troller of the Currency where the functions of these agencies are
closely related? What changes, if any, would you recommend to
increase the extent of coordination ? To what extent would you alter
the division among the Federal agencies of the authority to supervise
and examine banks ?
3. What would be the advantages and disadvantages of providing
that a member of the Federal Reserve Board should be a member of
the Board of Directors of the Federal Deposit Insurance Corporation ?
Would you recommend that this be done? Should the Comptroller of
the Currency be a member of the Federal Reserve Board ?
4. In what cases, if any, have the policies of other Government
agencies that lend and insure loans to private borrowers not been
appropriately coordinated with general monetary and credit policies?
5. What changes, if any, should be made in the powers of the Federal Reserve to lend and guarantee loans to nonbank borrowers?
Should either or both of these powers be possessed by both the Federal
Reserve and the Reconstruction Finance Corporation? If so, why?
If not, why not?
6. What would be the advantages and disadvantages of establishing
a National Monetary and Credit Council of the type proposed by the
Hoover Commission ? On balance, do you favor the establishment of
such a body ? If so, what should be its composition ?
VII. Deposit insurance
1. What changes, if any, in the laws and policies relating to Federal
insurance of bank deposits would contribute to the effectiveness of
general monetary and credit policies ?
VIII. Earnings of the Federal Reserve banks and their utilization,
1. What changes, if any, should be made in the ownership of the
Federal Reserve banks? In the dividend rates on Federal Reserve
stock?
2. What changes, if any, should be made in the legislative provisions relative to the disposal of Federal Reserve earnings in excess of
expenses ?




CHAPTER IV
REPLY

BY

PRESTON

DELANO,

COMPTROLLER

OF

THE

CURRENCY

1. Under what conditions and for what purposes are requests
for national bank charters denied ?
The Comptroller of the Currency for many years has used certain
criteria as guides in the approval or disapproval of applications for
national bank charters. In his instructions No. 4, promulgated in
1927, national bank examiners making preliminary investigations for
that purpose were instructed:
In making this investigation, the examiner is instructed to give full consideration to all factors entering into the proposition. Among other matters to be
considered are, first, the general character and experience of the organizers
and of the proposed officers of the new bank; second, the adequacy of existing
banking facilities and the need of further banking capital; third, the outlook for
the growth and development of the town or city in which the bank is to be
located; fourth, the methods and banking practices of the existing bank or banks,
the interest rates which they charge to customers, and the character of the service
whch as quasi public institutions they are rendering to their community: fifth,
the reasonable prospects for success of the new bank if efficiently managed.

This instruction is judicially noticed with approval by the Court
of Appeals of the District of Columbia in Apfel v. Mellon ( (1929) 33
F. (2d) 805).
Similar criteria have been crystallized into law by Congress (title
12, U. S. C., sec 264 (e) (2)), wherein it is provided that before being
admitted to deposit insurance by the Federal Deposit Insurance Corporation each national bank newly organized shall be certified to that
Corporation by the Comptroller of the Currency, whose certificate
shall show that consideration has been given to the following factors:
The financial history and condition of the bank, the adequacy of its
capital structure, its future earnings prospects, the general character
of its management, the convenience and needs of the community to
be served by the bank, and whether or not its corporate powers are
consistent with the purposes of this section.
The procedure followed at the present time by the Comptroller of
the Currency in the consideration of applications for charters still
follows the broad principles indicated above, although the present instructions to examiners are considerably more detailed. This procedure is briefly as follows:
A field examiner is designated in each case to visit the town or city
in which the proposed bank is to be situated to inquire into the several
factors enumerated above. In the course of this inquiry, he sounds
out the local demand for banking facilities; he investigates the competitive aspects of the proposed bank; he reviews the local sources of
income and wealth to determine whether the bank could be supported
and would be successful; he interviews and inquires into the qualifi-




199

200

MONETARY,

CREDIT,

A N D FISCAL

POLICIES

cations and the financial responsibility of the proposed management,
the proposed board of directors, and the principal stockholders.
At the same time, notice of the pending application is given to the
appropriate Federal Eeserve bank and also to the Federal Deposit
Insurance Corporation. It is customary for each of these agencies
to send an examiner to the town or city involved and to give the
Comptroller the benefit of its views after such investigation.
The Comptroller may therefore take adverse action upon an application for charter if he finds any substantial deficiency in any of the
factors enumerated. In practice, adverse action is taken with respect to a considerable proportion of applications received, as follows:
Year

Applications Applications
received
denied

1943
.1944
1945
1946.

Percent

Year
194719481949 V

Applications Applications
Percent
received
denied
20
17

U2

41
35

i To Sept. 15.
• ? 9 pending.

The Comptroller of the Currency desires that the national banking
system be maintained in a position to furnish banking service wherever
there is a demand for a national bank and the circumstances appear to
justify its establishment. The increase of wealth, the spread of industry, and the shifts of population afford the national banking system
opportunities for growth. Long experience in bank supervision has
demonstrated that the establishment of numerous weak banks, or banks
that by their competition weaken existing banks, is no source of advantage to the communities in which they exist. A careful screening
of new applications, not to perpetuate an existing monopoly or to
restrict the legitimate banking service rendered to any community, but
to ensure so far as possible at inception the organization of strong,
well-managed, soundly conceived, and favorably situated banks is
deemed in the interests of the industry, commerce, and citizenry of this
country.
2. What changes, if any, in the legislation relating to the chartering and operation of national banks would improve their usefulness to the economy and contribute to economic stability?
At the present time, the Comptroller of the Currency has no changes
of this nature to suggest, with the exception of the recommendations
set forth hereinafter regarding (a) local branch banking, and (6)
statutory capital requirements with respect to branch banking.
Defects of operation which at one time were troublesome, such as
the unsatisfactory organization of reserves, the inelasticity of the note
issue, and the collection of out-of-town checks, were corrected through
the organization of the Federal Eeserve System.
The national banking system, operating in the 48 States, the District
of Columbia, and the Territories, has more than one-half of the total
assets of commercial banks. It is maintaining its position in competition with the several State bank systems. It is believed the present
laws governing the operation of national banks are sufficiently comprehensive to permit them to meet all legitimate demands for bank
credit in their respective communities and to furnish modern, efficient



201 MONETARY, CREDIT, AND FISCAL POLICIES

banking service to industry, commerce, and to the public. Fundamentally the national banks are sound. Quality of management, in
general, is on an exceptionally high level. Sufficient bank credit has
been generated by all banking systems to sustain the Government and
the business of the Nation. No change is suggested as a contribution to
economic stability.
The Office of the Comptroller of the Currency is opposed to undue
development of either branch banking or group banking on a Nationwide basis or on a widespread sectional basis. The branch banking
privileges now enjoyed by national banks were granted only to the
extent granted to State banks by State law and were designed generally
to bring about competitive parity within the dual banking system.
However, our experience has indicated that branch banking within a
single large city offers great advantages to both the banking public of
such city and the bank itself, and is not subject to the several powerful
objections which can be made to more widespread branch banking.
Furthermore, there are sections and communities in many cities where
unit banks cannot be established without creating an over-banked condition or without resulting in uneconomic or unsafe banking facilities.
In some cities neither State nor National banks can have branches by
virtue of the limitations of State laws, even though a sound local bank,
if permitted to do so, could establish one or more branches in such a
community, to its own profit and the benefit of the public, without in
any manner endangering the banking system as a whole.
Therefore, in order to provide better and more easily available banking services, and to keep national banks abreast of present-day economic development in the cities, so necessary to the public under present conditions, it is recommended that national banks be authorized to
establish branches, with the approval of the Comptroller of the Currency, within the limits of the municipality in which the bank is situated, regardless of whether State law authorizes the establishment of
similar branches by State banks situated therein. Such a privilege
would substantially improve the usefulness of national banks to the
economy, and would not violate the principle of competitive equality
between State and National banks, since the State legislatures could
confer the same privilege upon State banks, if deemed advisable.
At the present time, section 5155 of the Revised Statutes (12 U. S. C.
36) contains two sets of capital requirements with respect to establishment and maintenance of branches by national banks. Section 5155
(d) requires that a national bank with branches must have capital at
least equal to "the aggregate minimum capital required by law for the
establishment of an equal number of national banking associations
situated in the various places where such association and its branches
are situated." This requirement is not unreasonable, and has not
caused any substantial difficulty or injustice in actual operation.
Section 5155 (c), as it applies to national banks in most of the
States, forbids a bank to have any branches outside of its own town
or city unless its capital is at least $500,000. This requirement seems
to have little justification, and actually has prevented national banks
in smaller towns from establishing a branch or branches in nearby
towns or villages, even though such branches would be of considerable
benefit to the communities concerned, and the proposed banking structure actually did not call for capital of $500,000 or more. This
excessive capital requirement has also had the effect, in some cases,




202

MONETARY, CREDIT, AND FISCAL POLICIES

of preventing banks from organizing as, or converting into national
banks, or becoming members of the Federal Eeserve System.
In view of the foregoing, we recommend elimination, or at least
amendment, of the last sentence of section 5155 (c). In our opinion,
the requirement of section 5155 (d) is a sufficient capital requirement
in this connection, since it is simply a statutory minimum, and the
Comptroller of the Currency is authorized to require such greater capital as he deems appropriate before permitting establishment of
national bank branches.
3. What changes, if any, should be made in the standards that
banks, including State-chartered banks, must meet in order to
qualify for membership in the Federal Eeserve System ?
National banks are automatically eligible for membership in the
Federal Reserve System by virtue of being chartered by the Comptroller of the Currency. With respect to national banks, therefore,
this question, to a considerable extent, is equivalent to that presented
in question 2 of the questionnaire.
With respect to standards and requirements for State bank membership in the Federal Eeserve System, it is believed that this is a
matter as to which the Board of Governors of the Federal Eeserve
System is peculiarly qualified to judge and make recommendations,
because of its decades of experience in that field and its knowledge of
the factors to be taken into consideration. However, the Office of
the Comptroller of the Currency strongly recommends that the standards for membership in the Federal Eeserve System, and for the operations of member banks, and the comparable standards with respect to
national banks, be maintained on a parity, so far as possible in order
to continue the existing beneficial equality of opportunity and competition among national banks and State member banks.
4. What are the principal differences, if any, between the^
bank-examination policies of the Comptroller of the Currency
and those of the FDIC and the Federal Eeserve? Please describe any such differences in some detail, giving the reasons for
them.
The primary differences between the approach to the bank supervision of the Office of the Comptroller of the Currency, the Federal
Eeserve System, and the FDIC, result from the somewhat different
functions of the three agencies. With respect to all national banks
and other banks under his supervision, the Comptroller of the Currency is charged with primary supervisory responsibility. State
member banks and nonmember insured banks are creatures of the
law of the several States, operated under the banking laws thereof,
and are subject to the primary supervisory authority of the State
superintendent of banks or comparable official or board. The
Federal Eeserve System examines State member banks to ascertain
whether they are operating in accordance with the laws, regulations, and conditions of membership to which they are subject by
reason of Federal Eeserve membership; and the examination functions of the FDIC are comparable, with chief emphasis derived from
the Corporation's status as insurer of bank deposits. Accordingly,
the examination activities of the Federal Eeserve System and of




203 MONETARY, CREDIT, AND FISCAL POLICIES

the FDIC ordinarily are performed in cooperation with State banking authorities, rather than separately.
Despite these important differences in function and approach, the
objectives of the three Federal bank supervisory agencies are the
same. Each bank is examined to determine solvency, to ascertain
that it is being operated in accordance with applicable laws, and to
determine the soundness of the policies (particularly credit policies)
of management. In connection with these objectives, there are
few, if any, differences in policy among the three agencies. This
desirable uniformity in policy is achieved through the practices and
procedures outlined in question 5.
5. To what extent and by what means have the policies of
the Comptroller of the Currency been coordinated with those
of the Federal Eeserve and the FDIC where the functions of
those agencies are closely related ? What changes, if any, would
you recommend to increase the extent of coordination?
To
what extent would you alter the division among the Federal
agencies of the authority to supervise and examine banks?
Please give reasons for your answer.
The policies of the three agencies are closely coordinated, to the
extent that their functions are related. This coordination is achieved
through frequent conferences and consultations, both among the top
officials of the agencies and the members of their staffs, for the purpose of developing tentative programs and policies with respect to
new subjects and problems, and changes in policies and procedures
to meet changed conditions calling for either major or minor modifications.
As an important example, it is to be noted that the forms for
examination reports, reports of condition, and reports of earnings,
expenses, and dividends have been substantially standardized for
the three agencies, and major changes therein are made only after
thorough interagency study and exchange of views. In addition,
all reports of examination of natioi^al banks are made available
to the Federal Eeserve System and to the FDIC, since national
banks, as members of the Federal Eeserve System and the FDIC,
are subject to the requirements of such memberships and therefore
must be taken into account by those agencies in the formulation of
Federal Eeserve and Federal deposit-insurance policies and practices.
By such interchange of information and opinions there is achieved
a higher degree of coordination among Federal bank supervisory
agencies than is generally realized.
We feel that it would be undesirable to alter the division of the
authority to supervise and examine banks. As indicated in our answer to question 4, they occupy quite different positions with respect
to the banks which they examine. The chief function of the Office
of the Comptroller of the Currency is to exercise general supervision
over national banks, since these are chartered by the Federal Government and operate under a Federal code of laws. The primary function of the FDIC is that of an insurer of bank deposits, and State
banking authorities are primarily responsible for general supervision
of the nonmember insured banks which the FDIC examines. The
98257—49

-14




204

MONETARY, CREDIT, AND FISCAL POLICIES

Federal Eeserve System is concerned chiefly with credit and monetary
matters; its examination and supervision of State member banks is
relatively a less important function. Nevertheless, the suggestion recently has been made from a semiofficial source that all Federal bank
supervision be unified within the Federal Eeserve System, apparently
for the purpose of subordinating bank supervision to national credit
policy.
In our opinion such a development would be inimical to the wellbeing of American banking and its effective performance of its important role in American economic life. Furthermore, it would tend
to undermine the confidence of bankers in the Federal supervisors,
who they now know to be concerned solely with the soundness of each
individual unit of the banking system and its ability to furnish the
fullest possible service to its community and the Nation. This valuable relationship would be lost to the extent that Federal bank supervision became merely one means for putting into effect current economic policies of the Federal Government. For these and related
reasons, this office firmly believes that any such unification would be
inadvisable, and that contentions to the contrary are based upon a
superficial understanding of the different functions of the Federal
supervisory agencies and the coordinated and efficient manner in
which they are performed.
6. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by the Hoover Commission? On balance, do you favor
the establishment of such a body? If so, what should be its
composition ?
Despite its designation as a National Monetary and Credit Council,
it appears that the body recommended by the Commission on Organization of the Executive Branch of the Government would have as its
purpose the coordination of the policies and operations of the lending, insuring, and guaranteeing functions of Federal Government
agencies, in the domestic field. (Eeport on Treasury Department
(March 1949) pp. 19-21, 32-33.)1
In the course of its frequent examination of 5,000 commercial banks
throughout the country, the Office of the Comptroller of the Currency
has encountered relatively little conflict, inconsistency or lack of coordination in the operations of the numerous Government agencies
engaged in lending, insuring, and guaranteeing loans, and the like.
It is believed that, to a considerable extent, there is at the present
time a practice of exchange of information regarding policies and
operations among those agencies. However, the agencies actually
engaged in such work are unquestionably in a better position to express opinions regarding the need for a Council of the nature
described.
Subject to the foregoing limitations, it is our opinion that a Council of this type would accomplish relatively little in addition to what
is now accomplished through voluntary coordination and exchange
of views by the departments and agencies concerned. If this is cor1 The functions of the National Monetary and Credit Council recommended by the Hoover
Commission, as outlined above, would be entirely different from the functions of the National
Monetary Commission proposed by S. 1559, 81st Cong. Our comments refer solely to a
body of the nature recommended by the Hoover Commission, to which the questionnaire
refers.




205 MONETARY, CREDIT, AND FISCAL POLICIES

rect, the existence of such a Council might tend to formalize and complicate the process of coordination, and to that extent might actually
impede the process. On balance, therefore, this office does not affirmatively favor the establishment of such a body, although it has no
basis for strong opposition thereto.
7. What would be the advantage and disadvantages of providing that the Board of Directors of the FDIC should be composed of the Comptroller of the Currency, the Chairman of the
Federal Eeserve Board, and an appointed Chairman? Would
you recommend that this be done ?
The banking system of the United States is often described as a
dual banking system, made up of some 5,000 national banks holding
more than half of the total deposits, and somewhat less than 10,000
State banks (including mutual savings banks) holding the remainder.
Examiners of the FDIC examine insured nonmember banks once each
year, ordinarily in cooperation with the State banking authorities.
National banks are examined only by the Comptroller of the Currency
the reports of examination being made available to the FDIC.
The present composition of the Board of Directors of the FDIC
provides direct contact with the primary supervisory authorities with
respect to all insured banks. The ex officio directorship of the Comptroller of the Currency makes for easy coordination, so far as desirable, of the insurance functions and policies of FDIC, and the
general supervisory functions and policies of the Comptroller. Likewise, the fact that joint examinations of the majority of insured State
banks are made by the FDIC and the State banking authorities gives
an opportunity for similar cooperation between the FDIC and the
State authorities. Consequently, the present composition of the
Board of Directors of the FDIC provides the highly desirable feature
of closed and continuous contact with the authorities, State and Federal, having primary supervisory responsibility with respect to every
part of the dual banking system. This is perhaps the most important
reason for including the Comptroller of the Currency as one of the
three directors of the FDIC.
It is true that the presence on the FDIC Board of the Chairman
of the Board of Governors of the Federal Eeserve System would
furnish the advantage of direct contact with the body charged with
Federal supervision of State member banks. To this extent the
FDIC (and to a lesser degree, the Federal Eeserve System) might
receive some benefit from the suggested change in the composition
of the Board of Directors of the FDIC.
However, if the FDIC had a three-man Board of Directors composed of the Comptroller of the Currency, the Chairman of the Federal Eeserve Board, and an appointed Chairman, a majority of the
Board would consist of directors with dual responsibilities. We
regard this as undesirable, for we believe that the FDIC should be
directed by a board of whom a majority are concerned solely with
the most effective performance of deposit-insurance functions.
Although a decision in this matter is difficult to make, we are inclined to believe that neither the change outlined in the questionnaire nor the alternative outlined above is desirable. The present
three-man Board of the FDIC has great advantages of flexibility and
convenience. In addition, the factors mentioned in the preceding



206

MONETARY,

CREDIT, AND FISCAL POLICIES

paragraphs indicate that the relatively limited advantages of a Federal Eeserve directorship on the FDIC Board would be outweighed
by the potential disadvantages. We therefore recommend against
a change of this nature in the composition of the Board of Directors
of the FDIC.
8. What would be the principal advantages and disadvantages
of reestablishing a gold-coin standard in this country? Do you
believe that such a standard should be reestablished ?
This office is not in a position to discuss this question adequately.
Our duties (other than ministerial) are restricted to bank examination and supervision, and do not call for determinations or activities
involving economic questions of this nature. For this reason, the bureau does not employ professional economists, within whose field these
subjects would fall.
Within the Treasury Department, problems of this character would
be dealt with by the Office of the Secretary.
A P P E N D I X TO CHAPTER I V
AUGUST 1 9 4 9 .
QUESTIONNAIRE ADDRESSED TO THE COMPTROLLER OF THE CURRENCY

1. Under what conditions and for what purposes are requests for
national bank charters denied?
2. What changes, if any, in the legislation relating to the chartering
and operation of national banks would improve their usefulness to the
economy and contribute to economic stability?
3. What changes, if any, should be made in the standards that banks,
including State-chartered banks, must meet in order to qualify for
membership in the Federal Eeserve System ?
4. What are the principal differences, if any, between the bankexamination policies of the Comptroller of the Currency and those of
the FDIC and the Federal Eeserve ? Please describe any such differences in some detail, giving the reasons for them.
5. That what extent and by what means have the policies of the
Comptroller of the Currency been coordinated with those of the Federal Eeserve and the FDIC where the functions of those agencies are
closely related ? What changes, if any, would you recommend to increase the extent of coordination? To what extent would you alter
the division among the Federal agencies of the authority to supervise
and examine banks ? Please give reasons for your answer.
6. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by
the Hoover Commission ? On balance, do you favor the establishment
of such a body ? If so, what should be its composition ?
7. What would be the advantages and disadvantages of providing
that the Board of Directors of the FDIC should be composed of the
Comptroller of the Currency, the Chairman of the Federal Eeserve
Board, and an appointed Chairman? Would you recommend that
this be done ?
8. What would be the principal advantages and disadvantages of
reestablishing a gold-coin standard in this country ? Do you believe
that such a standard should be reestablished?



CHAPTER V
R E P L Y

B Y

M A P L E

DEPOSIT

T. H A R L ,

I N S U R A N C E

CHAIRMAN,

F E D E R A L

CORPORATION

1. How broad do you consider the purposes of deposit insurance to be? Merely to protect small depositors? To prevent
losses of reserves by the banking system, or by large portions
of the system, through preventing fear-inspired withdrawals
of currency and shifts of deposit balances within the system?
To maintain the availability of credit at banks by creating confidence among bankers that they will not be subjected to runs
by their depositors ? Other purposes ?
We consider deposit insurance as having the following principal
purposes: The chief purpose is to protect small depositors. Another
major purpose is to maintain the confidence of depositors in the banks.
An additional function of deposit insurance is to improve the
standards of bank management and increase the soundness of the
banking system through examination and supervision of individual
banks by the Federal Deposit Insurance Corporation.
A further objective of deposit insurance is to restore to a community, in the event of a bank failure, a portion of the deposits
used in the community as a circulating medium.
Considering reserves in a broad sense, the losses of reserves by the
banking system through fear-inspired withdrawals of currency and
shifts of deposit balances within the system will be largely prevented
to the extent that deposit insurance maintains the confidence of the
mass of depositors in the banks. The legal reserves of banks which
are members of the Federal Reserve System, of course, are controlled
by the policies and operations of the Federal Reserve System and,
therefore, we do not believe that deposit insurance was intended
to exert any direct influence on such reserves.
Depositors' confidence creates confidence among bankers that they
will not be subjected to runs by their depositors, and this in turn
exerts a favorable influence in maintaining the availability of credit
at banks.
2. In the cases of banks that have fallen into such serious
financial difficulties that the FDIC had to take them over, have
you found that there are often large withdrawals of deposits
during the period before actual failure? If so, have these withdrawals included deposit accounts in excess of $5,000? Please
supply revelant statistics if these are available.
In several cases of insured banks merged with aid from this Corporation or placed in receivership, it is known that unusual withdrawal activity occurred during the period shortly before the closing of the bank. However, these withdrawals were not limited to ac-




207

208

MONETARY, CREDIT, AND FISCAL POLICIES

counts exceeding $5,000. Some depositors withdrew the entire amount
of the deposit; others withdrew only the amount in excess of $5,000.
In adition, some depositors with accounts below $5,000 withdrew
their entire deposit balances. For the most part, these cases involving unusual withdrawals occurred in the early stages of Federal deposit insurance. In recent years this type of depositor behavior has
almost entirely disappeared and in some cases, deposits have actually
increased in the period just prior to the receivership or merger.
The period during which Federal deposit insurance has been in
operation has been comparatively free from serious banking troubles.
In recent years the number of insured banks requiring financial aid
from this Corporation for the protection of depositors has declined
to almost negligible proportions. The activity in deposit accounts
in this period would furnish little basis for ascertaining the situation likely to be encountered in times of great financal stress. Accordingly, we have not made and do not have available detailed statistical studies of the activity in deposit accounts in banks receiving
Federal deposit insurance aid.
3. Does the information at your disposal indicate that bank
runs have often been initiated or reinforced at an early stage by
withdrawals of large deposit accounts?
No bank runs of any consequence have occurred since the Federal
Deposit Insurance Corporation has been in operation. Hence, this
Corporation has no direct information to—
indicate that bank runs have often been initiated or reinforced at an early stage
by withdrawals of large deposit accounts.

Several years ago a study was made by a project of the Works
Progress Administration of the behavior of deposits prior to suspension in a selected group of banks. The study covered 67 banks which
suspended during the period from November 1930 to March 1933.
These banks were considered representative of suspensions involving
banks with total deposits from $1,000,000 to $25,000,000 located in
urban areas. The results of the investigation were summarized as
follows:
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 in 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




209

MONETARY, CREDIT, AND FISCAL POLICIES

of holder (local or nonlocal), or type of holder (business or personal), seems
to be of comparatively minor importance.1

4. What changes, if any, in the coverage of deposit insurance
are desirable to further the purposes of the Employment Act?
What would be the advantages and disadvantages of providing
full insurance coverage of all deposits in insured banks? On
balance, would you favor such a policy ? Please give reasons for
your answer.
The purpose of the Employment Act of 1946 is stated as follows:
The Congress hereby declares that 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 selfemployment, for those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power.

As we have stated in the answer to question No. 1, the principal purposes of Federal Deposit Insurance are to protect small depositors, to
maintain the confidence of depositors in banks, to raise standards of
bank management and increase the soundness of the banking system,
and to aid in protecting the circulating medium. The accomplishment of these purposes would contribute to economic and financial
stability and thus serve to further the purposes of the Employment
Act.
During the period of its operation, Federal Deposit Insurance has
accomplished its primary purpose of protecting depositors. As a
result, the confidence of the depositors has been restored and maintained. That the third stated purpose of deposit insurance has been
fulfilled is attested by the fact that during the entire period of the
Corporation's operations, the condition of insured banks has steadily
improved and banks generally are in the best condition in our banking
history. Insofar as its function of protecting the circulating medium
is concerned, deposit insurance has effectively discharged this responsibility, and in this connection it should be noted that in more than 5
years there has not been any loss of circulating medium in any community due to the closiu^r of an insured bank.
Therefore, we are of the view that the Corporation, under the present insurance coverage, is making a maximum contribution to furthering the purposes of the Employment Act and in this respect there
would be no benefit to be gained in changing the coverage of deposit
insurance.
Those who favor changing the law to provide full insurance coverage
for deposits have advanced the following arguments:
1. Approximately 50 percent of dollar amount of deposits are
insured under present statutory limitations. If deposit insurance
covering 50 percent of deposits is desirable and necessary, 100
percent insurance would be more effective and would result in a
more complete fulfillment of the purposes of deposit insurance.
2. The present deposit insurance limit of $5,000 results in most
1

Federal Reserve Bulletin, March 1939, p. 178.




210

MONETARY, CREDIT, AND FISCAL POLICIES

of the larger deposits going to the big banks. Full insurance
coverage would result in smaller banks getting more of deposits
in excess of $5,000.
3. Due to the preponderance of large accounts in big banks,
the proportion of insured deposits is relatively low. Since assessments are based on total deposits, it is claimed that the big banks
carry more than a proportionate share of the costs of deposit insurance. The redistribution of deposits resulting from 100 percent insurance would shift some of the burden of deposit insurance protection from the big to the small banks.
4. In most cases of insured banks in difficulty, the Federal Deposit Insurance Corporation, under its merger procedure, protects all depositors in full, so w^hy not require insurance protection in full by law and thus take full advantage of the psychological benefits of 100 percent insurance.
Those who do not favor changing the law to provide for full insurance for deposits give the following reasons in support of their view:
1. Full insurance coverage would necessitate the imposition of
greater controls over the banking industry which would narrow
the area of managerial decision by individual banks. It is questionable just how much more control can be imposed on the present free-enterprise system of banking without stifling it. Somewhere in the process of increasing controls, the point would be
reached where the controls would do death to the system. Since
this point cannot be ascertained by hypothetical means, this hazard
to the free-enterprise system of banking must be taken into account when considering full deposit insurance coverage.
2. Full insurance coverage would destroy the influence for
sound banking which is now exerted upon bank management by
large depositors. This result, commonly called placing a
premium on bad banking, would have a decidedly unfavorable
effect upon banking practices in that it would break down bankmanagement standards developed to their present high quality
over the past 15 years.
3. There is no satisfactory assurance that the insurance fund
is adequate to provide full insurance protection.
4. Deposit insurance has achieved in full the objectives established for it and has functioned effectively during its entire existence. It is true that the Corporation has not faced a period of
serious trouble in the banking system. However, deposit insurance was designed to aid in preventing severe financial crises and
its effective functioning and the improvements and reforms in
the banking and monetary system made in 1933-35 have greatly
lessened the possibility of recurrence of such conditions. In view
of the 15 years of successful deposit-insurance operations, it would
be illogical to make such a drastic change based purely on speculation as to the necessity for and the results of such a change.
On balance, we do not favor amending the deposit-insurance law
to provide full insurance for deposits as the disadvantages, in our
opinion, substantially outweigh the advantages.
5. What changes, if any, should be made in the basis and rates
of deposit-insurance premiums?




211 MONETARY, CREDIT, AND FISCAL POLICIES

The Corporation has been conducting an extensive study in conjunction with representatives of the American Bankers Association
regarding the changes, if any, which should be made in the basis and
rates of deposit-insurance assessments. This study has not yet been
completed and, therefore, we are unable to state our recommendations
on that subject at this time.
6. What changes, if any, should be made in the commitments of
the Government to provide financial assistance at any time that
the resources of the FDIC might prove to be inadequate ?
We do not at this time recommend any change in the commitment
of the Federal Government to provide financial assistance to the
Federal Deposit Insurance Corporation.
7. How do the percentage losses to the Corporation in those
cases in which the FDIC itself acts as receiver for insured banks
compare with its percentage losses in those cases where others act
as receivers for insured banks?
The Corporation has acted as receiver for 77 insured banks which
had deposits of $34,000,000. The Corporation was not appointed
receiver in the case of 168 closed insured banks with $76,000,000 deposits.
In the banks for which the Corporation has acted as receiver the
Corporation disbursed 25.7 million dollars. The Corporation's loss
was 3.7 million dollars or 14.4 percent of disbursements. This loss was
11.0 percent of the total deposits of the banks.
In the banks for which others have acted as receiver the Corporation
disbursed 61.3 million dollars. Its loss was 10.8 million dollars or
17.7 percent of its disbursement. The loss was 14.3 percent of the
total deposits of the banks.
8. What would be the advantages and disadvantages of requiring all commercial banks to become members of the FDIC?
Would you recommend that this be done ?
An advantage in requiring all commercial banks to become insured
banks would be extension of the benefits and protection of deposit
insurance to depositors of approximately 1,100 noninsured commercial
banks.
A disadvantage would be that such compulsory insurance requirement would disturb the relations between the Corporation and the
State supervising authorities. Under the present law, the Corporation
operates as a unifying link between the State and Federal banking
systems. It is concerned equally with both classes of banks, State and
National. By establishing deposit insurance on an optional basis for
State nonmember banks, the authority of the States to charter and
supervise banks was preserved. Compulsory insurance for all commercial banks would result in either the State authorities controlling
the admission of banks to insurance or the Corporation dominating
the chartering of commercial banks by the State. Obviously, it would
be unsound to require the Corporation automatically to insure all commercial banks chartered by the State authorities. Likewise, it would
be an usurpation of a prerogative of the States to require that no State
commercial bank could operate without insurance by the Corporation.
This requirement would, in effect, transfer the chartering powers of
the States to this Corporation.



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MONETARY, CREDIT, AND FISCAL POLICIES

We believe the friction and pressures of compulsion would outweight any advantage that would ensue from requiring all commercial
banks to be insured. Therefore, we recommend against such a
proposal.
9. In your review of the examinations made by the Federal
Reserve and the Comptroller of the Currency, what have you
found to be the principal differences, if any, between the bankexamination policies of the FDIC and those of the Federal Eeserve
and the Comptroller of the Currency ?
There are no important differences between the bank-examination
policies of this Corporation and those of the Federal Reserve or the
Comptroller of the Currency. The existing differences are unimportant and are attributable mainly to the difference in the functions
and purposes of the three agencies. Complete cooperation exists between all three agencies. Uniformity of examination policy is gradually being achieved and close liaison now obtains with respect to a
uniform approach to corrective programs.
10. What changes, if any, should be made in the division among
the Federal agencies of the authority to supervise and examine
banks ? What would be the advantages of such changes ?
We do not at this time recommend any changes in the division
among Federal agencies of the authority to supervise and examine
banks.
11. What would be the advantages and disadvantages of adopting the Hoover Commission proposal that supervision of the
operations of the FDIC be vested in the Secretary of the Treasury ?
There would be no advantages in adopting this Hoover Commission
proposal. A review of causative conditions existing at the time of
creation of the Federal Deposit Insurance Corporation is necessary to
examine in proper perspective the disadvantages of the proposal.
At the time of the establishment of this Corporation in 1933, the
banking system was prostrate, confidence of depositors had vanished,
and the effectiveness of supervisory authorities to remedy the situation was at an all time low.
The condition of the banking system at that time and the part played
by the Corporation in restoring soundness and confidence was most
eloquently stated by the Honorable Arthur H. Vandenberg on the
floor of the Senate on July 25,1947:
* * * I ask Senators to remember back 15 years, to the days of the bank
holidays. I ask them to remember the utter paralysis in America as the result
of the bank holidays. I ask them to remember that those bank holidays did not
flow so much from insolvent banks as from the general lack of confidence in
American banks. The banks themselves, when they finally went through the
wringer, in 9 cases out of 10 proved that they had been solvent. It was not
tfteir lack of solvency which ruined the country for a decade; it was the lack
of public confidence in them, regardless of the nature and character of their
assets.
f
It was under those circumstances that Congress created the Federal Deposit
Insurance Corporation, and from the moment it was created and from the moment
it opened its doors there has never been a succeeding moment in the life of the
Nation when there has been the slightest lack of public confidence in our banking
system. As a result we went all through those perilous holidays when everything
else was collapsing on all sides. We went all through them without a single
bank faiure in the land. If it had not been for the contribution which the




213 MONETARY, CREDIT, AND FISCAL POLICIES
Federal Deposit Insurance made to the life of the Nation at that time, I dread
to think what the outcome might have been.

The law creating the Federal Deposit Insurance Corporation was
not hastily considered and passed by the Congress under stress of the
emergency existing in 1933. Numerous proposals for Federal deposit
insurance had been carefully studied by the Banking and Currency
Committees of both the Senate and House for more than a year before
adoption of the first deposit insurance law. During this period and
in the time between the date of enactment of the first law and the date
of enactment of the permanent law in 1935 much debate took place on
some of the very same proposals that have been made by the Hoover
Commission.
Serious consideration was devoted to the question of whether
Federal deposit insurance was to be a government guarantee of deposits or a mutual trust established and sponsored by the Government
and maintained by the banks. The present system, a mutual trust
arrangement, was adopted in preference to a direct governmental
guarantee. Thus, control of the Corporation by any of the executive
departments, including the Treasury, was automatically excluded as
being inconsistent with the mutual character of the Federal deposit
insurance system and a bipartisan board of directors was given authority for the management of the Corporation as a means of assuring
independent and impartial administration.
Extended argument was had on the question whether the Federal
Reserve Board should have any direct or indirect control over the
Corporation. Fear was freely expressed, especially by the small
banks, that if the Federal Reserve System should control the Federal
Deposit Insurance Corporation, deposit insurance would be used as a
means of forcing State banks into the Federal Reserve System, which
during its 20 years of existence prior to that time had been notably
unsuccessful in inducing State banks to become members. To allay
these fears the Corporation was established as an independent agency
thus assuring national banks, State member and State nonmember
banks of nondiscriminatory treatment and a proposal for Federal
Reserve representation on the Board of Directors of the Corporation
was rejected.
The Federal Deposit Insurance Corporation thus was intended as
became the unifying link between the State banking and National
banking systems. Consistent with this concept of Federal deposit
insurance as conceived by the Congress, the Corporation's policy has
always been one of strong advocacy and support of the dual system.
There are, therefore, fundamental reasons why the Federal Deposit
Insurance Corporation should remain an independent agency, free
from the control or interference of any other agency or department.
Its independence and the dual banking system are interdependent and
are inextricably bound together. To the extent that the independence
of the Corporation is impaired the dual banking system is endangered.
The independence of the Corporation is fundamental to the continuance of Federal deposit insurance as now consituted. Its independence
cannot be destroyed or whittled away without changing the basic
character of the Federal deposit insurance system and impairing the
dual banking system. Federal deposit insurance cannot function successfully as a mutual insurance fund while subjected or subordinated




214

MONETARY, CREDIT, AND FISCAL POLICIES

to the fiscal policies of the Treasury Department or the policies of any
other agency or department of the Federal Government.
12. What would be the advantages and disadvantages of providing that the Board of Directors of the FDIC should be composed of the Comptroller of the Currency, the Chairman of the
Federal Eeserve Board, and an appointed chairman? Would you
recommend that this be done ?
There would be no advantage in replacing one of the present appointive members of the Board of the Federal Deposit Insurance Cor^
poration with the Chairman of the Board of Governors of the Federal
Eeserve System.
There would be a number of disadvantages, viz:
A Board of Directors composed of two ex officio members and an
appointive member would result in a situation in which it would be
possible for the heads of the two other Federal banking agencies to
dominate and control the policies and operations of the Corporation.
This would be contrary to one of the fundamentals of Federal Deposit
Insurance as it is now constituted, viz, that it be administered by a
bipartisan board as an independent agency. At the time of creation
of the Corporation, the Congress considered and rejected proposals
for representation of the Federal Eeserve on the Board of the Federal
Deposit Insurance Corporation as being totally unacceptable. The
functions and the purposes of the Federal Eeserve System are different
from those of the Federal Deposit Insurance Corporation, and
although cooperation between both is desirable, the subordination of
one to the other would be destructive of the effectiveness of the agency
dominated by the other. We recommend against such a proposal.
IB. To what extent and by what means have the policies of the
FDIC been coordinated with those of the Federal Eeserve and the
Comptroller of the Currency where the functions of these agencies
are closely related ? What changes, if any, would you recommend
to increase the extent of coordination ?
Those functions of the Federal Deposit Insurance Corporation, the
Federal Eeserve System, and the Comptroller of the Currency, wThich
are related to each other pertain principally to the examination of
banks, the collection of reports from banks, and the publication of
banking statistics. Coordination of policies and work in these fields
has been achieved through consultation among the heads, officials, and
staff members of the three agencies.
The degree of coordination which has been achieved through consultation includes a uniform method of appraising the value and
quality of bank assets and adequacy of bank capital by bank examiners; close staff liaison in respect to uniform corrective measures;
closely similar forms for the reports of examinations; uniform report
forms for information collected from banks with respect to their assets
and liabilities, and their earnings, expenses, and dividends; and preparation of a single set of tabulations covering all operating commercial
and mutual savings banks.
Coordination has also been achieved in the field of regulation. The
Corporation and the Board of Governors of the Federal Eeserve System have promulgated uniform regulations governing the payment
of interest on deposits. In addition, the Corporation has cooperated




215 MONETARY,

CREDIT, AND FISCAL POLICIES

with the Federal Reserve in policing the latter's regulations T and U
and former regulation W in the insured nonmember State banks.
As to the changes, if any, which should be made to increase the
extent of coordination, we have no recommendation to make at this
time.
14. What would be the advantages and disadvantages of
establishing a national monetary and credit council of the type
proposed by the Hoover Commission ? On balance, do you favor
the establishment of such a body? If so, what should be its
composition?
The principal advantage which we see in the establishment of a
national monetary and credit council as proposed by the Hoover
Commission would be to provide a regular opportunity for the expression of views of all interested agencies on various types of problems
in the field of monetary and lending policy. However, we understand
that this result is largely accomplished now through the coordinating
efforts of the Treasury Department. Hence, the establishment of the
council probably would not have a vital impact on any fundamental
problem. Although we are not opposed to the establishment of the
council, we do not believe any great purpose will be served by its
creation. If the council is established, in our opinion it should be
composed of representatives of all monetary, banking, financial, and
credit agencies of the Government.
15. What change, if any, should be made in the standards that
banks must meet to qualify for membership in the Federal Reserve System? What would be the advantages of such changes?
We do not propose any changes in the standards that banks must
meet to qualify for membership in the Federal Reserve System.
16. What would be the principal advantages and disadvantages
of reestablishing a gold-coin standard in this country? Do you
believe that such a standard should be reestablished ? Please give
the reasons for your answer.
We would prefer not to state our views on this question, leaving
the answer to those agencies having a more direct interest in the
problem.
IT. What changes, if any, in the existing powers of the FDIC
would facilitate its operations and contribute to the purposes ot
the Employment Act ?
We have no changes to propose in the existing powers of the Federal
Deposit Insurance Corporation at this time.

A P P E N D I X TO CHAPTER

V
AUGUST 1949.

QUESTIONNAIRE ADDRESSED TO THE FEDERAL DEPOSIT INSURANCE
CORPORATION

1. How broad do you consider the purposes of deposit insurance to
be? Merely to protect small depositors? To prevent losses of reserves by the banking system, or by large portions of the system,



216

MONETARY, CREDIT, AND FISCAL POLICIES

through preventing fear-inspired withdrawals of currency and shifts
of deposit balances within the system ? To maintain the availability
of credit at banks by creating confidence among bankers that they will
not be subjected to runs by their depositors? Other purposes?
2. In the cases of banks that have fallen into such serious financial
difficulties that the FDIC had to take them over, have you found that
there are often large withdrawals of deposits during the period before
actual failure? If so, have these withdrawals included deposit accounts in excess of $5,000 ? Please supply relevant statistics if these
are available.
3. Does the information at your disposal indicate that bank runs
have often been initiated or reinforced at an early stage by withdrawals
of large deposit accounts ?
4. What changes, if any, in the coverage of deposit insurance are
desirable to further the purposes of the Employment Act? What
would be the advantages and disadvantages of providing full insurance
coverage of all deposits in insured banks? On balance, would you
favor such a policy ? Please give reasons for your answer.
5. What changes, if any, should be made in the basis and rates of
deposit insurance premiums ?
6. What changes, if any, should be made in the commitments of the
Government to provide financial assistance at any time that the resources of the FDIC might prove to be inadequate ?
7. How do the percentage losses to the Corporation in those cases
in which the FDIC itself acts as receiver for insured banks compare
with its percentage losses in those cases where others act as receivers
for insured banks ?
8. What would be the advantages and disadvantages of requiring
all commercial banks to become members of the FDIC ? Would you
recommend that this be done ?
9. In your review of the examinations made by the Federal Reserve
and the Comptroller of the Currency, what have you found to be the
principal differences, if any, between the bank examination policies of
the FDIC and those of the Federal Reserve and the Comptroller of
the Currency?
10. What changes, if any, should be made in the division among the
Federal agencies of the authority to supervise and examine banks?
What would be the advantages of such changes?
11. What would be the advantages and disadvantages of adopting
the Hoover Commission proposal that supervision of the operations
of the FDIC be vested in the Secretary of the Treasury ?
12. What would be the advantages and disadvantages of providing
that the Board of Directors of the FDIC should be composed of the
Comptroller of the Currency, the Chairman of the Federal Reserve
Board, and an appointed chairman ? Would you recommend that this
be done?
13. To what extent and by what means have the policies of the FDIC
been coordinated with those of the Federal Reserve and the Comptroller of the Currency where the functions of these agencies are closely
related ? What changes, if any, would you recommend to increase the
extent of coordination ?




217 MONETARY, CREDIT, AND FISCAL POLICIES

14. What would be the advantages and disadvantages of establishing a national monetary and credit council of the type proposed by
the Hoover Commission ? On balance, do you favor the establishment
of such a body ? If so, what should be its composition %
15. What changes, if any, should be made in the standards that banks
must meet to qualify for membership in the Federal Reserve System ?
What would be the advantages of such changes ?
16. What would be the principal advantages and disadvantages of
reestablishing a gold-coin standard in this country? Do you believe
that such a standard should be reestablished ? Please give the reasons
for your answer.
IT. What changes, if any, in the existing powers of the FDIC would
facilitate its operations and contribute to the purposes of the Employment Act?




CHAPTEE V I
REPLY BY HARLEY HISE, CHAIRMAN, BOARD OF DIRECTORS, RECONSTRUCTION FINANCE CORPORATION
1. What do you consider to be the major purposes and objectives of RFC loans and guaranties of loans to private borrowers?
In authorizing BFC to make loans to private borrowers directly
or in participation with banks or other lending institutions, the Congress stated the purposes and objectives to be: To aid in financing
agriculture, commerce and industry; to encourage small business; to
help in maintaining the economic stability of the country; and to
assist in promoting maximum employment and production. The
major purposes of BFC loans are to help finance new or established
business enterprises engaged in the production, distribution, and sale
of goods or the furnishing of services in which has developed a need
for working capital, and for funds to finance new construction and
expansion of existing plant facilities, the credit for which it not otherwise available on reasonable terms.
2. Do you believe that the EFC should operate continuously as
a lender and guarantor of loans to private borrowers, or that it
should operate in this field only in emergency periods ? If you
favor continuous operation, what are your principal reasons for
this?
In our opinion EFC should continuously be in a position to lend
to private borrowers, but its activities should be curtailed or expanded
as required by changes in general economic conditions. This presupposes, of course, that such continuance would be subject to existing
or similar statutory limitations which now restrict the Corporation's
lending activity to loans that cannot be obtained from private
sources on reasonable terms yet which offer reasonable assurance of
repayment,
It has been the Corporation's experience that even though employment and production may be at a high level, availability of private
credit is not present in many cases, particularly in the field of
small business. Not having access to equity capital sufficient for its
needs, small business is forced to look to credit sources for much of
its financing. Long-term credit is the primary need, but, according
to our experience, is not generally available from private sources,
notwithstanding that prospects of the companies indicate reasonable
assurance of repayment. For worthy small concerns not to have
any source of such credit would be handicapping seriously an important segment of the country's industry.
Demand also exists and to an increasing degree from large enterprises for long-term credit to be used for working capital, for refinancing of distressed indebtedness, and for plant modernization and

218




219 MONETARY, CREDIT, AND FISCAL POLICIES

expansion. Of primary importance in numerous such cases are the
long establishment of the business, the character of the products or the
service rendered, the employment feature and the fact that because
of regulations and other reasons lending banks can continue adequate
lines of credit with many of their borrowers only with the type of
assistance to be had from RFC.
The RFC's lending power constitutes a reservoir of credit which
can be tapped at any time by any adversely affected segment of the
economy or area of the country whenever and wherever needed. This
is a necessary safeguard in emergency periods, the beginning of whick
cannot be easily identified. Emergency periods and depressions do
not occur at the same time in all industries. Different industries and
different areas do not have their recessions at the same time. Continuous need for RFC financing also exists because of the incapacity
or unwillingness of private sources to supply credit to various segments of the national economy when the need arises in other than
periods of emergency. RFC should remain in position to carry out
congressional policies in time of cyclical business decline whose
severity might be alleviated by timely RFC aid. It has operated
during depressions, defense arming, war, reconversion, and recovery.
Congress has used the RFC as a vehicle for carrying out its policies
during each of these periods.
3. (a) What, if any, are the gaps or inadequacies in the private
financial system that justify Federal loans and guaranties of
loans to private borrowers ?
(b) What feasible changes, if any, in the structure, powers,
and policies of private financing institutions and in Government
laws and regulations applying to these institutions would lessen
the need for Federal loans and guaranties of loans to private
borrowers ?
(a) The gaps or inadequacies in the private financial system that
justify Federal loans and guarantees of loans to private borrowers are
due to the following:
(i) The risk involved in making certain types of loans. Since
measurement of this risk is not reducible to a formula or yardstick basis the human factor of judgment and changing economic
conditions automatically will continue to develop the so-called
gaps, and for these there can be no constructive remedy in legislation or regulation. Each case has to be judged on its merits.
These gaps or inadequacies occur whenever the private financial
system is unable or unwilling to supply long-term financial aid
to worthy applicants, especially small-business enterprises.
(ii) Private lenders do not have unlimited funds. While the
availability of loans from private sources would obviously be
restricted in periods of financial or economic distress, there are
many instances in which financial assistance is not available to
potential borrowers through private channels in so-called normal
times. The fact that the vast majority of funds available for
lending purposes by commercial banks are represented by deposits subject to immediate withdrawal or withdrawal on short
notice has a tendency to deter the making of a substantial number
of long-term loans.
98257—45)

15




220

MONETARY, CREDIT, AND FISCAL POLICIES

(iii) Private lenders will not make loans that they believe
are slow or cumbersome or unduly expensive to administer.
Small banks do not have ability to develop technique for successfully handling borderline loans. Most small-business loans
require time and patience to make and administer.
(iv) Private lenders fail to meet the need for certain types of
long-term credit. This lack of availability of long-term credit,
and particularly for small business is due not only to the fact
that the risk is greater, but that the cost of making and servicing
a small loan is proportionately greater than a large loan. The
smaller businesses face serious difficulty of obtaining long-term
financing. Accordingly, it is essential that smaller businesses
have some assured source of long-term credit. As a matter of
fact we have found that there is insufficient long-term private
credit available to some large businesses. While there may be
ample potential credit for all business, it does not always reach
the economic area when and where it is needed.
Some of the reasons heretofore advanced by banks for declining
loans, which were subsequently presented to RFC are: Maturity
requested too long; amount of loan too large; type of loan not
acceptable by the bank; enterprise located too far from bank;
bank furnishing short-term credit to applicant and unwilling to
grant long-term credit; collateral considered inadequate; bank
unwilling to make capital loan; applicant engaged in new enterprise or recently moved to community. In many cases the soundness of the requested credit was not questioned but for the foregoing or other reasons, loans were declined.
(6) While it is not the function of RFC to suggest changes in the
desirable ratios of sound capital to deposits or of loans to capital, many
and various suggestions for the alleviation of this condition have been
made, among them are: The extension of the ability of the insurance
companies to buy common stocks; the efforts on the part of SEC to
make small registrations for capital easier; the granting of the right
of fiduciary funds to invest more liberally; and the relaxation of taxes
on new businesses. There have been many more such suggestions
made. Many of these changes might endanger our banking structure
and in the long run prove to be more expensive than if a credit reservoir
is maintained by a Government agency.
4. (a) What are the relative advantages and disadvantages of
RFC loans and guaranties of loans in achieving the purposes indicated in (1) above?
(b) What considerations guide the RFC in determining when
it will extend its aid by lending and when it will extend its aid
by guaranteeing loans ?
(a) The advantages of RFC loans and guaranties of loans have
been discussed in the answers to questions 2 and 3. Advantages include longer maturities than are available through other channels of
credit, regular amortization in relation to earning capacity, no legal
limitations as to the amount or type of security, relatively reasonable
interest rates, availability to borrowers of services of RFC credit and
engineering staff for consultation.
(b) RFC policy is that (1) if at all possible a bank should make the
entire loan; (2) if the bank cannot make the entire loan, the RFC will



221 MONETARY, CREDIT, AND FISCAL POLICIES

take a participation; (3) if the bank cannot make the loan on a participation basis, the RFC will consider making a direct loan.
The RFC has consistently expressed the desire for local bank participation wherever possible and preferably on a basis enabling the
bank to make and administer the loan, thus assuring continued loan
relationship between the borrower and his banker.
5. (a) With respect to the provisions that the RFC shall not
lend or guarantee loans unless the applicant is unable to secure
credit from normal sources on reasonable terms, what are the RFC
interpretations of "normal sources" and "reasonable terms" ?
(b) What steps are taken by the RFC to ascertain whether an
applicant is able to secure credit from normal sources on reasonable terms ?
(a) "Normal sources" are considered those to which a particular
applicant might be expected to go and from which in the ordinary
conduct of his business he might be expected to receive loans. These
would normally include banks and private lending agencies in or
adjacent to his business area. Other sources are reputable factoring
concerns supplying specialized services in the handling of receivables
and inventory, finance and insurance companies, and dealers in investment securities. In connection with financing of public agencies both
dealers and investment firms handling municipal bonds are considered
normal sources of credit.
"Reasonable terms" is construed to mean that the conditions under
which credit may be available from private sources are clearly not
unreasonable as to maturity, interest rate, and other applicable provisions.
(b) As a general rule, an applicant is expected to show that his
efforts to secure credit from local banks have been unsuccessful.
Satisfactory evidence of such efforts must be presented to RFC. In
those instances where a factoring service would normally be utilized
or where new construction is to be undertaken of a type in which an
insurance company might be interested, the possibiltiy of obtaining
the desired credit from these sources must be fully explored and
evidence submitted as to the outcome. As to public agency applicants
they also are required to submit copies of correspondence from investment firms or other banking institutions that financial assistance is
not available on reasonable terms. Frequently the RFC is able to
work out a sound basis for a loan which banks have initially declined
but which they are then willing to make.
6. What principles guide the RFC in determining interest rates
on its loans and charges for its guaranty of loans ?
(a) Are these rates and charges uniform for all borrowers and
all types of loans ? If not, what is the basis for their differentiation ?
(b) What would be the advantages and disadvantages of providing that the interest charges by the RFC should be the same
as those generally prevailing on that type of loan in the area
where the borrower is located ?
The interest rate charged upon loans to business enterprises is fixed
at such amount as is determined to be reasonable and calculated to




222

MONETARY, CREDIT, AND FISCAL POLICIES

permit RFC's lending operations to be maintained on an over-all
sustaining basis.
(a) Interest rates and charges by RFC are uniform as applied to
loans and investments according to type. That is, there is a uniform
rate of interest in connection with loans to business enterprises; the
same applies to public agency loans and catastrophe loans.
(b) Interest rates vary so greatly within communities and sections
of the country that it would be impractical and almost impossible to
function on a basis other than one rate for one kind of loan. Thus
any claim of discrimination is avoided. There would be no advantage
in differing rates and competition is prevented by RFC's refusal to
make a loan if the money is obtainable privately at a reasonable rate.
7. Should the power to lend and guarantee loans to private borrowers be possessed by both the RFC and the Federal Reserve ?
If so, why ? If not, why not ?
One source of Federal assistance in a particular loan field appears
sufficient in the interest of consistent policies and procedure.
8. To what extent and by what means have the policies of the
RFC been coordinated with the general monetary and credit policies of the Federal Reserve and the Treasury? Describe the
degree and methods of coordination since the end of the war.
The RFC has always worked in close cooperation with the Federal
Reserve and Treasury to the extent that loans of a type which were
not conducive to sound national economy have not been encouraged.
The RFC has endeavored to keep abreast of general monetary and
credit policies of both the Federal Reserve Board and the Treasury
Department by having representatives present at conferences and
otherwise through official channels. In those instances where policies
established have application to the lending functions of the Corporation, appropriate action has been taken by the RFC Board.
9. (a) What do you consider to be the major purposes and objectives of the Federal National Mortgage Association?
(b) Outline briefly the activities and policies of this Association since the end of the war.
(a) The major purposes and objectives of the Federal National
Mortgage Association are generally to assist the housing program by
encouraging the construction of housing accommodations and investments in mortgages on homes and rental housing projects insured by
FHA, and homes guaranteed to by the Veterans' Administration. As a
means of accomplishing this objective, the Association established
and maintains a secondary market for the purchase of such mortgages
at par and accrued interest. This secondary market is used only where
private financing is unavailable.
(b) Since the war, the Association has provided a secondary market
for FHA and VA mortgages.
Under this program, RFC and FNMA presently hold 54,640 FHA
insured mortgages aggregating $389,957,000, and 41,473 V A guaranteed mortgages in the total amount of $247,474,000, which have been
acquired by purchase pursuant to the provisions of the secondary
market program, and these mortgages have been offered for sale to
eligible purchasers within the past month at prices ranging from




223 MONETARY, CREDIT, AND FISCAL POLICIES

100% to 102%. Furthermore, the Association also has outstanding
contracts to acquire additional mortgages as follows:
18,248 FHA mortgages.
52,172 VA mortgages—

$345, 935, 000
375, 924, 000

10. Do you favor the Hoover Commission recommendations:
(<z) The operations of the RFC should be placed under the
supervision of the Secretary of the Treasury ?
(6) The Federal National Mortgage Association should be
transferred to the Housing and Home Finance Agency ?
(a) The fact that in the performance of its duties, the RFC makes
direct loans to private individuals and institutions and is a moneyed
corporation, is in itself insufficient reason to put it in the Treasury
Department. The making of loans is but one of several techniques
by which the Corporation aids in financing various segments of the
economy. The functions of the Treasury Department in collecting
revenues, acting as custodian of public funds, managing the public
debt, etc., differ substantially from RFC's broad economic purposes.
(b) The Federal National Mortgage Association is a financial and
not a housing agency. As such, it properly belongs with RFC. As
heretofore stated, its primary objective and purpose is to provide a
secondary market for FHA insured or VA guaranteed home mortgages. RFC has operated the FNMA activity as an integral part of
its operations for many years and can do so as economically and efficiently as it is possible to conduct a business of this nature. The operation of this secondary market for such mortgages does not involve
any responsibility on the part of FNMA to determine questions pertaining to the necessity for the housing, the soundness of its financing,
or the adequacy or quality of its construction, as these matters are
for the consideration of the Federal Housing Administration or the
Veterans' Administration. We do not agree with the recommendation that the Federal National Mortgage Association should be transferred to the Housing and Home Finance Agency.
11. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by the Hoover Commission? On balance, do you favor
the establishment of such a body? If so, what should be its
composition ?
The advantages of the establishment of a National Monetary and
Credit Council of the type proposed by the Hoover Commission would
appear to be that such a body could represent an excellent forum for
the exchange of information and ideas as well as discussions pertaining to the various lending and kindred functions of the several governmental agencies so involved. Doubtless within such a body there would
be developed constructive suggestions which might better coordinate
their activities from the viewpoint of purposes, functions, and results
attained. If the powers to be exercised by such a council are intended
to be more than advisory in nature, then the possible advantages mentioned above would probably be nullified by resulting diffusion of
authority. As a matter of practical administration some of these elements would exist even in a council that was purely advisory. Each
agency at interest should be accorded the privilege of having a representative in attendance at the meetings.



224

MONETARY,

CREDIT, AND FISCAL POLICIES

A P P E N D I X TO CHAPTER

VI

QUESTIONNAIRE ADDRESSED TO THE RECONSTRUCTION FINANCE
CORPORATION

1. What do you consider to be the major purposes and objectives
of RFC loans and guaranties of loans to private borrowers ?
2. Do you believe that the RFC should operate continuously as a
lender and grantor of loans to private borrowers, or that it should
operate in this field only in emergency periods? If you favor continuous operation, what are your principal reasons for this ?
3. (a) What, if any, are the gaps or inadequacies in the private
financial system that justify Federal loans and guaranties of loans to
private borrowers ?
(b) What feasible changes, if any, in the structure, powers, and policies of private financing institutions and in Government laws and
regulations applying to these institutions would lessen the need for
Federal loans and guaranties of loans to private borrowers ?
4. (a) What are the relative advantages and disadvantages of RFC
loans and guaranties of loans in achieving the purposes indicated in (1)
above ?
(b) What considerations guide the RFC in determining when it
will extend its aid by lending and when it will extend its aid by guaranteeing loans ?
5. (a) With respect to the provision that the RFC shall not lend
or guarantee loans unless the applicant is unable to secure credit from
normal sources on reasonable terms, what are the RFC interpretations of "normal sources" and "reasonable terms" ?
(b) What steps are taken by the RFC to ascertain whether an
applicant is able to secure credit from normal sources on reasonable
terms ?
6. What principles guide the RFC in determining interest rates
on its loans and charges for its guaranty of loans ?
(a) Are these rates and charges uniform for all borrowers and
all types of loans ? If not, what is the basis for their differentiation ?
(b) What would be the advantages and disadvantages of providing that the interest charges by the RFC should be the same as those
generally prevailing on that type of loan in the area where the borrower is located ?
7. Should the power to lend and guarantee loans to private bor*
rowers be possessed by both the RFC and the Federal Reserve System ?
If so, why? If not, why not ?
8. To what extent and by what means have the policies of the RFC
been coordinated with the general monetary and credit policies of the
Federal Reserve and the Treasury ? Describe the degree and methods
of coordination since the end of the war.
9. (a) What do you consider to be the major purposes and objectives
of the Federal National Mortgage Association?




225 MONETARY, CREDIT, AND FISCAL POLICIES

(b) Outline briefly the activities and policies of this Association
since the end of the war.
10. Do you favor the Hoover Commission recommendations that—
(a) The operations of the RFC should be placed under the supervision of the Secretary of the Treasury ?
(b) The Federal National Mortgage Association should be transferred to the Housing and Home Finance Agency ?
11. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed
by the Hoover Commission ? On balance, do you favor the establishment of such a body ? If so, what should be its composition ?




CHAPTER VII
R E P L Y

B Y

R A Y M O N D

HOUSING
I.

A N D

G. F O L E Y ,
H O M E

ADMINISTRATOR,

F I N A N C E

T H E

A G E N C Y

QUESTIONS R E L A T I V E TO T H E FEDERAL SAVINGS AND L O A N I N S U R A N C E
CORPORATION

1. How broad do you consider the purposes of this insurance
to be ? Merely to protect the owners of small accounts at insured
savings and loan associations? To promote the willingness of
people to entrust funds to these associations, thereby enhancing
the availability of housing credit ? To prevent fear-inspired withdrawals of funds from these associations, thereby preventing
curtailment of the supply of housing credit in disturbed periods ?
To maintain the availability of credit at these associations by
creating confidence among their managers that they will not be
subjected to runs by those who supply funds?
Answer, question 1
It is our opinion that this insurance program was designed and established to meet very broad objectives and in recognition of the fact that
major economic disturbances may be the accumulative result of scattered individual hardships. For this reason insurance is considered
to have all of the purposes which are indicated by the specific questions
raised above. In terms of economic functions, it is probable that the
assurance of a continuous supply of housing credit and the prevention
of fear-inspired withdrawals are among the major objectives of the
Insurance Corporation. It should also be emphasized that insurance
of savings in the savings and loan field will probably operate to prevent panics which might spread to savings banks, commercial banks,
and other financial institutions. From this point of view, the insurance program of the Federal Savings and Loan Insurance Corporation and the Federal Deposit Insurance Corporation are complementary.
2. In what respects, if at all, do the present provisions relative
to the form of payment, to holders of insured accounts in defaulted institutions prevent the FSLIC from making its maximum contribution to the purposes of the Employment Act ? What
changes, if any, would you recommend in the methods of payment? What would be the advantages and disadvantages of providing that a holder might, at his option, receive from the FSLIC
in cash the full amount of his insured account immediately after
default by an association ? Would such a provision be likely to
increase or decrease the total cost to the FSLIC ?
226




227 MONETARY, CREDIT, AND FISCAL POLICIES

Answer, question 2
Two forms of insurance settlement up to $5,000 are available to
savers with funds in insured savings and loan associations in
default. First, the savers may demand the entire amount in savings
accounts in normally operating insured institutions. Second, payment may be taken, at the option of the insured account holder, in
the form of 10 percent cash, 45 percent in debentures due within 1
year, and 45 percent in debentures due within 3 years. The results
in terms of contribution to the purposes of the Employment Act will
obviously depend upon which form of payment is chosen by the shareholder.
With respect to the cash-debenture form of settlement, it is obvious
that the availability of the total funds is deferred and that the prompt
restoration of purchasing power is accordingly limited. Undoubtedly
investors themselves have recognized this deficiency since only six, with
savings amounting to $13,200, have demanded payment in this manner.
The almost universal demand for settlement by means of new accounts
suggests, in turn, its favor by the public, which action also is probably
motivated by measurement of the purchasing power effects. Indeed,
the newly acquired accounts would have the same availability for
spending as savings accounts in institutions not affected by default.
After careful study of past experience, it is recommended that the
Insurance Corporation be given the option to pay insurance claims
in cash. Not only would such a provision permit more economical
administration of the payment of insurance, but, in addition, it would
obviously serve to stimulate economic activity by reason of the addition
to the purchasing power of a community.
The above question also raises the point as to whether or not the
right of selection of settlement in cash, if statutory provision were
made for cash settlement, should be held by the owner of the insured
account. It is believed that more orderly direction of the payment of
insurance could be effected if the right were placed in the Insurance
Corporation. As indicated previously, such action would, in our
opinion, decrease the total cost to the FSLIC. Under the present
arrangement, a considerable amount of administrative detail is involved in selecting paying agents and drawing up the necessary
forms to close out the shares in the defaulted institution and to issue
the shares by the appointed agents.
The question of cash payment in the settlement of insurance claims
has been the subject of considerable debate for the past several years.
The proposal has been criticized by some as an attempt to simulate
liquidity and demand payments in the operations of savings and loan
associations. The point is made by certain opponents to this proposal
that savings and loan associations are for the most part mutual institutions operating on a share-capital basis and that investments in such
shares are not comparable to demand deposits in commercial banking
institutions. This being the case, it is argued, the payment of insurance settlements in cash would lead account holders in savings and
loan associations into the belief that their share investments are tantamount to demand deposits. This agency has taken the position that
the payment of insured accounts in cash, in the event an institution is
closed, in no way changes the share investment nature of accounts
in savings and loan associations, and that it would be considerably
more economical than the present somewhat cumbersome method of




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MONETARY, CREDIT, AND FISCAL POLICIES

purchasing shares, with cash, in another institution for the account
of investors in a defaulted institution.
3. Have you found that there are often large withdrawals of
funds before the actual default of an insured institution ? If so,
have these included accounts in excess of $5,000? Have they
tended to be concentrated in the accounts in excess of $5,000?
Answer, question 3
In connection with the associations which the Insurance Corporation has liquidated as receiver, we have found no evidence that there
were any large or unusual withdrawals during the 60-day period prior
to the appointment of the receiver, either of accounts in excess of $5,000
or accounts of $5,000 and under. However, it should be remembered
that in practically all of our receiverships the cause for action has
been that of impairment, and runs were not a complicating factor,
probably because the public was unaware of the true condition of the
associations. Attention is also called to the fact that we have had only
a total of seven receiverships to date and our observation is obviously
limited in scope accordingly.
4. What changes, if any, in the coverage of this insurance are
desirable to further the purposes of the Employment Act ? What
would be the advantages and disadvantages of providing full coverage of all accounts at insured institutions ? On balance, would
you favor such a policy ? Please give reasons for your answer.
Answer, question ^
The purposes of the Employment Act naturally meet their severest
test under economic distress. Consequently, the avoidance of such a
condition is in the interest of the public welfare and suggests the use
of every sound financial means of preventing or eliminating trouble.
Probably the most important suggested change in the insurance program which is pointed in this direction is that of giving the Insurance
Corporation the right to pay insurance claims in cash, as suggested in
the answer to question 2.
With respect to the specific inquiry about full insurance coverage, it
must be admitted that such a plan would have the merit of buttressing
public confidence to the limit. At the same time, it is believed that
complete coverage may be injurious to the long-term purpose of the
Employment Act. Among the more important reasons against total
insurance are the following:
(a) Private management may lose its sense of primary responsibility and contribute to unsound operation.
(b) There is an equalization of management which may destroy
the incentive for efficiency.
(c) Private funds with full insurance may compete unduly with
the direct obligations of Government.
We would favor a policy of continued limitation of amount, but may
make the suggestion that the insurance limit could be wisely increased
to $10,000. The present insurance coverage of insured savings and
loan associations is now about 93 percent of their savings accounts, and
the increase to $10,000 would approach full coverage. At the same
time, by not covering extremely large investments, institutions will not




229 MONETARY, CREDIT, AND FISCAL POLICIES

be faced with the unnecessary hazards of importune withdrawal of
large amounts.
5. What changes, if any, should be made in the commitments
of the Government to provide financial assistance at any time
that the resources of the FSLIC might prove to be inadequate?
Please give reasons for your answer.
Answer, question -5
Currently the Government itself has no mandatory legal commitment in the way of providing financial assistance in the event the resources of the FSLIC might prove to be inadequate. At the same time
it is obvious that the supreme test of the insurance program will depend upon the Corporation's ability to meet its obligations. On
various occasions many officials have indicated the moral responsibility of the Government, and it would seem that much could be
gained by providing the certainty which is made possible only by
legal provision. Not only should this add to public confidence and
thereby further the purposes of the Employment Act, but, in addition, it could be a means of saving loss to the Government. It should
be remembered that the payment of insurance is not the measure of
loss because the latter is determined only by the later liquidation of
the assets of institutions in default.
It is recommended that an initial appropriate action to take in this
respect would be to authorize the Federal Savings and Loan Insurance
Corporation to borrow, in case of need, directly from the United
States Treasury. Legislation has heretofore been recommended by
the Agency which would have the effect of confining the borrowing of
the Insurance Corporation to Treasury loans and which would fix the
maximum of such loans which might be outstanding at any one time
to $750,000,000. Such an action, if taken now by the Congress, would
make adequate provision for any foreseeable contingencies and would
certainly authorize an adequate source of borrowing to meet any
except the most drastic emergency situation. Attention is called to
the fact that a similar arrangement for acknowledged Government
support has already been authorized in the case of the Federal Deposit
Insurance Corporation.
6. What changes, if any, should be made in the basis and rates
of insurance premiums ?
Answer, question 6
It is believed that any insurance premium should be fixed at a rate
which will make the operation self-sustaining. For this reason, the
premium rate should be under constant scrutiny for the purpose of
maintaining a just charge. Such an evaluation is by no means easy
because, in view of the long-term nature of the real-estate cycle, the
risks in mortgage lending are not easily measured.
During the 15 years of operation, the Corporation has incurred net
losses of only $5,213,000, or slightly less than 5 percent of the accumulated net income to June 30, 1949. Such favorable experience
would at first glance suggest reduction in the rate, but, at the same
time, this must be weighed against such qualitative features as the
large volume of mortage loans made in the past 2 or 3 years and




230

MONETARY,

CREDIT, AND FISCAL POLICIES

the fact that the reserves of insured institutions have not increased
percentagewise in any pronounced manner during this period of time.
Because virtually all of the experience of the Insurance Corporation
has occurred in a rising real-estate market, it is our opinion that additional experience is needed before any decision is made on a reduction
in the premium rate. In short, a reduction in rate at this point could
not be based on sound actuarial experience, and it is, therefore, recommended that action be postponed.
I I . QUESTIONS RELATIVE TO THE FEDERAL HOUSING

ADMINISTRATION

1. Do you believe that Congress intended the FHA to use its
powers in an anticyclical way to inhibit inflationary booms and to
combat recession and depression? What legislative provisions
would have to be changed to enable the FHA to make a greater
contribution to economic stability?
Answer, question 1
In approving the original National Housing Act on June 27, 1934,
the intent of the Congress was to combat the depression of the early
thirties and to make a lasting contribution to the Nation's economic
stability. The provisions of the act by which these objectives were to
be achieved included the vehicles of loan insurance and the secondary
market. These vehicles provided the Government with leadership
and direction in the two key branches of private enterprise; namely,
construction and financing. Through their operation the Congress
provided effective incentives to the construction and financing industries to mobilize the economic resources of the Nation necessary to build
new housing and improve existing housing for moderate- and lowerincome families and to make their demands effective through more
liberal but sounder financing terms. The insurance vehicle under
titles I and II of the act was intended to encourage the release of funds
for the improvement and construction of housing and to encourage
the demand for these goods. By encouraging investment, employment
in the building trades and production in the durable-goods industries
would be stimulated and a greater degree of stability in residential
construction would be realized. The secondary-market vehicle under
title III of the act was intended to give wider marketability to mortgage securities. By promoting the freer flow of mortgage funds into
ancl out of securities based on residential properties, a greater degree
of stability in residential construction ancl mortgage markets would be
realized.
The economic conditions prevailing in the early thirties which were
emphasized in the hearings before the Senate and House Committees
on Banking and Currency clearly indicated the concern of the Congress with combating the depression and making a lasting contribution to greater economic stability in the residential construction and
mortgage markets by preventing the recurrence of these conditions on
a scale of similar magnitude in the future. Some of these conditions
were as follows:
{a) Unemployment in the building trades was very great. It was
estimated that more than 6,000,000 persons identified with the building
and allied trades were receiving public assistance.




231 MONETARY, CREDIT, AND FISCAL POLICIES

(b) Because of the neglect of repair work and the almost complete
stoppage of new construction, a rapid and accelerating deterioration
was taking place in housing standards.
(c) Despite the accumulation of reserves for investment by lending
institutions, it was almost impossible to secure advances of credit foi
the purpose either of modernization and rehabilitation or the construction of new dwellings.
(d) Notwithstanding the gigantic effort made by the Home Owners' Loan Corporation to stem the tide of mortgage foreclosures, these
foreclosures continued in appalling numbers, and financial institutions almost universally refused to advance funds to meet maturing
mortgages, to facilitate the acquisition of homes, or to enable the construction of new homes.
(e) The disastrous collapse of real estate and home values, and the
consequent loss of equities and accumulation of real estate in the assets
of lending institutions were pointed out as the results of unrealistic
and antiquated mortgage lending practices which were widely prevalent during the decade of the twenties. Some of the more harmful
of these practices were:
(1) Nonuniform and inflated appraisals.
(2) Restriction of first-mortgage loans to a minimum portion of
the appraised value of the property, with consequent loans on
second or junior liens at exorbitant interest rates and other finance
charges.
(3) Failure to adopt or enforce any standards with respect to
construction of new homes on the security of which credit was
extended.
(4) The widespread use of short-term instruments of credit to
secure advances of funds which necessarily represented long-time
credits.
(5) The failure of any market machinery or market practices
to give to mortgages the marketability essential to the realization
of funds when necessary because of local conditions or stringencies that developed in the money market.
(6) The neglect of careful examination of the relationship between the rate of building and the probable market, which led to
excessive building in price ranges in which the houses could not
be absorbed.
In the subsequent amendments to the National Housing Act, the
intent of the Congress was, chronologically, for the Federal Housing
Administration (a) to promote further recovery, (b) to combat the
recession beginning in the fall of 1937, (c) to meet emergency housing
needs during the defense, war, and immediate postwar periods on a
basis consistent with the price, priority, and allocation controls in
operation during this period, and (d) in the recent postwar years
when controls were terminated to increase the supply of housing for
veterans and at the same time inhibit the inflationary developments in
construction and land costs.
In the original act, the provision for the insurance of home improvement loans under title I expired on January 1, 1936. The success of
the insurance program under this title prompted the Congress to
extend this title periodically in order to promote further employment




232

MONETARY, CREDIT, AND FISCAL POLICIES

recovery in the building trades and in the manufacture of building
materials and supplies.
The first major amendments to the National Housing Act, approved
February 3, 1938, indicate that the Congress intended the Federal
Housing Administration to combat the recession which developed suddenly in the fall of 1937. As early as November 30, 1937, the Committee on Banking and Currency of the House of Representatives
Began hearings on amendments to the National Housing Act. The
Senate's committee also began hearings the following day. The objectives of the amendments were to stimulate the purchase of durable
goods and to stimulate the employment of labor in the construction
industry and in the building materials industry. Both objectives were
brought out forcefully in these hearings. To achieve these objectives
the amendments, as approved, provided for the renewal of the title I
home improvement program and mortgage insurance for the construction of rental housing for moderate and lower income families and
of small homes in the lower price ranges on more liberal financing
terms.
In the defense, war, and immediate postwar periods, the amendments to the National Housing Act were designed to meet the emergency housing needs of the Nation. The inflationary impact on the
Nation in filling these needs was to be met by price, priority, and
allocation controls. The first of these amendments, known as title VI,
defense housing insurance, was approved March 28, 1941, and the
intent of the Congress here was to use the mortgage-insurance vehicle
to stimulate the financing and construction of small homes for defense workers in established communities. Although the financing
terms for mortgage insurance were more liberal than for the regular small home mortgage-insurance program under title II, it is noteworthy that the Congress provided for the same basis of valuation.
In this respect, the intent of the Congress may be interpreted as
recognizing the need for dampening the incipient inflationary forces
in residential construction and land costs.
On May 26, 1942, title V I was amended to provide (a) for higher
insurable principal amounts and longer terms for small home mortgages and ( i ) for rental housing mortgage insurance on more liberal
terms than for the regular rental housing mortgage insurance program under title II. With respect to the latter, the Congress provided
for a more liberal valuation basis in "reasonable replacement cost"
than for the regular rental housing insurance program under title II
which provides for the Administrator's estimate of value. The intent
of the Congress in introducing this difference in valuation and in
liberalizing the financing terms for small homes may be interpreted
as giving greater recognition to the urgency in meeting the housing
shortage in war production centers.
During this defense and war period, the title I home improvement
program was also extended in order to provide financing for additional housing accommodations in existing structures and such extensions on the part of the Congress may also be interpreted as
giving greater recognition to meeting the housing shortage.
The first postwar amendments to the National Housing Act, known
as the Veteran's Emergency Housing Act of 1946, were approved
May 26, 1946. The act amended title VI and further liberalized the




233 MONETARY, CREDIT, AND FISCAL POLICIES

financing terms of both small home and rental housing mortgage insurance and adopted "necessary current cost" as the valuation basis.
These amendments were designed—
to assist in relieving the acute shortage of housing which now exists and to
increase the supply of housing accommodations available to veterans of World
War II at prices within their reasonable ability to pay.

Although the Congress liberalized the financing terms to achieve
the objective of relieving the housing shortage, the intent of the
Congress in inhibiting inflationary forces is indicated in the preamble to the act which reads as follows :
To expedite the availability of housing for veterans of World War II by
expediting the production and allocation of materials for housing purposes and
by curbing excessive pricing of new housing, and for other purposes.

The second major postwar amendment to title VI provided for the
insurance of loans to manufacturers of prefabricated houses. This
amendment was approved June 30, 1947, and its objective also was—
to assist in relieving the acute shortage of housing which now exists and to promote the production of housing for veterans of World War II at moderate prices or
rentals within their reasonable ability to pay, through the application of modern
industrial processes * * *.

This amendment was followed by three amendments, approved August
5,1947, December 27,1947, and March 31,1948, all of which increased
the authorization for insurance under title VI.
In the last of these three amendments, approved March 31, 1948,
and in subsequent amendments, the intent of the Congress may be
interpreted as being clearly in the direction of inhibiting inflationary
developments. This amendment provided for a single month's extension to the small home mortgage insurance program under title
VI to April 30,1948, and authority for new insurance under this provision of the National Housing Act has not been renewed. In place
of "necessary current cost" as the valuation basis, this amendment
provided for "value (as of the date the mortgage is accepted for
insurance) * * *". The objective of this change was to dampen
the inflationary pressures on construction and land costs by reducing
the appraisal base. In providing for only 1 month's extension for
this emergency small home mortgage insurance program, the intent
of the Congress was clear that henceforth small home mortgage insurance should be subject to the less liberal appraisal and financing
terms of the regular insurance program under title II. In effect,
the Congress by this amendment of March 31, 1948, intended to provide a transition from the veterans' emergency insurance program of
more liberal appraisal and financing terms for meeting the veterans'
housing shortage back to the stabilizing influence of the long-term
insurance program.
In the Housing Act of 1948 approved August 10,1948, the intent of
the Congress may be interpreted as giving fuller recognition to the
need for a transition from the emergency mortgage insurance programs to the regular insurance programs. Under title I, FHA title
VI and transitional period amendments of this act, one of these amendments to the emergency rental housing provision under title V I is in
line with the small home mortgage insurance amendment of March 31,
1948. It provided for an appraisal basis which would have the effect
of stabilizing costs of rental housing by limiting the maximum mort-




234

MONETARY, CREDIT, AND FISCAL POLICIES

gage amount eligible for insurance to a percentage of replacement cost
or cost prevailing on December 31, 1947, whichever is lower. This
appraisal basis was substituted for necessary current cost. This same
amendment also provided for a short-term extension of this veterans7
emergency rental housing program under title V I and the several
short-term extensions since then indicate the intent of the Congress
to provide for a transition to the stabilizing influence of the regular
long-term rental housing insurance program under title II.
Two other amendments, approved August 10, 1948, dealing with
insured financing of small home construction, also reflect the intent
of the Congress to encourage low-cost housing. One of these two
amendments provides for more liberal financing terms to operative
builders and home purchasers of new single-family home mortgages
of $6,000 or less. The other amendment is designed to assist and
encourage the application of cost-reduction techniques through largescale modernized site construction methods and the erection of houses
by modern industrial processes by providing insurance of construction
advances on houses with mortgage amounts of $6,000 or less.
With respect to the question on the legislative provisions which
would have to be changed to enable the Federal Housing Administration to make a greater contribution to economic stability, I should like
to list the following legislative proposals:
(а) The extension at least to June 1,1952, of the insurance program
for the modernization and repair of existing homes under title I. This
title expires March 1,1950.
(б) The extension of the insurance program under title I to insure
small home mortgages for families of low and moderate income particularly in suburban and outlying areas where it is not practicable to
obtain conformity for properties so located with many of the requirements essential to insurance of mortgages on housing in built-up urban
areas. The maximum amount of insurance outstanding should not
exceed $500,000,000. The maximum amount of mortgage should not
exceed $4,750, or 95 percent, of the appraised value for single-family,
owner-occupied homes, and $4,250, and 85 percent, of appraised value
for operative builders. The maximum term should be 30 years and
the maximum interest rate should be 5 percent with a maximum insurance premium of 1 percent. The present program expires March 1,
1950, and provides for a maximum mortgage of $4,500.
(c) Liberalization of the maximum loan terms for new home mortgage insurance under title II on lower priced homes by increasing the
maximum loan from $6,000 to $6,650, and an additional $950 for each
bedroom in excess of two, up to a maximum of four bedrooms.
(d) Liberalization of the maximum loan terms for mortgage insurance under title II on cooperative rental housing projects sponsored
particularly by veterans.
(e) Liberalization of maximum mortgage amount for insurance of
construction advances to operative builders using site-fabrication
methods. The maximum mortgage loan per dwelling should be raised
from $6,000 to $7,650 and the maximum loan percentage from 80 percent to 85 percent.
These legislative proposals are in principle incorporated in S. 2246
which was reported out by the Senate Banking and Currency Committee and in H. R. 6070 which was passed by the House of Representatives.




235 MONETARY, CREDIT, AND FISCAL POLICIES

In my opinion these changes in the National Housing Act will contribute to economic stability by providing the incentives to fill the
housing and home repair needs of the moderate and lower income
families and to make their demands effective through liberal financing
terms.
2. In practice, how has the FHA used its powers for countercyclical purposes ? Its limitations on interest rates ? Its charges
for insurance of mortgages ? Its limitations on the .maturity of
mortgages? Its appraisal policies? Limitations on the total
amount of mortgages insured ? Its other powers ?
Answer, question 2
Interest rates.—In practice, the Federal Housing Administration has
used its authority under the National Housing Act to limit interest
rates in order to promote economic recovery, to increase the supply of
housing, and to make a lasting contribution to economic stability. Its
interest rate policy has been governed by two principal considerations,
namely, the availability of funds among institutional lenders for
mortgage investments and the effective demand of home purchasers
and renters among families with moderate and lower incomes. This
policy has in general resulted in interest rates below the statutory
limits provided by the National Housing Act and its amendments for
the separate insurance programs. One of the most significant economic developments during the last two decades has been the accumulation of institutional funds seeking high-yield and high-grade investments. The insurance vehicle eliminated the major risk element in
residential mortgage investments which is the loss in the disposal
of the foreclosed mortgage security. This vehicle overcame in large
measure the widespread reluctance of financial institutions to advance
funds for mortgage investments which prevailed in the early thirties.
Moreover, it encouraged institutional lenders to use their accumulated
reserves for mortgage investments. However, the mortgage interest
rate structure which prevailed in the thirties was regional in character
and at levels which made home purchase or rent by families of moderate and lower incomes prohibitive. The Financial Survey of Urban
Housing, a Civil Works Administration project, prepared under the
supervision of the United States Department of Commerce, disclosed,
as of January 1, 1934, a regional structure of urban interest rates on
first mortgages which ranged from under 6 percent in middle Atlantic
cities to almost 10 percent in mountain cities. For second and third
mortgages, interest rates were over 10 percent in west south central
cities.
By eliminating the major risk element, and by making the insured
mortgage a negotiable instrument with wider marketability, the accumulated reserves of institutional lenders could be used on a Nationwide basis to meet the demands of mortgage investment. To make
this demand effective, the interest rates had to be set at levels which
home purchasers and renters of limited means could afford. In so
doing, the Federal Housing Administration has contributed to the
Nation's economic stability.
Insurance charges.—In practice the Federal Housing Administration has not used its powers in limiting the regular insurance premiums
for countercyclical purposes. The changes in insurance premiums
98257—49

16




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MONETARY, CREDIT, AND FISCAL POLICIES

followed changes in the statutory limits and it has been the policy of
the Administration to charge only the premium necessary to cover
the expenses of administering the separate insurance programs and
to provide adequate reserves for insurance losses. However, in response to a letter from the President to the Administrator of the National Housing Agency to cooperate in controlling inflationary developments produced by the war demands upon the Nation's economy,
on May 26, 1942, the Federal Housing Administration amended its
regulations to eliminate the prepayment premium where insured mortgages on small homes were prepaid in full without refinancing. The
objective of this provision in the regulation was to encourage home
owners with mortgages insured by the Federal Housing Administration to pay off these mortgages from their growing incomes and
savings and thereby reduce inflationary pressures on the prices of
consumer goods. Through June 30,1949, approximately 413,000 home
owners with mortgages insured by the Federal Housing Administration made such prepayments of their mortgages without any prepayment charges.
In cooperation with the Federal Reserve Board's efforts to stem
the incipient inflationary tide during the postwar years, a cash down
payment of at least 10 percent of the cost of each job was written into
the regulations governing the home improvement loan insurance program, effective May 10,1948. Lenders were also encouraged to scrutinize credits very closely to prevent overpricing on jobs, and overburdening of potential borrowers. The amendment to the regulations, requiring a copy of the dealer's contract or description of the
proposed job has served to reduce misunderstandings, and to clarify
for all parties concerned the contractual responsibilities of the dealers.,
As the incipient inflationary forces abated and a reversal of trend
became observable, the cash down-payment requirement was repealed,
effective April 28, 1949.
Maturity of mortgages; mortgage principal amounts; loan-value
ratios.—In practice the Federal Housing Administration has not
used its powers in limiting these terms of financing for countercyclical purposes for the reason that the governing considerations in
these terms of financing are the appraisal policies. The appraisal
policies directly affect these terms of financing and they are discussed in the following paragraph. Consequently, the administrative
rules and regulations for these terms of financing are identical with
the statutory limits provided in the National Housing Act and its
amendments.
Appraisal policies.—In practice the Federal Housing Administration has used its appraisal powers within the limits of its statutory authority for countercyclical purposes. For the regular small
home and rental housing mortgage insurance programs under title
II a determination of appraised value is a prerequisite for establishing the maximum insurable mortgage amounts. The Federal
Housing Administration has determined appraised value to represent long-term use. In making this determination, the Federal
Housing Administration takes into consideration three basic factors:
(1) Replacement cost, (2) available market price, and (3) capitalized amenity or rental income depending on whether the property
is intended for owner-occupancy or rental purposes.




237 MONETARY, CREDIT, AND FISCAL POLICIES

Conditions existing during the years 1934 through 1936 some-*
times resulted in values for long-term use in excess of the immediately available market price. These conditions were brought
about by the fact that there was an oversupply of residential properties in some areas and such properties were purchased at bargain
prices, i. e., a price less than value. The Federal Housing Administration's appraisal policies in effect tended to set a floor for residential property values at that time, thereby contributing to the
stability of property values.
Later, beginning generally in the fall of 1940, a diametrically
opposite situation was widely encountered, i. e., there was a growing
scarcity of properties available to the market, and from that period
until recently, in many areas, the market was paying a so-called
premium for ownership occupancy. Following its established and
widely recognized concept of valuation for long-term use, the Federal Housing Administration refused to recognize during those periods
of shortage the so-called premium amounts as value. On appraising
new construction the Federal Housing Administration refused to
recognize those elements of construction cost which were caused by
temporary shortages and materials and labor, such as delays in construction, payments of unusual bonuses, absence of trade discounts,
and the lower efficiency of labor. This portion of costs was interpreted as transitory and was disallowed in the valuation of residential
properties.
This appraisal policy was also followed in the emergency mortgage
insurance programs under title V I during the defense and war periods
and during the postwar period until May 26, 1946, when the amendment to title V I substituted "necessary current cost" for appraised
value. This basis of valuation remained in effect until March 31,1948,
for the emergency small-home insurance program and until August
10, 1948, for the emergency rental housing mortgage-insurance program. For the former program a 1 month's extension with "necessary
current cost" replaced by value was provided for in an amendment.
For the latter program a longer extension with "necessary current
cost" eliminated in favor of replacement cost or cost prevailing on
December 31, 1947, whichever is less, was provided for in an amendment. In administering the emergency housing programs under the
statutory provisions of necessary current cost, value, and replacement cost during the postwar period, administrative policy to inhibit
inflationary developments was formulated in a series of instructions
to field offices and these are as follows:
On June 3, 1946, field offices were instructed that commitments for
insurance under the small-home emergency insurance program could
be canceled at any time after 30 days from the date of commitment if
construction had not started. This was to enable the Federal Housing
Administration to reduce the amount of commitments outstanding
when transitory construction costs started to drop. On June 6. 1947,
field offices were further instructed to invoke a 30-day cancellation
clause where construction had not started within the 30-day period
in those areas where declining costs and reduced locality adjustments
would effect a decrease of 4 percent or more in the commitment
amounts.




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MONETARY, CREDIT, AND FISCAL POLICIES

On May 23,1947, field offices were instructed to reduce the amount
of commitment for emergency rental housing projects for which requests for extension or reissuance have been received when a decline
in the current cost would effect a 4-percent reduction in the amount
of commitments on mortgages of $200,000 or less or a reduction of
$8,000 or more in the amount of commitments on mortgages of more
than $200,000.
On September 17, 1947, field offices were instructed that in processing applications for refinancing small-home mortgages insured under
title VI, the new insured mortgage may not exceed the outstanding
balance of the old mortgage plus the cost of financing and alterations,
and repairs approved by the Commissioner, except in the case of purchases by World War II veterans. These instructions were designed
to control inflationary developments in the transfer of small-home
properties secured by mortgages insured under the emergency
program.
On March 25,1949, field offices were instructed (1) to determine the
extent of the effective demand for housing with reference to rentpaying capacity of families in the rental market and the paying and
carrying capacity of families in the home purchase market; and (2)
to reject applications for insurance on rental properties with rents
above the market, and on homes with prices in excess of the capacity
of purchasers. These instructions were followed by two others. The
first of these, dated April 4,1949, ordered market surveys of potential
rental housing demand and the determination of maximum rentals in
the potential market. The second, dated August 31, 1949, ordered
these maximum rentals to be the ceilings for future applications for
rental housing mortgage insurance and applications involving higher
rentals were to be rejected.
Total amount of mortgages insured.—In practice the Federal Housing Administration has used its powers to increase the aggregate
amount of mortgages insured in order to promote recovery and to
contribute to the stability of the construction and financing industries.
The original National Housing Act provided for a maximum face
amount of insurance under title II of $2,000,000,000. In the subsequent amendments to this title, the maximum amount of insurance was
based upon the outstanding balances of the mortgages insured and
provision was made for an increase in authorization with the approval
of the President up to a statutory limit.
Authorization of insurance under title VI is based on the face
amount of mortgages insured. The original authorization under title
V I provided for a maximum amount of $100,000,000 in mortgage insurance. To meet the emergency housing needs of this insurance
program, the Congress authorized eight increases between March 28,
1941, and May 26, 1946, at which time the aggregate amount of all
mortgages insured was limited to $2,800,000,000 and an additional
billion dollars with the approval of the President. Since that date,
the Congress has increased the authorization four times until, at the
present time, the authorization stands at $6,150,000,000. All but one
of these last four increases provided for increases in authorization
with the approval of the President. In all cases where such increases
in insurance authorization with the approval of the President were




244 MONETARY, CREDIT, AND FISCAL POLICIES

provided for in the amendments, the Federal Housing Administration has requested the approval of the President.
3. What legislation would you recommend for the purpose of
increasing FHA's contribution to general economic stability ?
Answer, question S
The legislation I would recommend for the purpose of increasing the
Federal Housing Administration's contribution to general economic
stability is as follows:
(a) To place title I, the home improvement loan insurance program, on a permanent basis. Although conceived originally as a
temporary recovery measure, its periodic extensions and renewals
by the Congress demonstrates a permanent need among lenders and
home owners. In meeting this need by permanent legislation, an important contribution to general economic stability can be made. A
permanent program of this kind can keep the Nation's homes in a
sound state of repair and improvement and thereby maintain and enhance the values of the Nation's homes. The demand for home repairs and improvement can contribute to maintaining employment
in the building trades in off-season periods and the level of production of building materials.
(b) To provide the President with authority to terminate or reinstate emergency insurance programs on an economically sound basis
depending on the economic conditions prevailing in the Nation. Such
authority would provide a degree of flexibility in the administration
of the insurance programs which would increase the Federal Housing
Administration's contribution to general economic stability. The
success of the emergency insurance programs during the defense, war,
and postwar periods testifies to their effectiveness in meeting the housing needs of the Nation. In meeting the housing needs of the Nation,
a significant contribution can be made to general economic stability.
4. What are the advantages and disadvantages of legislative
limitations on the height of interest rates and insurance charges
on insured mortgages ? In what ways, if at all, should the present
provisoins be altered?
Answer, question 4So long as there is the plethora of accumulated institutional funds
seeking high-yield and high-grade investments such as the insured
mortgage provides, there are several distinct advantages of maintaining the present limits. In the first place, the present limitations have
demonstrated their effectiveness in encouraging institutional investors to advance funds for insured mortgages and in stimulating the
demands of home purchasers and sponsors of rental housing. To
raise the present limits would only result in choking off some of the
demand for mortgage money. In the second place, raising the limits
would mean a reversion to the regional structure of interest rates prevailing in the early thirties. Interest rates in the East would not be
affected substantially, and in the West they would go up again and
have a depressing effect on mortgage investment. The disadvantages
of raising the present level of insurance charges are identical with
those of raising the legislative limits on interest rates. Since the




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MONETARY,

CREDIT, AND FISCAL POLICIES

insurance charge is paid by the home purchaser and is included in the
rent of the renter as a cost, to raise the cost of mortgage money would
have a depressing effect on the demand for housing.
III.

QUESTION RELATIVE TO THE FEDERAL H O M E L O A N B A N K S

1. What changes, if any, in the legislation relative to these
banks would you recommend in order to promote the purposes of
the Employment Act ?
Answer, question 1
The Federal home-loan banks constitute a reserve credit system serving approximately 3,800 member institutions, the bulk of which are
savings and loan associations. As presently established under existing
legislation, the Federal home-loan banks promote the purposes of the
Employment Act since their reservoir of credit which may be drawn
on by their member institutions will assist the member institutions, in
turn, to meet withdrawals in times of economic stress and thus aid in
stabilizing the purchasing power of the public which invests its funds
in the member institutions. The investors in member institutions of
the Federal home-loan banks comprise approximately 8,500,000 persons. In a broad sense, Federal home-loan banks also assist in stabilizing purchasing power in that their existence as credit reserve
institutions enables the member institutions to further encourage thrift
on the part of the public, with the knowledge that their savings will
not be hopelessly frozen and unavailable when needed.
Indirectly, Federal home loan banks as presently constituted serve
to promote employment through their power to advance funds to
member institutions which in turn may lend such funds for the financing of homes, including the construction of homes which might not
otherwise be built. This would particularly contribute to the purposes
of the Employment Act during times when member institutions were
not as a whole accumulating sufficient funds in the form of savings
from the public to meet the demands for loans, including construction
loans, and the credit which could be supplied by the Federal home-loan
banks to meet such demand would exist as a stabilizing factor in the
economy which contributed toward employment and maintenance of
purchasing power. Such member institutions currently hold home
mortgages totaling $10,000,000,000 which is 28 percent of the entire
nonfarm home mortgage debt in the United States.
In the light of the above discussion, it may be stated in reply to
the question that any new legislation which would strengthen the
ability of Federal home-loan banks and their member institutions to
carry out their functions would in turn promote the purposes of the
Employment Act, at least indirectly. Specific proposals for new legislation relative to the Federal home-loan banks which would aid
in carrying out the purposes of the Employment Act are the following:
Authority for Treasury to purchase FHL bank obligations.—This
proposal which appears in section 5 of H. R. 5596 and section 8 of
S. 2325 would authorize the Secretary of the Treasury to purchase
obligations of the Federal home-loan banks up to a total principal
amount of $1,000,000,000 held at any one time. These purchases
would be made upon terms and conditions as determined by the Secretary of the Treasury, including interest at a rate based upon the




241 MONETARY, CREDIT, AND FISCAL POLICIES

current average rate on outstanding marketable obligations of the
United States as of the last day of the month preceding the making of
such purchase.
This proposal, if enacted into law, could be considered as promoting
the purposes of the Employment Act of 1946. It would not only
promote such purposes by generally strengthening the Federal Home
Loan Bank System as a stabilizing factor in the economy as indicated
above, but it would assure that the banks could obtain funds at times
when there might not be a private market for Federal home loan bank
obligations, when interest rates on such obligations might be prohibitive, or when sale of such obligations privately might interfere
with United States Treasury financing. In this last connection it
should be noted that all Federal home loan bank financing is coordinated closely with United States Treasury financing and with
operations of the Federal Reserve Board Open Market Committee.
This additional source of funds and potential credit for member
institutions could operate materially to prevent the forced sale of
homes of individuals at sacrifice prices wThich would damage other
factors in the economy. It would also be helpful in preventing, due
to scarcity of funds, a cessation of home building, with a consequent
adverse effect on employment.
While the Home Loan Bank Board believes that this proposal is
basically sound and that there is substantial argument in its favor,
it recommends that action on the provision be postponed until its
discussions and study with the Federal Reserve Board are completed.
The Board is hopeful that these discussions will put it in a better
position to carry out recommendations of the President on this matter
in his last budget message. At the time the Treasury support proposal
was recommended to the Senate Banking and Currency Committee
in the Eightieth Congress, legislative proposals on collateral matters
were suggested by the Federal Reserve Board. These dealt in the
main with the question of liquidity requirements for institutions
which are members of Federal home loan banks. There have been
extended discussions with other agencies of the Government on the
subject with a view to achieving mutual agreement upon a recommendation to Congress on the subject of Treasury support for the Federal home loan banks in the event of certain economic emergencies.
The Bureau of the Budget proposed that the staff of the Home
Loan Bank Board continue to work with the staff of the Federal
Reserve Board to agree on a recommendation. Substantial progress
has been made in reducing the area of disagreement, and it is probable
that further discussions will permit a joint recommendation to be
made.
Retirement of United States-owned FHL tank stock.—This proposal which appears in section 6 of H. R. 5596 and section 5 of S. 2325
would accelerate the retirement of the Government-owned capital
stock in the Federal home loan banks. The capital stock of these
banks is owned partly by the Government, and partly by member
institutions which are now required to hold such stock equal to at
least 1 percent of the unpaid principal of their home mortgage loans,
with a minimum of $500. On July 31, 1949, the Government-owned
stock totaled $95,818,800, while the members owned $128,940,500.
The proposed amendment would increase members' stock holdings
by requiring each member, within 1 year, to hold such stock equal to




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MONETARY,

CREDIT, AND FISCAL POLICIES

at least 2 percent of the unpaid principal of such member's home
mortgage loans, home-purchase contracts, and similar obligations,
retaining the present $500 minimum.
Upon the taking effect of this requirement, each Federal home loan
bank would be required to retire an amount of its Government-owned
stock equal to the amount by which the stock then held by members
exceeded the amount required under the old law. Annually thereafter
each Federal home loan bank would be required to retire Governmentowned stock equal to 50 percent of the net increase in members' stock
since the last previous retirement. The existing Government capital
could not, at any time, be retired under the new provision, if such
retirement would reduce the aggregate capital stock, reserves, surplus,
and undivided profits of all "the banks under $200,000,000. The
amount was $251,492,000 on July 31, 1949. It is estimated that the
Government stock would be retired in full by the end of 3 years after
the enactment of the above-proposed amendment. The retirement of
the Government-owned stock would enable the United States Treasury
to use the funds represented thereby for the reduction of the public
debt for other purposes.
IV.

QUESTIONS RELATIVE TO THE P U B L I C HOUSING

ADMINISTRATION

1. How much discretion does this body have relative to the
amounts and timing of its loans and insurance of loans to local
public housing authorities? As to other devices affecting the
amounts and timing of these projects?
Ansioer, question 1
The United States Housing Act of 1937, as amended by the Housing Act of 1949, provides certain flexibility to the Public Housing
Administration in the timing of loans and annual contributions, when
authorized by the President.
In terms of money, the act provides that the Public Housing Administration is authorized to enter into contracts for annual contributions on and after July 1. 1949, in the amount of $85,000,000
per annum, which limit shall be increased by further amounts of
$55,000,000 on July 1 in each of the years 1950, 1951, and 1952, and
$58,000,000 on July 1, 1953. The act further provides that, subject
to the total authorization of not more than $308,000,000 for the additional low-rent program, the above amounts may be increased at
any time or times by additional amounts aggregating not more than
$55,000,000 upon a determination by the President, after receiving
advice from the Council of Economic Advisers as to the general
effect of such increase upon conditions in the building industry and
upon the national economy, that such action is in the public interest.
In terms of number of dwelling units to be started, the act provides that the Public Housing Administration may authorize the
commencement of construction of not to exceed 135,000 units per
year for the 6 years 1949 through 1954. The President may, under
the same conditions stated above, and subject to the total limitation
of 810,000 dwelling units, increase the authorization in any year
by not more than 65,000 units. He may also decrease the authorization by not more than 85,000 units.
Thus, the United States Housing Act of 1937, as amended, within
the limits stated above, does permit expansion or contraction of the



243 MONETARY, CREDIT, AND FISCAL POLICIES

public-housing program to counteract cyclical fluctuations in the
national economy.
2. To what extent, if at all, have these discretionary powers
been used for countercyclical purposes ?
Answer, question 2
The original United States Housing Act did not specifically provide for expansion and contraction of the program. Moreover, the
volume of housing under the original act was so small relatively
and the period during which it was built was so short and of the
same general economic character, that the United States Housing
Authority did not have to exercise whatever discretionary power it
may have had to vary the volume of construction.
3. What changes, if any, in the relevant legislation would
you recommend in order to promote the purposes of the Employment Act?
Answer, question 3
Within the volume limits of the present law, there is sufficient
flexibility to adjust the public housing program to cyclical fluctuations
in the economy. We do not recommend any changes at this time.
V . GENERAL QUESTIONS

1. To what extent and by what means are the policies of your
agencies coordinated with those of the RFC in the housing finance
field?
Answer, question 1
It is our view, in answering this rather broad question, that a good
degree of coordination exists between the policies of the Housing
Agency and its constituents with those of the RFC in the housing
finance field. The principal means by which this coordination is
both achieved and maintained is through the National Housing Council. The Council was established as an integral part of the Housing
and Home Finance Agency under the terms of Reorganization Plan
No. 3 of July 27, 1947. The Housing and Home Finance Administrator serves as chairman of the council, and membership is now composed o f :
i.
(a) The Federal Housing Commissioner.
(b) The Public Housing Commissioner.
(e) The Chairman, Home Loan Bank Board.
(d) The Administrator of Veterans' Affairs (or his designee).
(e) The Chairman, Board of Directors, Reconstruction Finance
Corporation (or his designee).
(/) The Secretary of Agriculture (or his designee).
(g) The Secretary of Commerce (or his designee).
(h) The Secretary of Labor (or his designee).
(i) The Administrator, Federal Security Agency (or his designee) .
The purpose of the National Housing Council as set forth in Reorganization Plan No. 3 is as follows:
The National Housing Council shall serve as a medium for promoting, to
the fullest extent practicable within revenues, the most effective use of the




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MONETARY, CREDIT, AND FISCAL POLICIES

housing functions and activities administered within the Housing and Home
Finance Agency and the other departments and agencies represented on said
Council in the furtherance of the housing policies and objectives established bylaw, for facilitating consistency between such housing functions and activities
and the general economic and fiscal policies of the Government, and for avoiding
duplication or overlapping of such housing functions and activities.

The Council has served as an effective means for keepiiig all of the
agencies which are members thereof advised of one another's programs
and basic policy decisions. It has also served as a means of working
out problems which may arise from time to time in connection with
the administration of the Government's various housing programs.
For example, since this question relates to RFC, a specific example in
that area is cited. Through Council discussions, it became apparent
that both the RFC and the FHA were dealing directly with the same
prefabrication firms in connection with the insurance of or actual
extension of loans. Responsible staff members of the two agencies
immediately developed a working arrangement under the terms of
which all information concerning specific applications in the possession of one agency is made available to the other, and there is a full
understanding and coordination of effort in the two loan programs.
2. To what extent and by what means are the policies of your
agencies coordinated with those of the Federal Reserve ?
Answer, question 2
Since the Board of Governors of the Federal Reserve System is not
included in the membership of the National Housing Council, there
does not exist the same formal means for the coordination of policies
of this agency with those of the Federal Reserve. At the same time,
there is a constant exchange of views at staff levels, and, wherever
necessary, there is consultation between members of the Board of Governors and the appropriate top officials of the Housing and Home
Finance Agency. One specific example of the coordination resulting
from this normal type of working arrangement relates to the tie-in
between an administrative down payment requirement of FHA on its
modernization credit program with the Regulation W requirements of
Federal Reserve. The FHA down payment requirement was in force
during approximately the same period as the reinstituted Regulation
W, was designed to accomplish the same general aim, and the termination of the FHA administrative ruling was discussed with appropriate
officials of Federal Reserve before the actual rescinding order was
issued. It should also be pointed out that in the preparation and submission of legislative proposals, the Bureau of the Budget serves in a
clearing and liaison capacity between the Housing and Home Finance
Agency and its constituents and the Board of Governors of the Federal
Reserve System. This clearance procedure in and of itself means that
the major policy considerations of interest to both agencies are continuously under joint discussion and consideration.
3. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by the Hoover Commission ? On balance, do you favor the
establishment of such a body? If so, what should be its composition?
Answer, question 3
In commenting on the Hoover Commission proposals to the Honorable John L. McClellan, chairman, Committee on Expenditures in the



245 MONETARY, CREDIT, AND FISCAL POLICIES

Executive Departments, United States Senate, on July 15, 1949, our
position was fully set forth on the question of establishing a National
Monetary and Credit Council. For your further information, our
comments on this subject were as follows :
In commenting on this recommendation, I should like to emphasize my agreement with the objective of closer coordination of economic policy within the
executive branch. I do not agree, however, that the establishment of a council of
the type described by the Commission is the appropriate vehicle for attaining
that objective. It would seem more appropriate to recognize that this is a coordinating responsibility which can best be discharged within the executive office
of the President and the Bureau of the Budget, where problems of program conflicts can best be resolved in the interests of fundamental governmental policy. In
short, I am inclined to share the misgivings expressed by Commissioner Howe
on the specific method suggested by the Commission in this connection.

APPENDIX TO CHAPTER V I I
AUGUST 1949.
QUESTIONNAIRE ADDRESSED TO THE ADMINISTRATOR OF THE HOUSING AND
HOME FINANCE AGENCY

/. Questions relative to the Federal Savings and Loan Insurance
Corporation
1. How broad do you consider the purposes of this insurance to be?
Merely to protect the owners of small accounts at insured savings and
loan associations? To promote the willingness of people to entrust
funds to these associations, thereby enhancing the availability of
housing credit ? To prevent fear-inspired withdrawals of funds from
these associations, thereby preventing curtailment of the supply of
housing credit in disturbed periods? To maintain the availability of
credit at these associations by creating confidence among their managers that they will not be subjected to runs by those who supply funds ?
2. In what respects, if at all, do the present provisions relative to
the form of payment to holders of insured accounts in defaulted institutions prevent the FSLIC from making its maximum contribution
to the purposes of the Employment Act ? What changes, if any, would
you recommend in the methods of payment ? What would be the advantages and disadvantages of providing that a holder might, at his
option, receive from the FSLIC in cash the full amount of his insured
account immediately after default by an association? Would such a
provision be likely to increase or decrease the total cost to the FSLIC ?
3. Have you found that there are often large withdrawals of funds
before the actual default of an insured institution ? If so, have these
included accounts in excess of $5,000? Have they tended to be concentrated in the accounts in excess of $5,000 ?
4. What changes, if any, in the coverage of this insurance are desirable to further the purposes of the Employment Act? What
would be the advantages and disadvantages of providing full coverage
of all accounts at insured institutions ? On balance, would you favor
such a policy ? Please give reasons for your answer.
5. What changes, if any, should be made in the commitments of
the Government to provide financial assistance at any time that the
resources of the FSLIC might prove to be inadequate ? Please give
reasons for your answer.




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MONETARY, CREDIT, AND FISCAL POLICIES

6. What changes, if any, should be made in the basis and rates of
insurance premiums ?
II. Questions relative to the Federal Housing Administration
1. Do you believe that Congress intended the FHA to use its powers
in an anticyclical way to inhibit inflationary booms and to combat
recession and depression? What legislative provisions would have
to be changed to enable the FHA to make a greater contribution to
economic stability ?
2. In practice, how has the FHA used its powers for countercyclical
purposes ? Its limitations on interest rates ? Its charges for insurance
of mortgages ? Its limitations on the maturity of mortgages ? Its appraisal policies ? Limitations on the total amount of mortgages insured ? Its other powers ?
3. What legislation would you recommend for the purpose of increasing the FHA's contribution to general economic stability?
4. What are the advantages and disadvantages of legislative limitations on the height of interest rates and insurance charges on insured
mortgages ? In what ways, if at all, should the present provisions be
altered?
III. Question relative to the Federal home-loan banks
1. What changes, if any, in the legislation relative to these banks
would you recommend in order to promote the purposes of the Employment Act?
IV. Questions relative to the Public Housing Administration
1. How much discretion does this body have relative to the amounts
and timing of its loans and insurance of loans to local public housing
authorities ? As to other devices affecting the amounts and timing of
these projects ?
2. To what extent, if at all, have these discretionary powers been
used for countercyclical purposes ?
3. What changes, if any, in the relevant legislation would you recommend in order to promote the purposes of the Employment Act ?
V. General questions
1. To what extent and by what means are the policies of your agencies coordinated with those of the RFC in the housing-finance field ?
2. To what extent and by what means are the policies of your agencies coordinated with those of the Federal Reserve ?
3. What would be the advantages and disadvantages of establishing
a National Monetary and Credit Council of the type proposed by the
Hoover Commission ? On balance, do you favor the establishment of
such a body ? If so, what should be its composition ?




CHAPTER VIII
REPLY BY I. W. DUGGAN, GOVERNOR, FARM CREDIT
ADMINISTRATION
1. What do you consider to be the major purposes and objectives of the Farm Credit Administration and of the Farm Credit
agencies under its jurisdiction?
The major purposes of the Farm Credit Administration and of the
banks, corporations, and associations supervised by it are to provide
a dependable source of long-term and short-term credit at all times
to farmers and to farmers' cooperative associations on a sound credit
basis through coordinated cooperative credit facilities and to obtain
loan funds from the investing public without the necessity of the Government guaranteeing the securities issued. A fundamental principle
of the Farm Credit Administration is the encouragement and development of agricultural cooperative institutions with farmer ownership
the ultimate objective, especially insofar as the institutions it supervises are concerned. A further objective, insofar as those banks, corporations, and associations are concerned, is farmer operation and
control to the extent consistent with a federally chartered Nation-wide
credit system which is subject to regulation and supervision by the
Government.
The system provides a permanent source of credit to farmers who
can qualify on a sound basis at the lowest possible cost consistent with
maintaining the institutions on a sound financial basis. The charges
to the member borrowers are based upon the cost of money, the expenses
of operation, and the building of necessary reserves. The purpose
from the beginning has been to make available special types of cooperative credit upon terms and conditions suited to the particular needs
of agricultural production and marketing.
The basic institutions of the Farm Credit System—the Federal land
banks and the national farm-loan associations, the Federal Farm Mortgage Corporation, the production-credit corporations and the production-credit associations, the banks for cooperatives, and the Federal
intermediate-credit banks—are instruments for effectuating the general policy 6f Congress for maintaining a sound and permanent system
of cooperative agricultural credit for the purpose of meeting the credit
needs of agriculture at minimum cost consistent with sound financial
and lending policies. These institutions are either themselves cooperative organizations which finance individual farmers or have the
financing of cooperative enterprises among their major functions.
Although the intermediate-credit banks and the production-credit corporations are wholly Government-owned, their corporate purposes are
such that in actual operation they are important and highly effective
agencies to aid the functioning of farmers' cooperative credit organizations.




247

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MONETARY, CREDIT, AND FISCAL POLICIES

Federal land bank system
The Federal land banks and national farm loan associations were
established in 1916 as permanent institutions to provide farm mortgage credit for farmers on terms fitted to their needs and at rates of
interest adequate to cover the costs of borrowed funds plus a margin
sufficient to defray necessary operating expenses and to build reserves.
Sound farm mortgage credit on amortization plans and other terms
and provisions adapted to the exigencies of the farming business is
available to all farmers who can qualify. Since such loans from the
Federal land banks have been available, some other lenders have
adopted many of these lending practices and have offered loans on
similar terms, especially in the better agricultural areas.
The initial capital of $9,000,000 of the Federal land banks, according to law, was to be provided by private subscriptions or, if such subscriptions were insufficient, by the Federal Government. A total of
$8,892,130 was subscribed by the Government. Each borrower through
a national farm loan association is required to subscribe for stock in
his local association in an amount equal to 5 percent of his loan. The
association in turn is required to subscribe to a like amount of stock
in the Federal land bank. Such stock is held by the bank and the association as additional collateral security for the repayment of the loan.
Also, the Federal Farm Loan Act provided a formula whereby borrower capital replaced Government capital, thus providing a means
for the banks to become entirely farmer-owned.
Federal Farm Mortgage Corporation
This Corporation created in 1934 has the following authorities: It
may finance Land Bank Commissioner loans, may purchase Federal
land-bank bonds, may make secured loans to the Federal land bank,
may exchange its bonds for Federal land-bank bonds, and may obtain
necessary funds through the sale of its own bonds. Through these
functions it provides a backlog of strength to the farm mortgage credit
structure of the Nation in the event of any emergency serious enough
to impair the availability of farm mortgage credit at reasonable rates
and terms.
The first of these authorities now is exercised only in connection with
the financing and collection of existing Land Bank Commissioner
loans. Authority to make new commissioner loans expired at the close
of business July 1, 1947. If the authority of the Land Bank Commissioner to make new loans should be renewed at any time in the
future, this function of the Corporation again would become important.
Experience has demonstrated that an available source of farm
mortgage credit at reasonable rates and terms during all times and
under all conditions is vital to the economy of the Nation. The Federal land banks can provide such a source of credit as long as they have
access to funds in the money market at reasonable rates. Should conditions again materialize which would cause other lenders to withdraw
from the farm mortgage field and general market conditions be such
that the Federal land banks would find it impossible to sell their bonds
in the open market at reasonable rates, the Federal Farm Mortgage
Corporation could purchase such bonds, thereby enabling the banks
to continue making new loans. Under such circumstances the authorities of the Corporation would become extremely important.




249 MONETARY, CREDIT, AND FISCAL POLICIES

The production-credit system
The production-credit corporations and the production-credit associations were established in 1933 to provide a permanent source of
short-term production credit for farmers, through local cooperative
credit associations designed to become wholly owned by their farmer
members. To assist in setting up this permanent cooperative production-credit system, $120,000,000 was appropriated in 1933 to capitalize the 12 production-credit corporations which, in turn, furnished
in the form of class A stock most of the original capital of the production-credit associations. As farmers became borrowers, they were
required to own class B (voting) stock in the associations to the extent
of 5 percent of their loans. An important objective of the system is
to accumulate member-owned capital and build adequate reserves in
the associations so that they will become sound and constructive lending organizations and be able to gradually repay the capital stock
which was furnished by the Government through the productioncredit corporations.
Banks for cooperatives
The 12 district banks for cooperatives and the central bank for cooperatives were established in 1933 as permanent institutions to make
loans to eligible cooperative associations engaged in marketing agricultural products, purchasing farm supplies, and furnishing farm
business services, for the purposes of helping finance the orderly
marketing, processing, and distribution of agricultural products, the
efficient and economical distribution of farm supplies, and the furnishing of farm business services.
The initial capital for the banks for cooperatives was subscribed
by the Governor of the Farm Credit Administration from funds
realized from assets of the revolving fund authorized by the Agricultural Marketing Act of 1929. In addition to this capital, each borrower from a bank for cooperatives is required to own capital stock
in the bank or make payments into a guaranty fund, if an association
is not authorized to purchase stock. The amount of capital which a
borrowing association is required to own is equal to $100 for each
$2,000 or fraction thereof of the amount of operating capital and
facility loans made to it. For commodity loans, the required amount
is 1 percent of the amount of the loan with credit given for stock
purchased in connection with other loans.
In addition to offering farmers' cooperatives credit service carefully adapted to their needs, an important objective of the Farm Credit
Administration is to encourage ownership of the banks for cooperatives by its borrowing associations insofar as practicable. Under the
present law, however, there is no effective method for the eventual
complete ownership of the banks by the borrowing cooperatives.
There is pending before Congress legislation (H. B. 848) which has
as its principal objective a reasonable and orderly method of retiring
Government capital and replacing it with the capital furnished by
the cooperative associations using the facilities of the banks. This
proposed legislation has the full support of all the leading farm
organizations and of the Department of Agriculture.
Federal intermediate credit banks
The 12 Federal intermediate credit banks, organized in 1923, were
created as banks of discount to provide a continuing and dependable



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MONETARY, CREDIT, AND FISCAL POLICIES

source from which local agricultural and livestock credit corporations,
State and National banks, and other primary lending institutions may
obtain funds to finance their short-term and seasonal agricultural
paper, consisting of loans for the production and marketing of crops
and livestock. The Federal intermediate credit banks are not authorized to make loans directly to individuals. Loanable funds used by
the credit banks are obtained principally from the money market
through the sale of consolidated collateral trust debentures which are
offered monthly. From time to time the banks also borrow money
for short terms from commercial banks. They are also authorized to
rediscount paper, having a maturity of not to exceed 9 months, with the
Federal Reserve banks. The Government assumes no liability for the
debentures or other obligations of the intermediate credit banks.
The Federal intermediate credit banks are the only source from
which production-credit associations obtain money. In addition, the
banks serve approximately 80 other credit organizations, most of which
obtain all their borrowed funds from the credit banks. The banks for
cooperatives also borrow from and rediscount some of their paper with
the intermediate credit banks. One of the principal objectives of the
system is to maintain sound credit standards as a basis for maintaining
confidence in the quality of its securities in the money markets. The
ability of the banks to provide a sustained credit service for agriculture depends upon their adherence to sound practices and policies in
all phases of their operations.
2. Do you believe that the farm credit agencies under your
jurisdiction should operate continuously or that they should operate only in emergency periods ? If you favor their continuous
operation, what are your principal reasons for this ?
The institutions under the supervision of the Farm Credit Administration must operate continuously if they are to reach the objectives
set forth above in reply to question 1. The attainment of these objectives requires ready access to the money markets, highly trained personnel, and a volume of business sufficient to permit efficient and lowcost operations. Self-sustaining institutions cannot meet such requirements if they operate only on an emergency and stand-by basis. Furthermore, continuous operation is a fundamental requirement of a
cooperative credit system which fulfills a need for a specialized credit
service to farmers. The characteristics peculiar to a farmer's business
make it essential that he establish a credit home, upon which he can
depend for his sound credit needs at all times and which is designed
to finance his entire farm business on terms and conditions that are
adapted to his particular farm operations. In order to be assured of
this credit service, members purchase stock in production credit associations and national farm loan associations, which are cooperative
organizations largely controlled by their members.
It should be emphasized that these cooperative lending institutions
derive their lending funds through the sale of bonds and debentures
and other borrowings not guaranteed by the Government; that they are
either owned by their members or are moving in that direction as
rapidly as practicable. All of the national farm loan associations are
wholly owned by farmer members. These associations and a few
direct borrowers, in turn own all of the capital stock of the Federal
land banks. Fifty-nine of the five hundred and three production


251 MONETARY, CREDIT, AND FISCAL POLICIES

credit associations are wholly owned by the farmer members, and in
the entire production credit system over 70 percent of all the capital
stock of the associations is owned by members. Thus, the ability of
these institutions to attain the objectives mentioned must be considered largely from the standpoint of their capacity as memberowned cooperative credit associations.
The lending of money to farmers and their cooperatives on a sound,
constructive basis is a highly technical business operation. Risks
must be recognized and evaluated helpful counsel must be given to
member borrowers and standards of credit service must be established.
Personnel able to meet the special needs of these institutions require
thorough training and seasoning. Such personnel can be developed
and retained only by permanent institutions offering steady employment and opportunity for advancement in a desirable career.
As stated, a primary aim is to provide continuous credit service at
low cost without reliance upon Government guaranty of the securities
issued. A prerequisite in this goal is the building of a favorable reputation for the securities in the money markets. This cannot be done
if the securities are offered by part-time institutions and if investors
associate those securities with emergency or distress lending activities.
The building of a ready market for securities at low rates of interest
depends upon regular and frequent offerings by fully active, permanent institutions which are in strong financial condition.
A reasonable and continuous volume of business also is necessary,
partly to build the financial strength needed to obtain loan funds at
low rates of interest, as just referred to, and partly to permit lowcost operations. The cost of administering credit service is greatly
affected by the number and dollar amount of loans handled per person
and per office. Low-cost service, therefore, is dependent upon the
maintenance of an adequate volume of business upon the books at
all times. A factor in maintaining this necessary volume is the readiness with which farmers are willing to subscribe to capital stock in
the lending institutions. Such investment would not be attractive if
the institutions operated only during emergency periods.
The national farm-loan associations, Federal land banks, production-credit associations, and banks for cooperatives thus are designed
to serve in the credit field as other farmers' cooperatives provide service
in marketing, purchasing farm supplies, and similar activities. Neither
marketing, purchasing, credit, nor any other cooperatives can function effectively if operations are limited to periods of emergency.
Except for the Federal Farm Mortgage Corporation, which is on a
stand-by basis, the wholly Government-owned corporations under the
jurisdiction of the Farm Credit Administration are a necessary part
of the cooperative credit system. The Federal intermediate credit
banks obtain the funds through the sale of debentures for the purpose
of discounting loans made by the production-credit associations and
other private credit organizations. The production-credit corporations provide the production-credit associations with capital that is
needed in excess of member-owned capital and supervision. Experience has shown that the lack of a dependable source of funds, lack of
adequate capital for local lenders, and lack of adequate supervision
were the primary weaknesses in short-term agricultural lending prior
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17




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MONETARY, CREDIT, AND FISCAL POLICIES

to the establishment of the production-credit system. Therefore, the
continuous functioning of these wholly Government-owned corporations is an integral part of the cooperative credit system essential to
its success.
This view with respect to the continuity of operations of the institutions comprising the Farm Credit Administration is consistent with
the attitude of the Congress when the authorizing legislation was
enacted. The history of this legislation does not suggest a stand-by or
intermittent role for these institutions. In authorizing the Federal
land banks and the production-credit system, for example, it was provided from the start that the Government capital in the Federal land
banks and the production-credit associations eventually would be retired and they would become fully member-owned institutions. It
seems obvious that the accumulation of member capital and the building of adequate reserves could not be expected to be accomplished
by limiting operations to emergency periods.
3. What, if any, are the gaps or inadequacies in the private
financial system that justify the operation of the farm credit
agencies that are under your jurisdiction?
The fundamental gap or inadequacy in the private financial system
that justifies the operation of the cooperative farm credit system is
the fact that other financial institutions are not economically adapted
to provide a dependable source of credit at all times on terms and conditions that fit the farmers' needs. Furthermore, farmers are not able
to group together to pledge their resources to obtain funds from the
money markets. A discussion of these inadequacies with respect to
the different types of agricultural credit follows:
Long-term farm mortgage credit
Capital turn-over in agriculture is normally a relatively slow process.
Therefore, credit to finance farmers' real estate and improvements
must necessarily be of a long-term nature. Another characteristic of
the farmer's business is that his income is subject to fluctuations from
year to year due to weather, insect pests, animal diseases, or to changes
in prices for his crops. These variations in income require flexibility
at certain times in the servicing of his mortgage contract. It is essential that mortgage credit service that fits the farmer's needs be available to all qualified farmers in all areas and during all periods of the
economic cycle.
The Federal land-bank system may offer amortized loans for periods
from 5 to 40 years and the terms of the loans are adapted to the
farmers' individual situations to the extent feasible. Appraisals are
made on the basis of normal agricultural value of farms, and the income of the farm for agricultural purposes is an important factor in
determining such value. Loans cannot legally exceed 65 percent of the
normal value, and the amount and terms are kept within such limits
that annual or semiannual installments can be met out of normal farm
income. The future payment fund provides a means whereby a farmer
can make advance payments during years of high income which can
be used during less favorable years. Worthy members of the national
farm loan associations who, for reasons beyond their control, find themselves unable to meet their loan installments usually can have their loan
repayments adjusted to fit their particular situation.




253 MONETARY, CREDIT, AND FISCAL POLICIES

When the characteristics of other farm mortgage lenders are analyzed. it can be seen that several important gaps would exist if it were
not for the Federal land banks. Farm mortgage loans by commercial
banks, while generally available in most parts of the country, are not
generally available on terms entirely suitable to the farming business,
especially insofar as the length of term is concerned. The amounts
of farm mortgage loans that commercial banks can make and the terms
which may be offered are affected by a variety of conditions and laws,
the principal governing factor being that these loans are made from
funds on deposit which are subject to withdrawal on demand and their
loan portfolios must be built with this circumstance constantly in
mind. In view of this need for a well balanced loan portfolio banks
usually limit the amount they are willing to lend on farm mortgages,
and at times individual banks find themselves "loaned up" even in
periods of high economic prosperity. National banks may lend up to
50 percent of appraised value for 5 years where the loan is to be repaid
in a lump sum. They may lend up to 60 percent for 10 years where
the loan is amortized so as to provide for a 40-percent reduction in
principal during the period.
The limitations on individual loans affect a large proportion of all
banks since they likewise apply to many State banks which are members of the Federal Reserve System. Furthermore, the banking laws
of several States have been patterned after the law for national banks.
It has been the general practice of commercial banks to make mortgage loans on an unamortized basis for short terms. In 1934, the
average term of these bank loans in the country as a whole was 1.9
years, and it was below 3 years in almost every region. In 1947, the
national average was 5.2 years, ranging down to 2.4 years in the east
South Central States.
Life-insurance companies, while not affected materially by shortage
of loanable funds during depression periods, can withdraw from the
agricultural lending field whenever they find it to their advantage to
do so. Most of the life-insurance companies suspended their farm
mortgage lending activities during the early 1930's, and during the
recent postwar period, at least one large company has withdrawn from
the farm lending field. Farm mortgage loans for the life-insurance
companies taken as a group represent only about 3 percent of their
total assets, and this makes it relatively easy for them to expand or
withdraw from the field, whichever course is to their advantage.
Another gap in the farm credit service offered by private financial
institutions is the fact that they tend to concentrate their farm loan
services in areas where agriculture is most stable and prosperous.
This is most pronounced in the case of life-insurance companies where,
in 1948, two-thirds of the farm mortgages they recorded were in the
10 States of Ohio, Indiana, Illinois, Missouri, Minnesota. Iowa, South
Dakota, Nebraska, Kansas, and Texas.
As mortgage lenders, individuals are not subject to restrictions as
to the amounts they can lend in relation to appraised values, nor is;
there any restriction of the terms of the loans they make. However,
their inability to take care of farm mortgage credit needs, is clearly
shown by the historical record. Individuals as a group have generally
extended credit liberally during good times but at relatively high
rates and for short terms. In the event of another depression it is




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MONETARY, CREDIT, AND FISCAL POLICIES

reasonable to expect that the average individual lender would restrict
lending and in many cases would find it necessary to foreclose promptly
when borrowers could not meet their payments.
The Federal land-bank system has been a consistent pace-setter in
establishing reasonable interest rates and terms for farm mortgage
loans. Average contract interest rates on farm mortgages recorded
have been consistently lower on land-bank loans than rates on loans
by any other major type of lender. There has been a greater reduction in interest rates generally on farm mortgage loans in the high
rate areas than in the low rate areas, with the result that there has
been a considerable narrowing of the spread between interest rates
charged in various parts of the country.
The following tabulation shows the percentages of mortgages recorded by each lender group to the total of all mortgages recorded
for the years 1934, 1937-40, and 1948. These three selected periods
represent depression, prewar, and prosperity conditions, respectively.
Percentage of amount of mortgages recorded by lender groups to total mortgages
recorded
1934
Federal land banks.
Land Bank Commissioner
Commercial banks
Insurance companies
Individuals
Miscellaneous
Total

1937-40

1948

40
30
7
8
14
6

8

10

29
18
32
9

31
18
35
6

100

100

100

4

During 1934, which was a year of heavy farm foreclosures, the
Federal land banks were called upon to furnish 40 percent of all farm
mortgage credit to farmers and the Land Bank Commissioner 30 percent, most of which was for the purpose of refinancing mortgages or
short-term debt held by other lenders. During the same year, commercial banks and insurance companies furnished only 7 percent and
3 percent, respectively, of the farm mortgage credit required by
farmers. Individuals furnished only 14 percent of the total. In
sharp contrast to these proportions, the Federal land banks furnished
only 10 percent of the total farm mortgage credit to farmers in 1948,
while commercial banks, insurance companies, and individuals furnished 31 percent, 18 percent, and 35 percent, respectively.
It is obvious from these facts that agricultural credit from both
private institutional and individual sources has been inadequate in
the past during periods of depression. This lack of adequate credit
during depression periods may be due in part to unwillingness of
private sources to take the risks that are inherent in making loans
to farmers. However, a more compelling reason, especially in the
case of commercial banks, is the fact that during periods when deposits
shrink the supply of loanable funds shrinks, thus reducing the ability
of these institutions to make loans at times when the demand may be
greatest. Also, during such periods banks are not in a position to
defer or to extend mortgage payments of individual farmers who
may have temporary difficulty in making their payments. Similar
factors also affect the ability of individuals to extend credit during
depression conditions.



255 MONETARY, CREDIT, AND FISCAL POLICIES

The period from 1933 has included the worst depression and the
greatest period of agricultural prosperity in history. Under these two
extreme conditions of economic activity, the Federal land-bank system
has served largely as a balance wheel in the farm mortgage field. The
adoption of the normal value concept of appraisal in the period of
depressed land values not only proved to be sound from the standpoint of the lender but sound from the standpoint of the borrower as
well, because it recognizes in effect that a long-term loan is to be paid
under average conditions most likely to prevail over the life of the loan
rather than the conditions existing at any given time. That is equally
true of loans being made during recent years when agriculture is
generally more prosperous than ever before.
Such a policy necessarily results in the accumulation of a larger
proportion of the total farm mortgage loans during a period of depression and the retention of a smaller proportion of the total in periods
of prosperity. Experience during the life of the land-bank system
indicates clearly, however, that it is necessary for the land-bank
system to obtain an important share of the total farm mortgage financing, if it is to remain an effective stabilizing influence. In order for
the system to be an effective yardstick, it is essential that its services
be available to every qualified borrower at all times.
Short-term production credit
Farmers also need an adequate and dependable source of short-term
production credit which is adapted to their particular requirements.
The needs of farmers for short-term production credit are quite different from the needs of other business for commercial loans. Farmers
who need credit for production purposes require loans for a full season
or until the crops or livestock being financed can be marketed. It is
also important that farmers obtain the financing of their entire shortterm requirements from one lender, rather than to have several loans
from different lenders, each secured, by a part of the farmer's crops,
livestock, or equipment. When a farmer has scattered debts with
several lenders, a plan of repayment is difficult to work out, and he is
always subject to the risk of having some part of his chattels foreclosed
if he should be unable to meet his payments on one of these debts.
A suitable source of credit to meet the needs peculiar to the agricultural and livestock industries was long a problem receiving consideration by the Congress and by the governmental agencies. These needs
became more acute as a result of changes in agriculture growing out
of our participation in the First World War. Other developments,
such as the trend toward mechanization of farming, increased substantially the demands of farmers for loans adapted to their requirements. Because of the slower turn-over in agriculture as compared
with business and industry generally, and the characteristic inability
of farmers to shift their production programs quickly, all these developments made the need for a continuing source of dependable credit
increasingly important.
The agricultural credit situation in the early 1920's was in a disorganized state. Credit was often impossible to obtain when most
needed and substantial losses were incurred when prices of agricultural products declined and many lenders were obliged to collect loans
through forced liquidation, thus further depressing prices of farm
commodities. In 1921 and 1922 the War Finance Corporation Act of




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MONETARY, CREDIT, AND FISCAL POLICIES

1918 was amended to permit that corporation to extend credit for agricultural purposes for a temporary period, while the Congress considered ways and means of providing more adequate, permanent facilities for such financing. The Federal intermediate credit banks then
were created in 1923 on a permanent basis, to supersede the War
Finance Corporation in the field of discounting agricultural paper for
banks and other financing institutions and in making direct loans to
farmers' cooperative marketing associations. Thus, the establishment
of the intermediate credit banks in 1923 was the first step by the Federal Government in providing for a continuing and dependable source
through which local lending institutions and farmers' cooperatives
could obtain funds to finance the production and marketing of crops
and livestock. To assure sound and stable operations, as well as an
ample supply of loanable funds, the Federal intermediate credit banks
were capitalized by the Government but required to finance their loan
and discount operations principally through the issuance and sale
of debentures in the money markets and other borrowings. To provide
additional assurance that these banks would be able to meet the demands that might be made upon them, the Federal Reserve Act was
amended to authorize them to discount agricultural paper for the
Federal intermediate credit banks.
Considerable amounts of credit were extended by this new system
for marketing purposes. However, even with these discount facilities
private lenders did not make sufficient use of them to meet the needs
for short-term agricultural credit on a national basis. The lack of
short-term production credit to farmers became extremely acute in
the early 1930's. To correct this weakness in the agricultural credit
situation, the production-credit corporations and associations were
established as a permanent system to provide local cooperative production credit associations with access to the discount facilities of
the intermediate-credit banks. Thus, the production-credit system
was originally established in 1933 to fill permanently a gap which
existed in the agricultural-credit situation. Experience had shown
that insufficient capital, inadequate supervision, lack of understanding of the farming and ranching business, and dependence on local
resources generally for loanable funds were serious weaknesses in agricultural lending. The structure for the Production Credit System was
designed, therefore, to provide safeguards which would minimize these
weaknesses.
Commercial banks are the principal source of short-term production
credit to farmers. However, there are definite limitations to the
credit service that can be offered to farmers by country banks. The
most important function of a bank is to act as a depositary for its
customers. Therefore, banks are organized in localities where funds
for deposit are available to them. Frequently communities with
plentiful deposit funds do not require large amounts of agricultural
credit, while areas which need such credit in comparatively large
amounts too often have only a limited supply of local-deposit funds.
It is also characteristic of agricultural sections that cycles of deposit
withdrawals coincide with demands for loan funds. Thus, as the
need increases the available supply of money diminishes. Conversely,
deposits increase at about the same time that loans are being repaid.
It is significant that 73.6 percent of the institutionally held nonreal-estate agricultural debt was held by commercial banks in 1948.




257 MONETARY, CREDIT, AND FISCAL POLICIES

During a period of shrinking deposits, the banks might be unable to
carry as large a proportion of the total as they did in 1948. During
the 10-year period 1937-48, the total held by banks was 66.4 percent.
Another significant point is the fact that 26.2 percent of the institutionally held non-real-estate debt is held by banks which are not members of the Federal Reserve System and, therefore, do not have as
ready access to Federal reserve rediscount privileges as do member
banks. In the event of a tight credit situation in the future, nonmember banks not amply supplied with liquid assets might find it
especially necessary to limit the amount of farm credit they extend
and be forced to call loans outstanding. This would have the effect
of placing a heavier load on other lenders.
The production credit associations have also been pace setters in
the field of short-term credit especially with regard to terms of loans.
The practice of budgeting loans as developed by the production credit
associations, that is, disbursing them in installments as needed by
the member and repayment when the products financed are sold, has
been adopted by some banks. A budgeted loan of this type serves
the farmer or rancher in many ways. It assures the member that the
funds will be available as needed to meet necessary costs; it reduces
greatly the interest expense since interest is charged only for the
actual number of days each dollar is outstanding; it saves time and
expensive trips; it provides for orderly retirement of the loan as
products are sold: and the analysis of credit requirements and repayment ability aids in avoiding overborrowing.
Bank* for cooperatives
In 1929, following years of extensive research for ways to improve
the orderly merchandising of agricultural commodities, and to make
agricultural financing more effective and productive, the Agricultural
Marketing Act was passed by Congress and approved by the President. The act laid down a national policy of encouraging and sponsoring the organization of agricultural producers into cooperative
associations to be owned and controlled by the farmers, and it provided for the making of loans to farmers' cooperatives for financing
their operations and the acquisition of necessary facilities.
Tn passing this legislation Congress gave recognition to the findings
in the study that there was a serious shortage of credit available to
fanners for the orderly marketing and distribution of the products
produced on their farms and sought to provide a permanent source of
credit for them on terms adapted to their needs and at reasonable
interest rates. Congress specifically stated that it desired to make
available to agriculture the funds needed to enable farmers' cooperative associations to market their own products and that the loans
should be made on terms that preserved farmer ownership*of the
associations.
The Farm Credit Act of 1933 made amendments to the Agricultural
Marketing Act and directed the Governor of the Farm Credit Administration to charter the 13 banks for cooperatives, to be capitalized
initiallv with funds salvaged from the assets of the revolving fund
originally provided for the Federal Farm Board.
Pursuant to these laws, the banks for cooperatives make three types
of loans: (1) Commoditv loans, i. e.. loans secured bv commodities for
the financing of seasonal operations; (2) operating capital loans,
cither on a seasonal or term basis, to supplement the associations' own



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MONETARY, CREDIT, AND FISCAL POLICIES

working capital required for general operations such as meeting pay
rolls, carrying inventories and receivables, and taking care of normal
operating charges; and (3) facility loans, for the construction, refinancing or purchase of fixed assets. These loan purchases are
sufficiently broad to serve the complete operating requirements of
farmers' cooperatives. Efforts are made to adapt each loan to the
specific needs of the borrower in order to further the announced objectives of Congress of building strong and effective farmers' cooperative organizations.
Research has disclosed that around 3,000,000, or about one-half, of
the 6,000,000 farmers in this country are members of at least one
farmers' cooperative association and some farmers belong to two or
three. Probably one-half million more farmers, without accepting
the responsibility of membership, rely upon farmers' cooperatives
as their main source for marketing or processing their farm products
or for furnishing their farm supplies or business services. Experience has demonstrated, both before and after the banks for cooperatives were created in 1933, that farmers' cooperatives cannot get financing of the kind and on the terms they need from ordinary commercial
sources.
Besides the banks for cooperatives, commercial banks are the only
important source of credit to farmers' cooperative associations. As
they are banks of deposit, they must, of necessity, operate under policies
designed primarily to protect the interests of their depositors. Statutory provisions limit the amount of funds that may be made available
to individual borrowers by commerical banks and these limitations,
as well as the requirements of liquidity to meet depositors' demands,
also restrict the period of time for which loans may be made. Because
of these limitations, the only areas in which commercial banks are
able to make financing available to farmers' cooperatives is in connection with their commodity loans (No. 1 above) and those operating
capital loans (No. 2 above) which are needed only for short periods
of time.
The short-term financing which farmers' cooperatives are able to
get from commercial banks is generally limited to those associations
located in or near the larger cities. Farmers' cooperatives serve
sizable groups of farmers who are, in effect, pooling their commodities
or combining their needs for supplies or services. The amounts which
the associations need to borrow to handle commodities or take care of
peak seasons' capital expenditures are therefore relatively large. The
lending limits of commercial banks, plus the usual seasonal shrinkage
of funds available for agricultural loans in farming communities
makes it difficult for local commercial banks to handle any sizable
amount of the short-term financing requirements of the cooperatives.
Only a very small portion of the long-term operating capital loans
or the loans needed for physical facilities (No. 3 above) can be obtained from commercial banks, due primarily to restrictions on the
periods of time for which commercial banks may lend and the fact
that the facilities are not primarily land. The facilities consist of
such things as grain elevators, dairy plants, cotton gins, and warehouses. The only source generally adaptable for this type of financing
besides the banks for cooperatives is the individual member of the
cooperative. Due to the amounts involved, the average member is




259 MONETARY, CREDIT, AND FISCAL POLICIES

not able, initially, to supply the funds necessary to pay for these facilities although he can and does do so over a period of years.
Without the banks for cooperatives, the associations would have a
source of credit (commercial banks) for only a part of their shortterm loan requirements and would have no dependable source of credit
generally available for their long-term operating capital loans or for
the loans necessary to acquire or improve facilities needed for the marketing, processing, or distribution of the commodities they handle.
4. What degree of control over the amounts, interest rates, and
other terms of loans by the farm credit agencies under your jurisdiction is exercised by the Farm Credit Administration in Washington? By the authorities in the 12 district offices? By the
national farm loan associations and the production-credit associations ?
Federal land bank loans
General.—It may be helpful to outline the procedure by which a
Federal land bank loan is made before separately discussing the degree
of control over the amounts, interest rates, and other terms of Federal
land bank loans, which is exercised by the Farm Credit Administration
in Washington, or by the authorities in the 12 district offices, or by
the national farm loan associations.
Application for such a loan is made through a local national farm
loan association, the territory of which includes the farm being
offered as security, and the membership of which consists of borrowers
from the Federal land bank. A paid secretary-treasurer is the active
executive officer of the association and there is also a loan committee
of three or more members, all selected by the association board of
directors (12 U. S. C. 712). Upon receipt of an application, the loan
committee makes, or causes to be made, such investigation as it may
deem necessary as to the character and solvency of the applicant, and
the sufficiency of the security offered (12 U. S. C. 751). This investigation ordinarily is made by the secretary-treasurer. The committee
may also request a report on the value of the security by a land bank
appraiser. The land bank appraiser is a public official appointed
by the Farm Credit Administration. When the application and
association report are submitted to the Federal land bank, the bank
will obtain a report by a land bank appraiser if the association has
not already done so; otherwise the bank will use the land bank appraiser report referred to it by the association. The Federal land
bank, by its proper officers, then makes the final decision as to any loan
which may be made or whether the application should be rejected
(12 U. S. C. 656, 751). It is the duty of the appraiser to determine
the normal value of the farm to be mortgaged as security. In making
said appraisal, the value of the farm for agricultural purposes shall
be the basis of appraisal and the normal earning power of the farm
shall be a principal factor (12 U. S. C. 771, "Fifth") . No loan may
be made unless the written report of the appraiser is favorable (12
U. S. C. 753). The loan committee of the association then causes a
wTritten report to be made of the results of such investigation or investigations, and no loan may be made by the Federal land bank
unless the report of the committee is favorable (12 U. S. C. 751). In
cases where the association has obtained a report from a land bank




260

MONETARY, CREDIT, AND FISCAL POLICIES

appraiser, it may notify the applicant of the amount and terms of the
loan approved by the loan committee, subject to subsequent approval
or disapproval by the Federal land bank (12 U. S. C. 751).
The Federal land banks may deposit their loans with the farm loan
registrar of the district as collateral security for farm loan bonds,
subject to the approval of the Farm Credit Administration (12 U. S. C.
857). The Federal Farm Loan Act also requires that loans to any one
borrower shall not exceed $25,000 unless approved by the Land Bank
Commissioner (12 U. S. C. 771, "Seventh"), and that similar Commissioner permission be given in the case of a loan to a livestock
corporation if not all but at least 75 percent in value and number of
shares of the stock of the corporation is owned by individuals personally actually engaged in the raising of livestock on the farm to be
mortgaged as security for the loan (12 U. S. C. 771, "Sixth"). Authority to act for the Farm Credit Administration and the Land Bank
Commissioner in these three respects has been delegated to a reviewing appraiser in each of the 12 Farm Credit districts, who is an official of the Farm Credit Administration and is not an employee of
the Federal land bank or any national farm loan association.
Amounts of loans.—Under the Federal Farm Loan Act, the amount
of loans to any one borrower shall in no case exceed a maximum of
$50,000, but loans to any one borrower shall not exceed $25,000 unless
approved by the Land Bank Commissioner (12 U. S. C. 771, "Seventh"). This $50,000 limitation may not be exceeded. As respects
approval by the Land Bank Commissioner of loans in excess of
$25,000, authority to give such approval has been delegated to the
reviewing appraiser in each of the 12 Farm Credit districts, who is an
official of the Farm Credit Administration.
In addition to the maximum dollar limitation on the amount of
loans, no loan may exceed 65 percent of the normal value of the farm
mortgaged as determined by the land bank appraiser (12 U. S. C. 771,
"Fifth"). Accordingly, the value assigned to a farm by the appraiser
in effect limits the amount of loan which may be made on that farm
to 65 percent of that value. The association loan committee, though,
may recommend a loan in a lesser amount if security considerations
are deemed to so require. When final decision on the amount of loan
is made in the Federal land bank, it may not exceed either 65 percent
of the appraised normal value, or the amount recommended by the
association loan committee, and it may be less if security considerations
are deemed so to require.
Interest rates.—Under the Federal Farm Loan Act, the interest rate
on Federal land bank loans made through national farm loan associations may not exceed 6 percent per annum (12 U. S. C. 771, "Third").
Otherwise, the basic interest provision now in effect since 1933 is as
follows (12 U. S. C. 771, "Second") :
RESTRICTIONS ENUMERATED.—No Federal land bank organized under this chapter shall make loans except upon the following terms and conditions:
*
SECOND.

*

*

*

*

*

AGREEMENT FOR R E P A Y M E N T ON AMORTIZATION

*

PLAN.—Every such mort-

gage shall contain an agreement providing for the repayment of the loan on an
amortization plan by means of a fixed number of annual or semiannual installments sufficient to cover, first, a charge on the loan at a rate not exceeding the
interest rate in the last series of farm loan bonds issued by the land bank making
the loan; second, a charge for administration and profits at a rate not exceeding,
except with the approval of the Governor of the Farm Credit Administration, 1
per centum per annum on the unpaid principal, said two rates combined consti-




261 MONETARY, CREDIT, AND FISCAL POLICIES
tuting the interest rate on the mortgage; and, third, such amounts to be applied
on the principal as will extinguish the debt within an agreed period, not less than
five years nor more than forty years: * * *.

The Farm Credit Administration also has the power (12 U. S. C.
831 ( b ) ) :
To review and alter at its discretion the rate of interest to be charged by
Federal land banks for loans made by them under the provisions of this subchapter, said rates to be uniform so far as practicable.

Inasmuch as the rates of interest now charged on association loans
exceed the last bond interest rate by more than 1 percent, such loan
interest rates necessarily were approved by the Farm Credit Administration. The current approval for the present interest rates on
loans made through an association or by a branch bank (Puerto Eico)
is as follows (6 CFE 10.4; as amended 14 F. E. 851) :
§ 10.4 Interest rates on loans made through an association or by a branch
bank.—Approval is hereby given to an interest rate of 4 per centum per annum on
loans by banks through associations generally, and to an interest rate of 4 %
per centum per annum on:
(a) Loans by the Federal Land Bank of Columbia applied for through
associations on and after August 1, 1948;
(b) Loans by the Federal Land Bank of Springfield applied for through
associations on and after January 1,1949; and
(c) Loans made by a branch bank [Puerto Rico] pursuant to section 672,
title 12, United States Code;
notwithstanding that the interest rate on the Federal farm loan bonds of the
last series issued prior to the making of any such loans may be less than 3 per
centum per annum (but for higher interest rates approved for loans on special
classes of property in the continental United States, see § 10.5).

The loans in Puerto Eico are made directly to the borrowers. Direct
loans may be made in the continental United States only if the Land
Bank Commissioner so authorizes in areas where there is no association through which the Federal land bank can accept applications for
loans (12 U. S. C. 723 (a)). In that event, the rate of interest on such
loans is required to be one-half of 1 percent per annum in excess of the
rate on association loans being made at the same time (12 U. S. C. 723
(b)). However, no direct loans are currently being made in the continental United States.
The approval of special interest rates by the Farm Credit Administration, referred to in the foregoing, is as follows (6 CFE 10.5) :
§ 10.5 Special interest rates.—For bank loans secured by first mortgages on the
following farm property in the continental United States:
(a) Land that is employed primarily in the production of naval stores ns
defined by section 2 of the Naval Stores Act (Sec. 2, 42 Stat. 1435; 7 U. S. C.
92) :
(b) Land used for the raising of livestock, in estimating the earning power
and in establishing the value of which leases or permits for the use of other
lands were taken into consideration and were a factor in determining the
amount of the loan; and
(c) A farm property, a substantial part of the earnings from which is
from orchard crops.
Approval is hereby given to the following interest rates:
(1) For loans through association, one-half of 1 per centum per annum in
excess of the interest rate on loans through associations not secured by
mortgages on the foregoing classes of farm property, such interest rate not
to exceed 6 per centum per annum;
(2) For direct loans, one-half of 1 per centum per annum in excess of the
interest rate approved for loans through associations under subparagraph
(1) of this paragraph ; and




262

MONETARY, CREDIT, AND FISCAL POLICIES

(3) For loans under section 25 (b) of the Farm Credit Act of 1937 (50
Stat. 711; 12 U. S. C. 724) through associations, the capital stock of which
is impaired, one-fourth of 1 per centum per annum less than the interest rate
approved for direct loans under subparagraph (2) of this paragraph.

In the two districts now having a basic 4^2-percent rate on association loans, the board of directors of the Federal land bank first adopted
a resolution providing for such interest rate, which was then approved
by the Farm Credit Administration.
Other terms.-—The statutory provision quoted under "Interest rates"
(12 U. S. C. 771, "Second"), requires that the mortgage given to
secure a Federal land bank loan shall contain an agreement providing
for repayment of the loan on an amortization plan by means of a fixed
number of annual or semiannual installments over a period of not less
than 5 years nor more than 40 years. In Puerto Rico, loans may not
be for a longer term than 20 years (12 U. S. C. 672). Actually, most
loans in the continental United States are made for a term of from 20
to 35 years. The association loan committee may recommend the term
of years for a particular loan; and the report of the land bank appraiser will include a term of years for which he considers the property to be satisfactory security; neither of which may be exceeded by
the Federal land bank.
The Farm Credit Administration has approved two general types
of reamortization plans. Under the so-called standard plan, the
amount of each installment (except the last) is the same, the portion
thereof applied on principal increasing, and the portion thereof applied on interest decreasing, as the loan is paid down. The so-called
Springfield plan, on the other hand, requires equal installments of
principal, the amount of interest decreasing with the unpaid balance.
The Federal land bank determines which plan is to be used, either
generally or in a particular case, although both the association loan
committee and the appraiser may make recommendations as to the
plan. Some special repayment plans also have been approved, as
where during completion of a conservation program or development
of an orchard, etc., lower principal payments are desired than under
the two general plans more commonly used.
The note and mortgage forms used in each of the States are prepared by the Federal land bank and submitted to the Farm Credit
Administration for approval at the time of each revision and before
printing. Aside from provisions designed to give the Federal land
bank a valid first lien under State law, and defining the repayment
plan, the Federal Farm Loan Act also requires certain other agreements, such as: to pay when due all taxes, liens, judgments, or assessments which may be lawfully assessed or levied against the property;
to maintain insurance on buildings and other improvements on the
property (12 U. S. C. 771, "Ninth"); and to use the proceeds of the
loan solely for the purposes set forth in the application (12 U. S. C.
771, "Tenth").
Federal intermediate credit banks
General.—The 12 Federal intermediate credit banks are primarily
banks of discount for agricultural and livestock lending institutions.
The credit banks are authorized to discount agricultural paper for,
and to make loans secured by such paper to, various types of lending
institutions including national and State banks, trust companies, agricultural credit corporations, incorporated livestock loan companies,



263 MONETARY, CREDIT, AND FISCAL POLICIES

savings institutions, cooperative banks, credit unions, and cooperative
associations of agricultural producers (12 U. S. C. 1031 (1)).
Similarly, the credit banks discount paper for, and make loans to,
the production credit associations and the banks for cooperatives
(12 U. S. C. 1031 (1)). The discounting of paper of production credit
associations is presently the major portion of the credit banks' business.
They are also authorized to make loans to cooperative associations
of agricultural or livestock producers on the security of staple agricultural products or livestock or other collateral approved by the Governor of the Farm Credit Administration (12 U. S. C. 1031 (3)).
Since loans to cooperative associations are generally made by the banks
for cooperatives, few loans of this character are made by the credit
banks.
The Farm Credit Administration is authorized to make such rules
and regulations, not inconsistent with law, as it deems necessary for
the efficient execution of the organic statute governing the credit banks
(12 U. S. C. 1101). The Farm Credit Administration generally consults with the credit banks before its rules and regulations are issued.
Amount of loans.—A credit bank's discounts for and loans to any
onefinancinginstitution are limited by statute to an aggregate amount
which, when added to the institution's other liabilities, will not exceed
the amount of its total liabilities permitted under the laws governing
the institution; and will not exceed twice the paid-in and unimpaired
capital and surplus of the institution in the case of a National or State
bank, trust company, or savings institution, or 10 times the paid-in
and unimpaired capital and surplus in the case of paper secured by
(12 U. S. C. 1032).
By a regulation of the Farm Credit Administration the maximum
amount of any one person's obligations to a financing institution that
may be discounted (or accepted as collateral for loans) by a credit
bank is limited to 20 percent of the offering institution's paid-in and
unimpaired capital and surplus in the case of crop production and
general agricultural paper, or 50 percent of such institution's paid-in
and unimpaired capital and surplus in the case of paper secured by
staple agricultural commodities or livestock; except that these limits
may be exceeded with the consent of the Intermediate Credit Commissioner (6 C. F. K, 43.6 (d)). Within those limits, the amount of a
credit bank's discounts for and loans to any financing institution is
determined by the bank.
Interest rates.—Under the statute the discount and interest rate to
be charged by any credit bank is established from time to time by the
bank with the approval of the Intermediate Credit Commissioner; and
except with the approval of the Governor, the discount and interest
rate may not exceed by more than 1 percent per annum the rate borne
by the last preceding issue of the bank's debentures (12 U. S. C. 1051).
The rate borne by the debentures, which may not exceed 6 percent per
annum, is fixed by a committee of the presidents of the banks (or by
the individual bank in the case of its individual issue of debentures),
subject to approval by the Farm Credit Administration (12 U. S. C.
1042, 1044, 883-884). The last issue of debentures, which was a consolidated issue by all 12 credit banks, bore a rate of 1.30 percent, and
the current discount and interest rate charged by the credit banks is
2 percent in 10 districts and 2% percent in the other 2, except that the
rate in Puerto Rico is now 2% percent. Special rates may be fixed




264

MONETARY, CREDIT, AND FISCAL POLICIES

from time to time in connection with the discounting of loans made
under certain Commodity Credit Corporation loan programs in which
earnings allowed to lending agencies are limited to a rate so low that
they would be unable to rediscount the notes wdth the intermediate
credit banks except at a loss. Only a relatively small amount of Commodity Credit Corporation paper has been discounted by the Federal
intermediate credit banks in recent years.
The statute provides that a credit bank may not discount paper
upon which the financing institution has charged the borrower a
rate of interest exceeding the bank's discount rate by more than 1 ^
percent per annum, except with the approval of the Farm Credit
Administration (12 U. S. C. 1052). The Farm Credit Administration, by regulation, has authorized the credit banks to accept paper
bearing a rate of interest exceeding the bank's discount rate by not
more than 4 percent per annum (6 C. F. R. 42.C).
Other terms.—Under the statute, discounts and loans by the credit
banks must mature within 3 years (12 U. S. C. 1033). The regulations of the Farm Credit Administration provide that paper accepted
for discount (or as collateral for loans) should generally mature at
the usual time for marketing the crops or livestock from which liquidation of the paper is expected; and, with certain exceptions, the
maturity of such paper is not to exceed one growing or marketing
season, usually not more than 12 months (6 C. F. R. 42.4).
Under the statute, loans by the credit banks to production credit
associations or to banks for cooperatives are to be secured by such
collateral as may be approved by the Governor (12 U. S. C. 1031 (1)).
The statute provides that a credit bank's loans to other financing institutions are to be secured by paper eligible for discount (12 U. S. C.
1031 (1)). Under regulations of the Farm Credit Administration,
when discounted paper is in default, the credit bank may accept, in
substitution, the financing institution's note secured by bonds or other
collateral (6 C. F. R. 43.4) ; and the credit bank may make interim
loans to a financing institution on its note secured by bonds or other
collateral, to finance the institution's advances on paper to be submitted to the bank for discount or as collateral for loans (6 C. F. R.
43.5).
Within the stated limits, the credit banks determine the appropriate
maturities of their discounts and loans, the acceptability of paper for
discount, and the adequacy of collateral for loans.
Production credit corporations and associations
General.—The 12 production credit corporations do not make loans.
They have the responsibility of organizing, capitalizing in part, and
supervising the production credit associations. At present there are
503 production credit associations, of which 59 are wholly member
owned.
The production credit associations make loans to their farmer members for general agricultural purposes (12 U. S. C. 1131g). The production credit associations obtain the major portion of their loan
funds by rediscounting their loan paper with, and borrowing from,
the Federal intermediate credit banks, and except with the approval
of the Governor, they may not rediscount paper with or borrow from
any other bank or agency (12 U. S. C. 1131h).




265MONETARY,CREDIT, AND FISCAL POLICIES

The statute provides that loans by a production credit association
are to be made under such rules and regulations as may be prescribed
by the production credit corporation with the approval of the Governor; and that the terms and conditions, rates of interest, and
security for an association's loans shall be such as may be prescribed
by the production credit corporation (12 U. S. C. 1131g). The production credit corporations generally consult with the associations
and with the Farm Credit Administration before rules and regulations are prescribed and approved.
Amounts of loans.—The aggregate amount of loans that a production credit association might make depends upon the amount of its
capital and surplus, since the amount of loan funds it might obtain
from the Federal intermediate credit bank is limited by the provisions
of the credit bank statute (12 U. S. C. 1032) to a maximum of 10 times
the associations' paid-in and unimpaired capital and surplus. In
practice, the amount of loan funds that the several production credit
associations obtain from the credit banks is less than the legal maximum, and generally ranges at the peak of the lending season from
about four to seven times the capital and surplus of the various assotions depending upon the financial strength of the particular association and the character of its loans. The amount of an association's
authorized capital is prescribed by the Governor (12 U. S. C. 1131d).
Each association has two classes of capital stock. Class A (nonvoting) stock held by the Government through the production credit corporations, and which is also owned by farmers and others, and class B
(voting) stock acquired by members in amounts equal to $5 for each
$100 or fraction thereof of their loans.
A loan to any individual whose indebtedness to the association exceeds 20 percent of its capital and guaranty fund must be approved
by the production credit corporation; and if his indebtedness exceeds
50 percent of its capital and guaranty fund, the loan must be approved by the Production Credit Commissioner of the Farm Credit
Administration (12 U. S. C. 1131g).
Within the foregoing limits, the amount of any particular loan is
determined by the association. Except for loans in excess of 20 percent of the association's capital and guaranty fund, and loans to
official personnel for which special approval is required by regulation
(6 C. F. E. 50.2 ( f ) ) , all loans are approved by the association at its
own discretion.
Interest rates.—The rate of interest charged by a production credit
association for loans is subject to regulation by the production credit
corporation with the approval of the Governor (12 U. S. C. 1131g).
Under the general regulation issued by the production credit corporations and approved by the Governor, the rate for various associations
is fixed at between 3 and 4 percent above the current discount rate of
the Federal intermediate credit bank (6 C. F. E. 50.4). At present,
the discount rate of the credit banks is 2 percent in some districts and
2^4 percent in others (2y2 percent in Puerto Eico) ; and the interest
rate charged by the various associations ranges from 5 to 6 percent
(except that two wholly member-owned associations have been
specially authorized to charge 4y2 and 4% percent respectively).
Special arrangements are made on loans guaranteed by the Commodity Credit Corporation to permit the associations to handle paper
at rates conforming to Commodity Credit Corporation loan programs.




266

MONETARY, CREDIT, AND FISCAL POLICIES

The maximum interest rate that associations may charged is also subject to limitation by the Farm Credit Administration, since a Federal
intermediate credit bank may not discount paper which bears interest
at a rate of more than iy 2 percent in excess of the credit bank's discount rate, unless a greater spread is approved by the Farm.Credit
Administration (12IT. S. C. 1052). The Farm Credit Administration
has authorized a spread of not more than 4 percent (6 C. F. R, 42.6).
Other terms.—The terms and conditions of association loans are
subject to such rules and regulations as the production credit corporations may prescribe with the approval of the Governor (12 U. S. 0.'
1133g). Regulations as to security requirements and the maturity of
loans have been prescribed in general terms, leaving a broad area of
discretion in the associations. The regulations provide that loans
may be secured or unsecured, but should not be made on the primary
security of real estate (sec. 6, Rules and Regulations for Production
Credit Associations). The associations determined what security will
be required for any particular loan, and they generally take liens on
crops, livestock, and equipment as security. The regulations provide
further that loans should usually mature within 1 year (sec. 7, Rules
and Regulations for Production Credit Associations). The associations determine the appropriate maturitv of any particular loan,
and usually fix the maturity at the expected time for marketing the
crops or livestock from which repayment of the loan is anticipated,
which is ordinarily within 1 year. Loans are generally disbursed in
installments as needed bv the member and repaid when the products
financed are sold. Evidence of ability to repay the loan through
normal production sources is a prime factor in approving a loan
application.
Banks for cooperatives
General.—The 12 district banks for cooperatives and the Central
Bank for Cooperatives are authorized to make loans to cooperative
associations of farmers engaged in marketing agricultural products,
purchasing farm supplies, and furnishing farm business services, for
the purposes of financing the effective merchandising of agricultural
commodities, the operations of the associations, and the construction
or acquisition of physical facilities (12 U. S. C. 1134c, 1134j. 1141c).
The 13 banks for cooperatives are also authorized to make loans to
and discount paper for one another, to participate in each other's loans,
and to borrow from and rediscount paper with the Federal intermediate credit banks or commercial banks (12 U. C. 1134c, 11341).
The Governor of the Farm Credit Administration is authorized to
prescribe the division of lending authority between the district banks
for cooperatives and the central bank on the bases of classes of borrowers and amounts of loans (12 IT. S. C. 1134j). In general, local
cooperative associations are served by the district banks while cooperative associations of national or broad regional scope extending over
several districts are served bv the central bank; and the central bank
participates with the district banks in loans which are in excess of the
maximum fixed for the district bank loans.
The Farm Credit Administration is authorized to prescribe the
terms and conditions under which loans may be made by the banks
for cooperatives (12 U. S. C. 1134c, 1134j, 1141f ( c ) ) . The Farm




267 MONETARY, CREDIT, AND FISCAL POLICIES

Credit Administration generally consults with the banks for cooperatives before prescribing general loan policies.
The lending operations of the central bank are under the control
of the cooperative bank commissioner who is, ex officio, the executive
officer, as well as the chairman of the board, of the central bank
(12 U. S. C. 1134g, 1134h).
Amounts of loans.—There is no legal limit on the aggregate amount
of loans that may be made by a bank for cooperatives, but that amount
is limited in practical effect by the bank's financial resources.
The Governor is authorized to prescribe limitations on the amount
of loans which may be made to individual borrowers (12 U. S. C.
1134j). The regulation prescribed by the Governor provides that
except writh the written approval of the cooperative bank commissioner, loans by a district bank to any one borrower may not exceed
the following percentages of the bank's combined capital, surplus,
and reserves: facility loans, 10 percent; operating capital loans, 15
percent; commodity loans (excluding loans on Commodity Credit
Corporation loan documents), 25 percent; the sum of facility and
operating capital loans, 15 percent; the sum of facility, operating
capital, and commodity loans, 25 percent (6 C. F. R. 71.1).
When a loan by a district bank would exceed those amounts, the
district bank will request the central bank to participate in the loan
for the excess amount; or, with the approval of the cooperative bank
commissioner, another district bank may participate in the loan (6
C. F. R. 71.2). Such participations are also frequently arranged
for loans by a district bank that do not exceed the prescribed limits.
There is no fixed limit on the amount of the central bank's loans
to any one borrower, except as noted below, but in actual practice
the central bank follows substantially the same limitations as the
district banks.
Loans by the banks for cooperatives for the construction or acquisition of physical facilities are limited by statute to not more than
60 percent of the appraised value of the security therefor (12 U. S. C.
1141e (c)). By regulation of the Farm Credit Administration, commodity loans are limited to not more than 65 percent of the value
of unhedged commodities or 85 percent of the value of hedged commodities. As a general rule, facility loans are not made in excess of
50 percent of the value of the security.
Within the foregoing limits, the banks for cooperatives determine
the amount of any particular loan.
Interest rates.—The Governor is authorized to prescribe the rates of
interest on loans by each bank for cooperatives, subject to the following statutory directions: The rate of interest shall not exceed 6 percent in any case; the rate of interest on operating capital loans shall
conform as nearly as may be practicable to a rate of 1 percent in excess
of the prevailing interest rate paid by production credit associations
to the Federal intermediate credit banks; the rate of interest on commodity loans shall conform as nearly as may be practicable to the
prevailing interest rate charged by the Federal intermediate credit
bank on commodity loans; and the rate of interest on facility loans
shall conform as nearly as may be practicable to the prevailing rate on
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18




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MONETARY, CREDIT, AND FISCAL POLICIES

Federal land-bank loans made to members of national farm-loan associtions (12 U. S. C. l l f l f (a)).
The present rates of interest charged by the banks for cooperatives
are as follows: 2% percent on commodity loans except in one district
where the rate is 2y2 percent; 3 percent on operating capital loans:
and 4 percent on facility loans. (For loans in Puerto Rico, the rates
are respectively, 2%, Sy2, and 4y2 percent.)
Other terms.—Facility loans are required by statute to be repaid
over a period of not more than 20 years (12 U. S. C. 1141e ( d ) ) . In
actual practice, these loans are made for a period not in excess of 10
years. No loan for the purchase or lease of facilities is to be made
unless it is determined that the purchase price or rent to be paid is
reasonable (12 U. S. C. 1141e (c)). The authority to make this determination, placed in the Governor by the statute, has been delegated by
him to the several banks.
The regulations of the Farm Credit Administration provide that
commodity loans are to be secured by a first lien on farm products or
farm supplies approved by the cooperative bank commissioner, of
sufficient value to afford an adequate margin of security without other
collateral (6 C. F. R. 70.2) ; and the commissioner has prescribed a
list of the classes of commodities acceptable as security for such loans
(6 C. F. R. 70.3). The regulations also provide that commodity loans
are to mature within the normal marketing period of the commodities
securing the loan (6 C. F. R. 70.2).
Under the regulations of the Farm Credit Administration, operating capital loans can be made with or without security of any kind,
and are to mature within 3 years.
Subject to the stated limitations, the banks for cooperatives determine the adequacy of the security and the appropriate maturity for
their loans.
5. What principles govern the determination of the interest
rates charged by the farm credit agencies under your jurisdiction ?
Federal land banks
Funds needed by the Federal land banks for making their loans
are obtained by the issuance and sale of consolidated Federal farm
loan bonds. These bonds are not guaranteed in any way by the United
States Government, but are the joint and several obligation of the 12
Federal land banks and are collateralized by the notes and mortgages
belonging to the Federal land banks. These notes and mortgages
in turn are secured by the farms of the individual borrowers from
the banks. The consolidated Federal farm loan bonds are sold to the
investing public at rates and terms consistent with money market
conditions and the long-term needs of the Federal land banks. In
addition to and consistent with applicable statutory provisions, the
interest rate policy of the Federal land bank system provides that the
rates paid by borrowers shall be sufficient to cover the cost of funds
used in its lending operations, the operating expenses of the Federal
land banks and national farm loan associations, and adequate provision for reserves in the Federal land banks and national farm loan
associations. Since the land banks comprise a cooperative system,
earnings in excess of all such fundamental costs constitute savings and
may be returned as dividends to the members of the system.




269 MONETARY, CREDIT, AND FISCAL POLICIES

Federal intermediate credit banks
It has been the consistent policy of the Farm Credit Administration
that the Federal intermediate credit banks are to maintain such
lending rates as are necessary to cover the cost of borrowed money,
other necessary operating expenses (including the cost of supervision
and examination by the Farm Credit Administration, and annual
audits of the General Accounting Office), and a reasonable margin of
net income to build reserves for losses and other contingencies and to
strengthen the capital structure of the banks.
Production credit system
The law requires that the rate of interest charged on loans made
by a production credit association will be prescribed by the production
credit corporation of the district. This rate covers the interest paid by
the association to the Federal intermediate credit bank of the district
for loanable funds, plus a spread for the association which, together
with the income derived from its investments and from loan service
fees, should provide the funds necessary to pay its operating expenses,
cover any losses on loans, and build necessary reserves.
Until about 2 years ago, this spread was fixed uniformly at 3 percent
per annum over the discount rate of the Federal intermediate credit
bank of the district. A considerable number of associations, after careful study of their needs for income by their local boards of directors,
and on consultation with their member borrowers, determined that it
was necessary to increase their interest spread. Accordingly, after
consideration of the needs of the associations for income based on
operating experience over a period of many years the rules and regulations were changed in 1947 to provide that:
The interest rate charged the borrowers shall be the rate prescribed by the
corporation, which shall be not less than 3 percent per annum nor more than 4
percent per annum above the discount rate of the Federal intermediate-credit
bank at the time the loan or advance is made, unless a lower or a higher rate is
prescribed by the corporation with the approval of the Production Credit Commissioner.

As of June 30,1949, the discount rate charged the associations by the
Federal intermediate-credit banks varied from 2 to 214 percent (2y2
percent in Puerto Rico), and more than half of the associations had
increased their interest spread above the former standard of 3 percent
per annum, but not in excess of 4 percent. These changes in interest
spread enable the associations affected to increase their net earnings
in order to build reserves faster, in order to be better prepared for
future contingencies, to handle an increasing volume of credit, and to
accelerate the repayment of Government capital.
Banks for cooperatives
The funds loaned by the banks for cooperatives consist of their
capital and funds borrowed from the Federal intermediate-credit
banks and commercial banks.
The interest rates on the three types of loans made by the banks for
cooperatives are, under the law, based on "the needs of the lending
agencies" and the requirements that they must be related to certain
types of loans made by the Federal intermediate-credit banks and the
Federal land banks. In applying these standards, the Farm Credit
Administration has followed a consistent policy of endeavoring to




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MONETARY, CREDIT, AND FISCAL POLICIES

establish rates which will cover the cost of money to the lending institutions and pay all operating costs, including provision for such
reserves as are necessary to keep the banks in a sound financial position.
The corporations under the supervision of the Farm Credit Administration are also assessed for the cost of supervision and examination
which are provided by the Washington office of the Farm Credit Administration. These amounts are considered as part of the operating
costs which have been mentioned.
6. What policies of the Federal farm-credit agencies (interest
rates, amounts of loan, bases for valuing property, etc.) tend
toward the maintenance of general economic stability and stable
general price levels, and what policies may tend toward
instability ?
As stated in the answer to question No. 1, one of the principal objectives of the lending institutions comprising the farm-credit system is to
provide a permanent and dependable source of credit for agriculture
on a sound basis, at the lowest cost consistent with maintaining the
lending institutions in a strong financial position, and upon terms
and conditions adapted to the needs of farmers and farmers' cooperatives. The fact that these lending institutions are continuously offering sound credit service in their respective fields at minimum cost consistent with the establishment of adequate reserves is an important
stabilizing influence in agriculture. Sound lending policies, as followed by the institutions under the supervision of the Farm Credit
Administration, discourage inflation during periods of rising prices
and provide for the maximum financial assistance to farmers and farmers' cooperatives that appears to be within their ability to repay on
appropriate terms from income during periods of declining prices.
The benefits of these lending policies and practices accrue not only
to those farmers and farmers' cooperative associations financed directly
by these institutions but extend to others as well, since the standards
set by the Farm Credit Administration have had a far-reaching influence upon the terms of loans granted by other lenders.
The coordination of lending policies through the district boards of
directors and through the central office is also a factor contributing
toward stability of the agricultural economy.
An important element in the operations of the farm-credit system,
which contributes materially to the economic stability of agriculture,
is the policy of maintaining a favorable market for securities issued
by the institutions of the system. The Federal land banks obtain the
major portion of their loanable funds through the issuance and sale
of consolidated Federal farm-loan bonds; the Federal intermediatecredit banks finance their lending operations principally through the
issuance of consolidated collateral trust debentures; and the Central
Bank for Cooperatives is authorized to issue and sell debentures. The
United States Government assumes no liability for these obligations,
either as to principal or interest. The banks of the system, having
established their position in the public money markets, have access to
the large reservoirs of funds in financial centers, thereby providing
agriculture with a high degree of assurance of a constant ample supply
of funds to meet all reasonable needs.
Another element of stability provided by the Farm Credit institutions is their supervision and training program. The operating personnel throughout the entire system are trained in the fundamental



271 MONETARY, CREDIT, AND FISCAL POLICIES

principles of sound credit and are, therefore, in a position to discuss
with the farmer his own financial situation and work out with him
a credit program that is likely to be successful to both the member
and the lending institution.
In the case of the Federal land banks, the appraisal and loan servicing policies are especially important as stabilizing influences. It is
the policy of the Farm Credit Administration to appraise farms offered
as security for land-bank loans on the basis of normal agricultural
value. This has resulted in valuing some properties above the market
value during the early 1930's when the market was extremely depressed
and considerably below the market during the inflated period of the
war and postwar years. In this manner, considerable support was
given to land values during the depression by extending credit courageously. On the other hand, credit is not extended on farm-mortgage
security at any time beyond an amount that is justified on the basis
of the normal net income from the farm.
The loan-servicing policy of the Federal land-bank system is to
offer every assistance available to all worthy borrowers, so they may
have every reasonable opportunity to maintain their loans in a satisfactory status and retire the indebtedness against their land. A borrower shall be considered worthy and his mortgage shall not be foreclosed if he (1) is doing his honest best; (2) is applying the proceeds
of production, over and above necessary living and operating expenses,
to the payment of primary obligations; (3) is taking proper care of
the property; and (4) has the capacity to work his way out of a reasonable burden of debt under normal conditions. Loans may be extended, deferred, reamortized, or placed on a variable or suspended
payment plan if, from the circumstances in a given case, it appears
that the assistance provided by such forebearance treatments is justified and will enable the borrower ultimately to retire his indebtedness.
The same general philosophy applies to loan servicing in all of the
lending units of the Farm Credit Administration.
Another stabilizing factor in the operations of the Federal land
banks is the use of long-term amortized loans. Annual or semiannual
installments are kept within limits which can be met under normal
conditions. Also, farmers are encouraged to make advance payments,
through the use of the future-payment fund, during years of high
farm income, which can be applied during years of low farm income.
The policies followed by the production-credit system contribute
to the stability of the agricultural economy. In making loans, the
production-credit association emphasizes the repayment ability of the
farmer rather than collateral as the principal element of soundness.
It is the policy of the production-credit system to analyze carefully
applications for loans and, before approving them, determine that the
funds are to be used for sound purposes and that they will assist the
borrower to produce and market his products in an orderly fashion.
The Farm Credit Administration considers it a disservice to permit
a farmer to saddle himself with a debt which may require a sell-out
of the business to repay, even though he may have sufficient collateral
security to make the loan safe for the lender.
Production-credit loans are generally made to mature within 1 year.
'Advances to meet expenses of a current or annually recurring nature
are expected to be repaid from the current year's income. Renewal
of a portion of some types of loans, such as those for the purchase of




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MONETARY, CREDIT, AND FISCAL POLICIES

heavy machinery and other items of a semicapital nature or those involving the refinancing of debts, are frequently anticipated at the
time the loans are made. If at maturity the credit factors remain
satisfactory, no difficulty is experienced by either the member or the
association in arranging for the renewal. This policy permits spreading the repayment of capital loans over more than 1 year if necessary,
thereby gearing repayment to the earning capacity of the farm or
ranch business. Associations encourage members to pay debts as
rapidly as is consistent with sound business operations and to use surplus cash to buy Government bonds or otherwise to strengthen the
financial position of their business. They also encourage farmers to
finance their entire business with one lender, thus permitting a better
analysis of his business and eliminating the risk of having some part
of his chattels foreclosed and sold.
Budgeted loans are set up so that the money is advanced to the
individual as it is needed throughout the year and repaid as products
financed are sold, thus helping him to prevent overborrowing and
gearing his loan to his ability to repay. Interest is paid only for the
number of days that the money is actually used by the borrower.
The banks for cooperatives are instrumental in strengthening farmers' marketing, purchasing, and servicing cooperatives. Farmers' cooperatives themselves contribute to orderly marketing and operate as
competitive pacemakers in their respective fields, and thus are an
influence which tends toward general economic stability.
None of the policies of the Farm Credit Administration or of the
corporations or associations under their supervision contribute toward
instability of the general economy or of the general price level.
7. To what extent and by what means are the policies of the
Federal farm-credit agencies coordinated with the general monetary and credit policies of the Federal Reserve and the Treasury?
The Farm Credit Administration consults with the Treasury prior
to the issuance of any bonds, debentures, or other similar obligations by institutions under its supervision. These consultations with
the Treasury embrace the timing of the security offering, the amount
involved, and the proposed prices, interest rates, and maturities. The
Treasury is also consulted by the Farm Credit Administration prior
to the consummation of transactions in Government securities to be
effected in the market on behalf of such institutions. The latter consultations cover the issues involved, amount, timing of the transactions, and the proposed prices. In practice, the Fiscal Assistant Secretary of the Treasury is consulted with respect to the issuance of
securities, and an official of the Federal Reserve Bank of New York
with respect to market transactions in Government securities.
The foregoing procedures are consistent with the Government Corporation Control Act (Public Law 248, 79th Cong., approved December 6,1945), and the directions of the Secretary of the Treasury issued
thereunder, with respect to Farm Credit Administration institutions
which are partly or entirelv owned by the Government. However,
similar procedures were followed by the Farm Credit Administration for many years prior to the passage of the act in question and#
have continued to be followed in cases which are not covered by the
act. For instance, all Government capital interest in the Federal
land banks has been retired, but financing programs and security




273 MONETARY, CREDIT, AND FISCAL POLICIES

transactions by these banks are discussed in advance with the Treasury and the Federal Reserve Bank of New York.
In cases where proposed offerings of securities or transactions in
Government securities, on behalf of Farm Credit institutions, would
have conflicted with financing transactions or policies of the Treasury
or the Federal Reserve System, the offerings or transactions on behalf
of the Farm Credit institutions have been rearranged to avoid such
conflict.
8. In what ways, if at all, does the Federal Government subsidize the Federal farm-credit agencies ? If possible, estimate the
annual amount of these subsidies.
The assistance of the Federal Government to credit agencies supervised by the Farm Credit Administration, as represented by its current investment in the capital of these agencies, is as follows:
Wholly Government-owned corporations:
Federal Farm Mortgage Corporation (capital stock)
Federal intermediate-credit banks (capital stock) and paidin surplus
Production-credit corporations (capital stock)
Mixed-ownership corporations: Banks for cooperatives (capital
stock)
Total

1
2
3

$10, 000

60, 500,000
46,235, 000

178,500,000
285, 245, 000

Dividends of $68,000,000 have been paid to the United States Treasury, leaving a
balance of earned surplus of $62,661,031 as of June 30, 1949.
2 Franchise taxes (dividends) of $7,619,521 have been paid to the United States Treasury, leaving a balance of earned surplus, including reserve for contingencies, of $36,089,216
as of June 30, 1949.
3 Earned surplus of $17,140,663 as of June 30, 1949.
1

Although the Government is assisting various institutions of the
Farm Credit Administration (except the Federal land-bank system)
by furnishing all or part of their capital funds and has accorded to
them certain tax exemptions, it receives certain returns which, although not directly related thereto, have the effect of reducing materially the cost incurred in furnishing capital and the loss of revenue
growing out of tax exemptions. To June 30, 1949, the Federal Farm
Mortgage Corporation has paid to the Treasury $68,000,000 in dividends and the Federal intermediate-credit banks have paid franchise
taxes aggregating $7,619,521. Moreover, all accumulated earnings of
the wholly owned Government corporations accrue to the Government, thereby increasing its equity in the institutions. At June 30,
1949, the earned surplus of the Federal Farm Mortgage Corporation
amounted to $62,661,031; the surplus and reserves of the Federal intermediate-credit banks aggregated $36,089,216: and those of the production-credit corporations amounted to $17,140,663.
In addition to these investments, the following amount is available, if need therefor should arise, for capital subscription from revolving funds held b}^ the United States Treasury, all of which are in a
stand-by status: Federal Farm Mortgage Corporation, $199,990,000.
(The Board of Directors has voted to recommend the return of this
amount to the general funds of the Treasury.)
There is also a revolving fund of $125,000,000 in the Treasury in a
stand-by status available for subscription to the capital stock of the
Federal land banks. The Federal land banks and national farm
loan associations are in a greatly strengthened net-worth position.
Experience has demonstrated there are numerous steps the banks can




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MONETARY, CREDIT, AND FISCAL POLICIES

take to effectively meet operating problems which are limited to individual districts, including interbank assistance. Therefore, the
banks consider they have sufficient resources, financial and otherwise,
to enable them to carry their worthy members and prospective members through any periods of distress except perhaps an economic
emergency of a Nation-wide character. In the event of such an emergency and should the banks be called upon to again finance outstanding farm mortgage debt to the extent of overtaxing their own resources, these funds would be available to be resubscribed in the banks
if considered advisable in the public interest.
All expenses of the credit agencies supervised by Farm Credit Administration (including assessments for supervisory and examination
expense of the Farm Credit Administration and the expense of audits
made by the General Accounting Office) are paid by them from their
income and not from appropriated funds. These assessments do not
include any charge for office space occupied by the Washington office
of the Farm Credit Administration in the Government-owned South
Building, or for general services rendered by the Department of Agriculture to its bureaus and agencies.
No contributions are required to be made to the civil-service retirement fund, nor to the Federal Employees' Compensation Commission, by the agencies whose employees are eligible for benefits; the
employer's portion is included in the over-all calculation of the amount
to be paid into the fund by the Federal Government. The employees
eligible for these benefits are those of the Federal land banks, Federal
intermediate credit banks, production credit corporations, and banks
for cooperatives. Employees of the national farm loan associations
and production credit associations are not covered by either the Social
Security Act or Civil Service Retirement Act; the associations in each
district, however, have developed or are developing a retirement plan
for their employees.
Tax exemption of farm credit agencies
The Federal land banks, national farm loan associations, and Federal intermediate credit banks are exempt from Federal and State
taxation except upon real estate held by them (12 U. S. C. 931,1111).
Similarly, the banks for cooperatives, production credit corporations,
and production credit associations, while they have Government capital, are exempt from Federal and State taxation except upon their
real property and tangible personal property; but they become subject to Federal and State taxation whenever all their Government
capital is retired (12' U. S. C. 1138c). Of the 503 production credit
associations, 59 have now retired all their Government capital and
pay Federal and State taxes levied generally on similar private corporations.
The Federal taxes from which the exempt farm credit agencies are
immune include: principally the income tax on corporations (26
U. S. C., ch. 1); the stamp taxes on the issue and transfer of corporate
securities and on conveyances of realty (26 U. S. C., chs. 11 and 31),
but the tax on conveyances would be payable by the other party to the
transaction; and excise taxes on the rental of safe deposit boxes (26
U. S. C., ch. 12) and on transportation and communications (26
U. S. C., ch. 30).
As already indicated, the 59 production credit associations that
have retired all their Government capital pay all of these Federal



275 MONETARY, CREDIT, AND FISCAL POLICIES

taxes. Further, the Federal excise taxes payable by manufacturers
or vendors of various articles, such as automobiles, tires and tubes,
gasoline, lubricating oils, electrical energy, air-conditioners, fans,
business machines, rubber articles, etc. (26 U. S. C., ch. 29), are applicable to such articles purchased by any of the farm credit units
and are included in the price paid by them for such articles.
All of the farm credit agencies are subject to State and local taxes
on their real property. The banks for cooperatives, production credit
corporations, and production credit associations are also subject to
State and local taxes on their tangible personal property. The taxexempt farm credit agencies are immune from other State taxes on
corporations. These other taxes vary widely among the States, but
are levied most commonly on the income of corporations or on their
intangible property or both. The 59 production credit associations
that have retired all their Government capital pay such State taxes.
The States commonly impose various excise taxes such as those on
sales generaly, on gasoline, on various legal documents, etc. The taxexempt farm credit agencies do not pay such excise taxes on their
purchases where the tax is levied on the purchaser; but where such
taxes are levied on the vendor, the purchases of all the farm credit
agencies are subject to the tax, which is included in the purchase price
paid by them. Similarly, excise taxes on legal documents are not
paid by the tax-exempt farm credit agencies, but in some instances
the other party to the transaction is required to pay the tax.
9. Do you favor adoption of the Hoover Commission recommendation that the Federal intermediate credit banks, the banks
for cooperatives, and the production credit corporations should
be consolidated, and that the merged system should adopt the
principle of mutualization ? Please give reasons for your answers.
We do not favor the adoption of the above recommendation on consolidation. We favor the principle of mutualization wherever feasible
and as rapidly as it can be done and at the same time provide credit at
reasonable interest rates. As yet we have been unable to work out a
practical plan for farmer-borrowers to acquire ownership of the
Federal intermediate credit banks and the production credit
corporations.
By reason of the differences in the organizational and financial
set-up of the several types of institutions mentioned, including the
investments by farmers' cooperatives in capital stock of the banks for
cooperatives, and the distinctive character of the several functions of
the different institutions, there appears to be no feasible basis upon
which these banks and corporations might be consolidated on a mutualization basis.
The Federal intermediate credit banks engage principally in the
discounting of seasonal production paper offered to them by and with
the endorsement of various types of local lending institutions, including production credit associations, privately capitalized agricultural and livestock credit corporations, and commercial banks. The
banks for cooperatives specialize in loans to farmers' cooperative associations. The production credit corporations do not engage in any
form of lending, but organize, supervise, and assist in capitalizing a
Nation-wide system of local cooperative production credit associations.




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MONETARY, CREDIT, AND FISCAL POLICIES

The sources from which these several institutions obtain their capital
also differ. The Federal intermediate credit banks and production
credit corporations are wholly owned by the Government. The banks
for cooperatives are capitalized in part through stock ownership of
borrowing cooperative associations and in part by funds provided by
the Government. Although the production credit corporations furnished most of the initial capital of the production credit associations,
these associations are making rapid progress in retiring Government
capital. Of the 503 production credit associations, 59 are now wholly
owned by their members and (as indicated under question 1) it is the
goal of all the associations to become wholly owned by farmers as soon
as feasible.
The Federal intermediate credit banks were not established for the
sole purpose of serving production credit associations. Their facilities
are utilized by the various types of local financing institutions and
cooperative associations. As of June 30, 1949, there were 80 agricultural and livestock credit corporations and 3 commercial banks rediscounting with the Federal intermediate credit banks, If the credit
banks were to assume responsibility for the supervision of the production credit associations, that phase of their operation would be in direct
competition with the other eligible financing institutions which utilize
the discount facilities of the banks.
The consolidation of the functions of the Fedefal intermediate
credit banks and the production credit corporations would present
serious problems. As stated, the intermediate credit banks are banks
of discount. Since they obtain their lending funds primarily through
the sale of non-Government-guaranteed debentures in the investment
markets and by borrowings from commercial banks, it is essential that
paper offered to them for discount be analyzed objectively from an
independent viewpoint without concurrent responsibility for supervising the management of the local lending institutions offering the
paper for discount. In this respect the operations of the credit banks
are similar to the discounting function of the Federal Reserve banks.
The separation of the discounting and supervising functions has long
been recognized in the commercial banking structure where the Federal Reserve banks discount paper for commercial banks which, however, are supervised by the Comptroller of the Currency or by State
banking authorities. To inject the intermediate credit banks into the
operations of the production credit associations through the medium
of supervision would be inconsistent with their primary functions.
There are in each district four separate and distinct corporations,
whose activities are coordinated or correlated through a common
board of directors, the district Farm Credit board. The members of
the district Farm Credit board are, ex officio, the directors of the four
separate corporations in each district. Through such common directorates, responsible for the affairs of all four institutions, there is
opportunuity for consistent policies and practices and for maximum
utilization of personnel and facilities.
10. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by the Hoover Commission ? On balance, do you favor the
establishment of such a body ? If so, what should be its
composition ?




277 MONETARY, CREDIT, AND FISCAL POLICIES

The Hoover Commission, on page 48 of the Report on Federal
Business Enterprises, made the following statement:
We recommended in our report on the Treasury Department that a National
Monetary and Credit Council should be appointed by the President to coordinate
and direct domestic lending and guaranties by the Government. There is already
a successful council concerned with foreign lending. This domestic Credit Council
should be located in the Treasury Department under the chairmanship of the
Secretary of the Treasury, with representatives of such agencies as the President may determine. This Council should consider the activities of agencies in
the credit field so as to secure coordination of purpose, and to avoid overlapping
activities and inconsistent credit policies.

On the other hand, the Hoover Commission in its report on the
Treasury Department, recommendation No. 9, made the following
recommendation:
We recommend that there be established a National Monetary and Credit
Council of domestic financial agencies in connection with the Treasury to advise
on policies and coordination of the operations of domestic lending and Government financial guaranties.

The recommendation in the Treasury Department report would
seem to limit the National Monetary and Credit Council to an advisory capacity, while the statement in the Report on Federal Business
Enterprises indicates that the Council would "coordinate and direct
domestic lending and guaranties by the Government" and that "this
Council should consider the activities of agencies in the credit field
so as to secure coordination of purpose, and to avoid overlapping
activities and inconsistent credit policies." We are assuming that the
purpose such a council would serve is that stated in the report on the
Treasury Department. If this assumption is correct, we have no objection to the recommendation. As to the composition of such a
council, we would like to limit our suggestion to the statement that
at least one of the members of the Council should represent the interests
of the cooperative lending institutions of the Farm Credit
Administration.
11. What changes, if any, in the organization and administration of the various Federal Farm Credit agencies and in their
relationships to each other would you recommend to increase their
efficiency and their effectiveness in achieving the objectives listed
in (1) above?
As has been indicated in answers to the other questions, the institutions supervised by the Farm Credit Administration were established
by the Congress over a period of years to provide permanent and dependable credit facilities for farmers and their cooperative organizations. Under existing provisions of law, the relationships of the Farm
Credit organizations in the districts have been made more effective by
having the members of the Farm Credit board serve as ex officio members of the boards of directors of the individual banks and corporations
than would have been possible with boards composed of different individuals. The national phases of the policies and procedures of the
several systems have been correlated through the supervisory functions of the Washington office of the Farm Credit Administration.
Since its creation the Farm Credit Administration and the institutions under its supervision have kept clearly in mind the purposes and
objectives for which they were established, and have consistently
endeavored to make their services more effective and more fitting for




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MONETARY, CREDIT, AND FISCAL POLICIES

the peculiar needs of those engaged in agriculture. On the basis of the
experience gained in administering these credit systems and in view
of changing conditions, the Farm Credit Administration has made a
continuous study of procedures and operations and of the changes that
are necessary to accomplish the purposes and objectives to the fullest
extent. As a result of the foregoing studies, changes have been made
which led to improved services, better coordination, and more economical operations, and which did not require legislation. An outstanding
example of this type of change is the decentralization of responsibilities, authorities, and functions to the district institutions and local
associations. Other changes have been made through necessary legislation as indicated by the number and frequency of amendments that
have been made to the laws governing our operations upon the recommendation of the Farm Credit Administration, and by similar recommendations now pending before the Congress, for the purpose of improving operations and rendering maximum service to farmers and
their cooperative organizations. As an example of this, H. R. 3699,
now pending in Congress, was recommended and sponsored by the
Department of Agriculture and the Farm Credit Administration to
bring about certain economies in operations and to provide greater
service to those who use the Federal land bank system. Another bill
which is also pending in the Congress, H. R. 848, contains provisions
which we favor and which, if enacted, would enable the 13 banks for
cooperatives to render greater service and to become eventually owned
by the cooperative associations which borrow from them. Both types
of actions, those requiring legislation and those not requiring legislation, have been worked out with the district Farm Credit boards and
officials.
The committee will be interested in the opinions of disinterested bodies who have studied from an objective point of view these systems
supervised by the Farm Credit Administration. The following is
quoted from the Task Force Report on Agriculture Activities (appendix M) Prepared for the Commission on Organization of the Executive Branch of the Government, January 1949, page 62:
Cooperative credit for American farmers was established in 1917 with the
passage of the Federal Farm Loan Act. Subsequent legislation has resulted in
a well-rounded credit system providing both long- and short-term credit to agricultural producers and their cooperatives. While the Congress provided temporary capitalization of the lending- agencies, the loanable funds are provided
through the sale of bonds and debentures to the investing public. These agencies
are rapidly becoming borrower-owned and controlled with Government capital
being returned to the Treasury, and with substantial administrative authority
being delegated to locally elected association farmer boards of directors. The
record of the cooperative credit system through the years is impressive, not only
because of the direct service rendered to borrowers, but because of its general
pace-setting value as well. It has operated at low cost, with as much control
delegated to borrowers as was compatible with sound lending practice. The
system has not only set the pace from a cost standpoint, but originated types of
special services to borrowers in time* of acute distress when private lending
agencies were faced with greatly curtailed lending operations. That the interest of the general public was furthered through the distressed decade from 1931
to 1940 would appear to be beyond question.

The following statement is quoted from page 13 of the Comptroller
General's Report on Audits of Corporations of the Farm Credit Administration, 1946 (80th Cong. 2d sess., H. Doc. No. 598) :
In our opinion the Farm Credit Administration and the corporations supervised by it have been well managed and effectively operated and have been no-




279 MONETARY, CREDIT, AND FISCAL POLICIES
tably successful in the credit fields in which they operate. This may be attributed
largely to the high degree of autonomy enjoyed in practice by the management
of the Farm Credit Administration. Credit for that success is due also to the
aggressiveness and resourcefulness of a career-management group who have
developed, guided, and operated the Farm Credit Administration and the corporations, and to the perpetuation of that group through continuous development
of competent leaders within the system.

We do not see any major changes which appear to be feasible at the
present time other than those proposed in pending legislation, upon
which we have reported favorably. We shall, of course, continue our
studies of the organization. As the need for changes arises we shall
make them if within our authority, and if not we shall submit recommendations through appropriate channels.

APPENDIX TO CHAPTER V I I I
AUGUST 1949.
QUESTIONNAIRE ADDRESSED TO THE FARM CREDIT ADMINISTRATION

1. What do you consider to be the major purposes and objectives
of the Farm Credit Administration and of the farm credit agencies
under its jurisdiction ?
2. Do you believe that the farm credit agencies under your jurisdiction should operate continuously or that they should operate only in
emergency periods? If you favor their continuous operation, what
are your principal reasons for this ?
3. What, if any, are the gaps or inadequacies in the private financial
system that justify the operation of the farm credit agencies that are
under your jurisdiction ?
4. What degree of control over the amounts, interest rates, and other
terms of loans by the farm credit agencies under your jurisdiction is
exercised by the Farm Credit Administration in Washington ? By the
authorities in the 12 district offices ? By the national farm loan associations and the production credit associations ?
5. What principles govern the determination of the interest rates
charged by the farm credit agencies under your jurisdiction?
6. What policies of the Federal farm credit agencies (interest rates,
amounts of loans, bases for valuing property, etc.) tend toward the
maintenance of general economic stability and stable general price
levels, and what policies may tend toward instability ?
7. To what extent and by what means are the policies of the Federal
farm credit agencies coordinated with the general monetary and credit
policies of the Federal Reserve and the Treasury ?
8. In what ways, if at all, does the Federal Government subsidize
the Federal farm credit agencies? If possible, estimate the annual
amount of these subsidies.
9. Do you favor adoption of the Hoover Commission recommendations that the Federal intermediate credit banks, the banks for cooperatives, and the production credit corporations should be consolidated, and that the merged system should adopt the principle of
mutualization ? Please give reasons for your answer.




280

MONETARY, CREDIT, AND FISCAL POLICIES

10. What would be the advantages and disadvantages of establishing a National Monetary and Credit Council of the type proposed by
the Hoover Commission ? On balance, do you favor the establishment
of such a body ? If so, what should be its composition ?
11. What changes, if any, in the organization and administration
of the various Federal farm credit agencies and in their relationships
to each other would you recommend to increase their efficiency and
their effectiveness in achieving the objectives listed in (1) above?




CHAPTER I X
R E P L Y B Y F R A N K P A C E , JR., D I R E C T O R , B U R E A U O F
BUDGET, E X E C U T I V E OFFICE OF T H E

T H E

PRESIDENT

M Y D E A R SENATOR DOUGLAS : In your letter of August 2 2 , 1 9 4 9 , you
have asked for the Bureau's views on nine major questions of monetary, credit, and fiscal policy which are currently being studied by a
subcommittee of the Joint Committee on the Economic Report under
your chairmanship.
Answers to six of these questions are enclosed. The other three
questions raise organizational issues which are currently under study
by the Bureau and on which, therefore, formal reply would be premature. However, I would be very glad to discuss these issues informally with you whenever convenient, and members of my staff are
available to discuss them with any members of your staff whom you
may designate.
Sincerely yours,
F R A N K P A C E , Jr., Director.
ANSWERS

TO

QUESTIONNAIRE

ADDRESSED TO T H E

DIRECTOR

OF

THE

B U R E A U OF THE BUDGET BY THE J O I N T COMMITTEE ON T H E E C O N O M I C
REPORT

2. What role has the Bureau of the Budget played in coordinating the policies of the various Federal agencies that supervise and
examine commercial banks? What are the principal obstacles
to successful coordination of the actions and policies of these
agencies ?
The Bureau of the Budget has played a relatively minor role in
coordinating the policies of the Federal bank supervisory agencies.
During the last decade few serious problems have arisen in this area.
Furthermore, direct cooperative action by the agencies has often not
required participation by this office. The normal coordination incident to review of agency budgets has not been possible because such
budgets are not currently reviewed by the Bureau and the Congress.
The Bureau, however, has helped to promote more effective coordination in several ways:
(a) As part of the normal process of legislative clearance, the Bureau has regularly referred draft legislation affecting bank supervision
and proposed agency reports on such legislation to the various agencies
with the objective of developing, wherever feasible, a unified administration position.
(b) The Bureau participates in the planning and appraisal of
statistical programs of joint concern to the supervising agencies. It
lias established an interagency committee to deal with problems of
banking statistics. One of the committee's achievements has been an




281

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MONETARY, CREDIT, AND FISCAL POLICIES

agreement on a single set of statistics covering all banks in the United
States (including those outside Federal supervision) to replace three
series previously prepared independently by the agencies.
(c) From time to time the Bureau has made studies of the organizational problems of these and related agencies. Staff advice on these
topics was provided at the request of the Commission on Organization
of the Executive Branch of the Government.
(d) The Bureau reviews the administrative expense limitations
proposed by the FDIC and sets personnel ceilings for the FDIC and
the Comptroller of the Currency.
(e) The Bureau recently made a comparative study of examination
programs of the three agencies and of the Home Loan Bank Board,
and is currently engaged in reviewing the findings with the agencies
involved.
( / ) From time to time the Bureau refers policy problems affecting
bank supervision to other agencies in the Executive Office of the President for assistance in review and coordination.
One of the problems involved in securing more complete coordination by either the President or the Congress is the autonomy of the
agencies concerned. An additional element of autonomy in the case
of the Federal Reserve System is that each of the 12 Reserve banks
in practice operates largely as an independent bank supervisory unit
with only minor review by the Board.
Other problems of coordination arise from:
(a) The divergent major functions and the varying types of banks
supervised by the three agencies.
(b) Need for cooperation with the 48 State bank supervisors.
Many supervisory policies affecting federally insured State banks can
be implemented best by joint action.
(c) The confidentiality of the basic data. This makes it difficult
to appraise the seriousness of existing problems and the effectiveness
of the execution of policies to meet such problems.
4. What role has the Bureau of the Budget played in coordinating the monetary, credit, and debt-management policies of
the Federal Reserve and the Treasury ?
The Bureau has not devoted any major efforts to coordination in
this area, because of the continuing close relationship between the two
agencies and because budgetary issues have not usually been involved.
However, the Bureau has played an increasing role in its legislative
clearance process in referring legislation and reports on these and
related topics to the two agencies. Unresolved policy questions have
also occasionally been referred to the Council of Economic Advisers
and to the President or his immediate staff.
5. Have the policies of the Government agencies that lend and
insure loans been satisfactorily coordinated with each other and
with general monetary and credit policies? If not, what have
been the major deficiencies?
Federal loan and loan-insurance programs fall largely into four
major groups, corresponding to the broader Government programs
of which they are a part. The major facts in each area are summarized in the following paragraphs:




283 MONETARY, CREDIT, AND FISCAL POLICIES

(a) Farm credit.—The main programs are those administered by
the Farm Credit Administration, the Farmers Home Administration,
and the Rural Electrification Administration. In addition, the Commodity Credit Corporation makes and guarantees short-term loans
as an adjunct of its price-support operations, and the Administrator
of Veterans' Affairs guarantees farm loans to veterans. With the exception of the last-named operation, all of these programs are supervised by the Secretary of Agriculture. Within the limits set by the
basic statutes the policies appear to have been consistent both with the
over-all agricultural program and with the prevailing Federal monetary and credit policies; for example, the valuation policies followed
on farm-mortgage loans have been based on long-run normal values
rather than market prices.
(b) Business credit.—The Reconstruction Finance Corporation
carries on the only active and reasonably comprehensive business-loan
program of the Federal Government. In addition, the Administrator of Veterans' Affairs guarantees a large number of relatively small
business loans to veterans. The industrial loan and guaranty program of the Federal Reserve banks is now virtually dormant. The
RFC maintains close relationships with the VA, and in some cases
makes loans to veterans covered by VA guaranties. Credit policies
of RFC have from time to time been adjusted to national credit and
economic policies; e. g., in recent months special efforts have been
made to provide needed credit assistance promptly to businesses in
depressed areas.
(c) Housing credit.—Government credit aids to housing consist
primarily of guaranties of private loans by the Federal Housing Commissioner and the Veterans' Administrator and direct loans and mortgage purchases by the RFC. In addition, the Federal home-loan
banks advance funds to member savings and loan associations (and
other member institutions) and the Public Housing Administration
purchases and indirectly guarantees the securities of local housing
authorities. Under recently enacted legislation, the Housing and
Home Finance Administrator has authority to make loans to local
public agencies for urban redevelopment and the Secretary of Agriculture is authorized to make loans for farm housing. The Housing
and Home Finance Administrator has general authority over the
policy of the three constituent agencies (FHA, PHA, and the Home
Loan Bank Board) and also presides over the National Housing Council, an advisory body on which the VA, the RFC, the Department of
Agriculture, and other agencies with housing programs are
represented.
Coordination of credit and noncredit aspects of the housing program, as well as coordination of the various types of housing credit,
have been greatly improved in recent years, but some shortcomings
are still evident. The liberal credit terms necessary to help meet
emergency postwar housing needs of particular groups have at times
conflicted with the need to achieve the lowest possible level of construction costs and sales prices. Similarly, the veterans' preference
objectives of the separate VA loan-guaranty program have at times
proved inconsistent with the objective of the general housing program
to improve housing standards.
98257—49

19




284

MONETARY, CREDIT, AND FISCAL POLICIES

(d) Foreign credit.—Active foreign lending operations of the Federal Government are centered in the Export-Import Bank, which
makes direct loans and guarantees private loans on its own account as
well as on behalf of the Economic Cooperation Administration. From
time to time the Treasury Department and the RFC have been authorized to make specific loans to foreign governments, but 110 unused
authority is now available. Review of the policy of these and other
foreign financing activities of the Federal Government is vested by
statute in the National Advisory Council 011 International Monetary
and Financial Problems, an interagency committee headed by the Secretary of the Treasury; other agencies represented include the ExportImport Bank, the Department of Commerce, the Federal Reserve
Board, the State Department, and the EC A. With some exceptions,
the terms and magnitudes of these operations have been dictated more
largely by considerations of foreign policy than of over-all credit
policy.
In summary, with the possible exception of certain aspects of the
housing credit programs, the credit programs within each area appear
to have been coordinated satisfactorily with each other as well as
with associated noncredit programs. Coordination of separate credit
programs with general monetary and credit policies has not always
been fully satisfactory. In part this is the result of the fact that the
process of coordination often has involved difficult decisions between
two' conflicting objectives, both of which were desirable. Aid to
veterans' housing (chiefly in the form of easier credit), for example,
has at times been given a higher priority than over-all credit policy.
By the same token, aid to small business may be so significant at
times in maintaining a competitive economic system, or aid to foreign
governments so important to' our national interest that credit for these
purposes is justified even when it conflicts with the objectives of overall credit policy. The purpose of coordination in such instances is
to make sure that decisions are reached on the basis of all relevant
considerations, rather than to assure that credit policy objectives are
always dominant.
6. What role has the Bureau of the Budget played in coordinating the policies discussed in (5) above? What have been the
major obstacles to the attainment of satisfactory coordination?
The role of the Bureau in coordinating these policies has varied for
different credit programs, depending in part upon the extent and
effectiveness of other methods of coordination. Problems of farm
credit and foreign credit have required less attention than those of
housing credit and business credit. The major types of Bureau
activity may be summarized as follows:
(а) In the case of agencies submitting budgets, the Bureau has
used the budget review process to explore problems of interagency
coordination and, where necessary, to bring them to the attention of
the President. For example, in preparing the 1949 budget, the rapid
expansion in business loans originally estimated by the RFC was
called to the attention of the Corporation as inconsistent with the antiinflation program.
(б) As part of its responsibilities for reviewing the organizational
structure of the Federal Government, the Bureau has initiated or
assisted in numerous reorganizations designed to bring about more




285 MONETARY, CREDIT, AND FISCAL POLICIES

effective execution of Federal credit programs. The Bureau prepared
the original Executive order setting up the National Housing Agency,
under temporary war powers, and the more recent reorganization
plan providing permanent authority for its successor, the Housing*
and Home Finance Agency. It participated in drafting the Executive order merging the credit program of the Smaller War Plants
Corporation with the business loan operations of the Reconstruction
Finance Corporation.
(r) In clearing proposed drafts of legislation and agency reports,
the Bureau has been able to help resolve many interagency differences
on legislative aspects of credit programs and often to secure Presidential determinations when the issues have required such action. The
objective has been to make sure that views of all interested agencies are
fully considered, and to determine wherever feasible the proposals
most consistent with the President's program.
(d) The Bureau, on its own initiative or participating with other
representatives of the President, has encouraged agencies to revise
operating policies which were not fully consistent with related programs or with over-all policies. For example, to help implement the
debt-liquidation portion of the wartime economic stabilization program, the President at the suggestion of the Bureau requested various;
Government credit agencies to review regulations and practices (e. g.,
FHA requirements discouraging prepayments) with the objective of
accelerating retirement of debt.
(e) By promoting consistency and comparability in statistics obtained from various sources, the Bureau helps provide a common basis
for policy decisions by agencies operating in the same or related areas.
In addition to the normal continuing activity of this type in all the
major credit areas, special assignments are carried out from time to
time. For example, the Clearing Office for Foreign Transactions
which summarizes the Government's foreign financing activities for
the use of the various agencies with international programs was the
result of an interagency study under the Bureau's leadership at the
request of the Senate Appropriations Committee.
The special obstacles to fully satisfactory coordination thus far have
been:
(a) The considerable autonomy or independence of several of the
agencies concerned.
(b) The authority of some credit agencies to vary interest rates,
down payments, etc.. with changing economic conditions is limited in
certain respects. In other cases the legislative intent is ambiguous,
and the agencies in question are understandably reluctant to make the
policy shifts wiiich may be required.
(c) Some agencies established to combat deflation and unemployment have not always been aware that their operations could aggravate inflation, specifically that even loans for productive purposes at
times can be inflationary.
8. What in your opinion should be the guiding principles in
determining, for any given period, whether the Federal budget
should be balanced, should show a surplus, or should show a
deficit? What principles should guide in determining the size
of any surplus or deficit ?




286

MONETARY, CREDIT, AND FISCAL POLICIES

No simple rule of thumb is adequate to determine over-all budgetary
policy. Rather, the policy which should be followed in any given
year depends upon a series of considerations, no one of which provides the complete answer.
{a) Requirements of economic policy.—The Federal Government
has a recognized responsibility to promote reasonable economic stability and progress. Fiscal policy represents one of the major
methods, if not the primary method, of fulfilling this responsibility.
Consequently budgetary policies can be considered sound only if they
contribute, to sound economic policies. Budgetary policies which do
not contribute to these objectives, moreover, are self-defeating, since
the volume of budget receipts, and even of certain expenditures, is
largely determined by the level of economic activity. As the President emphasized last summer, budgetary surpluses cannot ordinarily
be achieved in a declining national economy. Rather the way to
achieve such surpluses is to pursue the types of budgetary and other
policies which wTill increase national income and taxpaying capacity.
(b) Long-range fiscal outlook.—For any given year it is impractical
to count on achieving any specific goal, whether a balanced budget,
or a predetermined surplus or deficit. Over short periods, in fact,
budget receipts and expenditures not only fluctuate with changes in
the level of economic activity, but also are relatively uncontrollable
for various other legal and technical reasons. Some programs, like
interest on the public debt, constitute a fixed charge. Expenditures
on others are largely made to carry out firm commitments of various
sorts made in earlier years. Still others, e. g., certain public works,
can be slowed down or speeded up rapidly only by measures which
substantially increase the total cost.
For certain "open-end" programs, the conditions of expenditures are
set by the authorizing legislation, but the amounts spent are determined by costs or by decisions of private individuals and organizations
or of State and local governments. Short-run, largely unpredictable
fluctuations in expenditures not subject to control of either the President or the Congress (e. g., for agricultural price support or mortgage
purchases) can substantially change the surplus or deficit. If such
erratic changes in the budget outlook were to serve as the basis for
budget policy decisions, many continuing programs of great value
would be irreparably harmed at some times, and at others programs
of lesser priority could be introduced which would be difficult to
remove.
Rather the fundamental fiscal consideration should be the long-run
outlook for expenditures, receipts, and public debt. The policies contemplated in the budget of any given year, therefore, should be judged
primarily in terms of their impact on the budget and the public debt
over a period of years, rather than in terms of their interim effects.
(c) Productiveness of expenditures.—Within the limits set by the
previous considerations, it is also essential to give considerable weight
to the productiveness of specific major expenditure programs as well
as to the effect on private production of the tax structure. Federal
investments (including loans) which build up the productive capacity
of the Nation in the long run will add to national income and taxpaying capacity. It would be short-sighted either to eliminate such
expenditures or to starve the existing Government plant by inadequate
maintenance and improvement. In the postwar period we have un


287 MONETARY,

CREDIT, AND FISCAL POLICIES

fortunately had to hold expenditures of this type to an unduly small
share of the budget. These aspects of the budget are receiving
increasing attention in planning future programs.
(•d) International situation,—In the last decade the international
outlook has often been the major controlling element in the Federal
budget. As long as the cold war continues, the national security will
require maintenance of a large defense establishment and temporary
programs of aid and assistance to friendly nations may also be needed.
It is urgent that all efforts be continued to reduce the necessary outlays
for these purposes to the bare minimum. Nevertheless, as long as
we continue, as in recent years, to limit other expenditures only to
prior commitments and other urgently required domestic programs,
it may not at times be possible to balance the budget without changes
in either domestic or internationl programs which would be contrary
to our national interest, or without temporary revisions in taxes which
would do more harm than good.
9. Do you believe it is possible and desirable to formulate automatic guides for the Government's over-all taxing-spending policy %
If so, what types of guides would you recommend? What are
the principal obstacles to the successful formulation and use of
these guides ?
Since, as indicated above, the problems of budgetary policy are
complicated, automatic guides do not appear feasible. The appropriate policy often involves a decision between two or more conflicting
principles. We know of no way in which these conflicting principles
can be fitted into a single formula which gives simple and unambiguous
answers.
The fundamental importance of basing budgetary policies on longrun rather than short-run considerations has already been emphasized.
In this and several other respects, the proposals of the Committee for
Economic Development for "a stabilizing budget policy" have considerable merit as a starting point. We do not believe, however, that
this policy would be adequate, except for minor business fluctuations,
to fulfill the Government's responsibility to use fiscal policy as one
major instrument in achieving reasonable economic stability.

APPENDIX TO CHAPTER

I X
AUGUST 1949.

QUESTIONNAIRE ADDRESSED TO THE DIRECTOR OF THE BUREAU OF THE BUDGET

1. In what respects, if at all, has the division among Federal agencies of the authority to supervise and examine commercial banks had
undesirable results ? Has it led to conflicts of policy ? To undesirable
delays in taking action ? To unnecessary expenditures in performing
these functions ? Would you recommend that this division of authority
be altered ? If so, in what way ?
2. What role has the Bureau of the Budget played in coordinating
the policies of the various Federal agencies that supervise and examine
commercial banks? What are the principal obstacles to successful
coordination of the actions and policies of these agencies ?




288

MONETARY, CREDIT, AND FISCAL POLICIES

3. If the FDIC is continued as an independent agency, should it be
subject of title I of the Corporation Control Act of 1945 ?
4. What role has the Bureau of the Budget played in coordinating
the monetary, credit, and debt management policies of the Federal
Reserve and the Treasury ?
5. Have the policies of the Government agencies that lend and insure
loans been satisfactorily coordinated with each other and with general
monetary and credit policies? If not, what have been the major
deficiencies ?
6. What role has the Bureau of the Budget played in coordinating
the policies discussed in (5) above? What have been the major obstacles to the attainment of satisfactory coordination ?
7. What would be the advantages and disadvantages of establishing
a National Monetary and Credit Council of the type proposed by the
Hoover Commission ? On balance, would you favor the establishment
of such a body? If such a council were established, what provisions
relative to its composition, powers, and procedures would make it
function most satisfactorily ?
8. What, in your opinion, should be the guiding principles in determining, for any given period, whether the Federal budget should be
balanced, should show a surplus, or should show a deficit ? What principles should guide in determining the size of any surplus or deficit?
9. Do you believe it is possible and desirable to formulate automatic
guides for the Government's over-all taxing-spending policy ? If so,
what types of guides would you recommend ? What are the principal
obstacles to the successful formulation and use of such guides?




CHAPTER X
REPLIES BY BANKERS, ECONOMISTS, AND OTHERS TO A
GENERAL QUESTIONNAIRE
Only the materials included within quotation marks are direct
quotations from the respondents' replies. Other materials represent
a digest of the replies received.
1. What should be the guideposts and objectives of monetary
and credit policies ? For example, in formulating these policies
what consideration should be given to the behavior of general
price levels, to individual prices, to employment, to interest rates,
and so on ? What are your major criticisms, if any, of the guideposts and objectives of our monetary and credit policies in the
past?
A. ANSWERS BY ECONOMISTS

Howard R. Bowen: There is no single or simple guidepost. "The
general objective should be economic stability and expansion with
reasonably full employment and reasonably stable prices * * *."
tilmer V. Bratt: The problem is not so simple as to permit the
stabilization of a price index or the setting of quantitative limits on
credit for selective areas. The secular trend of prices should be gently
upward. Encourage secular increases in credit but discourage cyclical
increases.
Neil Carothers: (1) To maintain a sound currency system based
011 a gold standard; (2) to control credit to the degree that booms
will be restrained and depression periods will be ameliorated.
C. O. Fisher: Full operation of the economic system including a
high level of employment and production. No one criterion can be
relied upon; the authorities must exercise enlightened judgment. "In
the recent past, the monetary control has suffered by reason of the
fiscal policy of the Government which is designed to maintain the par
value of marketable Government securities."
Frank D. Graham: "There are two supreme objectives of rational
monetary and credit policy, namely: optimum employment and a substantially stable price level. * * * Monetary authorities, certainly, should make no attempt to influence individual prices, and it
is highly dubious whether they should seek to affect the level of interest rates (though obvious aberrations in the relationship of one rate
to another might well be attacked). Induced changes in the level of
interest rates have widespread repercussions not fully understood but,
in large measure, noxious."
Criticism of our policies in the past:
"The main criticisms of our monetary and credit policies in the past
are that they have paid no attention to (and the authorities denied
concern with) one of the above-stated supreme objectives of a rational




289

290

MONETARY, CREDIT, AND FISCAL POLICIES

monetary policy (the substanially stable price level), and that, so far
as they have pursued the other, they have shown inadequate resolution and have, in fact, been timid, unimaginative, and tardy even in
the inadequate measures taken."
Lloyd W. Mints: The primary aim should be a stable index of
wholesale prices. As a means to this end the stock of money should
increase at a rate about equal to the rate of growth in the economy.
"If we definitely announced that it would be the sole aim of the
monetary agents of the Government to stabilize an index of the price
level (wholesale) I am convinced that the system itself would without
further action maintain a high level of employment and output. There
might be some minor variations in employment, but I am doubtful
that they would be of much consequence."
Criticisms of past policy:
"In my opinion credit policies since the institution of the Federal
Eeserve System could hardly have been worse." It failed to adopt
any announced and definite criterion, it allowed the volume of money
to decline in the depressions following 1920 and 1929, during the
recent postwar period it did nothing to prevent inflation, and in the
first half of 1949 it actually reduced its holdings of governments and
absorbed bank reserves. "* * * during 1920-21 the Board supported deflation; during 1929-32 it failed to do anything of importance
to prevent deflation; during the war and from 1945 to 1948 it supported inflation; and when inflation finally ended and deflation set
in the Board kept step—it now supported deflation."
Roland /. Robinson: "The first goal of policy should be employment, the second goal should be prices; no other goals need be mentioned. These two goals do not need to be in conflict; if they are, it is
because of price rigidities and an excessive degree of labor or industry
monopoly. But the maximum national well-being means full use of
resources and if the price of that is some moderate fluctuation in the
price level, then that price must be paid."
Edward C. Simmons: The primary objective should be stabilization
of the cost of living.
Criticism: "In the past we have had no monetary policy because the
authorities have been permitted freedom to switch from one goal to
another, and thus we have been treated to alternate inflation and
deflation."
Philip E. Taylor: Stabilize price levels and industrial production.
EdwardF. Willett: Minimum interference with the free working of
economic laws. "My chief criticism of past policy is that too much
attention, relatively, has been given to the fiscal needs of the Government, as compared with the general economy."
Harry Gunnison Brown: "* * * One of these is stabilization
of business in general—not of any particular line or lines of business.
The other is the establishment of constancy, and, therefore, fairness,
in the standard of deferred payments, so that borrowers shall not
gain at the expense of lenders through a rising price level nor lenders
gain at the expense of borrowers through a falling price level * * *
no great attention, and probably no attention at all, should be paid
to individual prices or price changes, * * *."
Albert G. Hart: "* * * We must distinguish: (a) Primary
objectives; (b) supplementary objectives; (c) major strategic principles of policy; \d) indicators by which action should be guided.



291 MONETARY, CREDIT, AND FISCAL POLICIES

Most of what I have to say makes sense for both monetary and fiscal
policy—which must be viewed as having their major responsibilities
in common * * *. The primary objectives of monetary and credit
policy (in common with fiscal policy) are best stated as (i) avoidance
of mass unemployment; (ii) avoidance of inflation. If these objectives come into conflict * * * it will be because national policy
toward wage rates and specific prices needs overhauling."
The principal supplementary objectives are "(i) safeguarding freedom by maximizing reliance on even-handed and impersonal measures, and minimizing discretionary authority to issue 'directives'
to individual firms and households; (ii) safeguarding our form of
government by preserving congressional authority over basic policy
decisions; (iii) minimizing disturbances to the economies of our
friends abroad; (iv) protecting the access of small business to loans;
(v) holding down the cost and up the quality of financial services
used by the public."
The major strategic principles shotild be monetary security for the
public, cutting down the inherent instability of bank credit, learning
from experience, and working toward long-run stability on the demand side of the monetary equation.
The principal indicators should be unemployment statistics, price
index numbers, and a "feel" of the banking situation.
* * j g e e n o s e n s e i n trying to use deflationary monetary or
fiscal policy to reverse inflationary mistakes in wage policy—I don't
think it would work and suspect serious avoidable unemployment
would result."
Frederick A. Bradford: "The objectives of credit policy—should
be (a) the maintenance of sound credit conditions, and (6)
the stabilization of business at a satisfactory level so far as this is
possible and compatible with (a) above. I do not favor the stabilization of the general price level as a major objective of credit policy
for the reason that a substantial rising or falling price level is the
result of maladjustments which have previously developed in the
economy. Credit policy should aim at preventing * * * this maladjustment. If successful in this, alarming movements in the general
price level will not occur.
"For similar reasons, I do not view the amount of employment as
a main criterion of credit policy * * *. The law should require
that demand deposits of the banks should be offset on the assets side
of the statement by working-capital or self-liquidating paper and
reserves only, investment-type assets being limited to the banks'
capital funds and savings deposits."
Raymond P. Kent: The major objective should be the full employment of the labor resources of the country at all times. "Stability of
the general price level, which theorists used to think of as a prime
objective, can hardly be regarded as such at a time when so many
key prices do not respond readily, if at all, to changes in market
conditions."
B. H. Beckhart: "The guideposts and objectives of monetary policies should in general be (a) the checking of inflation and thus the
preventing of deflation * * * ( i ) reducing the amplitude of the
business cycle; (c) providing an appropriate environment, insofar as
possible, in which dynamic economic forces can have full sway * * *.




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MONETARY, CREDIT, AND FISCAL POLICIES

"Consideration should be given not only to general prices but also
to particular prices for the reason that inflation may occur in particular segments of the economy which should be checked before affecting the whole economy * * *.
"The principal criticism of the monetary and credit policies followed
since the termination of World War II is that too much emphasis has
been placed on the desirability of preventing the prices of Government
bonds from falling below par. This precluded the use of the interest
rate as a flexible instrument of control.
"Criticisms of policies followed in certain other periods may perhaps
be summarized somewhat as follows: Failure to raise discount rates
in 1919 (such action, however, was opposed by the U. S. Treasury) ;
the easy-money policies of 1924 and 1927; and the failure to follow
a more consistent and decisive policy in 1927 and 1928. In the financing of World War II a different level and structure of interest rates
doubtless should have been employed, but the responsibility for selecting the particular level and structure used must be attributed
to the Treasury rather than to the Federal Eeserve System. As a
final observation, I think it is fair to say that the Eeserve System
has always taken action more quickly to check deflation than inflation.
And yet deflation itself may be avoided only if inflation is checked."
Marcus Nadler: "* * * to help prevent major swings in the
business cycle. A great deal of attention should be given to the
behavior of prices in general but not to individual prices. The same
applies to general employment, although not to employment in individual industries. Interest rates should be considered more a means
to an end rather than an end in themselves. My major criticism of the
past policies of the monetary authorities is that they have been too
much concerned with prices of Government bonds and with preventing even a moderate increase in the cost of carrying the public debt."
Seymour E. Harris:"*
* * the attainment of a stable and growing economy. Those responsible should watch gold flows, monetary
supplies, exchange rates, prices, and the rate of interest as factors
influencing economic conditions; and output, employment and unemployment, as high output and employment and low unemployment
are the ultimate objectives of monetary policies. In general, the
monetary authorities should try to keep interest rates low as a stimulus
to business activity * * *. This does not mean that recourse
should not be had to higher rates of interest in periods of exuberance;
but that policy, because of its cumulative effects, should be used
with extreme caution."
Charles O. Abbott: "* * * preservation of balance in the rate
of change of critical economic factors should be the chief guidepost.
By critical * * *. I mean such elements as the volume of employment, the rate of capital formation, the volume of consumer disposable
income, the general price level, groups of related prices (agricultural
prices, prices of manufactured goods, stock prices, etc.), wage levels,
wages in groups of industries (the building trades, etc.), interest
rates, and profits. The kinds of economic rigidity that are often
implied in such cliches as 'full employment,' (absolutely) 'stable
prices,' 'price parity,' etc., are undesirable goals for monetary and
credit policies, and probably are impossible of attainment."
* * the objective of all governmental policy
E. E. Agger:
should be maximum output, relative full employment, and equitable




293 MONETARY, CREDIT, AND FISCAL POLICIES

distribution of social income. General price levels, individual prices,
the status of employment, interest rates, etc., are all data to be taken
into account but no one of these can of itself be regarded as sufficient.
The major criticism that I should make of our procedures in the
past is the lack of appreciation of the broad complexity of the problem. Our Federal Eeserve System was conceived as the capstone
of a purely commercial banking system, and while in time the concept of the Reserve System responsibility was broadened, and while
efforts were made to achieve other important economic objectives,
the powers of the System and the area within which it could operate
were not adequate to meet modern demands."
Kenyon iE. Poole: "* * * consideration must be given to all
relevant economic data and not to any one of them * * *. Maximum management flexibility is necessary. The essence of the problem is to put capable economists in the top positions and to encourage
secretaries of the Treasury to be interested in the problem of economic stabilization."
Paul
Strayer:
* * to achieve the stabilization of prices
and the continuance of high levels of employment. Individual prices
should not be controlled if a free market is to be preserved. With
minor exceptions the same position must be held with regard to interest rates. The major problem is the appropriate policy to follow
if prices start to rise while there is still unemployment. In this event
the maintenance of price stability should dominate and other remedies for unemployment should be used.
"The major criticism of past policy is that it has been timid and
ineffectual. A positive aggressive policy is needed."
James B. Trant: The guideposts and objectives should include behavior of prices, interest rates, employment, international trade,
and general economic conditions.
Anonymous: The objective should be the stability of the economy.
In a recession or depression easy money policy may contribute to
recovery, provided that expectations of entrepreneurs are favorable.
In the past the administration in power has fostered legislation which
contributed to an unfavorable outlook for profits and thus offset the
effects of an easy money policy. Recent monetary policy has been in
the direction of easier money but at the same time the administration
appears to be favoring a fourth round of wage increases, high support
prices for farm products, and so on, so that political measures may
defeat economic measures that are making for stability. Interest
rates cannot be given much weight so long as there is no free market
for Government securities.
C. R. "Whittlesey: Under ordinary peacetime conditions the main
objective should be the level of productive employment. The other
standards which have been employed (exchange rates, price level,
interest rates) are better viewed as means than as ends of policy. In
the past they were usually treated too mechanically and too little
attention was given to other factors which were also significant.
George R. Walker: The over-all objective should be to maintain a
high level of employment, a reasonably steady general price level, and
a steadily increasing national production and income. Both inflation
and deflation should be avoided. Under conditions of full employment there will be a tendency toward rising wages, rising costs, and
price inflation. The policy then should be to arrest the inflation even




294

MONETARY, CREDIT, AND FISCAL POLICIES

if the result is moderate unemployment (3,500,000). This assumes,
of course, an adequate system of unemployment benefits.
George N. Halm: The objective should be a high degree of economic
stability though not necessarily "full" employment. Next to fiscal
policies our monetary policies are the most important instrument of
control in a free economy. They should be greatly strengthened.
A main criticism of the present state of affairs is that the monetary
authorities have been deprived of the power of influencing the rates
of interest.
E. Sherman Adams: "The general objective of monetary policy
should be to contribute to economic stability. The essential task is to
curb inflationary uses of credit during boom periods. In recent years
too much emphasisis has been placed upon the sheer volume of money
and credit, upon the cost of servicing the public debt, and upon stability of interest rates and bond prices."
HowardS. Ellis: "The main guideposts to monetary and credit policies should be the behavior of some important index of prices and the
volume of employment. However, it is probably impossible to restrict the aims to a cut-and-dried formula. At times the behavior
of inventories and of certain individual prices, particularly of industrial raw materials and of securities, might assume great significance.
At other times, the state of international trade and capital movements
might be highly important,
"My major criticism of past money and credit policies would be that
the Federal Reserve has not realized the full potentialities of its existing powers for contributing to the stability of prices and employment."
Edward S. Shaw: "The objective of monetary and credit policies
should be to avoid sharp inflation either of prices or of unemployment. Most significant indexes include cost-of-living prices,
money-wage rates, and employment data. The development of more
complex indicators should be pressed, including among others, surveys
of business and consumer plans for expenditure.
"Significant errors have been made in selecting guideposts and objectives of policy. It has been a major error, for example, to fix a
pattern of interest rates on Government securities, since the result has
been to turn full responsibility for the money supply over to money
users."
B. ANSWTERS B Y

BANKERS

J. T. Brown, First National Bank, Jackson, Miss.: The most helpful guideposts are changes in the volume of credit and in the manner
in which it is being used, general conditions of business, the over-all
price structure, the employment situation, and gold movements and
international conditions. "The objectives of monetary and credit policies, reduced to their least common denominator are very well defined
in the Banking Act of 1933 as 'The maintenance of sound credit conditions and the accommodation of commerce, industry, and agriculture.'
To that very concise statement might be added further objective, viz,
the adjustment of the volume of credit to the volume of business. If
there is one thing that the banking system needs more than anything
else, that one thing is certainty. The rules may be harsh and difficult, yet if there is continuity of thought and action bankers will
adjust themselves to the situation and business will move along on an




295 MONETARY, CREDIT, AND FISCAL POLICIES

even keel. It is the everlasting threat of change that keeps things in a
constant state of flux and unrest."
Anonymous: "Monetary and credit policies should be shaped by
the object in view of keeping the economy on a stable level, keeping
in mind at all times the long-range best interests of the country. My
major criticism of the monetary and credit policies of the past is that
they have been shaped with too much emphasis on keeping that party
which is in control in power."
Anonymous: Assure stability and safety of the Federal financial
structure and banks; keep the price level as near stable as possible and
aid in stabilizing employment. "Stabilization of interest rates I think
should be subordinated to the above requirements."
R. C. Leffingwell, of J. P. Morgan <& Go., Inc., New York: These policies should be directed toward maintaining a favorable general
atmosphere for private enterprise. "We want neither inflation nor
deflation but flation; we want business to breathe * * *. The
frozen pattern of interest rates, the bond pegging policy of 1948, was
not wise. The price of money, that is, interest, is the most important
of all prices * * *. Our authorities undertook to freeze rates in
a perfect pattern covering maturities over a quarter century to come*
to abolish the price system for money * * *. That was not good."
Lon C. McCrory, Citizens State Bank of Dalhart, Tex.: The purpose
should be to maintain a sound currency and confidence in our Government. "Major criticisms are that the guideposts are too often plagued
by administrative and political yielding through influences brought
by powerful organizations—labor unions, veterans, etc. Except our
Government operate within its reasonable income, free from strangulation of worthy effort, it is difficult to maintain confidence."
Otis E. Fuller, Security State Bank <& Trust Co. of Beaumont, Tex.:
"Get Government out of all loaning or guaranteeing, like FHA."
H. H. Gardner, the Birmingham National Bank <& Farndale National Bank, Mich.: A fundamental consideration is the continuing
effectiveness of a sound, flexible, and responsive commercial banking
structure. Considerations of price and employment levels should of
course influence policy, as factors affecting the credit structure. "It is
not, how ever, the function of the banking system to shore up prices, or
to depress them, or to lend forced stimulus to a theoretical level of
employment as an objective * * *. Policies involving management of money and credit should apply only to the prevention or correction of abuses or destructive trends * * *."
J. R. Geis, The Farmers National Bank, Salina, Kans.: The objectives should be to provide a sound currency, cut down Government
expenditures by elimination of many credit and other agencies which
are now unnecessary to the maintenance of a sound economy, balance
the budget, and cut down the national debt.
* * * With the increase in the money supply, largely occasioned
through deficits in the Federal budget and the creation of a tremendous
debt, monetary authorities find their hands pretty well tied when it
comes to effective measures through adjustment to any extent of the
bank rate or through open market operations."
William S. Gray, Central Hanover Bank <£ Trust Co., New York:
The main objective should be to help prevent wide swings of business




296

MONETARY, CREDIT, AND FISCAL POLICIES

activity and of commodity prices. The major criticism is that the
credit policies on the whole have been inflationary.
James M. Kemper, Commerce Trust Co., Kansas City, Mo.: To alleviate wide fluctuations, but not attempt complete stabilization. I do
not want a planned economy * * *. Long-range public works
should be planned for those periods of severe distress and widespread
unemployment.
Criticism: Policy seems to have been one of conflicting objectives
and frequent changes. Do not like apparent objectives.
Ben DuBois, secretary of the Independent Bankers Association,
Sauk Centre, Minn.:
"The objectives of monetary and credit policies should be to secure
a reasonable degree of stability in our economy. There must be, we
presume, some elasticity in general price levels and considerable fluctuation in individual prices. Technology does not permit a strait-jacketing of individual prices. Monetary and credit policies, if properly
directed, can go a long way in obtaining the desired objective."
R. J. Hofmann, American National Bank of Cheyenne*, Wyo.: "Except during the period of war, I feel that the law of supply and demand
should be allowed to take care of price levels, employment, interest
rates, etc."
P. R. Easter day, the First National Bank of Lincoln, Nebr.:
" * * * The objectives * * * should apply principally to
employment problems and to the maintenance at all times of sufficient
credit facilities to insure as great a degree of stability in our economy
as is possible. I am afraid that we have tried to cover too many objectives in the past."
C. II. Kleinstuck, the First National Bank and Trust Company,
Kalamazoo: Mich.:
"The objective * * * should be the maintenance of a sound
economy. Changes in prices and in employment are indicators or
guideposts of the trends of general business conditions."
Fred W. Glos, the First National Bank, Elgin, III.: "It is time to
do something about taxes if the Administration really wants to give
the free-enterprise system a chance to extricate the country from the
current recession without pushing us further along the road toward
state socialism."
L. M. Giannini, Bank of America, San Francisco: These policies
should in the first instance be designed to maintain a sound currency
which will command confidence in domestic and foreign commerce.
They should permit the maintenance of a generally high and gradually
expanding level of production. It should not be assumed that satisr
factory monetary and credit conditions are the only prerequisites for
the attainment of this general objective. These policies should also
be designed to contribute to stability in the general level of prices, but
except m periods of general price inflation or deflation of major proportions, this objective would be of a secondary nature. In the interest of preserving our Republic it is mandatory that Congress maintain
its traditional control over the purse and sword of the Nation. To
do otherwise would be to lay the foundation for dictatorship.
Leo W. Seal, Hancock Bank, Bay St. Louis, Miss.: In formulating
these policies consideration should be given to supply and demand and
general business conditions. Price levels cannot be handled by these




297 MONETARY, CREDIT, AND FISCAL POLICIES

policies. Employment should be solved by general business conditions.
There has been too much emphasis on the philosophy of pump priming.
David Williams, Corn Exchange National Bank <& Trust Go., Philadelphia, Pa.: The objective should be avoidance of inflation and deflation by mitigating thefluctuationsin business activity and the price
structure without destroying private enterprise and private investment. The general level of prices, employment, and interest rates
should be given consideration, but the most emphasis should be placed
011 the causes of thefluctuationsin these factors. The major criticism
of monetary objectives in the past has been the use of deficit financing
to spur business activity, with the result that it discouraged private
enterprise and private capital investment.
Anonymous: The objectives should be to facilitate the extension of
sound and essential business credits, to avoid credit excesses, and to
contribute as much as possible to economic stability. My principal
criticism of monetary and credit policies in the past is that too much
emphasis has been placed on them. There is a tendency to place too*
much blame on current lending policies and to restrain even essential
credits in periods of inflation.
C.

ANSWERS BY STATE B A N K I N G

COMMISSIONERS

Eliott V. Bell, New York State Banking Department: "The primary objective of monetary and credit policies should be to contribute to stable economic progress. In formulating these policies,
the * * * authorities should be guided not by specific levels of
prices, interest rates, or other elements in the economic picture, but
rather by the general trend and behavior of these economic indicators.
JTo simple, automatically operating rules can or should be laid down."
The principal weaknesses of monetary and fiscal action in the past
have been: (1) Too much was expected and claimed for them; (2) too
little political independence was permitted those who had to formulate
and carry them out; (3) actions were frequently built up by publicity
as a means of appearing to take appropriate action when in fact they
were no more than a smoke screen to cover lack of effective action.
The basic weakness of attempts to influence economic conditions
through monetary and credit policies is that such attempts tend to
become a one-way affair. So long as Government has a controlling
voice, there will always be resistance to taking measures of an unpopular character, and inflationary measures are always unpopular.
Donald A. Hemenway, Commissioner of Banking, State of Vermont:
The objectives of monetary and credit policies should be (a) maintenance of sound conditions; (b) accommodation of agriculture, commerce, and industry.
D.

A N S W E R S B Y OFFICERS O F L I F E - I N S U R A N C E

COMPANIES

Alexander T. Maclean, Massachusetts Mutual Life Insurance Co.,
Springfield, Mass.: "* * * As far as the life insurance company
is concerned, we are naturally anxious that the financial policies of
the Government should result in a sound monetary system in which
the people would have confidence, and under which the value of the
dollar would change as little as possible. This is the very basis of
successful business, and the means of a satisfactory financial mode of




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MONETARY, CREDIT, AND FISCAL POLICIES

life. * * * We cannot be in sympathy with any plan whereby
the Government supplies the banks with excess funds, and in that
way depreciates the value of the dollar."
E.

A N S W E R S B Y OFFICERS OF O T H E R F I N A N C I A L

INSTITUTIONS

Paul E. Haney, 'Washington research representative, Scudder, Stevens & Clark: The chief objective of monetary and credit policy should
be to make the maximum contribution to reducing economic instability.
Within this broad objective are other objectives which can and should
be emphasized at different times: (1) Encouragement of production
and consumption and its counterpart, the discouragement of overconsumption, overinvestment, or excessive borrowing; (2) the maintenance of public confidence in Government credit; (3) facilitate rearmament for defense; (4) the facilitation of reconversion to a peacetime
economy; (5) contribution toward a proper management of the public
debt. The principal criticisms of policies followed in the past are
that they have at times been too narrowly concentrated on one limited
objective and that they have tried to accomplish too much without a
sufficient degree of cooperation and coordination with other Government fiscal and economic policies.
F. A N S W E R S

BY

OTHER TYPES

OF B U S I N E S S

ORGANIZATIONS

Clarence Francis, General Foods Corp., New* York: Monetary and
credit policies should and must concern themselves in varying degrees
with at least the following types of things: (1) Healthy business and
general economic conditions; (2) any speculative or other undue expansion of business inventories, capital investment, security or realestate booms, consumers' durable goods, or other commitments requiring credit; (3) marked distortions in comparative price levels; (4)
distortions amongst each other of prices, wages, and profits which
may be at least partly correctable by credit controls but which credit
controls alone cannot eliminate and should not seek to; (5) interest
rates, which in present conditions are only a minor factor as a guidepost or objective and which are always a tool of credit control rather
than an objective.
Our past monetary and credit policy is subject to a number of criticisms. In fact, it would hardly be unfair to say that these policies
could not be criticized because they did not exist. Our practices in
the monetary and credit field have been largely a succession of ad
hoc expedients, piecemeal actions (or inactions), and not too infrequently inconsistencies or contradictions of past or even concomitant
practices. Among these episodes are: (1) The complete subordination of the Eeserve System to the Treasury even in World War I, to
say nothing of World War I I ; (2) the monetary and credit policy
that led up to 1929; (3) the way Messrs. Eoosevelt and Warren devalued the dollar, day by day; (4) the acceptance by President Eoosevelt of the Thomas greenback amendment of 1933 (he signed the bill);
(5) the innumerable piecemeal amendments to the Federal Eeserve
Act; (6) the control of margins in the stock market by the Federal
Eeserve; (7) the impossible attempt to control inflation in 1947-48 by
credit regulations, reserve changes, etc., while the Eeserve banks stood




299 MONETARY, CREDIT, AND FISCAL POLICIES

ready to buy Federal securities in unlimited amounts in order to
preserve an "orderly condition" in the Government bond market.
John D. Biggers, Libbey-Owens-Ford Glass Co., Toledo: Economic
stability is the primary objective of monetary policy. In general, the
Federal Reserve should restrict the money supply and tighten the
reserve position of the banks in times of business expansion and rising
prices, and expand the money supply and ease the reserve position of
the banks in times of falling production and prices. "Some observers
feel that, in the late twenties, the Federal Reserve Board might have
applied the brakes at an earlier date than it did—namely, August
1929—because such a large volume of stock-exchange and real-estate
credit was built up in the years from 1925 to 1929. I believe there is
some justification for this view. Some observers also believe that the
Board should lay somewhat more weight on the general economic situation and somewhat less weight on the stabilization of the Government debt. I am inclined to believe that there is also some justification
for these views."
Meyer Kestnbaum, Hart Schaffner & Marx, Chicago: Monetary and
credit policies should be designed to advance the general welfare
through the healthy expansion of the economy, and this can be best
accomplished by minimizing the extreme fluctuations of the business
cycle. There is too much confidence in some quarters in our ability
to manage the economy by means of technical devices. Monetary
policies wisely conceived and judiciously applied can guide the economy in the right direction, but there is a great difference between
guidance and direct control. My principal criticism of the policies
that have been adopted in the past is that they have frequently been
contradictory, as, for example, our efforts to maintain low interest
rates.
2. In formulating its policies, what attention should the Federal
Reserve give to interest charges on the Government debt and to the
prices of Government securities? What should be the guiding
principles for any Federal Reserve action relating to the yields
and prices of Government securities ?
A.

ANSWERS BY

ECONOMISTS

Howard R. Bow en: There is no simple or general answer. "Interest
charges on the Government debt, the prices of Government securities,
and the general credit position of the Government are surely among
the many factors to be considered in monetary policy. The importance
of these particular factors will vary from time to time, depending
on psychological attitudes of the public and on the current responsibilities and commitments of the Government."
Elmer C. Bratt: "As soon as possible, Government securities should
be traded on a free market." Do not, however, withdraw support too
rapidly.
C. O. Fisher: "If politically possible, the Federal Reserve should
permit the prices of Government securities to fall somewhat below
par, if necessary for the maintenance of sound monetary policy. The
protection of bondholders, by the assurance of the maintenance of
98257—49

20




300

MONETARY, CREDIT, AND FISCAL POLICIES

par value of securities, is an empty illusion if this be accompanied by an
inflation of prices which, in its economic impact, is more serious than
would be a decrease in the prices of Government securities. It would
be wTell, for example, to adopt a monetary policy which, if needed,
would permit Government securities to fall to some such figure as 90
percent of par value."
Frank D. Graham: "It would be correct, and easy, to say that,
ideally, the Federal Reserve should give no attention to interest charges
on the public debt or the prices of Government securities, but this, no
doubt, would result in its dissolution. If the charges are a matter of
major concern, as now seems to be the case, the Government debt
should probably be segregated from other obligations. The best means
to this end, as I see it, is for the Federal Reserve to continue to stand
ready to take over all Government debt offered to it at a stated price
(par?) under granted power to change reserve requirements at will or
to borrow reserve funds from the members banks at fractionally
higher interest rates than the Government bonds sold to the Reserve
banks might carry. Neither of these operations would impose any
substantial cost on the Reserve banks and either would remove the
threat of inflation inherent in the policy of supporting the Government bond market without any offsetting machinery."
Lloyd W. Mints: " * * * I think the Federal Reserve System
should completely ignore the prices of Government bonds. The Government itself should have no policy in regard to this matter other
than selling at whatever yield may be necessary for the purpose of
obtaining the funds that are to be acquired by borrowing."
Roland /. Robinson: "Any time when money supply started to
increase very much, then the Federal Reserve should abandon price
support and curb the monetary increase. But under conditions of
1947, when money supply was not increasing, I am disposed to believe that their policy was correct. But I should not be in favor of
such support at all times. The first responsibility of the Federal
Reserve is monetary; but, when monetary factors are not contributing to instability (and I do not think they wTere in 1947), then assistance to the Treasury in financing is not inappropriate."
Edward G. Simmons: "Interest charges on the Government debt
(or prices of Government securities, which are the same thing) should
be disregarded. If the debt were once funded into consols without
maturity, the current nonsense could be eliminated. Since we muddled
the financing of the war by borrowing too much, we do not have to
continue with the same errors indefinitely. Let us pay a good high
price to salt down the debt and not go on with more inflation indefinitely, simply to be able to boast that the annual debt service charge
is, after all, not large."
Philip E. Taylor: " * * * The Treasury's concern with interest
changes results in appropriate action when it is desired to expand
employment, but it is counter to public interest in periods of potential
inflation."
Edward F. Willett: "Very little attention should be given to interest
charges and prices of Government securities. As far as possible, they
should be allowed to reach their natural level in a free market. Shortrun stabilization, as opposed to long-run control, may seem desirable
in case of emergency to prevent panic selling. The cost of a naturally
higher long-run rate than a lower one artifically maintained would be




301 MONETARY, CREDIT, AND FISCAL POLICIES

small as compared to the danger to our economy of keeping an artificial
rate and unbalancing our economy."
Harry Gunnison Brown: "* * * If it must seek to keep the
interest charge on Government borrowing lower than it would be in an
uncontrolled market, it may be forced to adopt policies tending to
price level instability. Fluctuating price levels and fluctuating business activity are evils too serious to consider lightly. The Federal
Eeserve System is, I believe, competent to deal with them effectively
if it is not interfered with by contrary duties, * * * In my opinion, the yield and prices of Government securities should not be a
responsibility of the Federal Eeserve System. I do not mean to assert
dogmatically, however, there could be no excuse for Federal Eeserve
action favorable to Government borrowing in a national emergency
such as a desperate war. Nevertheless, even in such a case, the considerations favoring drastic taxation as against reliance on borrowing
from the banking system to such an extent as to bring extensive inflation are very strong."
Albert G. Hart:
* * I do not believe monetary policy can
afford to be hobbled by a requirement to hold the yield on Government
securities within narrow bounds preassigned. Neither do I believe it
best to rely on this rate as the main tool of monetary policy, and 'let the
chips fall where they may' on the bond market.
"We do not have to be concerned with the annual interest charge.
My first recommendation here would be to stabilize interest paid to
bank creditors. I would reconcile this with the need for some flexibility in interest rates by adopting the 'security reserve' suggestion
much discussed in recent years (but with a very high reserve requirement) , and thus relieving the banks of the temptation to dump lowyield Governments whenever higher yield assets are available. The
rate to be paid here should be related to the services banks provide
gratis to customers.
"As to bond prices, it seems to me essential to avoid breaking down
symbols of monetary security. On this ground I would object to a
dramatic discount on Federal bonds. * * * On the other hand,
part of the strategy of debt management is to get bondholders to feel
that they have 'investments' rather than 'liquid assets.' From this
standpoint, public knowledge that bond prices may fluctuate is a good
thing. And under inflationary conditions, bond prices appreciably
below par (requiring holders to forego hope of capital gain, and in
many instances to sell below par value in a way they are reluctant to
do) can help keep the holders of our larg;e mass of bonds from counting
on them as a liquid reserve and thus being willing to pare down cash
or incuj debt. * * * But my main concern with this complex of
questions is to get away from the recent obnoxious situation where
xthe commitment' on the bond market has kept the Federal Eeserve
from using a tightening of bank reserves to check undesirable credit
expansion. In view of the strain on our economy resulting from the
'cold war,' danger of undesirable credit expansion will probably recur,
so that I deplore the recent tendency to assume this issue is dead."
Frederick A. Bradford: "* * * the Federal Eeserve should be
free to buy and sell Government securities as desired without concern
about the effect of such action on the prices or yields of Government
obligations. * * * Generally speaking, the Treasury should fix
the interest rate on its obligations according to conditions determined




302

MONETARY, CREDIT, AND FISCAL POLICIES

in a free market, leaving the Federal Reserve free to buy or sell Governments in accordance with sound credit policy."
Raymond P. Kent: "The Federal Reserve authorities should be free
of any responsibility to maintain a particular level of interest rates
upon the Government debt. It shoiild, as always, 'maintain an orderly
market' in Government securities, but it should be free to permit the
prices to go below par if it is convinced that such a result is necessary
to achieve the objective of continued full employment. The contention that a heavier burden of interest rates upon the national debt is
much cheaper in the long run than the costs of a severe inflation,
though often repeated, remains very pertinent."
B. H. Beckhart: "The Federal Reserve * * * should give minor
consideration to interest charges on the debt and to the prices of Government obligations. Interest rates need to be used as an instrument
of control and inability to make use of the interest rate, as such an
instrument means a loss of credit control by our monetary authorities.
"The Federal Reserve would be justified in intervening in the bond
market in case panic selling developed in Government obligations.
Such intervention, however, should be for short periods and should not
be directed toward maintaining the yields or prices of Government
obligations at any particular level."
Marcus Nadler: " * * * The maintenance of an orderly Government bond market should be one of the principal objectives of the
Federal Reserve authorities. I believe, however, that the Reserve
authorities and particularly the Treasury have laid too much emphasis on the rate of interest which the Treasury pays on the public
debt. The floating debt has increased too rapidly and may cause
trouble unless materially reduced in the not distant future."
Seymour E. Harris: "* * * interest rates on Government securities are a matter of major importance for the country and, therefore,
in formulating policies, the Federal Reserve should consider the effects
of its policies on these rates. * * * this case does not mean that
the Federal Reserve should influence rates in a manner to provide the
Government with the lowest possible interest rates. In fact, there is
a'great danger that the interests of the Government may take precedence over those of the economy as a whole."
Charles C. Abbott: "If we are to preserve a free market economy,
we must have a much freer money and capital market than we have
had since August 1945. Fluctuations in the money and capital markets should be confined only within those considerable limits which, if
exceeded, involve a threat to the stability of other markets."
Karl M. Arndt: "Interest charges on the Government debt—the
price of Government securities—belong to the class of secondary or
circumstantial objectives of Federal Reserve policy. I think it is
expedient to stabilize the bond market, but only if that can be done
without tying the hands of the System in its efforts to keep the economy
running at a high level * * *. I should like to see the Federal
securities market under some other discipline than that of just Federal Reserve policy, such as for example a specific legal requirement
that all banks of deposit must hold Government bonds in secondary
reserves * * *."
E. E. Agger: "* * * the Federal Reserve must inevitably give
considerable attention to the interest charges on the Government debt
and to the price of Government securities * * *. However, the



303 MONETARY, CREDIT, AND FISCAL POLICIES

most important objective here is not the lowest possible rates in the
fiscal interest. The problem should be considered in the light of the
whole economic situation."
Kenyan E. Poole: "The Federal Reserve has no choice but to follow
the Treasury on interest policy on the Government debt * * *
though the maintenance of a fixed pattern of interest rates has considerable appeal, this policy has been carried too far * * *."
Paul J. Strayer: "The Federal Reserve must pay attention to the
Government bond market but cannot discharge its other responsibilities if this consideration is allowed to dominate. A minimum program
would require the Federal Reserve to assure an orderly market and
attempt to prevent panic selling, but not to peg the level of bond prices
at any level. A rise in the interest charges on the Government debt is
less to be feared than a continuance of inflation."
James B. Trant: With our present debt structure the Federal Reserve
should give considerable attention to yields and prices of Governments.
It was, however, poor policy to build up such debt structure with such
low interest rates. The consequence has been a price level too high
and therefore a higher cost to the public than a greater interest charge
would have been.
Anonymous: The Federal Reserve must give consideration to prices
of Government bonds so long as refunding operations run at the present
high level. But the policy should not be to maintain yields on Governments at low levels unless this is compatible with the stability of the
economy. The policy since VJ-day has contributed to rising price
levels. "The Treasury has in the past pointed with pride to the low
interest rates on the Federal debt but nothing has been said about the
fact that these low interest rates were maintained by expansion of the
money supply when the only effect of the expansion must be a rise of
prices. Such procedure implies that the average citizen is easily
deceived or misled in that he will not recognize the fact that the saving
on the service charge of the debt is offset and more by the rise in
prices * * *. The Treasury cannot have its cake and eat it too.
It must not therefore dominate Federal Reserve policy * * *."
George R. Walker: "The Federal Reserve should not allow Government securities to fall below par or the interest rate on long-term
bonds to rise above 2% percent * * *."
C. R. Whittlesey: "Cost of debt financing should be, at most, an
incidental consideration—not more important than has been the case
since 1940 * * *. Policy of maint aining orderly conditions should,
by all means, be continued. To the extent that flexibility can be combined with orderliness it should be sought. Where, as happened in
1947-48, rigidity develops, other methods should be used for controlling credit * * *."
George N\ Halm: The present policy of stabilizing the yields and
prices of Governments has gone too far. A rigid rate of interest is
clearly wrong. The rate of interest has the important function of
directing the available loanable funds into the most productive uses.
We cannot dispense with this guidance in our capitalistic economy.
E. Sherman Adams: Interest charges on the debt and prices of Governments should not be ignored, but they should not be regarded as
major objectives or criteria. The Federal Reserve should of course
prevent disorderly conditions in the Government securities market and




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MONETARY, CREDIT, AND FISCAL POLICIES

wide gyrations in interest rates, but this is very different from a rigid
support-at-par program.
Howard S. Ellis: "In a war, the Federal Eeserve has categorically
an obligation to support the Government bond market. In peacetimes,
by and large, the prices of Governments should be determined by free
market forces, since the holdings of small individual savers are chiefly
in the form of redeemable issues. In the postwar period, the Federal
Eeserve System has been hamstrung in the exercise of central banking
functions by its categoric acceptance of the support of the Government
(or Treasury) pattern of interest rates, as its first obligation."
L. Albert Hahn: "* * * as a matter of principle the monetary
policy should not be influenced by any consideration of fiscal policy.
It is obviously impossible to maintain a sound monetary policy—
aimed at stabilizing the cycle—if the chief weapon, raising interest
rates, cannot be used because it would affect the position of the Treasury. I therefore also consider the large issue of sa vings bonds, which
are practically redeemable at sight, as a major mistake because it made
it practically impossible to raise interest rates. The orthodox idea of
converting as much as possible of the Government debt into long-term
obligations still remains valid."
Edward S. Shaw: "The principle of fixing a pattern of interest
rates on Government securities amounts to resignation of monetary
controls over commodity prices, factor prices, and employment. A
greater degree of flexibility must be allowed in Government security
prices, and more serious efforts must be made to put the public debt
into firm hands. By all means, the burden of interest charges in the
Federal budget must not be a consideration of monetary control."
B. ANSWERS BY BANKERS

Grover Key ton, Union Bank
Trust Co., Montgomery, Ala.:
" * * * the Government should at all times maintain its bonds at
par and should never let them go below par in the open market at
any time." Except for this policy it should not buy and sell bonds
in the market either to boost or depress their prices.
Anonymous: The Federal Eeserve should attempt to keep interest
rates low, but at times it may be in the long-range interest to let some
Government issues secure their natural level.
Anonymous: "As a governmental agency I think the Federal Eeserve should endeavor to keep the interest rate on governmental debt
at as low a figure as possible."
W. Lucal Woodall, Pitkin County Bank, Aspen, Colo.: "I oppose
depression of interest rates."
R. C. Leffingwell, J. P. Morgan & Co., New York: "Instead of
manipulating reserve requirements, the Federal Eeserve should permit
or cause interest rates and Goverment bond prices to vary, but should
maintain orderly markets. * * * Its action should be prompt but
mild in either direction. The guiding principle is to maintain an
orderly market and a favorable atmosphere, but not a frozen market.
It is not the function of the Federal Eeserve to fix prices and yields
of Government securities. The general welfare is more important
than the price of par."
Lon C. McCrory, Citizens State Bank of Dalhart, Tex.: "A low interest rate should be sought by the Federal Eeserve; however, a




305 MONETARY, CREDIT, AND FISCAL POLICIES

reasonable return should be given to the investor holding these securities. Bonds should be pegged at least at par to generate confidence
in Government securities."
Anonymous: "The guiding principle should not be the control of
interest rates, yields, or prices of Government securities, but efforts to
achieve relative stability of the value of the dollar. * * * The glaring example of inappropriate policy was during the recent inflation
when monetary policy was directed primarily to control interest rates
or to peg prices of Government securities instead of doing everything
possible to curb inflationary forces. * * * The argument that rising
interest rates entails cost to the Treasury and the taxpayer is inconsequential when compared with the social cost involved in clipping the
value of the dollar."
W. R. Gott, the National Deposit Bank, Arnold, Pa.: Government
bonds should be pegged at par. I further believe the Federal Reserve
has done a fine job in holding the bonds at the pegged prices.
H. II. Gardner, the Birmingham, National, and Ferndale National,
Michigan: Though every national facility must be utilized to implement a war effort even at the cost of financial orthodoxy, in a postwar period the Federal Reserve should revert to its primary status
as the regulator of credit conditions. In a time of undue credit expansion all borrowers, including the Treasury, should be subject to the
discipline of higher interest rates. "* * * The resources of the
Federal Reserve System should not be used to exempt Government
from the disciplines which, for the good of all, are applied to the
citizen, whether in an individual or corporate capacity."
J. R. Geis, the Farmers National Bank, Salina, Kans.: "The Federal
Reserve System should not be charged with the duty of maintaining
Government bond prices or keeping interest rates low for purposes
of encouraging more liberal Government spending; however, that has
been the policy for the past 15 years. * * * Promises have been
made to the investing public that the price of Government bonds would
be protected for the foreseeable future, and, under such conditions,
it will certainly be difficult to shift the position of the Federal Reserve
bank to the extent that would be necessary to insure an effective fiscal
and credit policy."
"William, S. Gray, Central Hanover Bank & Trust CoNew
York:
"Because of the huge public debt, the Eeserve authorities must maintain confidence in Government obligations. The guiding principle
should be to keep the Government bond market orderly; interest
charges should be secondary to a sound financial policy."
Ben DuBois, secretary, Independent Bankers Association, Sauk
Centre, Minn.; " * * * For the sake of confidence in Government
securities, there should be little fluctuations in prices and the Federal
Reserve seems to be in a position, through buying and selling of Government securities, to maintain a price that fluctuates mildly. This
policy should not be pursued so far as to jeopardize the pursuit of
stability in the economy as a whole."
E. Curtis Matthews, Piscataqua Savings Bank, Portsmouth, N. H.:
The Federal Reserve should give some attention to interest charges
and the prices of Government securities but "such attention should not
be sufficient to hinder the Svstem in carrying out its broad function of
credit control. * * * From November 1947 through November
1948 the Reserve banks were buying United States Treasury bonds in



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MONETARY, CREDIT, AND FISCAL POLICIES

large amounts to support bond prices. This action was directly inflationary and in a period when anti-inflationary moves were in order.
* * * At the start of the business recession last winter the Reserve banks in selling large amounts of Government bonds were exercising a deflationary policy at a time when such action should have
been reversed. This is clear evidence of its impotence to bring to force
its full powers to control credit while supporting Government bond
prices. * * *"
R. J. Hofmann, American National Bank of Cheyenne, Wyo.:
"Other Government agencies borrow money on the open market and
pay rates according to what the lenders believe the market and the use
justifies. I believe the Federal Government should operate on a similar
plan."
P. R. Easterday, the First National Bank of Lincoln, Nebr.: "* * *
The guiding principle of the Federal Reserve should be stabilization of
the Government bond market * * *. Due to the size of the Government debt, prices of Government securities and interest yields will
very definitely determine the general interest rate level for all other
securities. A substantial fluctuation in long-time interest rates can be
very disturbing to both borrowers and lenders * * *. Of course,
certain natural laws cannot be ignored, but nevertheless it would seem
that a properly conducted Federal Reserve System could eliminate
radical credit fluctuations."
C. H. Kleinstuck, the First National Bank and Trust Co., Kalamazoo, Mich.: The prime objective of the Federal Reserve should be
the maintenance of a vigorous and stable economy and to this end it
should regulate the availability and cost of credit. " * * * It is for
that reason desirable that the Federal Reserve Board be unhampered
by any other consideration than to maintain a sound economy and to
prevent the extremes of price fluctuations and the resulting booms and
depressions. The Federal Reserve therefore should be relieved in
times of peace from the necessity of maintaining a price structure on
Government bonds. * * * "
Fred W. Glos, the First National Bank, Elgin, III.: "To maintain a
policy of at least par for Government securities, especially from a
psychological standpoint * * *."
Leo W. Seal, Hancock Bank, Bay Saint Louis, Miss.: They should
not let thefluctuationbe too great. The Federal Reserve policy toward
the Government debt should prevent the public from becoming panicky
and lose confidence. As inflation begins to balloon, sell bonds; and
when deflation becomes apparent, buy bonds.
L. M. Giannini, Bank of America, San Francisco, Calif.: The interest
charge on the Government debt is only one of the elements in the total
cost of Government and only as such should it be given serious consideration in an appraisal by the Federal Reserve of prevailing general
conditions. Support of Government bonds to a reasonable extent
would be in order to maintain the confidence which is essential to the
maintenance of a sound economy.
Anonymous: Interest charges on the public debt should not be important factors in the determination of Federal Reserve policies,
though a certain amount of stability in Government security prices
must be maintained. With the present enormous debt, wide fluctuations in interest rates and bond prices would prove hazardous to our




307 MONETARY, CREDIT, AND FISCAL POLICIES

whole economy and business structure. The strenuous credit measures
of former days cannot now be undertaken with impunity.
David 'Williams, Corn Exchange National Bank & Trust Co., Philadelphia: "Total interest charges on Government debt should be given
only minor consideration by the Federal Reserve in the formulation of
its policies. The guiding principle relating to yields on United States
Government securities should be the maintenance of a sound banking
system by the regulation of interest rates in such a manner as to control extension of credit and still permit banks to operate profitably
and maintain their solvency."
C. ANSWERS BY STATE BANKING COMMISSIONERS

Elliott V. Bell, State Banking Department of New York: In time
of war a central banking system must become subordinate to the financial requirements of the conflict. But if this role is maintained for any
extended period the normal functions of the central bank become
atrophied, or at least unavailable. "* * * Thus, in the period of
postwar inflation, the compulsion which the Federal Reserve System
felt itself under to peg rigidly the Government security market made
it impossible for the System to take any effective measures to reduce
inflationary pressures. Instead, the Federal Reserve System was
forced to resort to increases in reserve requirements which were in
turn largely nullified by the fact that it was compelled to purchase
the Government securities which the banks sold in order to meet these
increased reserve requirements * * *."
In the face of a Government debt of some $250,000,000,000 the central
bank must inevitably have regard for the existence of an orderly market ; there can be no such thing as allowing the Government bond market tofluctuatewith complete freedom. "* * * But it should be made
plain, much plainer than has yet been done, that the obligation of the
central banking system is not to guarantee any fixed price for any
particular Government issue, but is rather to see to it that there is
always a market for any quantity of Government securities at some
level reasonably close to the last previous sale * * *."
E. F. Haworth, Commissioner of Finance of the State of Idaho:
"Present rates fair to both Government and investor. Should be supported at par."
E. ANSWERS BY OFFICERS OF OTHER FINANCIAL INSTITUTIONS

Paul E. Haney, Scudder, Stevens <& Clark, Washington, D. C.:
Though the Federal Reserve should give immediate attention to
interest charges on the Government debt, this should not be a primary
objective when in times like the present the total Federal interest
burden is not out of line with national income. It is important that
the Federal Reserve should maintain an orderly market for Government securities. A fixed price structure should not become an end
in itself. "A flexible price structure on Government bonds is preferable to a fixed structure. The guiding principle for Federal Reserve
action relating to yields and prices of Government securities should be
to integrate such actions with other monetary ancl credit policies so
that in harmony with fiscal and other economic policies they would




308

MONETARY,

CREDIT, AND FISCAL POLICIES

best serve the objective of maintaining economic and monetary
stability."
F. ANSWERS BY OTHER TYPES OF BUSINESS ORGANIZATIONS

Clarence Francis, General Foods Corp., New York: "As a primary
consideration, the Federal Reserve Board should give no attention to
interest charges on the Government debt or to the prices of Government securities. * * * The less the Federal Reserve intervenes in
supporting the Government security market, the less encouragement
it gives to unsound Federal finance. Nor should it intervene too
readily even if the bond market runs away on the up side. Obviously,
anything resembling panicky conditions on the down side in the Government bond market are undesirable, in view of the public ownership
of tens of billions of dollars' worth of bonds, and even though most
of those owned by ordinary individuals are nonmarketable and have
no price fluctuations.
But given the fact that banks can value their Government and
holdings at par, for rediscounting and for valuation of assets, and
given the fact that no selling based on fear of Government insolvency
is probable, and given on top of that, the fact that the Federal Reserve
can exercise practically unlimited powers of bond-market support, is
there not a tendency on the part of the Reserve officials to play 'firemen' too soon and to see 'disorderly' conditions where they do not
exist?"
Meyer Kestnbaum, Hart Schaffner <& Marx, Chicago: "* * * *
I am of the opinion that the support policy was not well considered.
There was justification for the support of bond prices at some point,
but the decision to place the support level above par seems to me to
have been unwise. In my opinion, the effect of slightly lower bond
prices would not have been serious, the effect of moderately higher
interest rates would have been helpful."
3. What changes, if any, should be made in the division of
authority within the Federal Reserve System and in the composition and method of selection of the System's governing
bodies ?
A. ANSWERS BY ECONOMISTS

Elmer C. Bratt: "I believe that substantial centralization of authority in the Federal Reserve System is inevitable. It may have
gone too far, but I have no suggestions to offer."
Neil Carothers: "No changes are vitally necessary."
C. O. Fisher: Select as members of the Board only "such people as
have demonstrated capacity for monetary statesmanship."
Lloyd W. Mints: "I see no need for a change in the method of selection of officials of the individual Reserve banks. * * * it seems
entirely inappropriate that there should be both an Open Market
Committee and a Board of Governors. The former should be abolished and its power given to the Board. Furthermore, I can see no
sense whatever in a board of as many as seven members. If Congress would designate the guide to action to be followed not more
than one person would really be required, although a board of three
would be acceptable. But even though Congress should continue the
discretionary power of the Board there is no need for more than



309 MONETARY, CREDIT, AND FISCAL POLICIES

three members. The Secretary of the Treasury should again be made
a member of the Board. * * *"
Edward O. Simmons: "Monetary policy is a Government function
and should therefore not be farmed out to bankers or any other business group. I would replace the Federal Reserve banks with a Government-owned central bank, control of which would rest with a threeman board of Government appointees. With the policy goal set by
Congress as maintaining stability of the cost of living, there would
he little high policy to be made."
Harry Gvmuson Brown: " * * * Something is probably to be
said * * * in favor of having a unified authority controlling both
the rediscount rate and open market operations, etc."
Frederick A. Bradford: "The division of authority within the Federal Reserve System appears to be satisfactory. In my judgment,
however, the Federal Reserve banks should be represented on the
Board of Governors. In 1935 I suggested a board of 15 members
of which the chairman and 2 vice chairmen should be appointed
by the president * * * the other 12 members to be selected by
the 12 Federal Reserve banks. Some such arrangement still seems
desirable. If 15 is felt to be too large a number, the representatives
of the Eeserve banks could be reduced to 6, thus providing for a
9-member board. The functions of the Federal Open Market Committee * * * should be taken over by the Board, the Open Market Committee as a separate body being abolished."
B. II. Beckhart: " * * * as a tentative suggestion I would propose that the Federal Open Market Committee * * * be enlarged
to in elude a representative from each Federal Reserve bank. This
proposal would increase the membership from 12 to 19 persons. To
the Open Market Committee as enlarged should be delegated not
only its present powers over open market operations but also the
powers of the Board of Governors * * * over changes in discount rates, in member bank reserve requirements, and in margin
requirement on security loans.
"The advantages of this change would seem to be twofold: (1) the
Open Market Committee would possess all credit control powers * * * and (2) the enlargement of the Committee to include
representatives of all the Reserve banks would permit continuous
expression of opinion by each of the regional banks."
Marcus Xadler: Increase the powers of the Open Market Committee to include the power to raise reserve requirements and margin
requirements. "The number of members representing regional banks
should be increased. In selecting members of the Board of Governors of the Federal Eeserve System, the utmost care should be taken
to pick men of outstanding ability and with wide experience in business and finance."
Seymour E. Harris: " * * * The tendency apparent since 1929
of increasing the authority of the Board against the Reserve banks
is the desired direction of movement. Even today the Reserve banks
exercise too much influence. The Reserve banks largely reflect the
views of bankers and large business. In the inflationary period of
1946-48. the Reserve banks along with the bankers were in the forefront in the opposition to what would have been a correct policy,
namely immobilization of additional Government securities with a
view to protecting the Government security against a hardening of



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MONETARY, CREDIT, AND FISCAL POLICIES

rates and some tightening of credit. So long as the bankers retain
much control of the System, so long will the System be operated too
much from the viewpoints of their interests. The airways companies do not control the CAB, nor the brokers and investment
bankers the SEC * * *. We still have to give expression to the
theory that banking is a public interest industry which should be
operated on behalf of the country."
James B. Trant: More responsibility for credit control should be
with the Federal Reserve banks themselves instead of placing all
the authority in the hands of the Federal Reserve Board, as is now
the case.
Anonymous: There is undue concentration of power in the Board.
The Reserve banks are closer to the country than the Board of Governors and for that reason should have more weight on the Open
Market Committee and in other respects. Board policies have often
defeated Reserve bank efforts to build up good working relations with
member banks. Members of the Board as well as the presidents of
the Reserve banks should be selected and appointed because of
their general economic literacy. In particular, the presidents are
often named by the Reserve bank directors because they are believed
to be good executives. The executive duties in a Reserve bank should
be delegated to the first vice president and the president should devote his time to the study of monetary and credit policy with special
reference to their impact on his own district as well as its national
impact.
E. Sherman Adams: "It might be desirable to have the presidents
of the Reserve banks serve in rotation as members of the Board. Salaries of Board members should be increased. Geographical limitations upon membership should be removed."
Howard S. Ellis: "I do not see any especial need for change."
Ed%oard S. Shaw: "In general the division of authority is satisfactory. The principal objection to the structure of the Federal Reserve
management has to do with the quality of the Board of Governors.
In general it is undistinguished. The recommendations of the Hoover
Commission are sound in this respect.
"The principle on which directors are chosen for the individual Reserve banks does not make sense. Directors should be chosen, not for
their representation of special interests, but for their capacity to contribute to intelligent banking policy."
B. ANSWERS BY BANKERS

T. Brown, First National Bank, Jackson, Miss.: "* * * There
should certainly be no further centralization of power, and what is
left of independence in the 12 Reserve banks should be carefully
preserved. * * *"
Grover Key ton, Union Bank & Trust Co., Montgomery, Ala.: " I am
opposed to the centralization of further powers with the Federal Reserve Board in Washington. Why not decentralize these powers and
put them back where they were originally intended, with the 12 Federal Reserve banks ?
"As it was originally intended, the 12 Federal Reserve banks were
represented by a majority on the Open Market Committee. I think
as the matter stands now, the Reserve Board has a majority repre-




311 MONETARY, CREDIT, AND FISCAL POLICIES

sentation and therefore dominates this committee. I think this should
be corrected."
Anonymous: "More power should be given to the separate Federal
Reserve banks. The number of Governors on the Federal Reserve
Board could very easily be reduced to three."
R. C. L effing well, J. P. Morgan <& Co., New York: "I am not prepared to suggest any change in the division of authority within the
Federal Reserve System. The present division of authority is cumbersome and complex, but it is democratic and allows for regional
expressions of opinion and some regional variations in practice. * * *"
Lon C. McCrory, Citizens State Bank of Dalhart, Tex.: "No change
should be made."
Anonymous: Some of the possibilities that might be considered are
the following: (a) Increase salaries of Board members to at least
$25,000 in order to attract men of high caliber; ( i ) select Board members and Reserve bank presidents on the basis of their broad knowledge and experience in the field of finance and economic processes:
(c) reorganize the Board to include the Secretary of the Treasury,
the Comptroller of the Currency, and probably the Chairman of the
FDIC in order to secure greater coordination and responsibilities.
Two or three presidents of the Reserve banks could be added to the
Board on the rotation principle so as to add regional knowledge and
experience. The present membership of the Board would of course
be reduced accordingly; (d) with such a reorganization, combine the
powers of the Board and the Open Market Committee; (e) the chairman of the Board should be selected by the Board rather than appointed by the President, in order to add to the Board's independence; (/) the board of directors of the regional Reserve banks should
be given greater responsibilities than they now have. "* * * Local
boards, representing many very able men, have been reduced to a perfunctory status without having adequate voice in matters of policy
or administration. * * *"
II. H. Gardner, the Birmingham National and Ferndale National
Bank, Mich.: "The Federal Reserve Board should be recognized as a
judicial body to interpret the act and to function as the counselor and
coordinator of the activities of the 12 banks. Though the Board has an
agency relationship to the Treasury, it was not intended to be a department of the Treasury. To the greatest extent possible, the 12
banks should be accorded autonomy, subject to the jurisdiction of the
Board, which should enjoy virtually the status of the Supreme Court,
within the prescribed purposes and limits of the act. The resources of
the Federal Reserve System are drawn from the people, through the
member banks. The greater the independence of the Federal Reserve
Board, and the broader the autonomy of the 12 banks operating within
the act, the more secure wTill be the ultimate welfare of the people."
Anonymous: Authority should not be further decentralized within
the System. "* * * It seems to me that the Board of Governors
should be the top authority in making policy within the System. The
Board should work closely with other Government agencies in order
to avoid cross purposes in economic policies of the Government. Further decentralization within the Federal Reserve System would add
confusion and weaken the necessary coordination within Government."




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MONETARY, CREDIT, AND FISCAL POLICIES

J. R. Geis, The Faimers National Bank, Salina, Kans.: "* * * I
believe the Advisory Committee of the Federal Reserve Board should
be given more than pure advisory authority. There has been too much
centralization of authority in the Reserve Board at the expense of
the district banks."
William S. Gray, Central Hanover Bank <& Trust Co., New York:
"Greater power should be given to the Federal Open Market Committee. Each Federal Reserve bank * * * should retain a reasonable degree of independence in matters related to their respective
sections, and each Federal Reserve bank should have a greater voice
in the formation of over-all policies."
Ben DuBois, Secretary, Independent Bankers Association, Sauk
Centre, Minn.: Perhaps the Federal Reserve Board should have
greater authority over the 12 regional banks. "* * * I do believe
that there is one segment of the banking fraternity that is not properly
represented on the Board, and that is the smaller banks of the country.
* * * We believe that an addition to the Board of what might be
called 'a country banker' would be helpful to the System and to the
economy as a whole. I can see no reason for the Federal Advisory
Council. We believe it has a tendency toward confusion."
C. H. Kleinstuck, the First National Bank & Trust Co., Kalamazoo,
Mich.: Since the powers of the Board of Governors are very great, our
democratic principles demand that membership on the Federal Reserve Board should be broadly representative. It should include representatives from each Reserve district.
Fred W. Glos, the First National Bank, Elgin, III.: "None—except
all political party considerations should be eliminated and purely
qualifications of personnel considered."
L. M. Giannini, Bank of America, San Francisco, Calif.: The directors of each Reserve bank should appoint the chairman, and the directors' appointment of the president and first vice president should not
be subject to approval by the Board of Governors. This would insure
more independence of action by the district banks. The Secretary of
the Treasury should, ex officio, sit in with the Open Market Committee
as an adviser, for the actions of the Committee vitally affect the Treasury, and the actions of the Treasury, current and contemplated, will
vitally affect the conditions under review by the Committee.
Anonymous: More of the policy-making powers of the Federal Reserve should be centered in the Open Market Committee. That Committee now determines open market policies, but the Board alone decides on reserve requirements and discount rates. These policies
should always be coordinated and there is no need for a division of
authority. If all decisions regarding credit policies were placed in
the Open Market Committee, this would give the regional banks more
voice and influence in credit policy. Such an arrangement seems wise
in a country as large and as diverse as ours. It is a mistake not to let
the Federal Reserve officers located in the large money markets, who
are most familiar with market conditions, have more of a voice in the
determination of credit policies. Members of the Federal Reserve
Board should have the status of Cabinet members and be paid
accordingly.
David Williams, Corn Exchange National Bank <& Trust Co., Philadelphia : "It is felt that too much power is concentrated in the Board of
Governors of the Reserve System. This concentration of power, as




313 MONETARY,

CREDIT, AND FISCAL POLICIES

provided for in the Banking Acts of 1933 and 1935, has resulted in
mitigating the effectiveness of the regional system. The Board of
Governors is a powerful body and the fact that its members are
appointed by the President makes it vulnerable to political direction.
It is believed that the Board of Governors should be elected by the
directors of the regional banks rather than appointed by the
President."
C. ANSWERS BY STATE BANKING COMMISSIONERS

Eliott V. Bell, New York State Banking Department: "The point of
greatest weakness within the System is the Federal Reserve Board.
The Federal Reserve Act of 1935 probably went too far in building up
the Board's power at the expense of the regional Federal Reserve
banks. While building up the power of the Board, no adequate measures were taken to build up the caliber of the Board. As at present
constituted, the Board of Governors probably has too many members
and the term of 14 years seems excessively long. Compensation paid
to the Board members is certainly inadequate and is disproportionately
small in comparison to the compensation paid the presidents of some
of the Federal Reserve banks over whom the Board exercises authority.
"Under existing circumstances there is little to be said for proposals
to increase the Board's power. On the contrary, a case could be made
for concentrating all Federal Reserve System powers with respect to
credit policy in the Open Market Committee which provides a broader
basis of representation, although still leaving a majority voice to the
Board."
D. ANSWERS BY OFFICERS OF LIFE INSURANCE COMPANIES

Alexander T. Maclean, Massachusetts Mutual Life Insurance Co. ;
"We believe that the Federal Reserve Board should be controlled by
the banks in the System and not so much by the Government. We
believe this for the reason that, naturally, the banks in the System
are more in touch with the business needs of the various localities than
anj^one else is likely to be."
E. ANSWERS BY OTHER TYPES OF BUSINESS ORGANIZATIONS

John D. Biggers, president, Libbey-Owem-Ford Glass Co.: "This
issue does not seem a critical one, as there is a large degree of consultation and coordination in the Federal Reserve System."
4. What changes, if any, should be made in the standards that
banks must meet to qualify for membership in the Federal Reserve
System ? Should any banks other than national banks be required
by law to become members of the System ?
A. ANSWERS BY ECONOMISTS

Howard R. Bowen: "I should prefer that all banks be national
banks, and that all banks be members of the Federal Reserve System
and of the FDIC. To accomplish this, I should recommend a lowering
of the capital requirement for membership in the Federal Reserve and
for a national charter. National supervision of all banking would be




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MONETARY, CREDIT, AND FISCAL POLICIES

quite consistent with the power of the Federal Government to regulate
the money supply."
Elmer C. Bratt: "I think all banks should be required to be members
of the Federal Reserve System. The standards to qualify for membership should be the standards otherwise required for any bank."
Neil Carothers: "Careful study should be made to determine conditions under which State banks could enter Federal Reserve without
inconvenience. Once the conditions have been determined, all State
banks should be forced into Federal Reserve, Pending this, no Federal
Reserve privileges should be granted State banks not in System."
G. O. Fisher: "Subject to a finding by the Federal Reserve Board, all
sound commercial banks should be permitted to join the System, even
though the technical requirements presently existing cannot be met.
All commercial banks, excepting possibly those with capital stock of
$25,000 or less, which are serving communities of smal