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82-2 14 E19m Monetary Policy and the Management of the Public Debt HEARINGS BEFORE THE SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT CONGRESS OF THE UNITED STATES EIGHTY- SECOND CONGRESS SECOND SESSION PURSUANT TO Section 5 (A) of Public Law 304 (79th Congress) MARCH 10, 11, 12, 13, 14, 17, 18, 19, 20, 21, 24, 25, 26, 27, 28, AND 31, 1952 Printed for the use of the Joint Committee on the Economic Report Monetary Policy and the Management of the Public Debt HEARINGS BEFORE THE SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT CONGRESS OF THE UNITED STATES EIGHTY- SECOND CONGRESS SECOND SESSION PURSUANT TO Section 5 (A) of Public Law 304 (79th Congress) MARCH 10, 11, 12, 13, 14, 17, 18, 19, 20, 21, 24, 25, 26, 27, 28, AND 31, 1952 Printed for the use of the Joint Committee on the Economic Report GARY OF THE MAY 22 1532 UNIVERSITY OF ILLINOIS UNITED STATES GOVERNMENT PRINTING OFFICE 97308 WASHINGTON : 1952 JOINT COMMITTEE ON THE ECONOMIC REPORT (Created pursuant to sec. 5 ( a ) of Public Law 304, 79th Cong. ) JOSEPH C. O'MAHONEY, Wyoming, Chairman EDWARD J. HART, New Jersey, Vice Chairman JOHN SPARKMAN, Alabama WRIGHT PATMAN, Texas RICHARD BOLLING, Missouri PAUL H. DOUGLAS, Illinois WILLIAM BENTON, Connecticut CLINTON D. MCKINNON, California JESSE P. WOLCOTT, Michigan ROBERT A. TAFT, Ohio CHRISTIAN A. HERTER, Massachusetts RALPH E. FLANDERS, Vermont ARTHUR V. WATKINS , Utah J. CALEB BOGGS, Delaware GROVER W. ENSLEY, Staff Director JOHN W. LEHMAN, Clerk SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT WRIGHT PATMAN, Texas, Chairman RICHARD BOLLING, Missouri PAUL H. DOUGLAS, Illinois JESSE P. WOLCOTT, Michigan RALPH E. FLANDERS, Vermont HENRY C. MURPHY, Economist to the Subcommittee II … 1 - e1 82-2 CONTENTS E19m Page Statement of: Appleby, Paul, dean of the Maxwell School of Citizenship and Public 573 Affairs of Syracuse UniversityBell, James Washington, chairman, Department of Economics, 911 Northwestern University ( submitted ). 248 Blough, Roy, member, Council of Economic Advisers . Brown, Edward Eagle, chairman, board of directors of the First 565 National Bank of Chicago__. 407 Bryan, Malcolm, president, Federal Reserve Bank of Atlanta. Cook, H. Earl, member Board of Directors , Federal Deposit Insurance Corporation, accompanied by E. H. Cramer and L. L. Robertson, 868 of the Federal Deposit Insurance Corporation_ Cumberland , W. W., Ladenburg, Thalmann & Co., New York City 922 (submitted ). Economists' National Committee on Monetary Policy, New York, a 940 submitted statement by 63 members__ Fennelly, John F., Investment Bankers Association of America, accompanied by Robert Craft, vice president, Guaranty Trust Co. 344 of New York___ Folsom, Marion B. , Chairman, Board of Trustees, Committee for Eco291 nomic Development ‒‒‒‒ 355, 380 Harris, Seymour E. , professor of economics, Harvard University324 Hemingway, W. L., American Bankers Association. Kemmerer, Donald L. , professor of American economic history, 926 University of Illinois ( submitted ) 143 . Keyserling, Leon H., chairman, Council of Economic Advisers_ 154, 185, 269 Lanston, Aubrey G. , president, accompanied by Leroy M. Piser, vice 389 president in charge of research, Aubrey G. Lanston & Co., Inc ‒‒‒‒ Martin, William McC. , Jr., Chairman, Board of Governors of the 73,99 Federal Reserve System_. Pollock, Dr. James K., professor of political science and chairman of 584 the department of political science, University of Michigan__. Powell, Oliver S. , Chairman , National Committee, Voluntary Credit Restraint Program, and member of the Board of Governors, of the Federal Reserve System, accompanied by George B. Vest, Robert C. 463 Masters, Charles H. Schmidt, and Harold L. Cheadle__ Preston, Howard H., professor of money and banking, University of 928 Washington ( submitted ) ____ Robinson, Leland Rex, professor of political economy, New York Uni932 versity ( submitted ) 552 Ruml, Beardsley__ Shanks, Carrol M., president of Prudential Insurance Co. of America, and chairman, committee on inflation control of the American Life 442 Convention and the Life Insurance Association of America. Snyder, John W. , Secretary of the Treasury, accompanied by mem7, 45 bers of the Treasury staff Sonne, H. Christian, chairman, board of trustees, National Planning Association _- _843 Spahr, Walter E., professor of economics, New York University ( sub935 mitted) --506 Sproul, Allan, president, Federal Reserve Bank of New York Thomson, J. Cameron, chairman , Committee on Monetary, Fiscal and 296 Debt Policy, Committee for Economic Development_. Trant, James B., dean, College of Commerce, and professor of money 939 and banking, Louisiana State University (submitted ) Wiggins, A. L. M., chairman, board of directors , Atlantic Coast Line 219, 235 Railroad Co., and associated railroad companies.. III IV CONTENTS Page Panel discussions : 747 How should our monetary and debt management policy be determined ?_ Participants : Bach, G. L., professor of economics, Carnegie Institute of Technology748 Goldenweiser, E. A. , member, Institute for Advanced Study, 761 Princeton University --Stein, Harold, staff director, Committee on Public Administra757 tion Cases___ 754 Viner, Jacob, professor of economics, Princeton University . 752 Wilmerding, Lucius, Jr__ The role of business, labor and agriculture in the determination of 799 monetary and debt management policyParticipants : Baker, John A. , legislative secretary, National Farmers 807 Union__. 801 Chamber of Commerce of the United States (submitted ). Kline, Allan B., president, American Farm Bureau Federation____ 809 Lincoln, Murray D. , president, Farm Bureau Insurance Cos. , 812 Columbus, Ohio.. Montgomery, Donald E., director of Washington office, Inter817 national Union, UAW-CIO823 Newsom, Herschel D. , master, the National Grange_ 827 Shishkin, Boris , economist, American Federation of Labor . Voorhis, Jerry, secretary, Cooperative League of the United States of America-831 597 The role of the banking system in a dynamic economyParticipants : Fleming, Robert V., president and chairman of the board, 598 the Riggs National Bank, Washington, D. C___. Lindow, Wesley, vice president, Irving Trust Co., New York 629 City-Reierson, Roy L., vice president, Bankers Trust Co. , New 633, 637 York CityTapp, Jesse W., executive vice president, Bank of America, 626 San Francisco, Calif‒‒‒‒‒‒ Woodward, Donald B. , second vice president, the Mutual Life Insurance Co. of New York... 602 685 What Should Our Monetary and Debt Management Policy Be ?---Participants : Ellis, Howard S. , professor of economics, University of Cali686 fornia____. Friedman, Milton, professor of economics, University of Chi688 cago Mikesell, Raymond F., professor of economics, University of 711 Virginia ---Samuelson, Paul, professor of economics, Massachusetts In691 stitute of Technology-Whittlesey, C. R. , professor of finance and economics , Uni698 versity of Pennsylvania .. Supplementary statements : 432 Bryan, Malcolm, president, Federal Reserve Bank of Atlanta_. 743 Friedman, Milton, University of Chicago ‒‒‒‒‒ 276 Keyserling, Leon H., chairman, Council of Economic Advisers. 746 Mikesell, Raymond F., University of Virginia.. Additional information furnished for the record : Behavior of Deposits Prior to Suspension in a Selected Group of 877 Banks CONTENTS Additional information furnished for the record- Continued Correspondence on debt management and monetary policy between the Federal Reserve System and the Treasury, and the Federal Reserve System and the President, during the period from the outbreak in Korea ( June 25, 1950 ) to the Treasury-Federal Reserve accord (March 4, 1951 ) . Correspondence with the Comptroller General concerning governmental agencies not audited by the General Accounting Office and the reasons therefor_ -_Dormant account balances in national banks at close of business on December 31 , 1951 ---Editorial in the New York Jourial of Commerce concerning the testimony of Prof. Seymour Harris, Professor Harris' answer thereto , and a rejoinder_____ Effect of changes in interest rates on the cost of servicing the public debt Excerpt from book by Carter Glass, entitled "An Adventure in Constructive Finance" ( 1927 ) . Federal Reserve System preparation of answers to questionnaire___ Financial responsibilities of member banks on account of membership in the Federal Reserve System-Impact of voluntary credit restraint program on demand for and supply of credit__. Legal status of the Board of Governors of the Federal Reserve System and of the Federal Reserve Banks_ Lending, Inc., Fifth District Commercial Banking Voluntary Credit Restraint Committee, report of Letter from Chairman Martin on miscellaneous legal points arising during the hearings . Letter from Library of Congress , to Joint Committee, relative to Federal Agencies having independent sources of incomeLetter from Preston Delano, to Congressman Patman , relative to affiliation between banks in Texas____ Letter received from Allan Sproul on the independence of the Federal Reserve System__. Letter to Congressman Patman from Carrol M. Shanks, regarding removal of Secretary of Treasury from the Federal Reserve Board___ Letter to Congressman Patman, from National Association of Manufacturers, regarding appearance at hearing . Letter to Senator Maybank, from Walter P. Reuther, CIO, relative to panel discussion on mortgage financing conducted by Senate Banking and Currency Committee, on February 6, 1952Memorandum from the President, regarding the need for credit restrictions, February 26, 1951- . Miscellaneous material requested of the Board of Governors of the Federal Reserve System_. Monetary Management, by E. A. Goldenweiser, excerpt from. "Open Mouth" Rule Ends in United States Bonds, article from New York Times____ Payments to the Treasury by Federal Reserve banks_ Remarks of Allan Sproul, president, Federal Reserve Bank of New York, at Seventy-fifth Annual Convention of American Bankers Association, San Francisco, Calif., November 2 , 1949____ Remarks of Allan Sproul, president, Federal Reserve Bank of New York, before Forty-fifth Annual Meeting of Life Insurance Association of America, New York City, December 12, 1951__ Report of the four member committee (Chas. E. Wilson, chairman ) , appointed on February 26, 1951, and reporting on May 17, 1951 . Reserve Bank reserve requirements and Federal Reserve credit_. Schedule of hearings (announced before opening ) __ Treasury Department, preparation of answers to questionnaire_ V Page 942 986 866 990 52 59 140 983 484 477 614 909 61 861 983 482 800 822 125 966 796 398 116 543 506 128 106 3 70 MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT MONDAY , MARCH 10, 1952 CONGRESS OF THE UNITED STATES , SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to notice, at 10:05 a. m. , in room 318 Senate Office Building, Representative Wright Patman ( chairman of the subcommittee ) presiding . Present : Representative Patman, Senators Douglas, Flanders ; Representatives Bolling and Wolcott. Also present : Grover W. Ensley, staff director ; Henry C. Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee. Representative PATMAN . The committee will please come to order . The Joint Committee on the Economic Report was created by the Employment Act of 1946. Its primary purpose, and the one which has given it its name, is to study the Economic Report of the President , and report to the Congress on its implications and its significance in terms of desirable congressional action. The committee also has authority directly or through subcommittees to make such inquiries into economic matters and to prepare such reports as it believes will be helpful to the Congress and to the public, generally. It is not a legislative committee and has no authority to bring in bills in either House. The Subcommittee on General Credit Control and Debt Management was appointed by Senator Joseph C. O'Mahoney, of Wyoming, chairman of the full committee, last spring, for the purpose of conducting a general inquiry into monetary policy and debt management. The members of the committee, in addition to the chairman , are Senators Paul H. Douglas, of Illinois, and Ralph E. Flanders, of Vermont, and Representatives Richard Bolling, of Missouri, and Jesse P. Wolcott, of Michigan . As most of you are aware, a similar subcommittee was appointed by Senator O'Mahoney in the spring of 1949 under the chairmanship of Senator Douglas. The membership of that committee was identical with the membership of the present subcommittee except that Representative Buchanan, who has since passed away, has been replaced by Representative Bolling. The subcommittee , under the chairmanship of Senator Douglas, divided its attention about equally between fiscal policy, meaning 1 2 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT primarily bugetary policy, and monetary policy. The present subcommittee, on the other hand , will devote its attention entirely to monetary and debt management policy. The more than 2 years which have elapsed since the hearings and the report of the earlier subcommittee have been packed with significant events. At that time the country was just emerging from a business recession, and Korea was merely an unfamiliar name on a map. Since that time, the international situation has greatly worsened, and Federal expenditures have been greatly increased by the necessity for strengthening our defenses. In the meantime, the country has passed through a serious period of inflation, spurred by the buying wave which followed the outbreak of hostilities in Korea. For about a year now we have had a precarious lull in inflationary price rises. National production is at a high level, and the same is true, with a few notable exceptions, of the level of employment. Despite the high level of defense expenditures the people as a whole are enjoying as high a standard of living as they have had at any time in the history of our country, but we cannot be complacent. On the one hand, there are serious indications of continuing inflationary dangers while, on the other, some people see signs of a coming recession. Clearly, it is time to give the situation another look, both with respect to the proper steps which should be taken in the field of monetary and debt management policy under present and possible future conditions and with respect to the extent to which our agencies are properly set up to handle the task which the Congress has delegated to them. It is in this spirit and with an open mind as to the right answers to all of the questions before us that the subcommittee has approached its task. As the first step in its investigation the subcommittee addressed a series of questions to the top Government officials concerned with these tasks, and to a large number of persons in the private economy. The answers to these questions have been published in a document entitled "Monetary Policy and the Management of the Public Debt ; Their Role in Achieving Price Stability and High-Level Employment ," which was released to the press a week ago last Friday. I should like again to express my thanks and those of the other members of the subcommittee to the large number of persons whose labors have made this document possible. It has placed before us in a much clearer manner than ever before a statement of the areas of agreement and disagreement among the Treasury Department, the Federal Reserve System, and the Council of Economic Advisers, with carefully reasoned statements supporting their respective views. In arriving at these statements, the agencies have, in my opinion, tended to move somewhat closer together. This is all to the good. The subcommittee has always emphasized in its dealings with each of the agencies that it sought as a first choice to obtain an agreed statement of their views, but to the extent that this was not compatible with the sincerely held convictions of the responsible agency heads, it desired to obtain reasoned statements of the nature and extent of their disagreements. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 3 The subcommittee has never sought and does not now seek to reopen old wounds. A week ago I furnished to the press a tentative schedule covering 3 weeks of hearings . This schedule, which I shall insert in the record at the close of these remarks, was arranged with a view to permitting the presentation of all important points of view on the principal issues before the subcommittee. I recognize, however, that setting up any schedule of this kind involves many questions of judgment and, as I said, in my press release a week ago I have invited the other members of the subcommittee to suggest any additional witnesses whom they may desire, and have said that I would be glad to make arrangements for their appearance, extending the duration of the hearings, if necessary, for this purpose. In addition, I should like to invite any other person who desires to be heard to make application to the subcommittee, and we will arrange, if possible, a personal presentation of views or for the submission of briefs. The hearings which we are starting today ought to be exceptionally fruitful because the preliminary spade work which has already been accomplished . Each of the official witnesses and many of the private ones have prepared or participated in the preparation of the answers included in our compendium. Their carefully thought out points of view have already been presented at length and they have had an opportunity to read and study the points of view of others. This will make it possible for each witness not only to greatly shorten his statement but it will permit him to direct it to the important points on which he finds himself in disagreement with other witnesses who have contributed to the symposium. It will also be of great assistance to the members of the subcommittee in directing their questions to significant points of difference in the various views which have been set before them. The first chapter of the symposium, which we released last week, is devoted to the replies of the Secretary of the Treasury , Mr. Snyder. These replies state the position of the Treasury Department on the principal issues of interest to the subcommittee in a clear and incisive manner, and provide a most appropriate background for the testimony of our first witness, Mr. John W. Snyder, Secretary of the Treasury. ( The schedule previously referred to is as follows :) CONGRESS OF THE UNITED STATES JOINT COMMITTEE ON THE ECONOMIC REPORT CHAIRMAN WRIGHT PATMAN OF THE SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT ANNOUNCES TENTATIVE SCHEDULE OF HEARINGS Representative Wright Patman, of Texas , chairman of the Subcommittee on General Credit Control and Debt Management of the Joint Committee on the Economic Report, today announced a tentative schedule of witnesses for the hearings of the subcommittee which will begin on Monday, March 10, and are expected to run for about 3 weeks . Chairman Patman said that he had asked the other members of the subcommittee Senators Paul H. Douglas, of Illinois, and Ralph E. Flanders, of Vermont, and Representatives Richard Bolling, of Missouri, and Jesse P. Wolcott, of Michigan-to suggest any additional witnesses whom they might desire and 4 1 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT that he would be glad to make arrangements for their appearance, extending the duration of the hearings if necessary for this purpose. The schedule announced by Chairman Patman, together with suggested topics of discussion for each of the round tables to be held in connection with the hearings, follow : First week Monday, March 10 : John W. Snyder, Secretary of the Treasury. Tuesday : March 11 : William McC. Martin , Jr., Chairman, Board of Governors, Federal Reserve System. Wednesday, March 12 : Leon Keyserling, Chairman , Council of Economic Advisers. Roy Blough, Member, Council of Economic Advisers. Friday, March 14 : A. L. M. Wiggins, chairman, board of directors, Atlantic Coast Line Railroad Co. (formerly Under Secretary of the Treasury ) . Preston Delano : Comptroller of the Currency. Maple T. Harl, Chairman , Board of Directors, Federal Deposit Insurance Corporation. Second week Monday, March 17 : Marion B. Folsom and J. Cameron Thomson, Committee for Economic Development. W. L. Hemingway, American Bankers Association . John F. Fennelly, Investment Bankers Association. Tuesday, March 18 : Seymour Harris, Harvard University. Aubrey G. Lanston, Aubrey G. Lanston & Co., United States Government security dealers. Wednesday, March 19 : Malcolm Bryan, President, Federal Reserve Bank, Atlanta. Oliver S. Powell , Member, Board of Governors, Federal Reserve System. Carrol M. Shanks, Life Insurance Association of America and American Life Convention. Thursday, March 20 : Beardsley Ruml, New York City. Allan Sproul, President, Federal Reserve Bank, New York. E. E. Brown, chairman, board of directors, First National Bank of Chicago. Friday, March 21 : Paul Appleby, Syracuse University. Third week Monday, March 24 : Panel discussion, The Role of the Banking System in a Dynamic Economy : Robert Fleming, Riggs National Bank, Washington, D. C. Wesley Lindow, Irving Trust Co. , New York. Roy Reierson, Bankers Trust Co. , New York. Jesse W. Tapp, Bank of America, San Francisco. Tuesday, March 25 : Panel discussion, What Should Our Monetary and DebtManagement Policy Be?: Milton Friedman, University of Chicago. Raymond Mikesell, University of Virginia. Paul Samuelson, Massachusetts Institute of Technology. C. R. Whittlesey, University of Pennsylvania. Wednesday, March 26 : Panel discussion, How should our monetary and debtmanagement policy be determined ?: G. L. Bach, Carnegie Institute of Technology, Pittsburgh. E. A. Goldenweiser, Institute for Advanced Study, Princeton. James K. Pollock, University of Michigan. Jacob Viner, Princeton University. Thursday, March 27 : Panel discussion, The role of business, labor, and agriculture in the determination of monetary and debt-management policy : ( Representatives of American Farm Bureau Federation, American Federation of Labor, Congress of Industrial Organizations, National Association of Manufacturers, The National Farmers Union, The National Grange, United States Chamber of Commerce) . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 5 Friday, March 28 : H. Christian Sonne : National Planning Association. Panel discussion on the role of the banking system in a dynamic economy (Monday, March 24) Participants.- Robert Fleming, Riggs National Bank, Washington, D. C.; Wesley Lindow, Irving Trust Co. , New York ; Roy Reierson, Bankers Trust Co., New York ; Jesse W. Tapp, Bank of America, San Francisco. Suggested topics for discussion.-1. What should be the role of the private financial community in the formulation of monetary policy ? To what extent does this role reflect its status as a special interest group and to what extent does it reflect its status as the repository of specialized skills and information valuable to the general interest ? 2. What is the responsibility of banking institutions for the economic development of their communities ? Should banks, as a long-term proposition, be more venturesome in undertaking lending risks ? Has a lack of venturesomeness on the part of banks contributed to the growth of Government-lending agencies ? How does this apply to the special problems and inflationary hazards of the present defense period ? 3. How successful has the voluntary credit-restraint program been ? What should be its role over a longer-term period ? Has the treatment accorded State and local governments been more rigorous than that accorded private business firms ? 4. To what extent do time deposits represent a stable form of savings ? Demand depoits ? Is it desirable to encourage the holding of savings in these forms ? Under what conditions ? Panel discussion on What should our monetary and debt management policy be? (Tuesday, March 25 ) Participants.-Milton Friedman, University of Chicago ; Raymond Mikesell, University of Virginia ; Paul Samuelson, Massachusetts Institute of Technology ; C. R. Whittlesey, University of Pennsylvania. Suggested topics for discussion.1. How much reliance should be placed on ( a ) direct controls, ( b ) selective credit controls, ( c ) general monetary ( i. e., "tight money" ) policies in combating inflation ? Under present circumstances ? Under other circumstances ? 2. Is a tight-money policy compatible with maximum production and employment ? 3. How desirable is a stable Government bond market? Now? Under conditions closer to total war? In a peacetime inflation ? 4. What kinds of securities should the Treasury issue ? Now ? Under other circumstances ? 5. What is the proper relationship between monetary and fiscal policy? Panel discussion on how should our monetary and debt-management policy be determined? (Wednesday, March 26 ) Participants.-G. L. Bach, Carnegie Institute of Technology, Pittsburgh ; E. A. Goldenweiser, Institute for Advanced Study, Princeton ; James K. Pollock, University of Michigan ; Jacob Viner, Princeton University. Suggested topics for discussion.1. What should be the role of the private financial community in the formulation of monetary policy ? What are the implications in this respect of the private ownership of the stock of the Federal Reserve banks ? 2. Is the division of authority over monetary policy between the Board of Governors and the Open Market Committee desirable ? If not, how should it be resolved ? 3. Should the monetary authority be vested in one man or a board ? What is its proper relationship to the Treasury, the President, Congress ? 4. What should be the role of the monetary authority in the determination of debt-management policy? Panel discussion on the role of business, labor, and agriculture in the determination of monetary and debt-management policy (Thursday, March 27 ) Participants.-Representatives of American Farm Bureau Federation, American Federation of Labor, Congress of Industrial Organizations, National Association of Manufacturers, The National Farmers Union, The National Grange, United States Chamber of Commerce. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Suggested topics for discussion.1. What are the special interests of business, labor, and agriculture in monetary policy ? How should each be represented in its formulation (except as they are represented in ordinary course in the formulation of Government policy generally ) ? 2. Should individual members of the Board of Governors or individual directors of the Federal Reserve banks represent special interest groups ? If so, should the interested groups participate in their selection ? 3. What monetary and debt management policy is most in the interests of business ? Of labor ? Of agriculture ? Now? Under other conditions ? (This schedule is reproduced exactly as given to the press for release on March 3, 1952. There were minor changes in the course of the hearings as indicated by the day-to-day record. ) Representative PATMAN. Before hearing from Mr. Snyder, I would like to ask if other members of the subcommittee would like to make statements . Senator Douglas, would you like to make a statement ? Senator DOUGLAS . I think, perhaps, Senator Flanders should have the right to lead off. Representative PATMAN. Senator Flanders ? Senator FLANDERS . Mr. Chairman, these very important hearings should attract the interest and demand the earnest consideration of all officials and institutions, public and private, which are concerned with inflation, in general, and the amount and value of our money and credit supply, in particular. As a minority member of this committee, I would like to bring my tribute to the careful and able staff work which has preceded the hearings. Comprehensive and incisive questionnaires were prepared in order to throw light on all significant aspects of general credit controls and debt management. This groundwork has resulted in the 1,300-page volumes of the compendium Monetary Policy and the Management of the Public Debt. The staff has also been largely responsible for making arrangements for these hearings in which various opinions may be further developed and examined by the committee. Following up this excellent staff work, it is proper to call public attention to the time, effort, and thought that have been given by those who have replied to the questionnaires sent out. It is clear that Government agencies, business groups, and individual economists have prepared their answers with great care. The high quality of these answers on monetary and banking theory, as well as on practical-policy proposals, has been gratifying. The compendium of these views provides a valuable reference to those of us concerned with immediate policy questions , and it also will, no doubt, long serve as an important source of material for all those who study these general problems. We may also hope that those who have labored to provide the committee with information have also reaped some benefit themselves from the process of thinking through the issues involved , and of formulating their answers . We are now entering upon the more direct work of the subcommittee in hearings, examination, and attempting to reconcile the views of witnesses. With the careful work that has been done and the high quality of the responses received, I am sure that we can continue this undertaking in an objective and unbiased manner. Our aim is to have a thorough MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 7 exploration of all the important aspects of the problems that are before us, and I am confident that this can be accomplished . Representative PATMAN. Mr. Bolling ? Representative BOLLING. No comment, Mr. Chairman . Representative PATMAN. Senator Douglas ? Senator DOUGLAS . I want to join Senator Flanders in congratulating the chairman and the staff for the very excellent job which they have done in preparing these two volumes of background material on monetary policy and debt management. Whatever differences of opinion may develop during the course of the hearings, I think Congressman Patman and Dr. Murphy are to be thanked for the fairness and comprehensiveness of their inquiry. I think that these two volumes are the best discussion that we have of the issues involved . It has been very helpful to have the frank statement by the Treasury and by the Federal Reserve and by the representatives of various shadings of opinion ; and I would say that if nothing more happened , that the subcommittee has already justified its existence. I want to join Senator Flanders in the hope that this will be an inquiry for truth and for public policy. In the course of that inquiry, it is inevitable that differences of opinion will develop, but I hope that we may be objective , and that we will credit each other with the best of motives. Representative PATMAN. Thank you, Senator Douglas . Mr. Wolcott ? Representative WOLCOTT. I have no statement. Representative PATMAN. Mr. Snyder, we would like to hear from you at this time. We appreciate your coming, and we shall look forward to hearing your testimony. STATEMENT OF HON. JOHN W. SNYDER, SECRETARY OF THE TREASURY , ACCOMPANIED BY MEMBERS OF THE TREASURY STAFF Secretary SNYDER. Thank you, Mr. Chairman. I have a prepared statement, Mr. Chairman , which, with your permission and that of the subcommittee, I would like to read into the record. Mr. Chairman and gentlemen , the hearings which are beginning this morning represent the culmination of a number of months of intensive study and preparation of replies to the questions raised by your subcommittee. Anyone who has worked on this complex project cannot help but be impressed with the scope and searching nature of the questions which were asked. In our already heavy work schedules it was not easy to find the time to set down the pros and cons of the many issues presented for generalized discussion in the questionnaire . In view of the importance of the study, however, we felt that time must be found ; and I am very glad that we were able to give full and considered replies to all of the questions submitted to us. I believe that everyone who reads the written replies received by the subcommittee will feel, as I do, that the body of material which you have assembled will be of great value in the field of debt management and monetary policy for many years to come. Not one point of view, but many points of view-I am almost tempted to say, all 8 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT points of view-seem to have been elicited by the subcommittee in the written answers to the various questionnaires which were sent out. A policy record, in the most fundamental sense, is not only a record of decisions made and actions taken-it is a record of appraisals, of conclusions , and of judgments. Those who replied to the subcommittee's questionnaires, it seems to me, have attempted to be fully responsive in this fundamental sense. I want to say here, Mr. Chairman, that I do hope that these 1,300 pages will be read with a great deal of care, and carefully digested by all people who are charged with any part of the preparation of the studies and the formulation of decisions in connection with debt management and monetary policies. I want to add my words to those of your colleagues who have addressed their remarks previously to the complimentary appreciation of what has gone ahead in laying the groundwork for these hearings. I think that we could well say that this has been the most carefully and most studiously prepared hearing on this subject that we have experienced. I am extremely hopeful that out of this fine foundation will grow discussions and studies that will be extremely helpful in the great problems we have in the future. In our own case, we found in replying to the questionnaire that it was often difficult to reconstruct past events in the context of the times when they took place. In our swiftly moving economy circumstances are always changing, and our views as to appropriate actions and policies must change with them. The would be little purpose in trying to reconstruct the background of important actions in the past unless the details gave us added ability to plan our future course wisely. This is true, I believe, with respect to the subjects which will be covered in the present hearings. In answering the questionnaire submitted earlier by the subcommittee, therefore, I have gone into considerable detail as to the reasons why the Treasury took certain actions at certain times ; what we hoped to accomplish by them and what- viewed retrospectively- we did accomplish. It will be of particular value, I feel , for the public to become better acquainted with the nature of the responsibilities with which the various agencies have been charged by the Congress-and the relation of practical policies to the fulfillment of these responsibilities . This represents, in my view, a most important part of the study which the subcommittee is undertaking. I should like to take a few minutes, therefore, to comment briefly on the nine general economic objectives which the Treasury Department seeks to further through the use of the powers which have been given to it by the Congress. These objectives, which are described more fully in the answer to question 2, are as follows : 1. To maintain confidence in the credit of the United States Government. This is the basic objective of all Treasury policies ; and , at the present time, it is the cornerstone of the financial soundness of this country, and a vital factor in the defense effort of the entire free world. In the broadest sense, safeguarding the credit of the Govcrnment depends upon our ability as a Nation to keep our freeenterprise economy healthy and growing, and to use our governmental instruments wisely in promoting this end. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 9 2. To promote revenue and expenditure programs which operate within the framework of a Federal budget policy appropriate to economic conditions. Through action of Congress and by executive decisions, the budget is subject to constant change ; and it is of the utmost importance that revenue and expenditure programs be kept appropriate to changing economic circumstances. The Treasury and the Bureau of the Budget work closely with the President and with the Congress to further this end . 3. To give continuing attention to greater efficiency and lower costs of governmental operations. I consider this objective a continuing obligation , not only of the Treasury Department but of every department and agency of the Government. Both within the department and in association with other branches of the Government, the Treasury carries on continuing programs aimed at providing maximum service on the part of the Government at the lowest possible cost to the taxpayers. 4. To direct our debt management programs toward (a) countering any pronounced inflationary or deflationary pressures (b) providing securities to meet the current needs of various investor groups, and ( c) maintaining a sound market for United States Government securities . Success in achieving these specific objectives of debt management is essential to the maintenance of confidence in the credit of the United States Government. Many of the questions sent to us by the subcommittee related to problems and actions in the area of debt management . The Treasury has attempted to give the fullest possible replies to these questions ; and I am hopeful that the hearings will provide a forum in which these fundamental matters of national financial policy can be thoroughly explored. 5. To use debt policy cooperatively with monetary - credit policy to contribute toward healthy economic growth and reasonable stability in the value of the dollar . The importance of this objective , I feel , is self- evident . It is a primary goal of both Treasury and Federal Reserve policy, and an important part of public economic policy in general, as expressed in the Employment Act of 1946. In addition to these five economic objectives of Treasury policy, there are other objectives which we keep constantly in mind. These are : 1 6. To conduct the day-to -day financial operations of the Treasury so as to avoid disruptive effects in the money market and to complement other economic programs. 7. To hold down the interest cost of the public debt to the extent that this is consistent with the foregoing objectives. 8. To assist in shaping and coordinating the foreign financial policy of the United States. 9. To manage the gold and silver reserves of the country in a manner consistent with our other domestic and foreign policy objectives. 10 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Each one of these specific objectives is important in itself ; and, generally, a number of them must be considered together in framing practical program which will further our basic goals of maintaining the confidence of the public in the debt obligations of the Government and promoting the economic well-being of the Nation. The present hearings, I feel , will provide an excellent opportunity for furthering public understanding of the responsibilities and policy objectives which I have just summarized . They are discussed at greater length- and in relation to many different situations-in the answers to the questionnaire . It is my further hope that the subcommittee will give careful consideration to the possibilities which I have brought forward in the answer to question 10, relating to the creation of a top -level advisory group to the President on broad questions of monetary and fiscal policy. In that question, it was suggested that a small consultative and discussion group be created within the Government. This group might consist of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Director of the Budget, the Chairman of the Council of Economic Advisers to the President, and the Chairman of the Securities and Exchange Commission. From time to time, the heads of other agencies (both permanent and special agencies ) might be added to the group, as various problems arise. This group would serve two major purposes. First, by regular and periodic meeting and discussion among the heads of the agencies having to do with fiscal and monetary policies, differences of opinion would become less likely to develop . A group of this nature would do much to achieve accord before discord arises. Second, the means would be provided for informal discussions with the President on broad questions of monetary and fiscal policy. The advisory group could report to the President-preferably on an informal and confidential basis-as often as desired . It is my present intention to recommend to the President that he consider the creation of a national council along the lines which I have just described , with advisory authority in the area of monetary and fiscal policy. Prior to doing so , however, I should like to obtain the views of the subcommittee as to the advisability-the pros and cons of such a step . I am looking forward with great interest, therefore , to the discussion of this matter in the hearings, and to your own deliberations with regard to it. The question of a national council which would act as an advisory group with respect to monetary and fiscal policy brings up another matter which I hope the subcommittee will find time to consider from · all angles. In question 9 of the questionnaire sent to me, a discussion . of the relationship between the President and the Federal Reserve System was called for. In answering this question, I indicated my opinion that it was desirable for the Federal Reserve System to retain its independent status. I expressed further, however, my strong feeling that it is natural, proper, and desirable for the President to seek to settle disputes by having all of the interested parties sit around a table to discuss their differences, in the interests of coordination . This, it seems to me, represents the essence of independence—that the President and the Board should have both the right and the duty to discuss the problems with each other, on the basis of a free interchange of views . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 11 The Joint Committee on the Economic Report is in a very good position to help obtain the kind of cooperation and cohesiveness of policy which we need to emphasize constantly in all branches of Government. This is because the committee has the responsibility for looking at the economic problems involved from every point of view. You are not concerned solely with revenues, for example, or with expenditures, or with appropriations ; rather it is your unique function among the committees of Congress to appraise the whole complex of measures and programs having a significant influence on the economic well-being of the country. Because of our appreciation of this fact, we have given special attention to the questions requesting general views. Right now, however, we are faced with a practical financing problem which must be worked out in the immediate future ; and I should like to discuss with you briefly how a problem of this sort, in practice, ties in with the more general considerations which govern Treasury policy. On the basis of the estimates in the President's budget, as much as $10 billion of the defense program may have to be financed by additional borrowing from the public before the end of the present calendar year. The budget is, of course , subject to revision as the year progresses, and particularly as we see how the expenditure program shapes up. Whatever the final figures turn out to be, however, the amounts which we shall have to borrow will be substantial. Earlier in this statement, I noted that the general goals of our debt management programs are (a) countering any pronounced inflationary or deflationary pressures, (b ) providing securities to meet the current needs of various investor groups, and ( c) maintaining a sound market for United States Government securities. These objectives are the guides which we use in arriving at policies which are appropriate to current economic conditions. The difficulties of this procedure in practice, however, and the many balanced judgments which are involved, could not be better illustrated than by our present situation . As I have stated, we may have to borrow as much as $10 billion in new money from the public before the end of this calendar year ; and it is generally agreed that these funds should be obtained to the greatest extent possible outside of the commercial banking system. From this point forward , however, we must proceed on the basis of a careful analysis of the many conflicting factors in the immediate outlook. There is no single, simple approach which will solve the entire problem for us. To begin with, we must be constantly watchful with respect to the development of inflationary or deflationary tendencies. There appears to be a lull, at present, in inflationary pressures ; but it would be imprudent to give less than full weight to the inflationary implications of our large defense program and of the deficit financing operations which will have to be undertaken in connection with it. For some time to come, defense production will draw heavily on our physical resources ; and the existence of a significant deficit will add to the supply of funds available for spending or saving. In the second place, we must take account of the fact that our present borrowing program will have to be geared to a set of circumstances which are unlike those experienced in connection with any previcus large - scale borrowing operations . In contrast to the World War II 97308-52-2 12 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT situation, for example, a large sector of industry and trade is engaged in substantially normal operations ; including operations such as capital expenditure programs-which draw on investment funds. When we found it necessary to borrow large sums of money early in World War II, moreover, the Government's debt was much smaller than it is now, both in absolute terms and in relation to the size of the economy. Today, our Government debt accounts for almost half of all the debt obligations in the country, public and private ; including-in addition to Federal securities-bonds of State and local governments, obligations of private corporations, mortgages, bank loans, consumer installment paper, et cetera . Public debt obligations represent an important part of the assets of our financial institutions , of numerous business corporations, and of millions of individuals and families throughout the Nation . Against this background, the practical meaning of the broad objectives of debt management which I outlined earlier becomes clear. It is evident that we must use great care to maintain an atmosphere which will be favorable not only to the purchase of new Government securities, but to the retention of current holdings and particularly, of course, the holdings of nonbank investors. To maintain investor confidence, inflationary or deflationary tendencies must be countered, and sound conditions must be maintained in the market for United States Government securities. To sell the greatest possible amount of securities outside of the commercial banking system, issues must be provided which will meet investor needs. Each one of the general requirements of a sound debt management program, therefore, is seen to have direct application to our present problem. In order to formulate a program suited to the current situation , the Treasury—as it has done in connection with each important financing operation in the past-has been making extensive analyses of the money and investment markets ; it has been discussing the problems on a continuing basis with representatives of the Federal Reserve System ; and it has been conducting a series of informal conferences and discussions-in which the Federal Reserve participates- with representatives of leading investor and financial groups and others during recent weeks. While I have found general agreement, as I noted earlier, on the need for securing the necessary amounts from nonbank investors, there is a wide divergence of views on how we ought to go about securing the funds ; and there are differences of opinion , also, as to measures which should be taken outside the area of debt management to maintain stability in the price structure and in the economy generally. These differences of opinion are to be expected. The problems involved are extremely complex ; they are all inter-related ; and they all touch on major aspects of public economic policy affecting wide areas of the economy. 1 When we review all of these facts in the Treasury, and evaluate them in terms of the problem at hand , the situation seems to us to add up to these conclusions : It is essential for the well -being of the country that the Treasury and the Federal Reserve continue to work in the closest cooperation . Both agencies are in wholehearted agreement on this matter. There is no substitute for working together on the important problems which we MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 13 shall have to solve jointly if the fundamental strength and productive power of the American Economy are to be maintained . I feel that an advisory council of the sort which I have discussed with the committee today would be of help in broadening the scope of cooperation . The spirit of cooperative effort , however, is the essence of the matter. The prospect of substantial deficit financing in the period immediately ahead underscores the importance of the broad economic objectives of the Treasury, and particularly of debt management policy. The Treasury has succeeded during the postwar period in reducing the proportion of the public debt held by the commercial banking system from 42 percent at the peak of World War II financing to 33 percent at the present time. Is has succeeded in maintaining savings bond ownership not only at the wartime peak, but at a figure which is now close to $58 billion- $9 billion higher than the amount held at the close of World War II financing. Our deficit financing program must conserve these gains-and it must add to them. For these reasons , the Treasury places great emphasis on the need for prudence with respect to policies which affect the Federal debt. As the subcommittee's questionnaires brought out so clearly, a governmental agency does not operate in the field of abstract theory ; full account must be given at all times to the practical implications of the policies and programs undertaken . The opportunity which the present hearings will provide for a discussion of measures appropriate to our present situation will , I am convinced , make a most important contribution to public understanding of the problems now confronting us. Representative PATMAN. Thank you , Mr. Secretary. Senator Douglas, would you like to ask any questions ? Senator DOUGLAS . Thank you, Mr. Chairman. Secretary Snyder, may I ask you what you think the policy of the Federal Reserve System should be in the event of a large refunding of Government securities or the issuance of a new set of Government securities ? Do you think that the Federal Reserve Board should be committed to buy a sufficient quantity of those securities so that the price may be maintained at the interest rates charged, and so that a general feeling of confidence may be given so that the issue may be subscribed ? Secretary SNYDER. Senator, I'think that is a matter that will have to be worked out between the Treasury and the Federal Reserve Board as the situations arise. I have found that the Board and the Open Market Committee have been very cooperative in our recent issues and our refundings , and I think that we have worked out a fine cooperative atmosphere, and I think that is a matter that we will have to continue to work out. Senator DOUGLAS. Mr. Secretary, I want to point out that my question to you was perfectly courteous. It was a question of what you thought the policy should be, and your answer, in effect constitutes refusal to answer the question. I want to know whether you think that it is a function of the Federal Reserve Board to purchase a sufficient quantity of Government securities in the event of a refunding of or a new issuance of securities so that the issue may go off successfully and be sold to the public at the interest rate charged ; and what you, in effect said was, "We will work that out. I am not going to reply to the question . " 14 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Now, with all kindness I do not think that is treating a congressional committee, which is trying to be fair with you, as a partySecretary SNYDER. Senator, I have no question as to your courtesy, and I did not raise any such question intentionally. Senator DOUGLAS. May I ask you what you think the policy of the Federal Reserve Board should be under those conditions ? Secretary SNYDER. I think that the policy of the Reserve Board should be one of cooperation with the Treasury. Senator DOUGLAS . And should the cooperation consist in purchasing a sufficient number of securities in the open market so that you can sell the securities at the interest rates which you decide upon ? Secretary SNYDER. I tried to answer that very positively, sir. Senator DOUGLAS . I could not understand the answer at all, and I would like to have the answer of the Secretary read back. Representative PATMAN. The reporter will read the Secretary's answer. (The Secretary's answer was read . ) Senator DOUGLAS. Would you like to add anything ? Secretary SNYDER. I would like to state, Senator, as each situation arises that will have to be a matter that will be worked out in the light of conditions at the time. Senator DOUGLAS . You do not wish to make a statement of general policy for the benefit of this congressional committee ? Secretary SNYDER. Not as to the Federal Reserve policies. Senator DOUGLAS . What do you think, thenSecretary SNYDER. Other than that, as I have stated , I think it is one of close cooperation . Senator DOUGLAS. Then you would not carry on any conversations with the Federal Reserve Board should a question such as I have described arise ? Secretary SNYDER. That is not my answer, Senator. If you will reread it, you will see that I said it is a matter in which we will have to cooperate most closely, and it will involve carrying on conversations, of course. Senator DOUGLAS. What do you think you will say to the Federal Reserve Board when you have these conversations ? Secretary SNYDER. That depends on the circumstances under which we are holding the conferences and the problems that face us. Senator DOUGLAS . This is what congressional committees frequently face from administrative officials when we are trying to work out policy. We are kept from the real point of view of the administrative officials, and it becomes almost impossible for us to arrive at any conclusion. I am very disappointed , Mr. Secretary, in your reply. Do you think that the Federal Reserve Board should purchase Government securities or should not purchase Government securities in the circumstances I have outlined ? Secretary SNYDER. The Federal Reserve's policy has been to conduct their Open Market Committee operations in support of the Treasury's financing operations and, thereforeSenator DOUGLAS . You mean to buy a sufficient quantity ? Secretary SNYDER. I think they should continue their policy of supporting the proper financing of Government operations. Senator DOUGLAS. Does that mean they should, if necessary, buy an unlimited quantity of Government securities ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 15 Secretary SNYDER. It will have to be bottomed on conditions at the time those decisions are made. ♥ Senator DOUGLAS . Is not the best protection for security issues the general prosperity of the country, a balanced budget, protection against the danger of future inflation , and a satisfactory interest rate ? If those.conditions are met, to what degree is it necessary for aritficial support to be given by the Federal Reserve System ? Secretary SNYDER. As the Senator knows, I have advocated balanced budgets ever since my opening statement when I became Secretary of the Treasury, and I still feel that we should maintain balanced budgets to the greatest possible extent. Senator DOUGLAS. If those conditions are met, why is it necessary for the Federal Reserve Board to purchase any securities ? Why couldn't the bond issue be met by the general investment market ? Secretary SNYDER. Well, in general, I think that you have stated a very proper reason for believing that there would be no occasion , but we would have to look at conditions that have occurred in the past, and also have to measure what might develop in the future as to just what would be the circumstances at any given time under any given condition of the market or of the amount of financing that the Government has to maintain, whether it be refunding or whether it be new issues . As to the using of the interest rate alone , that is a matter that has caused a great deal of debate and discussion, and one which we have tried to meet in our answers to the subcommittee's queries. We have to measure very carefully the decisions that will be made as to interest rates. Senator DOUGLAS. Well, certainly, in times past the Treasury has asked the Federal Reserve Board to stand ready to purchase Government bonds if there were not enough private subscriptions ; is that true ? Secretary SNYDER. The Federal Reserve has offered to do that , and been requestedSenator DOUGLAS. Has not the Treasury requested that it do that ? Secretary SNYDER. I was just finishing my answer. Senator DOUGLAS . I beg your pardon. Secretary SNYDER. I said they have offered to do that, and the Treasury has requested them to do that ; that is correct. Senator DOUGLAS. The Treasury has asked them to do that ? Secretary SNYDER. Asked them to support the financing. Senator DOUGLAS. What would you say to the contention that you are asking the Federal Reserve Board to do that which if practiced by a private underwriter with regard to private issuances , would render him liable to prosecution under the securities and exchange statute by the Securities and Exchange Commission for pegging the market ? Secretary SNYDER. I am sure the Federal Reserve Board got their legal opinion on that before they undertook it. Senator DOUGLAS. The Securities and Exchange Commission , in order to strike at one of the evils of private underwriting, provides that the issuing house should not without due notice create an artifical market by guaranteeing to support the price of securities by purchases. Now, has not the policy in the past sometimes been in effect to urge the Government to do that which is a penal offense for private underwriters to do ? 16 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Secretary SNYDER. I am quite certain that when the Federal Reserve adopted such a procedure that they carefully weighed the public welfare. Senator DOUGLAS . There is no penalty against the Federal Reserve Board's supporting the market without publicly proclaiming that it is doing so. It is not statutorily a criminal offense. But what I am trying to get at is this : Just as we are trying to create natural conditions in the stock market where issues can sell on their merits without artificial support should we not with respect to the Government securities market, depend on the general condition of the country, the soundness of the Federal budget, the protection against the danger of future inflation, and a realistic interest rate rather than upon artificial support through the purchase of bonds by the Federal Reserve to maintain bond prices ? Secretary SNYDER. I think that we have had to measure this each time. Of course, as you know, Senator, there was only 1 year in which there was any net Federal Reserve support of the Government bond market in the postwar period up until the time of Korea ; that is beside the point as to your question, but it is interesting to note that net purchases have not been generally the case all the way through the postwar period. Senator DOUGLAS. It was true 1 year. Secretary SNYDER. In 1 year ; that is correct, sir. (The following was submitted for the record :) This matter is discussed in detail in the answer to question 17 of the questionnaire submitted to the Secretary of the Treasury by the subcommittee. The following table provides statistical information relating to the discussion : Net purchases or net sales of Government bonds by the Federal Reserve, Jan. 1, 1946, to June 30 , 1950, inclusive Billion Jan. 1 to Dec. 31 , 1946, net sales . $0.2 Jan. 1 to Nov. 12, 1947, net sales__. (¹) 10.4 Nov. 13 to Dec. 15, 1948, net purchases3.9 Dec. 16 to Dec. 31, 1949, net sales_. 1.6 Jan. 1 to June 30, 1950, net sales__ 1 Less than $ 50 million. Senator DOUGLAS . It was true after Korea ? Secretary SNYDER. That is correct. I think we have to measure carefully the broad public interest, and I am sure that is what the Federal Reserve Board and the Open Market Committee take into consideration in carrying out their obligations. Senator DOUGLAS. There is a fundamental issue involved here, namely, whether you will provide so-called natural markets for Government securities or the degree to which you will provide artificial markets for Government securities. Perhaps, I am using question-begging words in referring to the purchase of the Federal Reserve as an artificial device, but the question is the degree to which the Government will maintain its own bond market or to the degree to which it will allow the bond market to be settled by natural forces in the private field . Secretary SNYDER. Well, it boils down to the meeting of a practical situation, I think, Senator, as long asSenator DOUGLAS. When you face a practical situation without any general philosophy you are apt to come to great difficulties ; and what MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 17 we are trying to do here, if this inquiry has any merit-and if it does not have merit we should close it out immediately, Mr. ChairmanSecretary SNYDER. Well, the question isSenator DOUGLAS ( continuing) . Is to see if we can try to work out general principles for meeting these concrete situations which lie ahead. Secretary SNYDER. The question then arises as to whether or not we should have an open-market operation. Senator DOUGLAS . No, that is not the question . It is the degreeSecretary SNYDER. I think so . Senator DOUGLAS ( continuing ) . To which the Federal Reserve System should be committed to enable a Treasury issue to be successful or the degree to which a Treasury issue should be allowed to take its own chances in the public bond market or the private bond market. Secretary SNYDER. I think we have to consider the public interest involved. With the large financings that we have to conduct in these days, with the debt the size it is, there must be some assurance mutually agreed on between the Federal Reserve and the Treasury that these operations will be carried out with assurance as to the stability of the Federal Government bond market. Senator DOUGLAS. In other words, the Federal Reserve System should be willing and agree to purchase a sufficient number of securities so that the issue can be sold? Secretary SNYDER. I think that is a matter that will have to be carefully weighed. Senator DOUGLAS . Who is to determine the interest rate ? Secretary SNYDER. Well, that matter is always discussed very carefully, sir. Senator DOUGLAS . Who is to make the final decision on it ? Secretary SNYDER. There is only one place that it can finally be made by law, and that is in the Treasury Department. Senator DOUGLAS . When the Treasury makes the decision , therefore, is the Federal Reserve Board supposed to purchase a sufficient number of bonds so that the issue can be a success at the interest rates determined by the Treasury? Secretary SNYDER. I think we can work out cooperation. Senator DOUGLAS. Cooperation is a beautiful word, but it is like an overcoat, it covers quite a range of reality. Secretary SNYDER. It has to do that, sir. In these days we have to face realities as well as theories. Senator DOUGLAS. Mr. Secretary, when the Federal Reserve Open Market Committee buys Federal securities , what happens ? How does it pay for these Government securities ? Secretary SNYDER. Well, of course, it pays for it out of the funds that it creates. Senator DOUGLAS. You mean it pays for them by check ? Secretary SNYDER. I beg pardon ? Senator DOUGLAS. You mean it pays for them by check ? Secretary SNYDER. Or by giving credits, which is the same thing. Senator DOUGLAS . When it pays for them by check, these checks go into the hands of the banks ? Secretary SNYDER. It goes to the credit of the bank ; yes, sir. Senator DOUGLAS . And the banks do what with the checks ? 18 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Secretary SNYDER. You are just talking about the mechanics of it, are you ? Senator DOUGLAS . That is right. Secretary SNYDER. When the Federal Reserve buys securities from the banks, why, it is Senator DOUGLAS . Let us take the situation when Federal Reserve buys from the banks or private security dealers. Secretary SNYDER. When it buys from a bank, of course, it will issue a check or give it direct credit on the books of one of the Federal Reserve banks. In either event that increases the deposit of the seller of the securities. Senator DOUGLAS . And of the member bank, is that not true ? Secretary SNYDER. Well then, of course, they increase the deposits. Senator DOUGLAS. Yes ; the deposits. When these checks are presented by the banks either directly or the banks ' acquiring these checks from the private security dealers, they are deposited by the banks, are they not, in their accounts with the Federal Reserve ? Secretary SNYDER. Yes ; the deposits with the Federal Reserve banks are member-bank reserves. Senator DOUGLAS . I understand. They, therefore, increase the deposits which the member banks have with the Federal Reserve ; is that not true ? Secretary SNYDER. Yes. Senator DOUGLAS. That is right. And it, therefore, increases the reserves which the member banks have ; is that not true ? Secretary SNYDER. That is correct. Senator DOUGLAS . The reserve requirements presently in effect are 14, 20, and 24 percent, respectively, for the country, reserve city, and central reserve city banks. On the average, I believe the reserve requirement is 16 percent, and that is for each dollar of short-time deposits there must be roughly a 16-percent reserve. That leads me to this question : When the reserves of the member banks increase, what happens to the lending capacity of the member banks ? Secretary SNYDER. In general, it is increased , of course. Senator DOUGLAS. And approximately in what ratio ? Secretary SNYDER. I do not know just what that ratio isSenator DOUGLAS. It is approximately 6 to 1 , at least theoretically. Secretary SNYDER. Generally, it is considered somewhere around 5 to 1. What it is precisely I do not know. Senator DOUGLAS . Well, the Federal Reserve says 6 to 1. The reserve ratio of 14 percent for the banks in the smaller cities, 20 percent is the next group of cities, and 24 in the largest citiesSecretary SNYDER. 5 to 1 or 6 to 1. Senator DOUGLAS. The Federal Reserve says 6 to 1. So that the increase of the reserves of the member banks in the Federal Reserve System increases their lending capacity in a sixfold ratio to that of their increase in reserves is that not true ? Secretary SNYDER. Something in that area. Senator DOUGLAS . Yes. Now, then, banks ; do the banks like to keep earning capacity idle ? Secretary SNYDER. Well, they would be accused of poor banking if they did. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 19 Senator DOUGLAS. That is right. Therefore, they will want to lend, assuming the risks are sound, up to the limit of their lending capacity, is that not true ? Secretary SNYDER. They, generally speaking, do that ; that is their policy. Senator DOUGLAS . That is, except when you have a period of depression . Secretary SNYDER. That is the policy of good banking management ; yes. Senator DOUGLAS. Except when you have a period of depression ? Secretary SNYDER. Yes. Senator DOUGLAS. Therefore, the increase of reserves will probably be accompanied by a parallel increase in bank loans, in a ratio up to 5 or 6 times that of the increasing reserves, is that not true ? Secretary SNYDER. It sometimes works out that way. Senator DOUGLAS. If we have a period of comparatively full employment, such as we have now with unemployment at roughly 3 percent, and unemployment chiefly in localized areas such as Detroit, New York, and certain other regions, will this increase in loans cause substantially more goods to be produced ? Will it put idle labor to work with idle resources producing commodities which otherwise would not be produced ? Secretary SNYDER. Would an increase in bank credit accomplish that ? Senator DOUGLAS . Yes. Secretary SNYDER. Well , it might aid in it ; yes. Senator DOUGLAS. I mean if you have comparatively full employment, in which virtually everyone has a job. Do you think you would effect any substantial reduction in unemployment below the 3.3 percent which we are supposed to have now? Secretary SNYDER. Well, then we get into the realities of the question. Now when we are talking about Senator DOUGLAS . Yes. Secretary SNYDER. The answer to your statement theoretically would be that any expansion of credit under conditions of full employment and full utilization of manufacturing capacity would only tend to oversupply the market. Senator DOUGLAS. Over-supply what market ? Secretary SNYDER. The credit market. Senator DOUGLAS . That is a vague phrase . My question was whether you thought there would be any significant increase in physical production because of a further expansion of bank loans when you have substantially full employment. Secretary SNYDER. Yes ; that is what I was addressing myself to. Senator DOUGLAS. Do you think there would be any significant increase in physical production ? Secretary SNYDER. I think that it all depends on whether you want credit to flow to increase production, and that is why I said we get into the realities of whether or not it is a question of supplying credit. Senator DOUGLAS. With unemployment down to 3.3 percent, do you think you can drive it down much further than that by an expansion in bank loans ? 20 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Secretary SNYDER. The question that we are really faced with, though, right now, Senator-I am willing to answer all your theoretical questions . Senator DOUGLAS. These are not theoretical questions, Mr. Secretary. Secretary SNYDER. Well, it turns out that way from a practical standpoint. Senator DOUGLAS . These are extremely broad and important questions. Secretary SNYDER. It turns out to be a theory against practice, because if in this defense program bank credit had been completely shut off, then the question would come up as to who would supply the credit to these expanding operations for the defense program. Senator DOUGLAS . Mr. Secretary, I am not proposing to shut off bank credit. I am merely saying if the Federal Reserve is asked to buy large quantities of Government securities in the open market, does it not create added bank reserves in the Federal Reserve System, and the answer to that has been "Yes" ; isn't that correct ? Secretary SNYDER. That is correct. Senator DOUGLAS . The next question was, with added bank reserves in the Federal Reserve System, does not this lead, too, to increased bank loans, and the answer to that was "Yes." The third question was do these increased bank loans in a period of comparatively full employment lead to an increase in production or do they lead to an increase in prices ? That is what I am coming to. Secretary SNYDER. Well, they could well lead to an increase in prices. Senator DOUGLAS . That is the point . Now, will they not lead to an increase in prices when the only unemployment which exists is seasonal and transitional, plus a few isolated pockets which cannot be removed by the expansion of bank credit ? Secretary SNYDER. Well, the question, of course, that is raised then is how to prevent that expansion of bank credit . We get into the problem of what could or could not prevent the expansion of bank credit. Senator DOUGLAS. Mr. Secretary, is it not true that the expansion of bank loans in a period of comparatively full employment will furnish the economy-public and private-with more monetary purchasing power, which will then be used for the purchase of commodities and for labor ? Secretary SNYDER. That is certainly true, and we have encouraged every possible way of holding back the expansion of inflationary bank credit. Senator DOUGLAS. Just a minute. I think you are pursuing contradictory aims, that is the point . The expansion of bank credit will furnish to private persons and to some degree the Government, added monetary purchasing power which they will use to bid for goods and services but virtually all the labor is employed so that in effect, you will have more purchasing power to buy the existing stock of goods and services. Will not that inevitably force prices up ? Secretary SNYDER. That is correct. Senator DOUGLAS . Well, that is inflation, is it not ? Secretary SNYDER. That is a definition of it. Senator DOUGLAS . That is right. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 21 Here is the point : In order to maintain the price of the bonds, you ask the Federal Reserve System to purchase large quantities of Government securities ; but the purchase of these large quantities leads to inflation, by adding to the reserves, and hence the lending capacity of banks. Now, then, you stated that one of your purposes was to prevent inflation . How much weight do you give to the prevention of inflation as compared to the maintenance of a bond market at a low interest rate ? When these two principles come in conflict, which is to have precedence ? Secretary SNYDER. Well, the question, of course, then comes into sharp focus as to whether interest rates are going to hold back the seeking of bank credit by users of bank credit. Senator DOUGLAS. Just a minute. Economists have frequently tried to emphasize the control of credit on the demand side by the interest rate. I want to assure you that that is not my point. I am not saying that an increase in the interest rate will appreciably decrease the private demand for capital. What I am asking is : Should it not be a function of Government to prevent the supply of bank credit from expanding more rapidly than the quantity of physical production , because if the quantity of bank credit does expand more rapidly than the quantity of physical production the inevitable result, as you have admitted, is an increase in prices. Secretary SNYDER. Well, the problem then arises as to directing available bank credit into the noninflationary areas. Senator DOUGLAS . What are those ? Secretary SNYDER. And thatSenator DOUGLAS . What are those ? Secretary SNYDER. Well, that would be for the normal supply of neded capital for the operation of necessary business ; and for, of necessity, in these conditions, the supply of credit to carry on the defense program. Senator DOUGLAS. Have you ever thought of the fact that possibly the total supply of bank credit should not be increased or at any rate should not be increased more rapidly than the volume of production ? How can you expect to pour additional credit into the economy and yet prevent that credit from spilling over in the form of an increase in prices in a period of full employment ? Secretary SNYDER. Well , in order to prevent it, we had to put controls in, because unless you control the production in nondefense areas then you are going to have created a situation demanding additional credit. But if you could control production and let the wages and the raw materials flow into the production of materials needed for defense requirements- if you could thus balance the demand and requirement for the use of labor and raw materials between the defense and the nondefense programs, we could hold total credit down to a certain level. Senator DOUGLAS . Mr. Secretary, if you force the Federal Reserve System to purchase additional large quantities of Government bonds, thus expanding bank reserves, thus expanding credit, the task of trying to prevent prices from increasing, after all this is done, it will be just as futile as when I fill this glass of water and keep pouring it in, and 22 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT then try to mop up the overflow with a pocket handkerchief. Why not get at the source and try to prevent the undue expansion of the total quantities of bank credit itself? Secretary SNYDER. We would like to accomplish that, Senator, as much as you would, of course. Senator DOUGLAS . If you force the Federal Market Committee to purchase unlimited quantities of Government bonds, far from stabilizing the price level, you are inflating the price level . Secretary SNYDER. How would you prevent the undue expansion of bank credit ? How would you meet the credit needs of the defense program when Congress has not put in the necessary control measures ? Senator DOUGLAS . Oh, I voted for those control measures . Secretary SNYDER. Just a minute, we are talking generally. Senator DOUGLAS. I voted for those control measures, and I think they have a limited degree of aid, but to depend solely upon direct controls to restrain prices when you are inflating the money supply is to my mind foolish-forgive me for saying so-and if anybody has more glasses of water, I will demonstrate again. Secretary SNYDER. We will accept the Senator DOUGLAS . Just pouring in credit, pouring in more credit and then to say put in direct controlsSecretary SNYDER. Senator, we will accept the demonstration ; you are spoiling one of your reports there. Senator DOUGLAS. It is just utterly foolish . Why not stop pouring? Secretary SNYDER. Well , I wish you would, because you are spoiling one of those fine reports there. [ Laughter. ] Senator DOUGLAS. I wish you would stop pouring credit or trying to force the Federal Reserve System to pour credit into the banking system ; where the damage is far greater by pouring the credit than in pouring the water. Secretary SNYDER. There is no question about that, Senator ; and it is a problem that we have to face very seriously ; you know that . I am no more an inflationist than you are. Senator DOUGLAS . You say you want to keep interest rates down, but you also want to prevent inflation. Which is better, a stable interest rate but expanding bank loans and rising prices or a stable price level even though it may mean a rising interest rate ? Secretary SNYDER. Well, Senator, as I have said many times , I have no doctrinaire views on holding interest rates generally over a long period of time at any one point . We have demonstrated that during the postwar period when the Treasury cooperated with the Federal Reserve in permitting interest rates to rise in the shortterm securities market, because we felt that was the proper thing to do. For a further discussion of this point, reference can be made to the answer to question 17 beginning on page 50 and the answer to question 28 beginning on page 103 of part I of the subcommittee's document containing the replies to questionnaires submitted by the subcommittee. Senator DOUGLAS . But here is my point : I think we have established it pretty clearly that if the Federal Reserve is forced to buy unlimited quantities of Government securities or large quantities of Government securities, the inevitable effect in a period of comparatively full MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 23 employment such as we have now, with only 3.3 percent unemployed, is to inflate the money supply, and drive up prices. This in turn, increases the cost of Government services, eats into the income of those with fixed incomes and creates all the havoc of inflation . Is that not a rather poor policy ? Secretary SNYDER. Well , let us take a look at the whole picture. Since the end of World War II financing, actually the bank-owned public debt has declined by over thirty billions of dollars. The point is we have not been Senator DOUGLAS . 1945 and 1946-that period was a very fortunate year, because the high war tax rates were in effect, and military expenditures had tapered off, and if we were to get into a discussion of budgetary policy, we would get into further issues, but I understood our chairman to say we were not going to discuss budgetary policy, so I am not going to pursue that subject any further. Secretary SNYDER. I am not trying to get into budgetary policy ; I am just trying to point out, though, that it is not a matter of continually forcing the Federal Reserve to buy over the long run. Senator DOUGLAS. I helped conduct hearings parallel to these 21/2 years ago, and the testimony was perfectly clear, supported by sufficient documents that were introduced, to indicate that the Treasury has generally insisted in the past that the Federal Reserve System purchase Government bonds in order to support the market, and did so until the famous accord of April , agreed upon in March , but dated , I believe, early in April 1951 . Now, some of us are a little fearful that this accord may be discontinued or if cooperation is obtained that it may be by the Federal Reserve agreeing to the policies of the Treasury. Now, I believe , we have a right to be fearful about that, Mr. Secretary. Secretary SNYDER. And the Treasury has a right to be hopeful— Senator DOUGLAS . You mean hopeful that there will be inflation ? Secretary SNYDER. That we will have accord. We do not have quite as much suspicion about an accord as you do. Senator DOUGLAS . And that the Federal Reserve will purchase unlimited supplies of Government bonds ? Secretary SNYDER. No , that we will have cooperation and the Fed. eral Reserve and the Treasury in the fashionSenator DOUGLAS . Does that accord , in your mind, carry with it the idea that there will be large purchases by the Federal Reserve ? Secretary SNYDER. It carries with it the idea that the Federal Reserve and the Treasury are going to sit down and work things out together to the best interests of the public. Senator DOUGLAS . Well, I do not know what to say that would reply to an answer like that. I suppose I ought to send bouquets to you both in the hope that you have a happy meeting. Secretary SNYDER. I hope you will share with me the hope that you will do that. [ Laughter.] Senator DOUGLAS. Are you worried about inflation ? Secretary SNYDER. Yes, sir ; I have been continually. Senator DOUGLAS. Yet the purchase of large quantities of bonds by the Federal Reserve System leads to inflation, does it not ? Secretary SNYDER. It contributes in a degree. 24 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. Therefore, I should think you would be very fearful and be afraid that the Federal Reserve System might buy large quantities of these bonds . Secretary SNYDER. We have the practical problem of managing the debt, Senator . Senator DOUGLAS . Which takes precedence, the management of the debt or the maintenance of a stable price level ? Secretary SNYDER. I think that they are interrelated . Senator DOUGLAS. But when they conflict which do you think is the more important ? Secretary SNYDER. You have to measure the conditions of the moment when you are making the decision-that is not a decision you make for all time. Senator DOUGLAS. That is, you might at certain times conclude that the management of the debt was more important than the maintenance of stable prices assuming the two are in conflict ? Secretary SNYDER. At times I think that you will find that it might be. Senator DOUGLAS. In a nonwar period ? Secretary SNYDER. I did not say that. That is why I pointed out. in times such as we are faced with now——— Senator DOUGLAS. During a nonwar period, do you think the management of the debt is more important than the maintenance of a stable price level ? Secretary SNYDER. I think that was the type of problem faced by the Employment Act of 1946. Senator DOUGLAS . The Employment Act does not solve that problem. Secretary SNYDER. I know it does not solve it. It points up to us the real problem of meeting both inflationary and deflationary pressures, and put the problem right up to Congress and to the Treasury and to all of the Government . Senator DOUGLAS. And the way the Treasury solved it is to look the issue squarely in the face and say, "We won't solve it " ? Secretary SNYDER. I will not project how we are going to handle all these issues in the future. I certainly could not, Senator, not in open session, unfortunately. Senator DOUGLAS . Then, since I am foreclosed from discussing the future, is it possible for me to discuss the past ? Secretary SNYDER. That is right. Senator DOUGLAS. Did not the purchase of securities, Government securities, by the Federal Reserve System after Korea, give rise to an increase in (a) in the reserves of member banks in the Federal Reserve System, ( b ) increased loans by the member banks to private industry and individuals and (c) an increase in the price level ? Secretary SNYDER. I think we cover that in answer 17 of the questionnaire . I will be glad to prepare anotherSenator DOUGLAS . Would you reply to it in hearings ? Secretary SNYDER. I would be glad to read that into the hearing, yes. Senator DOUGLAS . Answer 17 is quite an answer. It extends over some pages . Secretary SNYDER. Yes, sir. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 25 Senator DOUGLAS. I would like to ask you very briefly, did not the purchase of Government securities by the Federal Reserve System after Korea result in an increase in bank reserves in the Federal Reserve System ? Secretary SNYDER. I will be glad to read this into the record. Senator DOUGLAS . Mr. Chairman , I suggest that this is not an appropriate answer on the part of the Secretary. Secretary SNYDER. I want to suggest to the Senator that I have the responsibility to manage the debt, and I am going to be very careful how I answer each question . I want the best good to come out of these meetings. I am the person responsible for final decisions in the management of the debt, except in those cases in which the issuance of securities is subject to the approval of the President. I must be extremely careful of everything I say Senator DOUGLAS . I am asking you about the past. Secretary SNYDER. Yes, sir ; I want to give you exactly what happened in the past. I don't want to rely on memory. Senator DOUGLAS . May I say for the record , the answer to question 17 began on page 50, and it concludes on page 74. Is it the intention of the Secretary to read 24 pages into the record, each page of which consists of approximately a thousand words ? Secretary SNYDER . Well, I will add this sentence, substitute this for that. Of course, 17 is part of the record anyway and is available to the committee, but I would like to say here that at the start of the Korean invasion on June 25 , 1950, the Federal Reserve System was selling bonds, continuing that policy which had been adopted in November 1949, making bonds readily available as prices were marked down. From November 1949, to June 21 , 1950 , the Federal Reserve holdings. of bonds declined approximately $1,900,000,000. Senator DOUGLAS. Holdings of the Federal Reserve declined ? Secretary SNYDER. Yes , sir. Senator DOUGLAS . From June 1950 ? Secretary SNYDER. From November 1949 , to June 21 , 1950 . Senator DOUGLAS . Oh, well I am speaking of the period immediately after Korea , namely, from July 1, 1950 , on . Secretary SNYDER. Oh , Senator DOUGLAS. Is it not true that after Korea the holdings of the Federal Reserve System of Government bonds increased from 18.2 billions on June 28, 1950 , to 22.2 billions on March 7 , 1951 , or an increase of 4 billions ? These figures are found in the report of the Federal Reserve Bulletin for May 1951, page 515 , and in the same document, page 527 , the figures on all bank loans are given. These loans increased from 52 billions on June 30, 1950, to 62 billions on February 28 , 1951 , and 63 billions on March 28, or an increase in that time of 11 billions. That is, during the 8-month period when there was an increase of $4 billion in securities held by the Federal Reserve System, there was an increase of $ 11 billion or roughly 21 percent in bank loans. During the same period we also had an increase of 16.6 percent in wholesale prices. Now was not the increase in bank loans one of the reasons which permitted the increase in wholesale prices to take place ? Secretary SNYDER. It could have been one of the many reasons. 26 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . Well, was it not an important reason ; in fact, the important reason ? Secretary SNYDER. Well , I would not say it was the important reason. Senator DOUGLAS . What other important reason could there be ? Here you have bank credit increasing by 21 percent, wholesale prices increasing between 16 and 17 percent. The inference seems to me obvious. When you increase the quantity of money in relationship to goods, the price level rises. Secretary SNYDER. There was a general rushing in to buy by the consumer. Senator DOUGLAS . Yes ; but they could not have made these speculative purchases had they not been able to get the bank loans , and the bank loans would not have been obtained unless bank reserves had been expanded through the purchase of additional securities by the Reserve System. It was the purchase by the Reserve System of the securities which made bank credit available for speculative purchasing. Secretary SNYDER. There was a tremendous amount of stored-up savings in the business world that had no effectSenator DOUGLAS . These are not by any means all stored-up savings. These are loans, which made up the added monetary purchasing power. Secretary SNYDER. Loans were only a part of the picture. That is why I say that was not the whole matter. Senator DOUGLAS. Is it not interesting that you have an increase in the quantity of bank credit at about the same ratio as the increase in the price level ? Incidentally you will find that the increase in physical production and in velocity roughly balanced each other at about 8 or 9 percent apiece. You can therefore throw those out. It is the increase in the quantity of money and credit that primarily caused the increase in prices. Secretary SNYDER. It was, of course, recognized that efforts must be made to curtail credit expansion. Senator DOUGLAS. But during this entire time the Federal Reserve System, under encouragement from the Treasury, was purchasing enormous quantities of Government securities. Secretary SNYDER. Well, the total holdings of the Federal Reserve in Government securities today are not much different from what they were they are really lower than at the end of the war finance period. Senator DOUGLAS. I am not speaking about the war. I am taking this critical post-Korea period , and I am pointing out that in that period the Reserve purchased roughly $4 billion net of Government securities, building up member bank reserves. These increased member bank reserves in turn permitted member banks to increase loans, which they did in the total of $10 billion, that is up to March 1 , 1951 . This would be an increase in the quantity of credit of 19 percent with prices increasing by about 17 percent during the same period . And when you increase the quantity of money in relationship to goods, you increase the price level. Secretary SNYDER. Well , of course, Senator, it is interesting to note that since the accordSenator DOUGLAS . Well, since the accord, quite right. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 27 Secretary SNYDER. But loans have gone up just the same since the accord- credit has not been cut off-and prices have leveled off. That is the point I was making. The statistics which support this statement are as follows : Federal Reserve holdings of Government securities went up $1.6 billion between February 28 and December 26, 1951, and commercial bank loans went up $4.8 billion. But wholesale prices went down during this period-over 3 percent as measured by the Department of Labor's all-commodity wholesale prices index (900 commodities ) and 15 percent for the 28 commodities included in the Department of Labor's basic commodity index. Wholesale prices were, in fact, beginning to show a tendency to level off at the time the accord was reached. The following tables give the figures in detail : TABLE 1. Federal Reserve holdings of Government securities and commercial bank loans [In billions of dollars] Feb. 28, 1951 | Dec. 26, 1951 21.9 53.5 Federal Reserve holdings ... Loans of all commercial banks .. 23.5 58.3 Increase 1.6 4.8 TABLE 2.-Department of Labor index of all commodity wholesale prices [1926= 100] Month Week ended180. 1 1951- Jan . 2_. 176. 8 1951 - January. 178. 1 Jan. 9. 183. 6 February 178. 7 Jan. 16___. March_ 184. 0 180. 0 Jan. 23. 183. 6 April Jan. 30 180. 9 182.9 May. 182. 3 June_ Feb. 6 181. 7 Feb. 13 . 183. 4 179. 4 July 183. 3 Feb. 20__. 178. 0 August . 183. 0 177. 6 Feb. 27 September. Mar. 6__ 183. 5 178. 1 October November. Mar. 13... 183. 4 178. 3 December . 183.9 177. 8 Mar. 20___ . 183.9 Mar. 27. NOTE: The weekly index covers a much smaller number of commodities (115) than the monthly index (900); it is used primarily to indicate the trend of price changes in the interim periods between the publication of the monthly figures. TABLE 3.- Department of Labor index for 28 basic commodities [August 1939-100] Week ended1951-Jan. 2____ Jan. 9 . Jan. 16 Jan. 23 Jan. 30. Feb. 6Feb. 13 . Feb. 20 . Feb. 27. Mar. 6 . Mar. 13 ... Mar. 20 Mar. 27 . 97308-52-3 End ofmonth 370. 4 | 1951—Jan. 31___. Feb. 28_ 381. 7 Mar. 30 385.5 389.5 Apr. 30 388.7 May 31 388.9 June 29 389.7 July 31. 389. 2 Aug. 31. 387.9 Sept. 28 . 385. 7 Oct. 31 379. 6 Nov. 30 378. 4 Dec. 28 378. 4 388. 6 386.9 378.9 372. 0 359. 7 342.9 326.9 323. 2 328.9 326.9 327.6 327. 3 28 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. Well, now just a minute. They had some idle reserves, that is the answer to that. They had unused reserves upon which they could expand. Secretary SNYDER. But the fact that the Fed. was not buying Government bonds did not stopSenator DOUGLAS. But the past purchases, particularly in the winter, gave the banks reserves which they did not immediately use but which they could utilize in the subsequent period. Secretary SNYDER. Well , we would have to analyze to see what those reserve holdings were. ( The material subsequently submitted is as follows :) The table that follows shows excess reserves of member banks weekly for the year following the outbreak of hostilities in Korea. The figures fluctuated from week to week, but there was no significant upward trend as a result of the expansion of the Federal Reserve portfolio during the period. Member bank excess reserves 1950 June 28. July 5_____ . July 12 . July 19 July 26 Aug. 2 . Aug. 9. Aug. 16 Aug. 23. Aug. 30 . Sept. 6 Sept. 13. Sept. 20. Sept. 27. Oct. 4 . Oct. 11_____ Oct. 18---Oct. 25 Nov. 1 . Nov. 8 Nov. 15 Nov. 22. Nov. 29. Dec. 6 . Dec. 13. Dec. 20______ Dec. 27___ [ In millions of dollars ] Excess Reserves 1951 526 Jan. 3 . 791 Jan. 10 ‒‒‒‒‒ 904 Jan. 17____. 630 Jan. 24. 830 Jan. 31 . 842 Feb. 7-831 Feb. 14____. 685 Feb. 21. 756 Feb. 28518 Mar. 7 ---864 Mar. 14____. 931 Mar. 21. 353 Mar. 28. 862 Apr. 4 778 Apr. 11. 960 Apr. 18____. 1, 250 Apr. 25__. 687 May 2 727 May 9 . 719 May 16. 1,010 May 23538 May 30 . 679 June 6_. 949 June 13. 1, 100 June 20 866 June 27 759 Excess Reserves 1, 191 1, 111 969 650 937 826 741 577 700 716 1,042 577 488 646 987 1, 116 694 456 563 766 291 306 863 1, 070 840 538 Senator DOUGLAS . We could easily work that out by getting the figures on excess reserves by periods . I think that would show that the banks laid up for themselves reserves which they did not immediately use but which were available not only for the expansion in credit between July 1950 and April 1951 , but after April as well. The only conclusion I can draw is that the Federal Reserve under Treasury stimulus was a big contributor to inflation during this period. Secretary SNYDER. Well, there are many other factors besides that. This is discussed in question 17 of the questionnaire- page 69 of volume I. Senator DOUGLAS . It was the chief contributor . Secretary SNYDER. I doubt it. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 29 Senator DOUGLAS. In other words, according to you, the primary factor, the primary cause of inflation , is not the ratio between the total quantity between money and credit on the one hand , and total quantity of goods on the other, but some other element or elements ? Secretary SNYDER. I said I doubted that the Federal Reserve purchase of Government bonds was the important contributor to inflation , and I do say it. Senator DOUGLAS . Mr. Secretary, the purchase of these Government bonds increased member bank reserves by $4 billion . That would theoretically enable them to loan out from $20 billion to $24 billion more of credit, and you said that was their tendency, being unwilling to leave idle lending capacity. They actually increased their loans by $ 10 billion during the same period, increasing from 52 to 62 billions, an increase of 19 percent. They have expanded total loans $6 billion more since then, or have expanded the total quantity of credit by $16 billion, an increase of about 30 percent since Korea. Now how can you avoid the conclusion that it was the purchase of Government bonds during this period which was a primary factor that led to inflation, or that it was the main cause ? Secretary SNYDER. I don't consider it the main cause. Senator DOUGLAS. What would be the main cause then if this is not ? Secretary SNYDER. I think the general attitude, the scare buying. Senator DOUGLAS. But the scare buying was financed by credit . Secretary SNYDER. But not entirely by credit created this way, not by a long shot. Senator DOUGLAS . But partially by this. Secretary SNYDER. Well, partially, I am willing to admit partially, but it was not the important cause. This matter was discussed in the answer to question 17 of the questionnaire submitted to the Secretary of the Treasury by the subcommittee, as follows : " The primary cause of the inflationary situation, throughout the entire postwar period, was an unprecedented demand for goods by business and consumers generally. Before Korea, individuals bought goods to fulfill the stored-up demands which had resulted from the shortages of World War II ; and industry replaced and expanded plant and equipment in order to meet civilian peacetime needs. After Korea, individuals and businesses, remembering the shortages of World War II, bought goods in anticipation of shortages in the defense period ; and requirements for materials and goods were also stepped up sharply in order to meet the expanded military needs of the period. Some of these purchases were financed by an expansion of bank credit--but not all of them, by any means. Bank credit, for example, accounted for only about one-tenth of the 1950 financial needs of business corporations. " Senator DOUGLAS. In other words, it was not an important cause of inflation. Secretary SNYDER. I said not the important. Please don't let's get my words mixed up, Senator. I have a hard enough time with them as it is. Senator DOUGLAS . I have some trouble, too. Secretary SNYDER. It was a partial cause, but when you had to measure what the other side of the picture would have been. Now how would you have prevented the banks from going to the Federal to sell their bonds ? Would you have risked letting the price of the bonds go to the bottom ? Senator DOUGLAS. Then you say in order to maintain the price of the bonds the Federal Reserve should have purchased ? 30 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Secretary SNYDER. No, I am just asking you how would you have prevented it. Senator DOUGLAS. I am asking you, Mr. Secretary . Secretary SNYDER. You seem to be bringing up the point. I said I don't think it caused it, but we have to have the other side of it. Could you have prevented- by any measure that you took-the creation of a considerable amount of credit, and might not other steps that might have been taken by the Federal Reserve and the Treasury been somewhat more disruptive than what was done ? Senator DOUGLAS . Well, when the Federal Reserve ceased purchasing unlimited quantity of bonds , I believe you and others said that this policy would occasion a great fall in the price of the bonds. Secretary SNYDER. No, sir, I don't think you will find I ever made such a statement. Senator DOUGLAS. You were fearful of it, were you not ? Secretary SNYDER. I don't think you will find I ever made that statement, because prudence would tell me, as Secretary of the Treasury, who was responsible for debt management, not to make such statements. Senator DOUGLAS . What is all the shooting about then? Secretary SNYDER. Well, I don't know. Senator DOUGLAS. Well , I don't know either at this point. Secretary SNYDER. You are holding the guns, I am not. Senator DOUGLAS. If you didn't think there was any danger of the price of bonds falling disastrously, then why should the Federal Reserve System be compelled to purchase them ? Secretary SNYDER. I would be very interested in trying to find wherever I made such a statement, because prudence would tell me not to go out scaring people about the United States bond market. Senator DOUGLAS. Well, if you did not make such a statement, certain other highly placed men in the Government did make it. Secretary SNYDER. Of course, I don't control the voice of the Government. Senator DOUGLAS . Well, then you think that it is not necessary for the Federal Reserve Board to purchase the bonds in order to maintain the priceSecretary SNYDER. I don't think I ever made that statement, either. Senator DOUGLAS. Then what have you said, or has this been an exercise in trying to conceal your meaning from congressional committees ? Secretary SNYDER. No, it certainly has not been, but there has been such free conversation about what I have or haven't said, I thinkSenator DOUGLAS. Do you think it necessary for the Federal Reserve Board during this 8-month period following Korea to have purchased large quantities of Government bonds in order to maintain their price ? Secretary SNYDER. The Federal Reserve open market committee had to meet their responsibilities in assisting the Treasury to maintain the Government's financial operations. Senator DOUGLAS . Answer yes or no. Do you think they should have purchased these bonds during the period ? Secretary SNYDER. I think the operation was necessary. Senator DOUGLAS . You believe that it was necessary? Secretary SNYDER. Yes , sir. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 31 Senator DOUGLAS . Even though it occasioned this inflation ? Secretary SNYDER. I did not say it occasioned the inflation . I again want to be sure that I did not admit that, sir. It may have had a partial effect on it, yes, sir, but then we had to measure the partial effect on the other circumstances. Senator DOUGLAS. The effect it had on inflation according to you was not as bad as the beneficial effect of maintaining the price of Government bonds. Secretary SNYDER. Of not only the Government bonds, but the whole stability of the financial system. Senator DOUGLAS. Has the United States come to such a pass that its securities need artificial support ? Again I ask, are not the productivity of the country, the degree of financial soundness of the country, and some adjustment of interest rates sufficient to provide a market for Government bonds without "pegging" the market through Federal Reserve purchases ? Secretary SNYDER. I just want to recall what happened after World War I. We have got to consider that. Senator DOUGLAS . I believe we have heard of that. Secretary SNYDER. I think we have heard it, too . I certainly have. Senator DOUGLAS. Mr. Secretary, are the bonds that you issue now the same as were issued during the first world war ? Secretary SNYDER. No , they have all been liquidated . Senator DOUGLAS . Now, Mr. SecretarySecretary SNYDER. You asked a question. I am going to have to reply. Senator DOUGLAS . You reply as the State Department commonly replies. Now, Mr. Secretary, what about the differences in the types of savings bonds which are issued now- Series E, F, and G as compared to then ? Are those redeemable ? Secretary SNYDER. Yes, they are redeemable. Senator DOUGLAS . Can be cashed in at any time ? Secretary SNYDER. Yes, sir, at any time after they have been held a stated minimum period. Senator DOUGLAS . At any time ? Secretary SNYDER. That is correct. Senator DOUGLAS. And at what price ? Secretary SNYDER. There may be some notice period. Senator DOUGLAS. At what price ? Secretary SNYDER. At a stated price. Senator DOUGLAS. At par, isn't that true ? Secretary SNYDER. At a stated price on the back of the bond. Senator DOUGLAS . At par. Secretary SNYDER. Well, that is not exactly correct. Senator DOUGLAS . Is it not 99 44/100 percent correct ? Secretary SNYDER. I would have to look on the back of the bond and see how old it was and so on. Senator DOUGLAS . As a general rule are they redeemable at par or are they not redeemable at par ? Secretary SNYDER. At maturity they are redeemable at par. Senator DOUGLAS . Were the bonds in World War I redeemable at par? Secretary SNYDER. At maturity they were. 32 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. Were they redeemable by the Government at par? Secretary SNYDER. At maturity, yes. Senator DOUGLAS. What about the terms of maturity ? What about the difference in time ? Secretary SNYDER. We had not developed the savings-bond plan in World War I. Senator DOUGLAS . Precisely so. In other words, the length of maturity was a long, long time. Secretary SNYDER. But we are not talking about savings bonds. We are talking about the whole Government security market. Senator DOUGLAS. Well, that is an important element. Secretary SNYDER. Yes ; very important. Senator DOUGLAS. One argument which was commonly used as a justification for supporting the bond market was that you do not want bonds to fall to 82. There is no prospect that E, F, and G bonds would fall to 82, since they have short-time maturities which would come due quickly and would be redeemable at par at those times . Secretary SNYDER. I was not referring to the savings bonds. Senator DOUGLAS . What were you referring to ? Secretary SNYDER. To the whole Government financing picture when we were talking about where bond prices might go . Senator DOUGLAS. What were the other elements in this picture ? Secretary SNYDER. The savings bonds don't enter into this Federal Reserve matter that we are talking about because the Federal doesn't buy savings bonds. It is the other securities of the Government. Senator DOUGLAS. Suppose the Federal Reserve had not bought the securities ; what would have happened ? Secretary SNYDER. That is what I brought up. Senator DOUGLAS . What would have happened ? Secretary SNYDER. I don't know. Senator DOUGLAS . When the Federal Reserve stopped buying unlimited amounts of securities in April, did anything catastropic happen ? Secretary SNYDER. Of course, a long march of time had taken place between the beginning of Korea and when the— Senator DOUGLAS . Did anything catastropic happen when the Reserve stopped buying Government bonds ? Secretary SNYDER. No ; it has worked out very well. Senator DOUGLAS. You hope it will continue, do you not ? Secretary SNYDER. I hope it continues to work well. Senator DOUGLAS. You hope that the Federal Reserve System will not be committed to purchase bonds in unlimited quantities in order to support the Government bond market ? Secretary SNYDER. I hope that conditions will permit that ; yes, sir. Senator DOUGLAS . That is a consummation devoutly to be desired . Now, I am more interested in the future than in the past, but on pages 72 and 73 of your reply you make very serious charges against the Federal Reserve System. You imply that on three occasions the Federal Reserve System broke faith with you. That is the implication which I drew from your statement. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 33 First, on page 72, if you will consult your reply, in speaking of the summer of 1950, I read : The terms of the issue were approved by the President ; and the Chairman of the Board of Governors assured the Treasury of the full cooperation of the System in the refunding operation. On the first trading day after the announcement of the new issue was made, the Federal Reserve permitted the market to go off sharply, notwithstanding the fact that the issue had been proposed by the Federal Reserve and the Chairman of the Board of Governors had assured the Treasury of the System's full cooperation. That is equivalent , I think, to a charge ofSecretary SNYDER. I will just ask the staff to read into the record , if I may, the report. I am not trying to change any figures. Representative PATMAN. We will identify the person who is doing the reading, Mr. Secretary. Secretary SNYDER. Assistant Secretary Overby. Mr. OVERBY. Mr. Chairman , may we introduce into the record this statement : Hourly quotations on United States Government securities and World Bank bonds-we are not talking about World Bank bonds here - for November 24, 1950 . Senator DOUGLAS. Just a minute ; are we speaking of the same thing ? Mr. OVERBY. That was the first trading day after the announcement. Do you wish me to read this, Mr. Chairman ? Senator DOUGLAS . Yes ; I would appreciate it . Representative PATMAN. Go right ahead. Mr. OVERBY. There are quite a few issues, sir. Secretary SNYDER. Show it to the Senator so he can see the nature of it. Representative PATMAN . Suppose you let Senator Douglas see it. (The document above referred to is as follows :) : bonds Treasury 2%950 1112 0.25 % 1951-54% 234 100.29 2% 1951-53 S2eptember 100. 12 13951-55 % 16 101. .%951-53 1214 101.06 12% 2951-55 15 100. 2.% 212 1952-54 101.05 June 22% 1952-54 20 100. 2%952-55 1214 100.31 December 22% 1952-54 100.25 1953-552% 102.05 .%954-56 1214 103.25 .%955-60 1278 107.02 2_ 122 %956-58 103.25 2%956-59 1214 102.26 1956-59 % .234 108.17 .%958-63 1234 110. 15 1959-622 R. 24 June % 23 100. 24 D.ecember .% 2R 1959-62 100. 22 1234 %960-65__ 113. 01 R. 1212 %962-672 102.27 R. 9212 %163-682 04 102. 212 J.une 2R% 1964-69 101. 20 D.ecember % 1964-692 .22 R 14 101. R22 . 1965-70 2% 101. 10 R. 212 1966-712 % 101.09 2R% 212 J.une 1967-72 26 100. 212 September 2% 1967-72 104. 05 212 D.ecember .% 2R 1967-72 100.26 Certificates indebtedness :of 2.%/1/51 1118 : notes Treasury s/1/51 % 7114 2.B eries 1.45 % s/1/51 % 7114 2.C eries % 1.45 14 s/1/51 7% 2D eries % 1.45 s/1/51 % eries 8114 2.E % 1.46 %0/1/51 114 eries 1sA % 1.48 2 sF %eries 1114 0/15/51 2 % 1.49 114 11/1/51 2.% 1.49 % 32138 %/15/54 99.07 2% 3/15/55 112 99.15 Bid Treasury : bills Ask 2 1.37 -1.18 % 11/30/50 %1.18 -1.37 2 12/7/50 %1.20 -1.37 2 12/18/50 +)( 1 99.14 1.10 100.03 % 103.24 107.01 103.22 102.22 108.16 14 110. 100.21 100.20 113.00 102.26 102.03 101.19 101.13 101.09 101.08 104.00 1 -)(99.06 )(-5 1) )-1 ∙1) )-1 1) ) -3 4) 1) -2 ) 2) 100. 19 (4 6+ )100.30 )( 1 101.07 100.04 close Previous 10 ) -1 100. (124 )6+ )(+1 99.04 99.10 100.02 )( 5 - -1 ) -1 ) ) -1 ) -2 ) -5 -6 ) )(1 ) -1 )(2 )(-2 ) -1 ∙1) ) -1 101.18 -2 ) ) -1 101. 08 ) -2 101.07 -2 ) )(-8 103. 29 19 100. 100.24 102.04 107.00 103.20 20 102. 100.03 10:30 )99.03 (3 18 100. 18 100. 102.23 102.00 16 101. 101.11 101.06 101.05 25 100. 103.26 100.25 100.02 19 103. 19 102. 100.02 11 )4 5) ) -4 )(-4 )(-3 )(-4 ) -4 )(-11 )(-1 )-7 ) -1 )(-5 )(-4 )( 1 )(-1 -1 ) -1 , )2 )(+1 100.12 + )( 64 100. 24 103.22 24 100. 100.01 101.10 17 100. 112.30 108. 14 110. 12 100.29 102.03 100.02 12 )-4 ) -5 1 )101.04 (100. 364 (+ )18 (-2) (-364 23 )100. )2 1) 2) 6) ) -7 ) -3 ) -3 ) -5 5) ) -3 4) ) -4 4) ) -4 ) -4 ) -2 ) 15 )(-2 ) 64 (+ )+( 1 99.11 )(+1 ()-1 100.18 )(-2 )(2 )(-364 )(2 )(-1 2) -6 ) 7) 12 108. ) -5 110.10 5) 100.17 6) 100. 16 6) 112.27 102. 21 101.31 5) 101.15 5) ) -4 101.05 -5 ) )101.04 5) -4 ) -2 )(-15 (-2) 100.01 100.02 1 Hourly ¹Nov. bonds Bank World and securities Government S. U. on quotations ,1 24 950 -4 )99.04 )99.12 -4 100.01 103.25 100.18 100. 17 23 102. 102.00 101. 16 101. 11 101.06 103.21 102. 21 24 100. 100.02 12 1+ )3(00. 64 101.06 2:15 )(-1 3) 64 (+ 18 100. (-2) )(-1 -2 ) ) -1 ) -2 ) -4 ) -5 ) -5 ) -5 ) -5 -5 ) ) -6 4) ) -4 ) -4 ) -3 ) -4 ) -5 ) -2 )-( 12 )99.05 (2 3 )99.12 (- 100. 02 100..28 100. 12 101.16 101.06 15 100. 101.04 100.29 24 100. 102.03 103.23 106.28 103.21 102.22 108. 12 110. 10 100.18 100. 17 112. 27 102.24 102. 01 101.17 11 101. 101.07 101.05 24 100. 103.25 24 100. 100.01 )(2 (-3) )3 (-3 ) 3) 3) 4) ) 12 (-2) )(-1 (-64 + 18 3)100. -2) ) -1 )2 )(-1 c3:15 )(lose 34 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT ÎÎ .2Taxable bonds .3Unchanged bonds R.Restricted 2 12/21/50 2 0 12/28/5 2 51 1/4/ 21/11/51 2 1/18/51 2 1/25/51 2 1 2/1/5 22/8/51 2 51 2/15/ 2 /51 2/23 7/15/72 :3% 2_ World bond Bank :land bonds bank Federal 21/52%3-55 214 2.1/5%5-57 0 134 .of Secretary Assistant Fiscal the OSource : ffice -1.22 % 1.37 -1.24 % 1.37 -1.26 1.38 % % -1.28 1.38 %1.30 -1.38 1.38 -1.30 % -1.39 %1.319 %1.32 -1.39 -1.32 1.39 % 1.39 -1.35 % 14 102. 100.16 14 98. .day on previous close from changes net represent figures minus and lus P.of oint psrepresent athe econds points decimal after shown figures nd aprices ,are quotations other ll .Asigns yields represent percent with Q-thirty 1 uotations MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 35 36 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. You are trying to establish the fact that the market fell sharply, I take it. Mr. OVERBY. The market declined on that day, sir. Senator DOUGLAS . Which would you take as the best security-21 2's ? / Mr. OVERBY. It was a 5-year offering, if I remember the circumstances. Senator DOUGLAS. Would the 22's be all right ? Mr. OVERBY. Yes, sir ; the 21 / 2's of 1956-58 give an indication of what happened in the market generally. They were 103.25 at the close of the preceding trading day. Senator DOUGLAS. Suppose I take the 21/2's, 103.22 at 10 o'clock ; at 10:30 , 103.20 ; 11 o'clock, 103.19 ; 103.21 at the end of the day. That was a fall of four thirty- seconds, one-eighth of a point during the day. Would you say that was catastrophic ? Secretary SNYDER. I don't think I said it was catastrophic. Senator DOUGLAS. In other words, that the Federal Reserve should not have permitted the market to fall by one-eighth of a point ? Mr. OVERBY. On a short-term issue, that is of some consequence . Senator DOUGLAS. What you are saying in effect, therefore, since the Federal Reserve System acted improperly in allowing a fall of oneeighth, they should not have allowed a fall at all. I think four- thirtyseconds is rather small. Now did you have an agreement with the Chairman of the Federal Reserve Board that the Federal would purchase an unlimited quantity of bonds at the interest rates that you were issuing sufficient to maintain the price at the initial figure, 103.25 ? Mr. TICKTON. 103.25 . Senator DOUGLAS. Did the Chairman of the Federal Reserve Board pledge himself to purchase such a quantity as to maintain prices at the interest rates charged ? Secretary SNYDER. I stand on the statement in 17 that we were assured of cooperation . Senator DOUGLAS. Well, " cooperation" is a very vague word. That is one of the troubles here. You use the term "cooperation ," but you may mean dictation. Secretary SNYDER. I don't consider it dictation. There has never been any evidence of the Treasury sinceSenator DOUGLAS. Did you understand the Chairman of the Federal Reserve Board to pledge that he would see that the Open Market Committee bought such a number of bonds as would maintain fixed prices at the interest rates at which you were issuing these ? Secretary SNYDER. Senator, you agreed with me that it would be a very fine thing if we could continue the accord, and that is what I am going to try to do. I will stand on this answer, and I am not going to expand. Senator DOUGLAS . You wrote the statement. Secretary SNYDER. And I am going to stand on it . Senator DOUGLAS. What you say is that the Federal Reserve broke faith. Secretary SNYDER. I won't expand on that question, sir. I think it is answered. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 37 Senator DOUGLAS . Now on page 73 you refer to a conference between the Chairman, Board of Governors, the President and yourself in January 1951. You say : At this meeting the three of us-the President, the Chairman, and I-agreed that market stability was desirable, and the Chairman again assured the President that he need not be concerned about the 2 -percent long-term rates on Government securities. Did the Chairman of the Federal Reserve Board on that occasion make a pledge that the Federal Reserve Board would buy an unlimited quantity of Government securities so that the interest rate need not rise above 22 percent and so that the price of Government securities would be maintained ? Secretary SNYDER. I will stand on the statement made in the answer to the question there. Senator DOUGLAS. What is that , that the Chairman made such a pledge ? Secretary SNYDER. The words are there, sir. I will stand on what is there. Senator DOUGLAS . "Need not be concerned ." What do those words mean ? Secretary SNYDER. Well , what they mean is just what I have said right here, that "the Chairman again assured the President that he need not be concerned about the 2½ -percent long-term rate on Government securities . " Senator DOUGLAS. Did you understand that to mean that he agreed that the Federal Reserve System would purchase an unlimited quantity of bonds so as to maintain the price ? Secretary SNYDER. I understood it to be just what it said here, and I stand on that statement. Senator DOUGLAS . Talleyrand said that words were used to conceal thought. I have always thought that words should be used to express thought, and it is the lack of this quality which I find unsatisfactory in your testimony throughout. Secretary SNYDER. I have the responsibility of trying to continue to manage the debt, and I am going to try to do that, sir. We are getting along fine with the Federal Reserve Board , and I want that to continue . Senator DOUGLAS. Are you getting along fine with an organization which already you have accused twice of practicing bad faith ? Secretary SNYDER. You are putting the interpretation in there. Senator DOUGLAS . Let me go ahead and read this : It was against this background that I made a speech on January 18, 1951 , before the New York Board of Trade, announcing this policy. The market strengthened following this speech. Then some officials of the Federal Reserve System began to differ publicly with the policy. This created further uncertainties in the Government security market. At about this time, also-on January 29 the Open Market Committee further reduced its buying price for Victory loan 22's-which was the most significant of the long-term Treasury issuesand so forth . Representative BOLLING. Would you yield there ? Senator DOUGLAS . Yes, sir. 38 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative BOLLING. Mr. Secretary, when was the accord reached ? Secretary SNYDER. March 4, 1951 . Representative BOLLING. I gather that the accord received a great deal of publicity as the basis of its being an elimination of friction. It would be my impression that your desire would now be to maintain the good relations that had been obtained by the accord ? Secretary SNYDER. It certainly is my desire and my intent. Representative BOLLING. And the purpose of the answer to these questions was to relate the history as you saw it ? Secretary SNYDER. That is correct. Representative BOLLING. Thank you. Secretary SNYDER. The history as the facts were according to our records . Senator DOUGLAS. I would like to point out that I am merely asking questions on statements that the Secretary has made to the committee which, by implication , charge bad faith on the part of the Federal Resevre System. Secretary SNYDER. I stated the facts. You are putting in the implication. Senator DOUGLAS . Bad faith, at any rate, previous to the accord. Secretary SNYDER. I stated the facts. You are putting in the implication, sir. Senator DOUGLAS . I want to know whether there was a definite pledge by the Chairman of the Federal Reserve Board in both of these cases to buy unlimited quantities of Government bonds in order to maintain prices at the interest rates which you decided upon . That is the issue. If there was such a pledge, and if it was not later honored, then the Chairman may have been acting in bad faith, but there was not such accord, then I don't think these statements should be made. Of course there is also always a question as to the degree to which the Chairman can commit the Board itself. You raised this issue, Mr. Secretary, and we are simply trying to find out the facts. Secretary SNYDER. I simply related the facts as requested by the questionnaire, and there they are. I am not going to expand on them, with the permission of the chairman . Senator DOUGLAS. I ask for a ruling by the Chair. Representative PATMAN. What is your question that you stated is not answered properly, Senator Douglas ? Senator DOUGLAS . I asked whether the Secretary asserted that the Chairman of the Federal Reserve Board had promised to purchase an unlimited quantity of bonds in the open market in order to maintain prices at the interest rates fixed by the Treasury on those securities. Representative PATMAN. Obviously the session will last into the afternoon. I would like for you to pass that over for the present and continue your interrogation. Senator DOUGLAS. The third question involves the point that is in the third paragraph on page 73 : About this time a series of conferences was held between the Treasury, the Chairman of the Board of Governors, the chairmen of the two banking committees in Congress, and the chairman of the Joint Committee on the Economic Report. It was generally agreed between the parties involved that there should be no change in the existing situation in the Government security market, and no congressional hearings held on differences between the Treasury and the Fed- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 39 eral Reserve, for a short period while I was in the hospital recuperating from an eye operation. Shortly after these meetings, however a change in the Federal Reserve attitude began to be apparent ; and the Chairman of the Board informed the Treasury that, as of February 19, the Federal Reserve was no longer willing to maintain the existing situation in the Government security market. Now that is an implication that the Federal Reserve went back upon the promise, went back upon a general agreement that there would be no change in the governmental bond market. Secretary SNYDER. I have answered it in 17. Senator DOUGLAS. Did the Chairman of the Federal Reserve Board in the conferences which were held agree that the Reserve Board would purchase an unlimited quantity of Government bonds in order to maintain prices at the interest rates charged by the Treasury ? Secretary SNYDER. I stand on the answer that isSenator DOUGLAS. That is a refusal to answer. Secretary SNYDER. I have answered it in the question . Senator DOUGLAS. No ; you haven't. Secretary SNYDER. I am going to stand on the answer that is in the question. Senator DOUGLAS . I interpret that as a refusal to answer, as I interpret the reply to the other questions. Now, Mr. Secretary, may I ask you about this advisory council which you suggest. You would have that advisory credit council composed of the Secretary of the Treasury, the Chairman of the Federal Reserve Board, Director of the Budget, the Chairman of the Council of Economic Advisers, and the Chairman of the Securities and Exchange Commission. Aside from the Chairman of the Federal Reserve Board , how many of these would be Presidential appointees ? Secretary SNYDER. All of them. Senator DOUGLAS . All of them would be Presidential appointees. Of course, the Chairman of the Federal Reserve might himself be a Presidential appointee . Secretary SNYDER. I included him. I said all of them were. Senator DOUGLAS. But the majority of the members of the Board of the Federal Reserve System probably would tend not to be Presidential appointees, or might not be ? Secretary SNYDER. Well, all the members of the Board are Presidential appointees. It may not be the incumbent. Senator DOUGLAS . Not the incumbent President ? Secretary SNYDER. Maybe not by the incumbent President. Senator DOUGLAS . That is the point. Secretary SNYDER. That is right. Senator DOUGLAS . Now suppose this advisory council decided that the Federal Reserve Board should purchase an unlimited quantity of Government securities in order to maintain prices at the interest rates charged, and the Chairman of the Federal Reserve Board did not agree with this. To what degree would the opinion of the advisory council be controlling ? I believe you used the term " authoritative advice." Secretary SNYDER. Of course there is no one outside of the Federal Reserve Board that can force them to take any action. The Federal Reserve Board was set up by Congress and they make their final determination. 40 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Now it seems to me it would be extremely valuable for everybody to sit around the table and talk about the problems that each one represents, the responsibility that each one represents, so that there would be a full understanding of the problems that are faced by each, and that the decisions then would be made in the face of the responsibilities of each. Senator DOUGLAS . It might be an opportunity to twist the arm of the Federal Reserve System, too, might it not? Secretary SNYDER. Certainly the Treasury gets its arm twisted enough, and I would be glad to pass it around a little. Senator DOUGLAS. I do not want to have it understood that I am necessarily opposing such a monetary council. But it has great danger in the form now suggested. Secretary SNYDER. I think honestly, Senator, it would be a very good thing. Senator DOUGLAS. But I do want to point out some of the issues involved, and I am curious by what is meant by your phrase, "This would have advisory authority." Secretary SNYDER. That is right. Senator DOUGLAS. I can understand its offering advice, but I do not quite understand the meaning of the phrase "advisory authority." What do you mean by advisory authority ? Secretary SNYDER. Well, that term is used, "advisory authority" because that is the scope in which it would be used. Just offer advice about the various segments of the economy. Senator DOUGLAS. Well, then, why not strike the word " authority" from your statement and simply say "offer advice" ? Secretary SNYDER. That is all right. Senator DOUGLAS . That is, you do not wish to have this body have any iron-clad authority. Secretary SNYDER. It was not intended that it should have. Its only function would be advisory ; each agency would still have authority over its own operation. Senator DOUGLAS. Suppose there is a clear conflict with the rest of the Presidential appointees wanting the Federal Reserve System to buy an unlimited quantity of bonds at fixed prices and given interest rates ; and suppose that the Chairman of the Federal Reserve Board demurred ; should he be a good fellow and cooperate and go along even though in his judgment that will mean inflation, or should he be lacking in cooperation in order to preserve the solvency of the country ? Cooperation is a mystic phrase. Secretary SNYDER. Well, I am sure that the Federal Reserve Board would react the same as all the other agencies. Senator DOUGLAS. You mean that the Board would cooperate and agree to do what the rest wanted them to do? Secretary SNYDER. I did not say that, sir. I said they would have to operate within the scope of their own responsibility, but the decisions that they might make certainly might give some weight to the problems that are discussed around the table. Certainly that would fit within the scope of the limits of their decisions. You could make a decision one way or another many times, but if you have certain facts, it may lead you to a sounder decision than if you made it without all of those facts. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 41 Senator DOUGLAS . Is this an attempt to create at this juncture a climate of opinion which will make it psychologically impossible for the Chairman of the Reserve System to purchase unlimited quantitiesSecretary SNYDER. You are putting that thought in my mind. I did not have it in there at the time I made this suggestion. I doubt if I would use it if it did occur to me. Representative PATMAN. Senator Douglas , I have been determined to restrain myself and not interrupt at all, but I would like to suggest that you consider that this is comparable to the advisory group set up by the private commercial banks, is it not, Secretary Snyder ? Secretary SNYDER. Well, there are advisory groups all over the place in addition to the Federal Advisory Council . The Commerce Department has an advisory group , the State Department has an advisory group, the Treasury has half a dozen advisory groups or more. There is the National Advisory Council on International Monetary and Financial Problems. There are many groups of this nature, and they are extremely helpful in sitting down and talking over the various problems. It gives an opportunity in an informal fashion to discuss things rather than have them brought up bilaterally or otherwise. Senator DOUGLAS. That finishes my questions, Mr. Chairman . I want to thank you for the courtesy of permitting me to ask them, and to compliment you upon the fairness with which you have conducted the hearing. Representative PATMAN. The question you have brought up , if it is all right with you, the Chair will wait until this afternoon to make a ruling upon . Senator DOUGLAS . Certainly. Representative PATMAN. Mr. Bolling ? Representative BOLLING. Mr. Secretary, I would like to have you keep in mind that I was not a member of the former committee considering similar subjects. Are there any substantial differences between Government bonds and other bonds ? Secretary SNYDER. In what fashion ? Of course, one of them has the full credit of the Government behind it and other bonds are limited to the resources of the organization , the instrument issuing them. Representative BOLLING. There is at least that one difference. Secretary SNYDER. Well, that is a very big difference , of course. Representative BOLLING. What, in your judgment, would be the effect on the economy if there should be a substantial falling off of Government bonds ? Secretary SNYDER. That is a question I would like to answer in executive session, because I am the one and only person that is responsible for the final decisions on debt management, except that the President must approve all offerings of issues having maturities over 1 year. To discuss things of that sort in an open session-I cannot measure what the effect might be. Representative BOLLING. Mr. Chairman, there may be a number of questions I will want to ask if not in executive session, then for the committee to address a letter on further expansion of certain points. Secretary SNYDER. I think, Mr. Chairman, you must bear in mind that I do have that responsibility. 42 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative PATMAN. I assume the Secretary will be glad to answer any questions written and sent to him by correspondence. Secretary SNYDER. I do not want to withhold any information from the committee, but I do have to restrain myself in answering questions that in my judgment might have some effect on the general operation of debt management, because it must be remembered I cannot possibly detach myself as an individual from being Secretary of the Treasury. I cannot give personal opinions that would not be translated into the thinking of the Secretary of the Treasury, as much as I might try to do so . Representative BOLLING. Mr. Chairman, I am very anxious to avoid putting the Secretary in that position, and the other method will be perfectly satisfactory to me. I would like to pursue this problem that Senator Douglas raised. It may fall in the same category as my first question, of the future. I am entering into this hearing with a completely open mind, and I am interested in the future , not particularly in the past. I would like to make some assumptions so that this will be theoretical . Let us assume that the Congress enacts legislation which will provide for a substantial deficit . I assume also there is only one way in which the Treasury can raise the money to take care of that deficit. It will have to borrow it from some source. Secretary SNYDER. That is correct. Representative BOLLING. Granted the deficit, and the necessity of raising the money, what are the alternatives confronting the Treasury as to the question that Senator Douglas has raised ? Do you have any alternatives aside from those mentioned in the replies to your questionnaire in which you can borrow money without having inflationary impact ? Is there any alternative except those of support through Federal Reserve activity to the bond market dropping off ? Secretary SNYDER. Do you mean outside of congressional action ? Representative BOLLING. Yes , sir. Secretary SNYDER. Well, I think we have to carefully judge each one of the instances on the basis of the facts when it comes to a refunding operation, or when it comes to an offering of new money financing. I think we have got to measure it against the whole economy at the time that that operation is undertaken, because it changes from month to month . The last 6 months have seen a considerable change in the general situation in the economy. Representative BOLLING. What I am trying to get at is what are some of those factors you have to take into consideration aside from those that have already been discussed. Secretary SNYDER. We have to take into consideration the supply of funds at the time-whether the normal investment groups have surplus cash on hand that is seeking investments . We have to consider the approach to attracting as much nonbank investment as we can. We have got to measure all of those. We have got to consider trying to attract savings. We have got to give all of those considerations very careful study in order to try to meet the situation of keeping as much of this financing out of the bank area as we can. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 43 Representative BOLLING. Then suppose you in your consideration in this theoretical case discover that in your judgment a very substantial amount of the borrowing is going to have to be borrowing through the banks, commercial banks and otherwise, what alternatives then do you face ? What alternatives do you have? You have the two that I see, obviously, of letting the bond market take its course in a free market, and you have the other one of support through Federal Reserve activities. Are there any other alternatives ? Secretary SNYDER. None . Representative BOLLING. In other words, just the free market on the one hand, and a free market influenced by the Federal Reserve activities on the other hand . Those are the only two. Secretary SNYDER. You mean assisted by the Federal Reserve, you mean in their orderly market operations ? Representative BOLLING. Yes. That is all I wanted on that particular subject . Mr. Secretary, you say in your answer to question 34 on page 118 , about a third of the way down the page : Holdings of series E savings bonds amounted to 344 billion on December 31, 1951. and I think somewhere else it is indicated that that is about the highest level of series E holdings. I have before me a breadown of the cash sales and redemptions in those bonds through that period and through 1951. There are obviously, I think, each month more redemptions than there are sales . I assume that the fact that this is the highest point, December 31 , 1951 , is based on the very substantial amount of interest that accrued through that year . Secretary SNYDER. Well , actually the amount of cash investment in savings bonds is as high today as it was at the end of the war period after all of the stimulation of the war selling of savings bonds. The actual total of cash invested in the bonds today, in the E bonds, is over $1 billion more than it was at the end of the war. That is without the interest consideration, so the actual totals have been maintained and increased by over $ 1 billion since the end of the war. Analysis of series E savings bonds outstanding to show amount of cash investment and accrued discount [In millions of dollars] Month Year 1945 1946 1947 1948 1949 1950 1951 1952 Cash investment August.. December.. _do.. _do_ ..do. .__ do_. .__do__ February . 29,455 29, 298 29, 570 30, 219 31, 152 31, 153 30, 656 30, 653 Accrued discount 449 964 1,427 1,970 2, 614 3, 340 4, 072 4, 173 Amount outstanding 29, 905 30, 263 30, 997 32, 188 33, 766 34, 493 34, 727 34, 826 NOTE.- May not add to total amount outstanding due to rounding. Representative BOLLING. Mr. Secretary, I am curious as to your opinion—and this again may fall into the other area-I am getting the 97308-52-4 44 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT impression from the origin of A bonds in 1935 and their modification to E bonds of a later date, that the desire was to make E bonds sufficiently attractive to small uninformed investors so that it would be easy for people to have confidence and buy them. That that was done because it was assumed that this class of borrowing was actually deflationary rather than inflationary. Secretary SNYDER. In 1941 when we were entering upon defense financing prior to World War II, the E bond was designed to help drain off the surplus earning power of the public as we began to draw more of the materials and labor out of production for peacetime domestic consumption and put it into defense and war production. It had a dual purpose during the war of helping to finance the war deficit, and also as a very material assistance in controlling inflationary trends. Representative BOLLING. This is one method of financing a deficit that is actually somewhat deflationary. Secretary SNYDER. That is what ? Representative BOLLING. Somewhat deflationary. Secretary SNYDER. An anti-inflationary method, certainly. Representative BOLLING . Mr. Secretary, I am curious for your opinion, if you care to give it- if not in open session, then otherwise as to the relative position of an E bond today as compared with an E bond at the date of its inception in relation to interest, and so on. I gather that it was intended to have a favorable position . I wonder whether it now does have a favorable position. Secretary SNYDER. You mean competitive position ? Representative BOLLING. Yes. Secretary SNYDER. Well, I think that there were many things that entered into the original design of the E bond. We have always got to consider carefully the competitive position of the E bond ; we can't get it too competitive because we have got to have the support of all investment groups in supporting the distribution and the sale of it. That is correct, but we have certainly got to consider carefully at all time the attractiveness of the bond to the purchaser in every fashionin its liquidity and its ease of purchase, its ease of liquidation and the general confidence of the people in the instrument itself. Representative BOLLING. I haven't added up these monthly figures that I have, but they indicate a very substantial redemption over purchase for the year 1951 . Secretary SNYDER. Well, by January and February of this year that trend had changed quite a bit in the E bonds. Representative BOLLING. I don't have the figures for E alone for January and February. Secretary SNYDER. In the F's and G's it did not hold true, but in the E bonds, sales were up in January and February combined by 6 percent over the same 2 months of 1951 , and redemptions were down by 9 percent over the same 2 months, so there was a change in the trend there. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 45 The following table shows sales and redemptions of series E bonds in January and February of 1951 and January and February of 1952 : Series E bonds [In millions of dollars] Change 1951 1952 Amount Percent Sales: January.. February Total... Redemptions including accrued interest: January February Total.... 343 272 615 364 288 +21 +16 652 +37 +6.1 +5.9 +6.0 448 362 406 334 -42 -28 -9.4 -7.7 810 740 -70 -8.6 Representative BOLLING. Do you feel that the change in the trend is significant enough to indicate that as they are now is perfectly satisfactory or that the rather surprising net redemption in 1951 may require action further than has been taken already? Secretary SNYDER. That gets into the area that I would be glad to discuss in executive session, as to what we might or might not do with the savings bond. It is not a matter that we can discuss at this time because that might indicate an action that would have some effect on our markets . Representative BOLLING. I would want to follow that up in another fashion. Representative PATMAN. Mr. Wolcott ? Representative WOLCOTT. Should we continue this afternoon ? Representative PATMAN. Would 2:30 be satisfactory, Mr. Secretary ? Secretary SNYDER. Any time you say, Mr. Chairman . Representative PATMAN. The committee will recess until 2:30 . (Whereupon, at 12 : 15 p. m. , the subcommittee recessed to reconvene at 2 : 30 p. m. of the same day. ) AFTERNOON SESSION Representative PATMAN. The committee will come to order. Mr. Wolcott, of Michigan , would you like to ask any questions ? STATEMENT OF HON. JOHN W. SNYDER- Resumed Representative WOLCOTT. Very simple ones. Mr. Secretary, I think we all recognize deficit financing as a fundamental cause of inflation . Why is it? Secretary SNYDER. I beg your pardon ? 46 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative WOLCOTT. Why does deficit financing cause inflation ? Secretary SNYDER. Well, the fact is that it puts additional spending into the economy that is not compensated by drawing off a similar sum in revenues and, therefore, we have an unbalanced budget, and there is more poured into the economy than is withdrawn from it. Representative WOLCOTT. Is it not also due to the fact that the debt may be monetized ? Secretary SNYDER. I beg your pardon ? Representative WOLCOTT. Is it also due to the fact that the debt may be monetized ? Secretary SNYDER. There is also danger of monetization of the debt in deficit financing when you have to resort to bank financing of the new money needs. Representative WOLCOTT. In the thirties the Congress and the administration collaborated in an effort to bring about inflation, and I think we were reasonably successful in creating inflation . We found it advisable to continue inflation throughout the war as an easy means of financing the war. Now, you will recall that in the thirties, somewhere , we changed the theory of the Federal Reserve Act in respect to the flexibility of currency when we tied the volume of currency to debt. It used to be that the Federal Reserve would create currency as it was needed by business, and the needs of business were reflected largely by the commercial paper which was in the banks. Is not that substantially correct ? Secretary SNYDER. I think that is correct ; yes , sir . Representative WOLCOTT. Then, as a means of pumping some more money in our economic life line, we told the banks that they could put up evidences of Government debt as well as commercial paper, thereby divorcing the size or the amount of the currency from business needs. What I am leading up to is that we have accepted as a matter of policy that we must keep our debt and the value of our money wedded. In your discussions with the Federal Reserve or with anyone else, has any thought been given to the possibility of removing the influence which deficit financing has on the value of our money by sterilizing any part of our gold holdings or our bank-held Government debt beyond which the debt in gold cannot be monetized ? Secretary SNYDER. I would like to prepare a reply to that one, Mr. Congressman, please. Representative WOLCOTT. Just by way of foundation for the reply, it is not as simple as this, but we have about 28 billion of currency now outstanding. Secretary SNYDER. That is correct. Representative WOLCOTT. Theoretically if we wanted to put a ceiling on the amount of currency which could be issued at, we will say, 30 billion, with 25 percent of gold and 75 percent of debt-you do not have to answer it now, but this is just a background for your statement —could we provide that not more than a quarter of that or 7.5 billion in gold, and more than three quarters of it, or 2212 billion of debt-that would put a ceiling of 30 billion theoretically on the amount which could be issued ? It seems to me that this committee should be giving some thought to removing the influence which deficit financing, and the debt , have upon the value of our currency . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 47 Then, there are other things which we did in the thirties to cause inflation. We reduced the gold reserve behind Federal Reserve notes from 40 to 25 percent ; we reduced the reserve of deposit liability from 35 percent to 25 percent ; yet when the House in the Eightieth Congress restored those reserves to their respective 35 and 40 percent , somebody influenced the Senate against taking any action on it. Has the administration's opinion changed any in that respect since then, do you know ? Secretary SNYDER. May I study that question and prepare a reply ? Representative WOLCOTT. I should like to be told that I was not stating the truth, but there are those in the Congress who have been so unkind as to say it was the studied policy of the administrationto create inflation, and that it is now the studied policy of the administration to maintain inflation . Otherwise it would recommend an about-face in the things which we once did to create inflation, among which are the two that I have mentioned , and three or four other things which we did in the thirties and have continued since then to create and maintain cheap money. Would it not be well for this committee to give some consideration to a reversal of those processes by which we depreciated the value of the dollar ? Secretary SNYDER. I will include that in my comments on the first two questions, Mr. Congressman. (The material referred to is as follows :) The questions Representative Wolcott asked related primarily to Federal Reserve functions . Chairman Martin of the Board of Governors was asked substantially the same questions when he appeared as a witness before the subcommittee and agreed to prepare an answer to submit to the subcommittee. Such an answer has been prepared and I concur in it. I should like, therefore, to have it inserted at this point in answer to the questions which Representative Wolcott asked me. "The Federal Reserve Act as amended in 1945 requires that each Federal Reserve bank hold reserves in gold certificates equal to 25 percent against its Federal Reserve notes in circulation and against its deposits. In the case of Federal Reserve notes, the law also requires that each Reserve bank shall pledge with the Federal Reserve agent of its district collateral equal to 100 percent of the amount of such notes in circulation. Such collateral may consist of gold certificates , paper originating in commerce, agriculture, and industry- that is, so-called eligible paper-or direct obligations of the United States Government. "Prior to 1945, the required reserve percentages were 40 percent of gold certifi cate reserves against Federal Reserve notes and 35 percent of gold certificates or lawful money against deposits . The main reason for the lowering was that the gold reserve ratio had fallen significantly during World War II as a result particularly of the very large expansion of Federal Reserve notes in circulation because of wartime demands for currency. This increased volume of money has remained in circulation since the war. "The use of Government securities as collateral for Federal Reserve notes was authorized on a temporary basis by the Glass-Steagall Act of 1932 and was periodically renewed, and the authority was made permanent in 1945. This provision was necessitated by the large-scale withdrawal of currency from bank deposits in the early years of the depression, by the then reduced volume of eligible private paper in Reserve bank portfolios, and by the desirability of Federal Reserve purchases of Government securities in order to prevent the development of tight money conditions during the depression. "It would appear undesirable at this time to change either the legal reserve requirement regarding gold certificates or the legal collateral requirement regarding United States Government security holdings of the Federal Reserve banks. The legal provision permitting the Reserve banks to use Government securities as collateral for notes is necessary under present conditions, since the volume of commercial, agricultural, and industrial paper now held by these banks would be inadequate for the purpose. Also, the provisions of law regarding the 48 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT reserve requirements of the Reserve banks are important in enabling flexibility in monetary management to meet changing conditions. "These legal provisions are not inflationary per se. Federal Reserve credit is not created just because the basis for such creation is available. It is the duty of the Federal Reserve System to see that Reserve bank credit is adjusted to the needs of the economy. Changes in the volume of such credit outstanding are now determined mainly by actions of the Federal Reserve System in accommodating the credit needs of consumers, commerce, agriculture, industry, and State and local governments, as well as the Federal Government. Such actions are taken only after a careful review of the economic and financial situation in the country at the time and after a full consideration of their inflationary and deflationary implications . "An automatic check on the expansion of Federal Reserve bank credit, such as would be imposed by an increase in the ratio of gold certificates required against Federal Reserve notes and deposits would not be desirable. It was in part to prevent arbitrary and mechanical limitations on the volume of bank credit and money, resulting from too rigid a relationship between the credit and money supply and gold, that the Federal Reserve System was initially established." Representative WOLCOTT. You, perhaps , will recognize that this is a fetish with me. Secretary SNYDER. I beg your pardon ? Representative WOLCOTT. You will, perhaps, recognize that this is one of my fetishes . Secretary SNYDER. I did not hear what you said. Representative WOLCOTT. I say, you will realize that this is one of my fetishes. Secretary SNYDER. Yes ; but they are appropriate questions, as all are from the committee, and we would like to give a careful , studied reply to them. Representative WOLCOTT. You mentioned in your statement that pressures were not quite as great as they had been- this is on page 5— and you say that there appears to be a lull at the present in inflationary pressures, and you go on to say, of course, that it is merely a lull, indicating that we are on some sort of a plateau , a little below where we were a few months ago. What effect has "the accord," which you and the Federal Reserve reached, and the action which was taken by the Federal Reserve in not supporting the Government-bond market and increasing the rediscount rates to 134 from 112, and the issue by the Treasury of your 234 , which could not be monetized , what would you say what influence have those things had upon easing the situation ? Secretary SNYDER. Well, the raising of the rediscount rate had That took place in August. taken place prior to the accord. Representative WOLCOTT. I guess that is right. Secretary SNYDER. Yes. Well, there has been, of course, a leveling off of inflationary pressures in recent months. The cost index on a number of items has gone down, the pressure of large inventories has had some effect and has been in some evidence as a depressant ; the soft-goods area has had a depressing experience. I would say that we have been experiencing a lull in inflationary pressures, and I think that we all give due weight to the accord for being one of the many factors that brought about this situation . Of course, the production capacity of the Nation had a great deal to do with it, too, in being able to rise to the demands and supply much of the requirements, even under the increased volume of income. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 49 I think that we can sum it up by saying that the monetary steps that were taken were a part of the broad influence that brought about the situation we are experiencing now. I do feel that we must carefully keep in mind that as a result of defense spending inflation may become a trend again. Representative WOLCOTT. Would you care to comment upon what effect the reduction in the value of the dollar of 46.15 percent in the last 10 years has had upon the savings bond market ? Secretary SNYDER. Well, on the E bond market over the whole postwar period , I do not think that the consideration of any change in the purchasing value of the dollar had any particular effect. Up to Korea savings bond purchases were well maintained . There was some increase in redemptions along with increased withdrawals from other types of savings in the heavy goods buying experience that we had following Korea . It has tapered off in recent months, however. Representative WOLCOTT. When you say it has tapered off, you mean the Secretary SNYDER. The redemptions. Representative WOLCOTT. The redemptions ? Secretary SNYDER. And sales . Representative WOLCOTT. Since Korea ? Secretary SNYDER. The relationship between sales and redemptions has improved in recent months . Representative WOLCOTT. What I am leading up to , since Korea the value of the dollar has dropped from 59 cents or 60 cents, somewhere along there, to its present 52.85 . That has been the situation since Korea. It has dropped down 6 points since Korea . Has that any effect upon your savings bond market ? Secretary SNYDER. May I have you repeat the question ? I just could not hear it. Representative WOLCOTT. What effect has the drop of 6 percent in the value of our currency since Korea had upon your savings bond market ? Secretary SNYDER. Well , the indication I gave this morning was that for January and February, the most recent months for which we have a record the sales had gone up percentagewise over the same months for last year, and the redemptions had decreased over the same period. So it appears a corrective trend is being experienced . Representative Wolcott. There is not any question, is there, but what inflation has affected the market for Government bonds, especially in the field of savings bonds ? Now, what incentive, excepting through stabilization of our economy, can we use to create a better atmosphere in which bonds can be marketed , except to increase the interest rates slightly ? Secretary SNYDER. Mr. Chairman, may I ask the subcommittee, you and the subcommittee, this privilege-that anything that has to do with future actions in reference to securities of the United States Government-I be permitted to answer in writing for executive consideration ? Representative WOLCOTT. That is perfectly agreeable to me . Secretary SNYDER. Yes . Representative PATMAN. That will be all right. Secretary SNYDER. Thank you, sir. 50 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative WOLCOTT. We talk about these things so freely that I guess we do not respect your position in that field. Secretary SNYDER. Unfortunately, as I said this morning, I just cannot detach myself from being Secretary of the Treasury, and as much as I would like to talk freely on my own sometimes, whyRepresentative PATMAN. That will be eminently satisfactory, Mr. Secretary. I have some questions along that same line, but I will withhold them as you suggest . Secretary SNYDER. Thank you. Representative WOLCOTT. Would you recommend, as the President has, that we give the Federal Reserve additional power to increase reserves, reserve requirements ? Secretary SNYDER. I believe that in answers 35 and 36 I addressed myself to that problem. I will be glad to call attention to that answer. It has already been submitted . Representative WOLCOTT. The problem seems to be that the Federal Reserve Board at the present time has been unable to agree upon the amount of authority which they are going to ask us for. I wondered, when the President in the economic message asked for additional reserve authority, whether he and the Federal Reserve Board had come to some understanding in respect to the authority which they would ask for, how much they would ask for. Secretary SNYDER. I am not in a position to answer that. Representative WOLCOTT. Last year when we brought it up it was suggested that probably they would not have too much trouble in getting a little more authority to have some more reserves, and my memory is that we could not get the Board to agree on how much they should ask for, and so no action was taken . Have there been any discussions in respect to the restoration of these gold reserves that I mentioned behind the deposit liabilities issued by the Federal Reserve ? Secretary SNYDER. That looks like an easy question to answer, but I would like to do it in writing. I say I would like to answer that one in writing. Unfortunately, Mr. Congressman, too many times when I have said that we have had, or have not had, discussions the remarks have been interpreted as meaning we have some plans. That is the reason why I am making that request. Representative WOLCOTT. Well , we are all against inflation ; are we not? Secretary SNYDER. We can agree on that. Representative WOLCOTT. Now, speaking for myself, and I will not ask you for an answer to affirm my position, it seems to me that if we are against inflation, having created inflation legislatively in the 1930's, the Congress could stop the inflation if it did an about-face and restored the powers and authority and the standards and guides that were in existence in legislation in the 1930's before we changed them . Secretary SNYDER. Well, I think we would have to measure it very carefully against conditions at that time and conditions today, and the problems facing us at both times before we could make a complete acceptance of the theory of reversal. Representative WOLCOTT. Do you think that we have got to accept inflation as a matter of permanent governmental policy ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 51 Secretary SNYDER. I certainly hope not. We had up until last June an over-all balanced budget situation for 5 years, as you know-in fact, receipts exceeded expenditures by nearly $8 billion in that period. Í would be very hopeful that we can return to a balanced -budget situation as quickly as possible. Representative WOLCOTT. Thank you , Mr. Secretary. I think that is all I have, Mr. Chairman. Representative PATMAN. Mr. Secretary, I would like to ask you a few questions. I have two written out here that I think I will read to you first. About a year ago prices suddenly stopped advancing. Since then they have declined slightly, at least at wholesale. Some of the pricecontrol people and some of the monetary people have taken pretty complete credit for this. Others think that it was principally a natural reaction from the post -Korean buying spree. What do you think about it ? Secretary SNYDER. First, and most important in my mind, was a leveling off in consumer and business demand after the early rush to buy goods and stock large inventories after the outbreak of hostilities in Korea. Largely, this was the result of a rapid increase in the output of consumer and other civilian goods before defense demands had created a shortage of materials-thereby easing the fear that there would be shortages such as prevailed in World War II. Coupled with this has been an array of measures designed to alleviate particular areas of inflationary pressures. We have had priorities and allocations of scarce and strategic materials ; Government production loan guaranties and loans to increase production for national defense needs ; selective restrictions on credit in areas such as consumer credit and realestate credit ; the voluntary credit- restraint program ; and price and wage controls— all of which have made an important contribution to the over-all problem of inflation control. Representative PATMAN. You have said that you favored some flexibility in interest rates as an instrument for influencing inflationary and deflationary forces. Do you believe at the present level of interest rates on marketable securities that it is suited to present conditions ? Will you distinguish in your answer between short-term and long-term rates ? Secretary SNYDER. The present situation is one in which we are experiencing a lull- inflationary and deflationary forces seem to be about in balance. In this situation, stability in interest rates seems appropriate- in both the short- and long-term area. Representative PATMAN. I asked you the next question in writing and you have submitted the answer. It was, Could you present a table for the record showing the change in interest rates since the end of 1949 and tell us briefly what it shows. Secretary SNYDER. We would like to put the answer into the record, the answer that I have supplied. Representative PATMAN. You gave me a letter on that, and without objection we will insert that in the record at this point. It is quite interesting. 52 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT (The document referred to follows :) EFFECT OF CHANGES IN INTEREST RATES ON THE COST OF SERVICING THE PUBLIC DEBT GENERAL STATEMENT OF THE PROBLEM Interest costs are affected by four elements : ( 1 ) Changes in the total amount of the debt ; ( 2 ) the nature of the debt in which changes occur ; ( 3 ) changes in composition of the debt resulting from refunding operations ; and ( 4 ) changes in interest rates. There are five different classes of debt which must be considered in dealing with interest costs : ( 1 ) Short-term marketable debt which currently is responsive to changes in interest rates (e. g., Treasury bills and certificates of indebtedness ) ; (2 ) longer-term marketable debt which reflects changes in interest rates as the debt matures and is refunded ; (3) nonmarketable debt which has been affected by changes in rates, such as Treasury savings notes ; ( 4) nonmarketable debt, the rates on which have not yet been affected by changes in interest rates on other debt, such as United States Savings bonds ; ( 5 ) special issues for trust accounts which are affected by the over-all average rate of interest, viz., the Old-Age and Survivors Insurance Trust Fund and the Unemployment Trust Fund ; and (6 ) special issues which are not affected by changes in the average interest rate, such as the National Service Life Insurance Fund. Increases or decreases in interest rates affect interest costs to the Treasury on different types of debt in different ways, and at different times. For instance, the interest costs on short-term marketable debt is more quickly affected by changes in interest rates than the interest cost on long-term marketable securities, the nonmarketable debt, and the special obligations which are issued to trust funds and Government investment accounts. Changes in interest rates in Treasury bills are reflected more currently since they are rolled over every 91 days, but even here there is some overlapping of the effects of interest rate changes as between fiscal years. The amount of change in interest costs as a result of increased or decreased interest rates cannot be determined merely by comparing total interest payments in one fiscal year with that of another. One of the reasons for this is that the full effect of a change in the interest rate on actual expenditures is not reflected in expenditures until the fiscal year following the one in which the change in the rate has occurred . This is generally true in the case of securities which have a year or more to run. As an illustration , the interest on a 1-year certificate of indebtedness issued in August of one fiscal year would not be payable until August of the following year. The same sort of situation occurs with respect to securities, the interest on which is payable semiannually. For instance, a note or bond dated in the first half of a fiscal year would carry only one 6-month interest coupon payable in that fiscal year, and a bond or note issued in the second half of a fiscal year would not have any interest coupons payable during that fiscal year. CHANGES IN INTEREST RATES During the period from December 31, 1949, to February 29, 1952, the interest rates on 90-day Treasury bills fluctuated between 1,076 percent and 1,883 percent. The latest issue in December of 1949 was sold to yield 1.087 percent on an annual basis, as compared with a rate of 1.563 percent for the latest issue in February of 1952 , an increase of 0.476 percent. If this increase in rate should be applied to the total amount of 91-day Treasury bills outstanding on February 29, 1952, the increase in the annual interest cost on this segment of the debt would be $74 million.¹ The interest rate on an 112-month certificate of indebtedness dated March 1, 1952, was 1 % percent, as compared with a 1-year rate of 1 % percent in December of 1949, an increase of 34 percent. On the total amount of certificates of indebtedness outstanding on February 29, 1952 ($29 billion ) , this would result in an increase in the annual interest cost of $218 million . On April 1, 1951, as part of the Treasury-Federal Reserve accord, the Treasury issued $13,574 million of 24 percent of nonmarketable bonds in exchange for an equal amount of 22 percent marketable bonds of 1967-72 . An increase of 14 per- 1 Does not include the tax anticipation bills. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 53 cent in the interest rate on this amount of bonds would amount to $34 million on an annual basis. However, these bonds are exchangeable for 1½ percent 5-year marketable notes. Therefore, the effect of these exchange operations on interest -costs will vary from year to year and will be governed to a large extent by subsequent exchanges of the 24 percent nonmarketable bonds for the 12 percent marketable notes. The figures as of February 29, 1952, in connection with this exchange operation are as follows : NOTE. On February 29, 1952, the Federal Reserve System owned $22,528,000,000 of Government securities, the annual interest on which amounts to $439,000,000. Since Federal Reserve banks return to the Treasury 90 percent of their net earnings, a considerable portion of their interest earnings comes back to the Treasury. The net earnings paid to the Treasury for the calendar year 1951 amounted to $255,000,000. Amount outstanding 234 percent bonds. 1½ percent notes.. Total... 212 percent bonds exchanged (annual interest) . Increase in annual interest cost- Annual interest $12, 034, 000, 000 1. 540, 000, 000 $331, 000, 000 23, 000, 000 13, 574, 000, 000 354, 000, 000 339, OCO, 000 15, 000, 000 On March 1 , 1952 , the Treasury issued $922 million of 7-year taxable bonds carrying an interest coupon of 2 % percent. In December of 1949, the market yield on a 7-year taxable bond was approximately 12 percent. An increase of seveneighths of 1 percent on $922 million of securities would involve an increased annual interest cost of $8 million. Except for the above-mentioned bond the Treasury has not issued any marketable securities with maturities of over 5 years since December of 1949. The market yields, however, on the long-term restricted Treasury bonds of December 15, 1967-72 increased from 2.24 percent on December 31, 1949, to 2.72 percent on February 29, 1952, indicating that long-term financing in this area would have to be done at an increase of about one-half of 1 percent per annum. While the rate increases in the long-term area have not yet been reflected in Treasury interest payments, unless interest rates decline in the meantime the effects will be felt when maturing issues are refunded and in any long-term financing which may be conducted in the present emergency. Increases in interest rates appear to have affected the sale and redemption of Treasury savings notes, which are used to a large extent by corporations and others for the purpose of accumulating tax reserves. If these securities are to be kept attractive for investors, the interest return must be kept in line generally with short-term market rates. Consequently, the interest rate on savings notes must be responsive to changes in market yields, although there may be a time lag before all outstanding savings notes reflect such changes in yields. The 3-year rate on Treasury savings notes was increased on May 15, 1951, from 1.40 percent per annum to 1.88 percent. This increased rate on savings notes has not yet been fully reflected in interest payments . Of $8,044 million of these notes outstanding on February 29, 1952, $2,039 million represents the older, lower rate notes. The average interest rate on the notes outstanding is currently 1.758 percent compared with 1.360 percent on December 31, 1949, an increase of .398 percent. This represents an increase of $32 million in the annual interest charge on savings notes, based upon the present amount outstanding. There are two other large areas of the public debt where material changes in interest rates have not taken place. These are (a ) the United States savings bonds, and ( b ) the special issues to trust funds (e. g. Old-Age Survivors Trust Fund and State Unemployment Trust Fund ). Sales of United States Savings bonds have held up remarkably well, particularly among the smaller savers. The amount of outstanding Series E bonds (including interest accruals ) on February 29, 1952, was $34,903 million, as compared with $33,754 million on December 31, 1949. There are now approximately 7 million persons buying savings bonds regularly on payroll savings plans as compared with 42 million a couple of years ago. The number of $25, $50, and $100 denominations sold was $34,900,000 in the first 7 months of the fiscal year 1950 and about the same number in the comparable period of the fiscal year 1951 . 54 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Sales of these denominations increased to $40,500,000 in the first 7 months of the fiscal year 1952. Present law limits the interest rate on such bonds to 3 percent per annum, compounded semiannually. Series E bonds now yield 2.9 percent, compounded semiannually, if held to 10-year maturity , so there is little leeway for an increase in the rate of interest which can be paid on these bonds under existing law. Series F and G bonds yield 2.53 percent and 22 percent, respectively, if held to 12-year maturity. There is another large segment of public debt on which the impact of higher interest rates has been only partially reflected in Treasury interest payments . They are the special obligations issued to trust funds. There are over $36 billion of such special obligations outstanding. The interest rates on obligations issued to two of these trust funds (i. e. , Old-Age Survivors Trust Fund and Unemployment Trust Fund, amounting to over $20 billion ) are, by law, based upon the average interest rate on the total outstanding public debt, except when the average rate is not a multiple of % of 1 percent, the interest rate on the special securities is fixed at the next lower multiple of % percent. At the present time $20,775,000,000 of special obligations are held for account of the Old-Age and Unemployment Trust Funds, on which the average interest rate is 2.135 percent as compared with $16,399,000,000 of special issues held for such funds in December of 1949, at an average rate of 2 % percent. However, it should be pointed out that although the rate on special obligations currently being issued to these trust funds is 24 percent, over $19 billion of the special securities now held by the funds were issued when the average rate on the public debt was somewhat lower, and bear a rate of 2 % percent. At the end of this fiscal year all of the special securities held will have to be reissued on the basis of the average rate on the public debt at that time, which probably will result in a 24 rate on all of the Old-Age and Unemployment Trust Fund obligations. An increase of % of 1 percent on the special securities held for these funds would increase the annual interést charge by $26 million. Thus, in considering the additional cost of servicing the public debt as a result of increases in interest rates, care must be exercised in appraising the long-run effects not only on the marketable debt as it is refunded, but also on other categories. AVERAGE INTEREST RATES The amount of outstanding public debt, by classes and issues, and the rates of interest paid on the different issues, are published in the Daily Statement of the United States Treasury, as of the last day of each month. Copies of such statements as of December 31, 1949, and February 29, 1952, are attached . The average rates as of December 31 , 1949, and February 29, 1952 , are set forth on the following page : Average interest rates Type of securities Marketable: Treasury bills . Certificates of indebtedness. Notes.. Bonds.. Nonmarketable. Average for public issues ... Special issues... General average… - Dec. 31, 1949 Feb. 29, 1952 Percent 1.090 1.219 1.375 2.316 2.581 2.145 2.617 Percent 1.683 1.875 1.561 2.322 2.638 2.261 2.608 2.310 2.208 While the foregoing figures are of interest as an indication of the changes in average rates borne by interest-bearing securities outstanding now as compared with December 31, 1949, they do not reveal the ultimate effect of the changes on total costs to the Treasury. LONG-TERM PROJECTION OF INTEREST COSTS As has previously been mentioned , it will take some time before the higher rates are infiltrated throughout the different segments of the public debt. Not MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 55 only will the increases in rates be felt as maturing issues are refunded but they will also be reflected in increases in the costs of financing the budget deficits created by the defense mobilization program. In the general statement I made before the Subcommittee on Monetary, Credit, and Fiscal Policies of the Joint Committee on the Economic Report, on December 2, 1949, I said that— "Even a relatively small increase in the average interest rate on the debt would add a substantial amount to the total annual interest cost. It is estimated hat the interest on the debt will amount to $5.7 billion in the calendar year 1949. About $ 1 billion would be added to this amount if the average interest rate were one-half of 1 percent higher." No one can accurately predict the movement of interest rates in future years. There is a possibility that rates will further increase and at the same time it must be recognized that economic conditions in the future could produce lower interest rates. Likewise , it cannot be determined now what changes will take place in the future in the composition of the public debt. At the present time the total amount of interest-bearing debt outstanding, for the purpose of computing an average interest rate, is about $258 billion. The average interest rate has increased from 2.208 percent on December 31 , 1949, to 2.310 percent as of February 29, 1952. If this increase of 0.102 percent should be applied to the total amount of interest-bearing debt outstanding at the present time, mentioned above, the increase in the computed annual interest change would be about $262,815,000. If the over-all average rate should eventually be increased by one-fourth of 1 percent, the increase in the annual interest charge would amount to about $ 645,000,000, and if the over-all rate should be increased by one-half of 1 percent, the increase in the annual interest charge would be about $1,290,000,000. On the other hand if in the future the average interest rate should decline by one-tenth of 1 percent (based upon a $258 billion interest-bearing debt ) , the reduction in the annual interest charge would be about $258 million ; a reduction of one-fourth of 1 percent in the average rate would result in the annual interest charge being reduced $ 645,000,000 ; and a reduction of one-half of 1 percent would result in decreasing the annual interest charge by $1,290,000,000. Representative PATMAN. You stated in reply to the questions that have heretofore been submitted to you, Mr. Secretary, that you favor an independent Federal Reserve Board. I wish you would enlarge on that by stating independent of whom and independent of what ? Secretary SNYDER. Well , I considered my statement to be that I preferred to see the Federal Reserve Board remain an independent agency due to my high regard for the purposes for which it was created, and for the important influence that it can have, and does have, on our whole fiscal operation and monetary operation. The Federal Reserve Board has a most important function to fulfil , and I would like to have it preserved in the framework in which it was created. However, in these times, with our radidly developing economy, which has grown to the size that it has , and when our national debt has grown to the size that it has, Federal Reserve actions must be appraised in the light of these different circumstances. The Federal Reserve has undertaken , at the direction of the President, on several occasions to take over certain functions, such as regulation X in the real-estate field, and two or three other functions that have pretty well tied it into Executive direction. These actions were certainly with congressional sanction, and so it becomes apparent that the Congress realizes that this absolute independence must be temperate at times-in light of existing conditions-to meet the tremendous problem of trying to maintain the well-being of our over-all economy . But you asked independent of whom and of what ? In a general way, I do not think that the Federal Reserve should take any direction or dictation from anyone. But I think many times, of necessity, to carry out the functions as given to them, and the responsibilities as 56 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT given to them- by Congress-that the Federal Reserve certainly mustmeasure carefully the conditions and the times and the problems facing the Nation at the time they make decisions. Now, if that is an influence that somewhat tempers their absolute independence of action, then I think it must be tempered to that extent. But so far as not having any dictation or direction , that is the type of independence that I said I would like to see preserved . Representative PATMAN. In the beginning of your answer you stated that you would like to see it kept within the framework in which it was created . I understood you to say that, Mr. Secretary. Secretary SNYDER. That was right. Representative PATMAN. That being true, as the act was created, the Secretary of the Treasury was Chairman of the Board and the Comptroller of the Currency was on the Board and then, of course, and for many years afterwards the public debt was not very large, and it was not too important that these two officials be on the Board, probably, to carry out an independent administrative job. But do you believe that this law should be changed now and restored to the framework of its original creation by restoring the Secretary of the Treasury as Chairman of the Board, and placing on the Board the Comptroller of the Currency ? Secretary SNYDER. Well , I meant when I said "created," I meant created and developed , of course . Now, as to whether or not the Comptroller or the Secretary of the Treasury should be on that Board or not is a matter for careful deliberation. At times it would appear that there would be a very good advantage in having one or the other- I do not know whether it is necessary to have them both or not, or whether it is necessary to have either or not. In the discussion of how we should answer the questionnaire, we discussed that matter freely. I have not suggested , however, in answer to your questionnaire, that such legislation be considered- that the Secretary be put back on the Board. As a matter of fact, I specifically said, as I study it today, that I do not see the necessity for any legislation at this time to give the Treasury more authority over the Federal Reserve Board-I think that we are going to work this out within each agency's own responsibility. Representative PATMAN. Being more specific, you are opposed to the executive having any direct power to direct the Federal Reserve Board to do anything, and you are also opposed to the commercial banks, on the other side, having any direct power to direct the Federal Reserve Board to do anything. Your views, I assume, are that the original act contemplated that the public interest should be looked after first, and that neither the President nor the commercial banks would absolutely control the Board. Secretary SNYDER. Yes, sir. I feel that way, and that was the thought that prompted the recommendation that would bring about a better chance for consultation and discussion, so that the whole situation at any one particular time could be freely discussed on an advisory capacity basis, advising as to facts and other relevant considerations, rather than having any legislative action . Representative PATMAN . That is the reason you suggested the coordinating agency that you suggested , I believe, on page- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 57 Secretary SNYDER. Well, I did not call it coordinating Representative PATMAN . I called it that. Secretary SNYDER . Yes . Representative PATMAN. I mean something along that line to get the people around the table to coordinate their views and get consideration. Secretary SNYDER. I call it advisory. Representative PATMAN. An advisory committee. Secretary SNYDER . Yes . Representative PATMAN. Does it not compare in many ways with the advisory group that is set up by the commercial banks ? Secretary SNYDER. Well, it does because they have no coordinating authority, as I understand it. Representative PATMAN. What I mean is that Secretary SNYDER. But they have an advisory capacity. Representative PATMAN (continuing ) . They have an advisory committee, as they should have, to get their views over to this, what you might call a , supreme court of finance. On the other hand , the Government, as you suggest, should have some way- the people who are interested and the heads of these different departments and, particularly, the Secretary of the Treasury should have some way-of getting his voice heard and getting his views considered, although he would not have the power to direct that they be carried out . Secretary SNYDER. Well, we have found that such advisory groups have been extremely beneficial to the Treasury in its operations and in its responsibilities . We have found that such discussions, in many of which we sit side by side with Federal Reserve representatives, are very beneficial and helpful. Representative PATMAN. I agree with you that the Executive should not have the power to direct the Federal Reserve Board or the Federal Reserve banks to make loans or anything like that ; that is way beyond anything that I would even dream of. I do not think that that power should even be thought of, to give any Executive that power. But what I am wondering about is whether or not the public interest is paramont at all times in view of the present set-up, and I expect to try to get some light on that as we go along in these hearings. I know at first when the Comptroller of the Currency, selected by the President, and the Secretary of the Treasury, in the Cabinet selected by the President, when they were on that Board there was no question but what the public interest was represented through those two members of the Board, at least ; I am not saying that the others did not represent the public interest, too . In other words, they were appointed by somebody who was elected by the people and accountable to the people. Whatever was done by that Board then the people could charge to the administration in power and vote for or against it by reason of what the Board did, just like in foreign affairs with the State Department, but if you get the Federal Reserve Board so independent that there is no way to charge the administration in power with what is done by that Board , whether it is very beneficial or very devastating, there is no way for the people to charge the Administration in power ; do you not think that that should be given consideration, Mr. Secretary ? 58 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Secretary SNYDER. I would be very happy if this subcommittee during the course of its hearings would test out that thought among all the various groups . Personally, there are certain angles that I can see that would be advantageous, because the Secretary of the Treasury's tenure of office as a member would certainly be limited-I mean his tenure of membership on the Board would be limited-to his actual tenure in office as Secretary of the Treasury, and would not be prolonged beyond his active duties in connection with the operation of the Treasury, in which capacity he has the responsibility for debt management ; and, therefore, it could be advantageous. There are some areas which might indicate that it would not have advantage, but personally I have not any strong feelings one way or the other, and I would be very pleased to see what would be developed in these hearings on that subject as to others' views as to whether or not such a course would be helpful. I can see, as I have said, many areas in which it could be of advantage. There are others where the general feeling might be it would be just as well not to have the Secretary tied in too closely to the necessary decisions and operations of the Federal Reserve Board. Representative PATMAN. Of course, I refer to consideration of policy matters only. I am not even harboring any thought that the Executive or the Secretary of the Treasury should ever be allowed to direct the Board to make loans or anything like that or any Federal Reserve bankSecretary SNYDER. Well, that was the area in which I had my reservation for him to be a full-fledged member of the Board with full Board responsibilities. You have touched on the very area in which I had questions. Representative PATMAN. I recall, from reading about the Federal Reserve Act, that Senator Glass was insisting all the time that it should not be run by the banks, and President Wilson was the same way ; and I recall reading something in Senator Glass' book about it, about a conference, I guess. I assume that you read about that conference at the White House-in which President Wilson suggested it would be just the same as letting the railroads select the Interstate Commerce Commission to set the rates as to let the bankers run the Federal Reserve Board and have control over their policies . You recall that, I assume ? Secretary SNYDER. Yes, I recall that. Representative PATMAN. In other words, everything in the writing of that law was in the direction of preventing the banks from having control over the Federal Reserve System . Do you agree to that ? You do, do you not ? Secretary SNYDER. I think that is very appropriate . Representative PATMAN. Yes. At the same time there was not anything in there to indicate that it was desired by those pushing the legislation that they wanted the President to have the power to direct the Board to do certain things. Secretary SNYDER. I am quite sure that that is the legislative history. Representative PATMAN. That is right. I just wondered if we have not gotten away from that too far. Now, at first the terms of the members of the Board were much shorter than they are now, and at first I believe the longest term went up to 10 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 59 years, did it not, 10 years, and then later on it was extended to 12 years, and then later on it was extended to 14 years ? Secretary SNYDER. That is the present, 14. Representative PATMAN. Now, when the President appoints a member of the Board for 14 years, of course, he has no further control of that member. He is not supposed to have, and I am not advocating that he should have or that I want him to have. I want the members to be free and independent to use their own best judgment according to the facts as presented at the particular time. But a Board composed of members for 14 years, and no one on there that is under obligation to anyone who was elected by the people, as the Executive is elected by the people, I just wonder if that has gotten too far away and becoming too independent ? What do you think about that ? Secretary SNYDER. Well , there could be rather broad implications there ; it could get too far away. My recollection is, however, that the Secretary, when he was an ex officio member, was a full member of the Board with all responsibilities and not just a policy-making member. I think that is true. Representative PATMAN. I did not get that last. Secretary SYYDER. When I did not quite agree with putting the Secretary of the Treasury back into the position that he was originally as a member of the Board , it is because I think he was a full ex officio member with full responsibilities. Representative PATMAN. There is no question about that ; he was Chairman under the law. Secretary SNYDER. Yes . Representative PATMAN. He was Chairman of the Board. Secretary SNYDER. Yes . The original Federal Reserve Act provided thatA Federal Reserve Board is hereby created which shall consist of seven members, including the Secretary of the Treasury and the Comptroller of the Currency, who shall be members ex officio, and five members appointed by the President of the United States, by and with the advice and consent of the Senate. * * Of the five persons thus appointed, one shall be designated by the President as governor and one as vice governor of the Federal Reserve Board . The governor of the Federal Reserve Board, subject to its supervision, shall be the active executive officer. * * * The Secretary of the Treasury shall be ex officio Chairman of the Federal Reserve Board. * Representative PATMAN. And he, of course, did have full responsibilities. Secretary SNYDER. I feel that so far as policy-making in the areas in which fiscal and monetary operations are concerned, it might well be considered by your group as to whether or not it would be beneficial to give him that position . I would be glad to hear comment on that. Representative PATMAN. Anyway, we will give it consideration . Without objection , I will insert in the record at this point the statement in Senator Glass' book that I referred to a while ago. (The statement referred to is as follows :) The Honorable Carter Glass, of Virginia, had a lot to do with the passage of the Federal Reserve Act. In his book, An Adventure in Constructive Finance, published in 1927, describing a discussion of this very question by President Woodrow Wilson with an important group of bankers at the White House, it is stated on page 116 : said quietly : "When they had ended their arguments, Mr. Wilson 'Will one of you gentlemen tell me in what civilized country of the earth there are important government boards of control on which private interests are 97308-52-5 60 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT represented ?' There was painful silence for the longest single moment I ever spent ; and before it was broken Mr. Wilson further inquired : 'Which of you gentlemen thinks the railroads should select members of the Interstate Commerce Commission ?' There could be no convincing reply to either question, so the discussion turned to other points of the currency bill ; and, notwithstanding a desperate effort was made in the Senate to give the banks minority representation on the Reserve Board , the proposition did not prevail." Representative PATMAN. I wanted to ask you about the Research Department in the Treasury Department as compared to the Research Department in the Federal Reserve . Now, over the years I have been impressed- whether it is true or not I do not know, and I am not in a position to say-that the research staffs in the different divisions or offices of the Treasury-I would not say they had gone down in ability ; they have not, I am sure, and I am also sure that you have able, just as able, people there as you ever had in the world—but the number of people helping them and the amount of money available for that purpose seems to me to have been less and less . Is that correct or not ? Secretary SNYDER. It is true, and it has been over our very strong protests, because we have asked that we be given funds to bring in new people constantly and keep our organization in full operation for the tremendous responsibilities that we have ; but for some reason or other Congress has seen fit to curtail those funds . Representative PATMAN. But Congress has not curtailed the Federal Reserve. Of course, Congress has notSecretary SNYDER. Of course, Congress has no appropriation function over the Federal Reserve. Representative PATMAN. That is, it has not assumed it so far. Secretary SNYDER. I beg pardon ? Representative PATMAN. It has not assumed that power so far. Secretary SNYDER. Well , I will pass that one, but I am talking about the Treasury, and I am hopeful that out of this will grow some support to help us with appropriations , to help us build up our technical staff. I think we have an excellent one, but we need to have funds to build it up to a size that will meet all the problems of the time ; and I am very hopeful that this subcommittee will, in their wisdom, after they have studied this , see fit to help us out in that regard. Representative PATMAN. Well, I am personally right now committing myself to you on that problem . I am strongly in favor of that because I think that your divisions have been weakened somewhat by the lack of sufficient money to keep the necessary personnel. On the other hand, there is the Federal Reserve System which is not a competing agency-I am not claiming it is a competing agencybut it has unlimited funds at its disposal ; that is, they own about $20 billion in bonds. Are those all Government bonds ? Secretary SNYDER. Total holdings of Government securities are nearly $23 billion . Representative PATMAN. $23 billion in Government securities . Now, the interest on those Government bonds, of course, creates a considerable sum, and under present policies and practices they use that money as they see fit, and under existing law they are not even required to put any part of their earnings in the form of surplus back into the Treasury, but I understand what has been done customarily in the recent past- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 61 Secretary SNYDER. We have had a working arrangement that after they deductedRepresentative PATMAN. I beg your pardon ? Secretary SNYDER. We have had an arrangement with them for the past several years where a certain percentage is returned. Representative PATMAN. You mean about 90 percent ? That used to be the law. Secretary SNYDER. About 90 percent after certain adjustments. Representative PATMAN. That is right. But now these deductions, that means that they can spend any amount of money for research or anything else, and that is, of course, permissible under existing law and rules as distinguished from the Treasury that must come to Congress for their appropriation . Do you know of any other independent agency of Congress like that that does not come to Congress for their appropriations annually ? Secretary SNYDER. The only one that occurs to me quickly would be the FDIC , I am not specificallyRepresentative PATMAN. I think the Comptroller of the Currency in some respect, too . Secretary SNYDER. Yes, in some respect. Representative PATMAN. But outside of that there are 25 to 50 in a comparable situation that must come back to Congress for appropriations, and I think I will put the list in the record at this point . ( The list referred to is as follows :) THE LIBRARY OF CONGRESS, LEGISLATIVE REFERENCE SERVICE, AMERICAN LAW SECTION, Washington 25, D. C., March 6, 1952. To : Joint Committee on the Economic Report, Subcommittee on General Credit Control and Debt Management. (Attention : Mr. Henry C. Murphy. ) Subject : Federal Agencies Having Independent Sources of Income. In response to your letter of February 20, 1952 , we submit herewith a representive list of Federal agencies which have independent sources of income, classified to show whether ( a ) such income is available for expenditure by the agency without congressional authorization or appropriation , ( b ) it may be spent by the agency only with the annual authorization of Congress, or (c ) it must be turned in to the Treasury and the expenditures of the agency paid by moneys appropriated by Congress. The following agencies collect certain moneys which they are permitted to use in accordance with law without special congressional authorization or appropriation : Comptroller of the Currency : Assessments for bank examinations (12 U. S. C. 481, 482 ) . Assessments against insolvent banks for expenses of liquidation ( 12 U. S. C. 196) . Reimbursement by Federal Reserve banks for expenses of note issue and redemption ( 12 U. S. C. 420 ) . Federal Deposit Insurance Corporation : Premiums for deposit insurance ( 12 U. S. C. 1817 ) . Interest on investments (12 U. S. C. 1823 ) . Federal Reserve Board : Assessments against Federal Reserve banks for expenses of Boards ( 12 U. S. C. 243 ). Home Loan Bank Board : Assessments for examination of financial institutions (24 C. F. R. 123.20, 12 U. S. C. 1439a ) . Department of Agriculture : Charges for inspection and certification of certain farm products and license fees (7 U. S. C. 55, 499c, 585 ) . Federal Security Agency : Federal Credit Union fees ( 12 U. S. C. 1756 ) . Fees for examination of sea food ( 21 U. S. C. 372a ) . 62 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT General Services Administration : Fees for testing commodities (41 U. S. C. 219 ) . The following agencies are, to a large extent, supported from revenues of the enterprises operated or supervised by them, or from the property they administer , but they must obtain special authorization to use moneys in their hands for designated purposes, or in some cases, for any purposes : Federal Crop Insurance Corporation (7 U. S. C. 1508, 1516, Public Law 135, 82d China Trade Act Corporation fees ( 15 U. S. C. 157) . Office of Alien Property (Public Law 188, 82d Cong. ) . Commodity Credit Corporation ( 15 U. S. C. 712a, Public Law 135 , 82d Cong. ) . Export-Import Bank of Washington ( 15 U. S. C. 712a, Public Law 111, 82d Cong.) . Federal Crop Insurance Corporation ( 7 U. S. C. 1508, 1516, Public Law 135, 82d Cong. ) . Federal Farm Mortgage Corporation (15 U. S. C. 712a, Public Law 135 , 82d Cong. ) . Federal Intermediate Credit Banks (Public Law 135, 82d Cong. ) . Federal National Mortgage Association (Public Law 137 , 82d Cong. ) . Federal Prison Industries, Inc. ( Public Law 188, 82d Cong. ) . Federal Savings and Loan Insurance Corporation ( 15 U. S. C. 712a, Public Law 137, 82d Cong. ) . Home Owners Loan Corporation ( 15 U. S. C. 712a , Public Law 137, 82d Cong. ) . Inland Waterways Corporation ( Public Law 137 , 82d Cong. ) . Panama Canal Company (Public Law 203, 82d Cong. ) . Production Credit Corporations (Public Law 135, 82d Cong. ) . Public Housing Administration (Public Law 137, 82d Cong. ) . Federal Crop Insurance Corporation (7 U. S. C. 1508, 1516, Public Law 135, 82d Cong.) . Virgin Islands Corporation (Public Law 136, 82d Cong. ) . Tennessee Valley Authority ( 16 U. S. C. 831h-2 ) . The following agencies collect certain moneys which are covered into the Treasury and which can be withdrawn only upon appropriation by Congress : Attorney General : Aliens and immigrants. Various receipts ( 8 U. S. C. 115, 133, 155 ( c ) ) . Department of Agriculture : Farm Credit Administration- assessments for examination and supervision deposited in special fund in Treasury which is authorized to be appropriated for those purposes ( 12 U. S. C. 832 ) . Forest Service receipts ( 16 U. S. C. 580e ) . Inspection fees, etc. (7 U. S. C. 78, 149, 161a, 395, 415d, 499n, 511e) . Rural Electrification Administration-proceeds of loans, in certain circumstances (7 U. S. C. 903f) . Department of Commerce : China Trade Act Corporation fees ( 15 U. S. C. 157) . Service and publications, fees and charges (5 U. S. C. 276 ) . National Bureau of Standards, fees for tests, etc. (15 U. S. C. 276) . Patent Office fees (35 U, S. C. 79 ) . Department of Interior : Electricity-sales from various power projects ( 16 U. S. C. 825s, 825s-1, 832j , 8331 ) . Geological Survey- sale of publications ( 43 U. S. C. 41 ) . Grazing fees (43 U. S. C. 315i ) . Federal Power Commission : Water power license fees and charges ( 16 U. S. C. 810) . Federal Security Administrator : Food inspection fees ( 21 U. S. C. 24a , 46a ) . Post Office Department : Postal revenues (31 U. S. C. 495 ; 39 U. S. C. 786, cf. 39 U. S. C. 794a ) . Securities and Exchange Commission : Fees for registration of securities , national securities exchanges and qualification of trust indentures (15 U. S. C. 77f, 77ggg, 78ee) . A complete list of agencies which receive independent income could be made only after a detailed examination of the entire United States Code, which cannot be accomplished in the limited time available. Accordingly, the above list does MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 63 not purport to be comprehensive, either with respect to the agencies which receive moneys from outside sources or with respect to sources of revenue of the agencies listed. MARY LOUISE RAMSEY, American Law Section. Representative PATMAN. It occurs to me maybe we should give consideration to the question as to whether or not an agency like the Federal Reserve can be an agency of Congress and not come to Congress for its money. All other agencies do . I mean all other agencies do except two or three which you mentioned , which are the exceptions, and I think maybe our subcommittee should give some consideration to that. Who audits the Treasury, Mr. Snyder, the General Accounting Office ? Secretary SNYDER. GAO, the Comptroller General. Representative PATMAN. The Comptroller General ? Who audits the Federal Reserve System ? Secretary SNYDER. I do not know. Representative PATMAN. I will get that from them . The Comptroller General was provided for under the Norris Act. Secretary SNYDER. Mr. Lindsay Warren. Representative PATMAN. It was 15 years appointment, where a person could not succeed himself ; and he is free and independent, footlose and fancy-free. Secretary SNYDER. He is accountable only to Congress. Representative PATMAN. That is right . Representative WOLCOTT. Mr. Patman , will you yield a moment ? Representative PATMAN. Yes. Representative WOLCOTT. Is the Comptroller of the Currency a part of the Treasury ? Secretary SNYDER. The Comptroller of the Currency is under the general framework of the Treasury operation, yes. Representative WOLCOTT. In the framework, but he is independent of Treasury domination ? Secretary SNYDER. He is a Presidential appointment and, as you recall, I appeared before Congress in 1950 in connection with Reorganization Plan No. 1 -and in support of Reorganization Plan No. 26-recommending that the Comptroller be permitted to retain all of the functions vested in him by statute. (The Comptroller of the Currency, who is an official of the Treasury Department and is in charge of the supervision of national banks, and the Comptroller General, who is responsible only to Congress and its Government assistants, are different persons. ) Representative PATMAN. I would like now to ask a question about the Federal Reserve bank's supporting the Government bonds. Do you consider that there is a free market in the sale and purchase of Government securities, Mr. Secretary ? Secretary SNYDER. I think it must be recognized that there is a special situation existing in the Government security market. The Federal Reserve System uses open-market operations in Government securities for credit-control purposes. As long as open-market operations involve billions of dollars of transactions a year, we cannot 64 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT consider that the market for Government securities is an entirely free one. Representative PATMAN. In the ordinary sense of the word, like a commodity that is sold at the wholesale centers , you know, of bringing the best price where there is a demand at a certain price for a certain commodity, that is a free market as I consider it, where it is offered freely and bought freely, and the market is fixed by the demand of purchasers principally. Do you have that kind of a free market in theSecretary SNYDER. No ; I do not consider so . Also the Open Market Committee has realized that with a tremendous debt and with the financing that has to be done, you could not allow a small segment of that financing to upset the whole market and, therefore, the Open Market Committee has taken care of that kind of a situation. It is a little different from where you have a stock offering or a private bond offering. Whether that was a success or failure would be important, of course, to those interested, but it may not be of vital importance to the economy as a whole. And as I said a few minutes ago, I think that when it comes to complete freedom, if you are speaking of it in terms of absolute freedomno restraint one way or the other-that there is a limitation to that freedom by the very law permitting the Federal Reserve to conduct open market operations in Government securities. Representative PATMAN. And to that extent it would not be perfectly free, of course. I say, to that extent. Secretary SNYDER . Yes. Representative PATMAN. The bond market, I noticed , after it had commenced to slide, went down to about 96, and it has not fallen below that . Maybe I am mistaken, but I just noticed it occasionally. Has it fallen below, have the prices fallen below, 96, for long-term bonds ? Secretary SNYDER. On one occasion, one issue went to 95232. Representative PATMAN. Well, there must be some support there or it would slide on certain occasions much lower , would it not, Mr. Secretary ? Secretary SNYDER. Well, I think that the Open Market Committee has been interested in maintaining anRepresentative PATMAN. An orderly market around 96 ? Secretary SNYDER. I do not know what range of fluctuations is, but there has been an orderly market with only very minor Federal Reserve operations since last April . Representative PATMAN. Suppose they wanted to maintain a market at 100 percent, and assuming that, as Senator Douglas explained, that it would be highly inflationary, that is, the banks could sell the bonds to the Federal Reserve Bank and have reserves of a million dollars and would then have reserves with which to extend credit amounting to some $6 million ; that is all conceded. But is there not some way, some alternative action that can be taken ? Can't you have the Reserve requirements changed by the Congress in a way to offset that and still maintain the bonds at 100 cents on the dollar ? Secretary SNYDER. Well, that I would not like to answer. Representative PATMAN. What would you offer as a suggestion to consider in the way of a law for Congress to pass respecting reserves that would be helpful in preventing that kind of inflation? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 65 Secretary SNYDER. Well , since that is invading another agency's responsibility, I would not like to come out with an answer. Representative PATMAN. That is all right. I will not insist on it at this time at all. I wanted to ask you about some E bonds, but I will defer to your suggestion and put it in writing. Secretary SNYDER. We will be glad to try to answer whatever questions are put to us. Representative PATMAN. Will you tell us briefly what weight you believe should be given to increases in the interest costs on the public debt in determining our monetary policy ? Secretary SNYDER. I think we have to always measure very carefully what the corresponding advantages would be measured against the other problems that must be faced. I certainly do not have any fixed opinion ; I just do not have any desire to fix a rate and let that be the one rate for all time. I think that we have to look at it under the conditions and circumstances of periods in which we are operating. Representative PATMAN. Under existing law, Federal Reserve banks buy bonds only in the open market, do they not ? Except, I believe, back during the war there was a law enacted which permitted the Treasury to sell directly to the Federal Reserve banks obligations, short-term obligations, up to a certain amount . Secretary SNYDER. Five billion dollars. Representative PATMAN . Five billion dollars ? Secretary SNYDER. That is correct. Representative PATMAN. That authority expires this year ? Secretary SNYDER. We are asking for an extension . Representative PATMAN. You are asking for the extension ? Secretary SNYDER. That has only been used in temporary shortterm periods of a few days at a time, and never for any extended periods. It has permitted us to take care of a slight operational deficiency in balances. Representative PATMAN. And only for short-term obligations ? Secretary SNYDER. Only for a very limited time. Representative PATMAN. Senator Flanders has returned , and I will ask him if he has any questions. Senator FLANDERS. Mr. Chairman, I come into this thing fresh because I was absent all day. I did, however, read the Secretary's formal document on the train, and was much interested in his constructive suggestion for sort of a conference group on monetary and debt management policy. One question has been in my mind for some time past, and that has been-let me first say, Secretary, that I am one of those who places very much more trust in monetary and fiscal policies for controlling inflation than I do in direct controls of prices and rationing or particularly of price without rationing. Now, however, I have wondered some as to whether there were limitations on monetary control that would apply, for instance, at a time immediately after the outbreak of the war in Korea, at which time there was universal business and popular sentiment that the thing to do was to buy because the expectation was that prices were going up. Now, I have wondered whether in a broad spread movement of that sort, based on extraordinary happenings, whether monetary controls 66 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT alone would not have to be so drastic in order to control such a situation that they would be almost destructive. It is not like the day-to-day, month-to-month control of small movements by appropriate means, but you meet an emergency, and the question that comes to me is whether that emergency could be controlled by purely monetary means without creating a monetary crisis. Now, you are not responsible for monetary policies specifically in the sense that we feel that the Federal Reserve System is, so I should ask that question primarily of the Federal Reserve Board folks. But let us have a preliminary try-out with you, if you don't mind speaking on it. Secretary SNYDER. Well , of course , I would prefer for the Federal Reserve to address themselves to that subject. But I do have grave reservations in my own mind, as do you, Senator, that in a situation where there is a sudden upheaval of buying or rushing in to do financing of various sorts due to an act such as the outbreak of aggression in Korea-which left us for a considerable time, and even yet, doubtful as to where it is going and what its full impact might be-I think that to try to control a situation of that sort entirely by monetary regulations and procedures could well lead to disastrous results. This is because of the fact that in a spirited buying spree of that sort, controlled largely by the belief that there will be a scarcity of articles, price really is no restraining influence at all-purchasers would pay almost any price to get control of large quantities of articles or commodities. To try to control such a situation by monetary measures alone could well upset the operations that have to be going on in the economy regardless of that impulse of scare-buying, and I do feel that we have to take a very careful view of ever attempting to use strictly monetary measures to control such an occasion- such a condition. Senator FLANDERS . As I said , Mr. Chairman , I am asking that question as one who is convinced of the usefulness of the monetary control, and have placed prime dependence upon it, but I think still we should be concerned with the dangers or difficulties involved in it. Thank you, Mr. Secretary . Secretary SNYDER. Yes. Representative PATMAN. I want to ask you a question or two about the voluntary credit restraint program . Are you on that Board ? I do not believe you are on the committee. Secretary SNYDER. No, sir. Representative PATMAN. I think that is around the Federal Reserve Board. Governor Powell, I think, is in charge of that. Secretary SNYDER. That is correct. Representative PATMAN. I assume we will have Mr. Martin here tomorrow and he can tell us about that. You come in contact with that program ? Secretary SNYDER. Yes. I have been very enthusiastic about it, a very enthusiastic supporter of the program, and I think that in the two instances where we have had a voluntary credit restraint program-back in 1948 and again recently-I think that it has had a degree, an important degree, of influence on the restraint of bank credit. Representative PATMAN. Would you like to ask any further questions , Senator Douglas ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 67 Senator DOUGLAS. No. Representative PATMAN. Mr. Wolcott ? Representative WOLCOTT. That last answer you made, Mr. Secretary, inspires some discussion , and I do not know whether we want to go into it right now, but do you think that the regulation W or regulation X has been a deterrent to increases in the volume and velocity of credit, or has it acted merely to cut down the demand for goods in the lines in which they operate ? Secretary SNYDER. I would have to give you a studied reply on that one. I would be glad to try to prepare something. Representative WOLCOTT. I think I can go along with the idea that it cut down on the demand for goods. Secretary SNYDER. The reply I made was to the voluntary creditcontrol program . Representative WOLCOTT. The voluntary credit ? Secretary SNYDER. Yes, sir. Representative WOLCOTT. I beg your pardon ? Secretary SNYDER. That was the reply I made to it. Representative WOLCOTT. I did not catch the fact that you were talking about voluntary control . Secretary SNYDER. Yes. They asked about Mr. Powell's operation in the Federal Reserve on the voluntary credit control program , and that was what I was addressing my reply to. Representative WOLCOTT. All right. Representative PATMAN . Senator Flanders, do you have any more questions ? Senator FLANDERS . No, thank you. Representative PATMAN. Dr. Murphy, do you have any questions ? Mr. MURPHY. I would just like to ask several questions, Mr. Secretary. They may sound a trifle pedantic, but I think they may serve to clear up one of the matters that was discussed this morning. First, the total amount of debt that has to be placed is determined, is it not, principally by the receipts and expenditures of the Government ? It is a matter over which you have very little control. Secretary SNYDER. It is entirely controlled by that. Mr. MURPHY. And all debt, of course, must be held by someone. You desire under present circumstances that as little of the debt should be held by banks as possible. Secretary SNYDER. We have supported such an idea, both in practice and in theory ; we have attempted to try to get the debt into nonbank hands to the greatest extent possible. Mr. MURPHY. And since the whole debt must be financed, this is primarily a matter of maximizing holdings by nonbank investors. Now, this leads to the question of the means or techniques by which nonbank holdings of Government securities can be maximized . Is it always possible to sell additional amounts of Government securities simply by letting the market , as we will say, seek its own level, or do you feel that under some circumstances maintaining a reasonably stable market will permit you to sell more securities to nonbank investors and have them more firmly placed than you could by simply having Federal Reserve withdraw from the market and letting the market seek its own level ? Secretary SNYDER. Well, as I stated a while ago, Doctor, with the large debt operations that we have to work with the financing of 68 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT refundings and of new money operations—it is vitally important that each issue be successful. Mr. MURPHY. And can the success of these issues in itself be a means in the long immediate run for placing more rather than less securities with nonbank investors ? Secretary SNYDER. I think it could. Mr. MURPHY. By building up their confidence in the securities ? Secretary SNYDER. I think it would. It would give people confidence, whereas a very small issue could affect the whole debt if it were badly received . Mr. MURPHY. The only point I wanted to try to bring out, Mr. Secretary, was that the Federal support of a particular Treasury operation, by preserving confidence in the market, might be a way— and if properly handled would be a way of maximizing nonbank holdings rather than the reverse. Secretary SNYDER. I think so. Mr. MURPHY. That is all. Representative PATMAN. I will ask Dr. Grover W. Ensley, the staff director of the full committee, if he would like to ask any questions. Mr. ENSLEY. Just one, Mr. Secretary. I have been very much impressed with the answers to the subcommittee's questionnaire by the Treasury, as well as the representatives of the Federal Reserve System. I know that you personally spent many hours on this assignment. There must have been a tremendous amount of staff work going into this job. I think it would be interesting for the record to show the process, the method, that you used, as well as the Federal Reserve Board, in the preparation of these answers in such a short time and so elaborately. Undoubtedly you called in outside consultants, and we would like to know who they were, how did they work, and how did you evolve this excellent monograph in response Would you prepare a to the subcommittee's questions so quickly. memorandum on this for our printed record ? Secretary SNYDER. We will be pleased to do that because, as I stated in my opening remarks, we took this study very seriously, and we applied a great deal of time to the answers. For your information , I personally spent many, many hours with the study group over the period of preparation of answers, and we have conscientiously applied every possible source of information that we could gather. We have brought in a great number of outside consultants ; we brought in groups to talk with us on it, and I think it would be very constructive to show the procedure that we followed in trying to arrive at the replies to the questions that were submitted to us. We will be glad to do that. Senator DOUGLAS . Mr. Patman, in view of the questions of Dr. Murphy, I would like to be privileged, if I might, to ask some questions. Representative PATMAN. Certainly, Senator. Senator DOUGLAS. As we all know, last April the Reserve Board adopted the so-called policy of flexible support of the Governmentbond market, rather than absolute or rigid support. Has that policy of flexible support resulted in making it difficult for the Treasury to refund its issues, nonbank holdingsSecretary SNYDER. In the periodSenator DOUGLAS (continuing) . Since April of 1951 ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 69 Secretary SNYDER. We have been able to in the climate in which we have worked Senator DOUGLAS. That was done with only flexible support and with a net decrease in the total volume of Government securities held by the Reserve. Secretary SNYDER. Well , the Reserve holdings are a little higher than a year ago. The pertinent figures on Federal Reserve holdings of Government securities referred to are the following : Million $21, 881 Feb. 28, 1951 . 22, 514 Mar. 6, 1952___. Senator DOUGLAS . But the last figureSecretary SNYDER. It does not make any difference . Senator DOUGLAS. The last figures I saw were $ 300 million lower thanSecretary SNYDER. In June of 1951 , yes. Senator DOUGLAS . Well, if refunding operations since the accord were carried out successfully without any large degree of support from the Federal Reserve, what reason do you have for thinking they could not be carried out successfully prior to the accord without any appreciable degree of support ? Secretary SNYDER. If we could do all of our operations by back sighting, Senator, I think maybe we would be all right. If you are faced with a proposition at a certain time, there are certain unknowns- it falls on you to make a decision, and if we were always able to look backward to make a decisionSenator DOUGLAS . Does this mean that on the basis of hindsight you believe that the Treasury and Reserve policy from Korea until March was wrong ? Secretary SNYDER. No. Senator DOUGLAS. And from date of the accord on it was correct ? Let us Secretary SNYDER. I made no such statements, Senator. stick to what I said. Senator DOUGLAS. Let us go back to the point. If this worked successfully in a period of large refunding, that is, if the Federal Reserve, buying comparatively small quantities of Government bonds did not interfere with the large refunding operation of the Treasury, why could not the same policy have worked before April when your refundings, I think, were not nearly as great as they were later ? Why was it necessary to load the member banks up with $4 billion worth of Reserve dollars ? Secretary SNYDER. I hope that we can avoid any situation like that in the future. Representative PATMAN. Any other questions ? Senator DOUGLAS . The question was not directed to the future but directed to the past. I was trying to keep off the future lest I interfere with the confidential nature of the operations which we may have to carry on, but I thought if the future was barred to us it was at least permissable to analyze the past. Secretary SNYDER. Well, we are speculating and not analyzing when we say wouldn't certain things happen if certain things did happen . We might say today is a nice, pretty day, so, therefore , wasn't 2 weeks ago a pretty day. I just can't go on that theory. We 70 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT have to go back to the conditions which we faced at the time , Senator, when we made certain decisions. Senator DOUGLAS. I remember that the refunding problems of the Treasury were not as great in '50 as they were in '51 , isn't that true ? Secretary SNYDER. They were serious. Senator DOUGLAS. But not as great. You had this terrific volume of refundings in '51 which I believe you did not have in '50 , isn't that correct ? Secretary SNYDER. We had a heavy volume in both years. Senator DOUGLAS. And yet in a more severe situation in '51 than we had in '50 the operation was carried on very successfully without the Federal Reserve buying an appreciable quantity of Government bonds. In fact from June on they actually made net sales of Government bonds, diminishing the volume of securities held by the System. The question naturally comes if the problem was debtwise less severe in 1950, why was it necessary for the Reserve to purchase $4 billion worth of bonds and create billions of reserves upon which a $16 billion credit expansion was ultimately based, with an increase of 16 percent in the wholesale price level and an increase now of 10 percent in the cost of living and an increase in cost to the Federal Government of some $ 10 billion a year ? Secretary SNYDER. We are very pleased with our present relationship with the Treasury, Senator. Senator DOUGLAS . With the Federal Reserve ? Secretary SNYDER. I mean with the Federal Reserve. We are also pleased with our relationship with the Treasury and with this subcommittee. Senator DOUGLAS . Since the future and the past are both closed to us, we can find out nothing about either. I would like to know of what the present consists. Representative PATMAN. Mr. Secretary, we appreciate your attendance and we will feel free to call on you in the future. And of course in our requests we will make it subject to your convenience as much as possible. We appreciate your coming here today and giving us the benefit of your views and the answers to the questions that have been asked you . Thank you very kindly, Mr. Snyder. ( The information previously requested by Mr. Ensley follows :) PREPARATION OF ANSWERS TO QUESTIONNAIRE Submitted by the Subcommittee on General Credit Control and Debt Management of the Joint Committee on the Economic Report Early in August 1951 , the subcommittee submitted a list of questions covering a wide range of matters relating to the management of the public debt and monetary, credit, and fiscal policy, both in this country and abroad. In the course of extensive discussions during August and September this list was revised somewhat and some new questions were added which the Treasury staff thought would help to give a well-rounded presentation of its point of view on the underlying problems. These suggested additions were welcomed by the staff of the subcommittee. I felt that the fullest possible answers should be given to each of the questions, with the objective of providing the subcommittee with adequate basic materials upon which to undertake the comprehensive study which had been assigned to it. With this in mind, I made it clear to Treasury officials that I was prepared to spend as much time as was necessary in the months ahead to shape the answers MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 71 into final form. Furthermore, I instructed the General Counsel to act as official contact with this congressional subcommittee in the same manner as he is the contact with other committees of Congress. I instructed the Director of the Technical Staff, the Fiscal Assistant Secretary, and the General Counsel to detach. from other duties, insofar as possible, such members of their staffs as were necessary to prepare material for the answers to the questionnaire, and to assemble a group of consulting experts, both economic and legal, who could both help us prepare answers to the questions and provide varying points of view with respect to how the questions might be answered. The following consultants were contacted and were brought to the Treasury from time to time between mid-August and late December : Mr. Wesley Lindow, vice president and economist, Irving Trust Co. , New York, N. Y. Dr. G. Lee Bach, director of industrial administration , Carnegie Institute of Technology, Pittsburgh, Pa . Dr. Douglas Anderson Hayes, professor of business administration , Universtiy of Michigan, Ann Arbor, Mich. Mr. Miroslav Kriz, foreign research division , Federal Reserve Bank of New York, New York, N. Y. Dr. Paul W. McCracken, professor of business administration , University of Michigan, Ann Arbor, Mich. Dr. Marcus Nadler, Graduate School of Business Administration, New York University, New York, N. Y. Mr. Joseph J. O'Connell, Jr., Chapman , Bryson, Walsh & O'Connell, Washington, D. C. Dr. Roland I. Robinson, professor of banking, the School of Commerce, Northwestern University, Evanston , Ill . Judge Samuel I. Rosenman, New York, N. Y. Dr. Lawrence H. Seltzer, professor of economics, Wayne University, Detroit, Mich. Dr. Henry C. Wallich, Department of Economics, Yale University, New Haven, Conn. These men have had a wide range of experience in matters relating to debt management, monetary, credit, and fiscal policy. One was a former General Counsel of the Treasury, two were former Assistant Directors of the Treasury's Technical Staff, two were former members of the Research Staff of the Board of Governors of the Federal Reserve System, one was a former member and another a current member of the research staff of the Federal Reserve Bank of New York, one was a former member of the research staff of the Federal Reserve Bank of Minneapolis, and one was former counsel to the President of the United States. In the aggregate, they represented great technical ability and various points of view. They provided us with a great deal of help- both in Washington and at their home locations-and contributed many useful ideas and suggestions , many of which were worked into the final answers. A number of the questions dealt directly with general material on the subject of public debt management and monetary, credit and fiscal policy, and drafts of the answers to these questions were prepared initially by the consulting experts. In many cases, two or more answers were prepared in order to obtain a variety of ideas. Answers to some of the other questions, particularly those relating exclusively to Treasury operations and techniques, were prepared by officials dealing with these matters most closely. I met frequently in my office and in the Treasury conference room with the Treasury people and the consultants preparing the answers . Meetings generally ran from 1 to 2 hours, and there were about 25 of them during the course of the project. Each question was taken up on several occasions ; drafts of answers were discussed thoroughly ; competing points of views were analyzed ; and agreed-upon presentations were then developed, sometimes by Treasury staff members and sometimes by our consultants . After each answer had reached a semifinal stage, it was circulated to all members of the Treasury staff concerned for comment and was mailed to each consultant at his home location , where he went over it and submitted suggestions or alternative wordings for particular paragraphs or sentences . It was also sent to a number of outside people who had a great deal of experience in the debt management and fiscal-monetary field . Among these were the following, two of whom were former Under Secretaries of the Treasury : 72 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. Daniel W. Bell, president, American Security & Trust Co. , Washington, D. C. Dr. Harold Stonier, executive manager, American Bankers Association, New York, N. Y. Mr. A. L. M. Wiggins, chairman of boards of the Atlantic Coast Line Railroads and the Louisville & Nashville Railroad , Hartsville, S. C. The suggestion made by all people reviewing the draft answers were gone over by members of the Treasury's technical staff, who acted as the final coordinating group to revise the answers and incorporate the necessary adjustments. This procedure continued during the last part of August, September, October, and November. Late in November, I attended a NATO conference in Rome ; and the staff airmailed to me a set of revised answers to all questions which had been prepared up to that time. On my return trip I spent many hours aboard ship going over each answer carefully, making suggestions and changes where I felt it necessary . At this point, copies of our answers were sent to the Council of Economic Advisers and to the Board of Governors of the Federal Reserve System for their comment. Suggestions from these agencies were taken up by the staff in January and worked into the answers wherever possible. During January and in early February, I spent many hours with Treasury staff people, going over the answers in final form . The materials were carefully checked both in final draft and in galley proof and page proof ; and, where necessary, records were brought together and special files established to completely document the answers to some of the questions. Representative PATMAN. The committee will stand adjourned until 10 o'clock tomorrow at the same place. (Whereupon, at 3:50 p. m., the committee adjourned, to reconvene at 10 a. m., Thursday, March 11, 1952. ) MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT TUESDAY , MARCH 11 , 1952 CONGRESS OF THE UNITED STATES, SUBCOMMITTEE ON GENERAL CREDIT CONTROL, AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met , pursuant to recess, at 10 a. m., in room 318, Senate Office Building, Representative Wright Patman ( chairman of the subcommittee ) presiding. Present : Representative Patman ; Senators Douglas and Flanders ; Representatives Bolling and Wolcott. Also present : Grover W. Ensley, staff director ; Henry Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee. Representative PATMAN. The committee will please come to order. Senator Flanders, did you have a statement to make ? Senator FLANDERS . No ; I just wish to suggest that this present occasion reminds me of a passage in the Scriptures of the parable of the man out of whom seven devils were cast, leaving his interior swept and garnished , whereupon seven other devils saw the opportunity and moved in. We had one group yesterday and have another group today and I thought, perhaps, that that passage in the Scriptures might be appropriate. [Laughter. ] Representative PATMAN. You are calling them all devils ? Senator FLANDERS. Well, they are guilty until they are proved innocent. [ Laughter. ] Representative PATMAN. We have with us this morning Mr. Martin, Chairman of the Board of Governors of the Federal Reserve System. You have a prepared statement, I believe, Mr. Martin ? STATEMENT OF WILLIAM MCC. MARTIN, JR., CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. MARTIN. I have, Mr. Chairman . Representative PATMAN. Would you like to present your prepared statement before yielding to questions ? Mr. MARTIN. If it is agreeable to you, Mr. Chairman, I would. Representative PATMAN. It would be satisfactory to us. 1 Mr. MARTIN. Mr. Chairman and members of the committee, in coming before you today I should like to express what I know has 73 74 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT been in the minds of all of us in the Federal Reserve System in preparing the answers to your questionnaire. We have welcomed this opportunity to put down on paper our concepts of what our function is in the governmental structure and in the economy. You give us a heavy load of homework and we have all profited by it. I know that for me it has been more than a refresher course-it has been a liberal education in what I prefer to call reserve banking, rather than central banking operations. The task of preparing answers to the comprehensive and searching questions has been formidable and I will not pretend that I approached it without some reluctance . Now that the task is done and the results are published I realize how worth while has been the time and effort expended not only by those of us in the System but by the many others to whom you addressed questionnaires. Irrespective of the conclusions you may reach as a committee , you have assembled a body of information that I think will prove to be invaluable for a long time to all who are interested in the special problems of general credit control and debt management. Beyond that, however, we have all genuinely welcomed this inquiry. The Federal Reserve System is a servant of the Congress and , through you, of the people of the United States. You created it , you can abolish or change it . Our task is to carry out your will and it is our duty to lay before you all the facts at our command for which you ask and to give you our best judgment on these important matters . We are glad of the opportunity to make any contribution we can to the improvement of this reserve banking mechanism. Like all human institutions, it is not perfect or infallible. In the nearly four decades of its existence, the System has undoubtedly made mistakes. It has also learned from experience. One of the fundamental purposes of the Federal Reserve Act is to protect the value of the dollar. Yet that value today in terms of purchasing power is less than half of years of what it was when the System was founded . In this span of the country has engaged in two World Wars and is now in the throes of what might be called an undeclared war. With the vast economic changes brought about by military and security needs, monetary policy by itself cannot maintain economic stability and preserve unchanged the purchasing power of the dollar. Even aside from these disturbances, it is probably fair to say that monetary policy has not always been as timely or as effective as it could have been. Your first concern , I take it, is to look at the record of the past principally for the light it can throw on the road ahead. We are trying to look forward, as you are. In his first inaugural address as President, Woodrow Wilson included a statement, part of which is inscribed in the lobby of the Federal Reserve Building : We shall deal with our economic systemhe saidas it is and as it may be modified, not as it might be if we had a clean sheet of paper to write upon ; and step by step we shall make it what it should be, in the spirit of those who question their own wisdom and seek counsel and knowledge, not shallow self-satisfaction or the excitment of excursions whither they cannot tell. I am sure it is the purpose of this inquiry, as it is of all of us, to appraise judicially this reserve banking mechanism and to do whatever appears wise so that it may render the best possible public service. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 75 The Federal Reserve System and the Federal Reserve banks sometimes are referred to as bankers' banks, but that describes only a part of their functions . The various services which the Reserve banks perform for the banking community, such as supplying currency, transferring funds, and collecting checks, have proved to be an essential element in keeping the mechanics of modern-day commercial banking in step with the financial needs of a growing and changing private enterprise economy. The overriding purpose of this Reserve System is to serve the interests of the general public in business, industry, labor, agriculture, and all walks of life . As I understand the intent of this inquiry and of these hearings, it is to explore how that interest of the public can best be served in the area of general credit control and debt management on which the activities of the Federal Reserve System have so important a bearing. The approach to this broad subject by the members of this committee and of the Banking and Currency Committees and those of use to whom you entrust the duty of carrying out your wishes must be in the spirit to which President Wilson referred. We must always question our own wisdom and seek counsel and knowledge. Considering that money is one of the most controversial of all subjects, it is rather remarkable that the replies elicited by your questionaire reveal so little fundamental divergence. Honest judgments may differ as to whether the Reserve System, for example, has done its job well or poorly. There are bound to be differences of opinion concerning the structure and internal operations of the System but essentially I find very little difference in all the replies on fundamentals. There is a general recognition of the need for a mechanism of this kind to perform substantially the functions and to render the services that this System now furnishes. If the Congress were to do away with the present system some other way would have to be found to perform its function and to play its role in the economy. Basically, the job of the Federal Reserve System is that of monetary management-to increase the money supply and make it more easily available when there is evidence of weakness in the economy and to reduce the volume of money and make it less easily available when indications show that there is excessive expansion. In other -words, it is the business of monetary management to contribute to the broad objectives of steady economic progress which is the ultimate goal of all national policy. The instruments by which these broad purposes of monetary management are achieved are dealt with in detail in the answers to your questionnaire. How and when and why these instruments have been used is likewise set forth at some length. You will have to judge how wisely or unwisely they have been used in the revealing light of hindsight. You have to judge whether these instruments can be improved, or others provided . We have called attention to some of the various problems for which, perhaps, better answers can be found but we are not, as you may have noted, recommending any broad or sweeping changes. The test that, I have no doubt, you will apply is whether the public interest is well served. I think that, generally speaking , it has been well served by the System. The System is a unique concept, an ingenious merging of public and private interests in a characteristically democratic institution. The 97308-52-6 76 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT doctrine of the separation of powers, as Mr. Justice Brandeis once pointed out, was adopted "not to promote efficiency but to preclude the exercise of arbitrary power." The purpose was "not to avoid friction, but by means of the inevitable friction incident to the distribution of the Government powers among three departments, to save the people from autocracy. " Doubtless this reserve banking mechanism could be more efficiently devised or differently organized in the governmental structure but it would be at the cost, I think, of something far more important. In any case, such an institution will in the last analysis render good or bad public service depending upon the abilities of the human beings engaged in its operation rather than upon its organizational form and structure. And by the same token, the resolution of difficult problems and of conflicts of opinion must come out of the minds of men and not from the forms in which they chance to be organized. I have sought to indicate in a general way the attitude with which we have approached this important inquiry into the public's business as discharged by the Federal Reserve System. We have looked at this System, not as if we had a clean sheet of paper to write upon, but in the light of the concepts on which it was based and its performance over the years. We have tried to be honest with you and honest with ourselves . Certainly we have nothing to withhold or conceal . The record is an open book. We have sought to make clear that monetary policy cannot, by itself, achieve stable economic progress but that it is an indispensable means to that end. It must go hand in hand with fiscal policy and debt management . We have tried also to spell out as plainly as we can the meaning of the accord which we reached with the Treasury last March, in which you are naturally interested . Its achievement illustrates the point which I mentioned before that the solution of difficult problems and the reconciliation of differing viewpoints depends upon the ability of men to come to a meeting of minds in the best interest of the public rather than upon the forms of institutional organization . That accord was not a transitory or empty gesture. It is a reality under which debt management and monetary policy are moving together toward the same objectives with mutual understanding and meeting of minds. May I add that I concur fully in your chairman's confident prediction that the fundamental issues with which the committee is concerned "will be found vastly too complex to permit of facile generalization." I think it may prove useful to the members of the committee for me to present a summary which I have prepared of our replies to your questionnaire. This summary presents, first, the major points of reserve banking philosophy developed in the answers, second, some of the more important positions taken on the issues raised , and, third, several general points as to changes in banking structure and as to foreign monetary organization and experience. Each reply submitted undertakes to deal with the question asked on its own merits and to provide a direct, objective, and comprehensive answer. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 77 RESERVE BANKING PHILOSOPHY The following views are expressed with respect to the role of credit and monetary policy and the organization within the Government for such policy. 1. Flexible credit and monetary policy, together with flexible debt management policy and an adequate fiscal program, is essential to economic stability. 2. The established relationship of the Federal Reserve Board of Governors to other branches of the Government is consistent with and adequate for the function which the Reserve System performs. 3. The status of the Board as an independent establishment of the Government is sound on the basis of accepted principles of democratic governmental organization, regardless of any theoretical question as to the branch of the Government in which it falls. 4. Changes in money market conditions and in interest rates reflect the interplay of basic forces of supply and demand for short- and longterm credit. Supply is made up of new individual and corporate savings, accumulated cash balances offered for investment, repayments on past loans, and credit expansion by the commercial banking system. Demands from business enterprises, farmers, consumers, State, local, and foreign governments , and the Federal Government form the major components of credit demand. 5. Credit and monetary policy operates primarily through its effects on the availability and supply of credit ; it cuts out of the market or brings into it fringe credit demands. 6. In this process, credit and monetary policy affects, but does not determine, interest rates in the market. Interest rates are prices which perfom vital economic functions and they should be responsive to basic supply and demand conditions. In a rich, high savings economy with well integrated financial markets, significant changes in the availability of credit, and hence in the volume of spending, need be accompanied by only small changes in the cost of money. 7. On balance, the System, through its support of Government security prices, accentuated postwar inflationary pressures. 8. In early postwar years, the System favored and defended a support program as a part of transitional adjustment and sought other means of restraining inflationary credit expansion . This policy took account of the need for time to develop a debt-management program that would lodge a greater proportion of the public debt permanently in the hands of nonbank investors. As time passed and the System's support policy led to increasing monetization of the public debt, the Federal Reserve became more and more concerned about the contribution of its operations to inflationary pressures. 9. More flexible credit and monetary policies, applied through the discount and open market mechanism within the framework of an orderly Government securities market, have demonstrated their effectiveness since they were undertaken in March of 1951 . 10. In addition to measures affecting credit generally, flexible credit and monetary policy includes the use, in occasion, of selective credit regulations relating to stock market, consumer, and real estate credit-as well as voluntary measures. 78 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 11. Credit and monetary policy cannot be fully effective without public understanding and support. The System strives to keep the public fully informed on all credit and monetary developments . MAJOR POSITIONS Of the specific positions brought out in the answers to different questions, the following are the more important : 1. The Federal Reserve Board is subject to the Employment Act of 1946. Fairly interpreted , the congressional directive stated in this act implies a goal of monetary stability and needs no modification. 2. Existing Congressional directives to the Federal Reserve System afford a broad workable guide for policies and operations. 3. The status of the Board as an independent establishment of the Government, subject to the direction and scrutiny of the Congress, should be preserved . Budgetary discretion is essential to maintain the basic character of the Reserve System. 4. No legislation is required with respect to the organizational relationship between the Treasury and the Federal Reserve or the Executive and the Federal Reserve. 5. Advantages of the existing regional status and organization of the 12 Federal Reserve banks far outweigh disadvantages. 6. Considering the functions in Government of the Federal Reserve Board, a board type of organization may be preferable to a single governor type. The weight of advantage may lie, however, with a smaller size board- say, five men. 7. No substantial gain in efficiency of Federal Reserve decisionmaking would be likely from centralizing the authority for all credit instruments in one body, the Board or the Federal Open Market Committee. 8. Member bank borrowing at the Federal Reserve should be the principal means of obtaining additional bank reserves. Discount rate changes and open market operations should be the main instruments through which credit and monetary policies are adapted to changing conditions in the economy. This means increased use of the discount mechanism , increased importance of discount rates in comparision with credit policy experience of the past decade, and reliance on open market operations to reinforce discount policy. 9. The present organization for the execution of open-market operations is designed to protect the public interest. The Federal Open Market Committee is constantly studying this organization with a view to making adaptations which will improve it. 10. Open-market operations should be conducted impersonally without resort to moral suasion. 11. Only in exceptional circumstances should use be made of authority to change reserve requirements, which is a blunt and inflexible instrument . 12. The existing structure of reserve requirements could be modernized in some respects for purposes of more efficient and equitable administration . Also, standard legal reserve requirements could be applied to all banks without raising the question of the dual banking system, the preservation of which the Board favors. This is not an urgent problem at the present time, however. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 79 13. Extension of selective credit regulation to areas other than stock market, consumer, and real - estate credit is not feasible. Further experience with regulation in both the consumer and the real- estate credit areas is needed to determine their role on a long-run basis. 14. With effectiveness of discount policy and open-market operations reestablished , disadvantages of supplementary reserve proposals outweigh advantages . 15. Direct control or rationing of bank credit by the Federal Reserve or any Government agency should not be resorted to except in an extreme emergency. Several general points in the replies are of interest. These include : 1. Generally speaking, the banking system has kept pace with both the growing and changing credit needs of the different segments of the economy. Today business, agriculture, and consumers are more adequately supplied with banking services of various kinds than they were 25 years ago. 2. Commercial banks are meeting short- and intermediate-term credit needs of smal businesses reasonably satisfactorily. Provision of special long-term credit assistance in this area, such as would be authorized by bills introduced in recent years, namely, Government guarantee of loans made by private financing institutions or the establishment of special investment companies, would be untimely in an inflationary period . 3. Foreign experience with central banking and monetary policy does not yield lessons that are directly applicable to the United States . The following foreign developments are nevertheless suggestive : ( a ) It has been widely recognized , at least in the countries of the free world, that the central bank should have a large measure of independence within the governmental structure . (b ) In a number of foreign countries, postwar credit policy was first operated mainly through selective regulations, but subsequently such regulations have been supplemented or replaced by measures of general credit policy, such as reserve requirements and discount- rate changes. That finishes my prepared statement, Mr. Chairman . Representative PATMAN. Senator Flanders , would you like to ask some questions ? Senator FLANDERS . Yes. Mr. Martin, on page 2 of your remarks you state : One of the fundamental purposes of the Federal Reserve Act is to protect the value of the dollar. Now, is that specifically stated in the original legislation setting up the Federal Reserve System ? Mr. MARTIN. No , sir. It is not explicitly stated in the legislation , but it is inherent in the entire legislative history of the act and in the surrounding circumstances. Senator FLANDERS . Has it ever been in legislation, early or late, specifically stated as a fundamental purpose ? Mr. MARTIN . I do not think it has ever been stated explicitly in legislation. Senator FLANDERS. What you are saying then, is that it is implicit, and that if it is not taken into account the Federal Reserve Act cannot 80 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT be satisfactorily administered in the explicit purposes for which it was set up ? Mr. MARTIN. That is correct. Senator FLANDERS . On the same page 2 , down toward the end of the central paragraph, I see what you have stated more than once in the course of your two documents here, that— Monetary policy by itself cannot maintain economic stability and preserve unchanged the purchasing power of the dollar. I asked Secretary Snyder yesterday whether in such extreme cases as a general conviction on the part of both the business interests and the consumers of the country that prices were going to rise which, therefore, generated a broad- spread purchasing program, whether monetary policy alone could have kept it in control. I spoke, of course, as a specific example, of the buying wave which succeeded the opening of the troubles in Korea . Do you think monetary policy alone could have kept that under control ? Mr. MARTIN. No, sir ; I do not think monetary policy alone could have, but I do think that monetary policy was an indispensable part of any program of control. I think that we tend sometimes to exaggerate the role of monetary policy and at other times to underestimate the role of monetary policy. I think it can substantially lessen a buying wave such as occurred in the post-Korean period by gradually reducing the available supply of money . Now, that takes some time. There are psychological factors that enter into it, and if the push is very heavy, it takes a little time before you bring the push to a halt. Senator FLANDERS . Looking back on that period in retrospect you certainly would have, I take it, applied monetary measures quite definitely and quite strongly. Do I get from what you have said that you would not have expected them to be immediately and totally effective ? Mr. MARTIN. I do not think any one policy could have been immediately or totally effective. I think that when you get into a period of semihysteria, such as followed after Korea, that about all you can do is use all the weapons in your arsenal to check the inflationary pressures ; that is why we had selective credit controls, along with the monetary controls, and why we engaged in all the other activities of Government, including the voluntary credit restraint program. Senator FLANDERS . Yet you feel that those other things were applied early enough or were they applied a little bit later than they should have been ? Mr. MARTIN. Well, in retrospectSenator FLANDERS . Ideally ? Mr. MARTIN. Ideally, I think, they were applied later than they should have been, but that is hindsight, andSenator FLANDERS . Yes. Mr. MARTIN ( continuing) . I would say definitely in retrospect I think that we could have all of us in every endeavor acted a little bit more wisely if we had been prompter in seeing the dangers that lay ahead. However, we also had to recognize that we had a changing situation which could, for example, have developed into a Dunkirk in Korea, to MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 81 take the extreme case, and that we did not want to do anything that would hamper unduly the mobilization effort which was just coming into being. It was an extremely difficult period to pass judgment on. Senator FLANDERS . Are you implying from that that if we had been drastic with monetary policy we might have done more damage than good to the situation -that is, if we had shut off the supply of new money and new credit so drastically that the wave of buying was checked ? Would we have done damage to the productive activity of the country ? Mr. MARTIN. I think it is possible that we might have, and that was one of the considerations for not acting too drastically at the time. Senator FLANDERS. Going back just a moment to the point that a fundamental purpose is protecting the value of the dollar, has that ever been expressed in any legislative directives that have been given to the Federal Reserve Board ? Mr. MARTIN. I really do not know. It is implicit in the Employment Act of 1946, but there again it is not a direct statement. Senator FLANDERS . That Employment Act, as I remember it, does not mention the Federal Reserve System directly. Mr. MARTIN. No , sir. Senator FLANDERS . But as a branch of the Government it implies that that must be taken into account ? Mr. MARTIN. And I am accepting the Employment Act of 1946 as national policy and being applicable to the Federal Reserve System . Senator FLANDERS . Yes. Again on page 6 of your statement in the second full paragraph you say : We have sought to make clear that monetary policy cannot, by itself, achieve stable economic progress but that it is an indispensable means to that end. You say that monetary policy cannot by itself do the job of maintaining the purchasing power of the dollar, so that your position seems to be clear on that in this document. Mr. MARTIN. That is correct, sir. Senator FLANDERS. In your summary of your replies on page 3 you speak of a need for more flexible credit and monetary policies applied through the discount and open market mechanism within the framework of an orderly Government securities market ; and at a later point you speak of the increased importance of discount rates in comparison with credit policy experience of the past decade, and reliance on open market operations. Do I understand from that that the Reserve System is giving renewed emphasis to the discount function and that it has had some measure of success in reviving that part of the Reserve bank operations, or is that a hope, a purpose, or is it something that is actually under way ? Mr. MARTIN. No, that is something that we think is actually under way under the accord that we have with the Treasury . We have been operating extremely satisfactorily, and relations have been steadily improving between the staff of the Treasury and the staff of the Federal Reserve Board . Under the accord we endeavored to free the market without letting it become a disorderly market, and to permit the short -term rate that had been previously more or less pegged to adjust around the discount rate, which had been previously increased to 134 percent. That was a part of the understanding. At one point 82 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT near the end of this current year we had discounts get up to nearly a billion dollar level for the first time in a long time. Now, that was a temporary situation. Right now we are worried because some borrowing by the banks through the discount operation , we fear, is for excess profits tax purposes and we do not want that to happen. But we are seeing the gradual restoration of more normal market conditions instead of a market that for a long time was pretty stagnant and entirely dependent on the peg. Senator FLANDERS. What type of collateral is involved in this expanded rediscount market operation ? Mr. MARTIN . Almost entirely Government securities. Senator FLANDERS. There has been no particular increase in the discount of commercial paper ? Mr. MARTIN . There has been very little discounting of commercial paper or other types of loans with the Federal Reserve banks ; most borrowings from the Federal Reserve banks have been on Government securities as collateral . We used to have quite a few bankers' acceptances. I would like to see the bankers' acceptances market redeveloped , but it has been practically dormant for some time. I hope it will come back into being. Senator FLANDERS . Just one other group of elementary questions for the sake of having them in the record. It seems really silly to ask them, but I am going to ask them just the same. When the Treasury sells bonds to the bank, that increases or decreases the available money supply ? Mr. MARTIN. That increases the available money supply. Senator FLANDERS . All right. When the Treasury retires bonds held by the banks that decreases the money supply ? Mr. MARTIN . Decreases . Senator FLANDERS. When the Federal Reserve System buys Government bonds from the banks, what does that do to the money supply ? Mr. MARTIN. That increases the reserves of the member banks which, in turn, increases the money supply if they lend the money. Senator FLANDERS . So when the Government buys, that is, retires its bonds it decreases the money supply. When the Federal Reserve bank buys bonds from the commercial banks it increases the basis for credit, and so tends to increase the money supply. Mr. MARTIN. It is a creative process. Senator FLANDERS. Yes. And the reverse, of course, is true, when the banks sell, when the Reserve System sells bonds. I just put that into the record because it seemed to be a little bit mysterious that the Government selling should do the opposite thing from the Federal Reserve banks' selling in its effect on the money supply, so I just wanted that stated in the record . Mr. MARTIN . Yes. Senator FLANDERS . That is all, Mr. Chairman. Representative PATMAN. Mr. Bolling ? Representative BOLLING. Mr. Martin, yesterday in the colloquy between Senator Douglas and Secretary Snyder, after describing the activities of the Federal Reserve in the post-Korean period , and then putting into the record what happened in the expansion of credit, MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 83 Senator Douglas said , in speaking of the inflationary impact of the increase of the money supply : Well, was it not an important reason and the important reason, the increase, the support efforts of the Federal Reserve on the inflationary situation ? I would like to discuss that in the light of your own statement and in the light of some figures taken from the chart in part I, which includes your reply, the chart which begins on page 216, and details in brief form the actions of the Federal Reserve System since its inception , and in relation to some figures that have to do with the consumer's price index over two periods of years. I believe my figures are correct, but they could easily be corrected if they are not. In this chart you indicate that in a period 1942 to 1945 the Federal Reserve increased its holding of Government securities by $22 billion, bills $12.8 billion, certificates $8.4 billion, and notes $1.3 billion. You say that bond holdings decreased $500 million . I am not in a position to use exactly comparable figures, and , therefore, the comparison may not be completely fair, but I note that the monthly average of consumer's prices for 1943 - I do not have the 1942 figure was 123.7, and for 1945 128.6 , an increase of 4.9 in a period roughly the same period when the Federal Reserve increased its holdings of Government securities by 22 points. Then, in the period from January 1946 to August 1950, again from your chart it appears that the Federal Reserve reduced its holdings by a net of 5.9 billion. In that same period from 1945 to June, I have, of 1950, the consumer's price index went from 128.6 to 170.2 , which is a rise of about 42. I am sure my point is clear, it appears on the surface that during a period when large increases of Federal holdings existed that the consumer price index moved much more slowly than it did in a period where the exact reverse process was taking place in the holdings by the Federal Reserve ; they were reducing them, and yet the inflation , as indicated by consumer prices-that may not be the fairest waywas going at a greater rapidity. Mr. MARTIN. Well, you have just illustrated the difficulty of attributing to any one factor the shifts in prices. Now, since the Treasury- Federal accord there has been an increase in the volume of bank credit of a substantial amount. There would have been, in my judgment, a whole lot larger increase in that bank credit if it had not been for the Treasury- Federal accord, and we did not add reserves to the market during that period . Nevertheless, you have got to take care of the needs of essential financing. Now, the period you are talking about is a difficult one because it was a period of war and postwar readjustment. During the war, we created a lot of money and we sold a lot of Government securities to the public. Prices were held down by rationing, allocations, price controls, and voluntary savings by the people to help win the war. At the end of the war, the economy was extremely liquid . Because of the large volume of monetary resources created to finance the war, we had a condition of suppressed inflation . Then , when we removed wartime controls, inflationary forces took effect. After the immediate postwar transition inflation , we had still more inflation , and further 84 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT credit and monetary expansion contributed to the additional price advances. There is no way of blinking at that record . While it might be good tactics for me to say that there was no war or postwar inflation at all and that the Government including the Treasury and the Federal handled everything perfectly-I am not saying that. If you will notice in my statement, we at the Federal assume some of the responsibility. I think the Treasury and the Federal have a mutual responsibility for dealing with the inflation problem. And I want to say that no man has labored harder than has Secretary Snyder to meet the postwar inflation problem through fiscal action involving higher taxes. Another aspect of the problem , and it has many aspects, is that of debt management policy. We had to deal with the debt structure as it was at the end of the war ; we didn't have a clean sheet of paper, to go back to my earlier illustration . There were many suggestions for revising the schedules and maturities of Government securities and for shifting the debt held by the banks to nonbank investors . It was a very complex financing situation. No one has labored harder to improve that situation than Secretary Snyder. And I want to add that when I first went into the Treasury I had a whole lot of ideas about how I would change the thing overnight ; I revised my ideas when I saw the difficulties that were there. At one point, the Federal Reserve Board advocated , and I personally rather subscribed to , the idea of a supplementary reserve requirement for banks to be held in short-term Government securities. Because we had a balanced budget, even a budget surplus, and were trying to find some way of redistributing the undigested debt in the economy while restraining monetization of the debt at the same time, the supplementary reserve appeared quite a reasonable way to approach it . Now, recently I have veered away from the idea of such a supplementary reserve requirement. I have done this because, as we approach a deficit I do not want it to appear that the Federal and the Treasury. are using a supplementary reserve device as a method of compelling the banks to finance the deficit . I believe that we ought to finance this deficit in a noninflationary way by attracting the savings of nonbank investors into Government securities . The Treasury and the Federal are now working persistently on the steps necessary to accomplish this. Representative BOLLING. In line with that statement and the statement in your formal presentation, and your replies to Senator Flanders, I gather that it would be safe to say that you do not agree with an excerpt from a statement which appears in the hearings of the January 1951 Economic Report held by the joint committee from the statement by a group of economists entitled "The Failure of the Present Monetary Policy." The statement I have in mind, having reference to the immediate post-Korean period, is : "Indeed, prices would probably be today a little above their level in May if the Federal Reserve System had kept its holdings of Government securities unchanged instead of adding to them by 3.5 billion dollars." Mr. MARTIN. That is a judgment ; I personally would not completely concur in that judgment . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 85 Representative BOLLING. So that, in effect, in your mind, monetary policies are a very important aspect of the whole problem, not the important factor. Mr. MARTIN. That is right. Representative BOLLING. In the question of timing, I know it must be extremely difficult to make a generalization in reply to this kind of a question, but how long ordinarily would it be necessary for an action in the monetary field to have an effect ? I am speaking specifically to point 9 on page 3, where you say : More flexible credit and monetary policy applied to the discount and open market mechanism within the framework of an orderly Government securities market have demonstrated their effectiveness since they were undertaken in March of 1951 . I would like you to answer the general question in the light of that. Mr. MARTIN. I do not think you can give a categorical answer to that, but I would say, on the basis of the record, that whatever you attribute the forces to , it did not take very long at that time before there was some evidence . I am not one who claims for the Treasury-Federal accord all of the credit for restraining inflation since April 1951. But I do think that it was certainly one of the important factors because it made people stop, look, and listen all across the country as they saw the market forces once again come into play. Now, as regards time measurement, if you are a real enthusiast for monetary policy, you might say that the mortgage market dropped out of bed within X weeks. However, I do not think that you can measure effects so precisely in the kind of dynamic economy that we have today. Representative BOLLING. What are the other factors involved in your opinion, in this effect, not in detail, but in general ? Mr. MARTIN. Well, let us take the Treasury-Federal accord as an example. There is a limit to a buying binge in the sense that you reach a point where people have pretty well become overinventoried and overstocked. There is a diminution of enthusiasm for storing up for shortages . Then, there are subsidiary programs such as the impact of higher taxes, the increasing effectiveness of our selective credit controls, materials allocations, and our voluntary credit restraint program which came into effect about that time and attempted to postpone the financing of certain deferrable activities. I claim for the Treasury-Federal Reserve accord only that it was the spark which ignited a lot of powder that had been accumulating around that period and, therefore, was one of the elements along with fiscal action, selective controls, and other measures, as well as the constant awareness and alertness of public psychology to the programs we were facing. It was one of the elements that contributed to resolving the difficulty that we were then in in the business expansion field without undermining the drive to make progress on necessary defense work. Representative BOLLING. Mr. Martin, you probably are aware that I was not a member of the subcommittee which Senator Douglas chaired on monetary credit and fiscal policies. All other members of 86 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT this committee were, and this may not be an appropriate question . you do not wish to answer it, it is all right with me. On page 2 of this report there is stated : If It is the will of Congress that the primary power and responsibility for regulating the supply, availability, and cost of credit, in general, shall be vested. in the duly constituted authority of the Federal Reserve System, and the Treasury actions relative to money, credit and transactions in the Federal debt shall be made consistent with the policies of the Federal Reserve. Just as the words say, it appears to indicate that the policy of the Executive could be, in effect, if that were carried into execution , made subordinate to that of the Federal Reserve, and I would like to have your thinking on that particular recommendation. Mr. MARTIN. Well, the difficulty I find in the recommendation is that I have never been able to resolve in my own mind the line between debt management and monetary and credit control policies. I do not think you should subordinate the Treasury to the Federal Reserve or the Federal to the Terasury. I think that they have both got to be equals in approaching this problem from their respective responsibilities, one in debt management and the other in credit and monetary control ; you have got to have a merging of the thinking with respect to both to achieve a worth-while result. The nature of the problems that we are discussing here is not such that judgments on them can be precise . Their solution requires some experimentation, some probing, some accommodation of views . No one can be sufficiently arrogant intellectually to think that he can give an exact answer to any of them. It reminds me a little bit of when I was working in the foreign field, and I had a fellow for 5 years that would come to me and say : "Well, now, we have the problem of the British-held sterling balances, and we are going to have a meeting on Friday afternoon and settle that. " We have been meeting on this problem now for 5 years, and it is still a problem that is going to continue to be with us for a long time. I think you can only make progress over time on a complex and difficult problem. I think we are making progress on our credit and monetary and debt management problems at the present time. The Treasury and the Federal are working very hard today to accommodate the legitimate interests of both for the benefit of the people. Constructive public policy in the financial field is something that can come only from long, torturous, persistent, humble study. Representative BOLLING. One other thing, Mr. Martin : The Secretary of the Treasury yesterday in his statement suggested an advisory council. I would like to have your comment on that. Mr. MARTIN. No ; I did not comment on that, but I have read the Secretary's statement. Knowing Secretary Snyder, I appreciate the spirit in which the suggestion is offered. It is one of desiring to get beforehand as much information, intelligence , and judgment as possible on very difficult problems. But I have to confess to some uneasiness as I subject the proposal to analysis. It is difficult enough, as it is, with the New York Federal Reserve Bank as the operator or agent for the Open Market Committee, and an open market committee of 12 men, and the Treasury with its staff, to sit down and resolve some of these problems . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 87 Now, we are always glad to have advice from anyone and everyone, but at some point the power of decision must be encountered and be effective. I take it that his proposal is for a nonstatutory body on a semi- informal basis, although it is not worded quite that way. I would call your attention to the fact that the Federal Reserve has a judicial function to perform. We have been called the supreme court of finance and I do not want to overstress that. But it is the judicial judgment of the Federal Reserve with respect to its particular province which warrants our independence, and which has been in the thinking of all foreign governments in modern economics and of our own Government from the beginning of the System's existence. To maintain this position of judicial judgment is the problem in political science of the relationship of the central bank to the Treasury. I express my reservations about the advisory council quite respectfully because I know the spirit in which Secretary Snyder has presented this proposal . He has an honest desire to solve the problem. I would not want to see this council confined to just debt management and monetary and credit control. It ought to be quite considerably broader than that, and we ought to be very careful that the advisory function does not merge with the power of decision. Otherwise we will not be more effective in our operations but less effective, because it is difficult enough today to arrive at some of these decisions. Representative BOLLING. Putting it another way, do you feel that in the present state of affairs in the present state of statutes, that it is possible that the problems which you and the Treasury confront, in effect together, to be solved without changes in statute, changes in relationship , changes in organization ? Mr. MARTIN. I do , sir. Representative BOLLING. That is all. Representative PATMAN. Senator Douglas ? Senator DOUGLAS . Mr. Martin, my first question, in a sense, will cover ground that Senator Flanders referred to . Í merely want to bring it up in order that we may have a factual basis on which we may proceed. When the Open Market Committee buys Government bonds, how are these bonds paid for ? Mr. MARTIN. They are paid for by a check, by deposit. Senator DOUGLAS . You mean that the banks , the Federal Reserve banks, create creditMr. MARTIN. That is right, sir. Senator DOUGLAS (continuing ) . With which they buy Government bonds from private parties. Mr. MARTIN. That is right , sir. Senator DOUGLAS. What happens to these checks which the Federal draws from a created credit account ? What happens to those checks ? Mr. MARTIN. They go into the reserve account. Senator DOUGLAS. Yes ; that is the second step . What is the first step ? They are given to the holders of securities ; is that true ? Mr. MARTIN. That is right . Senator DOUGLAS. Then they are presented through member banks to the Federal Reserve System ; is that not true ? Mr. MARTIN. That is right . Senator DOUGLAS . When they are deposited in the Federal Reserve System, how are they set up as a credit? 88 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. MARTIN. To the reserve account of the bank, of the depositing bank. Senator DOUGLAS. Does this increase the lending capacity of the banks ? Mr. MARTIN. Under our present fractional reserve system by about a 6-to-1 ratio. Senator DOUGLAS. The average reserve is— Mr. MARTIN. Assuming they lend all the money, I think they can , on that basis. Senator DOUGLAS. So that if the Federal Reserve buys a million dollars worth of bonds that will increase the maximum lending capacity of the members banks by $6,000,000 ? Mr. MARTIN. Assuming that the demands for the credit are there. Senator DOUGLAS . I know. But is the lending capacity available. Mr. MARTIN. Yes. Senator DOUGLAS. Now, do banks like to keep idle assets ? Mr. MARTIN. They do not. Senator DOUGLAS . Therefore, if they have this lending capacity, does not this added lending capacity make them more ready to make loans than they otherwise would be? Mr. MARTIN. In a period of active credit demand, no doubt about it. Senator DOUGLAS . So that the purchase of Government bonds by the Federal Reserve System tends to lead to increased loans by member banks to private business ; is that not true ? Mr. MARTIN. Correct. Senator DOUGLAS. If there is not a commensurate increase in physical production, what then happens to the price level ? Mr. MARTIN. The price level tends to rise, sir. Senator DOUGLAS . Therefore, the purchase of these bonds by the Federal Reserve System tends to have an inflationary effect ? Mr. MARTIN. There is no doubt of it. Senator DOUGLAS . Yes. Now, then, if you look back on the period after Korea, was the purchase of $4 billion, approximately, of securities by the Federal Reserve System disassociated from the increase in bank loans of approximately $ 10 billion in that same period ? Mr. MARTIN. It was not disassociated . Senator DOUGLAS. But was it not a cause ? Mr. MARTIN . Not the only cause, sir. Senator DOUGLAS. Well, was it not a partial cause ? Mr. MARTIN. It was a partial cause ; yes, sir. Senator DOUGLAS. That is , when the member banks had more reserves in the Federal Reserve System, that permitted them to make more loans, and they did make more loans. Mr. MARTIN. That is right. Senator DOUGLAS. And the ratio immediately was nearly three-toone. Furthermore, did it not create excess reserves so that they had a margin upon which they could expand loans from April 1951 on ? Mr. MARTIN . No doubt about it. Senator DOUGLAS . So that part of the increase in loans since April 1951 was due to the purchase of securities by the Reserve System prior to April 1951 ? Mr. MARTIN. Part of it was , but part of that credit, we think, was needed to help readjust to a defense economy and to sustain the econ- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT- 89 omy. Since that time there has been no appreciable rise in the price level. Senator DOUGLAS. But there was an increase in prices , of course , between June 30, 1950, and March 1951 . Mr. MARTIN. That is correct, sir . Senator DOUGLAS. The increase in wholesale prices was approximately 17 percent. The increase in bank loans was approximately 19 percent. Do you think there was some connection between the increase of 19 percent in bank loans and the increase of 17 percent in wholesale prices ? Mr. MARTIN. I think there was some connection , but I would not say that was the onlySenator DOUGLAS . The coincidence is very close ; is it not ? Mr. MARTIN. You have to beware of statistical coincidences when you are interpreting a general economic development. Senator DOUGLAS. I just wanted to point out that we started upon a basis of logic , and this logic led you to the conclusion that an increase in Federal Reserve purchases of bonds would lead to an increase in bank loans, and that this in turn would lead to an increase in prices. Now, we turn from logic to history, and history seems to bear out logic, so that it is not merely a coincidence ; it seems to be the working of a law in fact . 'Mr. MARTIN. Well, there is nothing in my statement , Senator, that would contradict the general thesis that general monetary expansion has some influence on price developments ; the contrary is , in fact, stated. Senator DOUGLAS . But here is a case of a lack of monetary control being practiced by the Reserve. Mr. MARTIN . Also the converse is true. Senator DOUGLAS . A complete lack of monetary control , the complete flooding of the market with bank loans, with the result that prices go up. If you bring in the question of the velocity of the circulation of money, which I thought probably would be your next defense, I would like to counter and say that the increase in velocity and the increase of physical production approximately balanced each other, so if we use an equation of four terms and not merely two, we will find that the relationship still applies. Mr. MARTIN. No ; I was not going to counter with velocity because I find velocity very difficult to handle. Senator DOUGLAS . Well, the increase of velocity and the increase of physical production were roughly 8 percent, and may offset each other, roughly. Allowing those to balance each other you have an increase of 19 percent in bank credit and an increase of 17 percent in wholesale prices and you have said that an increase in bank credit, other things being equal , results in an increase in wholesale prices , so why did not the increase in bank credit during this period cause the increase in prices ? Mr. MARTIN. Well , I think that is perhaps too facile a generalization. Senator DOUGLAS . Well , I submit that it is an historical truth . Now, before I ask the next question, I want to say that you are a very fine public servant and an extremely tactful man, Mr. Martin. I marvel at the way you tread on eggshells . I say this very sincerely. 90 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Now, do you think that the policy of the Federal Reserve in making these purchases during this time was completely voluntarily, was it a completely voluntary decision ? Mr. MARTIN. Senator, I am not going to make any comment on anything except from the time I went to the Reserve Board. I was a subordinate in the Treasury prior to that time. Senator DOUGLAS . You were on the other side of the fence then. Mr. MARTIN. I can say to you- well, I would not make any assertions one way or the other except that I have complete confidence in Secretary of the Treasury Snyder. I have never worked with a more open-minded, intelligent man who wants to do the right thing at all times . He has made mistakes, I have made plenty of mistakes. I would just like to▬▬ Senator DOUGLAS . Mistakes can be very educational providing we recognize them so that they do not occur again, and that is my sole purpose in bringing out this history, both for clarification of the past and also possibly as a prophylactic against future aberrations. Mr. MARTIN. Let me say unequivocally, since it has been put in this framework, that since I have been in the Federal Reserve there has been-I will not say a hundred percent agreement on everything that has been done that would be going too far, but I would say there has been complete harmony of decision , and no dictation by the Treasury to the Federal Reserve. Senator DOUGLAS. Now, then, you say you would only comment personally on what has happened since you left the Treasury and became Chairman of the Federal Reserve Board . Would you submit for the record the documents of protest drawn up ( a) by the Open Market Committee, ( b ) by the Federal Reserve Board itself, which were submitted to the President and to the Secretary of the Treasury in the winter of 1950-51 ? Mr. MARTIN. Well , I think that raises the question of public policy, whether the minutes of the FederalSenator DOUGLAS . These are not minutes. These are letters of protest or letters of statements of position of the Federal Reserve Board and the Open Market Committee. Mr. MARTIN. I do not think that the records will add anything to the Senator DOUGLAS . May the committee be the judge of that ? Mr. MARTIN. I will be very glad to have the committee be the judge of that if they would take a look at itSenator DOUGLAS . Well , I am going to ask that the witness be requested to submit for the record and for the inspection of the press the documents which the Federal Reserve Board and its Open Market Committee prepared in the winter of 1950-51 , so that the full record of those transactions may now be made available to the public. Mr. MARTIN. Mr. Chairman, I would question a little bit the propriety of that as a matter of public policy. I would be perfectly willing to have you , Mr. Chairman, or your committee or anyone you designate, take a look at any records we have, and make a determination on what you want to do , but I think there is a very serious problem of public policy involved . Representative PATMAN. You think it is a matter that should be passed on or considered in executive session if at all ? Mr. MARTIN . I would so state. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 91 Senator DOUGLAS . Mr. Chairman, I do not wish to argue this point at length. I want to point out that at pages 72 and 73 of the report, the Secretary of the Treasury accused the Chairman of the Federal Reserve Board, by implication , of bad faith on no less than three separate occasions during this period . I would also like to point out that this was the period in which the Federal Reserve Board was purchasing large quantities of Government bonds with what seems to me to have been the clear effect of feeding inflation . Finally the Board decided it could not stand the policy any longer ; it made protests and these protests ultimately led to the triumph of the Federal Reserve point of view. This is all a vital public matter. I do not know why it should be hidden from the public gaze . I have always felt as you have stated, that popular support is needed for these measures, and in order to have popular support, popular understanding is necessary, as well ; and I have never felt that the Federal Reserve System was a private institution which could keep its documents from public analysis. Representative BOLLING. Mr. Chairman, if the Chair intends to rule on that at this time, I would like to be heard. If you intend to postpone it I would not. Representative PATMAN. I would like to hear you, Mr. Bolling. Representative BOLLING. I think involved in this is a very fundamental matter of public policy. I am not particularly aware of what the documents might contain, but it seems to me very clear that, particularly in the last few years, there has been a tendency on the part of Congress to infringe on the lower-level processes of decision-making in the executive branch, and I personally think it is a constitutional question, as well as a question of the advisability from a public policy point of view. I would feel very strongly that this should be approached deliberately, certainly with an initial examination on the part of the committee prior to making the full jump from privacy to publicity. Senator DOUGLAS. May I reply to my good friend and colleague, Congressman Bolling, that I had always understood that the Federal Reserve prided itself on being the agency of the Congress rather than the agency of the executive, and that this has been affirmed again and again by the Federal Reserve System. Congress is not asking in this case to have executive papers turned over to it. I am making the request that our agent- and I hope this does not sound too toughour creature-file with us vital papers affecting fundamental matters of public policy. Representative BOLLING . The Senator would agree, however -excuse me. Senator DOUGLAS . Yes . Representative BOLLING. The Senator would agree, however, if this particular approach is taken that inevitably it will probably be at least apparent that the Treasury will be compelled to present its side of the question or the public will not be served on the basis of information. Senator DOUGLAS . Well , I will make no such request upon the Treasury that they produce the papers ; but I do think it is proper for the Federal Reserve to produce the papers. With regard to the 97308-52-7 92 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT three questions which I had asked Secretary Snyder yesterday, and which he did not wish to answer, I told the chairman privately, and I said publicly, I am perfectly willing to abide by his ruling without appealing from that ruling. But very grave charges were made by the Secretary of the Treasury against the previous Federal Reserve Board, and it seems to me that since the Federal Reserve System is the creature of the Congress, that it is quite proper for Congress to ask for the papers, and I renew my request. Representative PATMAN. I wonder if it would be satisfactory-you are willing for the papers to be examined by members of this committee ? Senator DOUGLAS . No, I would like to have them made a part of the record so that Representative PATMAN. May I finish ? Senator DOUGLAS . I beg your pardon. Representative PATMAN. I wonder if it would be possible for Senator Douglas and Mr. Bolling to examine the documents first, and after they have examined the documents and if they insist upon it, why, then we will decide the question . Mr. MARTIN. Might I suggest, Mr. Chairman, that we might prepare a summary of the pertinent comments on this that your committee might take a look at and determine what they are. The problem of charges which the Senator raises is not going to be answered by anything in our records. Representative PATMAN. Well, he will see that for himself when he sees the documents. Senator DOUGLAS. May I say that I do not think that Congressman Bolling and I should examine the documents. If they are examined they should be examined by the committee as a whole, certainly not by two members of the same political party. Representative PATMAN. Well , yes, you have an objection there. Representative WOLCOTT. I will be glad to serve. Senator DOUGLAS. I must again respectfully suggest that the Federal Reserve is the creature of Congress ; that we are merely asking that our agent furnish us with information upon this matter. Å knowledge ofthe past is vital for the decisions of the future. Representative WOLCOTT. Senator, would you yield ? Representative PATMAN. Yes, Mr. Wolcott. Representative WOLCOTT. I think all of us who have had a year of law recognize the distinction between a servant and an agent, and I notice that the Chairman of the Federal Reserve System recognizes that the Federal Reserve System is the servant of the Congres, and we are supposed to have a little more domination over a servant than we would have over an agent. Mr. MARTIN . That is correct. Representative PATMAN. Had you finished , Senator Wolcott ? Representative WOLCOTT. I thank you for the promotion. Representative PATMAN. Senator Flanders wanted to be heard , and I wanted to make sure that you were through. Representative WOLCOTT. I just wanted to say seriously that the Federal Reserve was set up as the agent of the Congress, which was given the constitutional obligation, and they operate as a statutory agent of the legislative body, which was given the constitutional obligation to coin money and regulate the value of it. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 93 Now, I think that this committee, and I think the Congress, in line with Senator Douglas ' suggestion, has a right to determine any matter which involves its agent with respect to monetary policy, and I was going to suggest later in the day, perhaps, this is as good an opportunity as any—that perhaps for background we should have Mr. Eccles here. I notice that he is not on the list. Apparently he has not been invited to testify, and it probably was an oversight, but may I request now that Mr. Eccles be invited to appear ? Representative PATMAN. Certainly, and he will be invited . Senator Douglas ? Senator DOUGLAS . May I suggest that Thomas B. McCabe, the former Chairman of the Federal Reserve Board , be invited also ? Representative PATMAN. He will be invited. Had you finished , Mr. Wolcott ? Representative WOLCOTT. Yes. Representative PATMAN. Senator Flanders ? Senator FLANDERS. On this question , I would agree that we are well within our responsibilities in asking for these documents. I think we would not be discharging our responsibilities if we asked to, if we required that they be made public without looking at them. We should look at them first and then we decide whether or not it is within the public interest to make them public. Representative PATMAN. The committee is only a small committee and I think all five members can very well serve in examining the documents, and I wonder if you are willing to make them available to the whole committee in executive session , Mr. Martin. Mr. MARTIN. I will make them available in executive session. I meant what I said about the open record. Representative PATMAN. I wish you would elaborate on that statement, please. Mr. MARTIN. I said I meant what I said in my statement about our records being open. Now I question very much the wisdom as a matter of public policy of making the minutes of the Federal Reserve System public, so that hereafter we would have to write all minutes in terms of a public document. I think that is poor public policy. Representative PATMAN. Well , of course the committee can pass on the question of whether or not they should be made public , but I think under the law you are required to make a lot of information public, are you not, even the votes ? Mr. MARTIN. Our policy decisions in the open market committee are published annually and made available to you, Mr. Chairman. Representative PATMAN. There are rather full and complete records there, are there not ? Mr. MARTIN. That is right. Representative PATMAN. Even to how any particular member voted. Mr. MARTIN. That is correct, on policy questions. Representative PATMAN. Mr. Wolcott, would you like to ask some questions ? Oh, excuse me, Senator, had you completed your questioning? Senator DOUGLAS. I had not quite finished . Suppose the Federal Reserve System were to become a branch of the Treasury, what effect on its credit policy would be likely in a period of full employment ? 94 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. MARTIN. You can't determine that, Senator, because it depends on the Secretary of the Treasury. The Secretary of the Treasury is just as interested as the Federal. I can certainly speak for the present Secretary in that he is just as interested in restraining inflation. Senator DOUGLAS . Are not all the pressures in the direction of inflation, that is, the movement of costs and the movement of wages ? Mr. MARTIN. Pressures on inflation are very great always. Senator DOUGLAS . And aren't there certain advantages in a period of full employment in having the banking mechanism of the country somewhat insulated from inflationary pressures ? I am not asking for complete insulation, but somewhat insulated. Mr. MARTIN. I think it is very desirable to have it. Senator DOUGLAS. And a good deal of weather stripping, so to speak, might be very helpful in restraining inflation ; isn't that true ? Mr. MARTIN. I think that is the concept of the founders of the Federal Reserve System , and on examining it carefully again in preparing for this committee, I think they showed real wisdom in setting it up the way they did. Senator DOUGLAS. Would you favor having the Secretary of the Treasury a member of the Board of the Federal Reserve System ? Mr. MARTIN. That is a difficult question , Senator. I have flirted with the idea that we would have in the open market committee the active consultation with the Secretary of the Treasury which I think is essential to a satisfactory solution of common problems. Now at the present time we have it. We have daily and almost persistent consultation, but there is no actual provision whereby the Secretary of the Treasury or the Board come together except by sufferance. Now a lot of the people in the System and a lot of the proponents of independence get terribly upset at the thought of having the Secretary of the Treasury on the Board as he was at the start, with the Comptroller of the Currency. My feeling about it revolves around the question of the vote, the question as to whether the Secretary of the Treasury would be chairman of the open-market committee if he were a member of the committee and his office would be such that in the normal way you would expect him to be chairman ; is he to be chairman with 1 vote against 12 votes, which in a sense puts the Secretary of the Treasury in a rather bad relationship to the committee ? Nevertheless, we certainly wanted a voice and consultation in all of these problems. Now, as the chairman of the open-market committee at the present time when we have a 3- or 4-hour session of the committee, I go back to the Secretary of the Treasury and try to tell him, when we have arrived at a point of decision, what the thinking of the committee is. I would really be very happy if I did not have to tell him what transpired but could actually have had him present during the time the discussion was going on. Now, I realize the dangers of that. Senator Glass said that, with a strong man in the office of the Secretary of the Treasury, he would exert influence and therefore would distort the judicial process of an independent Federal Reserve System. I don't get too excited about that argument. You will appreciate, I know, that I am discussing this with you very honestly and openly.. I am not recommending that there be a change at the present time MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 95 because there are a lot of very sincere people opposed to it, and I have talked to them from coast to coast. I have explored this idea with a great many people. Particularly under the present atmosphere you get the reaction that this is just a device to put the Secretary of the Treasury in control of the Federal Reserve Board. Now, I think that public servants at some point have to stand up and be counted . If I am not strong enough to hold my own with the Secretary of the Treasury, then I am not entitled to the job I occupy. And if the legal position is such that the open-market committee has control, there is a very real question whether it would not be wise to have the Secretary of the Treasury a part of the deliberations. I know pretty well the background of this suggestion , and I recognize the dangers of it also . I want to emphasize again that I am not recommending at the present time that it be adopted . But I think your committee could render a very worth-while service by sincerely studying that problem from all angles. We now have the New York bank, the Treasury, and the Board of Governors in a situation where constant, daily, persistent study of these questions is required , and yet it is all done on an informal basis. Senator DOUGLAS. What would you say to the proposal advanced by some that the term of service of members of the Federal Reserve Board be reduced from 14 to 6 years ? Mr. MARTIN. Well, I would prefer that . Senator DOUGLAS . You would prefer it ? Mr. MARTIN . I would prefer it ; yes , sir. Senator DOUGLAS. That would make the Board of course the much more under the control of the president. Mr. MARTIN. I question that. I would like to see the term as we say in our answers here, reduced to 6 years with ability to take another term . Senator DOUGLAS . With a seven-man board that would mean one man would be retiring each year so that the President in the course of 4 years would appoint the majority of the Board. And furthermore, the prospect that a man would be coming up for reappointment shortly might make him more amenable than if he knew that he had a 14-year tenure. For instance, the 14-year tenure has applied to the New York Court of Appeals and has resulted in the court being almost completely independent. It is one of the finest courts in the country. Now if they felt that they were coming up for renomination every 6 years, might that not make the members of the Board much more amenable to what the President wanted ? Would it not tend to make the Board an executive agency rather than a congressional agency ? Mr. MARTIN. Well, I question that. I think that the type of man that we should have appointed to the Federal Reserve Board would be satisfied with a 6-year term , and I don't think he would change his approach . Senator DOUGLAS . You believe the members of the Board would always be strong, vigorous characters who can stand out against executive pressure and therefore you need not provide them with any protection ? Mr. MARTIN. Well, I think the 6 years would be some protection , Senator. You make it 14 and you have a tendency sometimes forvery few people serve 14 years. 96 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. But the knowledge that they can serve 14 years gives the members a good deal of independence. One final question . You speak of the equal status which you believe both the Federal Reserve and the Treasury should possess. What happens when you come to a question such as this : Should the market on Government bonds be supported at par ? The Treasury insists that the market should be supported at par. You feel that it should not. Under those conditions what happens to equality of status ? What happens to the blessed word "cooperation" about which we have heard so much ? Mr. MARTIN. There is nothing in the law which compels us to support bonds at the present time. Senator DOUGLAS. That is true, but suppose the Treasury pushes you to do so and you do not wish to do so. Then what should happen ? Mr. MARTIN. You have got to have a meeting of the minds. Senator DOUGLAS. That is highly desirable, but frequently in life that is not possible . Suppose what continues is a conflict of the minds, which is what prevailed as you well know for year after year after year prior to your coming to the Board. Mr. MARTIN. Well, it would be————— Senator DOUGLAS . And the issue was settled almost every time until early 1951 by the Board yielding. Now when there is a conflict between the two , which should be prevalent ? Mr. MARTIN. I think that you have got to adjust a conflict between the two. For the Federal to take the law into its own hands and just automatically let a Treasury financing fail would, I think, be a mistake. It would be an irresponsible action . Now let me explore that a little bit. The Open Market Committee developed, sort of grew like Topsy. The first committee was set up informally in 1923. The Banking Act of 1935 gave us our present set-up with participation by the presidents of the Reserve banks with the Board in an open-market committee. In 1937 with a lot of pressure on the market, the Federal, for the first time, supported Government security prices in the market on an orderly market basis. Our relationship with the Treasury through the war period-and I am not going to say whether I think the war was financed the right way or the wrong way, but through the war period-resulted in the establishment of the peg. That kind of market operation continued until last March. Now today in pricing a new Treasury issue, the Federal is in the position of underwriter. During the period of the offering the Federal tries to see to it that the Treasury's issue is successful, because one of the primary purposes Senator DOUGLAS. And therefore it should support the market in order to make it successful ? Mr. MARTIN . It stabilizes the market just the way any underwriter does. Senator DOUGLAS . I asked Secretary Snyder the question yesterday. This practice by private issuing houses would subject them to criminal penalty. Representative PATMAN. He did not use the word " support." He used the word "stabilize. " Mr. MARTIN. So far as I know, I haven't checked on SEC regulations recently, but I believe they permit a stabilizing operation during MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 97 a period of an offering. When the offering is over, the Federal is under no compulsion whatever to support the market. Its only responsibility to the public is that of maintaining an orderly market . Senator DOUGLAS. The question of letting a Federal bond issue fail completely is not in the sphere of controversy. The issue is between a policy of rigid support which the Treasury forced the Federal Reserve to adopt up until March of 1951 , versus a policy of flexible support which you have followed since then. Suppose the Treasury insists on rigid support, you still hold out for flexible support . Whose judgment should prevail ? Mr. MARTIN. All I can say at the moment is we would sit around the table and hammer it out. Senator DOUGLAS . Well, suppose you still have a conflict of wills and time presses and you have to make a decision . You are up against the gun of time. Mr. MARTIN. As I said earlier, Senator, I sincerely think that this is a problem that is not decided just in that way. I think that there has to be some give and take in it , and I don't think that an entirely one-way decision would resolve the problem. Senator DOUGLAS. Well, I may point out that in the midst of this terrific struggle of last year when it was not certain whether the will of the Treasury or the will of the Federal Reserve prevailed, in company with Senators Flanders , Fulbright, Gillette, Tobey, and Thye, I introduced a resolution, Senate Joint Resolution 45 , making effective the recommendation which our previous subcommittee on monetary policy had made, namely : That notwithstanding any other provisions, the primary power and responsibility for regulating the supply, availability , and cost of credit in general shall remain vested in the duly constituted authority of the Federal Reserve System and the policies and actions of the Secretary of the Treasury relative to money, credit, and transactions affecting the Federal debt shall be made consistent with the policies of such Federal Reserve authorities. That was introduced on March 6, 1951. Now I do not wish to give too much credit to this resolution , but I have heard that it was very helpful to the Federal Reserve, enabling it to assert its independence and to reach an accord with the Treasury. Mr. MARTIN . Well, I can't say anything on that, Senator, other than that the accord that was worked out was hammered out over a period of weeks of hard work. Senator DOUGLAS . It sometimes helps, however, to have a little legislative protection , and I notice the Federal Reserve flies to Congress when it wants protection and then tries to push Congress off and disavow any relationship when it wants to follow its own course. That is human, I suppose, and you are most certainly human. Mr. MARTIN. Well, as Mr. Wolcott says, we are the servant of Congress . Senator DOUGLAS. Now two more questions and then I will be finished. Would you object to an audit of your books by the General Accounting Auditing Office ? Mr. MARTIN. Yes ; I would. Senator DOUGLAS. Why do you object to that ? Every other governmental agency is audited by the General Accounting Auditing Office . You are the only agency so far as I know which audits itself. Mr. MARTIN. Well, I think that budgetary control is an essential 98 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT part of the independent judgment required for the operation that we are engaged in. I think that to preserve the public-private character of the Reserve System it is better for us to retain the auditing procedure in our own hands. Senator DOUGLAS . Is it safe to have any group audit its own accounts ? Mr. MARTIN . Well , I think that you have got a point there, and I can say to you that we have had our auditing procedures reviewed by outside accountants. Senator DOUGLAS . When was this ? Mr. MARTIN . Price, Waterhouse reviewed our auditing procedures a couple of years ago, and Arthur Anderson & Co. is going to audit us within the next few months. Senator DOUGLAS. After this question was raised by Representative Patman . Mr. MARTIN. After this question was raised by Congressman Patman. And I want to say, as we say in the answer to our question, that our auditing procedures and our budgetary procedures are laid out in the answers to these questions. We had been audited periodically by the auditors of the individual reserve banks coming in on rotation. Senator DOUGLAS . And who names the presidents of the reserve banks ? Mr. MARTIN. They are named by the Board of Directors, subject to the approval of the Board of Governors. Senator DOUGLAS. So that the auditors of the Federal Reserve banks whose presidents are selected by you have been coming in and auditing your books. Mr. MARTIN. Well, I don't think that is the best procedure. I don't think, however, that there is the slightest indication that the audits were improper or unsatisfactory. Senator DOUGLAS. I want to make the record clear that I am not charging that. Mr. MARTIN. All right. Senator DOUGLAS. But I do want to suggest this seems to be an We have in Lindsay Warren , the Compextraordinary procedure. troller General, one of the great public servants of all time, incorruptNow what objection is there ible, experienced , fair-minded , able. to having him audit your books ? Mr. MARTIN. Well, I think it would be better if we were audited by private auditors just on the independence thesis that you so ably espoused . Senator DOUGLAS. You can't be a public institution at one time and then a private institution some other time. When you want public protection you are a public institution . When you want special privilege you are private institution. Now you must be consistent on this matter. You cannot blow hot and cold in alternate sentences and in answer to divergent questions in the questionnaire. Mr. MARTIN. Well, we are a hybrid institution . Senator DOUGLAS. And therefore when it pleases you you are a priv ate organization, and when it pleases you , you are a public organ ization. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 99 Mr. MARTIN. I think that is an oversimplification . Senator DOUGLAS . That is all. Representative PATMAN. Mr. Wolcott , it is nearly 12. I wonder if it would suit you to commence your questioning in the afternoon session. Representative WOLCOTT. Perfectly all right. Representative PATMAN. Will it be satisfactory for you to come back in the afternoon , Mr. Martin ? Mr. MARTIN . Whatever time you say, Mr. Chairman . Representative PATMAN . Would 2 : 30 be all right ? Mr. MARTIN . 2:30 would be fine. Representative PATMAN. The committee will stand recessed until 2:30 this afternoon . (Whereupon, at 11:45 a . m. , a recess was taken, to reconvene at 2:30 p.m. ofthe same day. ) (The confidential correspondence referred to during this session appears on pp . 942-966 . ) AFTERNOON SESSION Representative PATMAN. The committee will come to order. Mr. Wolcott, you may proceed. STATEMENT OF WILLIAM MCC. MARTIN, JR.-Resumed Representative WOLCOTT. Mr. Martin, in the Treasury's answer to the question, and yours also, I think, you cover this question of the accord agreement. The history leading up to it indicates that there was some disagreement between the Treasury and the Federal Reserve previous to that with respect to policy, and the accord you entered into was supposed to be a solution of those problems . Was that on a permanent or a temporary basis ? I mean by that, the three or four major things which you agreed upon, were they to be in perpetuity or were they just temporary ? Mr. MARTIN. The answer to that, Mr. Wolcott, is that the original understanding on some of the items was to last through the end of the calendar year. Since the end of the calendar year we have continued to work just the same as if our agreement was in perpetuity. In order to answer you specifically I have to say that some of the points in the original accord expired on the 31st of this year, but they have since been renewed by implicit and explicit action . Representative WOLCOTT. Well , in respect to discount rates-this is in answer to question No. 18 by the Secretary of the Treasury, and I quote from that answer : It is expected that during the remainder of the yearwhich, I assume, would be 1951 ; is that right, 1951 ? Mr. MARTIN. That is right. Representative WOLCOTT ( continuing ) : The Federal Reserve discount rate, in the absence of compelling circumstances not then foreseen, would remain at 14 percent and that the Federal Reserve would operate to assure a satisfactory volume of exchanges in the refunding of maturing Treasury issues. Have you any agreement with the Treasury that that discount rate would be continued ? 100 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. MARTIN. No agreement with respect to that, sir. However, to allay any suspicion that may creep into speculators' minds, there is no intention at the moment of the Federal Reserve to change the rediscount rate. Representative WOLCOTT. I guess that answers my next question as to whether you have given any consideration to the manipulation of the discount rate to prevent inflation . 'Mr. MARTIN. I am sorry, I did not get that. Representative WOLCOTT. I say, I guess that answers my next question, which would be whether you have given any consideration to the manipulation of the discount rate to prevent inflation . Mr. MARTIN. Well, we are giving that consideration constantly because we now have the market, the play of the market, against which to gage things, and we are watching the lending trend very carefully, and working very closely with the Treasury to determine what the most appropriate steps are from here on out. Representative WOLCOTT. I think we are in agreement that inflationary pressures are not quite as great as they were a few months ago ? Mr. MARTIN. That is right ? Representative WOLCOTT. Do you attribute that at all to the use of your indirect controls ? Mr. MARTIN. You mean to selective Representative WOLCOTT. No, not selective controls . Maybe we had better clear this up. Mr. MARTIN. I see. Representative WOLCOTT. The use of the orthodox controls which the Federal Reserve has traditionally had to stabilize our economy we refer to here in Congress as the indirect controls , that is, reserve requirements, rediscount rates, open market operation, and things of that character . Mr. MARTIN . Yes, sir. I attribute a part of the slowing up of inflation to the unpegging of the market that occurred at the time of the accord . I do not attribute all of the lull to that, but a part of it. Representative WOLCOTT. Could you attribute some of it, perhaps, to the fact that you had previously increased the rediscount rates from a low of 1 percent in three steps up to 134 percent ? Mr. MARTIN. Yes, sir ; I would say that played a part. I would say that the increase in reserve requirements at the start of last year played a part. Representative WOLCOTT. What influence did the issues of 234 , 29year bonds, which could not be monetized have ? Did that have an influence on the market, on inflation? Mr. MARTIN. Yes. I think that was a very successful operation that removed a large overhang in the long-term market. Representative WOLCOTT. Do you think Mr. MARTIN. Pardon me, but I was just going to say that we succeeded in placing about 8 billion of those with investors, and an additional 5 billion were in the Federal Reserve portfolio , so you removed the direct overhang to the long-term market to the tune of about $ 13 billion. Representative WOLCOTT. Do you think that the economy had a right to suppose that because you had done those things that the Government was going to firm up its monetary policy and that, perhaps, MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 101 helped somewhat ? In other words, that we were, perhaps, about at the peak of the inflation , as inflation was caused by cheap money policies, that the Government, perhaps, from then on might be expected to firm up our economy and use these indirect controls to stabilize the economy ? Mr. MARTIN . Yes, I do . I think that the mere effect of the Treasury and the Federal Reserve getting together on a program for a minimum monetization of the debt and for financing the Government's requirements, was one of the most salutary things that came out of the accord. Representative WOLCOTT. If the application of a little of that would help , why would not a little larger dose do the major job ? I do not mean necessarily by increasing discount rates alone ; I mean the utilization of all of the indirect controls you have over the volume of credit- why can we not stabilize our economy through the use of indirect controls ? Mr. MARTIN. Because the country has a mobilization program, we have to make certain that a large amount of credit flows into defense output and also make certain that the financing of the whole program goes forward satisfactorily. We are living in a time of considerable unrest and differing points of view among people, and I think Representative WOLCOTT. Would you think that inflation causes unrest ? Mr. MARTIN. Inflation is one of the factors in unrest, but at the moment there is no necessity for any further measures to restrain inflation. Inflation, I think, is asleep at the moment. Representative WOLCOTT. In view of the fact that we are about to give consideration to a continuance of DPA, you might want to qualify that a little bit in the revision of your remarks . [ Laughter. ] Mr. MARTIN. That does not mean that the pressures could not break out again at any time. Representative WOLCOTT. Getting a little, perhaps, ridiculous, to bring out the point, what would happen if you raised the rediscount rate to 7 percent, with the usury rates in most of the States east of the Mississippi 7 or 8 percent ? Mr. MARTIN. It might have a considerable psychological impact, and there just would not be any sizeable amount of borrowing through discounts. Representative WOLCOTT. What would happen if there were any borrowing ? Mr. MARTIN. There would not be many loans ; there would be a reluctance on the part of banks to get reserves through the discountrate process . Representative WOLCOTT. The banks would not be loaning anything ; the banks would not be loaning anything, would they ? ? Mr. MARTIN. Well , the banks, if they had reserves, would be lending. Representative WOLCOTT. Yes. Mr. MARTIN. Unless they needed additional reserves. Representative WOLCOTT. But if you control the rate of interest through the manipulation of rediscount rates, you control the money market pretty much, do you not ? 102 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. MARTIN . No ; we influence but do not control the market. We are the marginal buyer and seller in the market, but the market is determined by the interplay of the forces of supply and demand. Representative WOLCOTT. Then, what effect has an increase in the rediscount rate on inflation ? Mr. MARTIN. It has the effect of making it more expensive to borrow when there is a need for the borrowing. Representative WOLCOTT. So that, at least, is an indication of a firmer policy on the part of the Federal Reserve and, perhaps , the administration ? Mr. MARTIN. That is right ; and in our judgment it is not necessary to have a firmer policy at the present time. Representative WOLCOTT. Now, the President, in his economic message, asked for, in your behalf as I understand it, authority to increase reserves, and in reading your statement there is an implication , if you do not say so outright, that you do not want any further authority or you do not think it is necessary or advisable, something like that. Mr. MARTIN. At the present time, we do not, Mr. Wolcott. I cannot see what an increase in reserve requirements would do at the present time except to put additional pressure on the Government securities market. Representative WOLCOTT. How would you go about stabilizing under these conditions of credit inflation were you not compelled to give consideration to debt management ? Mr. MARTIN. Well, you would be compelled to give consideration to debt management. Representative WOLCOTT. Just say that we have no debt, that is, the debt is not an influence, something that does not have to be considered, similar, perhaps, to the credit inflation of 1929. How would you go about preventing credit inflation ? Mr. MARTIN. When there is no debt at all ? Representative WOLCOTT. We will just assume that. You do not have to take into consideration debt management. Mr. MARTIN. You would go about it in exactly the same way. Representative WOLCOTT. What way? Mr. MARTIN. You would increase the discount rate, reenforce it with restrictive open market operations, and see what the market forces would do to the supply and demand for money. Representative WOLCOTT. It might raise the reserve requirements, might it not ? Mr. MARTIN. You might raise reserve requirements at that point, assuming statutory authority, and without any Government debt there would be no pressure on the Government securities market. Representative WOLCOTT. You surely would not continue supporting the Government bond market under those circumstances ? Mr. MARTIN. That is right. Representative WOLCOTT. Would you, perhaps, recommend to the Congress that they restore the gold reserve behind the Federal Reserve notes from 25 percent to the earlier 40 percent, and behind the deposit liability from 25 to 35 percent ? Mr. MARTIN. I Would not see any necessity for that at the presentRepresentative WOLCOTT. I am just assuming a condition whichMr. MARTIN. Oh, under those conditions ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 103 Representative WOLCOTT. Yes. What I am trying to find out when I get all through is what influence debt management has upon the powers which would ordinarily be exercised by the Federal Reserve to stabilize our economy. So you would use all of these methods, these indirect methods, would you not ? Mr. MARTIN. That is correct. Representative WOLCOTT. And you probably would recommend to the Congress that they restore to the 40 and 35 percent, respectively, the reserve behind-the gold reserve behind-deposit liability and Federal Reserve notes . Mr. MARTIN . Under your hypothesis I might request an increase in reserve requirements, but that would depend on a number of circumstances. Representative WOLCOTT. Yes. You are not going to ask for a restoration of gold reserves of 40 percent ? Mr. MARTIN. No , sir. Representative WOLCOTT. You are not going to ask for any increase in reserve requirements, Federal Reserve? Mr. MARTIN. Not at this time, sir. Representative WOLCOTT. Does that mean that because of the influence which debt management has on the value of the money that so long as we have a high national debt we must accept inflation as a matter of Government policy ? Mr. MARTIN. No, sir ; because we have-we have succeeded in restraining inflation at the moment ; we have a large debt. It means that it is essentialRepresentative WOLCOTT. We have got inflation . Mr. MARTIN . What is that ? Representative WOLCOTT. We have got inflation . Mr. MARTIN. Well, we have hadRepresentative WOLCOTT. The value of the dollar has been going down constantly, it has been going down 6 or 7 percent since Korea, and setting an all-time low now of 52.85 . It was 59, was it not, at the time of Korea ? Mr. MARTIN. I don't have the figures on that- that is substantially correct. The purchasing power of the consumer's dollar has declined about 10 percent since Korea . Representative WOLCOTT. What can be done, what can we do , to prevent any further drop ? Must we accept as a matter of policy continuing inflation ? Mr. MARTIN . I see no reason to . Representative WOLCOTT. What can we do about it ? Mr. MARTIN. Well, we have got to do everything we can to get our budget in balance. Representative WOLCOTT. What is that ? That is what we are here for. Mr. MARTIN. We want to get our budget in balance as nearly as we can, and if we are running a deficit we want to finance that deficit out of the genuine savings of the people until such time as we can balance the budget at a later date. Representative WOLCOTT. Well, the balancing of the budget is not alone a solution, is it ? We balanced the budget last year, and when 104 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT the dollar was depreciating 6 percent there must have been some other things that we have got to do besides balance the budget. Mr. MARTIN. Would you repeat that, Mr. Wolcott ? Representative WOLCOTT. I said the balancing of the budget would not alone correct inflation, because we balanced the budget last year. Mr. MARTIN. We have to pursue an active restrictive monetary policy ; that is also indespensible. Representative WOLCOTT. An active restrictive monetary policy ? Mr. MARTIN. A restrictive monetary policy ; yes sir. Representative WOLCOTT. What are you doing to restrict it now ? Mr. MARTIN. At the present time ? Well, we have reduced our holdings of Government securities. Recently, by and large, monetary policy has been pretty neutral ; the money stream has kept just about steady. Representative WOLCOTT. It has not been restricted to the point where it has had any influence on inflation. Mr. MARTIN. Well, I beg to differ with you there. It seems to me that our studies show thatRepresentative WOLCOTT. How can you differ with me when the dollar has been depreciating in value constantly almost proportionately as we indulge in deficit financing ? Mr. MARTIN. May I ask Mr. Young to answer this question ? Representative WOLCOTT. Certainly. Mr. YOUNG. The big increase in prices following Korea was in the 8 months immediately thereafter. Subsequent to that sensitive prices and wholesale prices receded somewhat and leveled off, and the rate of increase in consumer's prices also leveled off gradually. In February there was a decline in consumer prices and since December there has been a further decline in wholesale prices. Representative WOLCOTT. Mr. Wilson tells us that we have got to continue price controls and we have got to continue these other controls because of the impact which defense spending is going to have upon the value of our currency sometime in the future. He has been telling that to us since the middle of last year when, I think, he said that we were going to meet the impact in the summer sometime, and then we were going to meet it in October, and then we were going to meet it in January, and then we were going to meet it sometime this spring, sometime this summer, and I think his last statement is that we are probably going to meet it sometime in October, 1952 ; so the only reason why we have got to continue these direct controls is because of the possibility that some time in the future deficit financing, due to our defense effort, is going to make prices higher. Mr. MARTIN. That is substantially correct, Mr. Wolcott. Representative WOLCOTT. Then, can we assume that the use of the indirect controls that you have has caused this leveling- off process ? Mr. MARTIN. One of the important factors in causing the leveling- off process ; yes, sir. Representative WOLCOTT. Were it not for debt management-getting back to that hypothesis, were it not for debt management, would you recommend that we continue or not continue the practice of inflating the debt against the Federal Reserve notes, or would you think we might safetly go back to the law in the thirties when we had to put up commercial paper in addition to those ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 105 Mr. MARTIN. In postwar years, there has been quite a increase in bank holdings of commercial paper, but I should not think that it would be Representative WOLCOTT. We did not have then, and— Mr. MARTIN . But we had a large volume of excess reserves in the banks during most of the thirties. Representative WOLCOTT. As I understand the original purpose of the Federal Reserve System it was to provide a flexible currency to meet the demands of business , from time to time. You could put it out or you could contract it, and there was an affiliation between the amount of commercial paper which you had and the volume of money which you issued, and that was the original intention , was it not ? Mr. MARTIN. Yes. That was the way they thought it would work. Representative WOLCOTT. The volume of the needs of business for cash would be determined by the amount of commercial paper ; that was the guide, was it not ? Mr. MARTIN. Yes, I would say that that is what they thought. The original Federal Reserve Act was to correct an inelastic currency, and to mobilize bank reserves. Representative WOLCOTT. Now, to lick a depression in the thirties we abandoned that idea , did we not ? We substituted debt for commercial paper ? Mr. MARTIN. That is correct . To lick depression and create excess the Federal Reserve bought securities in the open market and also lowered discount rates. Representative WOLCOTT. And we so wedded our debt to the value of our currency in the abandonment of the idea that the Federal Reserve which was set up to meet the business demand with respect to money, that the value of our currency is dependent largely or is influenced largely by the debt. Mr. MARTIN. That happened during the war. One of our principal problems today is the value of public debt ; that is right. Representative WOLCOTT. Have we got to continue to have our currency depreciate proportionately as our debt goes up , or is there not some way that we can correct that situation and remove that influence ? Otherwise, it seems to me, we are sunk. We will have deficits this year ranging anywhere from 10 to 14 billion ; we will have them next year from 14 to 20 billion , perhaps. We are entering another deficit financing era which we are told might be carried on for 10 years. If the value of the dollar has shrunk 6 percent in the last 18 months, it might shrink 12 percent in the next 3 years , and we will then have a 40-cent dollar. Now, it seems to me that this committee, and you and the Treasury, with all the help we can get, ought to find a solution to it . It is not too simple, but does it not occur to you that we might have some studies looking to the discovery of a method of sterilization of some part of the debt, bank-held debt, and some part of gold, above which gold and the bank-held Government debt could not be monetized , and thereby remove the pressure, the influence , which deficit financing has on the value of the money ? Mr. MARTIN. The important thing is to eliminate the deficit . I think we should have such studies, and I will be glad to have a paper prepared for you on how we can go about it. 106 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative WOLCOTT. I wish you would, because for a couple of years I have had this hare-brained idea in my head that somehow, sometime or other, we were going to find a solution to that problem, and when we found a solution to that problem we probably could stabilize our curency and stabilize our economy. Frankly, I cannot take very seriously the use of direct controls until that basic reason for inflation is solved. It has been said here, and I think we all agree, that when you put on direct price controls or direct consumer credit controls you almost automatically put into operation the machinery for the creation of just enough more credit to offset all the deflationary influences that accompany the application of direct price controls and consumer credit controls. If I may use an example of what I mean-this is my own opinion and I do not ask you to agree with me on it, but I wish you would have it in mind in preparing this paper-to me the selective application of consumer credit controls has no more influence upon inflation than to rest your hand lightly upon a child's toy balloon with the expectation that you were going to prevent its inflation. You have got to cut the air off at the source. Now, the source, to me, is the Federal Reserve System. Mr. MARTIN. Well, I will give you a paper on that. I agree that selective controls, like consumer credit controls, are supplementary to restrictive discounts and open-market operations and not a substitute for them . (Supplementary statement by Mr. Martin follows :) RESERVE BANK RESERVE REQUIREMENTS AND FEDERAL RESERVE CREDIT The Federal Reserve Act as amended in 1945 requires that each Federal Reserve bank hold reserves in gold certificates equal to 25 percent against its Federal Reserve notes in circulation and against its deposits. In the case of Federal Reserve notes, the law also requires that each Reserve bank shall pledge with the Federal Reserve agent of its district collateral equal to 100 percent of the amount of such notes in circulation . Such collateral may consist of gold certificates ; paper originating in commerce, agriculture, and industry-that is, so-called eligible paper-or direct obligations of the United States Government. Prior to 1945 the required reserve percentages were 40 percent of gold certificate reserves against Federal Reserve notes and 35 percent of gold certificates or lawful money against deposits . The main reason for the lowering was that the gold reserve ratio had fallen significantly during World War II as a result particularly of the very large expansion of Federal Reserve notes in circulation because of wartime demands for currency. This increased volume of money has remained in circulation since the war. The use of Government securities as collateral for Federal Reserve notes was authorized on a temporary basis by the Glass-Steagall Act of 1932 and was periodically renewed, and the authority was made permanent in 1945. This provision was necessitated by the large-scale withdrawal of currency from bank deposits in the early years of the depression, by the then reduced volume of eligible private paper in Reserve bank portfolios, and by the desirability of Federal Reserve purchases of Government securities in order to prevent the development of tight money conditions during the depression. It would appear undesirable at this time to change either the legal reserve requirement regarding gold certificates or the legal collateral requirement regarding United States Government security holdings of the Federal Reserve banks. The legal provision permitting the Reserve banks to use Government securities as collateral for notes is necessary under present conditions, since the volume of commercial, agricultural, and industrial paper now held by these banks would be inadequate for the purpose . Also, the provisions of law regarding the reserve requirements of the Reserve banks are important in enabling flexibility in monetary management to meet changing conditions. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 107 These legal provisions are not inflationary per se. Federal Reserve credit is not created just because the basis for such creation is available. It is the duty of the Federal Reserve System to see that Reserve bank credit is adjusted to the needs of the economy. Changes in the volume of such credit outstanding are now determined mainly by actions of the Federal Reserve System in accommodating the credit needs of consumers, commerce, agriculture, industry, and State and local governments, as well as the Federal Government. Such actions are taken only after a careful review of the economic and financial situation in the country at the time and after a full consideration of their inflationary and deflationary implications. An automatic check on the expansion of Federal Reserve bank credit, such as would be imposed by an increase in the ratio of gold certificates required against Federal Reserve notes and deposits, would not be desirable. It was in part to prevent arbitrary and mechanical limitations on the volume of bank credit and money, resulting from too rigid a relationship between the credit and money supply and gold, that the Federal Reserve System was initially established. Representative WOLCOTT. I think that would be in keeping with the original purpose of the Federal Reserve Act ; and you commented on the original purpose when, on page 212 of volume I in your answers, you quote the then chairman of the Committee on Banking and Currency , whom I assume to be Senator Glass, as follows : Senate bill 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. That, I think, very briefly sets out the reasons why the Congress set up a Federal Reserve System. Then, you recognize that in your annual report for 1923 , in which you say the problem "in good administration under the Federal Reserve System is not only that of limiting the field of uses of Federal Reserve credit to productive purposes but also of limiting the volume of credit within the field of its appropriate uses to such amount as may be economically justified ; that is, justified by commensurate increase in the Nation's aggregate productivity " —that is what you say on page 212 . Representative PATMAN. Mr. Wolcott , will you yield for what I believe to be a correction ? Representative WOLCOTT. Yes. Representative PATMAN. It says here the report to the Senate in 1913. I believe that Senator Robert Owen was chairman of the Senate Banking and Currency Committee at that time. Representative WOLCOTT. I was not sure ; I think, perhaps you are right. Representative PATMAN. And Senator Glass was then the chairman of the House Committee on Banking and Currency. Representative WOLCOTT. That is right. This would be Senator Robert Owen. Representative PATMAN. That is right. Representative WOLCOTT. I did not want to take any credit from Senator Owen with respect to the co- sponsorship of the Federal Reserve Act. Then, again in the 1945 bank report which yoù quoted , you said : 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 97308-52-8 108 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT policy permit, to an economic environment favorable to the highest possible degree of sustained production and employment. Traditionally this over-all policy has been followed by easing credit conditions when deflationary factors prevailed and, conversely, by restrictive measures when inflationary forces threatened. Now, it seems to me that if you had the independent status that we intended you should have when Congress set up the act, if you were allowed to exercise it, if you were allowed to do the job that we set you up to do, not to manage the debt, that is, but to stabilize our economyrecognized as recently as 1945 as your purpose and objective-the Federal Reserve, with the powers it now has, could have prevented this inflation. It can likewise prevent further inflation, and I think that we in this committee have got to determine what deficiencies there are in the act, but we have not run onto any so far. You say you do not need any statut ory authority to raise reserve requirements . They have been as high as 7 percent , have they not , under existing law? Mr. MARTIN. The reserve requirements ? Representative WOLCOTT. I mean the rediscount rate, pardon me. Were they not as high as and up to 7 percent in 1929 when the Board belatedly approved the applications of the banks for an increase in rediscount rates ? Mr. MARTIN. It was up that high during part of 1920 and 1921 ; the rate reached 6 percent in the fall of 1929. Representative WOLCOTT. It was up to 6 percent ? Mr. MARTIN. That is right. Representative WOLCOTT. Now, the Board can initiate those increases, can they not ? Mr. MARTIN. That is right , but the initiative ordinarily is taken by a Federal Reserve bank. Representative WOLCOTT. So this situation is similar but somewhat different from that which confronted us in the credit inflation of 1929. At that time the Board had to wait for action to be taken. initially by the Federal Reserve banks, did they not ? Now, the Board itself can initiate changes in rediscount rates. Once they were as high as 7 percent ; since then we have inflated the currency, pumped more blood into the economic stream , as much as we can get into the veins of the body meanwhile putting rediscount rates down to an all - time low of 1 percent. Now, it seems to me that if we could find the golden mean between those two extremes with, perhaps, the utilization of a few of your other powers that we could stabilize and still carry the debt. I remember on the administration level shortly after World War II we were told that it should be our objective to stabilize at about an 80 -cent dollar, and if we did we could carry the debt and do all the other things we had to do. At the same time we encouraged production to get productivity and stability. I still think that we can do that if we recognize that the real cause of inflation is that we have wedded our debt to our money so closely that increases in the debt, which are going to be inevitable for the next 8 or 10 years, are going to be reflected in proportionate decreases in the value of our currency. If we find that answer, then I think the Federal Reserve Board can come in here and recommend what it has to have in the way of legislation . If you have to have more authority to raise reserves, and you come in and make a case out for it, I do not think they are going to quibble too much MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 109 about that. You do not now need any statutory authority to raise the rediscount rates. You do not now need any more statutory authority in respect to open-market operations , or do you? Mr. MARTIN. No , sir. Representative WOLCOTT. I am sure that the Congress-the House, at least, next year-would be willing to restore the gold reserve requirements to where they were before we reduced them to lick the depression ; it was done in the Eightieth Congress. The Eightieth Congress -there is nothing political in this at all-I am just taking pride in the fact that in the Eightieth Congress we had 2 years of balanced budgets, and took the initiative in stabilizing our economy. I think if the Senate had to do it over again they would have considered the bills which were passed by the House in keeping with our policy, and not have been so susceptible to administration pressures that inflation be continued for political expediency beyond the time when it was necessary to help finance the war. That is our problem. How are we going to find out what the Federal Reserve Board is going to do from now to prevent further depreciation in the value of the dollar short of divorcing debt from money ? Mr. MARTIN. The Board is going to devote its best efforts to prevent the depreciation of the dollar. Representative WOLCOTT. That is a good answer. That is the best that I know of that you can give under the circumstances ; but it is not the answer that I think you would give if you were at liberty to manipulate or to utilize these indirect controls, as I think you would, were it not for the influence which the administration , concerned with debt management, brings to you in respect to policy. That is why I started out to ask you about this accord. There is nothing permanent about it ; you can change it, you are not bound by it. You can state to the Treasury, "Here now, from now on we are going out and stabilize this economy. Mr. MARTIN. Well , we have got to have fiscal policy , debt management, and monetary policy working closely together to achieve that stabilization you are seeking. Representative WOLCOTT. You have it under this present situation , yes ; but you would not have it, that is, it would not have the same degree of influence if you divorced your debt from your money. Do you know what the discount rate from the Bank of England is ? Mr. MARTIN . It is, I thinkWhat Representative WOLCOTT. I know what it was yesterday. is it now? Mr. MARTIN. Two and a half to four-4 percent. It was raised today to 4 percent. Representative WOLCOTT. Raised today, was it ? Mr. MARTIN . Yes, sir. Representative WOLCOTT. To 4 percent ? Mr. MARTIN . Yes. Representative WOLCOTT. That compares with our 134. I think I have taken all the time that I should, Mr. Chairman. Representative PATMAN. Mr. Martin, in your testimony are you expressing your own views or the views of the Federal Reserve Board ? Mr. MARTIN. In the testimony I have handed you , Mr. Chairman , I am expressing views that are concurred in by the Board of Governors ? 110 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative PATMAN. By the Board of Governors ? Mr. MARTIN. That is correct. Representative PATMAN. Mention was made this morning about commercial banks selling Government bonds to the Federal Reserve Banks through the Open Market Committee, I assume, and thereby accumulating reserves that can be expanded six times which is, of course, inflationary, highly inflationary. Do you know of any remedy that could be enacted by the Congress that would permit you to support the Government bond market and the bonds at a hundred percent and, at the same time, prevent commercial banks from having that privilege of adding to their reserves ? Mr. MARTIN. Well, I presume the banks could be compelled to hold Government securities. Representative PATMAN. That is what I am talking about . Mr. MARTIN . I see. Representative PATMAN. In other words, freeze them in the banks for that purpose . Mr. MARTIN. That could be done ; I think it would be most unwise . Representative PATMAN. Of course, it is a drastic remedy, but any control is a drastic remedy, whether it is a direct or indirect control or anything else, it is a drastic remedy to be resorted to only in case of emergency, but it could be done that way could it not, Mr. Martin ? Mr. MARTIN. It could be done ; yes, sir . We could also order banks to stop lending. Representative PATMAN. You could do most anything in that direction to stop the inflationary trend that Senator Douglas has talked about ? Mr. MARTIN. That is right. Representative PATMAN. Or the effects caused from it. I want to ask you about the voluntary restraints, the voluntary credit restraint program. I believe the official name of it is the voluntary credit restraint program. The Federal Reserve Board is represented on that committee. Mr. MARTIN. That is right , sir . Representative PATMAN . I believe Mr. Powell, a member of your organization , is on the Board, and is head of the committee ? Mr. MARTIN . That is correct, sir. Representative PATMAN. I notice that the other members of that committee are representatives of commercial banks and insurance companies and investment bankers ; they are the people who are involved in this. Does it occur to you that the Government should be better represented on that Board ? I do not mean to say that Governor Powell would not represent the Government interest and the people's interest, but it seems to be pretty dominantly composed of people who are selfishly interested . Mr. MARTIN. Well, those are the people who would be selfishly interested in undertaking the lending or the underwriting. They are sacrificing profits by foregoing their financing opportunities. Representative PATMAN. It is up to them. You think that is a good policy to pursue ? Mr. MARTIN. I think that the voluntary credit restraint program has succeeded in organizing the managerial resources of the banking and business community to look for the longer-range profit instead of the shorter-range profit . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 111 Representative PATMAN. You would not recommend that other people connected with the Government be on that Board ? Mr. MARTIN. No , sir ; I do not think it would work as a voluntary program in that way. I would be very much interested to have Governor Powell answer that question also when he testifies before your committee. Representative PATMAN. Taking your reasoning, would that not apply to regulation W? Why not give the people a voluntary restraint credit program ? Mr. MARTIN. We have endeavored to consult regularly with the trade on regulation W. Representative PATMAN. I know, but you are not just consulting here ; you are giving them-you make it voluntary. They are doing it themselves. Why do you not let the people affected by regulation W do the same thing ? Mr. MARTIN. Well , think of how many people there are affected by regulation W. Representative PATMAN. The number is not the important thing ; it is the principle involved. Mr. MARTIN. How would you devise the administrative procedure other than consulting with the trade groups ? Representative PATMAN. Well , they have trade groups , all of them , I know. Mr. MARTIN . We try to consult with all of them on regulation W. While I am not particularly keen on regulations W and X, I consider them necessary at a time like this, because we have got to use all the weapons in our arsenal to restrain inflation. The reason I am not more sympathetic with them is that they impinge on so many individuals and so many businesses, and intervene in so much of the life of the people . Representative PATMAN. The ones affected by Regulation W have another selfish interest, too . It would have the tendency to restrain the abuse of credit ; that is, they want to get their money back when they sell their goods. They do not want to give such terms so that payments will be unlikely, and they want to demand a substantial amount in cash. They wish a substantial amount in cash or its equivalent. Mr. MARTIN. That is right. So our interest in regulation W is in the over-all money supply and not in the trade practice aspect of it. Representative PATMAN. It is just an interest in the over-all money supply ? Well, is not your interest in the voluntary restraint committee, too , in the over-all money supply ? Mr. MARTIN. In the over-all supply of credit, plus a desire to see some of the demand for financing postponed until a later time when that demand may be needed considerably more. For instance , take a museum, or something like that. Some people may seek to finance such items under present high employment conditions . They could be financed much better a few years from now when we have less employment and less need for conserving our resources than we have at the moment. Representative PATMAN. How much has the credit increased under regulation W in the past calendar year ? Mr. MARTIN. Have you got that figure now? 112 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. YOUNG. About $50 million , I believe. Mr. MARTIN . About $50 million. Representative PATMAN. How much has it increased in credit through the banks and insurance companies and investment bankers, all of them, that are involved in the restraint committee program ? Mr. MARTIN. Do you mean, how much has been deferred as a result of thatRepresentative PATMAN. No, not as a result, but how much has happened anyway ? Now, this $50 million, that increase happened notwithstanding the controls and what has happened with the othergive me a comparable figure. Have the banks increased many billions of dollars in the past year ? Mr. MARTIN. A large part of that is for defense work. That is true, but a large part of it is for defense. Representative PATMAN. Well, part of this $50 million would be for defense work, too. You know, they have to have automobiles to travel back and forth. Mr. MARTIN. About $4.1 billion, Mr. Chairman. Representative PATMAN. You mean the commercial banks ? Mr. MARTIN. Commercial banks ; that is right, sir. Mr. YOUNG. Business loans of commercial banks. What other loans ? Representative PATMAN. Business loans ? Would there not be any increaseMr. YOUNG. Real estate loans $1 billion. Representative PATMAN. $1 billion ? Mr. YOUNG. All other about $800 million . Representative PATMAN. About $7 billion ? Mr. YOUNG. For total loans of commercial banks ; that is correct . Representative PATMAN. Now, you are giving some people a lot of power here who are not connected with the Government ; they are not directly responsible to the people or to anybody elected by the people and you are giving them the right to say who will get credit and who will not get credit. Do you not think somebody who is more directly connected with the Government should be on that Board in view of those circumstances and the facts ? Mr. MARTIN. We have a Federal Reserve representative at each meeting, Mr. Chairman. Representative PATMAN. Well , of course, that is a little bit-I do not know at these meetings-if there is a conflict of interest between the banks and the Government, which side would the Federal Reserve Board representative take ? Mr. MARTIN. The Federal Reserve representative would naturally take what he conceives to be the interest of the defense program and the Government. Representative PATMAN. In a case of conflict of interest where it was just a question of deciding which side he would take, the one that he would take would be on the side of national defense, if there is a defense issue. Mr. MARTIN. That is right ; and it is very difficult to determine whether some of these are defense or not. Representative PATMAN. That is right ; unless you know the facts in any particular case. Mr. MARTIN . That is correct. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 113 Representative PATMAN. And I thoroughly agree with you . Now, on regulation X, why could you not administer it the same way through a volntary committee, just like the voluntary restraint committee here, rather than have the compulsory process that you have ? Mr. MARTIN. Mr. Young tells me there has been a supplementary voluntary program in connection with real estate credit. Representative PATMAN. Supplementary program ? It is not set up by law, is it ? Mr. YOUNG. It is under the voluntary credit restraint program. Representative PATMAN. I see . It is under the Defense Production Act ? Mr. YOUNG. To deal with certain areas not covered by regulation X. Representative PATMAN. You could set it up for regulation W that way, could you not ? Mr. YOUNG. The lenders subject to regulation W have considered themselves and been considered by the voluntary credit restraint program, as outside of that program since they were otherwise covered . There were discussions with the sales finance industry, I believe , at one time as to whether or not they cared to come into the volunteer credit restraint program , and they thought that they would prefer to remain out, although they circulated among lenders copies of the voluntary credit restraint program statements of principles. Representative PATMAN. That does not sound like what I have been hearing. Do you mean to say that they were given an opportunity of joining in on a voluntary basis ? Mr. YOUNG. Not as a substitute for regulation W. Representative PATMAN. Oh, you are going to have regulation W, too ? Well, I do not blame them; I would not want a double-barreled thing. Mr. YOUNG. To give them a chance to Representative PATMAN. But they were not offered the same opportunity that the bankers were offered ? Mr. YOUNG. They were not offered the same opportunity, but the consumer installment credit field has special features. Representative PATMAN. Well , would you be willing to offer them that opportunity? Mr. MARTIN. I would have to study it considerably more, Mr. Chairman. Representative PATMAN. How many people do you have trying to enforce regulation W, I mean in the way of policing it ? Mr. MARTIN . I would say not over 150 for the whole country. Representative PATMAN. I get complaints that they are going to people's homes and calling people out, interrogating them, about buying something on the installment plan. Mr. MARTIN. Well , we have hadRepresentaitve PATMAN. Do you have people doing that ? Mr. MARTIN. We have had lots of complaints of that. We have tried to minimize that type of enforcement. I think they are exaggerated, but it is not a happy lot to be the policeman at anything these days. Representative PATMAN. I know, but it is rather ironical that you should chase somebody down to their own home and call them out to ask them about a wheelbarrow that they bought on the installment plan. You let the bankers have a credit of millions of dollars a year without restraint. 114 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. MARTIN. The banks as well as all other lenders are subject to regulation W and regulation X. I know of only one case where someone has complained because he was questioned at his home. Naturally, we have been doing our best to enforce the regulations. I do not like any better than you do having Federal Reserve people going to people's homes. Representative PATMAN. Do you not think we could well afford to do without regulation W for the next year on a trial run basis ? Mr. MARTIN. Unless we get more flexibility than we now have with it, I question how much serviceability there is in it. Representative PATMAN. You mean a shorter term in which to pay than 18 months on automobiles and trucks ? Mr. MARTIN. No. I mean the flexibility for us to tighten it if we felt that conditions warranted it. At the moment we would not make any material change in the regulation if we had full authority. Representative PATMAN. But you would like to have the power so that in the event you needed it, you would have it there ? Mr. MARTIN . That is correct. Representative PATMAN. On fighting inflation , I guess the best way on earth is to induce people to invest in E bonds or to keep their savings intact and not spend them ; is that right ? Mr. MARTIN. That would be very desirable. Representative PATMAN. That is the best way. Well , what is the amount of the demand deposits in commercial banks now, do you know, approximately ? Mr. MARTIN. About a hundred billion . Representative PATMAN. If there is some way of inducing the people not to give checks on their deposits and to keep them intact, it would be a very constructive move to fight inflation, would it not ? Mr. MARTIN. It would. Representative PATMAN. What do you think about restoring the privilege we have taken away from the commercial banks of paying interest on demand deposits. You know, that was a rather arbitrary action on the part of Congress but it was done a few years ago. Suppose Congress were to restore that privilege of letting banks pay interest on demand deposits, and they were to commence paying interest , would that not have a tendency to retard inflation ? Mr. MARTIN. If they retained the deposits, yes. Representative PATMAN. Well, do you think it would be an inducement ? Do you not think it would be an inducement if they got paid for it ? Mr. MARTIN. It would be some inducement ; yes, sir. Representative PATMAN. According to the amount they were paid . Mr. MARTIN. It would be progressively more of an inducement the more they were paid. Representative PATMAN. Well , this E bond campaign is a good thing, and they pay a pretty small rate, and that keeps a lot of the savings from going into the channels of trade and distribution, does it not ? Mr. MARTIN . It does. Representative PATMAN. This would work in the same way, except that it would be on their actual deposits. Would you recommend any change in that law, Mr. Martin ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 115 Mr. MARTIN. Not without considerably more study than I have been able to give it up to this moment, Mr. Chairman . Representative PATMAN. You would want to study this some more ? Mr. MARTIN. I would want to study it some more. Representative PATMAN. But you admit it would be a fine weapon to fight inflation ? Mr. MARTIN. It would be a weapon to fight inflation. Representative PATMAN. Well , its usefulness would depend on the amount that the banks would pay, would it not ? Mr. MARTIN. That is correct, but it would also introduce a major new factor in the money market. Representative PATMAN . And the ability of the banks to pay a sufficient amount, to make it sufficiently attractive, to induce people to keep their deposits there and not spend them. Mr. MARTIN. They can shift their demand deposits now into time deposits or over into savings banks. Representative PATMAN. They get nearly as much there as they do on the E bonds. Mr. MARTIN. That is correct . Representative PATMAN. But that requires a change. Was that law to make it unlawful for banks to pay interest on demand deposits, was that considered as permanent legislation at the time it passed ? I do not recall just the debate in question. Mr. MARTIN. I am afraid I do not know, Mr. Chairman. Mr. YOUNG. I am not familiar with that, Mr. Chairman. Representative PATMAN. My recollection is rather indistinct , but I thoughtMr. YOUNG. It was an amendment to the act. Representative PATMAN. But I believe it was more of a temporary device. Mr. YOUNG. I believe not, sir. Representative PATMAN. I think it was passed in 1935. Mr. YOUNG. It was in the Banking Act of 1935 for insured banks and in the Banking Act of 1933 for member banks. Representative PATMAN. And the best of my recollection is that there was not a great deal of discussion about it on either floor, and was it not put in in conference ? Mr. YOUNG. I think the feeling about it, Mr. Chairman, was that the practice of paying interest on demand deposits had been a factor in the twenties operating to result in the deterioration of the quality of our banking. Representative PATMAN. I recall that, sir. Mr. YOUNG. It got rather competitive in that period . Representative PATMAN. That was a persuasive argument. Mr. YOUNG. And it was a factor in the crisis of 1930 to 1933 . Representative PATMAN. Would that argument be equally persuasive now in view of the fact that deposits are insured up to $10,000 ? Mr. YOUNG. It is not so persuasive now, but it would have to be given careful consideration. Representative PATMAN. Anyway, you are not recommending it and you are not deciding against it ? You are going to consider it ? Mr. MARTIN. Yes. 116 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative PATMAN. The Federal Reserve bank earnings now are practically all from Government bonds, Government securities, are they not, Mr. Martin ? Mr. MARTIN. That is correct, sir. Representative PATMAN. It was contemplated in the original act that a certain amount would be paid to the Treasury over and above expenses ; I believe they call it a franchise tax, do they not ? Mr. MARTIN. That is right, sir. Representative PATMAN. And90 percent and then the law was amended two or three time ; first it said after a surplus of a certain amount had been accumulated, then it was amended again to increase the amount of the surplus, but finally the banks commenced to pay into the Treasury 90 percent. When was the law changed to repeal that provision ? Mr. MARTIN. The law was never actually changed, Mr. Chairman. Both committees in the House and Senate were informed of the practice that was going to be used. I would personally be glad to see the law formally changed or see a franchise tax restored . Representative PATMAN. You say the law was not changed ? I think you are mistaken there, Mr. Martin. M 'r. MARTIN . Am I ? Representative PATMAN. I think the law was changed . In other words, the 90 percent provision was repealed . Mr. YOUNG. That was repealed . The 90 percent that is now in operationRepresentative PATMAN. The what? Mr. YOUNG. The 90 percent payment that is now in operation is by an agreement between the Treasury and the Representative PATMAN. I did not ask you about that, Mr. Young. I am going to get to that. Mr. YOUNG. You are correct ; it was repealed by the Banking Act of 1933 . Representative PATMAN . The original law was that after the payment of the expenses and after the accumulation of a certain amount in the reserve fund of each bank, the remainder-90 percent of the remainder- would go over to the Treasury as a franchise tax. Now, in some way that law got repealed. I do not know how. I have not looked into the history of it. I just know it was repealed, but the question I am asking you is, When was that repealed ? Mr. MARTIN. We will get you the data and put it in the record, Mr. Chairman . That is some more homework I will have to do. Representative PATMAN. And any discussion that you find in either House about it, I would like to have my attention called to that, too, if you please. ay Mr. MARTIN. Right, sir. (The supplementary statement by Chairman Martin follows :) PAYMENTS TO TREASURY BY FEDERAL RESERVE BANKS FRANCHISE TAX ON FEDERAL RESERVE BANKS In section 7 of the original Federal Reserve Act, it was provided that all earnings, after necessary expense and dividends, should be paid to the United States as a franchise tax, except that one-half of such net earnings should be paid into the Federal Reserve bank surplus until it amounted to 40 percent of its paid-in capital stock. In 1919 , this provision was amended to provide that the net MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 117 earnings after expenses and dividends should be paid into the surplus fund until it amounted to 100 percent of the bank's subscribed capital stock, and that thereafter only 10 percent should be paid into the surplus fund. In other words, the law required that, after accumulation of the prescribed surplus, 90 percent of net earnings of the Reserve banks be paid to the United States as a franchise tax ; and this situation continued until 1933. The Banking Act of 1933 eliminated the requirement for the payment of a franchise tax but, at the same time, required the Federal Reserve banks to subscribe $139,000,000 for Federal Deposit Insurance Corporation capital stock, an amount equal to one-half of their surplus on January 1, 1933. The bill which became the Banking Act of 1933, as reported in both Houses of Congress and as passed by the Senate, contained the provision eliminating payment of the franchise tax by the Federal Reserve banks. However, when the bill was under consideration by the House, this provision for the elimination of the tax was stricken from the bill. The conference committee, however, followed the Senate version in this respect and restored the provision. The reports of the Banking and Currency Committees on the Banking Act of 1933 do not show reasons why the franchise tax was being eliminated . However, when the bill was presented to the House the chairman of the House committee stated, with respect to the subscription of $ 150,000,000 by the Treasury for stock in the Federal Deposit Insurance Corporation, that"This fund covers the larger part of sums that have been paid into the Treasury by the 12 Federal Reserve banks in lieu of a franchise tax. Approximately $150,000,000 is to be subscribed by the Federal Reserve banks, the plan requiring that each Federal Reserve bank subscribe for the capital stock of the Deposit Insurance Corporation in an amount equal to one-half of its surplus" (Congressional Record, vol. 77, pt. 4, p. 3836 ) . During debates in 1932 on an earlier draft of a similar bill, Senator Glass had stated his reasons for a proposal to eliminate the franchise tax. When the 1933 bill came before the House of Representatives, Representatives Patman and Keller expressed their opposition to the proposal. Excerpts from the statements by Senator Glass and Representatives Patman and Keller are attached. SUBSCRIPTION TO CAPITAL STOCK OF THE FEDERAL DEPOSIT INSURANCE CORPORATION The Banking Act of 1933 creating the Federal Deposit Insurance Corporation required that each Federal Reserve bank subscribe to non-dividend-paying stock of the Corporation in an amount equal to one-half of the Reserve bank's surplus on January 1 , 1933. When the proposal for cancellation of the Federal Deposit Insurance Corporation stock was under consideration, the Board recommended, and the legislation provided, that the amount received by the Corporation from the Federal Reserve banks for such stock be paid to the Treasury rather than returned to the Reserve banks . This was done in October 1947. PAYMENT OF INTEREST ON FEDERAL RESERVE NOTES In April 1947 the Board of Governors announced that it had decided to invoke the authority granted to it under section 16 of the Federal Reserve Act to levy an interest charge on Federal Reserve notes issued by the Federal Reserve banks. The purpose of this interest charge was to pay to the Treasury approximately 90 percent of the net earnings of the Federal Reserve banks for that Such payments have been continued for succeeding years. The statement pointed out that at the end of 1946 the surplus of each Federal Reserve bank was equal to its subscribed capital and that under this policy the Board would be able to accomplish the same results as were accomplished by the payment of a franchise tax. Prior to the adoption of the policy the proposal was discussed by Chairman Eccles with Representatives of Congress and with the Secretary of the Treasury. In particular, the matter was the subject for discussion between Representative Patman and Chairman Eccles at the hearings March 4, 1947, before the Committee on Banking and Currency on H. R. 2233 ( p. 29 ) . DISTRIBUTION OF FEDERAL RESERVE BANK NET PROFITS, WITH SPECIAL REFERENCE TO PAYMENTS TO THE TREASURY From earnings of the Federal Reserve banks since organization through 1951 the Treasury has received $ 1,175,000,000 as franchise tax, contribution for the 118 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT purchase of stock in the Federal Deposit Insurance Corporation, and interest on Federal Reserve notes. Net profits of the Federal Reserve banks since organization has been disposed of as follows : $1, 175, 000, 000 Total payments to Treasury. Franchise tax FDIC stock___ . Interest on Federal Reserve notes : 1947___ 1948. 1949_ 1950 1951 149, 000, 000 139, 000, 000$75, 000, 000 167, 000 , 000 193, 000, 000 197, 000, 000 255, 000, 000 887, 000, 000 Dividends to member banks_ . Paid U. S. Treasury from earnings on funds received from the Treasury for the purpose of making working capital loans to industry (sec. 13b loans ) Net transfers toReserves for contingencies_. Surplus ( sec. 7 ) ‒‒‒‒‒ Net profits since organization_. 306, 000, 000 2,000,000 106, 000, 000 538, 000, 000 2, 127, 000, 000 ATTACHMENTS Excerpts from statement by Representative Patman (Congressional Record, vol. 77, pt. 4, p. 3842) During debates in 1933 on the bill , Representative Patman, in commenting upon this proposed amendment, stated : "The money [ for the Federal Deposit Insurance Corporation ] is coming from three sources ; namely, $150,000,000 from the Treasury of the United States , $150,000,000 from the surplus fund of the Federal Reserve banks , which, as a matter of right, should be in the Treasury of the United States today. That money does not belong to the Federal Reserve banks. It belongs to the United States Treasury. It never has belonged to those banks. It never was intended that those banks should get that money. Therefore, of the $450,000,000 appropriated, $300,000,000 of it represents the people's money, coming from the Treasury of the United States. The other one-third will come from the depositors , one-half of 1 percent being assessed against the deposits of the banks. "Surplus fund of Federal Reserve banks.-Now, let me tell you about this surplus fund of the Federal Reserve banks. When those banks were organized, they were not intended as profit-making institutions. It was stated they were going to use the credit of this Nation, and for the purpose of compensating the people for the use of that credit, when they paid their operating expenses and 6-percent dividends on the amount of capital invested by the member banks the remainder would go into the Treasury as a franchise tax. As conclusive evidence, if a member bank should fail or should withdraw from this System, that member bank would only get its capital stock back. It does not get back a part of that surplus, because that surplus does not belong to the member bank. It belongs to the Treasury of the United States. "Evidence of intent. The law provides that in the event a Federal Reserve bank becomes insolvent and it is necessary to liquidate that bank after the expenses of the bank are paid, the surplus goes into the Treasury of the United States. If the theory of the gentleman from Alabama, Mr. Steagall, is correct, that surplus should go back to the member banks that subscribed to the capital stock in that particular Federal Reserve bank. It is written into the law from beginning to end, that as to those banks using the credit of our Nation in the manner they are, the excess profits they make shall be paid into the Treasury of the United States. Now you come along in section 3 of this bill and attempt to change the entire policy of our Government in that regard. You attempt to divert from the Treasury of the United States back to the Federal Reserve banks that surplus, when there was written into the law language that said it should go into the Treasury of the United States . Now you come here and claim you are going MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 119 to use that money as an insurance premium to insure bank deposits for private banks, and that it is necessary to do it in the interest of the general welfare. Yes ; I say it is all right to do it in the interest of the general welfare, but do not restrict it to just 6,000 banks . Give all banks an opportunity to come in , and when this bill is subject to amendment under the 5-minute rule, I expect to offer two amendments in particular. "One is to strike out section 3 which changes the policy of this Government in regard to the excess earnings of the Federal Reserve banks. * * Excerpts from statement by Senator Glass (Congressional Record, vol. 75, pt . 9, pp. 9885-9886) During debates in 1932 on an earlier draft of the bill, Senator Glass, in commenting upon this proposed amendment, stated : "Section 4 of the bill relates to the distribution of earnings. Although the Federal Government has never expended a dollar in the maintenance of the Federal Reserve System and does not own one dollar of proprietary interest, it has collected in excess of $150,000,000 from the earnings of the Federal Reserve banks upon the pretense that it was a franchise tax for privileges granted. Senators will find upon examination that the 12 Federal Reserve banks do, without charge, a fiscal business for the United States Government that 20 times over compensates the Government for any privilege the Federal Reserve banks may have 16* * * The Federal Reserve banks do a fiscal business for the United States Government that has never been paid for. The Government has not floated a loan since the beginning of the World War that it has not done it through the agencies and instrumentalities of the Federal Reserve Banking System. "We propose now a different distribution of the earnings of the System. We propose to pay the member banks 6 percent cumulative dividends on their stock, as always has been done. Then we propose to transfer future earnings of the banks to surplus account. We propose to recapture from the Federal Treasury $125,000,000 of the $150,000,000 and odd that has been paid into the Treasury, and pass it to the credit of a revolving fund for prompt liquidation of failed banks. * * * * * * 66* * * In other words, we propose to take $125,000,000 from the Federal Treasury, which we conceive to be a recapture of a part of a larger amount paid into the Treasury to which it was not entitled. Then we propose to take onequarter [ subsequently changed to one-half ] of the existing surplus of the Federal Reserve banks themselves and apply it to this fund ; but hereafter the future earnings of the Federal Reserve banks will go to the surplus fund of the Federal Reserve banks and none to the Government." Excerpts from statement by Representative Keller ( Congressional Record, vol. 77, pt. 4, pp. 3913, 3914 ) During debates in 1933 on the bill, Representative Keller, in commenting upon this proposed amendment, stated : "This bill is in most regards a splendid bill. It represents a vast amount of labor on the part of the committee. But for all their thought and care somehow a section has found its way into this bill that would nullify most of its benefits. I refer to section 3, which seeks to turn over to this privately owned bankers' banking system for all time to come every penny of the franchise tax which has existed from the start. "A previous Congress, as representatives of our people, saw fit to give a small group of our citizens the power to issue money. For that privilege it exacted a small tax. That small group has paid itself a generous profit on that privilege in the past, and it now comes to the representatives of a sovereign power and asks that it be given all the profit. "Now, what does this section 3 mean? It means this and nothing less, that if section 3 becomes the law we forever give up all claims to any return to the Government whatever. If section 3 had been in the original law, we would not have received the $ 149,000,000 which we have received, but the Federal Reserve System would have added that amount to the present $ 279,000,000 surplus, or $428,000,000 would belong to this purely private banking system. 120 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT "Therefore, if we keep section 3 in this bill, it means the people will never receive another penny from this private banking system for the tremendously valuable franchise which it holds. Any man who votes to retain it in the bill votes to take from the people all the hundreds of millions of money which will come to them if this section is left out of this bill." Representative PATMAN. Anyway, notwithstanding the repeal of that 90-percent provision, you have agreed voluntarily to pay-the Federal Reserve banks, each bank-into the Treasury that 90 percent just as though the law were effective at this time, and you are doing that now ? Mr. MARTIN . That is right. Representative PATMAN. The point I am getting to now is with respect to a Federal Reserve bank. Who determines the expenses of that bank ; who determines what they can legally spend that money for and what it cannot be spent for, and the purposes for which it can be used ? Who determines that at each bank ? Mr. MARTIN. Each Reserve bank has a board of directors . Representative PATMAN. And they determine it ? Mr. MARTIN . They determine it. We have some budgetary procedures which are listed in the answers to the questionnaire, but I think they are rather a distinguished group of directors who have had a good deal of business experience, and who pass on it. Representative PATMAN. Yes ; I am sure they all are fine people. But, now, who supervises that ; after they pass on it, who looks over it ? Mr. MARTIN. The Board of Governors, sir. Representative PATMAN . The Board of Governors looks over it ? Mr. MARTIN . That is correct, sir. Representative PATMAN. And what policy do they have concerning the expenditure of these funds ? Do you lay down any rules that you can spend it for this purpose but you cannot spend for that purpose, and do you have any do's and don'ts in it? Mr. MARTIN . We have a very careful budget review on a businessRepresentative PATMAN. Do you have a copy of that that I could see ? Mr. MARTIN. In the answer to the questions we have listedRepresentative PATMAN. I have seen that. You need not furnish anything that is already furnished or has already been furnished, in answer to the questions. Mr. MARTIN . Well, we tried to cover our procedures thoroughly. Representative PATMAN. I was given information here a while back that the Federal Reserve banks have gotten into the policy and habit of even calling conferences, inviting people from a distance and paying their way and their hotel bills and paying for the meetings . Have you run into anything like that ? Mr. MARTIN. All the expenses of the Reserve banks are accounted for by major functions in the statement of expenses already submitted . They are all accounted for. Representative PATMAN. You mean where something like that would be itemized ; it would be identified ? Mr. MARTIN. It is my understanding it would be included under the appropriate functional classification. Representative PATMAN. My attention has been called to the statements being gotten out by these banks, one in particular-and it hap- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 121 pened to be the Dallas, Tex., bank ; I will name it so that others will not be involved-that is on the fringe of or border of propaganda, pure propaganda, to influence legislation or the action of the Congress. Do you know anything about that ? Mr. MARTIN. No , sir ; I do not know the particular reference. Representative PATMAN. Well, who would pass on the legality of such an expenditure as that ? Suppose they do get out a booklet there or something of that order, and they distribute it at their own expense, who would pass on whether or not that was a legal expenditure ? Mr. MARTIN . The board of directors of the bank. Representative PATMAN . Of that bank? Mr. MARTIN. Operating under budget approvals from the Board of Governors here in Washington . Representative PATMAN. Who audits that bank ? Mr. MARTIN. As stated in the reply to the questionnaire, each Federal Reserve bank is audited by a resident auditor, an officer of the bank, appointed by the board of directors, who is responsible directly to the directors. In addition, each Federal Reserve bank is examined at least once a year by the Federal Reserve Board through its staff of examiners. Representative PATMAN. And the Federal Reserve Board- whe does the Federal Reserve Board get ? Mr. MARTIN . Who audits the Federal Reserve Board ? Representative PATMAN. Yes. Mr. MARTIN . Well, we are about to have a noted private firm audit our accounts. Representative PATMAN. Who selected this private firm ? Mr. MARTIN. It was selected by the Board of Governors. Representative PATMAN. Well, since you are a servant of the Congress, why did you not ask the Congress to suggest someone to audit the Federal Reserve Board and the Federal Reserve Bank ? Mr. MARTIN. Because, Mr. Chairman, budgetary control of our operations, of our budget, is fundamental in our concept of the independent status of the System. If you want to nationalize the System , why, the surest way to do it is through control of the budget . If we are not handling our budgetary expenses properly, why, the Banking and Currency Committee, your committee, any other committee, can see listed our expenses and what they are for and why we expended the money, and we are subject to your comments on it . But just let me mention one thing, the voluntary restraint program as one How in the world could we have embarked upon that example . program unless we had known in advance that we were going to encounter a period of excitement and expansion of credit ? We had to have budgetary discretion to organize and set up that program, which was provided for under the Defense Production Act as a means of working toward the preservation of the purchasing power of the dollar. Representative PATMAN. You mean by that that you must have a large amount of money at your disposal, and you do not know how much it will take . Mr. MARTIN . We make a very careful estimate. We follow a budget procedure all the way through, but the discretion as to whether we should exceed the budget or not, we think, is a fundamental prerogative of an effective Reserve banking system. 122 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative PATMAN. I notice you said that you are under the direction and scrutiny of Congress . Mr. MARTIN. That is correct. Representative PATMAN. Now, of course, normally an agency of Congress is required to submit to an examination by the General Accounting Office, and I noticed this morning in your answers to Senator Douglas ' questions you oppose that. You do not believe that is a good thing to do, to have your 12 banks and the Board audited by the General Accounting Office. Mr. MARTIN . Because I think that would be a step toward nationalization of the System . Representative PATMAN. Nationalization of the System ? Well, is it not pretty well nationalized now, Mr. Martin ? On every issue of money that belongs to the Government, the Bureau of Printing and Engraving prints the money. Mr. MARTIN. I do not believe it is today, Mr. Chairman . I think that it maintains a balance between the public and the private status. I think that is the concept on which it was founded and the way it should be maintained . Representative PATMAN . You do not mean to say that the small amount of stock that the banks hold, 6 percent of their capital, 3 percent paid up, I believe it is-6 percent capital and 3 percent paid- that is not enough to where you would say that the banks own the Federal Reserve System, do you? Mr. MARTIN . No , sir ; I would not say that. I think that the Federal Reserve banks are quasi -public institutions, and I think that this stock ownership is a means of providing for member-bank participation. It is a part of the democratic process to provide for participation by the member banks in determining who some of the directors of the Reserve banks will be. While I do not think it is a vital thing, it seems to me that the advantages of retaining that ownership for the purpose of obtaining this participation on a democratic basis in the individual Federal Reserve banks more than outweighs any disadvantages. Representative PATMAN. It is more of a token subscription , is it not ? Mr. MARTIN. It is more of a token ; yes, sir. Representative PATMAN. It does not really amount to anything so far as Mr. MARTIN. It does not amount to a great deal in terms of stockholders ' control, but it does give them a participation and interest in the System that I think they would not have without it. Representative PATMAN. What is the business done by the banks in a year ? Does it run into two or three hundred billion or a trillion dollars a year ? Mr. MARTIN. The collection of checks, I would not have any way Representative PATMAN. Let us see, it was not two trillion dollars last year, was it ? Mr. YOUNG. It could have been. Representative PATMAN . Two trillion dollars ? Mr. YOUNG. Largely, in collections of checks. Representative PATMAN. That is in clearing checks ? Mr. YOUNG. In clearing checks. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 123 Representative PATMAN. In transactions-two trillion dollars ; that is two thousand billion dollars. I cannot comprehend that much money, but certainly Mr. MARTIN. There is a lot of service rendered. Representative PATMAN. Yes ; a lot of service rendered ; I know there is. Concerning the scrutiny of Congress, normally the Congress appropriates money for its agencies. How would you feel about turning in all of your funds to the Treasury, like dozens of other agencies do now, and getting a direct appropriation from Congress each year ? Mr. MARTIN. Well, I would think that our status as an independent agency had been severely challenged by such a process. Representative PATMAN. Why would it ? That would just be under the scrutiny of Congress, and you say you are under the scrutiny of Congress. Mr. MARTIN. We are under the scrutiny of Congress, but we retain budgetary discretion. Now, the Congress can take it away from us. Representative PATMAN. But you are not under it in an effective way. Now, under parliamentary rules and procedures it is easy to say that you are under the scrutiny of Congress, but you are not inconvenienced by it if they have no power to control the purse strings of your agency. It is a rather cumbersome procedure to pass specific laws controlling an agency, so you are not under much restraint or inconvenience at all . Of course, I do not mean inconvenience just to inconvenience you, but I mean to quickly pass upon policies, and even major policies. Mr. MARTIN. The Board's funds are not appropriated funds. They come through assessments on the Reserve banks, and that is part of the mechanics of the Reserve System. Representative PATMAN. From which banks, the Federal Reserve ? Mr. MARTIN. The Federal Reserve banks . Representative PATMAN. Well, the Federal Reserve banks use Government money, do they not ? Mr. MARTIN. Not for their expenses. Representative PATMAN. I mean that is what they deal in with Government money. They deal in credit of the Nation, do they not ? Mr. MARTIN. They deal Representative PATMAN. That is their stock in trade. Without that they would not have anything, would they? Mr. MARTIN. No. They are the service mechanism for the banking machinery of the country, and as such the concept was that the System would have an independent status to perform that service. And I think that budgetary discretion is vital to it. Representative PATMAN. And you would be opposed to any change in the law whereby you would deposit your funds in the Treasury like other departments, like other agencies do , and have to come to Congress for your funds ? Mr. MARTIN. I do, sir. Representative PATMAN. You would be opposed to that ? Mr. MARTIN. I would be opposed to it. Representative PATMAN. Mr. Bolling , did you want to ask some questions ? 97308-52-9 124 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Representative BOLLING. Yes, Mr. Chairman ; I have some more. Mr. Martin, the President's Economic Report transmitted in January recommended that Congress provide power for the Board of Governors of the Federal Reserve System to impose additional bank reserve requirements . Are you familiar with the nature of the proposed weapons that are suggested by that proposal of the President ? Mr. MARTIN. Well , I do not know what weapons were proposed, Mr. Bolling, becauseRepresentative BOLLING. They were not proposed specifically, and I am trying to find out whether you know what specifically was in the President's mind when he made the suggestion . Mr. MARTIN. No , sir ; I do not. Representative BOLLING . I gather from your statement that you do not feel that at this time such additionalMr. MARTIN . That is correct. Representative BOLLING. You think that there should be consideration given by this committee to making them available, not with the idea that they would be used now, but that they might be necessary in the future ? Mr. MARTIN . Well, I think we would always like to have stand-by authority, and I think it would be very desirable for your committee to review the whole reserve situation . But at the moment I do not think we need it, and I would hesitate to request authority when we do not need it. Representative BOLLING. Do I gather from that that you do not foresee the possibility of needing it ? Mr. MARTIN. At the moment I do not foresee the possibility of it. Representative BOLLING. On the 26th of February 1951 , the President, in a memorandum requested of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve, the Director of the Defense Mobilization, and the Chairman of the Council of Economic Advisers to study ways and means to provide the necessary restraints on private credit expansion and , at the same time, to make it possible to maintain stability in the market for Government securities. He also said : While this study is under way, I hope that no attempt will be made to change the interest rate pattern, so that stability in the Government security market will be maintained. When this memorandum from the President was released on the 26th of February, Mr. Wilson expressed the hope that a report could be made by the four agency heads to the President within 10 days or 2 weeks. If my memory serves me correctly, the accord between the Federal Reserve and the Treasury was in March ? Mr. MARTIN . March 4. Representative BOLLING . In this report that Mr. Wilson had ex-. pressed the hope would be made to the President within 10 days or 2 weeks, was filed on May 11. In reaching their accord in early March of 1951 , did the Treasury and the Board consult with the Director of Defense Mobilization and the Chairman of the Council of Economic Advisers prior to the announcement of that accord ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 125 Mr. MARTIN. I do not think we formally consulted with them with respect to the terms of the accord. Mr. Wilson was informed of the progress that was being made, and Mr. Keyserling was informed that the accord was being made and the general essence of the accord was discussed with them. I do not know that we can truthfully say that they actively participated in the formulation of the accord, but they were consulted about it. Representative BOLLING. Mr. Chairman , I would like unanimous consent to print in the record at this point the memorandum from the President to the four agencies, together with the report of the four agencies, submitted to the President on May 11 . Representative PATMAN. Without objection it will be done. (The documents referred to follow :) The President met this morning (February 26, 1951 ) with the following : Mr. Thomas McCabe, Chairman, Board of Governors , Federal Reserve System Mr. Charles Wilson, Director, Office of Defense Mobilization Mr. Edward Foley, Under Secretary of the Treasury Mr. Charles Murphy, special counsel to the President The Council of Economic Advisers, Mr. Leon H. Keyserling, Chairman ; Mr. John D. Clark and Mr. Roy Blough Mr. William McChesney Martin, Assistant Secretary of the Treasury Mr. Allan Sproul , Vice Chairman , Federal Reserve Open Market Committee Mr. Harry A. McDonald, Chairman, Securities and Exchange Commission. The President read the attached memorandum to the group and there was a general discussion of the subject covered by the memorandum. The President did not ask any of those present for any commitments on the subjects under discussion, but expressed the hope that they would go ahead speedily with the study requested. Mr. Wilson expressed the hope that a report could be made to the President within 10 days or 2 weeks. Memorandum for : The Secretary of the Treasury, The Chairman of the Board of Governors of the Federal Reserve System , The Director of Defense Mobilization , The Chairman of Council of Economic Advisers. I have been much concerned with the problem of reconciling two objectives : First, the need to maintain stability in the Government security market and full confidence in the public credit of the United States, and second, the need to restrain private credit expansion at this time. How to reconcile these two objectives is an important facet of the complex problem of controlling inflation during a defense emergency which requires the full use of our economic resources. It would be relatively simple to restrain private credit if that were our only objective, or to maintain stability in the Government security market if that were our only objective. But in the current situation , both objectives must be achieved within the framework of a complete and consistent economic program . We must maintain a stable market for the very large financing operations of the Government. At the same time, we must maintain flexible methods of dealing with private credit in order to fight inflation. We must impose restraints upon nonessential private lending and investment. At the same time, we must maintain the lending and credit facilities which are necessary to expand the industrial base for a constant build-up of our total economic strength. Instead of fighting inflation by the traditional method of directing controls toward reducing the over-all level of employment and productive activity, a defense emergency imposes the harder task of fighting inflation while striving to expand both employment and production above what would be regarded as maximum levels in normal peacetime. What we do about private credit expansion and about the Government securities market is, of course, only a part of the problem that confronts us. ful program for achieving production growth and economic stability in these critical times must be based upon much broader considerations. 126 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT We must make a unified, consistent, and comprehensive attack upon our economic problems all along the line. Our program must include, in proper proportion, production expansion policy, manpower policy, tax policy, credit policy, debt management and monetary policy, and a wide range of direct and indirect controls over materials, prices, and wages. All of these policies are necessary ; each of them must be used in harmony with the rest ; none must be used in ways that nullify others. We have been striving in this emergency to develop such a unified program in the public interest. Much progress has already been made, both on the production front and on the antiinflation front. Many peacetime activities of Government, including the activities of lending and financing agencies, have been pruned down. Cut-backs of civilian supplies and allocations of essential materials have been successfully undertaken. Important expansion programs for basic materials and productive capacity needed in the defense effort have been gotten underway. Price and wage controls have been initiated . Restraints on consumer and real estate credit have been applied. Large tax increases have been enacted, and additional tax proposals are now pending. In all these fields further action is being planned and will be taken as needed. One outstanding problem which has thus far not been solved to our complete satisfaction is that of reconciling the policies concerning public-debt management and private credit control. Considering the difficulty of this problem, we should not be discourged because an ideal solution has not yet been fund. The essence of this problem is to reconcile two important objectives, neither of which can be sacrificed . On the one hand, we must maintain stability in the Government security market and confidence in the public credit of the United States. This is important at all times. It is imperative now. We shall have to refinance the billions of dollars of Government securities which will come due later this year. We shall have to borrow billions of dollars to finance the defense effort during the second half of this calendar year, even assuming the early enactment of large additional taxes, because of the seasonal nature of tax receipts which concentrate collections in the first half of the year, and because of the inevitable lag between the imposition of new taxes and their collection by the Treasury. Such huge financial operations can be carried out successfully only if there is full confidence in the public credit of the United States based upon a stable securities market. On the other hand, we must curb the expansion of private loans, not only by the banking system but also by financial institutions of all types, which would add to inflationary pressures. This type of inflationary pressure must be stopped, to the greatest extent consistent with the defense effort and the achievement of its production goals. The maintenance of stability in the Government securities market necessarily limits substantially the extent to which changes in the interest rate can be used in an attempt to curb private credit expansion. Because of this fact, much of the discussion of this problem has centered around the question of which is to be sacrificed-stability in the Government securities market or control of private credit expansion . I am firmly convinced that this is an erroneous statement of the problem. We need not sacrifice either. Changing the interest rate is only one of several methods to be considered for curbing credit expansion. Through careful consideration of a much wider range of methods, I believe we can achieve a sound reconciliation in the national interest between maintaining stability and confidence in public credit operations and restraining expansion of inflationary private credit. We have effective agencies for considering this problem and arriving at a proper solution . Over the years, a number of important steps have been taken toward developing effective machinery for consistent and comprehensive national economic policies. One of the earliest steps in this century was the establishment of the Federal Reserve System before World War I. At that time, under far simpler conditions than those now confronting us, the Federal Reserve System was regarded as the main and central organ for economic stabilization. After World War II, in a much more complex economic situation and a much more complex framework of governmental activities affecting the economy, the Council of Economic Advisers was established by the Congress under the Employment Act of 1946 to advise the President and help prepare reports to the Congress concerning how all major economic policies might be combined to promote our economic strength and health. Still more recently, in the current defense emergency, the Office of Defense Mobilization has been established to coordinate MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 127 and direct operations in the mobilization effort. In addition, some of the established departments, such as the Treasury Department, have always performed economic functions which go beyond specialized problems and affect the whole economy . Consequently, I am requesting the Secretary of the Treasury, the Chairman of the Federal Reserve Board, the Director of Defense Mobilization, and the Chairman of the Council of Economic Advisers to study ways and means to provide the necessary restraint on private credit expansion and at the same time to make it possible to maintain stability in the market for Government securities. While this study is underway, I hope that no attempt will be made to change the interest rate pattern, so that stability in the Government security market will be maintained. Among other things, I ask that you consider specifically the desirability of measures : ( 1 ) to limit private lending through voluntary actions by private groups, through Government-sponsored voluntary actions such as was done in a narrow field by the Capital Issues Committee of World War I, and through direct Government controls ; and (2 ) to provide the Federal Reserve System with powers to impose additional reserve requirements on banks. Under the first heading, I am sure that you are aware of the efforts that are already underway by the American Bankers Association , the Investment Bankers Association , and the life insurance association. I want you to consider the desirability of this or other kinds of private voluntary action in bringing about restraint on the part of lenders and borrowers. I should like you to consider also the establishment of a committee similar to the Capital Issues Committee of World War I, but operating in a broader area. The objectives of such a Committee would be to prevail upon borrowers to reduce their spending and to curtail their borrowing, and to prevail upon lenders to limit their lending. The activities of this committee could be correlated with those of the defense agencies under Mr. Wilson with the objective of curtailing unnecessary uses of essential materials. Furthermore, I should like you to consider the necessity and feasibility of using the powers provided in the Emergency Banking Act of 1933 to curtail lending by member banks of the Federal Reserve System. These powers are vested in the Secretary of the Treasury subject to my approval. The Secretary could by regulation delegate the administration of this program to the 12 Federal Reserve Banks, each to act in its own Federal Reserve District under some flexible procedure. The program could be extended to institutions other than member banks, if desired, by using the powers provided by the Trading with the Enemy Act. Under the second heading, you will recall the recommendation I made to the Congress a number of times in recent years to provide additional authority for the Federal Reserve System to establish bank reserve requirements. I should like you to consider the desirability of making that or another recommendation with the same general purpose at the present time. You are all aware of the importance of this problem, and the need for an early resolution . I should like your study to proceed as rapidly as possible in order that I may receive your recommendations at a very early date. asking the Director of Defense Mobilization to arrange for calling this group together at mutually convenient times. At the same time that we are working to solve this problem of maintaining the stability of the Government securities market and restraining private credit expansion , we shall, of course, continue vigorously to review Government lending and loan guarantee operations. Since the middle of last year, we have taken a series of steps to curtail such operations and limit them to amounts needed in this defense period. I am directing the agencies concerned to report to me by March 15 on the nature and extent of their current lending and loan guarantee activities, so that these operations may again be reviewed as part of our over-all anti-inflationary program. EXECUTIVE OFFICE OF THE PRESIDENT, OFFICE OF DEFENSE MOBILIZATION, Washington, May 17, 1951. The PRESIDENT, The White House, Washington, D. C. DEAR MR. PRESIDENT : Referring to your memorandum of February 26, 1951, addressed to the Secretary of the Treasury, Chairman of the Board of Governors of the Federal Reserve System, the Director of the Office of Defense Mobilization, 128 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT and the Chairman of the Council of Economic Advisers, asking us to study ways and means to provide necessary restraint on private credit expansion and at the same time make it possible to maintain stability in the market for Government securities, I am enclosing herewith a signed report of this committee. I have been acting as chairman of the committee, and the report speaks for itself. Sincerely yours, CHARLES E. WILSON. REPORT OF THE FOUR-MEMBER COMMITTEE APPOINTED FEBRUARY 26, 1951 INTRODUCTION The President's memorandum of February 26, 1951, to the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Director of Defense Mobilization, and the Chairman of the Council of Economic Advisers stated : "I am requesting the Secretary of the Treasury, the Chairman of the Federal Reserve Board, the Director of Defense Mobilization, and the Chairman of the Council of Economic Advisers to study ways and means to provide the necessary restraint on private credit expansion and at the same time to make it possible to maintain stability in the market for Government securities." The present problem of restraining the expansion of credit must be attacked under conditions differing vastly from those of any other inflationary period in the Nation's history. To a large degree the problem is fashioned by the continuing influence of the tremendous accumulation of public debt during World War II, and by the imminent task not only of refunding the large portion of that debt which matures in the near future but also of undertaking new financing. Conditions in the market for Government , securities become, therefore, a compelling consideration . Within this framework, nonetheless, restraints must be exerted on over-all credit expansion , particularly for nondefense purposes, in order to keep combined Government and private demands within the bounds of available supplies of goods and services and yet not interfere with the maximum possible expansion of output in vital lines . We submit to you in the present report ( I ) a brief review of current problems of credit control, as they have emerged in the postwar period and as we face them in connection with the national defense effort ; ( II ) a review of the accomplishments in these fields since your memorandum of February 26 ; ( III ) a summary of credit controls available under permanent , expiring, and proposed legislation ; and ( IV ) our conclusions and recommendations with respect to further needed actions. I. CURRENT PROBLEMS OF CREDIT CONTROL During World War II, because of the large Government deficits, banks and other financial institutions and many other investors bought large quantities of Government securities. In the postwar period , Federal Reserve use of traditional instruments to restrain credit was conditioned by the objective of maintaining a market for these securities without a substantial and general increase in interest rates. This latter objective limited the effective use of open market operations for purposes of counteracting inflation . The possible restrictive effect of increases in reserve requirements was also limited by the large holdings of Government securities by banks and other institutions. General credit control again became a matter of national concern when new inflationary pressures developed after the initiation of the expanded defense program. Various measures were adopted by the Federal Reserve and other Government agencies in this period to restrain credit expansion . Nevertheless, the needs of public debt management, the large available supply of liquid assets , and the increased accent upon full employment and production, continued to limit the Federal Reserve System's pursuit of a more effective policy of credit limitation . The period since the outbreak in Korea has been characterized by anticipation on the part of consumers and business concerns of the effects of the expanded national security program. This anticipatory buying was financed in a variety of ways. Credit expansion was one of the available means which financed the enhanced demand, and the support policy was one of the factors which facilitated credit expansion . Commercial banks and other financial institutions were in a favorable position to extend credit, since they could always sell Government MONETARY FOLICY AND MANAGEMENT OF PUBLIC DEBT 129 securities and the Federal Reserve System stood ready to make purchases whenever other investors were not ready to buy at prevailing prices. While any feasible Federal Reserve policy could not have prevented individuals and business concerns from financing their purchases, a stronger policy of credit restraint could have made it more difficult and would have reduced the total amount. Part of the credit extended , of course, was necessary , and as a result the American economy today is better stocked and better tooled for tackling a large defense production program than it was at the time of the Korean outbreak. The fact that some credit extension serves a highly useful purpose in the defense effort, while other is less useful or even harmful under present circumstances, makes it desirable to use credit controls as selectively as possible. While selective credit controls , such as consumer credit, real-estate credit, and credit for securities markets, have a continued usefulness in the mobilization period, general credit curtailment, or a general rise in interest rates , does not have so selective an impact in relation to defense priorities. General credit control is, however, essential to reinforce the effectiveness of the voluntary and other efforts of restraint. The objective of a discriminating credit policy is further aided by Government agencies through loan guarantees, tax amortization, and direct financial aid to defense-related activities. Supplemented by such programs , general credit controls are an effective instrument in the program of mobilization and stabilization . They must, of course, be reconciled with the Government's requirements for refunding and new financing. Credit policy will be modified in character and intensity as the mobilization effort passes through various stages. We are now shifting from the preparatory to the production phase of the defense effort. In the preparatory stage, private credit expanded while Government budgets showed a surplus. Expenditures for the defense programs have now commenced to increase substantially and as long as these expenditures are not financed on a pay-as-we-go basis the Treasury will be faced with the need for deficit financing in addition to large refunding operations . There is at the same time no certainty that private demand for investment and credit will subside. At the peak of defense production direct controls of materials may curtail private credit demands. But physical controls are still in the developmental stage and their full effect cannot be foreseen. We are facing therefore a period in which we have to deal with both the problem of Federal financing and the need for controlling private credit expansion . The large existing inventories and the fluctuations in the public's appraisal of the seriousness of the international situation may create a temporary relaxation in the demand for credit. Such a relaxation , however, may be of short duration only, and the slightest darkening of international relations may set in motion another wave of buying. Even if requirements of national security should remain high for a considerable time, we hope that an increase in total output may, after a few years, permit a relaxation or modification of physical controls . We would then enter another stage, still fully within the period of mobilization, during which some expansion in the production of consumer goods and in private investment might lead to a renewed growth in demand for private credit. In that event, our chief reliance must be on fiscal, monetary, and credit policy. II. ACCOMPLISHMENTS There has been a substantial record of accomplishment since the President appointed this Committee on February 26, 1951 . On March 4, the Treasury and the Federal Reserve System announced that they had reached "full accord with respect to debt management and policies to be pursued which would affect the successful financing of the Government's requirements and, at the same time, would minimize monetization of the public debt". On March 4, the Treasury announced the offering of a new investment series of 24 percent long-term nonmarketable bonds in exchange for the outstanding 22 percent marketable bonds of June 15 and December 15, 1967-72. Subsequently, during the time allowed investors for the exchange, more than $13.5 billion of the outstanding amount of $19.7 billion of 22 percent marketables were offered in exchange for the new nonmarketables. Of the total exchange, $5.6 billion were owned by the Federal Reserve Banks and Government investment accounts, and of these approximately 20 percent was acquired in the few weeks prior to the Treasury's announcement and during the period in which exchange was permitted. 130 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Since March 5, prices of outstanding Government securities have been permitted to decline, a number of the issues falling below par. An important result of this action has been the effect in the markets for mortgages and new capital issues. It is still too early to appraise conclusively the effectiveness of this measure. It may be noted that, beginning in April, the rate of expansion in bank loans began to slacken. But this change may also reflect seasonal factors in the demand for credit, the softening of consumer demand that became apparent in that month, and voluntary credit restraints then undertaken, as well as the decline of security prices. It appears that new commitments by insurance companies and savings banks to purchase mortgages have been reduced. Some plans for new securities to be issued have been withdrawn or postponed and others have had to be revised, although the total volume of new issues has continued very large. The new tone in the market may have an important effect upon many new offerings that were, or might otherwise have been, contemplated. 4. On March 9, a program for voluntary credit restraint was instituted by the Board of Governors of the Federal Reserve System, pursuant to section 708 of the Defense Production Act of 1950, after consultation with the Office of the Attorney General and with the Federal Trade Commission. This program is now in full operation and includes major financial institutions throughout the Nation. The program has set up a national committee as well as regional committees covering all sections of the country. The national committee has issued three bulletins, the first dealing with means of restraining inventory financing, the second with the principles to be followed in financing capital expansion programs and the third with State and local government financing. These bulletins, together with the statement of principles of the program, have been distributed to all financing institutions participating in the program to provide a common guide for combating inflationary loan expansion in their respective fields. Other bulletins, as may be appropriate and helpful, will be issued from time to time. Meanwhile financing institutions are requesting the regional committees for opinions as to the desirability under present conditions of loans in debatable classes. These opinions are being relayed to all committees to insure uniform policy Nation-wide. While there has not yet been time to build up a body of statistical information to enable the committee to analyze thoroughly the effects of the program, there are indications that the initiation of the program has had a salutary effect on the trend of credit. Endorsements of the program and pledges of wholehearted cooperation have been received from many representative industry groups. Under these circumstances, those connected with the program are most encouraged, and it is the committee's view that the authorization for this unique cooperative effort as one means of restraining the further expansion of private credit should be continued . On March 12, the Director of Defense Mobilization appointed five task forces. from among the personnel of the Treasury, Board of Governors of the Federal Reserve System, the Council of Economic Advisers, and the Office of Defense Mobilization to implement the joint studies of these agencies undertaken in response to the President's memorandum . On March 23, the Director of Defense Mobilization wrote the Secretary of Commerce, referring to the President's memorandum of February 26, 1951, and suggested that the Business Advisory Council of the Department of Commerce undertake a program to complement the voluntary credit restraint program. The implication of the letter was that efforts of lending institutions to limit credit expansion would be more effective if borrowers exercised restraint in their requests for financing. As a result, the business advisory council has undertaken a continuing Nation-wide program to bring to the attention of lenders and borrowers the fact that the success of the voluntary credit restraint program rests equally on both of them. On May 7, the Director of Defense Mobilization wrote the Governors of all States, the mayors of all major cities and financial officers of principal counties and other political subdivisions. He requested that all State and municipal projects, which necessitated borrowing and which were postponable, be postponed. In particular, he asked that every proposed borrowing by a State or municipality of $1 million or over, before being consummated, receive the approval of one of the regional committees appointed under the voluntary credit restraint program. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 131 III- -CREDIT CONTROLS AVAILABLE UNDER PERMANENT LEGISLATION , EXPIRING LEGISLATION AND PROPOSED LEGISLATION The following summary indicates the more important actions for credit restraint that can be taken under existing legislation, that can be employed if expiring legislation (notably the Defense Production Act of 1950) is extended, and that could be initiated if new legislation were passed in conformance with the recommendation made by the committee. Such a classification clarifies the problem and indicates the responsibilities of the several branches and agencies of the Government in implementing a program designed to achieve credit restraint and stability in the market for Government securities . 1. Permanent legislation (a ) The Federal Reserve System has power to change rediscount rates. (b) The Open Market Committee of the Federal Reserve System has the authority to conduct open-market operations in Government securities and such transactions can be undertaken with a view to stabilizing the market for such securities and tightening or relaxing credit conditions. (c) Existing legislation would permit the Board of Governors of the Federal Reserve System to raise reserve requirements of central reserve city banks very slightly above existing levels. (d) Under existing legislation the Board of Governors can amend regulations T and U so as to raise margin requirements for listed securities to 100 percent, and restrict withdrawals and substitutions of securities in margin accounts. (e) Section 5 of the Trading with the Enemy Act of 1917, as amended, and section 4 of the Emergency Banking Act of 1933 authorize the President, by Executive order, to regulate and limit the issuance of credit. While these powers should not be exercised except in an extraordinary emergency, the statutory authority appears to be sufficient. 2. Expiring legislation (a) Section 708 of the Defense Production Act of 1950 provides the legislative basis for the present voluntary credit restraint program. (b) Regulation X of the Board of Governors of the Federal Reserve System, which governs the extension of real estate construction credit, stems from authority granted the President under section 602 of the Defense Production Act of 1950 ; he in turn is permitted to utilize the services of the Federal Reserve System in this connection . Present authority would permit the Board of Governors to restrict the use of real estate construction credit substantially more than has already been done. Should the proposed change in the act be enacted (H. R. 3871 and S. 1397, 82d Cong. 1st sess., sec. 106 ) it would be possible to restrain the use of real estate credit in the purchase of existing structures. (c) Section 601 of the Defense Production Act of 1950 authorizes the Board of Governors of the Federal Reserve System to exercise consumer credit controls in accordance with Executive Order 8843 (August 9, 1941 ) . Regulation W of the Board of Governors restricts the use of consumer credit ; the use of such credit could be tightened substantially beyond the degree currently permitted . 3. Proposed legislation (a ) As noted above, section 106 of H. R. 3871 and S. 1397 would permit restrictions on the use of real estate credit in connection with the purchase of existing structures. (b) Section 611 of H. R. 3871 and S. 1397 would permit the President, whenever he determines that speculative trading on boards of trade causes or threatens to cause unwarranted changes in the price of any commodity, to prescribe rules governing the margin to be required with respect to speculative purchases or sales for future delivery. The provisions of section 21 of the Securities and Exchange Act of 1934 are made applicable in administering and enforcing this provision. (c) Reserve requirements of commercial banks have been raised virtually to the limits of existing authority. It is recommended that, as an emergency measure, legislation be sought to empower the Reserve authorities for a limited period to impose additional reserve requirements, either increasing the authorized percentages or in some other appropriate way that will have a minimum adverse effect on the Government security market. The refunding and new issue operations of the Treasury in the last half of this calendar year alone amount to in the neighborhood of $50 132 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT billion. Under these circumstances, it is imperative that any additional requirements for bank reserves imposed by the Federal Reserve should be such that they do not have a disruptive effect on the market for Government securities. In view of the emergency such requirements should apply to all insured banks. The feasibility of permitting nonmember insured banks to hold the additional reserves in balances with their correspondents should be explored . The task force on supplementary reserve requirements has considered various plans for reenforcing existing bank reserve requirements and has reported that. two plans offer the greatest promise, namely ; ( 1 ) The loan-expansion reserve plan and (2 ) the primary (securities feature ) reserve plan, which provides for. additional required reserves and gives a bank, under conditions to be prescribed by regulation, the option of holding the additional reserves in the form of cash or Government securities. The provisions of these plans may be summarized as follows : Loan-expansion reserves. -Every insured bank receiving demand deposits, other than a mutual savings bank, would be required to maintain additional reserves equal to a percentage, to be prescribed by the Board of Governors of the Federal Reserve System, of that part of its loans and investments in excess of a certain prescribed base. In computing loans and investments, all assets of the bank would be included except ( 1 ) cash, ( 2 ) balances due from banks, (3 ) direct obligations of the United States , and (4 ) such special types of assets as the Board might prescribe from time to time. Primary reserves and Government securities.-Either in substitution for or in addition to the requirement discussed above, an insured bank receiving demand deposits, other than a mutual savings bank, might be required to maintain additional reserves equal to a limited percentage of its demand deposits, in addition to the deposit balances now required . Such percentages could be different with respect to banks in central reserve cities, reserve cities , or elsewhere. In lieu of such a deposit balance, a bank under certain conditions, could count Government securities either at an amount equal to the dollar amount of the deposit balance which the securities replace or at some lesser figure . For example, the Board might prescribe that, for reserve purposes, $1.50, or $2 or $2.50 in securities might be equivalent to $1 of cash. Within a few days the Board of Governors will ask the Congress to consider definitive legislation providing for supplementary requirements. IV. CONCLUSIONS AND RECOMMENDATIONS Conclusions The measures thus far adopted make up the beginning of an effective program of credit restraint. There is, however, no assurance that these measures will prove sufficient to deal with the inflationary situation that may be anticipated as the national security program expands. Additional measures are needed to contribute to the anti-inflationary program and at the same time maintain stability in the market for Government securities. In general, the additional measures which should be taken are : The extension and reinforcement of the voluntary credit restraint program, whose work this committee wholeheartedly endorses ; the enactment of legislation to permit continuation and some broadening of selective credit controls ; an emergency increase in the authority of the Board of Governors to require, in case of need, supplementary reserves for all insured banks. With a view to the possibility that all other anti-inflationary measures fail, or that needed powers may not be obtained in time, plans should be readied for the imposition of mandatory limits on total credits extended by banks and other financial institutions (excepting essential loans ) if, in an extraordinary emergency, such controls should become necessary. Recommendations 1. That section 708 of the Defense Production Act of 1950, which provides the legislative basis for the voluntary credit restraint program, be extended. 2. That close liaison be maintained between the Office of Defense Mobilization and the Voluntary Credit Restraint Committee. The Voluntary Credit Restraint Committee cannot exercise the most informed judgment regarding lending policy unless it is guided by up-to-date criteria of the shifting requirements of the defense program . 3. That the cooperation of such bodies as the Council of State Governors and the United States Conference of Mayors be enlisted by the Voluntary Credit MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 133 Retraint Committee to help postpone issues of State and municipal securities to finance deferable expenditures. 4. That the appropriate Government agency consider whether financing institutions, not now included in the voluntary credit restraint program, be included in it. 5. That Government loan and loan guarantee agencies should follow policies consistent with those of comparable private lending institutions as set forth in the statement of principles of the national voluntary credit restraint program, If the policies of the two groups of lenders are not coordinated the voluntary program might be undermined . This subject is more fully treated in the forthcoming report of the Director of the Budget, the Director of Defense Mobilization, and the Chairman of the Council of Economic Advisers on the policies of Government lending agencies that was requested by the President to complement the work of the present committee. 6. That section 601 of the Defense Production Act of 1950, which provides authority for regulation W of the Board of Governors restricting the use of consumer credit, be extended. 7. That section 602 of the Defense Production Act of 1950, which furnishes the legislative basis for regulation X of the Board of Governors regulating the extension of real-estate construction credit, be extended and that the proposed change in the act (sec. 106, H. R. 3871 and S. 1397, 82d Cong., 1st sess. ) , which would make it possible to restrain the use of real-estate credit in the purchase of existing structures, be enacted. 8. That section 611 of H. R. 3871 and S. 1397 be enacted, which would permit the President, whenever he determines that speculative trading on boards of trade causes or threatens to cause unwarranted changes in the price of any commodity, to prescribe rules governing the margin to be required with respect to speculative purchases or sales for future delivery. 9. The committee recommended that the Congress be urged to act promptly and favorably on the proposals for emergency additional bank-reserve requirements, when these are advanced by the Board of Governors of the Federal Reserve System . 10. That mandatory control of credit be imposed only if the problem to be solved is most serious, and only after a demonstration that more moderate measures are too slow in their impact, or too uncertain in operation, or are otherwise inadequate. While we do not propose the imposition of such mandatory controls at this time, detailed plans for their imposition, in the unfortunate event they become necessary, should be prepared. 11. We have pointed out in this report that credit controls must play an important role in a program of economic stabilization that is in accord with the necessities of the defense program and the Government's financial requirements. We wish to point out with equal emphasis that neither selective nor general credit controls can, in themselves, assure such economic stabilization . Economic stabilization requires, first and most importantly, a pay-as-we-go tax program. Any failure in this respect aggravates immeasurably the problems of economic stabilization. Even with adequate fiscal and credit policies there still remain inflationary pressures during the expansion of the security program. During that period, therefore, direct controls , such as allocations and price and wage controls, are essential. Only in a rounded program in which each control measure contributes its share can we accomplish the purposes of mobilization and stabilization. C. E. WILSON, The Director of Defense Mobilization , Chairman. JOHN W. SNYDER , The Secretary of the Treasury. Wм. MCC. MARTIN, Jr. , The Chairman of the Board of Governors of the Federal Reserve System. LEON H. KEYSERLING , The Chairman of the Council of Economic Advisers. Representative BOLLING. The report, which came out on the 17th of May, and was transmitted by a letter from Mr. Wilson and was signed by Mr. Wilson, Mr. Snyder, yourself, and Mr. Keyserling, included this statement : Within a few days the Board of Governors will ask the Congress to consider definitive legislation providing for supplementary requirements. 134 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT That deals with reserves. It is pretty obvious that your view has changed substantially since that time. Mr. MARTIN. Mr. Bolling, the best made plans of mice and men "gang aft agley." Representative BOLLING. Would you, in view of that "gang aft agley" discuss what are the major differences in your mind between the economic conditions now and those of last May? Mr. MARTIN. I think that right now there are a number of soft spots in the economy. Starting last April or May, textiles, shoes , and several other industrial lines, including output of consumer durables, were beginning to slow down, and over the summer a number of other lines began to slow down. So far activity in these areas has not revived significantly. Department-store sales are currently running lower than they were a year ago. It is too early to tell what the spring situation is going to be, but so far there has been no sign of any marked upturn in department-store sales. When I say that it does not mean that we are not watching very carefully for the possibility of an upsurge. But there has been quite a shift in the economic climate and in general economic activity, apart from the defense activity, since last April or May. You must also remember that during that period we had W and X amended by Congress in July, and to put it bluntly, it is quite possible that, if we had asked for special authority to impose additional reserve requirements at that time, we might not have gotten it. Representative BOLLING. Then, that comes back to the thing that concerns me. There is inevitably a lag even in an issue such as this, in which there seems to be relatively little controversy . It would seem to me that if inflation is only asleep, and therefore not dead, and perfectly capable of awakening again, that considering the recognizable legislative lag between the request for the new tool and its granting, and remembering back to the very brief period which brought on a very substantial inflation in the post- Korean period , I am a little concerned at the idea that there is going to be no concrete proposal from anybody on this other tool, the supplementary reserve requirements. I do not know how to assess exactly the legislative lag that exists, but it certainly is a matter of several months , and it is conceivable that considerable damage could be done in a very short period. Mr. MARTIN. My best judgment on that is that we do not need the authority at this time. We still have two points in our existing reserve requirement authority with respect to central reserve cities. I would not see any point in increasing those requirements because I think that would just put pressure on the market for public debt. I agree with Mr. Wolcott that it would be nice if we did not have the present large public debt, but we have it, and we have got to handle it. I think that, with a Government securities market that is now relatively free of any interference by the Federal Reserve, and which is on the whole becoming stronger, and has more vitality than it has had for some time, there is every reason to believe that the weapons we have are adequate to deal with prospective situations . I would like, of course, to get flexibility restored in regulations W and X, granted that they are not too impressive credit control weapons-and Mr. Chairman, I certainly would agree with you that regulations W and X are not loaded with dynamite as far as credit control is con- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 135 cerned . But I do feel that in a period like this we need to have such weapons in our arsenal. However, I would question very much whether we ought to get involved at this time in the use of a loan ex4 pansion reserve plan, which would be an administrative headache, or in the use of some other type of supplementary reserve plan. On the other hand, this might be a good time to review whether reserve requirements ought to be made uniform for all banks. There are a number of studies that would be desirable on this question . So far as the immediate problem is concerned , however, there is serious question as to whether any additional reserve requirement authority is the course to pursue. Representative BOLLING. Mr. Martin , if inflationary pressure started pushing prices up could you conceive of a situation where it might be desirable for the Federal Reserve, in addition to not supporting the Government bond market, actually selling part of its $22 billion in holdings of Government bonds in order to restrict reserves ? Mr. MARTIN. I think that is a situation- you can conceive of a lot of situations, but I would not want to comment on a hypothesis of that sort. I thing that the Federal Reserve certainly intends to be only the marginal supplier or the marginal buyer in the market, and we want to maintain an orderly market for Government securities. I do not want to engage in a hypothetical discussion . Representative BOLLING. I see. That is all right with me. Mr. Martin, we had some discussion yesterday with Secretary Snyder on the question of E bonds and their competitive position , and so on. I wonder if you would care to make any comments on the situation with regard to saving bonds ? Mr. MARTIN. No , Mr. Bolling, I would not. It seems to me that any comments on interest rates on savings bonds or specific issues ought to be in executive session, and I certainly would not want to be in the position of commenting on the Treasury's present problem, which they are struggling day and night to resolve. Representative BOLLING. I sympathize with your position on that. Mr. Chairman, I would like for us to pursue that through questions and letters so that we can have it as part of our own consideration . Representative PATMAN. You meanRepresentative BOLLING. For the committee to send certain questions to Mr. Martin. Representative PATMAN. Certainly. Representative BOLLING. Is that satisfactory ? Mr. MARTIN. Yes ; that is perfectly satisfactory . Representative PATMAN. The fact that I asked you certain questions does not mean that I am advocating the things that I mentioned . Mr. MARTIN. I understand . Representative PATMAN. Mr. Martin, I am learning a lot . Mr. MARTIN . I can assure you I am, too , Mr. Chairman. Representative PATMAN. I do not know much myself, but these four gentlemen on the committee with me know a lot, and I am learning a lot from them, and the staff members here. I am not just pulling something out of the hat when I mention about the appropriations through Congress. I desire to invite your attention to the fact that there are a number of agencies now supported from revenues of the enterprises operated or supervised by them or 136 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT from property they administer, but they must obtain special authorization to use moneys in their hands for designated purposes or in some cases for any purpose whatsoever. I refer to the Federal Housing Administration, the Home Loan Bank Board, the Office of Alien Property, the Commodity Credit Corporation, the Export-Import Bank of Washington, the Federal Crop Insurance Corp., the Federal Farm Mortgage Corp. , the Federal Intermediate Credit Banks, the Federal National Mortgage Association, the Federal Prison Industries, Inc., the Federal Savings & Loan Insurance Corp., the Home Owners Loan Corporation, the Inland Waterways Corp. , the Panama Canal Co. , the production credit corporations, Public Housing Administration, the Reconstruction Finance Corp. , the Virgin Islands Corp., the Tennessee Valley Authority. The following agencies collect certain moneys which are covered into the Treasury. That is what I asked you about a while ago— which are covered into the Treasury, and which can be withdrawn only on appropriations by Congress. The Attorney General, fees of aliens and immigrants, various receipts of the Department of Agriculture, including the Farm Credit Administration, the Forest Service receipts, inspection fees, Rural Electrification Administration ; the Department of Commerce, including the China Trade Act Corp. fees, service and publications, fees and charges, National Bureau of Standards, fees for tests, and so forth, the Patent Office fees ; the Department of Interior, electricity, sales from various power projects, the Geological Survey, sale of publications, grazing fees ; the Federal Power Commission, water power license fees and charges ; the Federal Security Administrator, including food inspection fees ; the Post Office Department, postal revenues ; and the Securities and Exchange Commission fees for registration of securities, national securities exchanges and qualification of trust indentures. I read these off, Mr. Martin, to let you know that it was not something new that I was proposing, but something that has been in effect a long time concerning other agencies, some of them not as important, I do not claim , as your own agency, but some, of course, rather important themselves, like the Post Office Department, for instance. Mr. MARTIN. I understand that thoroughly. I would just like to make the comment that I have the greatest respect for all those agencies that you listed. One of them I had the privilege to head for a 3-year period , but I feel definitely, and I would like to have this in the record , that the Federal Reserve is in different category, and that its independence is something entirely different from any of those agencies ; that it has a unique status and a unique place in our economy, and that as such, budgetary control is a vital element in preserving that position. That is essentially my thinking, and I just wanted you to have it. Representative PATMAN. Of course, if it were necessary to sell all your bonds and you did not have any income, why, you would naturally expect an appropiration from Congress, would you not? Mr. MARTIN . No , we would have to find some other source of income. You might be interested to know that the Open Market Committee really got its start by the need for several of the Reserve banks for earnings ; the need for earnings is why they wanted to make some investments. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 137 Representative PATMAN. Well, that is what reminded me of it , and not the reverse of it. Dr. Murphy, would you like to ask any questions ? Mr. MURPHY. I have three questions, Mr. Chairman. First, there has been a great deal of discussion during the past 2 days of the amount of United States securities which Federal has purchased for the purpose of supporting the Government bond market, and I think it should be placed in the record what has been the net change in the Government security portfolio of the Federal Reserve banks from the end of the war to the present time. It is my understanding that during that period the portfolio has decreased rather than increased in total amount ; is that correct ? Mr. MARTIN . I think that is correct. We will put the exact figure in the record. Mr. MURPHY. Would you insert it in the record , Mr. Chairman ? Mr. MARTIN. Certainly, we would be delighted to . (The information referred to follows :) At the end of 1945 , following the Victory Loan drive , the Federal Reserve held $24.3 billion of Government securities and at the end of February 1952 holdings were $22.5 billion . The net decline over the entire period of $1.8 billion reflected a reduction in the period January 1946 through June 1950 of $6 billion and an expansion of $4.2 billion from July 1950 through February 1952. The decline in the period prior to the Korean outbreak reflected in part the Treasury's program of using both large excess cash balances and current cash surpluses for retirement of publicly held debt. This program, which totaled about $31 billion, was focused largely on securities held by banks, including the Reserve banks. Changes in the Federal Reserve portfolio of Government securities need to be related to the other factors affecting bank reserves in order to be adequately evaluated. Over the full period January 1946 through February 1952, commercial banks were supplied with over $5 billion of new reserves from factors outside the direct control of the Federal Reserve, such as a net gold inflow and a reduction in Treasury cash holdings and Treasury deposits at the Reserve banks . Since the Federal Reserve reduced its holdings on balance by only $1.8 billion over this period , it did not fully offset the effect of these changes and total member bank reserves expanded nearly $4 billion. This increase in reserve balances made possible an expansion in total bank deposits of about $ 13 billion, including a decrease in Treasury deposits at commercial banks of $22 billion and an increase in privately held deposits of $35 billion. Mr. MURPHY. Second, the subcommittee of 2 years ago, under the chairmanship of Senator Douglas, included in its report the following statement : We believe that to restore the free domestic convertibility of money into gold coin or gold bullion at this time would militate against rather than promote the purposes of the Employment Act, and we recommend that no step in this direc* tion be taken. * * What would be your reaction to this subcommittee including a statement to the same effect in its report ? Mr. MARTIN. I concur in that statement. Mr. MURPHY. Finally, Mr. Martin , in the questions which we submitted to you we did not include any questions on public - debt instruments, because we did not want to burden you unnecessarily ; but , would you care to comment on the pros and cons of the advisability of issuing a bond, the repayment of which would be guaranteed in terms of purchasing power ? Mr. MARTIN. I would comment that there are administrative difficulties in the issuance of such a bond, but I am sure you know them 138 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT better than I do, Dr. Murphy, and I question very much whether it could be worked out on a satisfactory basis. Mr. MURPHY. That is all, Mr. Chairman. Representative PATMAN. Dr. Ensley ? Mr. ENSLEY. Mr. Chairman , Mr. Bolling a short time ago inserted in the record a memorandum from the President last February designating this special committee- I believe the so-called Wilson committee Mr. MARTIN. Correct. Mr. ENSLEY. He also inserted the May 17th report of that committee. In the light of the experience of that committee do you have any suggestions or recommendations with respect to the possibility of future committees of that type set up specially to look into a special problem ? Mr. MARTIN. Oh, I think they can be very helpful when set up to look into a special problem. Mr. ENSLEY. That is all I have, sir. Representative WOLCOTT. Mr. Patman, may I ask a question ? Representative PATMAN. Mr. Wolcott. Representative WOLCOTT. In view of Mr. Murphy's question about the gold, I was a member of that committee, and I had some doubts as to the advisability of putting that into that report without some explanatory language, because so many people were of the opinion that the restoration of the gold standard, some sort of gold standard, might be advisable, and I think, in consequence of my criticism of it at that time, the words "at this time" were put in. It originally read : We believe that to restore the free domestic convertibility of money into gold coin or gold bullion would militate againstAnd it was my suggestion that that language "at this time" be put in, reserving the right to suggest later on that we have some studies as to the desirability of restoring the gold standard. That was 2 years and a half ago. I wonder if the same situation prevails now that prevailed at that time ? Mr. MARTIN. Well, my judgment would be that it does. I think that as long as we have Russia a hostile power, and the world in the general upset condition that it is, that we are operating on the right basis today . Representative WOLCOTT. Going on further, we say in that report : We also recommend a thorough congressional review of existing legislation relating to the power to change the price of gold with a view to repealing any legislation that might be so construed as to permit a change in the price of gold by other than congressional action . Now, that apparently had in mind the Gold Reserve Act which gave the PresidentMr. MARTIN . Of 1934- the 1934 act. Representative WOLCOTT. Yes ; which gave the President the authority to further devalue gold . I understand that that authority has expired, has it not ? Mr. MARTIN. That is correct. Representative WOLCOTT. Is there any other power or authority that you know of that that language might apply to now? Mr. MARTIN. I do not think so, but I would have to check it to be absolutely certain. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 139 Representative WOLCOTT. I think, Mr. Murphy, that perhaps we might have that answer before we recognize that there might be some authority somewhere outside of Congress to further devalue gold . (The material referred to above is as follows :) AUTHORITY TO CHANGE THE PRICE OF GOLD The President was authorized to change the weight of the gold dollar by section 43 of the so-called Thomas amendment of May 12 , 1933, as amended by section 12 of the Gold Reserve Act of 1934. That authority of the President, however, was in effect only for a temporary period and terminated on June 30, 1943. Under sections 8 and 9 of the Gold Reserve Act of 1934, the Secretary of the Treasury has authority to purchase and sell gold at home or abroad "at such rates and upon such terms and conditions as he may deem most advantageous to the public interest." In addition , the Secretary is authorized by section 10 of the Gold Reserve Act , with the approval of the President, "to deal in gold" for the account of the stabilization fund established by that section. These powers of the Secretary, however, are effectively limited by provisions of the Bretton Woods Agreements Act of 1945 and the Articles of Agreement of the International Monetary Fund. The Articles of Agreement of the Fund, which the United States has accepted under the Bretton Woods Agreements Act, provide that no member of the fund shall buy gold at more , or sell gold at less , than par value, plus or minus a margin or charge which the fund is authorized to prescribe and which has been set at one-fourth of 1 percent. Thus the United States, as a member country, may not purchase gold at a price greater , or sell gold at a price less , than par value in relation to the dollar, plus or minus the prescribed margin. Moreover, the par value of the dollar cannot be changed without the consent of Congress, since section 5 of the Bretton Woods Agreements Act provides that "neither the President nor any person or agency shall on behalf of the United States * * * propose or agree to any change in the par value of the United States dollar" unless such action is authorized by Congress. Under section 14 (a ) of the Federal Reserve Act, the Federal Reserve banks are authorized to deal in gold at home or abroad. However, the authority of the Reserve banks to purchase and sell gold under this section must also be read in connection with the provisions of the Articles of Agreement of the International Monetary Fund and the Bretton Woods Agreements Act mentioned above, as well as the provisions of the Gold Reserve Act of 1934. A further discussion of the authority of the Secretary of the Treasury to deal in gold is contained in the answer given by the Secretary of the Treasury in reply to question D-12 of the questionnaire submitted to him by the Subcommittee on General Credit Control and Debt Management of the Joint Committee on the Economic Report. Representative WOLCOTT. Has any discussion been had on the desirability of this country's initiating an international monetary conference which would be particiapted in by the four countries looking to the possible restoration of the gold standard ? Mr. MARTIN. I do not know of any, sir. I think the International Monetary FundRepresentative WOLCOTT. I should have said outside the International Monetary Fund, because I think that- my own thinking and my own thought is that the study should be made outside of the fund, because the restoration of the gold standard would, of course, contemplate the dissolution of the International Fund. [ Laughter. ] (Mr. Murphy is a member of the staff of the International Monetary Fund. ) You do not know of any conference ? Mr. MARTIN. No , I do not know of any, sir. Representative WOLCOTT. All right. Thank you. Representative PATMAN. Any other questions ? Mr. Martin, we appreciate the very fine and comprehensive statement that you have given us this morning, and we especially appreci97308-52-10 140 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT ate your forthright answers to our questions. We will probably ask you to meet with us in executive session sometime at your convenience and go over the documents that were discussed at the morning session, and any further questions we desire to ask you in writing , I assume that you will be willing to answer ? Mr. MARTIN. I would be very glad to answer them. Representative PATMAN. Is there anything else ? Mr. MARTIN. Might I say one thing? Representative PATMAN. Yes , sir. Mr. MARTIN. Mr. Chairman , I would like to say that we have had the finest cooperation from Dr. Murphy with our staff, and that it has been a real pleasure for the Board to work on these problems. Representative PATMAN. We are glad to hear that, Mr. Martin . Thank you very much. Mr. MURPHY. Thank you very much. (Supplementary statement filed by Mr. Martin is as follows :) The Secretary of the Treasury was asked to prepare and insert at the end of his remarks a statement for the record indicating the process whereby the answers to the questionnaire were compiled, with particular reference to the use of outside consultants . It was stated that a similar record would be obtained from the Federal Reserve. In view of this the following statement is submitted : PROCEDURE AND OUTSIDE CONSULTANTS USED IN PREPARING REPLIES TO THE QUESTIONNAIRES OF THE SUBCOMMITTEE ADDRESSED TO THE CHAIRMAN OF THE BOARD OF GOVERNORS AND THE CHAIRMAN OF THE FEDERAL OPEN MARKET COMMITTEE OF THE FEDERAL RESERVE SYSTEM The answers to these questions were prepared by the Board's regular staff. This was considered the most appropriate procedure in order that the material submitted might be based on experience and background developed within the system . Outside specialists served on a consultative basis to criticize the drafts of replies prepared by the staff and to discuss general subjects and specific answers selected by the Chairman, other Board members, or the staff. "This procedure for using regular staff in preparing replies to 61 questions covering the scope and detail of those submitted by the subcommittee presented a task of great magnitude, even though adjustments were made in the regular workload of the staff members involved . As a consequence the time required for completing the answers was much longer than originally scheduled , staff members devoted a great deal of overtime over a period of 3 to 4 months to preparing replies, and a considerable amount of regular work was given less attention or postponed. Responsibility for organization of the work on answers, the critical review of them, and their revision was given to the Director of the Division of Research and Statistics. His internal advisory group was the senior staff ; those who were most active on this assignment were the Assistant to the Chairman, the Assistant to the Board, the Economic Adviser to the Board, the Secretary of the Board, the General Counsel, and the Directors of the Divisions of International Finance, Examinations, Bank Operations, and Selective Credit Regulation. The senior staff group was relied on to select members of the staff to prepare draft replies to individual questions, to consult with staff members on problems raised by answers, to prepare replies to key questions, and to review answers generally. Work on answers to individual questions—their preparation and revisioninvolved a substantial proportion of the time of more than 30 other staff members throughout the organization who were selected on the basis of their specialty and the subject material covered by the question. In this manner the Board drew on its complete resources of professional, technical, clerical, and stenographic staff not only in the Division of Research and Statistics but also in the Office of the Secretary, the Legal Division , and the Divisions of Bank Operations, International Finance, Examinations, and Selective Credit Controls. While this spreading of the work increased the problems of organizing the flow of work and of reviewing and integrating the replies, the procedure was necessary in order to prepare the answers along with other duties . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 141 Replies were developed through a process of draft, review, and redraft. The first draft of all answers was largely completed by the end of October, the second draft by late November, and the third draft by December 21. The first draft was prepared with a minimum of group consultation and the complete draft was circulated to all authors for comment . The second and third drafts were reviewed largely by the senior staff. For most questions the revision of the third draft was submitted to the subcommittee to be set in type and was proofed and checked through the page proof stage. Preparation of the replies to some questions required modification of the above procedures, especially A-3, E-27, and the open market questions. Question E-27 was prepared in cooperation with the Federal Reserve banks and the banks supplied a part of the material presented in the reply and reviewed the draft reply. The staff of the New York bank collaborated in preparing the reply to the open market questions and reviewed the policy record presented in the reply to A-3. The chairman and the other members of the Board were continually reviewing the replies as they were prepared, devoted many meetings to the replies, and made many suggestions. The Chairman was in constant contact with his senior staff discussing points raised by the answers and making decisions on content. A group of 10 outside experts was appointed for consultation on the replies. These experts included some who had had extensive experience within the System and others without such experience but with recognized standing in the fields of money and credit and of Government structure and finance. These consultants commented by mail on both the first and the second drafts. Their main contributions , however, were made at a 3-day round-the-table discussion with the staff focused on subjects and questions selected by the staff and the Board. These meetings were held November 30 and December 1 and 2. The consultants were Robert deP. Calkins, E. A. Goldenweiser, Chester Morrill, Carl E. Parry, Herbert V. Prochnow, R. J. Saulnier, Theodore W. Schultz, Walter W. Stewart, Jacob Viner, and L. Wilmerding, Jr. The Board's expenditures for their services totaled $6,655 . Representative PATMAN. We will stand in recess until tomorrow morning at 10 o'clock, when we will meet in the committee room of the House Banking and Currency Committee. (Whereupon, at 4:20 p. m. , the subcommittee recessed to reconvene at 10 a. m., Wednesday, March 12 , 1952 in room 1301 , New House Office Buiding . ) MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT WEDNESDAY, MARCH 12, 1952 CONGRESS OF THE UNITED STATES , SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington , D. C. The subcommittee met, pursuant to recess , at 10:05 a. m., in room 1301 , New House Office Building, Representative Wright Patman (chairman of the subcommittee ) presiding. Present : Representative Patman , Senator Douglas , Representatives Bolling and Wolcott. Also present : Grover W. Ensley, staff director ; Henry Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee. Representative PATMAN. The committee will please come to order. It was suggested at the meeting yesterday afternoon that Mr. McCabe and Mr. Eccles be invited to appear before this committee. Each one of these gentlemen has been invited, but each one has reserved a decision in the matter. However, if they want to appear and testify, time will be arranged for their appearance . The time suggested to them was satisfactory, so the invitations have been extended. This morning we have with us Mr. Keyserling and Mr. Blough, members of the Council of Economic Advisers representing the Council of Econmic Advisers, before our committee. Mr. Keyserling, are you ready to proceed ? Mr. KEYSERLING. Yes, Mr. Chairman. Representative PATMAN. Will you suggest as to how you would like to proceed ? Would you like to first make a statement or what would be your pleasure ? STATEMENT OF LEON H. KEYSERLING, CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS Mr. KEYSERLING . Mr. Chairman, I have a prepared statement, in accord with the customary procedure, which is available for the committee and for others interested in it. I would much prefer rather than reading the statement in full to try to summarize the statement, but since summarizing the statement is a little more difficult than reading it, I would like to have a chance to summarize it and then have the questions come after the summary , because the mingling of my effort 143 144 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT to summarize it with questions at the same time might not gain the advantage of time that would be gained by summarizing it rather than reading it. Representative PATMAN. That will be satisfactory and we will respect your wishes, so you may proceed , Mr. Keyserling. Mr. KEYSERLING. Mr. Chairman and members of the committee, I welcome this opportunity to discuss before you the role of monetary policy and the management of the public debt in achieving price stability and high-level employment. By high-level employment, we must mean the fairly consistent expansion of employment opportunity, because our labor force grows greatly from year to year. And since our technology is dynamic, our productive power tends to increase more rapidly than employment. With manpower and technology both advancing, our economy must expand in order to be stable. It cannot be stable by standing still. In addition to a stable and growing economy, we must make sure that our resources are being devoted to necessary purposes, and these change with the times. For example, if we now had a stable and growing economy without any defense program, we would be living in a fool's paradise. Monetary policy and debt management are not ends in themselves. They are specific instruments which can be used wisely only in the context of the functioning of the economy as a whole, the objectives to which we now adhere as a nation , and the relative urgency and priority of problems arising in our economy under the threatening current of world conditions. Consequently, I believe that I can be most helpful to the committee, not by commencing with a technical discussion of monetary and debt management problems, but rather by outlining first what seem to me the most salient features in the current and foreseeable economic situation under a national policy of building our defenses, and then in this perspective evaluating the practical range and nature of relevant monetary and debt management policies. For example, the size and pace of the defense program, its effect upon the disposition and utilization of our economic resources, and the specific character of the problems it imposes upon the whole economy, are vitally important starting points for a consideration of specific economic measures, including monetary and debt management policies. These considerations seem to me doubly valid because much of the traditional theory about monetary policy, sometimes recited out of context, found its original roots in the minds of philosophers rather than practicing economists. These men sought to describe a static and perfectly consistent economic system, which probably never existed in the world of reality, and which in any event has little relevance to the dynamic American economy of today and to the entirely novel and rapidly moving problems with which we must now deal . One of the reasons why monetary officials in recent years have not pursued some of these theories relentlessly to their logical results has been, not that others prevented them from doing so, but rather that they themselves have shrunk from the appalling practical consequences of such action. This may explain why the differences in viewpoint concerning monetary policy and debt management, expressed by those charged with practical problems and public responsibility, have not been so great as MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 145 the differences expressed by some commentators in search of sensation and by some theorists not challenged by the duty to act. So far as I have been able to observe, the differences between what a responsible Treasury official and a responsible Federal Reserve official would actually do under current conditions, if either had complete authority to do as he pleased, are small differences contrasted with their magnification by those who are not sobered by imminent and vital responsibilities to perform. The evidence already brought before this committee that the Secretary of the Treasury and the Chairman of the Federal Reserve Board, and their associates, have sought to reach working agreements, is not hard to explain. This development has not resulted from compulsion either by the Congress or by the President . It has resulted from the compulsion of economic reality, based upon looking frankly at conditions both at home and abroad . Economic conditions at home do not leave a very wide range of election in monetary and debt management policy. While there may still be some shadings of emphasis, the underlying situation and the limitations which it imposes upon novel experimentation or wide deviation from a fairly well-established course make it only natural that men in positions of active responsibility should be anxious and able to reconcile their views . And conditions abroad make it apparent to all men of good will that the American people and their public officials must do their best to pull together in a common cause. I can find nothing suspicious or surreptitious in the fact that the Secretary of the Treasury and the Chairman of the Federal Reserve Board are trying, and it is to be hoped successfully trying, to harmonize their views. All that this proves to me is that Mr. Snyder and Mr. Martin, and their associates, are sensible, hard - headed , experienced , and patriotic men. I shall endeavor, if it please the committee, to commence with a general description of the economic problems now confronting this Nation in the course of a defense effort novel both in character and purpose. I believe that only in this perspective can the more specialized problems of monetary policy and debt management be intelligently depicted or intelligently solved . Some of the fuss and fury stirred up in these specialized areas has resulted from looking at a few trees without surveying the forest. I do so because it is my view that a great mistake has been made in looking at monetary and fiscal policy within a narrow framework rather than trying to fit it into our economy today, its dynamic problems and its world responsibilities, and I think if we start from that point of vantage we not only get a better perspective but come nearer to realizing the limitation upon monetary and management policy and what it can and cannot do. Proposition No. 1 is that our transcendently important economic problem today is how much of our productive power and economic resources should be allocated to national defense . Obviously, the size and pace of the defense program most importantly affects the degree of inflationary pressures, the fiscal situation of the Government, and the entire range of economic policies worthy of serious attention . 146 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT By national defense , I mean the whole range of programs which reflect our undertakings to enlarge the mutual security of the free world. Consistent with a position that I have always taken, I voice no opinion as to how large or how fast these undertakings should be from the viewpoint of national security. I may have views on this as a citizen, but in my role as chairman of the Council of Economic Advisers I have nothing to offer which can compete with the superior judgment of those in our defense and international agencies, subject to the ultimate judgment of the President and the Congress. But I feel compelled to raise my voice as an economist in the public service when I witness the growth of a strong, if not predominant, sentiment that our security program as a whole must be drastically reduced in order to maintain a strong economy. The clear facts since the original Korean aggression, and the weight of judgment now as to the economic outlook, simply do not support the proposition that we must slash the security program to protect our economy. The primary test of whether a security program of given size and pace, in a long period of partial mobilization, is weakening or impairing our general economic strength, cannot be determined by looking only at the dollar value of the security program, nor by looking only at the deficit in the Federal budget, even though these be important considerations. The primary test of the impact of the security program upon our general economic strength involves these three paramount questions, and these three alone in my judgment : 1. Is the security program, through its drain upon our resources , leaving or threatening to leave our business system with inadequate resources or incentives to safeguard and advance that productive power which is the ultimate source of our economic strength ? 2. Is the security program imposing such strain or deprivation upon consumers as to weaken the strength or morale of our people— 155 million strong ? 3. Is the security program, by its very nature, incompatible with the protection of the Nation against further inflation, assuming that we do not want to resort, during a long period of partial mobilization, to a scope or intensity of controls which in the long run might impair our productive power or corrode our basic freedoms ? My views are so well known on the subject that, from the economic point of view, the security program is not imposing that kind of strain on our economy, that I will summarize very briefly on these three points. First, it cannot be argued that the prospective or present size of the security program is unduly impairing our productive strength , when at a uniform price level we had in 1951 by far the highest level of investment in plant and equipment, which is at the heart of our productive strength, and in business investment generally, that we have ever had in our history, and where as a matter of fact the main question validly raised then was not whether business had the funds, the incentives, the manpower to invest adequately in productive equipment, but rather whether in view of the inflationary dangers the level of over-all business investment was too high and ought to be further curbed. Second, from the viewpoint of consumer supplies, the year 1951 was only slightly lower than 1950, in fact by some measurements it MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 147 was higher, and in any event it was higher than in any other year in our history, and here again the main operating force at the present time upon the level of consumer supplies is not restrictions imposing deprivations on the people, but their unwillingness in many areas even to buy at the level of available supplies . In the third place, we come to the question of whether the program is of a size which makes the stabilization of prices impractical without excessive controls. The record on that indicates that over the past year we have had a very unusual record of price stability for a high level economy. Wholesale prices have trended somewhat downward ; retail prices moved up slightly for a large part of the year, but their trend has been downward in the most recent period. As we look forward to the remainder of the year 1952 and beyond, it is a curious paradox that some of those who a year or so ago were extremely doubtful about the capacity of our productive resources to support the demands of the security program are now exhibiting trepidation lest even with the security program we run into a recession due to the inability of the economy to maintain demand for that part of our productive resources which are not employed in the security program. I do not believe that this trepidation is justified , for reasons which it would not be germane to develop at length here . Nonetheless, the trepidation at least underscores the point that there is a growing recognition that the security program can be borne by the economy without excessive strain . I would be the last person imaginable to take the unsound position that the security program should be maintained at now contemplated levels, or raised above these levels, in order to maintain high-level production and employment. That is manifestly not an appropriate function for a security program. I am firmly convinced that our economy now has or must find the ways to maintain stability and growth, if and when the world situation permits a vast reduction in the security program. The only point I am making here is that, while we should by all means reduce the security program when the best informed appraisal of the world situation dictates that course, we do not need and should not dare to do so before that time on general economic grounds. The question of the necessary size of the security program should not be confused with the question of efficiency and the weeding out of waste in its execution . Every sensible person will agree that it would be a net gain, if ways could be found to get the same amount of security for less money. I hope that such ways can be found , and I commend every effort toward that end. But I believe that only confusion and danger to this country can result from failing to distinguish between trying to get necessary security as economically as feasible, and trying to cut security below necessary levels on the ground that we do not have the economic strength to do the job without embarrassment or impairment of our economy. Since we have the resources of manpower, materials , and business and institutional skills to carry forward the security program, we cannot say that we do not have the means to finance it. It would be somewhat better, in my judgment, to pay for a security program at the now contemplated level entirely out of taxation rather than partly by borrowing. But , even if it is financed partly by borrowing, the Con- 148 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT gress will need to weigh whether the amount of borrowing involved could threaten the Nation to the extent that it would be threatened by a deficiency in national security. I have dwelt upon this point at some length , because I believe that it is the greatest economic issue which we face as a Nation, and one alongside of which other economic issues pale into relative insignificance . It seems to me that those who do not give top priority to this question cannot find the right answer on other questions of economic policy. We have reasonable grounds for believing that, if we are strong enough to resist and deter the Communist menace, the American economy will continue its timeless progress toward new productive achievements and even greater strength . But if, through mistaken economic analysis concerning the capacity of our economy, we should fall down on this top job, then no other policies could save us from dangers beyond description. Proposition No. 2 is that, with a large security burden, economic policy must concentrate above all upon the expansion of production . And here I would summarize briefly, what I think is my known view that, while we must to a degree use controls to help allocate our resources so that we can do the security program more effectively, they are no substitute for and are not of equivalent value in the American economy to the expansion of production. We can outproduce the Russians ; we cannot hope to outcontrol them , and I think that particularly for a long period of partial mobilization we must be very careful not to resort to controls to a degree which, while they might accomplish the purpose of allocating resources or restricting inflation , would at the same time dim the edge of the most important of all our great nonsecret weapons, the capacity to produce ; and that capacity to produce, as I shall indicate, could be seriously and indiscriminately impaired by the use of controls along lines which , while they might have been relevant to the simple problem of using all - out weapons to fight the traditional kinds of inflation or deflation, are not so relevant to the particular problems of this kind of new and difficult mobilization effort. The facts speak for themselves . Not only in World War II when we had a slack use of our resources at the beginning of the war, but even since 1950 when we had a situation of many a tight use of our resources at the beginning of the mobilization effort , we have nonetheless expanded over-all production about apace with the defense program, and for that reason, which is the most fundamental of all economic reasons getting beyond any type of specialized analysis, for that basic reason alone we have thus far carried the security program with an advancement of our investment and productive tools and equipment which is the real source of our strength , and without serious impairment of our civilian economy or our civilian morale. Proposition No. 3 is that the expansion of production must be responsive to the priorities of national needs. We cannot do everything at once. And in my ardent advocacy of production I do not claim that we do not have to sacrifice some things , or that we can , rich as we are, do everything at the same time. This means that balance must be maintained in the utilization of our resources. Balance in the utilization of our resources means very simply that in this kind of mobilization effort some things must be expanded at the same time that other things are contracted. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 149 We must expand the production of steel facilities, contract the production of automobiles. We must expand the production of weapons, contract the production of houses, and so on all up and down the line ; and, in seeking to arrive at a wise composite of resource use in that dual process of expansion and contraction, we must rely largely upon selective devices directed to those particular ends and cannot rely to the degree that in a classical fight against an all -out inflation or a classical fight against an all - out depression we could adopt on a broad scale measures of a contracting character or measures of an expanding character. We have to ask ourselves, in adopting measures of a general character to contract or to expand the economy, would they contract first the things that we want to contract, or would they contract first the very things that we must of necessity expand rapidly if we want to build up the productive strength and the wise composition of our total strength, which, at least according to my analysis, is at the heart of this whole problem. Proposition No. 4 follows naturally from the third , the task of curbing inflation in a defense economy must be reconciled with the need at one and the same time for expansion in some areas and for contraction in others. We are not fighting basically a war against inflation . We are not fighting basically a war against a depression . We are fighting primarily a new kind of limited international engagement, and the tasks and problems of that kind of situation are different either from the tasks of 1932 which called for an all -out use of antideflationary weapons, or the tasks of some of the kinds of all -out inflations which have occurred in some countries at some periods of time. Proposition No. 5 is that the nature of our current and foreseeable economic tasks is too complicated for extreme or major reliance on any one type of economic measure . This applies to monetary policy as well as to other policies. As indicated above, the complicated and unique character of the current defense program requires a combination of efforts, some designed to expand parts of the economy rapidly, and others designed to contract other parts of the economy with similar rapidity ( insofar as the increase in over-all production does not in itself take care of the necessary expansion of the security program) . Theoretically, one might argue that one type of economic policy might be predominantly relied upon in the current situation to prompt all of the necessary and varied adjustments in resource use. For example, it might be argued theoretically that, since tax reductions are stimulating and tax increases repressive, a complex tax scheme could be worked out on paper which would provide sufficient inducements for expansion wherever needed and sufficient restraints for contraction wherever needed . But the effort to formulate and apply such a complicated and refined tax system would deprive the tax system of one of its main virtues-namely, that it is rather generalized- and would make taxation more complicated and cumbersome, more detailed and personalized, than the most extreme kind of price and wage control. Similarly, one could work out theoretically on paper a price- control policy, or a credit- control policy, or a policy governing the allocation of materials , so comprehensive and so discriminating as to accom 150 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT plish by that one device alone all of the objectives for the economy which must now be sought. But the utilization of any one device to this extent would break down of its own weight, and would result in a system of controls far more harsh, rigid, and excessive than the moderate utilization of a variety of weapons in mild proportion . These comments are applicable to general monetary policy. I am heartily in accord with the moderate utilization of monetary policy to exercise some general restraining influence in an inflationary period . But intrinsic limitations upon its utility lead to major reliance upon a variety of other measures. Representative PATMAN. Mr. Keyserling, since you have elaborated on all these points rather fully, don't you think that you could go through them and just bring out the points and then yield for questions ? Probably a lot of it could be brought out through the questioning. Mr. KEYSERLING. Yes ; I can certainly do that. The first point I make is that monetary policy is hardly adjusted under present circumstances to the expansionary phases of the task, and that is vitally important in building up our strength. Second, insofar as it is adjusted to the contracting phases , it is commonly recognized by various authorities with whom I agree and whom I cite here, that for general monetary policy to be pushed far enough to produce a general contraction of the economy and thus to have a pronounced effect upon prices or upon investment, it would have to be pushed far enough to result in a general contraction of employment and production. And I set forth in my prepared statement various statements from various sources to that effect, and that in that way by producing a general contraction of production and employment, we would far outweigh the benefits which might be derived, particularly because, as I have said, the contraction would not be selective and for reasons which I could give would be more likely to occur first in those areas which we are seeking affirmately to expand, and last in those speculative and relatively nonessential areas which other more selective measures can more quickly contract. The next point I make is that there is general agreement among the authorities that monetary policy directed toward variations in the money supply and changes in interest rates and through the composite of those factors to effect the level of investment would by common agreement among the authorities have to be under current circumstances rather narrow, and that there may be real questions whether if so narrow they would produce such limited adjustments in interest rates and in other sectors of lending as to make it very questionable as to whether much would be accomplished, except a general upward push in interest rates, and as to whether that is desirable from the viewpoint of long-range trends, I suppose the committee's judgment is as good as mine. Now I have summarized several pages. Proposition No. 6 is that the current and foreseeable economic situation calls for an admixture of economic tools, without excessive reliance upon anyone. Now let me read there a statement from Dr. Goldenweiser in Harper's magazine for April 1951 : First, we must bend every effort to increase production by greater exertion , greater efficiency, longer hours, fewer leisure people, less of the gracious things MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 151 of life * Second, we must economize-make sure that no money is spent unnecessarily * * *. Third , as large a share of the necessary expenditures as possible must be met by taxation * *. Fourth, the Government must borrow what has to be borrowed (insofar as possible ) in such a way as to * tap income that would otherwise be spent by the person receiving it Fifth, the Government should borrow from the banks only the unavoidable minimum * * * . Sixth, over-all restraint should be exercised over loans by * * Finally * * * price and banks to businesses and individuals wage controls-to hold the line until the other measures become effective—are highly desirable. * The foregoing seems to me to set forth admirably, and in proper order, the rounded elements in a program for stability and growth. Further, I would like to stress the extent to which most of those who have been challenged by the responsibilities of practical action, and particularly by the responsibilities of public office, find themselves in essential agreement in this matter-although there will always be some shadings of emphasis. Then proposition No. 7 , which is my final one, Mr. Chairman , and which I would like to read. Proposition No. 7 is that basic economic policies which affect the whole Nation should seek harmony, and that under our system the most powerful force toward this harmony is men of good will working cooperatively together. With this force present, neither new machinery nor new legislative definitions of authority seems essential. Above all, there is widespread agreement that those agencies of public authority which vitally affect the national economy should try to reconcile their actions, because pulling in opposite directions is manifestly hurtful regardless of which side is on the side of the angels ." There will always, of course, be differences of opinion on policy issues. But neither sober and reflective businessmen nor anybody else would want various important agencies of public power, each vitally affecting the economy, to pursue conflicting policies of a fundamental character for an enduring length of time. Nothing could be more inefficient, more uneconomical , more demoralizing to our business system, or more conducive to the undermining of the people's confidence in public authority, and I think the people must have confidence not in only one public authority but in all public authorities. Senator DOUGLAS. Is this irrespective of their performance ? Mr. KEYSERLING. No, sir ; not irrespective of their performance . That is not the point I am making, but no one agency has a monopoly on correct performance at all times. It is true that different agencies of public power have different accents of responsibility, and different prime objectives and functions. But no one of them can believe that its perspective or its point of emphasis is transcendently important, to the exclusion of all others. The very fact that in our democracy there are at the national level so many agencies of public power, makes it essential that a process of reconcilitation and harmonization move constantly forward. It has always been this way ; and it will always be this way. The possibility of some fundamental collision of policy between two agencies of public power which fundamentally affect the national economy is by no means limited to the case of the Treasury and the Federal Reserve Board. Other agencies of public power are now undertaking functions quite as vital to the economy as a whole, and 152 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT quite as important to the lives and fortunes of the individual. For example, it would be hard to imagine a more far-reaching authority than that of allocating scarce materials throughout the economy, which carries with it the very power of life or death over substantial segments of our business system. The relationship between monetary policy and fiscal policy is indeed important ; but no one can prove that it is of a very different category of importance from the relationship between price policy and wage policy, or tax policy and spending and lending policy, or defense policy and policies affecting industrial and civilian supplies. The Congress has consistently and increasingly recognized that all of these policies are vital , that no one of them is supreme, and that constantly improved machinery should be sought both in the legislative and the executive branch for evaluating these policies as a whole and their relationship to one another. The Joint Committee on the Economic Report and the Council of Economic Advisers are both statutory examples of this recognition. The advent of the defense program has intensified the search, both by the people and their Government, for basic mutuality of purpose and basic consistency of effort among the various instruments of public power affecting the whole economy and its very security. Whenever there might be a fundamental collision of policy between any two or more agencies of public power which fundamentally affect the national economy, manifestly the solution does not lie in arid debate as to how independent one or the other is or should be , or in proposals to subordinate one to the other by legislative fiat. If by independence one means that men of integrity should look for the right answers and express their views vigorously without suppression or recrimination, that, of course, is desirable. Nor would I undertake to enter upon discussion of the question turning upon the fact that the Congress has established the Federal Reserve Board in a different relationship to the Government from that applying to the executive departments. This is a matter of congressional policy. But in no event can any realistic concept of independence mean that there is no relationship or interdependence among the policies and problems. dealt with by the various important agencies of public power importantly affecting the national economy. Consequently, they must all' try to work together on problems which affect them all. In the final analysis, in the event of collision, all agencies of publicpower must recognize the ultimate and decisive authority of the Congress ; and all must recognize that the Presidential office under our traditions and experience has always had the legitimate function of lending its influence toward harmonizing the executory or administrative aspects of national economic policy. But the genius of our system resides not so much in reliance upon command as in reliance upon voluntary accommodation through hard work, fair purposes, and mutual respect. Surely the Council of Economic Advisers, which finds its life in a statute the essence of which is cooperation, cannot bring itself to believe that cooperation is not the best method in dealings. between any important organs of public power. From the peculiar vantage point of the Council of Economic Advisers, it has seemed to me that the Treasury and the Federal Reserve Board, as well as other agencies, have worked harder and with a finer spirit than the general public realizes to join hands in the national MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 153 interest in these trying times . For example , those not involved in the process hardly realize how thoroughly the reports to the Congress under the Employment Act of 1946 are made the subject of full discussion, interchange of views, and a wise spirit of give and take among all of the agencies concerned with national economic policy. I have always found the Treasury and the Federal Reserve Board independent in the sense of being sturdy and vigorous in the assertion of their views ; but I have never found any of them independent in the sense of being remote or unapproachable, provincial or narrowminded, or overzealous in the control of its own domain. The result of this process of cooperation has not been perfect. But it has produced over the years, I believe, a more intelligent and harmonious approach to the problems of our national economy than would have been possible under any other approach. Based upon my observation of the relationships now in effect, I do not see the need for additional formal machinery, or for new legislative efforts to redefine relationships or relative responsibilities. I believe instead that we must continue to work together, seeking to improve our tools of economic analysis, to achieve even greater objectivity, and to enlarge the popular understanding of what we are trying to do. These things depend upon men, and not upon laws. I think the men with whom I have worked measure up to the task, and that is what is most important. At the same time, if it should be deemed desirable to follow the suggestion recently made by the Secretary of the Treasury, to the effect that the Treasury, the Federal Reserve Board, the Council of Economic Advisers, and certain other agencies recognize more explicitly through some new cooperative unit their mutual interests , and if the Federal Reserve Board should feel likewise, such a proposal would certainly meet with the hearty support of the Council of Economic Advisers . In summary, I think we are in an economic situation different from any we have faced before, that it calls for a composite of measures to use our resources wisely, bringing on rapid expansion in some areas and contraction in others. That consequentlly most of the classical approaches designed to deal theoretically with the over-all contraction of the economy to avoid inflation or its over-all expansion to avoid depression are not highly relevant to the current situation . That consequently what we must rely more upon is selective devices to achieve differing results and different trends in different areas of the economy. That consequently we should refrain from using excessively abrupt and generalized weapons which would accomplish some useful purposes which in the main would be outweighed by the use of the blunt weapon on a broad scale. That broadly speaking the trends over the past long period of time toward lower interest rates and a more abundant credit generally speaking are associated with, though by no means entirely responsible for, the great growth in our productive capacity, and broadly speaking the more generous sharing of its benefits both on the business side and on the consumer side. Consequently I think that the range of policy called for in these times is first an intense and active stimulation of our productive genius 154 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT which I do not think has gone anywhere far enough, and which both on the economic side and on the moral side can stimulate and hold together the American people as nothing else can. Second, the moderate use of controls so as not to interfere with that productive genius, and the use of those controls in a composite pattern which has proved moderately successful over the past year, moderately successful during World War II, although I think tax policy was then too lax, and with that, Mr. Chairman, I would be very glad to answer any questions that the committee may have in mind . (The prepared statement submitted by Mr. Keyserling in its entirety is as follows :) TESTIMONY OF LEON H. KEYSERLING, CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS, BEFORE SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, WEDNESDAY, MARCH 12, 1952 Mr. Chairman and members of the committee : I welcome this opportunity to discuss before you the role of monetary policy and the management of the public debt in achieving price stability and high-level employment. By highlevel employment, we must mean the fairly consistent expansion of employment opportunity, because our labor force grows greatly from year to year. And since our technology is dynamic, our productive power tends to increase more rapidly than employment. With manpower and technology both advancing, our economy must expand in order to be stable. It cannot be stable by standing still. In addition to a stable and growing economy, we must make sure that our resources are being devoted to necessary purposes, and these change with the times. For example, if we now had a stable and growing economy without any defense program , we would be living in a fool's paradise. Monetary policy and debt management are not ends in themselves. They are specific instruments which can be used wisely only in the context of the functioning of the economy as a whole, the objectives to which we now adhere as a Nation, and the relative urgency and priority of problems arising in our economy under the threatening current of world conditions. Consequently, I believe that I can be most helpful to the committee, not by commencing with a technical discussion of monetary and debt-management problems, but rather by outlining first what seem to me the most salient features in the current and foreseeable economic situation under a national policy of building our defenses, and then in this perspective evaluating the practical range and nature of relevant monetary and debt-management policies. For example, the size and pace of the defense program, its effect upon the disposition and utilization of our economic resources, and the specific character of the problems it imposes upon the whole economy, are vitally important starting points for a consideration of specific economic measures, including monetary and debt-management policies. These considerations seem to me doubly valid because much of the traditional theory about monetary policy, sometimes recited out of context, found its original roots in the minds of philosophers rather than practicing economists. These men sought to describe a static and perfectly consistent economic system, which probably never existed in the world of reality, and which in any event has little relevance to the dynamic American economy of today and to the entirely novel and rapidly moving problems with which we must now deal. One of the reasons why monetary officials in recent years have not pursued some of these theories relentlessly to their logical results has been, not that others prevented them from doing so, but rather that they themselves have shrunk from the appalling prac- . tical consequences of such action. This may explain why the differences in viewpoint concerning monetary policy and debt management, expressed by those charged with practical problems and public responsibility, have not been so great as the differences expressed by some commentators in search of sensation and by some theorists not challenged by the duty to act. So far as I have been able to observe, the differences between what a responsible Treasury official and a responsible Federal Reserve official would actually do under current conditions, if either had complete authority to do as he pleased, are small differences contrasted with their magnification by those who are not sobered by imminent and vital responsibilities to perform. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 155 The evidence already brought before this committee that the Secretary of the Treasury and the Chairman of the Federal Reserve Board and their associates have sought to reach working agreements is not hard to explain. This development has not resulted from compulsion, either by the Congress or by the President. It has resulted from the compulsion of economic reality, based upon looking frankly at conditions both at home and abroad . Economic conditions at home do not leave a very wide range of election in monetary and debt management policy. While there may still be some shadings of emphasis, the underlying situation and the limitations which it imposes upon novel experimentation or wide deviation from a fairly well-established course make it only natural that men in positions of active responsibility should be anxious and able to reconcile their views. And conditions abroad make it apparent to all men of good will that the American people and their public officials must do their best to pull together in a common cause. I can find nothing suspicious or surreptitious in the fact that the Secretary of the Treasury and the Chairman of the Federal Reserve Board are tryingand it is to be hoped successfully trying to harmonize their views. All that this proves to me is that Mr. Snyder and Mr. Martin and their associates are sensible, hard-headed, experienced, and patriotic men . I shall endeavor, if it please the committee, to commence with a general description of the economic problems now confronting this Nation in the course of a defense effort novel both in character and purpose. I believe that only in this perspective can the more specialized problems of monetary policy and debt management be intelligently depicted or intelligently solved . Some of the fuss and fury stirred up in these specialized areas has resulted from looking at a few trees without surveying the forest. Proposition No. 1 is that our transcendently important economic problem today is how much of our productive power and economic resources should be allocated to national defense. Obviously, the size and pace of the defense program most importantly affect the degree of inflationary pressures, the fiscal situation of the Government, and the entire range of economic policies worthy of serious attention . By national defense I mean the whole range of programs which reflect our undertakings to enlarge the mutual security of the free world. Consistent with a position that I have always taken, I voice no opinion as to how large or how fast these undertakings should be from the viewpoint of national security. I may have views on this as a citizen, but in my role as Chairman of the Council of Economic Advisers I have nothing to offer which can compete with the superior judgment of those in our defense and international agencies, subject to the ultimate judgment of the President and the Congress. But I feel compelled to raise my voice as an economist in the public service when I witness the growth of a strong, if not predominant, sentiment that our security program as a whole must be drastically reduced in order to maintain a strong economy. The clear facts since the original Korean aggression , and the weight of judgment now as to the economic outlook, simply do not support the proposition that we must slash the security program to protect our economy. The primary test of whether a security program of given size and pace in a long period of partial mobilization is weakening or impairing our general economic strength cannot be determined by looking only at the dollar value of the security program nor by looking only at the deficit in the Federal budget, even though these be important considerations. The primary test of the impact of the security program upon our general economic strength involves these three paramount questions : (1) Is the security program, through its drain upon our resources , leaving or threatening to leave our business system with inadequate resources or incentives to safeguard and advance that productive power which is the ultimate source of our economic strength? ( 2 ) Is the security program imposing such strain or deprivation upon consumers as to weaken the strength or morale of our people-155 million strong ? (3) Is the security program, by its very nature, incompatible with the protection of the Nation against further inflation, assuming that we do not want to resort during a long period of partial mobilization to a scope or intensity of controls which in the long run might impair our productive power or corrode our basic freedoms ? 97308-52- -11 156 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT By none of these three paramount tests can respectable evidence be adduced that the now contemplated security program is excessive from the viewpoint of the economist, if it is not excessive from the viewpoint of its primary purpose to make us as secure as we can reasonably hope to be in a threatening and uncertain world. It can hardly be argued that the security program is in process of impairing our basic productive strength. In 1951 gross private domestic investment was at an annual rate of approximately $59 billion, contrasted with about $52½ billion in 1950 and about $472 billion in the previous peak year 1948. All comparisons are in terms of 1951 prices. Investment in producers' durable equipment, which is at the heart of our productive strength, was above $272 billion in 1951 , contrasted with about $24 billion in 1950, and about $23 billion in the previous peak year 1948. The growth of our productive strength has been even more impressive when measured by facilities and supplies in certain key areas, such as steel , aluminum , and electric power. In fact, the pertinent issue with respect to private capital formation in 1951 was not whether business had available the materials, the manpower, the funds, and the incentives to build adequately our productive strength, but rather whether capital formation was proceeding at a higher level than desirable. Nor can it be argued that the security program is in process of reducing consumer supplies below satisfactory levels. With the possible exception of 1950, the year 1951 witnessed the highest level of consumer supplies on record. few things, such as housing and automobiles, were produced at a somewhat lower level than in 1950, but at a much higher level than in any year before World War II. Similarly, it cannot be said that the size or pace of the security program is inconsistent with the maintenance of economic stability. The past year has almost established a new record for general price stability. Wholesale prices have tended slightly downward since March 1951. Retail prices during the past year have moved very moderately upward, but have begun to turn downward in recent weeks. This stability has not been achieved under an anti-inflationary program which most informed persons would call excessively severe. On the contrary, it has been achieved under policies of taxes, credit controls, and direct controls which have been somewhat milder and looser than most experts thought necessary and the major explanation of this has been our enormous productive power and the general amplitude of supplies. As we look forward to the remainder of the year 1952 and beyond, it is a curious paradox that some of those who a year or so ago were extremely doubtful about the capacity of our productive resources to support the demands of the security program are now exhibiting trepidation lest even with the security program we run into a recession due to the inability of the economy to maintain demand for that part of our productive resources which are not employed in the security program . I do not believe that this trepidation is justified , for reasons which it would not be germane to develop at length here. Nonetheless, the trepidation at least underscores the point that there is a growing recognition that the securiy program can be borne by the economy without excessive strain. I would be the last person imaginable to take the unsound position that the security program should be maintained at now contemplated levels, or raised above these levels, in order to maintain high-level production and employment . That is manifestly not an appropriate function for a security program. I am firmly convinced that our economy now has or must find the ways to maintain stability and growth, if and when the world situation permits a vast reduction in the security program. The only point I am making here is that while we should by all means reduce the security program when the best informed appraisal of the world situation dictates that course, we do not need and should not dare to do so before that time on general economic grounds. The question of the necessary size of the security program should not be confused with the question of efficiency and the weeding out of waste in its execution. Every sensible person will agree that it would be a net gain, if ways could be found to get the same amount of security for less money. I hope that such ways can be found , and I commend every effort toward that end. But I believe that only confusion and danger to this country can result from failing to distinguish between trying to get necessary security as economically as feasible, and trying to cut security below necessary levels on the ground that we do not have the economic strength to do the job. Since we have the resources of manpower, materials, and business and institutional skills to carry forward the security program, we cannot say that we do MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 157 not have the means to finance it. It would be somewhat better, in my judgment, to pay for a security program at the now contemplated level entirely out of taxation rather than partly by borrowing. But even if it is financed partly by borrowing, the Congress will need to weigh whether the amount of borrowing involved could threaten the Nation to the extent that it would be threatened by a deficiency in national security. I have dwelt upon this point at some length, because I believe that it is the greatest economic issue which we face as a nation, and one alongside of which other economic issues pale into relative insignificance. It seems to me that those who do not give top priority to this question, cannot find the right answer on other questions of economic policy. We have reasonable grounds for believing that, if we are strong enough to resist and deter the Communist menace, the American economy will continue its timeless progress toward new productive achievements and even greater strength. But if, through mistaken economic analysis concerning the capacity of our economy, we should fall down on this top job, then no other policies could save us from dangers beyond description . Proposition No. 2 is that, with a large security burden, economic policy must concentrate above all upon the expansion of production. When any nation assumes a large defense burden, there are only two major ways of carrying it. One way is to expand total output, so that defense needs can be served without subtracting too much from other economic needs. The second way is to use economic controls to divert productive resources away from other purposes and toward defense purposes. Even in a nation as strong and productive as the United States, both of these methods must be used for the time. being. But it is clearly in our interest, particularly in a long period of partial mobilization, to accomplish as much of the defense program as possible through the expansion of production, rather than through drawing down upon other elements in our national economic strength. This is the basic philosophy of the current mobilization program. The soundness of this philosophy is conclusively demonstrated by all experíDuring World War II at its peak, we allocated to defense purposes annually almost as much resources as the total product of our economy during the year before the war started . But we so expanded total output that we were able to do this without a damaging curtailment of civilian supplies, and while carrying forward many industrial expansion programs to provide the sinews for the war effort. Further, when the war was over, we found that the expansion of our productive facilities could be translated into peacetime goods and services: without serious or prolonged economic dislocation. Since the Korean outbreak,. although our then existing productive resources were more fully utilized in mid-1950 than in 1939, we nonetheless have relied predominantly upon our genius: for still further productive expansion to carry the additional burden. Since mid-1950, our expansion of total output has roughly kept pace with the expanding: defense program, and consequently the defense program has not resulted in impairment of our industrial or civilian strength. We have used controls to facilitate an orderly transition, and to deal with specific shortages. But fortunately, we have not fallen into the error of substituting the philosophy of allout controls for the philosophy of all-out production. It is by doing the job in the American way that we have kept our economy so strong, and in fact made it stronger. Our greatest reserve strength still lies in our capacity further to increase production. The ceiling of our productive ability has no more been reached in 1952 than in 1950 or in 1948. Without appreciably lengthening the workweek, and without applying the forced pressures of a full-war economy, we have ample resources to increase total production by at least 5 percent per annum over the next few years . If additional pressure should require us to do so, we could for at least a few years almost double the annual rate of productive increase. It is: this which, more than all else in material things, gives us our true measure of superiority over the Russian system. Insofar as we need to fight inflation through the imposition of controls and! restraints, indirect or direct, we must do so in ways that do not seriously militate . against the achievement of our productive potential. This has a most important bearing upon the nature of controls that we can afford to use, and upon the extent to which we can afford to use them. Those who would employ without reservation the classical measures of "fighting inflation," seem not to have taken: into account the imperative necessity for fighting inflation in ways that do not repress the general rate of productive advance which is the surest way to keep our economy strong throughout an enduring defense period. 158 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Proposition No. 3 is that the expansion of production must be responsive to the priorities of national needs. We cannot do everything at once. This means that balance must be maintained in the utilization of our resources . Great though our productive resources are, we cannot afford to do everything at once. While some lines of production must be rapidly expanded, others must be contracted. For example, in order to build more airplanes, we must for a time build less automobiles . In order to build more plants to produce steel, we must for a time build less houses than we otherwise would. Further, expansion and contraction in various areas must achieve sufficient consistency to avoid excessive economic dislocation and to fulfill the defense program itself. For example, if the expansion of machine tool facilities were not sufficiently coordinated with the defense program, bottlenecks would multiply in the execution of the defense program . If defense expansion and civilian contraction were not harmonized , either the manpower and the materials for the defense program would be lacking, or excessive and premature disutilization of manpower and materials would occur. The most important decisions of a defense period, both private and public, involve this concurrent expansion in some areas and contraction in other areas. Hence the economic policies to be used must be far more refined and selective than if the simple purpose were to produce a general expansion or contraction of the economy as a whole. We are not fighting primarily an inflation or a depression ; we are fighting primarily a limited international struggle. It follows that the classical economic theories directed toward producing general stimulation or general contraction throughout the whole economy, i. e., the traditional "anti-inflationary" or "antideflationary" policies, are not suitable for universal or broadside application to the current problems of the defense economy. Proposition No. 4 is that the task of curbing inflation in a defense economy must be reconciled with the need at one and the same time for expansion in some areas and for contraction in others. The essence of controlling inflation is to prevent available funds, coupled with the desire to spend them, from exceeding by great amounts the available goods and services for which these funds would be used . When the simple purpose is to expand general buying power to facilitate recovery from a depression , or to contract total buying power in order to cut down the demand for goods and services of all kinds , it is relatively easy to apply the classical set of "anti-inflationary" or "antideflationary" weapons. But in the current situation , it is necessary to couple some types of expansion with some types of contraction, and consequently to expand some types of investment and other buying while contracting others. Therefore, efforts to influence spending must be conformed to the pattern of resource use which the defense program demands. It follows that measures to contract spending power and employment and production in some areas, no less than measures to produce expansion in other areas, must be sufficiently selective and discriminating to expedite the defense program, to build up the industrial mobilization base, to expand some other areas of production , and at the same time to exercise necessary restraints in still other areas. All this must be borne clearly in mind as one reviews available economic tools, not in terms of how they were talked about by some classical economists who never attempted to use them and who never imagined the current situation, but rather in terms of how these tools may now be applied by practical people in the face of tasks confronting the Nation quite different in character from any in the past. Proposition No. 5 is that the nature of our current and foreseeable economic tasks is too complicated for extreme or major reliance on any one type of economic measure. This applies to monetary policy as well as to other policies. As indicated above, the complicated and unique character of the current defense program requires a combination of efforts , some designed to expand parts of the economy rapidly, and others designed to contract other parts of the economy with similar rapidity ( insofar as the increase in over-all production does not in itself take care of the necessary expansion of the security program) . Theoretically, one might argue that any one type of economic policy might be predominantly relied upon in the current situation to prompt all of the necessary and varied adjustments in resource use. For example, it might be argued theoretically that, since tax reductions are stimulating and tax increases repressive, a complex tax scheme could be worked out which provides sufficient inducements for expansion wherever needed and sufficient restraints for contraction wherever needed. But the effort to formulate and apply such a complicated and refined MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 159 tax system would deprive the tax system of one of its main virtues- namely, that it is rather generalized -and would make taxation more complicated and cumbersome, more detailed and personalized, than the most extreme kind of price and wage control. Similarly, one could work out theoretically a pricecontrol policy, or a credit-control policy, or a policy governing the allocation of materials, so comprehensive and so discriminating as to accomplish by that one device alone all of the objectives for the economy which must now be sought. But the utilization of any one device to this extent would break down of its own weight, and would result in a system of controls far more harsh, rigid, and excessive than the moderate utilization of a variety of weapons in mild proportion. These comments are applicable to general monetary policy. I am heartily in accord with the moderate utilization of monetary policy to exercise some general restraining influence in an inflationary period. But intrinsic limitations upon its utility lead to major reliance upon a variety of other measures. Clearly, monetary policy is hardly the device for stimulating the rapid expansion in some areas of the economy which is now desirable. General monetary policy is a suitable device, within appropriate limits, for imposing some necessary restraints upon the economy. But if most of the restraint is to be highly selective , as I think it must be under current conditions for reasons which I have already given, general monetary policy cannot do very much of the job. And if monetary policy were to be exercised for the purpose of putting brakes upon the rate of activity of the economy as a whole, it could hardly be pushed far enough to do this under current conditions without reducing substantially the over-all level of production and employment--which would cut directly across the vital objective of utilizing our resources fully and expanding our over-all productive strength. In this connection the inability to place great reliance upon general monetary policy has been fully recognized by those who are regarded as outstanding exponents of its appropriate use geared to the time in which it is used. Thus in a statement before the Joint Committee on the Economic Report on May 12 , 1948, Mr. Allan Sproul, president of the Federal Reserve Bank of New York, had this to say : "A general monetary control, if used drastically enough, works through a restriction of production. The steps in the process are restriction of money supply, rise of interest rates, contraction of employment and production, contraction of income. I know of no monetary device which would enable us to avoid these consequences . * * In order to get the effect our critics suggest, would mean that our action would have to be drastic enough to lower the money income of a large segment of the consuming public. To accomplish this by over-all monetary or credit action would mean a serious decline in production and employment. Such action could only be justified if we were faced with a runaway inflation due solely or primarily to monetary causes. That is not our present situation and that cannot be the right policy now." It is hard, indeed, to find in the current situation any reason for departing from the principles which Mr. Sproul set forth so cogently in May 1948. The immediate inflationary trends now are certainly not as pronounced as they were in May 1948, and the need not to reduce substantially the total of production and employment is certainly greater now than it was at that time. Still more important is this consideration : Even if it were to be conceded that the over-all reduction in production and employment were not too high a price to pay for the drastic use of general monetary policy, it does not appear that this reduction would concentrate in those areas where the economy can best afford such a reduction under current conditions. On the contrary, analysis indicates that such a policy would be first reflected in the reduction of production and employment in those very areas where the further expansion of facilities and output is most critically needed , and would appear last, if at all, in those highly speculative and nonessential areas where more selective and pointed measures can be effective quickly. Recently, before the forty-fifth annual meeting of the Life Insurance Association of America on December 12, 1951, Mr. Sproul had this to say : "All that should be claimed for general credit controls, in my opinion , is that combined with other measures working in the same direction , such as fiscal policy, debt management, and, in extraordinary circumstances, direct controls , they can contribute to anti-inflationary and anti-deflationary forces. * * * It seems to me that the same circumstances which are responsible for the problems of coordinating debt management and credit policy contribute to the effectiveness of mild general credit policies , and that we can have an expanding economy without throwing too much of the gasoline of easy credit on the fires of active business." 160 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT It is my belief that the limitations now placed upon the utilization of general monetary policy, by the imperative need for expanding over-all production, and by the need for being highly selective in imposing restraints upon particular segments of the economy, are perhaps more important than other reasons advanced for the very moderate utilization of general monetary policy. These other reasons include the size of the national debt, its carrying costs, and its profound influence upon the country's financial structure. For example, Dr. E. A. Goldenweiser, a first-rate theoretical economist with great practical experience within the Federal Reserve System, in the American Economic Review in June 1947 , recognized the undesirability of substantial increases in the long-term interest rate, saying : "Not only would such a rise increase the cost of borrowing to the Government at the time of refunding, but it would make inroads on the capital values of securities acquired by institutions and individuals in support of the war effort. The Government is determined not to repeat the experience after the First World War when Government securities went down to the 80's. One reason, among others, for this determination is the size of the debt and its dominant position in the country's financial structure." I feel that, if the security program is to be carried forward and not dangerously reduced, the economic and fiscal outlook make these comments of Dr. Goldenweiser in 1947 at least as pertinent today. The Federal surplus of 1947 has been replaced by a deficit, which will increase for a time. The problems of Treasury financing will be larger, not smaller, than in 1947. It should also be taken into consideration that extreme changes in the interest rates on long-term Government obligations are out of the question under current conditions, and that very small variations might not achieve the stated purpose of narrowing the gap between these interest rates and interest rates on other types of obligations. In testifying before the Joint Committee on the Economic Report on November 22, 1949, Mr. Marriner Eccles had this to say : "In a falling bond market, with general credit demand strong, rates on other securities and loans would tend to rise at least proportionately as much. Under these conditions, can it be expected that insurance companies or savings and loan associations or other institutional investors would act materially differently with the yield on Governments at 3 percent than they do now at 22 percent? "Loans or investment, other than Government securities, would have as much, if not more, relative attractiveness to lenders and investors . Few, if any, borrowers would be priced out of the market for funds by rate increases of the size contemplated . * * * "Any moderate rise in long-term interest rates would not, in itself, reduce significantly the demand for money. Investing institutions, which are now switching from long-term Government bonds to private credit forms, would still be motivated to do so by a continuing margin of return between the two kinds of investment." The Congress has had occasion to observe in recent months that the effort to increase the interest rate on long-term Government obligations has been accompanied by efforts to move up other interest rates. An outstanding recent example has been in the field of housing, where ironically the argument was advanced, not that interest rates should be raised to repress credit expansion, but rather that interest rates should be raised to enlarge the volume of housing loans. While my mind is not wedded inflexibly to any particular level of interest rates in general, and while some flexibility in the general interest structure may be desirable, care should certainly be taken not to jeopardize the maintenance of a generally low interest rate structure by departures from it whichwhile small at first-might gain dangerous momentum. When one considers the painful process by which the interest rate structure as a whole has been brought far below the levels obtaining prior to the great depression, plus the indisputable evidence that this trend has been a major contributory factor in the great and sustained productive expansion of the economy and the more equitable sharing of its benefits among a wider range of business firms and consumers, the case against risking a reversal of that trend is strong indeed. None of the foregoing should be interpreted as an expression of disagreement at this time with the accord reached between the Treasury and the Federal Reserve Board last March , involving some experimentation with flexibility in interest rate policy. To be sure, I am still prone to reserve judgment, depending upon the further unfolding of events, as to whether this mild modification in policy has MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 161 been demonstrably beneficial . It has had some desirable and some undesirable results, and the net balance is far from clear. But the main point I now desire to make is that the accord of March 1951 , as I understand it, is consistent with a view held by the Treasury and the Federal Reserve Board, in which the other distinguished authorities whom I have cited seem to join. This view in essence is that variations in monetary policy and interest rate policy must be kept within very narrow limits indeed under current conditions. And consequently, monetary policy can be no more than one mild tool among many in the quest for economic stability and growth within a high-defense environment. I do not dissent from what has been done. However, I do maintain that the relative economic stability during the past year has been due not to one device, but instead to a wide variety of factors-productive growth, higher taxes, general abundance of consumer supplies, high voluntary savings, selective as well as general credit restraints, price and wage stabilization, and the movement of the defense build-up at a somewhat slower pace than had been estimated a year ago. By the same token, I cannot accept the viewpoint that the main key to future economic stability consists in pushing monetary manipulation as far as it seemingly would be pushed by those who regard it as a panacea and not simply as one useful device among many. It is a device which cannot be relied upon heavily, without bringing in its train undesirable consequences of a certain character far outweighing any speculative and thus far unproved benefits which might follow. Proposition No. 6 is that the current and foreseeable economic situation calls for an admixture of economic tools , without excessive reliance upon any one. It has become common practice for some overexuberant proponents of a particular economic policy to ascribe to it alone the entire or major credit for some desirable result which has been achieved . This they do by setting in juxtaposition the utilization of this policy and the desirable result. Those who are strong for price controls can point to the coincidence of price controls and a stable price level at times ; those who are against price controls can point to periods where prices remained stable without price controls, and other periods when prices moved upward even with price controls. Those who claim that the money supply is the all-controlling factor can point to periods when an increase in the money supply was accompanied by an expansion of credit and by price inflation ; but those who believe to the contrary can point to periods when prices rose rapidly while the money supply was contracting. Most of these demonstrations are rather spurious, because coincidence is not the same as cause and effect, and because at any given time there are many forces at work in the economy and no single one can be designated as being all-prevailing or decisive in its influence. The most responsible weight of opinion seems to me to be that economic stability and growth depend upon a variety of measures used in moderation , without excessive zeal in the application of any one. A well-balanced perspective on this point appears in an article by Dr. E. A. Goldenweiser, in Harper's magazine for April 1951. Dr. Goldenweiser had this to say : "First, we must bend every effort to increase production by greater exertion, greater efficiency , longer hours, fewer leisure people, less of the gracious things of life * * *. Second, we must economize- make sure that no money is spent unnecessarily. * * * Third, as large a share of the necessary expendi* Fourth, the Government tures as possible must be met by taxation. * must borrow what has to be borrowed ( insofar as possible ) in such a way as to tap income that would otherwise be spent by the person receiving it . * * Fifth, the Government should borrow from the banks only the unavoidable minimum . * * * Sixth, over-all restraint should be exercised over loans by banks to businesses and individuals. * * * Finally * * * price and wage controls-to hold the line until the other measures become effective-are highly desirable." The foregoing seems to me to set forth admirably, and in proper order, the rounded elements in a program for stability and growth. Further, I would like to stress the extent to which most of those who have been challenged by the responsibilities of practical action, and particularly by the responsibilities of public office, find themselves in essential agreement in this matter-although there will always be some shadings of emphasis. The economist who has to maintain only a theoretical position, or to write his name imperishably ( in his belief ) into the literature of his profession, may mistake the shadings for the essence and magnify the differences of view. But 162 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT in all my dealings with responsible public officials, in the Treasury, the Federal Reserve Board, and elsewhere, I have continuously been impressed by the amount of agreement on fundamentals. The Council of Economic Advisers undertakes long and searching consultation with the whole range of those concerned with economic policy, both private and public, at least twice a year in the development of our semiannual published reports. To be sure, some differences of viewpoint arise. But in the overwhelming majority of cases, these prove susceptible to accommodation, on the part of men who after all are looking at the same facts and who share the objective of a stable and growing American economy. Proposition No. 7 is that basic economic policies which affect the whole Nation should seek harmony, and that under our system the most powerful force toward this harmony is men of good will working cooperatively together. With this force present, neither new machinery nor new legislative definitions of authority seems essential. Above all, there is widespread agreement that those agencies of public authority which vitally affect the national economy should try to reconcile their actions, because pulling in opposite directions is manifestly hurtful regardless of which side is "on the side of the angels .' There will always, of course, be differences of opinion on policy issues. But neither sober and reflective businessmen nor anybody else would want various important agencies of public power, each vitally affecting the economy, to pursue conflicting policies of a fundamental character for an enduring length of time. Nothing could be more inefficient, more uneconomical, more demoralizing to our business system, or more conducive to the undermining of the people's confidence in public authority. It is true that different agencies of public power have different accents of responsibility and different prime objectives and functions. But no one of them can believe that its perspective or its point of emphasis is transcendently important to the exclusion of all others. The very fact that in our democracy there are at the national level so many agencies of public power makes it essential that a process of reconciliation and harmonization move constantly forward. It has always been this way ; and it will always be this way. The possibility of some fundamental collision of policy between two agencies of public power which fundamentally affect the national economy is by no means limited to the case of the Treasury and the Federal Reserve Board. Other agencies of public power are now undertaking functions quite as vital to the economy as a whole, and quite as important to the lives and fortunes of the individual. For example, it would be hard to imagine a more far-reaching authority than that of allocating scarce materials throughout the economy, which carries with it the very power of life or death over substantial segments of our business system. The relationship between monetary policy and fiscal policy is indeed important, but no one can prove that it is of a very different category of importance from the relationship between price policy and wage policy or tax policy and spending and lending policy or defense policy and policies affecting industrial and civilian supplies. The Congress has consistently and increasingly recognized that all of these policies are vital, that no one of them is supreme, and that constantly improved machinery should be sought, both in the legislative and the executive branch, for evaluating these policies as a whole and their relationship to one another. The Joint Committee on the Economic Report and the Council of Economic Advisers are both statutory examples of this recognition. The advent of the defense program has intensified the search, both by the people and their Government, for basic mutuality of purpose and basic consistency of effort among the various instruments of public power affecting the whole economy and its very security. Whenever there might be a fundamental collision of policy between any two or more agencies of public power which fundamentally affect the national economy, manifestly the solution does not lie in arid debate as to how "independent" one or the other is or should be or in proposals to subordinate one to the other by legislative fiat. If by "independence" one means that men of integrity should look for the right answers and express their views vigorously without suppression or recrimination , that, of course, is desirable. Nor would I undertake to enter upon discussion of the question turning upon the fact that the Congress has established the Federal Reserve Board in a different relationship to the Government from that applying to the executive departments. This is a matter of congressional policy. But in no event can any realistic concept of "independence" mean that there is no relationship or interdependence among the policies and problems dealt with by the various important agencies of public power impor- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 163 tantly affecting the national economy. Consequently, they must all try to work together on problems which affect them all. In the final analysis, in the event of collision , all agencies of public power must recognize the ultimate and decisive authority of the Congress ; and all must recognize that the Presidential office has always had the legitimate function of lending its influence toward harmonizing the executory or administrative aspects of national economic policy. But the genius of our system resides not so much in reliance upon command as in reliance upon voluntary accommodation through hard work, fair purposes , and mutual respect. Surely the Council of Economic Advisers, which finds its life in a statute the essence of which is cooperation , cannot bring itself to believe that cooperation is not the best method in dealings between any important organs of public power. From the peculiar vantage point of the Council of Economic Advisers , it has seemed to me that the Treasury and the Federal Reserve Board, as well as other agencies, have worked harder and with a finer spirit than the general public realizes to join hands in the national interest in these trying times . For example, those not involved in the process hardly realize how thoroughly the reports to the Congress under the Employment Act of 1946 are made the subject of full discussion, interchange of views, and a wise spirit of give and take among all of the agencies concerned with national economic policy. I have always found the Treasury and the Federal Reserve Board " independent" in the sense of being sturdy and vigorous in the assertion of their views ; but I have never found any of them " independent" in the sense of being remote or unapproachable, provincial or narrow-minded, or overzealous in the control of its own domain. The result of this process of cooperation has not been perfect. But it has produced over the years, I believe, a more intelligent and harmonious approach to the problems of our national economy than would have been possible under any other approach. Based upon my observation of the relationships now in effect, I do not see the need for additional formal machinery, or for new legislative efforts to redefine relationships or relative responsibilities. I believe instead that we must continue to work together, seeking to improve our tools of economic analysis, to achieve even greater objectivity, and to enlarge the popular understanding of what we are trying to do. These things depend upon men, and not upon laws. I think the men with whom I have worked measure up to the task, and that is what is most important. At the same time, if it should be deemed desirable to follow the suggestion recently made by the Secretary of the Treasury, to the effect that the Treasury, the Federal Reserve Board, the Council of Economic Advisers, and certain other agencies recognize more explicitly through some new cooperative unit their mutual interests, and if the Federal Reserve Board should feel likewise, such a proposal would certainly meet with the hearty support of the Council of Economic Advisers. Representative PATMAN. Senator Douglas, would you like to ask some questions ? Senator DOUGLAS . First, let me thank you, Mr. Keyserling, for your statement. May I ask if it is a function of the Council of Economic Advisers to offer current advice on economic developments to the President ? Mr. KEYSERLING . Yes , sir. Senator DOUGLAS . Do you understand it to be a function of the Council of Economic Advisers also to offer current advice to the Congress ? Mr. KEYSERLING . Yes, sir. I would like, if there is any question about that, to state briefly why I think so. Senator DOUGLAS. No ; that is not necessary at all. Now did you watch the situation currently from the 1st of July 1950 , until the 1st of March 1951 ? Mr. KEYSERLING. I have tried to. Senator DOUGLAS. You kept in touch with current figures ? Mr. KEYSERLING . Yes , sir. 164 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. Month by month, week by week, and in some cases day by day. And therefore you were continuously apprised of what was happening. Were you aware that the Federal Reserve Board through its open market committee was purchasing large quantities of Government securities during this period ? Mr. KEYSERLING. I would be inclined to think that one would be aware of that, and I was aware of it. Senator DOUGLAS. Were you ? Mr. KEYSERLING . Yes. Senator DOUGLAS . You were aware of it ? Mr. KEYSERLING. Yes. Senator DOUGLAS . Were you aware of the fact that during these 8 months the Federal Reserve, depending on the precise termination date, purchased from $312 to $4 billion of Government securities ? Mr. KEYSERLING . Yes , sir. Senator DOUGLAS. Were you aware of the fact that bank reserves in the Federal Reserve System were rising during this period ? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS . Rising by not quite as much as the purchases of bonds, but by substantially as much . Did you think there was a connection between the purchase of Government bonds by the Federal Reserve System and the rise in bank reserves ? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS . An immediate and direct connection ? Mr. KEYSERLING. That is a question of degree, but I would be willing to answer it by saying there is a substantial and important connection. Senator DOUGLAS . And a direct connection ? Mr. KEYSERLING . And direct connection . Senator DOUGLAS . The Federal Reserve Board testified yesterday that the purchase of Government bonds is paid for by checks which, moving through the banking system, are deposited in the Federal Reserve System and automatically become reserves of the member banks. Mr. KEYSERLING. I agree with that. Senator DOUGLAS. Did you notice that bank loans were increasing ? Mr. KEYSERLING. Yes ; bank loans were increasing. Senator DOUGLAS. Bank loans increased during the period of 8 months by ten billions of dollars, or an increase of approximately 18 percent. Did you notice that ? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. Did you think there was a connection between the increase in bank loans and the increase in bank reserves ? Mr. KEYSERLING. By no means the probable direct and substantial connection that there was with respect to the earlier parts of what you recited, Senator. Senator DOUGLAS . Is it not true that an increase in bank reserves makes possible an increase in bank loans due to the fractional reserve system ? Mr. KEYSERLING. I think I would approach it from the other end and look at the volume of investment that took place. Senator DOUGLAS. I am not speaking of investment banking. I am not speaking of savings. I am speaking of bank loans, that is, of created credit. Of course , the fundamental distinction in banking is MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 165 between the investment of savings through the investment machinery and the creation of bank credit in the commercial banking system. Mr. KEYSERLING. Senator, let me begin by saying as a coloration to my whole discussion, that at points where we differ , either of us may be right, and let's proceed from there. Now let me answer your last question , if I may. I have used the word "investment" in a somewhat different sense from what you have used it. I have used the word "investment" to express the use of funds to command materials, money, and human effort in the production of facilities, plant equipment, and housing, and other things of that kind, and I think that the point at which money exercises an inflationary impact upon the economy is when it begins to command goods and services. In other words , you and I can exchange loans ad infinitum , and more and more loans, so long as we do not do anything with them. Senator DOUGLAS . What do you understand the difference between commercial banking and investment banking to be ? Mr. KEYSERLING . 7 May I answer the other question and then come back to that ? I want to carry through with the idea . Senator DOUGLAS . There seems to me to be a connection between the increase in bank reserves in the Federal Reserve System and the increase in bank loans. I am referring to the Federal Reserve Bulletin for May 1951 , on page 527. In the second column it is marked "Loans." whereas the third, fourth, and fifth columns are "Investments ," so I am not speaking about loans and investments. I am speaking of loans. Mr. KEYSERLING. Senator, I am not at all sure there will be any disagreement if I can carry through on the one idea I am trying to express here. Senator DOUGLAS . Did you see any connection between the increase in bank reserves in the Federal Reserve System and the increase in short-term bank loans ? Mr. KEYSERLING. I was trying to discuss , Senator , how much connection I saw. A question like that cannot be answered "yes" or "no." There is some connection between any two coincident events of a large character in the economy. What I am trying to say is that in looking at the question of investmentSenator DOUGLAS. I am not speaking of investment . I am speaking of loans, commercial loans. Mr. KEYSERLING. But the loans have no effect upon the economy until they are translated into some kind of overt economic action . Senator DOUGLAS. Let me ask you this : Is it not true that in the case of commercial loans what happens is that the loan is made first and it is made in the form of a credit which is set up to the account of the borrowers so that the loan creates the deposit, whereas in investment banking the savings are made out of the current incomes of individuals and corporations and are then deposited in financial institutions, which then act as middlemen to distribute these sums to the places where the investments are made ? In the case of the investments, therefore, the saving creates the deposit, the deposit creates the loan or investment, whereas in the case of commercial banking the credit is created by the bank when the amount of the loan is deposited to the account of the borrower and the borrower draws upon. 166 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT In the case of commercial banking, therefore, the creation of this new credit constitutes an addition to the total money supply, whereas in the case of the investment banking what we have is a diversion of existing income for the purposes of investment and saving rather than for consumption . Now, isn't that distinction a valid distinction ? Mr. KEYSERLING. Yes, sir, it is a valid distinction, but I think the distinction I am making is also a valid distinction, and let me carry it through to indicate its significance to this general point. The general point I am making is that you can start at either end of this road and the end I start at is this : That ultimately the impact on an economy occurs when manpower, materials, and economic activity are generated to command resources. In other words, if you and I lend loansSenator DOUGLAS. We did not have much unemployment in 1950 . So that there was not much possibility of putting idle people to work on idle resources. - Mr. KEYSERLING. I did not say that. Let me carry this forward. You and I, Senator, to simplify this thing, possibly oversimplify it, can lend money back and forth to each other, or a bank and individual or two kinds of banks can lend money back and forth to each other, and the volume of loans increases by that. It is only at the point where the loan is used for a dynamic economic function that it exercises a strain on the economy. Now, the point I am making is that, looking at the volume of investment, using investment in the broad sense of how our business system was commanding resources of manpower and materials and plant and equipment, which is what exerts the inflationary strain, during the period that you refer to -and here I come to the part of it that is directly relevent to your question- I do not see as clearly as you do that the variation in bank reserves or the variations in the factors that you mentioned were the controlling or even the major factors in the actual level of capital formation which took place. I think that, under the conditions obtaining between the middle of 1950 and early 1951 , the amplitude of business resources was such of all kinds, depreciation reserves, accrued profits, capacity to borrow that they would have maintained under any set of circumstances except changes so drastic in the economy that they would have knocked it for a loop, and I think the level of business outlays between 1950 and 1951 was conditioned primarily by availability of manpower, by the prospect of big markets, particularly in view of a new and growing defense program, by the general capital position of these businesses resulting from many accrued years of prosperity with unusually high profits even after taxes. In other words, the part at which I must respectfully depart from you, Senator, is the extent to which you ascribe functionings in the economy to a particular limited set of events . Now, I am perfectly willing to admit that that played some part, but I happen to think that that particular development played a relatively very small part in the level of business investmentSenator DOUGLAS . Wait a minute ; I am speaking of loans- let that be understood-commercial loans. Do you think that the increase in the reserves played a very small part in the increase in loans, the increase in reserves being around $31/2 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 167 billion, the increase in loans during the same period was around $10 billion. Do you say that the increase in reserves played a very small part in the increase in loans ? Mr. KEYSERLING. I think that is true within any variant that any responsible public official would have wanted to apply if he had had absolute power to contract that volume of loans . Now, I am perfectly willing to admitSenator DOUGLAS . Did not the increase in reserves make possible an increase in loans ? Mr. KEYSERLING. It made possible an increase in loans, butSenator DOUGLAS . And is it not true that on the whole each added dollar of reserves makes possible increased loans of $6 ? Mr. KEYSERLING. I think you could get different computations as to whether it is $6 or $5 , but broadly speaking there is a connection . Senator DOUGLAS . Required reserves of the class C banks were 14 percent, of the class B banks 20 percent, of the class A banks 24 percent . They were up virtually to their maximum. Class A could have gone up to 26, but it was 24. The general average is approximately 16 percent, a little over 16, so that you have a potential multiplier- and I want to put that word "potential" in-a potential multiplier of 6 ; isn't that true ? Mr. KEYSERLING. Yes, but I thinkSenator DOUGLAS. If that is true, an increase of $3 billion in reserve would have made possible an increase of about $ 18 billion in loans. Now, a $ 10 billion increase did occur. Is it your contention there was little connection between the increase in reserves and the increase in loans ? Mr. KEYSERLING. It is my contention that if the Federal Reserve Board had been following at that time the policy which-I think this is the easiest way I can describe it : If the Federal Reserve Board had been following at that time the policy which they are following now as described by them before this committee and reflecting the "accord," if that policy had then been in effect rather than the policy which was then in effect, it is my contention that the ultimate level of business investment , of capital formation, of economic activity in that sector of the economy, would during that period have been, under all the conditions playing upon it, approximately the same . Now, that is all I am trying to say, and I think that is important . Senator DOUGLAS . I appreciate your reply, which I think is somewhat elliptical to the question which I asked . My question is : Was there any connection or appreciable connection between the increase in reserves of banks in the Federal Reserve System and the expansion of commercial loans which they made to private business ? Mr. KEYSERLING. Why, Senator, on the line of questioning which asks if there is any connection , I am perfectly willing to agree that there is a connection . Senator DOUGLAS . Do you think there is an appreciable connection ? Mr. KEYSERLING. You move from "any" to " appreciable" to "great" to "prevalent. " Senator DOUGLAS . One step at a time. Mr. KEYSERLING. Yes, but that one step at a time involves some leaps. 168 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . Do you think there is any appreciable connection between the increase in reserves and the increase in loans by banks ? Mr. KEYSERLING . Yes, there is some connection. Senator DOUGLAS. An appreciable connection ? Mr. KEYSERLING. Well, Senator, I think I have made myself clear on that. You are more adept than I am in synonyms, but no two synonyms mean the exact same thing. Senator DOUGLAS. You are more adept than I am. I feel I am moving in a semantic wilderness. Mr. KEYSERLING. No, sir ; I think that the basic issue in the period under discussion is whether, in view of the complexion of the national job that we had to do at that time, the level of capital formation was too high or too low or misdirected . That is the ultimate result of these various beginnings of economic policies. Now, what I am saying is this : First, that I don't believe that the composition would have been very different during that period if there had pertained during that period the policy which you think represents an improvement over the policy then pertaining. Senator DOUGLAS. For the moment I haven't come out with conclusions at all. I am merely trying to establish a chain of causation, and then when we reach conclusions that is something else. At the moment I am simply asking you a very simple question : Do you think there was an appreciable connection between the increase of $312 billion in bank reserves in the Federal Reserve, and the increase of $10 billion in the loans made by banks to private borrowers ? Mr. KEYSERLING. Well, Senator, I am willing to go along with you on accepting the word "appreciable." I do think that while your questioning precedes your conclusions, your questioning is moving inexorably toward your conclusions. Senator DOUGLAS. If truth leads us there, let us not shy away. Now, I agree with you in this statement that there is an appreciable connection because I would like to point out that according to the Federal Reserve bulletin for May, page 515 , which I would like to have checked , final column, the excess reserves of member banks as of June 28 , 1950, was said to be $526 million. That is, on the basis of the reserves which the member banks had at the end of June, there was only $526 million above that required for their existing outstanding quantity of loans. Therefore, if used up, every dollar of this excess reserve- and you never can use up all your reserves they would only have been able to have expanded loans by about $3 billions . As a matter of fact, you can't use up every dollar. You have to have some margins. Probably they could not have expanded their loans more than a billion to a billion and a half. But the Federal Reserve Board purchased large quantities of Government bonds, hence built up the reserves of the member banks, and hence increased the lending capacity of banks. And, as a matter of fact, if you trace this relationship the banks approximately kept their loans in pace with the reserves which they built up, because by February 28, 1951, excess reserves amounted to only $700 million , so that they had obviously loaned up to the capacity of the reserves which had been created for them , and it seems to me that the conclusion is perfectly clear that the increase in loans could MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 169 not have occurred to any appreciable degree had there not been this purchase of Government securities by the Federal Reserve . Is there anything wrong with that line of reasoning? Mr. KEYSERLING . I am here to be questioned and not to ask questions. I realize that. Senator DOUGLAS. Is it not true, then- if you don't wish to comment that the increased loans were made possible virtually entirely by the increase in bank reserve which in turn, as you have testified, was made possible by the purchase of securities by the Federal Reserve System ? Mr. KEYSERLING . There is a connection between the two , but I would then want to raise the question of how much less the policy of increasing bank reserves would have had to be in order to result actually in an appreciably lower level of loans. Now, you yourself say, Senator, that the level of loans did not push up to the maximum at all times of the possibility. All I am saying is that under the conditions then pertaining in the economy, I cannot see how the variant in policy which you suggest, insofar as I get it, would have resulted actually in a lower level of capital formation during that particular period . Senator DOUGLAS . Wait a minute. Did the increased bank reserves account for the major portion, or at least make possible the major portion of the bank loans ? Mr. KEYSERLING. Yes ; that is the way our system works. Senator DOUGLAS . Good. It has taken a long time to develop that fact . Now, then, when you increase the quantity of bank loans, other things being equal, what happens to the price level ? And here we are dealing not with investment, not with the diversion of an already existing national monetary income into one direction rather than another, but with the creation of monetary purchasing power by the banking system itself, namely, through the making of a loan and the crediting of that loan as a deposit . Because it is true, though the commercial bankers sometimes deny this fact, that the commercial banks are manufacturing agencies. They manufacture bank credit, which they sell. Representative PATMAN. Senator Douglas, I think that is generally admitted now. A few years ago it was not admitted, but I think Mr. Eccles impressed that point so strongly that it is now generally accepted. Senator DOUGLAS . Now, what is the effect of an increase in the quantity of bank credit, other things being equal, upon the price level ? Mr. KEYSERLING. Senator, the whole point I am making turns upon your phrase "other things being equal. " Senator DOUGLAS . One step at a time . Mr. KEYSERLING. But other things were not equal then and other things are not equal now. Senator DOUGLAS . Let us take one thing at a time. You just take the questions that I ask. Other things being equal, what is the effect of an increase in the quantity of money upon prices ? Mr. KEYSERLING. But, Senator Senator DOUGLAS . Yes or no . Mr. KEYSERLING . I am engaging in an economic discussion , not an inquisition. I can't answer that yes or no. 170 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . All right ; if there is anything inquisitorial, I will strike this. Mr. KEYSERLING . I can't answer a question like that yes or no. Senator DOUGLAS. Is this an unfair question ? You are the Chairman of the Council of Economic Advisers, the most important economic position in the country. I am asking you a very basic economic question which every student in the introductory course in economics is supposed to know, and which every Congressman ought to know. What is the effect, other things being equal , of an increase in quantity of bank credit upon prices ? Mr. KEYSERLING. Senator, I said at the beginning of my statement, and I again say-and I think this is relevant to your questionthat the examination of this problem in terms of an assumption , even for purposes of discussion , that other things are equal is the probing of this problem in just that kind of tight little logical symmetrical nondynamic world of theoretical economists which does not cover the problems that we have to deal with. Senator DOUGLAS . But we are both subject to the laws of logic , and one of the laws of logic is the method of one step at a time. Now I am asking you a very simple question . I hope you won't decline to answer it. Other things being equal, what is the effect of an increase in the quantity of active bank credit upon prices ? Mr. KEYSERLING. Other things being equal, the effect is to increase prices. Senator DOUGLAS . Well, now, why didn't you come to that before ? It is perfectly simple. Suppose you have $20 here representing the quantity of money, and this package of cigarettes representing the quantity of goodsthen you add another $20 to the existing $20, the price which was $20 before is now $40, isn't that true, each being offered for the other ? Isn't that true ? Mr. KEYSERLING . That is, of course, true, Senator . Senator DOUGLAS . Well, then, that is a very simple relationship , but it is highly important to get it established . Now, then, other things being equal, what would be the effect of an increase in the quantity of bank credit during the period in question ? Mr. KEYSERLING. Senator, I should like to point out with reference to the rules of logic, that it is also the rule of logic that anybody can set up a logical system which is not necessarily correct. Anybody can take a hypothesis and proceed step by step by deductions from it to certain conclusions, and that is what you are doing now. I disagree with your conclusions. Senator DOUGLAS. I am taking an historical analogy, moving forward both by event and by logic-if there is anything wrong with my facts or my logic, I want to have it pointed out. Here we have this increase of $10 billion in bank loans. How much was the increase in wholesale prices during this period ? Mr. KEYSERLING . Senator, there was a substantial increase in wholesaleSenator DOUGLAS . Do you accept the index of the Bureau of Labor Statistics ? Mr. KEYSERLING. Yes, of course. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 171 Senator DOUGLAS . I believe that shows an increase of between 16 and 17 percent during the period in question. The increase in bank loans of $ 10 billion amounted to an increase of 18 percent in the volume of bank loans. Do you think the percentage increase in the quantity of bank loans had any relationship to the percentage increase in prices ? Mr. KEYSERLING . Well, now, we are back again to any relationship. Senator DOUGLAS . Do you think it had any relationship ? Mr. KEYSERLING . It had some relationship . Let me say this : that I can take a chart showing trends in prices in bank loans , in the money supply, and all the factors to which you refer, a chart running from 1946 to 1951 , and if one is simply trying to prove a thesis, you can take different points in time on that chart where you can prove by your line of logic directly contrary thesis because you have a complicated economy in which you have a different juxtaposition of events, and if you want to, you can say because prices rose so much in this period and something else happened, there is that cause and effect, but there are other periods of time in the past 5 years where you had a rising price level with a decreasing money supply. Senator DOUGLAS . Mr. Keyserling, you have said that there was a logical connection between the increase in quantity of bank loans and increase in the price level . Now, I point out that historically also these two were associated . I thought you were going to say that there were other factors operating during this period which negatived the increase in bank loans so that bank loans were not a cause. Mr. KEYSERLING . No ; I was going to saySenator DOUGLAS . I want to play fair with you. I want to suggest you want to name any of these other factors ? to you , do you Mr. KEYSERLING. I was going to say there are other factors operating to which I would ascribe the main casual effect upon the rising prices during that period. Senator DOUGLAS. The main causes were not the increase in bank loans. Mr. KEYSERLING. Well , now, there again you have moved a step because I don't think that the increase in bank loans was exactly correlated with these differentiations in reserve policies. Senator DOUGLAS. Now, wait a minute. You have just said that the increase in bank loans was caused by the increase in reserves. Mr. KEYSERLING. Well, I first say there was a relationship, and then an appreciable relationship , but I never said was caused bySenator DOUGLAS. Then you said a very direct relationship . Mr. KEYSERLING. You see, you start with a relationship , then you move to an appreciable relationship , then to a direct relationship , then to cause. Senator DOUGLAS . I thought you were under way finally. If you wish to retrace your stepsRepresentative BOLLING. Could I interrupt ? Mr. KEYSERLING. I think there is a great difference . Representative BOLLING. Mr. Keyserling, are there any other ways by which banks can create reserves ? I gather that during 1950-51 the banks created reserves by selling their bonds to the Federal Reserve . Suppose it had been profitable 97308-52- -12 172 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT for them to make loans , couldn't they have acquired revenue by selling bonds on the open market ? Mr. KEYSERLING. Go ahead, Senator, don't let me interrupt you. Is Representative BOLLING . The question was addressed to you. there only one way in which commercial banks can create reserves when they are confronting a very favorable market for loans ? Mr. KEYSERLING . I don't think so . Representative BOLLING. What are some of the others ? Mr. KEYSERLING. I think the one you mentioned is one way. Representative BOLLING. They can do that regardless of whether the bonds were at par or otherwise ? Mr. KEYSERLING. Well, there are differing degrees of opinion as to with what facility they could do it under these varying circumstances, but I think they could do it. Representative BOLLING. That is all, Senator. Thank you. Senator DOUGLAS. Do I understand you to say that you think there is no appreciable connection between the proportionate increase in the quantity of bank loans▬▬ Mr. KEYSERLING. I agreed with you, Senator, that there was an appreciable connection if you do not find the difference between some connection and appreciable connection too appreciable. Senator DOUGLAS. Are you saying there was no causal connection between the increase in bank loans and the increase in prices ? Mr. KEYSERLING . Well, if there is some connection there is some causal connection . Senator DOUGLAS . Are you saying there was a causal connection between the increase in bank loans and the increase in prices ? Mr. KEYSERLING. Some causal connection. Senator DOUGLAS. And then the increase in bank loans was a cause for the increase in prices ? Mr. KEYSERLING. One of the causes . Senator DOUGLAS . An appreciable cause ? Mr. KEYSERLING . Senator, despite what you say, I am not interested in dialectics. I am interested in trying to convey to you what I am saying here as best I can and trying to answer your questions, because, as I said beforeSenator DOUGLAS . Please credit me with the same desire. Mr. KEYSERLING . Yes , sir. Senator DOUGLAS . I am trying to find out-you are the supreme economic adviser to the Government-whether you think there was an appreciable connection during this crucial period between the increase in bank loans and the increase in prices which quantitatively happened to be identical and for which you say there is a logical connection as well. Mr. KEYSERLING . Well, first as to the point that they were quantitatively identical, I would say that that is a nonconclusive coincidence because there were many other periods within recent economic history where they were not only quantitatively identical but were moving in opposite directions. Senator DOUGLAS. May I point out in this case the actual quantitative relationship is in harmony with the logical relationship and not contrary to it. Mr. KEYSERLING. If you want to assume, Senator, that you start with a theory that A causes B, and then at times- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 173 Senator DOUGLAS . You agree to that theory. Mr. KEYSERLING. May I conclude this ? Senator DOUGLAS . Surely . Mr. KEYSERLING. If you want to start with the theory that A causes B, and then say that at points where an empirical observation that A causes B it is in harmony, but at point of empirical observation where A does not cause B, where A happens and B does not happen, they are not in harmony, of course you are correct. But the point I am making is that if we look at the period over the past 5 or 6 years, there are so many periods where this harmony did not exist that one cannot subscribe , at least as I look at it, to the conclusion that this is the main conditioning factor within the range of our economy on price trends under current conditions or on the level of capital formation. Now, what I am really trying to develop , Senator- and I think that at least part of this you will agree with that what we want to look at ultimately is what is happening in the economy. Senator DOUGLAS. I notice that in that economy during this period there was a 17 percent increase in wholesale prices, an increase of 8 percent in the cost of living, which has since gone up to 10, an increase in the cost of identical services to the Government of around $8 to $ 10 billion, and an impairment of the standard of life of those living on fixed incomes, so that that is a great thing that was happening. I will change the word "great. " That was a very powerful force operating to the detriment of great groups in the community. Mr. KEYSERLING. Senator, I think- let me try to illustrate the point I am bringing before the committee, in this way-that if today, with the variation in monetary policy which has taken place, if today, A, you had no price control, and, B, the economy were hit by an event comparable to what happened when the Chinese invaded North Korea, with a $23 billion annual rate of personal savings , with the position which business is now in, with the material situations as it now exists, I believe and, of course, this is a belief because that is not happening now, but it illustrates my point-that if now the economy were hit by a situation comparable to that Chinese situation , that you could very, very easily and probably would have a sharp upward spurt in prices, in inventory accumulation , in hoarding, in consumer buying, and that you would have it under the existing policy as well as under the one which then pertained . Now, that is the basic point I am making, and I do not desire to dissent from your proposition that all these things have a relationship . I am simply saying that these other economic factors are quite as important in the situation as the one to which you attach particular attention, and that consequently in looking at all of them together, we can't look at this one device and say this is the way to do it, and we can't accept this as the answer and say we have to push this as far as we can without considering alternative ways or other necessary ways of stabilizing prices, and without weighing some of the collateral consequences of trying to do it in this particular way. Senator DOUGLAS. Are you finished? Mr. KEYSERLING . Yes , sir. Senator DOUGLAS . Let me say that in order to show that I do not totally disregard other factors, as to matters of record, that the index 174 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT of physical production, although it is not completely satisfactory, increased, as I remember, in this period by about 8 to 10 percent. Let me also indicate that the velocity of circulation of credit increased by about 8 to 10 percent during this period. Of course, the money supply is affected by the velocity of credit as well as by the total amount of credit, and if the quantity times the velocity, the product of the two, increases in proportion to the increase in physical production , the price level is static. But if it increases in a greater proportion than the increase in production , the price level tends to rise. What we had during this period was the fact that the increase in velocity roughly counterbalanced the increase in productivity, and, therefore, the same amount of money turning over more rapidly was offset by the increased quantities of goods at the same price level, but we increased the total active amount of commercial loans by 18 percent, and prices rose by 17 percent, precisely as we would expect under the well -known quantity theory of money formula. I am not saying that this was the sole cause ; nobody says that was the sole cause in the tempestuous stream of events over this era. I am quite well aware that the scare buying that took place after Korea was a situation where everybody said they were not going to do any excessive buying, or any hoarding, but rushed out to get the goods before some other hoarder got there. I do not deny that there was a drawing down of savings accounts, and that this would naturally drive up the prices of automobiles and durable consumer goods . We did have a drawing down of savings and a distortion of prices. What I want to point out is that the Federal Reserve System added to this difficulty by permitting, and indeed stimulating, the creation of $10 billion of additional credit, so that far from introducing a stabilizing factor into this situation they introduced a further unstabilizing factor in increasing the total money supply. Now, I have been in favor of selective controls. I favored the stronger selective controls on consumer credit that Congress adopted , and fought and bled and died for that on the floor of the Senate, as Congressman Patman and Congressman Bolling did on the floor of the House. Representative PATMAN. There were certain types I was opposed to, regulation W, particularly. Senator DOUGLAS . I favored the restriction on loans for housing, in the way of selective controls. I am not saying that we should regret selective controls, but I am saying that it is reckless to rely on selective controls exclusively when you have the central banking mechanism of the country inflating the mony supply. That is my statement . Now, let me ask you a question. As you watched matters during this period did you call to the attention of the President, the Secretary of the Treasury, or any group of administrative officials that you believed that there was a connection between the purchase of Government bonds by the Federal Reserve System and the rise in the price level ? Mr. KEYSERLING . I do not recall having called that particular fact toSenator DOUGLAS . That is, you do not recall it ? Mr. KEYSERLING. I do not recall it. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 175 Senator DOUGLAS. Did you offer any advice as to whether the policy of the Federal Reserve System in purchasing these bonds should be continued or discontinued ? Mr. KEYSERLING . There were various discussions of that, Senator. I believe that those discussions took more crystallized form a little later on. Senator DOUGLAS . Well, I am speaking of the 8-month period from July 1950 to the 1st of March 1951 . Mr. KEYSERLING. I was not affirmatively responsible at any time for the adviceSenator DOUGLAS. Did you offer any advice ? Mr. KEYSERLING . That is what I am intending to say. I was not at any time affirmatively responsible for advice which led to this change in policy. Does that answer your question ? Senator DOUGLAS . No ; it does not. Did you call attention to the President or any executive officer that prices were rising, that the credit supply was increasing, that reserves were rising, that Federal purchases of bonds were increasing, and there was a connection between these events ? Mr. KEYSERLING. All of those things we called to his attention and tried to be worked out. Senator DOUGLAS . You pointed out that there was a connection ? Mr. KEYSERLING . But not in the point of emphasis that you make because, frankly, my interpretation does not square with yours as to the relative weight to be attached to the various factors. Senator DOUGLAS . Well, you admit there was a connection ? Mr. KEYSERLING. All- they are all interconnected, but I did not advise that this factor was as important as you, quite properly, I mean-these are matters of judgment -seem to think it was, because I did not think, and still do not think, that that was as important as you think. I did not place as much stress on it as you place on it. Senator DOUGLAS . Did you advise a discontinuance of policy of the Federal in purchasing unlimited quantities of bonds during this time ? Mr. KEYSERLING. I think I answered that question by saying that I was not affirmatively responsible for advising the change in policy reflected in the March accord. Senator DOUGLAS . That answers the second question on the so - called accord which I had not come to. Did you advise the continuance or the discontinuance of the policy during the period July 1 , 1950 , to March 1 , 1951 ? Mr. KEYSERLING. I can only answer that by saying that, as I think back now to what my views were then, that if it had been left to me I would not have advised discontinuance of the policy , and I hope that answers your question adequately. Senator DOUGLAS . In other words, that you were in favor of the continuance of the previous policy ? Mr. KEYSERLING . I think that would be too strong a statement , Senator. Senator DOUGLAS . Or were you neutral on the subject ? Mr. KEYSERLING. I would say that I am neutral on the subject in the sense that I believe that that particular variation does not have the economic significance which you attach to it and, consequently, since it produces- 176 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . That is, you did not regard it as important ? Mr. KEYSERLING. I do not regard it as of central significance within the range of the type of action that either the Federal Reserve Board or the Treasury would be willing to take if either had an absolutely free hand. In other words , I do not believe that , within the range of what the Federal Reserve Board would do, that this particular policy, in view of all of the factors playing on the economy, is of central or general significance. Senator DOUGLAS. Did you make any reports to the President or to any other high administrative official on this matter during this period ? Mr. KEYSERLING. Senator, I believe that I can stand on the proposition thatSenator DOUGLAS . Did you or did you not make any reports to the President ? Mr. KEYSERLING. The only reason I cannot answer that is because, since we talked with the President orally on an indefinite number of occasions, and so forth, it is hard to separate them out, but I think I have answered your question fully when I say that if it had been left to me I would not during this period have recommended this change in policy. Now, I want to make it equally clear that that does not mean that I now say that the change was undesirable ; that it may not have produced good results. I think it has produced some good results . I think it has produced some bad results, and I would not be prepared yet to make a judgment on its net effect. Senator DOUGLAS. In other words , everything that exists at a given time is all right ? Mr. KEYSERLING. Oh, no. Senator DOUGLAS. It was all right for the Federal Reserve Board to purchase the bonds and all right for the Federal Reserve Board to discontinue buying them ? Mr. KEYSERLING. I did not say that at all. Senator , you asked me, in effect, what my view was at that time, and I think I answered that fully when I said if it had been left to me I would not have made a recommendation for that change, which is another way of saying that I do not believe that the needSenator DOUGLAS . You did not think this policy did any real damage? Mr. KEYSERLING. What is that ? Senator DOUGLAS . You did not think this policy of purchasing unlimited quantities of Government bonds during this period did any real damage ? Mr. KEYSERLING . I do not think on balance that it is clear that it did damage, and I do not think you have let me explain why I do not think it is clear that it has not done damage. Senator DOUGLAS . I would be delighted to have you do that. Mr. KEYSERLING. There are two reasons why I do not think it clear that it has done damage, and here, Senator , is where I have a somewhat different approach from you to the analysis of these problems. Before I reach a final conclusion as to whether an economic policy has done damage, I want to look at what I call the end results in the economy. In my judgment, the end results in the economy are the level and distribution of the production of its resources. In other MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 177 words, here we are producing, we are making certain goods and services and business skills and judgments available for defense, certain ones available for consumption, certain ones available for investment- and I am using "investment " in the broad general sense of the business build-up. Now, the first thing I would want to look at in that period to which you refer is to look at what was happening to those three components and ask these questions : In view of the fact that we have limited resources at full employment, were consumers getting too many goods ? Was business getting too much capital formation ? Was the defense program moving too fast or too slow? Now, let me take the business side of it first because that is the one on which you are mostly concentrating. My view is that it is not clear that all types of capital formation at that time were too high. I think there were many types of capital formation going forward, which, from the viewpoint of our productive strength, from the viewpoint of the additional burden of the defense program , had to be carried forward. I am glad they were carried forward as fast as they were. I wish some of them had been carried forward faster. Consequently, I would not, with ease, recommend or indulge in a general restrictive policy until I knew or felt or thought that that restrictive policy would begin to operate upon the kinds of activities which were nonessential before commencing to operate upon those which seemed to me to be at the very heart of the mobilization effort. Senator DOUGLAS. Mr. Keyserling, would it be impolite if I interjected something in here ? Mr. KEYSERLING . No, sir. Senator DOUGLAS . I want to make it clear that I am not saying that the Federal Reserve System should have sold Federal bonds. I am not saying it should have diminished reserves. The question is merely whether they should have expanded them. I am not advocating a policy of restriction, but I am asking whether they should have expanded the money supply more rapidly than the index of production. Mr. KEYSERLING. I think the difference, Senator, between saying they should not have expanded them and saying they should have restricted them still gets to the point that I assume you feel if they had not expanded them there would have been a lower level of capital formation, because if they would have been the same level of capital formation, my point is that so far as the functioning economy is concerned your strains and pressures would have been the same. Senator DOUGLAS . Where did this capital formation come from, Mr. Keyserling ? Mr. KEYSERLING. It came from the effort of labor, from the directing skill of business, and from the availability of financial and physical resources to do jobs which, in terms of the mobilization program, businessmen thought it would be profitable or patriotic or both to do. Senator DOUGLAS. May I ask you this : How did the increase in bank loans make possible all these desirable results ? Mr. KEYSERLING . It does not alone make them possible. Senator DOUGLAS . Well, that is the issue, whether it was necessary to increase bank loans as much as they did expand in order to put more labor to use, to get greater skill for management , and so forth. 178 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT How did this increase in loans do that when there was virtually full employment at the time ? Mr. KEYSERLING. Senator, the question I have raised is different and, I think, very important. The point I have made is that- may I resort for just a second to this tool of logic ? Senator DOUGLAS . Surely. Mr. KEYSERLING. Proposition A : It must be assumed from the point of view of your line of discourse that if the expansion of the kind of credit that you are talking about had been less, not by a restrictive policy but by not letting it expand, it must be assumed that there would have been a lower level of the end result which commands our resources, namely, construction , building, employment, and so forth and so on. Senator DOUGLAS . These things do not come out of the air, Mr. Keyserling. How was it that this increase in loans made possible the increase in production , the increase in savings, the increase in investment, and so on? Mr. KEYSERLING. I am not, through my own fault-I have not made myself clear, Senator. I am saying that if the varying policy which you suggest, if the varying policy which you suggest had not appreciably changed the level of capital formation, of investment and of employment in specific lines of economic activity, if it had not substantially changed those levels, its ultimate effect upon the economy and upon the price level would have been nugatory because it is the spending of funds for business activities, whether by business or consumers, that puts the pressure on prices . To state it another way, if there had been other factors at play in the economy which would have resulted in an equal level of capital formation, of investment and in business activity, with or without this variant you suggest, then I cannot ascribe much importance to the variant. Now, that happens to be what I think. It may be wrong, but I do not think that the variant that you suggest would have much changed the level at the end of what would have happened in the economy during that period to employment, to investment, to capital formation. The I raise a second questions which seems to beSenator DOUGLAS . Let us take this first one, and I want to make it clear. Is it your contention that it was necessary in order to get this expansion in production that bank loans should be increased by $ 10 billion ? Mr. KEYSERLING. No ; my contention is that if the expansion of bank loans was not necessary to that purpose, and if that expansion in production would have taken place anyway, it is that expansion which exerts the impact upon the economy ; that is the point I am making. Senator DOUGLAS . These double negatives are very hard to follow. Is it your statement then that it was the increase in production which required the increased bank loans ? Mr. KEYSERLING. No. It is my statement that what increased the strain upon the economy is what the functioning business system did . In other words, if you have a shortage of steel, and you undertake a steel expansion program which puts an increasing demand upon steel to build steel plants, that is what exerts the pressure. Now, if you say that that would have taken place equally without the expansion of the bank loans, then I say that the expansion of the MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 179 bank loans is not what made it take place, which is the very point I have been trying to develop ; and that since it did take place, that is what put the pressure on the economy, and this is equally true of other areas of business activities . Senator DOUGLAS . I take it what you are saying is that it was the demand for production in specific lines which created the demand for added bank credit which, in turn , may have driven prices up. I am not trying to misrepresent your position , I am trying to find out what it is. Mr. KEYSERLING. I incline toward the view that it is more-I do not want to say better or more fruitful-it is more the way I approach it than the way you approach it . Either way may be right. I start approaching it from the other end and moving backward ; you start approaching itSenator DOUGLAS . You approach it from the standpoint of the demand for bank funds, I think, and you seem to say that- I do not want to misrepresent your position , but that position if pushed to its ultimate conclusion, is that if the demands are made upon the banking system for more bank funds, it is the function of the banking system to respond by creating the funds, otherwise it would check the expansion potential. That makes the banking system a purely passive instrument, adapting itself to changes in the demands for loan capital. Mr. KEYSERLING. I do think, Senator, that under the general economic conditions prevailing at that time, and prevailing now, while the banking system is not entirely passive, it is appreciably more passive than your position indicates. In other words, I do think that, with the general outlook as it was mid- 1950 , with the prospect dangling before the country of a vastly expanding defense program, with businessmen's energies being directed toward the servicing of that program and the realizing of the market opportunity, which actually or speculatively it would create, then in the nature of our economic system and , I think, this gets back to the question that Congressman Bolling asked, ways would have been found to service that dynamic desire of business to increase production ; and if you believe that that level of productive increase was too high or that level of capital formation was too high, then I would suggest that the ways which could have been found quickly to curb it would have resided more outside of this particular technique than within this particular technique ; if, on the other hand, one is not prepared to say that the level of investment and capital formation and productive build-up was too great during that period , then I do not think hat the net result was bad ; and if one is prepared to say that it would ve been the same whether or not we had this expansion of bank it , then I say that under that particular hypothesis the expansion k credit did not have much to do with the end result, and that it nd result which conditioned the economy and the strain on and the price level . DOUGLAS. Mr. Keyserling, an increase in investment in the and the increase of production in the larger sense, as I e accounted for by one or all of three factors : (a ) A he amount of unemployment so that men otherwise to work on resources otherwise not occupied with ity. 180 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT On the 1st of July 1950, 5.2 percent of the labor force was unemployed ; on the 1st of March 1951 , 3.4 percent were unemployed , a decrease of 1.8 percent. Let us say there was a 2 percent greater utilization of the labor force. ( b ) The second factor that would operate would be a more effective utilization of an existing stock of capital and labor which might also be used ; but (c ) this refers not to the general index of production but to investment- you could have a decrease in the amounts consumed and an increase in the amounts invested by a temporary diminution of the standard of life of the American people. Now, it is precisely this which , I think, also occurred during this period of which, I am very frank to say, I cannot think the Council of Economic Advisers or the administration did pay proper attention to. During this period we had an increase in wholesale prices of 17 percent, an increase in the cost of living of 8 percent. This meant that those living on annuities and fixed incomes had their purchasing power diminished proportionately ; it also meant that those receiving interest in fixed money terms had their incomes reduced proportionately ; it meant that salaried workers , whose incomes move very sluggishly in response to changes in the cost of living, had their real incomes reduced almost proportionately . It meant that the unskilled workers, who tend to be unorganized , had their real incomes reduced , and that the organized workers, while protecting themselves better during this period than in previous periods, lost ground during the intervening time. Now what I think happened , therefore, was that through this policy the real standard of life of large segments of the American people was decreased, and these gains were transferred to speculators in the community who, out of the abundance of their funds , could invest some of them, yes, and also spend some in night clubs and in Florida, I think that we had a great blow inflicted upon large groups of the American people. Because the chain of causation was difficult to follow, the connection between the purchase of the bonds by the Federal Reserve at the beginning of the process, and the increase in the cost of living at the end was not seen by the people, and apparently was not seen by the pilots on the ship . I am saying that though the soundings were being taken, the depth of the channel presumably being known, the location of the ship being plotted , nevertheless the ship in this respect was allowed to run on the ground . Mr. KEYSERLING. Senator, there is a lot in what you said there so that I would like to call your further attention to some aspects of it. Senator DOUGLAS. Certainly. Mr. KEYSERLING. The first comment I will make explains why I am a little skeptical of these juxtapositions in point of time. From what you just said— and I am sure you do not intend it that way, it is just that your statement was not qualified enough-do you mean to contend that the general consequence of a rising price level in the American economy at all times is to either reduce the standard of living or to shift the availability of resources to the people in the direction of what you call the few speculators as against the many ? Would you state that? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 181 Senator DOUGLAS. That must be accompanied by an increase in production ; and even then it will result in a decrease in the standard of living of those with fixed incomes or relatively fixed incomes. Mr. KEYSERLING. Yes, but that is a separate question which goesSenator DOUGLAS. Well , it is part of it, and the classes which I detailed are quite large in number. If you take old people, retired people, if you will take recipients of interest, if you take salaried workers, if you take unskilled workers, if you take large sections of the organized workers, you get the majority of the American people, and there is a transfer of incomes from these people to speculators who purchase commodities at lower prices which they can later hold for higher prices, so that there is a great internal shift in the distribution of incomes, even though you may have this 5 -percent increase in the total level of production. I am willing to say, possibly, that you did get a 2-percent increase in production through inflation by a decrease in the unemployed . I am willing, possibly, to admit that. I would say that was purchased at a terrific price, at a great diminution of the cost of living of the vast majority of Americans . Without being self-righteous-and it is very easy for a senator to be selfrighteous-I have not felt that the Council was sufficiently concerned with this problem of inflation and the evil consequences thereof, and that you look at times on an increase in the price level with the same kindly eye that you look upon the increase in the index of production , whereas the two are very different things . Mr. KEYSERLING. Senator, since you made one remark there recently just now, which is personalized, although in no sense personal, I am sure, I think that the Council of Economic Advisers has been very much concerned about inflationary trends, and I think that we have, rightly or wrongly, been in the forefront of those advocating a range of affirmative measures to contain inflation . Senator DOUGLAS. You have in everything except the essential steps . You advocated specific controls but no control over the general supply of money . Mr. KEYSERLING. Senator, that gets back to the question of our not agreeing as to what is the essential factor . Senator DOUGLAS . It should have been . Mr. KEYSERLING . Let me point out that various points of time in the past 6 years can be selected where, if one simply looks at the juxtaposition of events , you can make quite as conclusive a case that this was not the central factor as if you select this particular period of time to show that it was. Now, getting back to the question of the stabilization of prices, we are very much concerned about the rising price level, and we have at no time looked at it with an acquiescent eye. As a matter of fact, rightly or wrongly, we proposed rather drastic measures as far back as 1946. Senator DOUGLAS . What did you propose from 1950 to 1951 ? Mr. KEYSERLING. From 1950 to 1951 ? Senator DOUGLAS . Yes. Mr. KEYSERLING. We proposed higher taxation ; selective- we proposed 182 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. In which I supported you. I think I was one of nine members of the Senate who voted for higher taxes on a crucial roll call. Mr. KEYSERLING. I hope we can keep you with us on that, Senator . Senator DOUGLAS. I congratulate you on being right on that point.. [ Laughter. ] Mr. KEYSERLING. And we proposed price and wage stabilization . Senator DOUGLAS. Of individual items ; that is, price control on individual items . Mr. KEYSERLING. As distinguished from what ? Senator DOUGLAS . Well , taking individual items, fixing price ceilings on individual items. Mr. KEYSERLING . If that is what you mean by price control, yes . Senator DOUGLAS . Yes, certainly . Mr. KEYSERLING . Yes . Senator DOUGLAS. But you did not propose placing any restriction upon the total quantity of money. Mr. KEYSERLING. Senator, I think you have fairly well established the fact that I do not ascribe to that factor the degree of importance that you do. Senator DOUGLAS . I am afraid I have absorbed too much of the time of the committee, and Congressman Bolling wants to ask a question. Representative BOLLING. My memory may not serve me, but my impression was that the first request that came from the administration to the Congress , after Korea , dealt largely in the field of credit , of all kinds ; am I not correct in that memory, that it included proposals for credit controls that were bitterly complained about as completely controlling the credit of the country? Mr. KEYSERLING. Well now, Congressman , let me say this-and I know that you will join with me in it, and so will Senator DouglasI think he and I are going to agree on the first thing today-you know some poet said, "Earth bears no balsam for mistakes." I am not here to claim either that I never made mistakes or that the administration never made mistakes or that the Congress never made mistakes, and I do not want to go into a review of who made the most mistakes the fastest ; but the Congressman is generally correct, that long before we got into the area in this new situation of direct controls, we emphasized the importance of certain kinds of general controls, not only higher taxation . It was not only higher taxation, but we also recommended , and I think I have been delinquent , Senator, in not mentioning this sooner, because I do not think that the difference between us is as great as would seem to be, we were not apathetic to the value of some general restraint upon the monetary stream and upon lending through these general devices. Senator DOUGLAS . Then there was a connection, after all, between them ? Mr. KEYSERLING . What is that ? Senator DOUGLAS. Then you did think there was a connection after all between the total quantity of money and the price level ? Mr. KEYSERLING. Why, of course , there is a connection . Senator DOUGLAS. Well, now we see it and now we don't. Mr. KEYSERLING. I never said there was no connection . I have not said there was no connection , Senator. But we proposed various re- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 183 serve plans directed toward reconciling this kind of general restraint with certain other objectives of national policy and of national need , which seemed to us equally important. The basic difficulty I have with the proposition as you state it, Senator, is, first, it would seem to me that you ascribe to this particular device a relatively greater weight than I do, and that I place more reliance on a wide range of devices in proportion . Second, that you do not weigh at all the fact that every particular economic tool has points of disadvantage as well as points of advantage. In other words, taxation has points of advantage ; it clearly has points of disadvantage. It is repressive of initiative , which is always a bad thing per se. Price control has points of advantage and points of disadvantage ; selective credit controls have, as the chairman very quickly pointed out, advantages and disadvantages, and quite correctly so ; and so has this general measure. Now, the only thing I am saying is, let us take each of these measures and not get exuberant about any one of them ; let us weigh the advantages and disadvantages of each of them ; let us recognize that with respect to any of them the advantages at a particular point of time may outweigh the disadvantages or vice versa, and let us try to build a blended program which uses each in just proportion , but does not try to claim-because I think it is claiming too much that any one of them is the central conditioning factor or the central salvation factor. Representative PATMAN. May I interrupt there for just a moment ? This discussion has been on a very high plane- in fact, I consider it a very high intellectual and professional plane . I personally have enjoyed it very much, and am glad that the discussion went on as it did. We do not want to retard it ; we want to encourage it. We must hear Mr. Blough too , and we cannot do it this morning. I have conferred with Mr. Wolcott and Mr. Bolling, but I have not conferred with Senator Douglas because he has been busy asking the questions, but we would like to have a meeting tomorow morning here in this room and continue this discussion and have the same two witnesses before us . If we do not get through tomorrow morning we will continue it in the afternoon. Will that be satisfactory to you? Senator DOUGLAS. Oh, perfectly. May I thank the chairman for the complete impartiality and courtesy with which he has conducted these hearings and in permitting me to ask certainly more than my arithmetical share of questions. There is just one final thing. Representative PATMAN. It has been very interesting and enlightening to me. Senator DOUGLAS. I have just one final question, and I promise this will be the end. What are the disadvantages of a flexible system of support, such as has been adopted since last April ? What have been the disadvantages ? If there are grave disadvantages, perhaps , it should not have been adopted since April of 1951, and, perhaps, if there have not been disadvantages, the question will come, might it not have been desirable to have adopted this system before April of 1951 ? Mr. KEYSERLING. Should I attempt to answer that now or should I cogitate upon that until tomorrow ? Representative PATMAN. Suppose we wait until tomorrow. 184 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. KEYSERLING. I can do it now, but I will be glad to wait until tomorrow. Representative PATMAN. There is an amendment up on the Floor soon after 12 o'clock, and it involves the Small Defense Plants Corporation. Mr. KEYSERLING. Mr. Chairman, may I make just one comment ? I want to make it perfectly clear to the members of the press and others here that in saying there have been advantages and disadvantages in this I have not said that this particular step was undesirable. I just want a careful appraisal and analysis of it and, as a matter of fact, I do not think we have had enough experience with it to be sure, but I would like an opportunity tomorrow to appraise the advantages and disadvantages ; but I do not want to be misunderstood to have said that I am at this point condemning that experimental effort to see the consequences of a somewhat different policy from the one which pertained before. Representative PATMAN. Just a moment, if you please. Since we did not get to Dr. Blough, his prepared statement which has been distributed will not be released now; it will not be released until he testifies tomorrow. Without objection we will stand in recess until tomorrow morning in this room in open session at 10 o'clock. (Whereupon, at 11:50 a . m. , the joint committee recessed to reconvene Thursday, March 13, 1952, at 10 a. m. ) MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT THURSDAY, MARCH 13, 1952 CONGRESS OF THE UNITED STATES, SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to recess, at 10:15 o'clock a. m., in room 1301 , New House Office Building, Representative Wright Patman ( chairman of the subcommittee ) presiding. Present : Representative Patman ( chairman of the subcommittee ) , Senators Douglas and Flanders, and Representative Bolling. Also present : Grover W. Ensley , staff director ; Henry Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee. Representative PATMAN. The committee will please come to order. Mr. Keyserling, I would like to ask you a few questions. You mentioned yesterday the expansion of industry in 1951 , describing it as the year of the greatest expansion in history , I believe. STATEMENT OF LEON H. KEYSERLING, CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS- Resumed Mr. KEYSERLING . Yes , sir. Representative PATMAN. Isn't it a fact that a large part of the money or the capital used for expansion in 1951 was from retained earnings and depreciation ? Mr. KEYSERLING . Yes ; a good part of it was, Mr. Chairman . As a matter of fact that has been a phenomenon of the whole post- World War II period not only in 1951 but in 1948 which was another year of heavy business investment. The portion of investment which was carried by retained earnings as against borrowing was higher than in pre-World War II periods of rapid industrial expansion. Representative PATMAN. Our committee made an investigation of that. To the best of my recollection about three- fourths of the capital expenditures came from retained earnings and depreciation and obsolescence deductions . Isn't that enough to cause some concern , Mr. Keyserling ? Mr. KEYSERLING. The Council of Economic Advisers, in its various reports commenting on the interrelationship among business investment and the price and profit structure and the picture on borrow185 186 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT ! ing, had occasion, I believe first in 1948 to point out the thought that possibly too large a portion of the funds for investment were what we might call financing currently out of the price structure. That was one of the reasons why we thought in 1948, as I recall, that a somewhat lower price structure and a somewhat lower level of general profits after taxes would have been consistent with supporting an adequate level of business investment. Representative PATMAN. In other words, whenever you get your capital from the price structure, you are compelling the consumers to pay your cost of expansion in the prices that they pay for products. That is correct, isn't it ? And one witness referred to it before a committee that I was on some couple of years ago as costless capital, and I thought it was a good phrase that expressed exactly what it is, costless capital. In other words, concerns that are big enough in the particular field in which they are engaged to raise prices at will can get their capital by increasing their prices, and in that way it becomes costless capital. And the reason I am concerned about it is that I do not see how a small independent merchant or a small manufacturer can possibly have an equal break or an equality of opportunity, we will say, in an economy which permits his big competitor across the street to get his money through an increase in prices, and thereby get costless capital to run his operation, when the small independent must go to the market and borrow his money and pay the going rate of interest on it . Doesn't it occur to you that there is possibly a problem there that should receive some attention ? Mr. KEYSERLING. Yes, there is a problem there, Mr. Chairman and members of the committee, and I have a problem here. On the one hand I don't want to talk too much. Some of the papers have said I talk too much. Maybe I do . Representative PATMAN. The committee is not complaining. Mr. KEYSERLING. Good. In the very nature of things, the kind of questions which you are asking, and properly, require considerably analytical attention. I would like to make a few remarks about the point you raise. L In the first place, as I look at the economy, I look first at what I call the ultimate economic consequences . The ultimate economic consequences that any economy is engaged in is the production of goods and services and the allocation of resources. Consequently, tax policy, price policy, credit policy, and other policies are merely instruments ; the ultimate objective which we seek is— under a free system as we understand it-the maximization of our technology and our manpower toward expanding production accompanied by stability, although that does not mean a static economy. It means a stable rate of progress such as our technology can accomplish , rather than fits and starts or booms and busts. And we look at the problem of the allocation of resources , which means how much of our resources are at a particular time going into business investment , capital formation, how much is going into ultimate consumption , how much is going into Government programs, from the viewpoint of how well allocation of resources accomplishes two purposes. First, a stable and growing economy ; and, second, certain other national objectives which we must serve . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 187 For example, the defense program does not add to a stable and growing economy. That is not why it is undertaken . It is one of the burdens we must carry. On the other hand, in the question of business investment and immediate enjoinment of goods and services, you have to maintain a balance. It seems to me that is the central problem of our economy, because if investment moves too fast relative to consumption you can get what some people call overproduction, and what others call underconsumption. I don't care much about the terms, and you have an investment boom followed by a decline. On the other hand, it is possible in an economy to get overconsumption, which means in the final analysis that you are living too richly in the present and not thinking enough about building up your plant and equipment . Now, what I look at ultimately in an economy at any time is whether those relative activities seem to be bearing a healthy relationship to one another. When you come over to the question of money flows, whether you are talking about it in terms of income within the economy-and tax policy and credit policy and price policy and wage policy all have impact upon those money flows-I don't look at it from the viewpoint of the money flows as a thing in themselves , but rather how they seem to contribute to the wise and intelligent support of the intelligent use of our resources . Now, the basic question I would ask with respect to the question you have raised is, first, have we been getting over the last few years a sensible allocation of resources between business investment and ultimate consumption . And, second, have we been getting it through a series of tools which are within the limits of our free system the best way of getting it, or would other ways seem somewhat better, or does getting it in that way have certain counterbalancing defects to set off the benefits achieved ? Now, on the first part of the question, I incline toward the view in general and over-all, although there have been some excesses, that particularly since the advent of the Korean outbreak we have not been overdeveloping our productive facilities as against immediate consumption, because I think that in the long run that is the way to build the kind of strength that we need to carry this kind of security burden, and I think we are going to have to carry it for a long, long time. Therefore, I would not be prepared now to support the thesis which I supported in other periods of prosperity : that we ran the risk of having overinvestment at the expense of underconsumption . In fact, frankly I incline toward the view-and some of my friends have thought that I have left them on this-that over the past year or two and on into the next year or two we have been enjoying and are going to enjoy a somewhat higher level of consumption than seems to me consistent with the world responsibilities that we face, and the part of our resources that we ought to devote to carrying those responsibilities. Now, when you come to the question that you have raised as to whether the method by which business investment has been financednamely, partly out of borrowing, partly out of the price structure, 97308-52-13 188 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT partly out of accumulated reserves , and partly out of profits- whether the post-World War II trend of financing a larger part of business investment out of sources which financed a smaller part before World War II is desirable or undesirable, I would not have any positive judgment on that . And , even if I had a positive judgment, it might be wrong. I think it requires a lot more analytical observation. As I say, the Council inclined toward the view at least before the defense emergency that too large a share was being financed out of the current price structure and out of current prices, and that the effect of that prior to the Korean emergency was commencing to face us with the problem of whether at that high price level relative to the consumer demand in the economy we were going to run into one of the more or less traditional periods of overproduction or possibly more appropriately stated underconsumption . That was our view prior to the Korean emergency . Now, when you get into the Korean emergency, it changes the situation a bit because the whole question of the balance between investment and productive equipment and current consumption shifts, for the reasons I have given. So, I am not so sure now as I was then-frankly, as I was in 1948that this is an unhealthy tendency. I still incline toward the view taking into account all the factors, including the factor of maintaining a clear road for small business as well as for large, taking into account that we must think of the future as well as the present, that I would like to see somewhat more of the financing of business investment out of borrowing made available on terms that can be supported not only by the large concerns but by the small , rather than financing too large a part of new business needs out of price increases and an administered price system based on what the traffic will bear. That is a long answer. Representative PATMAN. That is all right, I think it is a good answer, and I can see on the side of justification that it is possible that the concerns would not be able to raise the capital necessary to have the production that is needed for our economy, unless we permitted something like that. That is to be considered too . Although it is in the direction of concentration of industrial power, and in the direction of monopoly eventually ; yet in an emergency, if you cannot get capital otherwise for the purposes of industrial expansion, possibly it is justified . I don't know. I am seeking the answer. But normally, under normal conditions and normal times, my horseback opinion, is that it is a very dangerous thing to permit. I think we should look carefully into it. Now, I am anxious to have this discussion continued about these Government bonds. Yesterday Senator Douglas was asking you about the good things about pegging the market and the bad things about pegging the market. If Senator Douglas is ready to continue on that, I will yield to him. Senator DOUGLAS . First, let me say, Mr. Chairman, that I think I took much more than my arithmetical share of the time yesterday. Representative PATMAN. I was going to yield to Mr. Bolling, but he said he had to go to a committee in a few minutes . And it would be all right, although I realize that it is probably Mr. Bolling's time, for you to go ahead. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 189 We are all very much interested in the questions that you ask and the discussion in general, and we are certainly glad for you to continue, and we are delighted to listen to you. Senator DOUGLAS. At the end of the session yesterday, I asked Mr. Keyserling if he would state what he regarded as the disadvantages of the so-called accord reached approximately a year ago between the Federal Reserve and the Treasury. That accord, as we all know, instead of providing for the Federal Reserve buying an unlimited quantity of Government bonds in order to maintain the price at a fixed price of slightly above par, it provided for only limited support of the Government bond market, with the understanding that, if this required the price of Government bonds to fall off slightly, then that risk should be taken . Now, that was done and the total quantity of Government bonds held by the Fed. is now slightly less than what it was a year ago. The Government bonds have not fallen off very appreciably. They have fallen , I believe, to somewhere in the 97's. The Treasury increased the interest rate of long-time refunding from 212 to 24. The price level has been relatively stable with some decrease in wholesale prices, though the cost of living to consumers has gone up a few points due to the prior increase in wholesale prices and as these goods have moved downstream been reflected in higher costs to the consumer. In other words, we had a reversal of the policy which had been adopted before. This reversal of policy has not been accompanied by any catastrophic reduction in the price of Government bonds. It has been accompanied by a diminution or by a recession of the increase in the price level, and it has also been accompanied, as you well know, by great industrial expansion. Now, in view of these apparently obvious advantages, I wondered if you would be willing to state for the record what you regard as the disadvantages of the flexible support policy. Mr. KEYSERLING. Well, in order to do that, again I think I would like to ask the committee for the privilege to make a rather systematic analysis of this problem, because I think it falls into numerous parts. Of course, I would like to answer questions at any time in that analysis, but it is rather a complicated question. Representative PATMAN. I assume that will be satisfactory Senator. Senator DOUGLAS . Certainly. I will try not to be captious by interruptions, and any questions that I raise will be for clarification. Mr. KEYSERLING. I will try to do a better job on the answers than I did yesterday, Senator. Senator DOUGLAS . You did all right. Mr. KEYSERLING. First of all , I want to clarify the position which I yesterday took. I want to make a differentiation based on one of the questions which Senator Douglas asked me. Senator Douglas asked me whether prior to the accord I had recommended , or the Council had recommended, a change in the policy as commonly understood before the accord. I stated that I had made no such recommendation , and I stated that if the decision had been in my hands I would not have made the change. I want to make two things clear in connection with that, because it has been subject to some misinterpretation in the press, inadvertently. In the first place, that statement on my part yesterday, and repeated 190 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT today, was nothing new. The Council of Economic Advisers twice a year publishes reports embodying its views on the economic situation and what policies and what changes in policies should at particular times be considered by the President and the Congress . Now, it is a matter of record that in the January 1951 Report of the Council of Economic Advisers, 2 months, approximately, before the accord, we did not recommend that change, so that what I said yesterday and what I said today is simply repeating the fact, the known fact, that the Council of Economic Advisers was not among those advocating this change. Senator DOUGLAS. Mr. Keyserling, would it be unfair of me to ask another question ? Mr. KEYSERLING. No question is ever unfair. Senator DOUGLAS. Well, they sometimes are. Would you be willing to state whether you favored the continuation of the policy which the Federal Reserve then followed, buying an unlimited quantity of bonds in order to maintain the price at the interest rates then charged ? Mr. KEYSERLING. If it does not seem a distinction without a difference or the splitting of a hair, I think there is a difference between not advocating at a particular time a basic change in policy and feeling necessarily that the then pertaining policy is essential to be maintained. The difference is that my general view is that in an economy as complex as ours the weight should be on the side of doing what has been done, unless a moderately strong case can be made for making a change. Therefore, I would not want to say that, because we had not recommended this particular change, we had our hearts or minds set against it ; that we believed it would be dangerous to make it. I would say, rather, that we did not recommend it because , on the complexion of the situation as we then analyzed it, we did not regard it as of central importance. We regarded other things as of more importance, and we concentrated our fire on what we thought were the important things. Now, I think I can illustrate that a little further by further clarification. I think that position is entirely consistent with what I said yesterday at the end of the discussion and which was not completely understood in all quarters. The fact that I did not and that the Council did not before this accord affirmatively recommend it should not be interpreted to mean that I am now taking the position that the accord was undesirable ; and that distinction , I think, is so clear that it needs no further elaboration . In the first place, it was something new, and something new will always have differing opinions prior to its testing as to what its consequences are going to be. At no time subsequent to the accord have I expressed a view challenging on over- all balance the fact that up to now I am willing to concede that the Federal Reserve Board and the Treasury, in working out this accord, not only did what they thought was best, but I am not prepared to say that what they did was wrong. On the question of whether what they did was right, I simply say that the period which has elapsed between then and now is not conclusive on that point, and I will come to that further in the course of some of the other things I have to say. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 191 Senator DOUGLAS . You are going to list some of the disadvantages which affect Mr. KEYSERLING. I am coming to that, Senator . I just want to make my position clear : that my position now on the accord is that I am not prepared to challenge what the Treasury or the Federal Reserve Board did ; and , if I were prepared morally to challenge it , I would do it. If I have any defect, it is my willingness to state what I think, and I am not bound by any edict from anybody as to following any particular line. I am not now, and I never have been. Broadly speaking, I hope the committee will assume that the views which I have expressed privately-and I think I am entitled to express views privately to the President-are in accord with the views which have appeared in our published reports . That is the way I have always been, and at the time when I can't be that way I won't be here. There may be other reasons why I won't be here. Now, coming to the question that Senator Douglas has raised about my attitude toward the advantages and disadvantages, I had not intended yesterday to compress that within the limits of an analysis of the advantages and disadvantages of this particular accord. Although I do not want to duck, I will get into it, but I did not feel that I could discuss that question in fairness to myself without pointing out that the basic issue I have raised is not with respect to the advantages and disadvantages of this mild change which has been tried for a short time, but rather the question of how effective this particular device of monetary policy can be in seeking the objectives sought for it, what it can do, what it can't do , what its limitations are , what its dangers are. And most importantly, not that it should not be used among other things, but that I believe that in the current situation it is one of he relatively moderate and relatively minor things which may be used among many dealing with the subject both of stability and growth. The second point I want to make in a general way, and then I will get down to specifics, is that we cannot in questioning, in analyzing the effect of a policy-we have to bear these things in mind : first, its objective. I take it that the stated objective of this particular policy as expressed by Senator Douglas-and let me see if I get it correctly—is to contract the base, if not to contract to hold level, to hold level rather than to permit the expansion ofSenator DOUGLAS. As a matter of fact, I have been trying to keep my own views somewhat out of this. I did not think that we were examining my views. I am not saying that we should contract the economy. I did not say that the Federal Reserve should sell Government bonds and reduce the money supply. I merely questioned whether the Federal Reserve should have expanded the money supply from June 1950 to March 1951 as much as it did. I don't believe it should have, and I would like to point out that when the accord then went into effect , the unlimited purchase of Government bonds stopped and no catastropic consequences seem to have been incurred. I want to say it is not my view that you should enforce a contraction, a reduction in prices, and create unemployment . That is not my contention at all. 192 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT It is natural that we should not expand money supply faster than the index of physical production , taking into account the velocity of credit, and the aim is that so far as possible we should have a stable price level so that savings can proceed within a stable price level and not out of the inflated profits coming from price increases. Mr. KEYSERLING. Senator, I think that if I had completed the unduly long sentence upon which I had started it would have become clear that I was going to state the proposition as you stated it, but be that as it may-and I do not want to intrude your views into my discussion of my views, so let me try to restate it in general terms. The argument advanced for the utilization of this particular policy under discussion seems to me to run as follows : That by repressing, whether by preventing the expansion or by cutting back, the availability of a base for loans, that will have an effect upon the volume of loans ; that the volume of loans, in turn , has an effect upon the price level ; that it is a desirable objective to hold the price level, or at least to prevent it from moving forward in rapid inflation. And that consequently this policy under discussion is a basic device for stabilizing prices. More specifically, in the particular period between the middle of 1950 and the accord of March 1951 , that if this device had been used, presumably in about the combination that it was used since then or in some more extreme combination , it would have stabilized prices, or conversely, that the main reason for the price increase between the middle of 1950 or late 1950 and March 1951 was the failure to use this particular device for these particular reasons. Now, I think broadly speaking, that is about the position of those who advocate this policy and its extensive use. Now, I say in connection with that the following considerations have to be taken into account : First, does the advocated policy accomplish the objective sought ? Now, that in itself is a difficult question, because we have a complex economy with many factors operating. I do not want to take the time of the committee with the examination of a chart which shows that unless we resort to independent analysis periods can be shown where you have had converse movements of prices and expansion of credit or prices and expansion of bank reserves, and so forth and so on. But I will say that you have periods when different conclusions are indicated, if you take these different factors. So you have to resort to independent and additional analysis besides the mere juxtaposition of two events to prove or draw a judgment about cause and effect. Therefore, it is a difficult problem. But there are other problems besides. The other problems are these, and I will state the problems and then come back to the factual analysis of them. The other problems are these : First, even if it is admitted that a particular economic policy will accomplish, and does accomplish, the stated objective, and even if it is admitted that the stated objective is sound, you have the question of whether it generate other consequences which may not be so desirable. I want to address some attention to that, but first I want to give some specific examples of that in the field of economic policy, which I did in my opening statement. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 193 Certainly, since taxation is repressive, you could completely restrain an inflation, or at least I think you could, by making taxes so heavy that people just did not have enough money to force up the price of available supplies, so that if one were looking simply at cause and effect in a situation where the cause and effect is, I think, as clear as in this case, and if one were looking solely at the objective of restraining price rises, one could say , Why go through all this bother of an infinite complexion of economic policies which need to be reconciled and understood by the public ? Why not just slap on enough taxes to do it. Well, the fairly obvious answer, it seems to me, is that you have to ask the question what other consequences would result, and what are the other objectives of economic policy. The other consequences or result would be that the taxes at that point, although I am not prepared to say at exactly what point, would become so repressive that they would not only hold down prices, they would hold down initiative, they would hold down public support, they would hold down the growth of production, they would hold down the support of the people for the Government policies as a whole , which is absolutely basic. Now, I do not want to make this tedious by giving other examples, but I could take almost any single element in economic policy. Take price control . If you want to stop price rises, why not have a price-control law which is so tough and which has so many enforcement agencies that it just says prices can't increase. I think that is technically feasible. I think if all the resources of the Government which are being put into a variety of economic programs were put solely into price control , you could hold the price level that way, but you would have other consequences. In the first place, I do not believe that an absolutely frozen price system is consistent with those adjustments within our economy on the production side and on the resource side that we must retain , unless we are prepared to accompany price control by the kind of absolute control of manpower and materials and other things, which is a completely controlled system, which I am against. In other words , you have to allow some fluidity in the price structure so you can't use price control excessively because it has attendant consequences which outweigh its benefit when you get to a certain point. So you have to consider not only whether policy A assures result A, but what policy A does with respect to result B, result C, and result D if it is pushed far enough to accomplish result A. That is the second point . The third point I make is that in addition to all of that after defining what you are trying to do, you have to consider not only whether the policy will accomplish your result, but whether in view of its collateral consequences there are other ways of accomplishing the result, at least as to point of emphasis, which seem to give more hope or more promise based on experience and analysis—and we must use both- in view of the whole situation. Now, the only main point that I am making about this particular phase of monetary policy is that I ask the committee to look at all of those phases of the problem. 194 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT If, after looking at all of those phases of the problem, it comes up with a clear and crystal finding, A, that the price stabilization between February of last year and now is mainly attributable to this policy ; B, that the policy if continued for that purpose and pushed much further-and I think it would need to be to achieve the same purpose under a different set of facts-has no collateral effect measured against other policies, then I would say take this policy and go to town with it. But, on the other hand, if it is shown you need a mixture or variety of policies on this situation , and if you try to ascribe a weight to them on the basis of analysis , then I think the committee ought to consider that . With that foundation, my general approach, which I think cannot be as confining as a simple vigorous demonstration of a particular policy moving from A to B to C-because there are other policies at play and other objectives at play-let us look at it more specifically. First of all, what are the objectives of economic policy that we are trying to accomplish ? I still feel, first of all, that most important for a period of partial mobilization over an enduring period of time where we are allocating 18 to 25 percent of our national product to a noneconomic purpose, to a wasteful economic purpose, to a wasteful purpose in terms of economics, although we must do it for reasons of national security , but it is not economically productive, it is a true burden upon the economy, as distinguished from a burden simply measured by dollars or by price changes, the defense program is a true burden upon the economy, it is most important to realize as to the defense program that in the final analysis it can be supported out of nothing but production. Only production can support guns and tanks and airplanes and the other things we have to do. Senator DOUGLAS. Would you resent an interruption ? Mr. KEYSERLING. No, sir. Senator DOUGLAS. Did I understand you to say that price changes were not a burden on the economy? Mr. KEYSERLING. No ; I did not say that. I said that in the final analysis the burden of the defense program on the economy is primarily the resources it diverts from other purposes. Senator DOUGLAS. You did not mention price changes ? Mr. KEYSERLING. I think I made some reference to it, simply to indicate that I wouldSenator DOUGLAS . You say an over-all increase in prices is a burden on the economy ? Mr. KEYSERLING. Sometimes it is and sometimes it is not, but I want to discuss that in some detail, Senator. I think sometimes it is and sometimes it is not. That is just the point I want to make. Now, therefore, in the complexion of the economic policies that we use at this time, we must place heavy weight on this productive factor. Now, let us set against this productive factor the theory of this particuular type of monetary control as I understand it, and not only as I understand it, but if I have not misquoted some of the people, such as Goldenweiser and Sproul and others, whose views I set forth in my statement, I would think there is rather common consent on this point. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 195 The general theory of this particular device is that through, I don't like to say contracting, because the Senator says he does not want to contract, he wants to restrain, but let us say through placing certain restraints on the money supply you ultimately bring about less pressure on prices . However , it seems to me that the authorities are in relative agreement that in order to bring about that pressure on prices, I mean a downward pressure or a restraining pressureSenator DOUGLAS. Again I want to protest. I am not saying that the price level should necessarily fall . My point is simply that we should try to prevent it from rising appreciably ; that the stability of the price level should be the goal. Mr. KEYSERLING . I would agree with that, although I am not quite sure that some aspects of the price structure do not need to fall if we are going to get some harmoniousSenator DOUGLAS . I am speaking of the general price level. Mr. KEYSERLING . The general price level. Anyhow, whether you speak of it in terms of preventing it from rising or from restraining it, the general theory nonetheless is, as I undestand it and as the authorities seem to concur, that for this particular device to be used toward that purpose, it has to be pushed to the extent where it results in a general decline in production and employment. Senator DOUGLAS. I must protest that you might have picked out quotations from Mr. Sproul and Dr. Goldenweiser to this effect, but certainly that is not my position nor is it I think a general position of the advocates of merely limiting the purchase of Government bonds by the Federal Reserve. I want to make it clear that those are not my positions and I do not believe they represent fairly or in any representative fashion the point of view of those who seek to stabilize the general price level through credit and monetary control. Mr. KEYSERLING. Let's illustrate that by a test, Senator. Could the pressures upon the price level in the period between the middle of 1950 and March 1951 , the period to which you correctly direct attention, could the pressures upon price levels during that period have been restrained more than they were restrained without reducing either the level of consumption, the level of business investment, the level of employment, the level of expansion in plant and facilities , and so forth ? Senator DOUGLAS. Are you going to argue that question or merely raise it ? Mr. KEYERSLING. It would be rather novel to me because I haven't observed it in the commentators' Senator DOUGLAS . Are you saying that a stable general price level would restrain consumption, would result in unemployment, and so forth ? I would be much interested if that is your point of view. Mr. KEYSERLING. No ; that is not what I am arguing. I think a stable price level is consistent with that, but I say that under the expansion of consumption and investment and inventory accumulation, in other words the rapidly expanding use of resources which actually took place during that period, I do not see how price increases could have been prevented without restraining some of those resource uses . 196 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . Let me ask you this further question. To the degree that these added purchases were made by drawing on savings, that could have proceeded outside of the commercial banking system. The question is as to whether we should have added to these other factors this increase of $10 billion in commercial loans. Would the increase in prices have been as great if the issuance of bank loans had been more restrained, on the presumption that the issuance of bank loans would have been more restrained if the reserves had not mounted and the reserves would not have mounted if the Federal Reserve System had not purchased the bonds ? I am not contending that general flow of money solely determines individual prices. I am not ruling out the possibility of drawing on accumulated savings. I am merely saying that the total supply of bank loans does affect the general level of prices, and that when you expand bank loans, that has an effect on the general price level if it is not accompanied by a corresponding increase in physical production. Mr. KEYSERLING. Senator, in the period under review, my departure from you is not as great as you think it is, but it is important in one vital respect. I am not arguing that the general expansion of credit or the general expansion of bank loans under the conditions prevailing during that period did not have any effect upon prices. What I am saying is that the only way a restraint upon that factor could have had an appreciable result upon the price level would be if it were carried far enough to restrain the demand of the people for the acquisition of resources. Senator DOUGLAS . Let me ask you this questionMr. KEYSERLING. Let me illustrate that a little bit. Let's illustrate that in various areas. Suppose - not suppose because it actually happened. In the period between November 1950, and early 1951 , people in the New York area felt that because they had heard that there was going to beand this is not a limited illustration ; it can be generalized into a lot of what was happening-felt that in the view of this Chinese intervention and the thought that it might result in this or that or the other thing, and their vivid recollection of past shortages, they flooded the department stores and started buying more pillow cases and more bed sheets, and that on a broad scale was an important factor in the particular kind of price inflation spurt which occurred at that time. Now in the absence of price control, I say that in the short runand I am talking here mostly about short- run consequences- whether those people ran in to buy those pillow cases by drawing down upon their savings, or whether they ran in to buy them by saving less, or whether they ran in to buy them because of an expansion of credit, is not the prime factor in the price increases in those areas at those times. They were trying to buy more pillow cases. Now all I am saying is that if you try to trace through how a contraction in the general monetary supply through this device would impact upon those sources of inflation, all I am saying is that for it to do that-and I do not deny that there is a connection and that it could do that you would have to push it far enough to accomplish certain other things at the same time, and that on net balance they would have been undesirable in that period . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 197 Senator DOUGLAS. Mr. Keyserling, I am not blaming you for this because I know I interjected in your argument once or twice, but the original question was directed to the period since the accord . What bad results in your opinion has that accord had ? What disadvantages have occurred as the result of it ? I wonder if you would be willing to turn your attention to this period subsequent to April 1951 a period of almost a year under which we have operated with this accord. That was the question that I hoped you would answer yesterday. Mr. KEYSERLING. Yes, sir ; but there is a direct connection between the two. Senator DOUGLAS. Time is somewhat limited, and half an hour has passed since you started the discussion. You have not yet come to it. I say it is not entirely your fault because I have twice interrupted, but if we could at least declare a truce for the time being on the period prior to the accord , would you be willing to move to the period since the accord ? Mr. KEYSERLING. Yes, sir ; but let us consider this, Senator , and I want to say that I hope you will not take exception to this. Frankly I think-and this is consistent with the whole argument I am making that one of the disadvantages of the accord - and I want to emphasize again that I am not saying on net balance it was undesirable-is the extent to which on a Nation-wide basis people have claimed for it more than it has accomplished . Now I think that is a very important issue of economic policy, and you can't separate that from the claim that the absence of the accord before February was responsible for the price increases before February. Senator DOUGLAS . Remember this is politicallyMr. KEYSERLING . No, sir ; I am not talking politically. Senator DOUGLAS. I want to use it as an illustration . We always run into this question when any character comes up for appraisal. We may say, "Well , he is not as good as he is cracked up to be," but that is not my question . What positive faults are there in the man and what are the positive faults in this accord ? That is the question I am asking. Mr. KEYSERLING. Senator, if you are willing to say that the accord has not been———— Senator DOUGLAS . Oh, no, no, not at all. I am merely saying I want to know what are the positive faults of the accord , what evil consequences or bad consequences have followed in its wake. You said it had advantages and it had disadvantages . Well , now I want to hear the disadvantages. I have yet to hear any disadvantages. Mr. KEYSERLING . Senator, I do not want to be in any respect captious about this, but I cannot avoid the consequence of this observation : That if I have rheumatism and a doctor tells me that drinking a glass of water will cure me of that rheumatism , and I drink a glass of water, and later I feel better, I do not think that the sole question is whether the glass of water did me any harm. There is also the question of whether that doctor should be allowed to go around the country saying that drinking a glass of water is a cure for rheumatism , and I think that that is an essential part of this discussion. 198 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . Wait a minute, you said that the accord had advantages and disadvantages. Mr. KEYSERLING . I think one of the disadvantagesSenator DOUGLAS. What are the disadvantages ? Mr. KEYSERLING. I think one of the disadvantages-and I will come to others—is that it has led people to say on the basis of a juxtaposition of events which are not cause and effect, that this policy is the central core of price stability in this kind of mobilization period. Now that has very important consequences , because it has a bearing upon the extent to which we rely upon tax policy, it has a bearing upon the extent to which we rely upon price and wage controls , it has a bearing upon the extent to which we rely upon select controls, and therefore it has a bearing on the whole thing. So I say again that the question of whether or not the accord has led some people to overappraise its significance has a direct bearing upon the value of the accord. Senator DOUGLAS. Are there any positive disadvantages ? Mr. KEYSERLING. Coming to the positive disadvantages, I would like to amplify it a little bit by saying that I have never said basically that this particular accord had demonstrated positive disadvantages, but that to carry the accord to the point where it would have to be carried to operate as a major stabilizing factor, it would have profound disadvantages . Senator DOUGLAS . Has it had any disadvantages to date ? Mr. KEYSERLING. Well, it has had the one I mentioned, which I think is significant . Senator DOUGLAS. Aside from that ? Mr. KEYSERLING. I think that it exercised some unstabilizing and uncertain influences. Senator DOUGLAS. In what respect ? Mr. KEYSERLING. Well, I think it caused interest rates to move upward. Senator DOUGLAS . I think that is true. The interest rate has risen from 212 to 234 percent on Governments, and there has been an upward movement in interest rates generally. Do you regard this increase of interest rates as sufficiently serious so that the accord should be discontinued ? Mr. KEYSERLING . No ; I have at no time taken the position that the accord should be discontinued . Senator DOUGLAS . To what extent would the policy have to be carried to have other injurious effects besides a rise in the interest rates ? Mr. KEYSERLING. Senator, I would first have to discuss the question to what extent it would have to be carried to have beneficial effects, because the basic point I am makingSenator DOUGLAS. Then, do you think it has had any beneficial effects ? Mr. KEYSERLING. I do not think that it has provable and substantial beneficial effect except that other things being equal, to use a phrase which you used yesterday, Senator, other things being equal, I think it is very much better for the Treasury and the Federal Reserve Board to be appearing to the public in the light of reconciling their views than to be in conflict. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 199 Senator DOUGLAS. In other words, the advantages have been psychological rather than economic. Mr. KEYSERLING. Well, I do not think there is any clear line between the two . I would say that that is perfectly logical with my general position, because since I say that these milder variations in this particular policy do not have very much effect on the economy, I would much rather not see the Federal Reserve Board and the Treasury fighting about an issue which seems to me not so important as many other economic issues with which we now have to deal. Senator DOUGLAS . On balance have the beneficial effects been less. than the disadvantages in policy ? Mr. KEYSERLING. I would be inclined to say that up to the present time the beneficial effects have outweighed the detrimental effects. Senator DOUGLAS. That is, the harmony between the Federal Reserve Board and the Treasury has been more important than the rise in interest rates ? Mr. KEYSERLING. Up to the present time I would say on balance that that would be my view. Senator DOUGLAS . Suppose you could have obtained harmony by the Federal Reserve Board adopting the policy of the Treasury so that you would have had harmony with the diametrically opposite policy. Now, in that event you would have had harmony plus stability in interest rates, and so, therefore, according to your reasoning, it would have been still more beneficial, would it not , because you would have added to the lower interest rates the advantage of harmony. Mr. KEYSERLING . I am not sayingSenator DOUGLAS . By the method of logic that seems to follow. You say that the disadvantage of the record is that it has raised interest rates, and I grant you that. I think that should be granted . It increased interest rates slightly. That is a disadvantage. But you think that is outweighed by the harmony between the Federal Reserve Board and the Treasury. Now, if the accord had not been concluded , if the Reserve had continued its previous policy of buying unlimited quantities of Government bonds, let us grant that the interest rate would probably remain lower, and you would also have had harmony ; so I would think you might argue that instead of offsetting one against the other, the two would be added and would reinforce each other. The only conclusion I can draw from your statement is that it would have been still better if the accord had not been reached . Mr. KEYSERLING. I have not said that, and I did not thinkSenator DOUGLAS . It follows implicitly from the contents of your argument . Mr. KEYSERLING. No ; you draw that conclusion only because-I think there are certain limits on logic in this situation, too, for reasons that I gave yesterday. You can follow logic within a narrow framework which precludes from consideration a lot of things that ought to be in that framework before you start using logic. Logic is simply a tool. Senator DOUGLAS . Would it not have been better not to have had the accord ? Mr. KEYSTERLING. Senator, I have said on balance looking at it now, that I think the accord has had some net benefits . 200 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. Simply because the Treasury finally gave in ? Mr. KEYSERLING. I did not say simply because of that. Senator DOUGLAS . You said the harmony outweighed the raise in the interest rate. The harmony was produced by one side yielding to the other. Up to March it had been the Reserve which had yielded to the Treasury. Subsequent to March it was the Treasury which yielded to the Federal Reserve. Mr. KEYSERLING . Senator, my basic position is that if one looks only at the changes which have thus far been made, my analysis is that their effect upon the economy has not been large. Now obviously you disagree with that. We have been over that ground. You think that it had a profound effect upon the price level between the middle of 1950- I mean not having that accord-between the middle of 1950 and February of 1951. I do not think so. You think it has had a profound effect upon the price level between March of last year and now. I do not think so. Now we can go over that on a more factual basis . But the main point I am making is that, since I do not think that the mild permutation between the situation before the accord and the situation after the accord has had this profound effect upon the economy, then I think there is room for saying that one of the major concerns here up to this point is whether two agencies of Government, of public power, if you do not want to call it Government, concerned with the policy which up to this point and within these limits does not seem to me to have had any great effect one way or the other, stand before the people in trying times as able or unable to reconcile their differences. And I am glad they have reconciled their differences, and I think it is a net factor of a favorable factor. Senator DOUGLAS. May I interrupt ? Do I understand your position that the limited purchase versus unlimited purchase of Government bonds has very little effect on the general price level ? Mr. KEYSERLING. It depends on the quantity of purchase and the time of purchase and the terms of purchase and what else is happening in the economy at the time. Senator DOUGLAS . I am referring to one period in which the Reserve purchased $312 billion of Government bonds from June 1950 to March 1951. As I understand it in your judgment that did not have much effect on price level. Mr. KEYSERLING. That is my judgment. Senator DOUGLAS. And from the period April 1951 to March 1952 the Federal Reserve Board has not purchased additional quantities of Government bonds, in fact it has slightly diminished its holdings. Do you say that has not had a steadying effect on prices, that there is no indication that the increase in prices during the previous period , and the relative stability of prices during the latter period have been tied to the bond purchase policy of the Reserve ? Mr. KEYSERLING. I think that in both periods it has had some very slight effect. Senator DOUGLAS. But not appreciable ? Mr. KEYSERLING. Taking this last period first, I think that the basic reasons for price stability since March 1951 , I would place them in this orderSenator DOUGLAS. I am trying-well , I will let you complete your statement. I do not want to interrupt. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 201 Mr. KEYSERLING. I would say that since March 1951 the basic reasons for price stability have been the following. First, while there was an inflationary spurt caused largely by inventory accumulation and by rapidly advancing consumer buying after the Chinese interventionSenator DOUGLAS. Are we speaking of the period July 1950 to March 1951 now ? Mr. KEYSERLING. I am speaking of the period from March 1951 until the current time. Senator DOUGLAS. Which is a period of comparative price stability. Mr. KEYSERLING . Yes, sir ; and I was starting to say that while there had been this inflationary spurt after the Chinese intervention , nonetheless it is my view not only now but was my recorded view going back to the first Korean assault and to the second, that in the long pull over the next few years as of from then the basic size of the defense program and its basic pace in a period of partial mobilization, related to the then productive power of our economy, the supplies then available in our economy, and the likelihood of productive expansion over the next year and a half, was such that in the long run the inflationary pressure strain of the defense program would not be great. Now that is what has happened and that is the main factor. You are asking why prices have been stabilized since March of 1951 . Senator DOUGLAS . Now would it be improper for me to ask, whether the stability of prices has or has not been aided then by the cessation of purchase of bonds by the Federal Reserve ? Mr. KEYSERLING. It has been aided , but if I were to list the eight reasons which I would ascribe for price stability , I would list that seventh or eighth, not first. Senator DOUGLAS. Then I take it your position is that changes in the money supply in these last two periods at least have had very little effect upon the price level, that is from July 1950 to March 1951 , a period of advancing prices when one policy was followed , leading to an expanded money supply that is, and the period April 1951 -March 1952 when prices have remained relatively stable and Federal Reserve holdings of securities have remained relatively stable ? Mr. KEYSERLING. If I were listing the eight reasons for rapid price increases between the Korean aggression and February of 1951 , and the reasons for the relative price stability between February 1951 and the current time, if I were listing the six reasons or the eight reasons for that, I would list this particular reason in the degree that that policy was used as about seventh or eighth, and not as first. Senator DOUGLAS . The issue is very clearly joined then . Representative PATMAN. Would you indicate what the seven or eight are ? Mr. KEYSERLING. I would say first the basic relationship between our productive capacity and the demands upon our resources. Senator DOUGLAS . May I interject there. The index of unemployment was 5.2 percent the 1st of July 1950 , and it fell to 3.4 percent in February 1951 , or a decrease of 1.8 percent, so that there was a transfer of idle labor. It is at present I believe 3.4 percent, for February 1952 , so that it has since remained constant. Now I grant that possibly a price increase did play a large factor in the reduction of unemployment by 1.8 percent. 202 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT My point is this : That the increase in production was about 10 percent and that therefore the greater utilization of idle resources accounts for only a small fraction of the increase in physical production. Mr. KEYSERLING . No ; I did not say that the greater utilization of idle resources was the main factor in the increase in total production . I think part of the increase in total production has been due to increased productivity . Senator DOUGLAS. Why was the increase in productivity dependent upon the increase in the money supply ? That is, could not the increased productivity have occurred without such a large or rapid expansion of the money supply? think that we need to be wary of assuming that because productivity increases, it increases because of governmental policy. Now the truth of the matter is there has been this long time of increase in porductivity at the rate of 3 percent a year more or less irrespective of Government policy. Government policy may dampen it down, or may accelerate it somewhat, but the long-time trend proceeds in Republican administrations, as well as in Democratic administrations and so on , and I think frequently there is an error in assuming that because productivity has advanced, it is due to governmental policy. Sometimes it is like the fly on the axle of the chariot wheel in the Roman chariot race who at the end of the race got down off the wheel and said, "See what a long distance I have traveled." Mr. KEYSERLING. Well now, Senator , I did not say that the increase in productivity was due to Government policy, although I think that has been a factor in it, and I did not say that the increase in productivity was due to the increase in the money supply. I simply started to enumerate the reasons why I think there has been relative price stability from March 1951 until the current time, and I do think that the first and most important of those reasons and I was just parenthetically stating why the increased production had taken place- is that in March 1951 the general level of production had been raised very far above what it was at the time of the Korean outbreak. There had been expansion in basic productive capacity, there had been expansion of various other kinds of output, and if you want the figure in uniform prices of the changes in the gross national product during that period, I will read them. Senator DOUGLAS. I have them here. I would prefer not to use gross national product because there are all kinds of inadequacies in that figure. I prefer to take the index of physical production. Let the record show there was an increase in the Federal Reserve index of industrial production from 200 in June, 198 in July to 219 in March 1951 , or an increase of about 10 percent, but nearly all of this occurred in the single month of August- when there was a jump of approximately 6 percent. Mr. KEYSERLING. Well, anyhow I would say the first and foremost factor in the price stability over the past 12 months has been the increase in production, measuring the productive level during that period with the productive level at the outset of the Korean trouble. In other words, I do ascribe to the realization of our productive capacity a very, very important role in preventing or avoiding price inflation . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 203 Now a second factor, the factor of second importance which in a sense relates to the first, because production must be measured against utilization of resources, the fact is-and I say this not critically but descriptively-that the actual pace of the take of the defense program, as we all know, has in actuality been slower than was contemplated by the business community and by the Government when estimates of the economic outlook were made in late 1950 or in early 1951, so that you have had two complementary and interdependent factors playing . First, a great increase in total production , and a particularly large increase in the strategic areas of shortage , which had a good deal to do with the inflation . Second, and at the same time, a pacing of the defense programs take upon the economy considerably slower than had been contemplated . I am not saying that critically or in terms of praise . That depends and I do think that the first and most important of those reait has been a factor in the economy. Those are two factors. Now let's move on to a third factor. I think a third factor has been the excellent judgment displayed by the Congress in raising taxes. Now, the fact that the Congress has not been willing to raise taxes still further has tended to obscure the fact that never before in peacetime history did a Congress do so realistic and forthright a job in increasing taxes as much as it did between the original Korean outbreak up to the present time. I think on a comparable basis and allowing for the differences in the circumstances, that they did a much more commendable job this time than in World War II. Now, I think that is an immensely important factor in the effect upon price structure. We have imposed a very heavy additional tax burden upon the American business community and upon the American people. That is factor No. 3. I think factor No. 4- and when I get below 3, I am not as clear as to the order of the importance, I mean whether it is 4 , 5 , 6 , or 6, 5 , 4. Let us say another factor in the fourth category is the level of saving. Now, of course you may say that the level of saving is affected by these other steps which are taken, and there you get into a circular process as to whether price control promoted savings by making the people feel that they were not going to have to buy against price increases, or on the other hand that savings made price control effective because if the people had tried to spend more price control could not have been effective. I think it is interrelated , and I would not want to claim excessive partisanship toward the relative weight of the two factors. But anyway, partly due to the abundance of supplies, partly due to the restocking which took place in the end of 1951 , partly due, whether desirably or undesirably there has been a sense of decreasing urgency about the pace of the defense program-and I state that merely obJectively because I do not want to be implied as criticizing it one way or another-anyway, partly due to all those factors the American people have over the past year been saving at a fantastically high rate. I won't say abnormally, because I do not know what norms are in this kind of time, but anyway fantastically high by past measure-14 97308-52- 204 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT ments, and I would ascribe to that a very important influence upon price structure. Next, I think that price and wage controls at least in a short period of time have had a very important effect on it, because while I agree with those people who say that it is not the most basic remedy, and while I agree that it cannot in the long run contain prices , if the other conditions are not favorable, yet I think that the statement that price and wage stabilization for a period of time deals simply with the effects and not the causes is an understatement. I think that in the dynamics of the way collective bargaining works, the way price policy works, that you get a push upon prices not only from the demand side but also from the cost side. I think, for example, taking a current example, that if you were to have excessive wage increases-I do not want to get into the question of what would be excessive, because agencies of Government are now wrestling with that problem, but the illustration serves anyway— if you were to have excessive wage increases in the steel industry, I think under current conditions that could give a very important fillup to the inflationary trend. And getting back to the relationship between that and these other policies, I hardly see just how monetary policy within doable ranges could have any direct and quick impact upon that urgent situation arising in the steel industry. So I would put price and wage stabilization at least for a time as an important contributing factor in the fifth or sixth category. Then I think the allocation of materials is extremely important. I think whether scarce materials are wisely or foolishly allocated among various claimants, the pacing of that, how well it is figured out, how it is done, that has a very important effect upon the price structure both in direct economic terms and upon the sense which it produces in the business community either that they are going to be in great trouble or not in great trouble, depending partly on how intelligently that job is done. Now somewhere within that range at that point I would put the effect upon the general price structure, under these times, of the permutation in monetary policy of the size and character which have been undertaken and which it seems to me either the Federal Reserve Board or the Treasury would be willing to undertake in view of all the circumstances now prevailing. That is about where I would place it. Now I am perfectly willing to concede that it has some effect, and I am perfectly willing to concede that if that particular device were pushed far enough, just as if taxes were pushed-by "far enough" I mean too far- just as if taxes were pushed too far or price control too far, it could have a compelling effect. But then I move over to say that within the range of that policy as it has been operating, I would enumerate it as one of the factors but certainly not the controlling factor. Senator DOUGLAS. You would put it almost at the bottom. Mr. KEYSERLING. I would not range it as high as the others that I have mentioned. Senator DOUGLAS. You have said you would put it at the very bottom of all these factors. Mr. KEYSERLING. Well, I could mention some others that I would put even lower. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 205 Senator DOUGLAS . You mentioned six or seven that are higher. What would be lower ? Mr. KEYSERLING. Well, I think that under the current situation exhortations to people not to ask for higher wages or to be wise in their price policy, I would put that lower. Senator DOUGLAS. I would agree with you on that point. Mr. Chairman, the witness has taken some time in replying to my questions. I think I should now fade out. Representative PATMAN. Mr. Bolling ? Representative BOLLING. Mr. Keyserling, the first question that I have is one to which I am very anxious to get a full answer, but I am aware that the question may be a lengthy one. But I want a rather long answer and I am aware that it will take you back over some territory that you have already covered . I raised the question with Mr. Martin the other day, that between 1942 and 1945 the Federal Reserve increased its holdings of Government securities by $22,000,000,000, and the consumer price index moved up four- plus points. During the period between 1946 and 1950 there was a net increase in the Federal Reserve holdings of about $5.9 billion , and the consumer price index moved up 40-plus. Now the periods of time are not exactly comparable and I made no effort to make them exactly comparable. I am aware that you have already discussed some of these things, but I would like to get for my own mind your ideas of the differences between the two situations. What were the factors that maintained comparative stability in the 1942-45 period, and what were the factors that made prices raise so fast in the other period ? Mr. KEYSERLING. Well, I will try to answer that as briefly as I can , but the most important part of my response is this : that the facts which you have cited showing at various times an inverse trend in these different elements is a factual illustration of what I was stating generally. I find that some business economists, labor economists, and others have slipped into the habit of starting with a thesis and then it does not require very great intellectual ingenuity to take a long-term chart in a complex economy and pick out periods where A caused B, and where A was the sole cause of B. I just don't believe that. I believe that that is almost never true. And the only concern I have about the attempted correlation between the monetary policy between the middle of 1950 and March 1951 , and the attempted correlation between March 1951 and the current time, in juxtaposition to the price structure, is that it is an oversimplification, I do not say that it has no validity. I do not say that it was not one factor, but there are many other factors. Now, the citation which the Congressman has given simply gives factual illustrations of points in time where very different things happened under a different complex of factors. Now, you asked what were the reasons for that. I do not want to bore the committee with a discussion of the whole economic trend of World War II or even of the 1946-47 period , but I would say simply that in World War II it was demonstrated that ! 206 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT even with the allotment of 50 percent of our resources, approximately, to war production as contrasted with a 20-percent range now, meaning a greater strain upon the economy, that even with that and even with a tax policy which in that time I think took an inadequate amount of excess purchasing power out of the economy as against borrowing, and even with financing of about half of the war effort through borrowing, even with all those things which were much more extreme than anything we have had in recent times, nonetheless, as you point out, there was achieved for a long period of time quite a large degree of price stability, which seems to me to indicate at least-and I do not want to prove too much for it-that we cannot single out as the determining factor in price stability a factor which was not present at that time because at that time the Federal Reserve Board did support the Government bond market and at that time it did follow the policy of taking up these obligations as they occurred. Now, I do not mean by that- and I want to take a moderate position on that— that an even better job might not have been during World War II if a somewhat more flexible policy similar to the one now in effect between the Federal Reserve Board and the Treasury had then maintained. Maybe that would have been still better. I am not arbitrary on that. I simply say that it is one factor in the picture and does not seem on analysis to be the major factor within the range of what is doable in that area now. Now, I also think that during that period of World War II we would have been better advised to have collected somewhat more in taxes, although I do not believe you can be on a pay-as-you-go basis in a total war, because we did, through not doing that, give the people the impression , including our working groups, that they were increasing their real incomes because they were getting more wages at a stable price level, but the only reason they were registering that gain was because they were not allowed to spend the money. If they had tried to spend the money, the increased production of civilian goods was not underneath it, and, consequently, when they did try to spend the money after the war, that, among other things, forced up the price of those goods. So I think it was in that sense a suppressed inflation, and I won't say it was a subterfuge, because on balance I don't know-you certainly could not have financed the whole war out of taxation, and maybe the right balance was struck, but if that was the right balance we had to pay the cost for it in postwar inflation . Now, whether the cost in postwar inflation was on net balance a greater cost to our economy than the cost of a different system of taxation during the war, I don't think any man can answer. I think it takes an awful lot of analysis. It is a terribly difficult question . So much for the World War II period. Now, coming over to the other period that you refer to, Congressman, the 1946-47 period , there were a lot of factors operating then. I think personally that the direct controls were demolished somewhat too rapidly in that period . I think the backlog of demand for a tremendous accumulated nature of war-created shortages was an immensely important factor. We had practically full employment at high and growing wage levels. We had a large accumulation of savings, and all of those MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 207 things in combination forced the price level up rapidly during that period. If we had wanted to hold the price level reasonably stable during that period, I think we would have had to defer the demolition of price and wage stabilization, and I think we would have had to have a higher tax program. But there again that brings me to the other point that Senator Douglas raised about price trends and gives me an opportunity to discuss the third phase of the main point I made. As you recall, I said three things. I said first that in weighing a particular policy device, one has to ask first will it accomplish the objective claimed for it, namely, in this instance, how much effect will it have upon price stability. Second, if it will accomplish that objective, what are its collateral consequences and what are alternative methods of accomplishing that objective. But third, and perhaps most important of all, is the question : Is that objective the sole or the predominant objective in the economy ? Now, let us apply that to the question of prices. There is a great inclination to the view that price stability is our primary economic objective. I do not attribute that to you, Senator. Senator DOUGLAS . I would say that it is a prime objective. Yes, I would be very glad to say that. Mr. KEYSERLING . I think it is one very important objective. Senator DOUGLAS . I would say it is a primary objective. Mr. KEYSERLING. I would agree that it is a prime objective, but I will say that in the operations of the American economy, particularly when since no election on our part we have had these great shifts in the problem with which we have had to deal, I do not know just how one could equate what degree of price stability would be consistent under our system with the other things we have had to do at the same time. In other words , let us look at the situation going back to 1950. In 1949 we ran into a recession . Some people thought that was going to be quite serious, others did not think so. In other words, it was the first important postwar testing of the stability of our economy. In 1950 we started recovering from that recession, and there was some ambivalence in the situation then . In the middle of 1950 we got a different burden. Now frankly I do not think economists, including ourselves or others, have really moved on to an adequate analysis of at just what point price trends equate with other objectives. In other words, to what extent would the productive changes between 1950 and 1952 have been the same if we had had absolute price control . My inclination is to think that on balance, through not having absolute price control, the productive advantages outweighed the somewhat lesser stability. I cannot prove it but that is my inclination . Second, there needs to be further analysis of the relationship between the changes in the general price level and how those changes affect resources and incomes throughout the economy. I would say that if it could be shown-this is a theoretical picture to illustrate the point, Mr. Chairman and members of the committee-that a change in the price level was accompanied by an apportionment of resources throughout the country which apportioned to each group exactly the 208 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT same additional number of dollars, manifestly you would be working with more chips but you would be back where you started from. Therefore changes in prices either upward or downward affect the economy adversely in one of two ways. Either they produce a certain redistribution of resources which in the long run affects economic stability, because things get out of balance, or they produce a social redistribution of benefits which we as a nation do not think is consistent with fairness or justice, and they may do a complexion of those two things. But it does not follow from that automatically that a generally rising price level in the United States always produces the changes in an undesirable direction . I would be prepared to say that rapid upward spurts of prices at particular times do produce these consequences in an undesirable direction , and I, of course, am not arguing against but rather for a firm stabilization program, and a rounded stabilization program. But I do not think that price is the only thing that we can look at in the economy in determining economic policy. And consequently when you prove that a monetary policy if pushed far enough would hold the price line-and I think it would, any policy if pushed far enough would you have to examine what the consequences of pushing the policy that far would be not only upon prices but upon production, upon the allocation of productive resources, which is vitally important in this defense period. And the main point I made on this monetary issue is that if it were pushed far enough, actually to hold the price line, not to hold it now, because I think many things are holding it now, but if it were actually pushed far enough actually to hold the price line, not to hold it now, sion and March 1951 , if it alone were relied upon or almost entirely relied upon, if it were pushed far enough absolutely to hold the price line, it would have to be pushed so far that in its consequences upon the national debt , upon the financing thereof, upon changes in interest rates, upon productive incentives and upon the allocation of resources, then it would produce lots of other things that nobody would want to countenance. And that is the essence, Congressman, of my whole position here. Representative BOLLING. Mr. Keyserling, our military build-up program places its major emphasis not just on the production of hardware but on the production of productive facilities and the development of production facilities. We could have used two techniques in achieving that. One would obviously have been direct Government construction, the other was the one we chose, private expansion, with various aids and assistances. Where could that private expansion come from in credit terms other than through an increase in credit available ? Mr. KEYSERLING. I think that there would have to be some increase in credit available to produce so rapid an expansion as has occurred. Representative BOLLING . This is the question that I am not at all clear on. You have said several times that the diversion of productive capacity for military defense purposes is in a sense completely negative from an economic point of view. Is there a difference in the negativeness between the production of hardware and the creation of new production that does not produce hardware for some time ? Do I make that clear ? MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 209 Mr. KEYSERLING. Yes, there is a big difference and there is also a difference between the production of end fighting weapons and the production of facilities for their production. Let us take both of those points. First of all, when I said that a military program while necessary on grounds of national security does not add to our economic strength or our productive facilities, I was referring to fighting weapons. I was not referring to that part of what is sometimes called the security build-up which consists in the production of productive facilities, because most of those productive facilities, as we learned after World War II, can be substantially transformed to the production of civilian goods. Now that is the first part of the question. In other words, I would not apply the comment that the military build-up is not economic and in an economic sense wasteful , although it is necessary on grounds of security, I would not apply that to the expansion of a steel plant even though the expanded output of that plant for the time being goes into the increased production of military end items, unless one said that that would be a net loss after the defense program because we would then have a disutilization of those facilities. I think as a nation we have got to find ways to use those facilities and can. As a matter of fact, I do not think that in any of the important areas of the expansion of productive facilities the expansion has moved much if at all above the correlated factor with what the need in that area would be anyway within a few years if we are going to have a highlevel employment with a growing labor force and improved technology. Now coming to the second question as I understand it, of course the inflation strain of the expansion of these productive facilities is mostly while they are being built, because while they are being built they are not even adding to the flow of goods, so that the balance is entirely negative during the time they are being built , but that is true of any building effort. Where you are building a productive tool, you haven't got it until you build it. That is true of a fighting weapon, and you have to strike a balance, and that is why I think the problem of allocation of resource use is the central question of this whole mobilization program, the central question . How much of your resources are you going to put into fighting weapons as against plant build-up, plant build- up as against civilian supplies, how long it takes to get the plant before you get the benefits of it, and so forth, and so on ? And it is just because I think that that is the central question that I have raised these questions as to whether general monetary policy is the kind of weapon which addresses itself to these adjustment problems. Now, again I am forced to say-I am not saying don't use this weapon, but I am saying-when you look at the nature of the problems, your problem of expanding production , your problem of getting this allocation of resources, your problem of priorities after all , a defense mobilization is a problem of national decisions on which things you want to do first when you can't do everything- and so forth, and so on, if I list those problems and then listed the range of weapons to deal with them, I would not put this particular weapon near the top be- 210 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT cause of its generalized character and its corollary consequences if it is pushed too far. Now, that does not mean it should not be used at all any more than it means that the other weapons should not be used at all . I think they should be used in blend . The Council of Economic Advisers from the very beginning has not been an opponent but an advocate of general credit and monetary restraints . We have proposed various increases in reserves toward that end as one way of trying to reconcile that problem with the problem of the management of the national debt, and, as I here again say and want to emphasize, I would not as of this time list myself, for whatever it is worth, as being opposed to the accord that was reached, and I would not list myself as saying that on net balance as of now its benefits have not outweighed its disadvantages. I think its benefits have slightly outweighed its disadvantages. I am afraid of it mostly because of the excessive things claimed for it. Representative BOLLING. In the last part of your statement two things came up that I want to pursue a little. You speak of the generalized character of the effect of monetary policy. Would you expand on what you mean by that ? Mr. KEYSERLING. I mean that it does not operate to produce the selective kind of expansion and contraction which is so important to a defense mobilization. In other words, you see we have got to distinguish various situations . A large body of economic policy and a large body of the thinking about economic policy grew up during times when you were thinking of (a ) dealing with a general depression or (b) dealing with a general inflation, and then the policy very simply ran as follows : If you are in a generally depressionary situation, let's lift prices, lift the money supply, lift the general level of demand- let's lift everything and get out of this trough. Now in the typical inflationary situation-and by the typical inflationary situation I do not mean one that we have had typically. I think it is more a stereotype than anything actually that has happened. That is regarded as the converse of the situation I have described. We have too much of everything . We are rising too fast. Let's cut everything down. You decrease the money supply. You try to push the price level downward, and so forth and so on. Now, the point I am making is that the kind of long-term partial defense mobilization which we are now confronting does not fit into either of those two categories. It presents us with entirely novel kind of problems, and the novelty of the problem arises from the fact that manifestly we are undertaking at one and the same time a rapid expansion of some very important things, and to support it, a rapid contraction of other very important things. We must rapidly expand military weapons, we must rapidly expand the industrial mobilization base to increase our total strength, and we must correspondingly contract insofar as we haven't got the resources to do both, housing, automobiles, and other things. Therefore I say that a general policy which was properly conceived to produce and be effective through a general contraction of economic activity finding its way quickly into all the crevices of the MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 211 economy cannot be used very vigorously and very far-reachingly in this kind of situation. It can be used to exercise some dampening effect, and I am not against that. But it cannot be used as strongly as advocated by those who proposed it in an entirely different framework because we haven't got the problem that they were thinking of when they developed over the years that particular branch of theory. That is what I mean when I say it is a generalized weapon. Representative BOLLING. You mentioned previously the question of supplemental reserves. Do you have some specific suggestions on that at this time ? Mr. KEYSERLING. I do not have specific suggestions at this time, partly because I really haven't gotten very much into the techniques of the relative merits of the different types of reserves. We have from time to time advocated authority in the Federal Reserve to increase bank reserves . I understand that the current position of the Reserve Board is that they do not want that authority at this time because they do not feel that they should use it at this time. And I do not have any specific reserve plan now to advocate. Representative BOLLING. I raised this question with Mr. Martin the other day. In view of the inevitable legislative lag, and the possibility of our needing an additional tool in this field, is it psychological reasons that make it unwise to ask for the tool at this time ? Mr. KEYSERLING . I do not intend to say that it would be unwise to ask for it at this time. I simply say that it is my understanding that the operating agency feels that way and that I have no specific plan to offer. I would be prepared to say in response to your general question that it has always been my general view-and I think the view of the Council that in this kind of fluid situation it is very bad to try every few weeks or even every few months to revise your kit of tools to what the outlook looks like for the next few weeks. And it would be the part of wisdom for a discretionary agency like the Federal Reserve Board to have a wide amplitude of tools that it could rather quickly draw upon in view of the legislation lag. Representative BOLLING . Senator Flanders. Senator FLANDERS . Mr. Keyserling, would you think it an oversimplification to say that in the absence of direct controls, prices respond to the relationship between the money supply and the production ? Mr. KEYSERLING. Oh, definitely they do, particularly if by "money supply" you mean not the static volume of money but its turn-over and so forth and so on. Senator FLANDERS . Yes ; it is the availability of the money supply ? Mr. KEYSERLING . Oh, yes, definitely . Senator FLANDERS. Now would you also say that price-and - wage controls are effective primarily in the short run, or do you feel they can be effective in the long run over periods in which the relationship between the money supply and production is leading toward inflation ? Mr. KEYSERLING. I think that the question of what is in the short run and what is in the long run, Senator, would be differently defined 212 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT by different people. I mean some people would say that 2 years is in the short run, others would say 3 and others 1. Senator FLANDERS . What would you say ? Mr. KEYSERLING . I would not be as sure as some people are, but I would say this : That it has been my view from the beginning that if we are embarked upon many years of partial mobilization, taking into account the economic problems and the psychological problems and the problems of public consents, that I would go light in the long run on priceand-wage controls, and try to work toward a productive situation where within a reasonable short period of time they could be taken off. That is my general position . Senator FLANDERS . Now, in giving your low rating to monetary controls, are you giving a low rating to the effect of money supply in this balance between money and goods ? Mr. KEYSERLİNG. No ; because in the first place, in giving this low rating to money supply, Senator, I want to restate something that I think I said when you were not here. I am giving a low rating only within an assumption that the monetary authorities, for reasons that seem to me important, could not push monetary controls to their logical or extreme conclusion. In other words, if the monetary authorities were willing to produce extreme changes in interest rates, in the availability of credit and in the money supply, I would certainly not then give a low rating in terms of its effect upon the price structure. I think if you pushed it far enough, you could bring the price structure downward through that method probably more quickly than in any other way. Senator FLANDERS. Now, would you say that there was any difference in that relation , that is, that pushing it to the extreme is dangerous ; in that respect does the money supply differ from any of the other factors that you have mentioned ? Isn't any tool pushed to its extreme dangerous ? Mr. KEYSERLING. I agree with that. Senator FLANDERS . You see, I am trying to find out why you put the money supply so low when it is apparently a prime factor in the equation . Mr. KEYSERLING. Well, first of all I would say that I gave specific illustrations in different areas of economic policy where tax policy and price policy were equally susceptible to disability if pushed too far. Now, in my rating I simply said this : I said that I thought—and this is a matter of judgment—that as applying particularly to the period between March 1951 and now— and I have been talking not about the application of monetary theory in that connection but about the application of the specific change that was made, which was a minor change- I said that on my evaluation that that minor change, I thought, had had less influence upon price stability during this period than such things as the direct controls, the increases in taxes which have taken place, the fundamental increase in production which has taken place, the allocation of materials in accord with certain criteria, and I think I mentioned the others . Senator FLANDERS. Let us go back to another period . Would you feel that in the period after June 1950 that the money supply factor MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 213 was satisfactorily handled, that is, that not using it was the thing to do ? Mr. KEYSERLING. I think I said to Senator Douglas that looking backward I was not prepared to stand on the ground that it would have been undesirable to have made this change represented by the accord somewhat sooner. In other words, I am not taking the position that the accord was made precisely at the right time, that if it had been made sooner it might not have made its contribution to stability . I am simply taking the position-let's put it this way- that if the accord had been made in the middle of 1950 rather than in March 1951, I still think, although I cannot prove, that much or most of the price inflation which took place between the Chinese intervention and February 1951 would have occurred anyway, because of the other powerful factors at work. Senator FLANDERS . I may say that in questioning I think, or perhaps I made a statement instead of questioning, both Mr. Martin and Secretary Snyder raised the question as to whether monetary control alone sufficient to have stopped the price rise would not have been destructive . I believe that an endeavor to completely negative the price rise by monetary controls alone would have been destructive. To that extent, if that is your position-and I think it is-I find myself agreeing with you, but I cannot agree with the low position you have given the monetary policy in this series. I judge that of the things you have given that you rate only exhortation lower, and that is low indeed. It seems to me you cannot give so low a position to one of two primary factors. Mr. KEYSERLING. Well, Senator, you may be right on that, but if I sought to move them around and to put one of the others at the bottom , take for example tax policy, I would find it very hard to put that at the bottom. And in the short-run situation, frankly I would find it very hard to put price and wage stabilization at the bottom because I think in this the short-run situation, that it is very important. Senator FLANDERS. On tax policy, for instance, I take it that you feel that increased taxation necessarily and universally is antiinflationary ? Mr. KEYSERLING . No , sir, not at all. Senator FLANDERS . I just want to see you pull that down just a little. Mr. KEYSERLING. Well, I am glad you are helping me do that. Senator FLANDERS . Is that your position ? Mr. KEYSERLING. No ; that is not my position at all. I say the tax policy, as well as other economic policies, illustrate the point that they have competing effects, and that some of the effects are good and some are bad. Insofar as taxation is generally repressive , it always has to that extent a competing bad effect. There are certain things you do not want to repress. You do not want to repress reward for effort, but on balance you have to do some of it . Now, I think, not getting to the point of whether it is an arbitrary figure of 20 percent, 19 or 21 , taxation can reach the point where its repressive effects far outweigh its beneficial effects, and I think it can reach the point where on net balance it may be inflationary. 214 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator FLANDERS. Would you consider that there are any of its effects which immediately affect prices unfavorably ? Take excise taxes, for instance, do you consider it inflationary when a fur coat has added to it the price of the excise tax ? Mr. KEYSERLING. No, I do not . Senator FLANDERS . Or when gasoline has added to it the price of an increased excise tax ? Mr. KEYSERLING. I find the gasoline question a little harder because I regard a fur coat as a luxury and I do not know whether gasoline is a luxury or not in our economy. Clearly, in one sense it is not, but clearly the extent of its use is involved. Senator_FLANDERS . Now, I am led into a little byway by this last remark. If you consider inflationary only price rises in necessities, then why should the Stabilization Administration cover the whole water front of luxuries, necessities, and every other blooming thing there is ? Don't you find yourself at odds with them in that if you think that inflation relates primarily to necessities ? Mr. KEYSERLING. Well, in the first place, Senator, trying hard not to quibble, I do not think I said that I never regarded price rises in luxuries as potentially inflationary. I think price rises in luxuries could be inflationary, and therefore I did not say categorically that I would never try to restrain price increases on luxuries. I did try to convey the general impression that the restraint of price increases on luxuries, such as fur coats, seems to me less important by far than the restraint of price increases on necessities. Now, I go one step further than that and say that I would incline heavily toward the view that in a long-range defense mobilization the effort involved , the complexity involved, the general spirit involved in trying to price-control all luxuries far outweighs the benefits. Now, I want to fair about that, and you realize the position I am in. That is my general position. I would not want that to be interpreted as a judgment on any particular price action being taken by OPS, because they are an operating agency and they are closer to it than I am. But my general view is—and I have expressed it many times—that for a partial mobilization of long duration , price controls should be selective rather than covering the whole economy. And I have never followed the argument for this kind of situation that if you control anything you have to control everything. Senator FLANDERS . I have a number of other questions I could ask, sir, but I do not think they are of great importance. I presume that you have already explored- I have not been here all the time-the apparent speaking with two voices in your section B, formulation of fiscal and monetary policy, pages 849 and 850 (committee print entitled " Monetary Policy and the Management of the Public Debt " ) . Page 849 at the end of the third paragraph from the top : Nevertheless, we do not question the desirability of making monetary policy chiefly the responsibility of an authority having some degree of independence from all Government departments and agencies engaged in borrowing or lending. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 215 While at the end of the third paragraph on the next page there is this sentence : The President, as Chief Executive and head of the executive branch, is the only one person in the Government in whom this power of policy coordination can be lodged. Now do you see any conflict between those two statements ? Mr. KEYSERLING. Šenator, I do not see a conflict between the two statements , but I do not think that the two statements provide an answer to the question or to the problem. I do not think there is a conflict between saying that the Congress in its judgment may set up one agency directly within the executive structure, as for example the Treasury, and that the Congress in its judgment may set up another agency such as the Federal Reserve Board outside the executive structure, which is the first statement, and saying that when the Congress does that, nonetheless , particularly in times of urgency the President as the chief coordinating executive officer must try to lend the influence of his office, using that word in the proper sense, to deal with the problem of coordination among those agencies, since they both profoundly affect the economy. And I think the Congress at times has recognized that, because the Congress at times, having set up executive departments and having set up the Federal Reserve Board, has in certain statutes given certain functions in part to an executive officer under the President and in part to the Federal Reserve Board. For example, the power to deal with the problem of housing shortages in this current situation has been given by the Congress in part to the Federal Reserve Board—and I say this not critically-in part to the Housing and Home Finance Administrator, in part to Mr. Wilson. Now clearly in that decision the Congress has recognized, ( a) that it wants to use all of these facilities, and ( b ) that there is a relationship among them. And once that is done, it necessarily does impose upon the President some degree of responsibility of coordination . So I think the two answers are consistent. Now, let me get to the part of my comment that says that they did not answer the problem. I do not think that the problem of how one reconciles quasi-independent agencies, independent agencies- the term "independent agencies" of course has been used in a lot of different ways. There are a lot of agencies that are called independent agencies that are within the executive structure . I do not think of course that is a political science question rather than an economic question-that question has been completely resolved , particularly for an emergency period of this kind . Senator FLANDERS. I noted in the questioning of both Mr. Snyder and Mr. Martin that those gentlemen steered off from any clear expression of principle such as asking the Congress to decide or anybody else to decide which was paramount, the stability of the prices of Government securities or the stability of the dollar, and apparently it figured out as near as I could make out, to this statement. That given the Secretary of the Treasury of the particular characteristics and the experience and ability, and given a board repre- 216 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT sented in a chairman of the particular person or characteristics and experience and ability, we might be assured that there would be no trouble. That seemed to be the result which both of those two gentlemen asked us to accept as the solution certainly to the present situation and presumably for all future situations. Do you think that is a good solution ? Mr. KEYSERLING. Senator, I think that in the current situation- the only way I can state whether I think it is a good solution is to use a technique which I tried on something else. If I were making the decision now, Senator, I would leave it about as it is. I would leave it about as it is and rely upon the Treasury and the Federal Reserve Board to continue to work this thing out. That is the import of my prepared statement, that that seems to me to be the most prudent of solutions available at the current time. Now, on the long-range question which, as, I say, is one of the political science or of the structure of the organization of public power, that is more difficult. One of the reasons that it is more difficult is that, as I said in my statement, in my prepared statement, the argument for independence may be based-and let me say I am not applying this particularly to the Federal Reserve Board, because I will get in a situation here where this general discussion will seem to be my view. I want to state categorically that in the current situation my view would be that the most prudent course would be to let things go as they are. Now, talking about the subject of independence not as related particularly to the Federal Reserve Board but more generally, it rests upon a variety of grounds which I think it is worth saying something about. One ground on which it rests is that if an agency is vested with very important functions vitally affecting the whole economy, it should be free of political influence. I have never been able to see where that argument applies more to one agency than to many other agencies that I could name which most assuredly profoundly affect the whole economy and I believe that the argument that bodies exercising powerful public functions should be free either of the Congress or of the President on that particular ground falls down under our system. I have not been able to differentiate between one power and another. I think that there is no power more vital than the question of our national defense or under the current situation, as I pointed out yesterday, the allocation of scarce materials which affects the very life and death of businessmen or of all industries, or the question of what kind of prices you make hundreds of thousands of businessmen charge or what kind of wages you make millions of workers accept. Those are also enormously important powers over the economy, and they are equally susceptible to improper pressures. And if you are going to make the argument on that ground that a particular function should be independent, it just seems to go to the whole question of the philosophy of our system, so I cannot follow that argument very much. Then you come to the argument of whether as a matter of practical fact you can have one important economic function free- wheeling in times like these as against others. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 217 There it is my general view—and I think implicit in the Employment Act and in the concept of the Council of Economic Advisersthat an effort has to be made to reconcile these policies, certainly the policies of the Treasury and of the Federal Reserve Board need to be reconciled, using that term in its just sense of trying to arrive at a harmonious solution of a problem on which both are vitally affected . I get back to my initial point that for that process of reconciliation I as an observer would say with the present situation taking into account all the factors they can move further in that direction by trying to work together than by having a new legislative definition of their respective functions . Senator FLANDERS . Thank you . I would like, Mr. Chairman, just to make a brief commentary on this without asking further questions. From the testimony of Dr. Keyserling and the testimony of others and from my own thinking on the subject, it seems to me that the two things that are primary are the money supply and the production . I see the limitations in using money supply, the monetary policy as the sole agent of stabilization because it is very liable to affect the production adversely if carried to its extreme limits, but I would still make it primary, of equal importance with production . I would say that savings was an element in monetary policy. I would say that taxation , the taking away of the available money supply, is an element of monetary policy, and I would find monetary policy a coequal with production at the top of this list. That is just simply a statement of my position . Mr. KEYSERLING. Mr. Chairman , might I just make one brief comment. That the definition of monetary policy by Senator Flanders, with which I do not disagree particularly, was not the one I used in placing it lower on the list. In other words, if you embraced taxation and savings within that scope, I would certainly bring it to the top of the list and Senator FLANDERS . Would reduce the money supply available for the purchase of goods ? Mr. KEYSERLING . Oh, yes ; taxation reduces the money supply, and when I placed this monetary supply at the bottom of of the list, clearly I was not including taxation . I was talking more to the particular type of monetary devise which had been mostly discussed here during the 3 days. But if you say that the money supply means the available spending funds, and the taxation is one important method of reducing it, then I would agree with you, and under that definition put it at the top of the list. Senator FLANDERS . Let us compromise , if we can, by moving it up three or four spaces on your list, even in its narrow sense, but I do not want to push that matter too far. Representative BOLLING. Mr. Murphy, do you have any questions ? Mr. MURPHY. I just want to ask one question , Mr. Keyserling. The Douglas committee in its report 2 years ago included a statement that it believed it would militate against the purposes of the Employment Act rather than work in favor of them if the United States should return at this time to a free domestic convertibility of its currency into either gold coin or gold bullion. What would be your reaction to a reaffirmation of that position in the report of this committee ? 218 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. KEYSERLING. Well , in the first place, I do not like the statement that a return to the free convertibility-the gold standard , isn't that what you are referring to ? Mr. MURPHY. That is correct. Mr. KEYSERLING. I do not like the statement setting that in juxtaposition to the Employment Act, because the statement of the Employment Act is so broad that it is really a statement of objectives for a stable and growing economy, and I do not like it said that it is the Employment Act which stands in the way of this. I would put it on a broader ground and say that it would be in accord with my judgment that a return to that at this time would be inconsistent with the interests of the American economy, taking into account its stability, its growth, its monetary and debt management problems, its current defense problems, taking them all into account. In other words, taking into account our interests as a nation , I would not be in favor now of a return to the gold standard. Mr. MURPHY. The particular phrase in the Douglas report which I was groping for is as follows : We believe that to restore the free domestic convertibility of money in gold coin or gold bullion at this time would militate against rather than promote the purposes of the Employment Act, and we recommend that no action in this direction be taken. You agree with the conclusion but you would place it on a broader ground than the Employment Act ? Mr. KEYSERLING. Yes. Mr. MURPHY. That is all. Representative BOLLING. Mr. Keyserling, thank you very much in behalf of the committee. The committee is now in recess until tomorrow at 10. (Whereupon, at 12:20 p. m., the subcommittee recessed to reconvene at 10 a. m., Friday, March 14, 1952.) MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT FRIDAY , MARCH 14, 1952 CONGRESS OF THE UNITED STATES , SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to recess, at 10 : 10 o'clock a. m. , in room 1301 , New House Office Building, Representative Wright Patman (chairman of the subcommittee ) presiding. Present : Representative Patman (chairman of the subcommittee ) , Senator Douglas ; and Representatives Bolling and Wolcott. Also present : Grover W. Ensley, staff director ; Henry Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee . Representative PATMAN. The committee will please come to order. Mr. Wiggins, we are delighted to have you as a witness this morning. It happens that I have known Mr. Wiggins for a number of years, and I do not know of a more versatile business and industrial leader in the United States than A. L. M. Wiggins. I have had the pleasure and the privilege of visiting with him in his home town and in his home State, and I know something about his many fine civic and patriotic connections, and the wonderful work he has done as just a good American citizen, and I personally value his views highly, and I am glad that he has favored us with his presence here. Not only has he been a leader among the small-business groups of different types , but he is a leader among the banking group as well. In fact, he was a past president of the American Bankers Association , which itself is quite an honor, as we all know. Mr. Wiggins, do you have a prepared statement ? STATEMENT OF A. L. M. WIGGINS Mr. WIGGINS. Mr. Chairman , I have a prepared statement, and with the permission of the committee I would like to file this statement and then more or less summarize informally some of the points that I have undertaken to make in more detail in the statement, if that would be satisfactory. Representative PATMAN. That will be satisfactory. You may proceed. 219 97308-52-15 220 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT If you do not mind, I will get someone to read the first two paragraphs for you, or you can read them. I want the committee to know something about your connections. Suppose you go ahead and read them, if you will. Mr. WIGGINS. My name is A. L. M. Wiggins, of Hartsville, S. C. I am chairman of the boards of directors of the Atlantic Coast Line Railroad Co., the Louisville & Nashville Railroad Co. , and several smaller associated railroads. I am also chairman of the board of directors of the Bank of Hartsville, Hartsville , S. C. , capital stock $ 100,000, and president of a small nonbanking trust company. For the larger part of my business career I have been a director and manager of a number of small-business institutions engaged in finance, merchandising, agriculture, and manufacturing, and newspaper publishing. From January 1947 to July 1948 I was Under Secretary of the Treasury. In this capacity, one of my duties was to assist the Secretary of the Treasury in the management of the public debt and, in particular, to maintain liaison with the Board of Governors of the Federal Reserve System, and other representatives of the openmarket committee . Senator DOUGLAS. You had an interesting time, Mr. Wiggins . Mr. WIGGINS. Quite interesting, sir. Representative PATMAN. All right, you may proceed if you desire. If you wish to yield for questions, that will be satisfactory. Mr. WIGGINS. My discussion, gentlemen, is more of the practical approach, based on the experience that I have indicated . The questionnaires and the answers that were sent out and received , in my opinion, constitute the most valuable collection of thinking in the field of money, in money management, problems of debt management, and other collateral questions that I have found anywhere . I have read the entire 1,300 pages of this report since it was published about- since I got a copy about 10 days ago, and it is very instructive and illuminating, and I congratulate the committee on the character of the questions. I wish to confine my discussion to three areas, and one of them, Mr. Chairman, is a relatively small one, and I might dispose of that first, which would be in inverse order to the statement. The question has been raised about the ownership of stock in the Federal Reserve banks. I think it might be well if I disposed of that first, and then the other two are related and are really more important. The question has been raised as to whether or not the stock of the Federal Reserve banks should be owned by the Government instead of by the member banks. In my opinion it should not be owned by the Government. The Federal Reserve banks represent a combination of Government and private business under which the control is vested in the Government. But it is through the ownership of the stock by the banks that the Reserve System mobilizes the services of able individuals as directors. These men represent private enterprise and represent the public, and while the control is vested in the Board of Governors almost entirely, at the same time these directors bring the viewpoint of business, industry, and agriculture and banking to the officers of their banks. I think that it is highly important for MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 221 the Reserve banks to maintain close touch with conditions prevailing in their respective districts, and this is the only official relationship of the Federal Reserve System with business , agriculture, and industry. The members elect, it is true, part of the board, the Board of Governors appoint part of the board, and if the Government owned the stock there would be no particular basis on which member banks would select men to serve on the boards of these respective banks, In fact, I think the relationship should be encouraged rather than discouraged, and I have been able to find no sound reason for the Government to acquire the stock in the Federal Reserve banks unless the ultimate objective is to destroy the independence of the System and make it merely a Government bureau. Now, that is all the comment, Mr. Chairman , that I had on that particular point . Representatives PATMAN. I want to ask you one or two questions on that point, Mr. Wiggins. Do you consider the Federal Reserve System is a public institution ? Mr. WIGGINS. So far as the-yes ; it is a public institution . Representative PATMAN. A public institution ? You do not consider the amount of stock owned by the commercial banks as sufficient to give them control of the institution ? Mr. WIGGINS. The stock ownership , in my opinion, has nothing to do with the control . It is a peculiar type of stock that earns only 6 percent. The owners of the stock have no interest in the earnings of the bank beyond the 6 percent dividend they get. Representative PATMAN. And they have only paid in 3 percent. Mr. WIGGINS. Well, they get 6 percent on the amount paid in. Representative PATMAN. Yes, they get 6 percent. Mr. WIGGINS. Six percent on the amount paid in. They have paid in only half of the par amount of the stock. Representative PATMAN. In other countries of the world, do you know of another country where the central bank is not owned by the government ? Mr. WIGGINS. At the moment, I do not. Representative PATMAN. I think the fact is, Mr. Wiggins, that in all countries the central bank is owned by the government, and in this country I do not consider that the commercial banks own the Federal Reserve banking system because they have that token amount of stock, which is so small and insignificant compared to the business done by these institutions ; you agree with that, do you not ? Mr. WIGGINS. That is right. Representative PATMAN. It is too small to consider that they would have any supervisory power by reason of the ownership of that small amount of stock which gives them a 6 percent dividend each year ? Mr. WIGGINS . That is correct, sir . Representative PATMAN. Yes. That is all on that particular question I would like to ask. I believe you said that covered your discussion of that ? Mr. WIGGINS. Yes. Senator DOUGLAS. May I ask a question ? Representative PATMAN. Yes. 222 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS . There has been some information from New York that many of the private bankers would like to assert a claim to the residual earnings of the Federal Reserve System. What is your feeling on that ? Mr. WIGGINS. I think the residual earnings belong to the Federal Reserve Banks ; it is part of their capital structure, and should be owned by the banks, the Federal Reserve banks, I mean, and that the member banks, the stockholders, should have no interest in those residual earnings . Senator DOUGLAS. Well, at present, as I understand it, by a decision of the Federal Reserve they have voluntarily turned over 90 percent of the net earnings to the Government. Now, there have been some groups in New York saying that since the private bankers own, as as they say, the Federal Reserve bank, they should receive these net earnings, which run up to around $200 million a year. In your judgment, should those go to the private banks or should those earnings continue, as now, to go to the Government of the United States ? Mr. WIGGINS. I think unquestionably they should remain in the Federal Reserve banks for disposition either to the Govrenment or to be added to surplus, as they may see fit. Senator DOUGLAS. You would say that the decision as to these matters should be left to the Board of Governors of the Federal Reserve System ? Mr. WIGGINS. It raises a question as to whether the amounts paid by the Federal Reserve banks to the Treasury should be fixed by some statutory provision or not. I have sometimes thought that the particular vehicle used by the Federal Reserve was open to some question. I think it could be done by statutory enactment if Congress disagreed with the policies followed by the Federal Reserve. Senator DOUGLAS. Suppose the Federal Reserve Board were to distribute these earnings to the owners of the stock in the the Federal Reserve banks, and turn these earnings back to the private banks rather than to the Government, would you feel that that was a wise policy ? Mr. WIGGINS. I do not. Senator DOUGLAS. You think it might be advisable for Congress to try to prevent that policy from being carried into effect, by statutory enactment ? Mr. WIGGINS. Senator, I am not certain , but my recollection is that the law now provides a limitation of the dividend to 6 percent. Representative PATMAN. It is cumulative but maximum ; and section 16 of the Federal Reserve Act provides a means for levying a franchise tax for the Federal Government and I think it is necessary that that be done. I do not think anyone should contest that right because, after all, it is the credit of the Nation that is being used by these banks. The small amount of stock that has been invested would not support the huge credit structure of the 12 Federal Reserve banks. It would be just nothing ; it would just be a fly speck. It would not be anything, and so I do not see how any person who is familiar with the situation would contend that-how much do they have invested now, about $200 million, the commercial banks ? Mr. WIGGINS. I do not have the figures ; I can look it up. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 223 Representative PATMAN. It is around $200 million , and that would mean if they were entitled to that money they would get a hundred percent dividend every year using the Government's credit. (The paid-in capital of the 12 Federal Reserve banks totaled $237 million on December 31 , 1951. ) Senator DOUGLAS . My question is this : Is there anything in the statutes which would forbid the Board of Governors of the Federal Reserve System from distributing the earnings to the owners of the stock rather than turning the earnings over to the Government ? Representative PATMAN. I think that is a good question to look into. Mr. WIGGINS . It is my understanding that the law provides a limitation of 6 percent ; I would not be positive. (A letter from Chairman Martin covering this point appears on p. 910. ) Representative PATMAN. All right, you may proceed , Mr. Wiggins. Mr. WIGGINS. In order to conserve the time of the committee, I direct the remaining statement to an area that has two angles : one is the problems of restraining inflation and, in particular, the use of the machinery of the Federal Reserve System, including open market operations for the control of credit ; and the second one is the operation of the Federal Reserve System and the Treasury Department and other Government departments and agencies in the fields in which they have a common interest, and I will treat both of those along together because they are closely related. In my statement I have given figures showing what happened to the deposit structure, debt structure, and the ownership of Government securities by commercial banks during the war period . Those figures are familiar to the members of the committee, and I will not repeat them. Those figures indicate, however, certain facts or reflect certain situations that are significant , highly significant, and I will list a few. One, that the total of the Federal Government debt increased to an amount during the war period that exceeded all other debt , public and private ; two, that in order to sell successfully Government securities during the war period, a rigid interest rate structure was maintained by agreement between the Treasury Department and the Federal Reserve System, and this rate structure was maintained until the middle of 1947 . Third, that about one-third of the increase in the public debt resulting from deficit financing found its way into the commercial banks , thereby multiplying the money deposit supply, and this added, of course, to the inflationary developments that were, in part, the result of the war conditions. Fourth, that the purchasing value of the dollar has declined in large measure during the war period, between January 1 , 1940, and the last date I have, January 1 , 1951 , about 45 percent ; and five , that at the end of 1945 , Government securities constituted 57 percent of the assets of all banks ; and, six, as a result of the support of the Government in financing the war and the scarcity of other desirable investments, many investment institutions found their position at the end of the war overbalanced in investments in Government securities , 224 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT an unbalanced portfolio, and seventh, that as a result of the campaigns for the sale of bonds, the ownership of the public debt became widely distributed with the result that a substantial majority of American families became owners of Government securities, many for the first time. These facts indicate that following that period there would , of necessity, be considerable adjustment in the investment position of many institutions, including banks and of individuals. Another factor, of course, was the vast accumulation of liquid wealth on the part of individuals throughout the country. That has been estimated at the present time as some $200 billion , and , of course, this liquid wealth is always a factor in any of our considerations because if it should become dislodged and move into the spending stream it could have a tremendous effect on our economy. It is there, and it is a question of how-whether it is going to stay there or whether some substantial parts may become dislodged through various conditions. It is against that background of the build-up in Government debt, deficit financing, and all of the other factors that I have mentioned , and many others, that the Federal Reserve System has had to perform its difficult functions in providing stability in the financial system, and also that those factors were of an inflationary nature, either actual or potential . Now, at the end of World War II there was general fear that we were going into a period of recession, and many actions were taken to prevent that. The wartime pattern of interest rates was maintained until the middle of 1947 and at that time it was felt on the part of the Treasury and the Federal Reserve that the time had come to relieve our economy of this strait-jacket of interest rates and begin to move toward some freedom in the market . Now, it happened at that time that the Federal Reserve was maintaining a rigid buying rate of three-eighths of 1 percent on bills, and the Treasury Department was selling certificates at the coupon rate of %, 1 -year certificates. They began to move to raise those rates, and step by step they were raised during the summer of 1947 . Senator DOUGLAS. You are referring to the short-time rates ? Mr. WIGGINS. The short-time rates. That program continued during the summer and fall of 1947, and it encouraged banks and other investors to buy short-term securities because of the higher rates, and the hope was that it would take some of the pressure off of the demand for the long-term bonds which were then selling at about 104 for the 1967-72, or a yield of about 214 percent. However, the demand for the long-term bonds continued ; there was an absence of investment in the long-term investment field at that time, and so it seemed that the stage was set for really a "bull" market that might put the interest rate down to 2 percent. I speak of that with some confidence because I was sitting in the middle of it there in the Terasury, and participated in the policy discussions in the Treasury and with the Federal Reserve at that time. Unfortunately, at that time the Federal Reserve System did not own any long-term Government bonds- substantially none. But the Treasury in its various investments , had a substantial amount of MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 225 long-term Government bonds, and so, by agreement, and with full understanding and with a common purpose between the Federal Reserve and the Treasury Department, the Treasury made available to the Open Market Committee long-term market bonds which they sold from day to day in an effort to meet the demand and to prevent a further decline in the rate as being desirable in the public interest. I emphasize that somewhat, Mr. Chairman, because the feeling, the thinking, seems to be abroad that the Treasury has always opposed any increase in the interest rates, and here was a period in which the Treasury very positively not only favored an increase in interest rates but took vigorous action to put the rates up . It was not so much a matter of putting the rates up as keeping the prices of Government bonds from going through the roof. And so we sat there in the Treasury, and from day to day made available to the Open Market Committee these long-term Governments and some days they would sell a hundred million dollars of it, which is a lot of money in Hartsville, S. C.; and it amazed me to see how the market absorbed these tremendous amounts of long-term Government bonds with so little effect on the interest rate or the price. We sold during that period a billion and a half dollars of these long-term bonds, and still the pressure was there. Senator DOUGLAS . Did the Federal Reserve buy any of these for itself ? Mr. WIGGINS. No , sir ; they sold them for the account of the Treasury on the market . Senator DOUGLAS. And did not buy any for themselves ? Mr. WIGGINS. No , sir. Now, at the end of that period we found, after consultation with investors, that there was still an unsatisfied demand for long-term bonds. It seemed to me that they thought that the Government would never want to borrow any more money or nobody else, so in agreement with the Federal Reserve, and working it out, both on a staff level and policy level, the Treasury issued an 18-year, 212 percent nonmarketable issue. They sold about a billion dollars worth, and that mopped up all the loose money around in the investment markets. As a proof of that, within weeks the investors who needed to adjust their portfolios looked around to sell some long-term Governments that they owned, and found that there was no money available in the investment market and, as a result, the price-the pressure on the other side quickly developed. The Federal Reserve during that later period bought bonds because of the tremendous offerings in the investment market of longterm Government bonds, and the curious thing to me was that some of those who had bought the bonds a few weeks before at 104, with the 214 yield, within a period of a few months were selling the bonds at 102 on down to 100 and a fraction , and taking a loss on it. But that is what happened ; and it was during that period that the Federal Reserve bought a great deal of the long-term bonds at increased interest rates that finally got up to 2.48, which was just-kept the bonds just slightly above par, 10014 , I believe. This shows how quickly a situation can reverse itself ; and I have often wondered if we did not oversupply the market with Government bonds in our efforts to bring the prices down, and choked it too much , because the situation reversed itself so quickly. The Federal came in, in order to provide an orderly market, and bought a great many bonds. $ 226 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Now, they continued to reduce their buying price slowly, and then on the famous December 24 , 1947, the bankers having accused them of giving them a very poor Christmas present, the Federal Reserve reduced its buying rate to just a little above par, resulting, of course, in a substantial loss to many investors who had bought those bonds at a premium. Another interesting factor is that between the middle of 1947 and the middle of 1948 , when all of this movement of rates took place, in which the Treasury and the Federal Reserve were seeking to get to what we called at that time a breathing market as against the old rigid market, but not an absolutely free market, because you could not go from one to the other too quickly-there had to be an intermediate step-during all this period, and in spite of all of the purchases of long-time bonds by the Federal, between June 30 , 1947 , and June 30, 1948, in spite of all these transactions, the ownership of Federal securities by the Federal Reserve System actually declined a half billion dollars. We hear much about the great purchases by the Federal Reserve of long-term bonds during that period . We do not hear much about the fact that actually it was a buying and selling program in which the net result was a reduction of Federal Reserve holdings of Government securities during that period. What happened during that period was that the holdings by commercial banks declined 5,400,000,000, the holdings of insurance companies declined a billion eight, the holdings of savings bonds by individuals went up a billion six, the holdings by trust funds went up $3 billion , and the total debt declined 6 billion. I would like to make this observation : That not only did this big reversal in the market take place within a few weeks ' time, and was unanticipated both by the Federal Reserve and the Treasury, I think I am safe in saying, and all of this churning around in an effort to get to a breathing market, which we accomplished to some extent to a considerable extent-particularly in the short-term field-the situation changed again by 1949 ; and, whereas, most of the efforts of that period were directed both by the Federal Reserve and the Treasury to restrictive objectives, anti -inflationary objectives, by 1949 the situation had changed again to the point that the Federal Reserve, in its money market management and credit control found it necessary to take steps of an expansive nature. For instance, they reduced the stock margin requirements from 75 to 50 percent, installment credit terms were liberalized, and the reserve requirements of banks were reduced during that period by 4 percentage points on demand deposits, and 21/2 percent on time deposits. That, of course, was during a period in which it looked as if we might be going into a recession , and was done for that purpose, and properly done. So, I come back to the proposition that action , reaction-to take an action , you do not know just what reaction is going to happen. Sometimes it is a great deal more than you have anticipated, and sometimes it is not at all what you anticipate. But in any event I would like to make the point that during that period there was the highest degree of cooperation between the Federal Reserve and the Treasury ; their objectives were largely the same. The only differences that arose, frankly, were that the Federal thought we should move faster, with MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 227 more shock effect of these various moves, and the Treasury Department thought that in an operation of that magnitude, with the widespread ownership of the debt, that the proper policy would be to move step by step and slowly make the transition . That is the only difference of viewpoint. Both had the same ultimate objective. Now, coming back to the changes taking place in 1947 and 1948, the important factor-one highly important factor-in that period was that we had a budget surplus of 2 years. Senator DOUGLAS . You were fortunate in being in the Treasury during a period when the wartime tax rates had not yet been greatly reduced, and when expenses had fallen off . Mr. WIGGINS . That is correct, sir . Senator DOUGLAS . It was only accidental that this happened during the period of the Eightieth Congress. [ Laughter. ] Mr. WIGGINS. At any rate, the effect of a budget surplus at that time was terribly important in all of the monetary and debt management operations that went on. Now, gentlemen, I come to this observation, which I hope will be accepted in the same spirit in which I give it : that many of the difficulties of the Treasury Department in its debt management, and of the Federal Reserve System in monetary control and credit restraint stem from the actions of Congress. The principal difficulty is the fiscal situation that is created when Congress appropriates for expenditure amounts of money substantially greater than it provides taxes to cover. If Congress were sufficiently interested in inflation as a primary objectiveSenator DOUGLAS. In restraining inflation . Mr. WIGGINS . How is that ? Senator DOUGLAS . In restraining inflation. Mr. WIGGINS . In restraining inflation, it would under inflationary conditions provide a budget surplus instead of a deficit. I recognize all of the difficulties involved , of course, but I am stating a principle. It is an axiom that under inflationary conditions expenditures should be kept at a minimum. However, many appropriations, laws, and policies of Government are of a definitely inflationary character . To illustrate, and I am sure I am not embarrassing the SenatorSenator DOUGLAS . I am turning my eyes down in proper modesty. Mr. WIGGINS . To illustrate, we have but to recall the historic effort of Senator Douglas to eliminate or reduce many of the appropriations under the rivers and harbors bill in 1950 for projects of little or no real value, and the failure of the Senate to respond to his sound arguments for a reduction in the appropriations. Senator DOUGLAS . Mr. Wiggins, I want to thank you for this compliment, but I also want to say that while the Congress is frequently at fault in the matter of these appropriations, I do not think you should absolve the executive branch from its share of responsibility. This frequently, is even greater because whenever any proposal is made to reduce an appropriation the proper administrative official immediately declares that we are plunging a knife into the operations of Government, and the whole weight of the executive department is thrown against anyone who tries to make the cut. The officials of the department or agency in question will call you up on the telephone and remonstrate with you, and then in about an 228 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT hour you begin to get telephone calls from people in your own State, and the inference that I draw from all this is that the departments have their groups of outside friends with whom they get in touch, and the heat is turned on you. Then , if your effort to make a reduction seems to be reaching serious proportions, the President always rushes to the air waves and declares that a foul blow is being struck either at the security of the country or the welfare of the people of the United States, and the cry is taken up by the administrative bugle men, who proceed to pour on their reports from downtown, and issue press statements . The result is that you face not merely the political interests of your colleagues, but you also face the mass power of the executive agencies of the Government. In this present situation, when the President has submitted a budget which, on the administrative side, calls for a deficit of 142 billion, with no remonstrance from the Council of Economic Advisers-no remonstrance that has been published, at least, and I see Mr. Keyserling and Mr. Blough in the room-and when any proposal comes to cut a specific appropriation, it is promptly labeled by the Secretary of Defense, the Secretary of State, or the Cabinet official involved, as tampering with the security of the Nation ; they assert that not a dollar can be cut from the defense appropriation, not a dollar from foreign aid, and we will hear the same piteous song whenever each and every item is taken up. While I can well understand the desire of a former Assistant Secretary of the Treasury, who has suffered at the hands of Congress, to get in a polite dig at the Congress and we certainly have our faultsstill, in all justice, I think, having leveled your guns at us, now that you are a private citizen you should turn them in the direction of the Treasury itself, 1600 Pennsylvania Avenue, and the old State, War and Navy Building, where the Executive Offices of the President are now located. So, after this barrage upon our position on Capitol Hill , will you also level your artillery fire on Pennsylvania Avenue ? Mr. WIGGINS . Senator, I am not attempting to say why these things happen ; I am stating them as actual facts that add to the difficulty of the monetary authority. Senator DOUGLAS . That is true ; but behind the reluctance of Congress to cut is the opposition of the administration toward cuts. Representative PATMAN. If I am any judge of the temper of Congress now, it will come more nearly to balancing the budget this year than it has in 10 years . Senator DOUGLAS. And then listen to the cries from downtown. Representative PATMAN. Well , there are a lot of cries that will be ignored. Mr. WIGGINS. However, I think, gentlemen , we might observe that the executive departments spend no money that Congress does not appropriate. I think that is a fair statement. It also might be pointed out that laws and Government policies that tie the support of agricultural prices to changes in the prices of industrial products, on the one hand and, on the other, escalate industrial hourly wages on the basis of the increase in the cost of living, that this combination constitutes a system of built-in inflation that results in progressive deterioration in the purchasing power of the dollar. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 229 I am not questioning the advisability of either of these . I am stating that they do have an inflationary impact. It is also true that administrative agencies of Government, particularly in the lending and guaranteeing field , frequently follow policies and programs that add to inflationary pressures. Senator DOUGLAS . Would you excuse a slang comment ! "Now you're talking." Mr. WIGGINS . These facts add up to the insistent and continuous need for a coordination of the policies of the Congress and of the administrative agencies if an anti-inflationary policy is to be effective . They also bring out the point, and I am reading this , because I want to be exact, " I am afraid I will get off the beam if I ad libthey also bring out the point that the problems of restraining inflation are involved in the actions of Government on many fronts and that while, at the same time, efforts are being made by the monetary authorities to restrain inflationary pressures, other actions by Government are directly inflationary and make difficult, if not impossible, the success of the efforts of the monetary authorities in the limited areas in which they operate. I have made the observation here that the basic difficulty in combating inflation is that in actual practice most people who say they are opposed to inflation, actually embrace programs for personal profit or benefit that are highly inflationary ; and my theory is that a dam cannot be built that will successfully restrain the forces of inflation if sections of it are missing, no more than a dam will hold back the water of a river if the dam is full of holes. Many people consider the device of raising interest rates as the principal means for controlling inflation , the principal effective device. Such a proposal is painless to most people, and profitable to many, and while this is a most desirable device as a part of an overall program, it will not do the job alone, and in my opinion, it is highly overrated. I then have a discussion here of the effect of increases in shortterm and long-term rates. I think most of these fact are well recognized, namely, that increases or decreases in short-term rates do not restrain the borrower, and being to the benefit of the lender, do not deter the lender from making loans. The principal value in the short-term field affecting banks primarily, is the lack of funds to lend , and that is the point at which the open-market operations of the Federal Reserve are most effective . However, there is a limitation there due to the fact that the commercial banks own, as of December 31 , 1951 , a large amount of short-term Governments that are running off within a year, $33,000,000,000 worth, so that increases or decreases in interest rates, the buying and selling of short-terms, is not much of a deterrent to a bank that has bills coming due every week. It can merely collect its money when the bills come due and not buy any more and , of course, a small increase in the short -term rate does not affect the price of that security so much as it does in the long-term field. Now, in the long-term field the effect is different because a relatively small increase in the rate has a substantial effect in the price, just as in the 1947-48 changes in rates of one-quarter resulted in a decrease in the price of nearly $4 on the hundred . So, I would say, 230 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT that a rise in rates and a reduction in price on long-term securities does affect the lender who must take the loss if he sells his bonds to get money to make loans for some other purpose, and if he must lose $3 or $4 on the hundred to do that , that is a deterrent to his selling those bonds. It is not much of a deterrent to the borrower, and being a borrower myself I speak with some personal knowledge, where you need the money for an essential purpose, particularly for a defense purpose, you must have the money, if the rates are a quarter higher you pay the quarter higher, and I must admit that you get some satisfaction in knowing that that comes off as an expense, of which Uncle Sam absorbs 52 percent, which somewhat softens the blow, but it is not too serious a deterrent to the borrower as it is to the lender. Senator DOUGLAS . What about the borrower of long-term capital funds for private investment ? A rise in the interest rate there will diminish the quantity of capital demand , will it not, on the part of industrial companies ? Mr. WIGGINS . I think unquestionably that is true, Senator, in the case where there is a discretionary situation in which you are planning a 20- or 40 -year program, as to whether you do it now or whether you do it later. I think the difference in interest rates, particularly with public utilities that have a narrow margin, that they will adjust their programs, depending on the cost of the money. Senator DOUGLAS. That is right . Mr. WIGGINS . Now, I mentioned that the discount rate of the Federal Reserve was a very effective instrument in the earlier years when we had a smaller debt, and it is a useful instrument, but not as effective as it formerly was, particularly while the banks own such a large amount of short-term governments. The question has been raised about reserve requirements of member banks. Of course, increasing reserve requirements reduces the capacity of the bank to lend, and that is the nerve center of making loans because it affects the availability of funds . The present reserve technique, however, creates a great many inequities ; it is a somewhat brutal method , an ax method, and in spite of a rate classification based on two types of deposits and different sizes of cities, in order to try to reduce the inequities, it is highly questionable whether the present classification base is suitable for the present banking system. I doubt it very seriously. Many studies have been made as to the desirability of changing the base for reserve requirements, and one suggestion has been made that it be done entirely on a classification of deposits. That plan would also have some inequities, as any plan of reserve requirements would have, but it might be highly effective in the use of reserve requirements as an instrument of credit control . I think if any change is made in the base of reserve requirements it requires a great deal of further study, and any change, of course , should be made at a period of relative monetary ease, so as not to disturb the financial situation too much. Now, the objections that I have found among banks to the use of that device-to the Federal Reserve using it, one objection is that when the Federal Reserve increases reserve requirements, in effect, it merely means transferring earning assets from the member banks to the Federal Reserve, because if a bank has to part with some of its MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 231 Government securities to get the cash for the additional reserves , and then the Federal Reserve takes the cash and puts it in Government securities the net effect is that it transfers the earnings from the member bank to that extent. It has been suggested that these excess reserve requirements might be required in the form of Government securities. I do not think that proposition has too much merit because it merely would make the bank, in some cases, an unwilling owner of a certain type of Government security that would be used for that particular purpose. It would, in part, overcome the objection that these excess reserve requirements deplete the earnings of the bank. Another device has been suggested that reserve requirements above a safety level- and I think banking thought generally is that reserves are for two purposes, one, a safety factor ; and the other a device for controlling the credit and the money supply in the markets-the other suggestion was that on required reserves above the safety level, the Federal Reserve pay interest to the member banks so at to overcome the objection of transferring earning assets by increasing reserve requirements. I would like to point out, however, that the use of reserve requirements with banks as a vehicle of credit control-it applies only to banks does not directly affect other lenders who, in many cases, are competing with the banks in making loans. It is an arm that restrains: just the banks, and only slightly indirectly restrains their competitors who are out, in many cases, for the same type of loans that the banks are making. Senator DOUGLAS. You mean building and loan associations, and insurance companies ? Mr. WIGGINS. Yes , sir. Now, to move on and to broaden the base a little bit, I raise the question of the major governmental policy, as expressed in the Employment Act of 1946 , questions about which were asked in many of the questionnaires. That act, of course, is specifically directed at employment. It also provides that an objective of the policy shall be maximum production and purchasing power, and all of this done "in a manner calculated to foster and promote free competitive enterprise and the general welfare." Now, while the emphasis is on employment , recognition is given to the maximum purchasing power. I think the inference of most people is that it means real purchasing power and not dollar purchasing power ; and I personally think it is terribly unfortunate that in the wording of that act it does not contain a specific statement of objectiveof national policy to maintain long-run monetary stability . Frankly, I do not think that the recent history of the legislative and administrative departments of Government yields convincing evidence that the guiding policy has been one of maintaining long-rum monetary stability. I have tremendous respect for the American dollar, for the integrity of it, and consider the depreciation and discount of that dollar as a threat to our national welfare and the welfare of the rest of the world . Throughout history, disasters in varying degrees have always, almost always, followed periods of serious inflation . 232 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT In spite of that statement, I think we must recognize that under the necessity of World War II the Government had to borrow vast sums of money ; that there was need for quick expansion of military facilities and production, and that these required a substantial expansion of the monetary supply. There was no other way to do it. Now, in restrospect it appears to some that the money supply was increased too much and, of course, if we had financed more of the war from nonbank borrowing we would have increased the monetary supply less, but the question we are dealing with now is the monetary supply as it exists, and whether it is too great or too little or about the right amount. Some think it is too great. On the other hand, in terms of the vast outlays for the defense effort that are being made and are in contemplation we may find that the money supply is not too great, and we may find it necessary from time to time even to expand it some. My own views are that the economic policy under present conditions should be directed against inflation through appropriate action by Government on every front, including Congress and the administrative departments while, at the same time, avoiding as much as posisble actions that will have serious adverse effects in other areas, and avoiding, so far as possible, rigidities in the operation of the privateenterprise system. Selective controls and allocation of materials appear to be essential in such a program, but the application of such controls should be subject to administrative flexibility so that they may be adjusted, dropped, or increased as the needs of the situation develop . It would be a mistake to place entire reliance or too much reliance on the use of interest rates through monetary management to control inflation. The need is to deal with the problem on every front under a consistent and coordinated policy of Congress and the executive departments. Senator DOUGLAS. Mr. Wiggins, I do not want to take up too much time, but I would like to make it clear that those of us who believe in the essential need for monetary management do not so much emphasize the interest rate as the supply of bank credit. In other words, we aim to get price stability through the maintenance of the supply of money and credit in relationship to the volume of production rather than depending upon changes in the interest rate. I mention this because I think the advocates of monetary management have in some cases stated their case badly in merely emphasizing the interest rate, and because this has been used as sort of a whipping boy by the opponents of what I would term anti- inflationary monetary management. Mr. WIGGINS. Of course, Senator, the practical effect is that the Federal Reserve, if it refuses to buy Government securities and thereby supplies the banks with increased money, increased reserves, the effect is bound to be that the price will go down and the interest rate will go up. Senator DOUGLAS. Yes, that may and probably will be an effect. The country will then have to choose whether it prefers a stable price level even though that may mean rising interest rates or whether it wishes stable interest rates even though that entails rising prices, and that is really one of the fundamental issues at stake. Mr. WIGGINS. Yes. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 233 Senator DOUGLAS. I am very glad you bring it out. Mr. WIGGINS . Now, in this connection I think we must consider as an important factor a somewhat unpredictable thing that I like to call human behavior. Officials of the Federal Reserve frequently refer to the psychological effect of an action taken rather than the actual economic or monetary effect, and it is an important factor, as we all know, particularly in a country like this, where we have such vast resources, along with a great degree of freedom to use those resources pretty much as we want. I would like to give one illustration that his impressed me, namely, that at the beginning of 1951 I think all of us generally agreed that inflationary pressures would likely be rather strong in 1951 , and it did not develop to the extent that most people anticipated , and one of the most important factors, in my judgment, was a curious phenomenon that developed between the first and second quarters of 1951 , in which people shifted from spending to saving. I note that whereas the disposable personal income between those two quarters went up, at an annual rate of 5 billion, personal savings increased between those two quarters at an annual rate of 11.6 billion. I mention that because, so far as I know, it was an unpredictable human behavior that few, if any, anticipated , so that this factor of how people react to given things is still an unknown field to the human mind, and so, in the light of the fact that a vast majority of American families own Government securities, when we deal with the price and interest rate on Government securities we are dealing with a factor in which the possible action of large numbers of people needs to be considered. I developed a strong respect for the size of the national debt when I was in the Treasury, its proportion to all debt and its widespread ownership , and all the factors involved . To me, it is an atomic bomb, chain reaction , in the minds of the people. I do not think it is necessarily one that is going to explode in our face, I want to be quick to say that ; I think it can be handled successfully and satisfactorily, and I think it can be raised to a much larger amount under war necessity with perfect ability on the part of this country to service it. But, after all, the public debt is based on the confidence of the people in it, which is one factor ; and, second, the productive capacity of this country to service it, and there is little question about the latter, and we must , by all means , preserve the former. However, any disturbance to that confidence is a matter of serious concern and, again, I hope the Members of Congress will not misinterpret me and my motive when I say that many individual owners of Government securities and potential buyers are concerned over the vast expenditures of Government, some of which they consider unnecessary or even wasteful and, particularly, when, in spite of heavy taxes Government expenditures promise to exceed Government revenues. Others look with concern on the decline in the value of the longterm securities below par. I might say that in 1947 , 1948 , neither the Federal Reserve nor the Treasury thought in terms of long-term securities going below par. That has been a later development, and these individuals who are concerned somewhat with the decline of $3 from a hundred to 97, they are always concerned with how much 234 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT more decline may take place through the decision of the monetary authorities as to the price of those securities. I think, however, there is more concern about the deterioration in the purchasing value of their savings bonds and savings accounts in banks and life-insurance policies than with the $3 drop in the price of long-term Government bonds. I emphasize, Mr. Chairman, that all of these factors enter into the reactions of human beings as to what they might do, and we must consider at all times not only the economic and financial effects of actions taken in debt management and monetary management but what the human behavior that will result from that might develop. I would like to add again that I found the highest degree of cooperation between the Federal Reserve and the Treasury while I was there, and I might say the finest sort of devotion on the part of the Federal Reserve officials to their public duties , and a spirit of public service on the part of both that when these problems arose in which there were differences of viewpoints, that the spirit of what is the best thing in the public interest to be done under the circumstances was the catalyst that usually resolved those differences . Now, there are some people that think that in the exercise of discretionary administrative policy of national importance there should not be any difference between top officials, but if they occur there ought to be some supreme authority of law or the Chief Executive should dictate what the answer is, the policy to be followed . I think it is highly important within the executive departments of Government for there to be that degree of coordination of policy, and so I support the proposal that an advisory council be set up by Executive action, not by law- it is not needed by law-and I might say that in 1947 and 1948 at times there were informal groups set up to deal with certain areas of credit and money, and it was found to be a useful agency . The purpose of this advisory group would be to exchange information and views for coordinating administrative policy. And while I think it would be desirable for the Chairman of the Board of Governors or his representative to sit with this group, I do not believe that he or the Federal Reserve Board should in any degree be bound by any decisions reached by such administrative advisory group . On the other hand, the Board of Governors should give tremendous weight to any decisions or conclusions reached by such an administrative policy group, because it is assumed that that group represents the combined judgment of top administrative officials as to the proper policies to be followed. However, the Federal Reserve System has specific statutory duties that involve semijudicial decisions that are based not only on tangible factors but intangibles, and in my opinion they could not conscientiously discharge their duties if bound by the dictates of the executive department of Government. And while I think it is highly desirable for the Chief Executive to coordinate policies within the executive departments, I think it would be highly improper for him to dictate actions to be taken by such semijudicial bodies, for example, as the Federal Reserve System or the Interstate Commerce Commission , Securities and Exchange Commission, or similar bodies. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 235 He should communicate his views directly or through such a coordinating advisory group within the executive department to the Federal Reserve System, and they should be aware at all times of the factors involved in administrative decisions. But to subordinate a semijudicial and an independent body set up by Congress to the directives of the Chief Executive, in my opinion would destroy the effectiveness of such agencies. As I have indicated , usually the differences between the Federal Reserve and the Treasury are resolved . In the first place there are not too many, and most of those that turn up are resolved , and it is only occasionally that a serious difference develops . And in my opinion , in spite of the fact that an authoritarian set-up would get the results definite and directly, that it would be too high a price to pay to lose all of the benefits of our basic principles of checks and balances among thinking men in trying to find answers for difficult problems in such fields as monetary management and debt management . And I should also like to make this point, gentlemen : That we should recognize that no man and no group of men dealing with the various problems of our public debt and monetary system are omniscient. Too many factors are involved , not only economic and financial but in the realm of possibilities of human behavior for any one man or any group to know all the answers . And I think it would be a catastrophe if we were to make the Federal Reserve System merely an administrative agency of the executive department of this Government . However, I would like to raise this red flag-I don't like to use the words " red flag"-but this warning that the history of central banking, as was brought out earlier by the chairman, is that central banking cannot get too far away from the policies of Government too long ; and that while central banks historically have won battles against the Government, they have always lost the war. That is history and that is the condition throughout the rest of the world. Now, gentlemen , I have a summary here, but I think that I have covered the field , and in the interest of timeRepresentative PATMAN. Well, we will insert the whole statement in the record, Mr. Wiggins . Mr. WIGGINS. Thank you very much. (The prepared statement submitted by Mr. Wiggins reads, in full, as follows :) STATEMENT OF A. L. M. WIGGINS BEFORE THE SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT My name is A. L. M. Wiggins, of Hartsville, S. C. I am chairman of the boards of directors of the Atlantic Coast Line Railroad Co., the Louisville & Nashville Railroad Co., and several smaller associated railroads. I am also chairman of the board of directors of the Bank of Hartsville, Hartsville, S. C. , capital stock $100,000, and president of a small nonbanking trust company. For the larger part of my business career I have been a director and manager of a number of small-business institutions engaged in finance, merchandising, agriculture, and manufacturing. From January 1947 to July 1948 I was Under Secretary of the Treasury. In this capacity, one of my duties was to assist the Secretary of the Treasury in the management of the public debt, and, in par97308-52-16 236 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT ticular, to maintain liaison with the Board of Governors of the Federal Reserve System and other reppresentatives of the open-market committee. In the interest of conserving time my statement will be limited largely to three areas of questions raised by this committee. In this connection I wish to congratulate this committee and its staff on the preparation of the comprehensive and searching questionnaires which were sent to governmental agencies, economists, and financial institutions and their representatives. The replies constitute a wealth of financial literature, objective reporting, keen analysis, frank opinions, and constructive suggestions in the field of finance, money, banking, debt management, and fiscal affairs. The three areas which I wish to discuss are : (1 ) The problems of restraining inflation, and, in particular, the use of the machinery of the Federal Reserve System, includingopen-market operations , for control of credit. (2 ) The operations of the Federal Reserve System and the Treasury Department and other Government departments and agencies in fields in which they have a common interest. (3) The question of ownership of the stock of the Federal Reserve banks. A brief review of certain factual background is necessary as a basis for discussion of items ( 1) and ( 2 ) : During the 6-year war period from the end of 1939 to the end of 1945, money in circulation quadrupled from $6 billion to $26 billion. During the same period, bank deposits increased from $56 billion to $121 billion, or a total increase in money supply from $63 billion to $148 billion. During this period the ownership of Government securities by the banking system, including Federal Reserve banks, increased $97 billion. During the six calendar years 1940-45, inclusive, the gross public debt increased $231 billion, or five times. During the same 6-year period, expenditures of the Government exceeded receipts in the conventional budget by the amount of $210 billion. In the calendar 5-year postwar period, 1946-50, inclusive, Government debt was reduced $22 billion, largely through the use of excess cash balances from the Victory loan in 1945 and the use of a net budget surplus of $1 billion during this period. During the same period, as a result of debt reduction and the use of trust funds, the debt was managed so as to reduce the holdings of Government securities by commercial banks and the Federal Reserve banks by nearly $32 billion. Certain significant facts should be observed : (1 ) Total Federal Government debt increased to an amount that exceeded the total of all other debt, municipal and private. (2 ) In order successfully to sell Government securities during the war period, a rigid interest-rate structure was maintained by agreement between the Treasury Department and the Federal Reserve System and this rate structure was maintained until the middle of 1947. (3 ) About one-third of the increase in the public debt resulting from deficit financing found its way into the commercial banks, thereby multiplying the deposit-money supply. This added substantially to inflationary developments that were, in part, a result of war conditions. (4) The purchasing value of the dollar in terms of the cost of living declined between January 1, 1940, and January 1, 1951, by 45 percent. (5 ) At the end of 1945, Government securities constituted 57 percent of the total assets of all banks. (6) As a result of their support of the Government in financing the war and the scarcity of other desirable investments, many investment institutions found their position on December 31, 1945, overbalanced with investments in Government securities. (7) In response to campaigns for the sale of bonds, the ownership of the public debt was widely distributed, with the result that a substantial majority of American families became owners of Government securities, many for the first time. It is clearly evident from the above facts that at the end of World War II there was need for a substantial readjustment of the investment position of many investors , particularly institutional. When and as opportunities were presented for a better diversification of investments and for securing a better rate of return, they found it necessary to sell Government securities. With commercial banks holding nearly $91 billion of United States Government securities on December 31, 1945, of which a substantial proportion was in short-term maturities, they had abundant resources which any one bank could convert into MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 237 reserves through the sale of the securities or by permitting them to run off as they fell due. Another development of the war period was the large accumulation of personal savings, a substantial part of which consisted of liquid assets . It is estimated that at the present time liquid assets owned by individuals, of which a substantial part is represented by Government securities, aggregate a total of some $200 billion. These savings may be dislodged and find their way into the spending stream. It is against this background, of which I have mentioned only a few factors, that the Federal Reserve System has had to perform its difficult functions of providing stability in the financial system . Practically every factor in the situation contributed to inflationary pressures, actual or potential. Following the cessation of World War II, there was general apprehension throughout the country of a postwar recession . Due to prompt measures taken by Government, a recession did not materialize, but our economy promptly moved into increased production and employment. During this transition period, however, it was felt that the wartime pattern of interest rates should be maintained so as to avoid any disturbance that might hinder the transition from a wartime to a peacetime economy. By the middle of 1947, our economic machine was forging ahead , inflationary pressures had developed , and , in the absence of a demand for loans by business and industry, investors were reaching for Government securities at higher prices and at declining rates. I wish to discuss some of the actions of the Treasury Department in debt management in which I had a small part, as well as actions taken by the Federal Reserve System in monetary and credit control in that period. As a result of numerous conferences between Treasury and Federal Reserve officials in the second quarter of 1947, there was agreement that the time had arrived for the removal of the wartime rigidities of the fixed pattern of interest rates that had been maintained for Government securities. As a result of this understanding and common objective , the Federal Reserve discontinued its policy of a fixed buying rate of three-eighths of 1 percent on Treasury bills and the Treasury Department, in its refunding operations, began gradually to raise the rate on 1-year certificates from seven-eighths of 1 percent. This program continued during the summer and fall of 1947 and encouraged banks and other investors to purchase short-term securities at the better rates rather than reach for the longer bonds at premium prices which netted a return at that time of about 2.25 percent. Simultaneously, a program was being carried out to relieve the pressure of investment funds on the long-term bond market. At that time, the Federal Reserve System owned practically no long-term Government bonds and, therefore, in its open-market operations was unable to supply the market with that type of investment. The Treasury Department, however, held large amounts of long-term bonds in various investment accounts. After consultations and discussions, both at a staff level and at a policy level, between the Treasury and the Federal Reserve and in full agreement, the Treasury Department, through the open-market committee of the Federal Reserve, sold large amounts of long-term Government bonds so as to fill the demand and to prevent a further decline in the long-term interest rate. During this period, the Treasury sold $ 1.5 billion of long-term bonds. However, the amount was not adequate to satisfy the demand nor to increase the market yield on such securities. Thereupon, the Treasury Department, after consultation with the Federal Reserve and with full agreement on the part of both, sold a nonmarketable 18-year issue in the amount of $1 billion. The purpose of this sale was to mop up any remaining investment funds that were exerting upward pressure on the market. The entire program was anti-inflationary. In a matter of weeks the situation reversed itself. Other desirable forms of investment became available to investors at better yields than long-term Governments and investors finding themselves bare of funds began unloading longterm Governments on the Federal Reserve in substantial amounts . It was a curious phenomenon that many investors who were eager buyers of long-term Governments on a 24 -percent yield basis should so quickly become eager sellers at a higher interest rate and at some loss . The Federal Reserve moved promptly to stabilize the situation and found it necessary to make large purchases of long-term Governments. It was during this latter period of 1947 that the Federal Reserve, in consultation with the Treasury, began to reduce its buying prices slightly and, on December 24, 1947, made a substantial reduction in the price it was willing to pay for long-term Government bonds. It was thought that this somewhat drastic reduction might serve to stabilize the market at the new 238 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT level. Such did not prove to be the case. Under the needs of many investment institutions to obtain funds for other investments and out of the fears that had been generated by the reduction of the prices at which the Federal Reserve was willing to buy long-term Government securities that further price reductions might be ahead, a large volume of long-term Governments was sold by investors and purchased by the Federal Reserve. In the meantime, the rate on short-term Governments continued to rise as a result of the coordinated policies of the Federal Reserve in its open-market operations and of the Treasury Department in its debt management program. At the increasing rates on short-term securities, investors other than the Federal Reserve were large buyers. The result was that between the middle of 1947 and the middle of 1948, the Federal Reserve purchased large amounts of Government bonds through its open-market operations, but at the same time, reduced its holdings of bills, notes, and certificates with the net result that its total holdings of all Government securities actually declined during the period by half a billion dollars. During the same period the holdings of Government securities by commercial banks declined $5,400,000,000 , the holdings by insurance companies declined $1,800,000,000, savings bonds held by individuals increased $1,600,000,000 and holdings of United States Government agencies and trust funds increased $3,000 ,000,000 and the total gross debt of the Government declined $6,000,000,000. It is interesting to observe that whereas the principal monetary and debt management policies in 1947 and 1948 were restrictive and designed to be anti-inflationary in effect, we find that in 1949 the Federal Reserve found it necessary to take steps of an expansible nature. Stock-market margin requirements were reduced from 75 to 50 percent, consumer installment credit was liberalized and reserve requirements of banks were reduced during a period of several months in 1949 by 4 percentage points on demand deposits and 2½ percentage points on time deposits. It was during this period that there was some evidence of a business recession. It might be questioned whether or not the nature, the methods and the extent of the restrictive measures taken in 1947 and 1948 may have contributed to the necessity for contra actions in 1949. At this point I would like to emphasize the high degree of cooperation between the Treasury and the Federal Reserve System during 1947-48 in a common objective to remove the rigidities of the wartime pattern of interest rates and to bring about some degree of freedom in the money markets. Naturally there were some differences of opinion between the Treasury and the Federal Reserve as to details of the various moves that were required to accomplish this objective, the principal difference being that the Federal Reserve, on the whole, thought it desirable to increase interest rates faster and with a more shocking effect on the market, psychologically as well as actual, while the Treasury position generally was that in an operation of such magnitude and involving a Government debt structure that represented more than half of all the debt outstanding in the United States, the reduction in the market value of Government securities through Government action should be made slowly, step by step, and adjusted to conditions as they might develop during the program. I believe it is generally admitted in the financial world that the shift in 1947-48 from the rigidity of the wartime pattern of short-term interest rates to what we called at that time a "breathing market" was accomplished with a minimum of adverse repercussions. It should also be pointed out that the program of increasing long-term interest rates during that period through the sale to the market of long-term Government bonds was possible only because the Treasury Department had in its investment accounts large amounts of such bonds which it turned over to the Open Market Committee for sale. Here was evidence of the high degree of cooperation between the two agencies for a common objective. It should be kept in mind that an important factor in the situation during this period was a budget surplus in the fiscal years 1947 and 1948 aggregating $9 billion. This surplus served not only to reduce the debt, but its use in extinguishing bank-held Government securities served also to reduce inflationary credit pressures by reducing bank reserves. A budget surplus simplifies the problem of restraining inflationary credit, whereas a substantial budget deficit multiplies inflationary credit pressures. Many of the difficulties of the Treasury in debt management and of the Federal Reserve System in monetary control and credit restraint stem from the actions of Congress. The principal difficulty is the fiscal situation that it created when Congress appropriates for expenditure amounts of money substantially greater than it provides taxes to cover. If Congress were sufficiently interested in re- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 239 straining inflation, it would , under inflationary conditions, provide a budget surplus instead of a deficit. It is an axiom that under inflationary conditions expenditures should be kept to a minimum. However, many appropriations, laws, and policies of Government are of a definitely inflationary character. To illustrate, we have but to recall the historic effort of Senator Douglas to eliminate or reduce many of the appropriations under the rivers and harbors bill in 1950 for projects of little or no real value and the failure of the Senate to respond to his sound arguments for a reduction in that appropriation . Also , it might be pointed out that the laws and governmental policies that tie the support of agricultural prices to changes in the prices of industrial products on the one hand, and on the other escalate industrial hourly wages on a basis of the increase in the cost of living-this combination constitutes a system of builtin inflation that results in progresive deterioration in the purchasing power of the dollar. It is also true that agencies of Government, particularly in the lending or guaranteeing field , frequently follow policies and programs that add to inflationary pressures . These facts add up to the insistent and continuous need for a coordination of the policies of Congress and of the administrative agencies if an anti-inflationary policy is to be effective. They also bring out the point that the problems of restraining inflation are involved in the actions of Government on many fronts and that while, at the same time, efforts are being made by the monetary authorities to restrain inflationary pressures, other actions by Government are directly inflationary and make difficult, if not impossible, the success of the efforts of the monetary authorities in the limited areas in which they operate. The basic difficulty in averting or combating inflation is that while people generally are opposed to inflation in theory, in actual practice many embrace programs for personal profit or benefit that are highly inflationary. A dam cannot be built that successfully will restrain the forees of inflation if sections of it are missing, no more than a dam will hold back the water of a river if the dam is full of holes. Many people consider the device of raising interest rates as the principal means for controlling inflation. Such a proposal is painless to most people and profitable to many. While this is a desirable device as part of an over-all program, it will not do the job alone and, in my opinion, is highly overrated . Small increases in short-term interest rates have some value psychologically but actually produce little credit restraint. The short-term borrower, if funds are required for a necessary purpose, is not deterred by a small increase in rate. The short-term lender is not deterred but may be encouraged to make loans when his rate of return is increased. The real deterrent to the short-term lender is the lack of funds to lend and it is in this area that open-market operations of the Federal Reserve System are most effective. One difficulty in curtailing such funds is that a bank with large holdings of short-term Government securities may secure reserves by allowing its securities to run off at maturity. As of the most recent date for which figures are available, December 31, 1951 , shortterm Government securities held by banks, other than the Federal Reserve, amounted to $33 billion. A small increase in the interest rate on such securities has little effect on the decline in price and such decline may be more than offset by the higher rate obtainable from a loan. So long as the commercial banking system owns such a substantial amount of short-term Government securities, the effectiveness of a slightly increased short-term interest rate will not be too important in reducing the acquisition of reserves by banks. On the other hand, a small increase in the interest rate on long-term Governments reduces prices substantially and is a deterrent to the sale of such securities because of the loss involved. It is more effective in restraining the lender, who must take a loss in the sale of his bonds than it is on the borrower who needs the funds, particularly under present tax laws where the larger part of the increased interest cost to the borrower is absorbed by the Government through reduction in the taxpayers' taxable income. The discount rate set by the Federal Reserve was an effective instrument of credit control in the earlier years of the system. While it has an important place in present-day operations, it has limited effectiveness so long as the banks own large amounts of short-term Government securities. Reserve requirements of member banks of the Federal Reserve System constitute an effective brake on bank lending. Increasing reserve requirements reduces the capacity of a bank to make loans. However, the reserve technique creates many inequities and is a somewhat brutal method of securing results. 240 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT In spite of a rate classification based on a combination of two classes of deposits and on different types of cities, which device attempts to eliminate some of the inequities, it is highly questionable whether the present classification base is suitable for today's banking conditions. Studies have been made over a period of years of the desirability of measuring bank reserves entirely by classifications of deposits. Such a plan would also have within it some inequities, but might be highly effective in the use of reserve requirements as an instrument of credit control. If any change is made in the base on which reserves are required, it should be carefully designed and should be instituted in a period of relative monetary ease. The objection of banks to reserve requirements that are higher than may be needed for safety are that such reserves are nonearning assets of the banks but are earning assets of the Federal Reserve System. An increase in reserve requirements merely transfers earning assets from the member banks to the Federal Reserve. It has been suggested that reserve requirements be changed so that only part of these reserves would be required in cash and part in certain types of shortterm Government securities on which the owning banks would receive the interest. This proposal is of doubtful merit. In effect, it would force some banks to become unwilling holders of a particular type of Government securities. Another suggestion has been made that when reserve requirements are above certain percentages of deposits that the Federal Reserve banks should be required to pay interest to the member banks on the excess reserves required. It should be noted that the use of reserve requirements as a vehicle of credit control, applies only to banks and does not directly affect other lenders- some of whom compete with banks in making loans. Any discussion of the problems of dealing with inflation raises the question of over-all major policy under the directive of the Employment Act of 1946. While this act specifically provides for a national policy as to employment by creating and maintaining "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," it also states as an objective of the policy to promote maximum "production and purchasing power," and all of this to be done "in a manner calculated to foster and promote free competitive enterprise and the general welfare." Emphasis in this policy directive is on employment, but recognition is given to the need for maintaining maximum purchasing power. Although the inference is that what is meant is real purchasing power, which requires relative stability of the dollar. I think it is unfortunate that the wording of this act does not contain a more specific statement of national policy to maintain long-run monetary stability. An examination of legislative and administrative history of the Federal Government for the past few years does not yield convincing evidence that the guiding policy has been one of maintaining long-run monetary stability . I have tremendous respect for the American dollar as one of the most important single factors in the world today. The integrity of the dollar must be preserved. Any depreciation or discount of that dollar is a threat to our own national welfare and the welfare of the rest of the world. Throughout history, disasters in varying degrees have almost always followed periods of seriousinflation. However, there can be little doubt that under the necessity of the Government borrowing vast sums to finance World War II and the need for quick expansion of military facilities and production, that a substantial increase in the monetary supply was required. It may now appear in retrospect that the money supply during the war period was increased to a greater degree than was desirable. If it had been possible to place a larger proportion of the public debt in the hands of nonbank holders and less in the banking system, there would have been less increase in the monetary supply. The question now is whether or not the money supply is too great in terms of the needs of the present defense effort. At times, this appears to be the case, but, on the other hand, in terms of the vast outlays that are being made and are in contemplation, we may find that the money supply is not too great. In the meantime, we have the practical problem of restraining inflationary pressuresand dealing with the money supply as it now exists. Credit needs for the defense effort must be filled while, at the same time, it is highly desirable that inflation be restrained. My own views are that economic policy under present conditions should be directed against inflation through appropriate action by the Government on every front, while at the same time avoiding as much as possible actions that MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 241 will have serious adverse effects in other areas and avoiding so far as possible rigidities in the operation of the private enterprise system. Selective controls and allocation of materials appear to be essential in such a program, but the application of such controls should be subject to administrative flexibility so that they may be adjusted, dropped or increased as the needs of the situation develop. It would be a mistake to place entire reliance or too much reliance on the use of interest rates through monetary management to control inflation . The need is to deal with this problem on the broad front under a consistent and coordinated policy of Congress and the executive department of Government. To deal with this problem on the monetary front alone is to ignore the many areas of inflationary pressures other than in the field of credit and monetary supply. In this connection, there is an intangible factor somewhat unpredictable that we might call human behavior. The officials of the Federal Reserve System frequently refer to the effect of actions which are taken as psychological rather than economic. This factor is one of tremendous import in a country in which people have such vast resources along with a large degree of freedom to use these resources as they desire. As an illustration, there was general agreement among economists at the beginning of 1951 that inflationary pressures throughout the year would be strong. Such did not develop to the extent anticipated . Almost no one anticipated the abrupt change that took place between the first quarter of 1951 and the second quarter in the shift from spending to saving on the part of individuals. Disposable personal income increased between these two quarters at an annual rate of $5 billion, yet personal savings increased at the rate of $11.6 billion. Personal savings more than doubled between these two quarters both in dollars and in percent of disposable income. The sudden shift from spending to saving on the part of the people did much to cool off the pressure on prices of consumer goods. In dealing with the public debt and changes in prices of Government securities, we should keep in mind the fact that a substantial majority of the American people owns Government securities and reacts to developments that affect the value of such securities, even though the savings bonds held by most individuals are insulated against price decline. I have a tremendous respect for the size of the national debt, its proportion to all debt and its widespread ownership. The ownership of that debt is based on the confidence of the owners in the Government. Any disturbance to that confidence is a matter of serious concern. Fairly, I think it might be said that many individual owners of Government securities and potential buyers are concerned over the vast expenditures of Government, some of which they consider unnecessary or even wasteful, and particularly when , in spite of heavy taxes, Government expenditures promise to exceed revenues. Others look with concern at the decline in the value of the long-term securities below par. Many of them do not understand economic theory, but do understand the fact that whereas they paid $100 for a long-term Government bond, it is now worth only $97, and are concerned with the possibility of a much further decline in prices. They also have concern over the deterioration in the purchasing value of their dollar investments made in recent years, whether in savings bonds, bank savings accounts, or life insurance. In a free country in which we have universal and quick communications, we must deal with the factor of human behavior and public reactions to current events. All of these considerations have a bearing on the sale of 'Government securities, particularly to individuals. While in the Treasury, in 1947-48, I came to have tremendous respect for the officials of the Federal Reserve System and their devotion to public service. In dealing with intricate problems of monetary control and debt management, about which, at times, there were different viewpoints and different evaluations of the effect of proposed actions, there was always evidence of a desire, fully shared by the officers of the Treasury Department, to resolve such differences in the interest of the general welfare. The spirit of public service was the catalyst in the presence of which all discussions of policies and measures were considered. There are those who believe that in the exercise of discretionary administrative policy of national importance, there should be no differences of views among top officials and if they occur, a supreme authority of law or the Chief Executive should dictate the policy to be followed. Generally speaking, it is of highest importance that even though differences of opinion are to be expected among thinking men, effective results in carrying out a policy cannot be achieved 242 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT in the executive department of Government unless there is a coordination of effort among the various departments and agencies under a common policy. For this reason, I support the proposal that an advisory council be set up, by executive action, headed by the Secretary of the Treasury, and including the various executive agencies of Government dealing with credit and money, for the purpose of exchanging information and views and for coordinating administrative policy. While it would be proper and desirable for the Chairman of the Board of Governors of the Federal Reserve System or his representative to be a member of this group, he should not necessarily be bound by any policy decision reached by the group. The Board of Governors of the Federal Reserve System should give tremendous weight to any conclusions reached by such a policy group because it is assumed that any decisions reached will represent the combined judgment of top administrative officials as to proper policies to be followed in fiscal, monetary and credit affairs. However, the Federal Reserve System has specific statutory duties that involve semijudicial decisions that are based not only on tangible factors but intangibles and they could not conscientiously discharge their duties if bound by the dictates of the executive department of Government. It is proper and desirable for the Chief Executive to coordinate the activities of Government that are under his direction under a common policy but, in my opinion, would be highly improper for him to dictate actions to be taken by such semijudicial, independent bodies as the Federal Reserve System, the Interstate Commerce Commission, the Securities and Exchange Commission or other similar bodies. I think that he has the right and duty, however, to communicate his views to such agencies and that these views should be received with respect and careful consideration. However, to subordinate semijudicial and independent bodies set up by the Congress to the directives of the Chief Executive would destroy the effective value of such agencies. Recognizing the differences of viewpoint on desirable action may arise between the Treasury Department and the Federal Reserve, a proper question is how such differences may be resolved . Fact No. 1 is that the differences are few. The second fact is that almost without exception such differences are reconciled . This is done through discussion and agreement and sometimes through 'compromise, but always in a spirit of trying to find the right answer in the national interest. It is my firm conviction that such a method of dealing with common problems between an agency of Congress and an executive department is of the essence of democratic government. In some cases, the results are not as definite nor as effective as they would be with an authoritative set-up under which one might be subordinated to the other or both directed by a supreme authority. However, in my humble opinion, this is a cheap price to pay for the preservation of the basic principle of checks and balances in a democratic government. We should recognize that no man and no group of men dealing with the vast problems of our public debt and our monetary system are omniscient . Too many factors are involved, not only economic and financial, but in the realm of the probabilities of human behavior for any one man or group of men to know all of the right answers. It would be a catastrophe to weaken or destroy the independence of the Federal Reserve System as a semijudicial body by making it merely an administrative agency subordinate to the Treasury Department or subject to direction by the Chief Executive. On the other hand, the officials of the Federal Reserve System should give every consideration to the problems of the Treasury Department, the difficulties of managing the huge public debt and major governmental policies. It is my understanding that such is the present policy of the Federal Reserve System. It might be pointed out that the history of central banking throughout the world is tragic evidence that such institutions lose their independence if their actions are inconsistent with major governmental policies. Central banks win battles against government but governments always win the war. Summarizing : (1 ) The needs for financing World War II and the multiplication of productive facilities to carry on the war resulted in a huge increase in the public debt and in the money supply. (2 ) While the larger part of such increase was necessary there remains a question as to whether or not such money supply is more than is desirable for a peacetime economy. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 243 (3) The result of the increased Government debt and increased money supply was to depreciate the purchasing value of the dollar-another name for inflation. (4 ) The results of the sale of large amounts of Government securities were : (a) to create an unbalanced investment situation on the part of many institutions that required a later liquidation of part of such securities ; ( b ) to fill the banking system with a large volume of short-term Government securities which made funds available to any bank not only through sale but also by allowing such securities to run off as they fall due ; and ( c ) to make the vast majority of the people of this country holders of Government securities either through direct ownership or indirectly by institutions. (5) The policies of Congress have been, on the whole, inflationary not only during the period of World War II but since. Congress , under the Constitution, is charged with the responsibility for regulating the value of money. It has the powers to perform this function and should be held responsible for substantial changes in the purchasing value of the dollar. It should be recognized that Congress, over a period of time, represents the will of the people. ( 6) The public generally, while opposing inflation in principle, actually desire a certain amount of inflation as it may affect their particular interests. It is but natural that the farmer should want higher prices for farm products, the workingman higher wages for his services, the businessman higher profits, and the lenders higher interest rates. All of these objectives are inflationary except to the extent that higher interest rates are contra-inflationary . (7) Congressional inflationary actions in the presence of the large monetary supply and the huge Government debt have added to the difficulties of the Treasury Department in debt management and, in particular, have multiplied the difficulties of the Federal Reserve System in its money market management directed toward restraining credit. (8) Under certain conditions, there is conflict between monetary control and debt management. The almost continuous necessity for refunding maturing obligations and the frequent need for borrowing money in the management of the debt require a considerable degree of monetary stability for successful accomplishment. Proper monetary management at times necessarily requires actions that disturb the money markets. The objectives of proper debt management to preserve confidence in the public debt and permit its orderly handling are essential to the national welfare. On the other hand, monetary management that seeks to adjust the credit situation to changing needs and changing conditions is also highly desirable in the public interest. Decisions in both fields are highly complex and are based not only on known financial and economic factors but on the uncertainties of the future, including the factor of human behavior. or group of men can, with precision, correctly evaluate all of the factors involved. in debt management and monetary management. (9) With the widespread ownership of the public debt among individuals, the attitudes of people toward the Government debt constitute an important consideration of the possible public reactions to actions taken. Serious reductions in the prices of Government securities are disturbing to many people. ( 10 ) The basic consideration in monetary management and debt management. is that so far as possible they should be consistent with each other in spite of the fact that they have different primary objectives. A high degree of close cooperation and coordination is necessary between the two in the interest of both. The greatest care should be exercised that : (a ) Actions in one field should not seriously disturb operations in the other field ; ( b ) that careful consideration: should be given to the long-run adverse effect of actions taken to accomplish immediate desirable objectives ; and ( c ) in view of the intricacies of the problems involved in debt management and monetary management and the necessity for the exercise of judgment that is based not only on known factors but unknown factors and with changes in conditions beyond the control of monetary authorities, that there should be no mandate or directive by law that would restrict the necessary freedom of actions for proper debt management and monetary management. (11 ) The close working together by the Treasury Department and the Federal Reserve System has resulted in a high degree of cooperation in which differences: have been minimized. It is in the interest of both that actions of one should not be contrary to the objectives of the other. While admitting that thinking men will not always agree on every specific action to be taken in the field of monetary control and debt management, it is far more important in terms of our democratic system of checks and balances that the freedom to disagree be 244 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT preserved rather than to destroy the independence of either the Treasury or the Federal Reserve System in working out problems common to both. Neither should the Federal Reserve System become subordinate to the executive department of Government nor should it be allowed to take over the functions of that department. The third item in my discussion is on the question of ownership of stock in the Federal Reserve banks. The stock in these banks is now held by the member banks. This stock carries a fixed dividend and the stockholders have no interest in any earnings of the banks in excess of the amount required to pay the dividend. The question has been raised as to whether or not in view of the fact that the Federal Reserve is controlled by the Government, the Government should also own the stock of the Federal Reserve banks. I can see no reason why the ownership of the stock by the Government would provide any governmental control not now exercised or available. The only advantage to the Government in such ownership would be to receive the dividend on the investment of the Government to acquire this stock. The difference in the dividend and the cost of the money with which to buy the stock is not of sufficient amount to have an important bearing on the question. If the Government owned the stock of the Reserve banks, the implications would be that the Reserve System was merely an executive agency of the Government, such as the RFC for instance, and subject to Executive direction . The Federal Reserve banks represent a combination of Government and private business under which control is vested in the Government. It is through the ownership of the stock of the Reserve banks by member banks that the Reserve system mobilizes the services of able individuals as directors of the regional banks . These men represent the private-enterprise system and the public. Although the powers of the directors of the Federal Reserve banks are limited and although the control of the policies of the banks is vested in the Board of Governors, at the same time these directors bring a viewpoint of banking, industry, agriculture, and business to the officers of their respective banks that is valuable to the Reserve banks in maintaining close touch with conditions prevailing in their respective districts . The Federal System has no other direct official relationship with business, commerce, and agriculture except through the boards of directors of the various Reserve banks. Such relationships constitute a highly desirable feature of the Federal Reserve System . Member-bank ownership of the stock in the Reserve banks not only gives the banks an opportunity to vote in the election of six of the nine directors of each bank, but affords a relationship in which bankers have a direct interest in the functioning of the Reserve System. To divest the member banks from this stock ownership would result in losing a valuable asset of support to the System and an interest on the part of banks and other businessmen in the System's operations. The operations of the Federal Reserve System are so intimately related to commerce and industry and the operations of the chartered banking system that it is highly desirable in the national interest that such relationships be encouraged rather than discouraged. A basic concept of the Federal Reserve System is to serve the local needs of every area of the Nation by diffusing operations through regional and branches of regional banks. If the participation of public representatives as Reserve bank directors elected by the banks were eliminated, we would then have only a concentrated bureaucratic direction of the System by the Board of Governors. Such would not be in the public interest. I can find no sound reason for the Government to acquire the stock of the Federal Reserve banks unless the objective is to destroy the independence of the System and make of it merely a Government bureau. Representative PATMAN. I will state that you have given the best reason for the continuance of the token ownership by the commercial banks of the Federal Reserve System that I have heard given , the most logical reason for it. Mr. WIGGINS. Thank you very much, sir. There is some more detail in my statement, Mr. Chairman, than I gave. Representative PATMAN. Mr. Wolcott ? Senator Douglas ? Senator DOUGLAS. I want to compliment the witness on his extraordinary able statement. It is indeed one of the ablest statements which I have ever heard on the subject. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 245 Mr. WIGGINS. Thank you very much, sir. Representative PATMAN. Mr. Bolling ? Representative BOLLING. No questions, Mr. Chairman . Representative PATMAN. I will ask two or three questions of Mr. Wiggins. You know, the Comptroller General in the General Accounting Office usually audits and has control of the auditing and general supervision of the bookkeeping of public agencies. Do you believe that the General Accounting Office should be given the power to audit the books of the Federal Reserve System and the Federal Reserve Board ? Mr. WIGGINS . Mr. Chairman, I can see no particular objective except to give another agency some more work, and they would probably want another appropriation to do it . The Federal Reserve has an effective internal audit, and I do not know what would be accomplished by it or what the desirable objective is. Representative PATMAN. It costs as much money to have a private audit as it would for the Government auditor. Mr. WIGGINS. I really am not familiar with the type of audits that the Federal Reserve make except that I know they do have a very elaborate system of audit of their own. Representative PATMAN. The question involved here is they audit their own books, whether or not that is a good policy. Mr. WIGGINS. I am strong for an internal audit regardless of whether you have another auditor or not. I think it is the most effective means of controlling a business, with a unit of the same business , an independent group charged with the same responsibilities that some other auditors would perform. Representative PATMAN. Another question on annual appropriations. Most of the agencies of the Government and public bodies depend upon Congress for annual appropriations. In that way they are under the direction and scrutiny of what you might call their master, the Congress . Would you be in favor of the Federal Reserve System turning in all of its receipts like most of the other agencies do, and receiving money for their support and salaries, maintenance, and operation from a budget like other agencies are required to do ? Mr. WIGGINS. Frankly, I would not want to run that business if it had to be done that way. I think that the type of operations of a huge banking system, that the men at the head of it should be given the authority to run it without requiring an appropriation of Congress for their detailed expenses and costs. I do not know how you would cover the losses that they might take on Government securities. It would be an expense of the operation. That certainly could not be covered by statute, I mean by any particular appropriation. I think they ought to have the freedom that they now have, Mr. Chairman . Representative PATMAN. Of course, so far as independence is concerned, Mr. Wiggins, the Supreme Court receives its annual appropriations from Congress . It is a coordinate branch of our Government, and it is just as independent, I believe, as any part of our Government can possibly be, and they certainly have not found it to be any handicap, and it seems to be a part of our traditional system, but the question is whether or not we should make an exception in this case. Take the executive branch 246 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT of the Government. It is dependent upon Congress for every dollar under their control and every dollar that they spend. Mr. WIGGINS. That is true. Representative PATMAN. So the argument that it destroys the independence of the agency I believe is somewhat weakened by the experience of the executive and the judicial branches of our Government. Mr. WIGGINS. The Federal Reserve System, however, is an incomeproducing operating business, and I think is entirely different from such operations as the courts, where it is a matter of expense. The Congress does fix the salaries of the members of the Board of Governors, which I think is proper, but it does not fix the salaries: of the presidents of the Federal Reserve banks, and I think many Congressmen might think when you came to appropriating an amount that would be necessary to employ the type of ability that is required for the president of a bank, that the salary would be too high. I am afraid that Congress would not appropriate adequately to get the type of personnel that we now have in the Federal Reserve System, and in my opinion it needs the best men that can be found. Representative PATMAN. Without arguing the question with you, Mr. Wiggins , Congress has been rather liberal with the Supreme Court for instance. They receive rather liberal salaries and allowances and retirement benefits, and if you add it all up , I suspect it would amount to about as much as the presidents of the respective Federal Reserve banks receive. Mr. WIGGINS. I think the Supreme Court, Mr. Chairman , is a holy of holies that we regard with such high favor that we ought not to compare this banking system with the Supreme Court. It might be compared with something else. Representative PATMAN. And so far as its status as a revenue-bearing agency is concerned , we should keep in mind, too, that all its revenues are by reason of its holdings of United States Government securities. Mr. WIGGINS. And the note-issuing privilege. Representative PATMAN. Yes ; using the credit of the country. If you want to put the Supreme Court in a comparable situation, you can just turn over $20 billion worth of Government bonds and say, "All the interest on that money you can use to run the judicial system," and then put the rest of it back into the Treasury. Mr. WIGGINS. My opinion , Mr. Chairman, is that if the Congress is not satisfied with the way the Federal Reserve System is run, then they might take over the functions of appropriating and requiring the receipts to be brought into the Treasury, but the practical facts are that you need as presidents of some of your Federal Reserve banks the ablest financial brains in America ; and you have got it, in my opinion. You are competing with the presidents of banks that pay salaries that are very high in terms of the salary that a Congressman gets. Senator DOUGLAS. There we come to a point, namely, that the salaries of members of the Federal Reserve Board are appreciably below the salaries of the presidents of the Federal Reserve banks, although the position of the Federal Reserve Board is really much more important in framing general policy than the operating heads of the banks. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 247 Would you favor increasing the salaries of the Federal Reserve Board ? Mr. WIGGINS. I certainly would . I think it is a shame that those men receive the salaries they get when they occupy a position of such importance in our whole economy, when you have to draw from a source of the kind of men you want, men who receive salaries several times as great . I do not think that in some cases you will get that type of man with salary alone. In some cases you have that type of man already on the Federal Reserve Board where the salary is less important to him than a sense of serving the Government. Senator DOUGLAS. You are aware of what happened when some of us tried to increase the salaries of members of the Federal Reserve Board from $15,000 up, I believe , to $22,500. The record is perfectly clear that the Federal Deposit Insurance Corporation with all its influence injected itself in the situation and said, "You can't increase the salaries of the Federal Reserve Board unless you increase ours. We are as important as they are." And I am sorry to say that a large proportion of your fellow bankers went along with the Federal Deposit Insurance Corporation , because my files are full of telegrams from the bankers of my State protesting against an increase in the salaries of members of the Federal Reserve Board. Now I hope that you can use your influence with your fellow members of the American Bankers Association on this question. Mr. WIGGINS. Well, the question of comparative salaries is always raised when you change anybody's salary. It is a tough problem in business, of course, with your own personnel . Senator DOUGLAS. I was greatly disappointed in the attitude of the Federal Deposit Insurance Corporation. Representative PATMAN. Mr. Wiggins, we thank you very kindly sir. Mr. WIGGINS. Thank you, gentlemen. Representative PATMAN. Mr. Wiggins, will you come back just a moment please. I forgot to call on Dr. Murphy and Dr. Ensley and ask if they wanted to ask any questions. Mr. ENSLEY. I have no questions. Representative PATMAN. Dr. Murphy ? Mr. MURPHY. I have only one question . years ago said : The Douglas report 2 We believe that to restore the free domestic convertibility of money into gold -coin or gold bullion at this time would militate against rather than promote the purposes of the Employment Act, and we recommend that no action in this direction be taken. What would be your reaction if this committee reiterated that statement or some variation of it in its report ? Would you comment on that, Mr. Wiggins? Mr. WIGGINS. Would you mind reading the heart of that ? I did not quite hear you, Mr. Murphy. Mr. MURPHY ( reading) : We believe that to restore the free domestic convertibility of money into gold coin or gold bullion at this time would militate against rather than promote the purposes of the Employment Act, and we recommend that no action in this direction be taken. 248 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT That was stated in the Douglas report 2 years ago. The question is, Do you think it would be a constructive thing for this committee in its report to reaffirm that position ? Mr. WIGGINS . There are a number of people who toy with the idea of making gold convertible to cure many of our economic ills. I am ashamed to admit that I wrote a treatise on gold about 30 years ago and I hope it will never be read or discovered , because what I said at that time is so foolish today that I am ashamed to admit that I wrote it. In my opinion if there is any substantial demand or advocacy of making gold freely convertible, I think it might be well for the committee to express itself somewhat along the same lines as it formerly expressed itself. I personally think that making gold freely convertible would only result in transferring the hiding of the gold in the ground at Fort Knox to hiding it under the mattresses and in the socks over the country. I think if you really want to deflate, Senator-we were talking about. deflating if you would announce on a certain day that anybody can go to any bank in the country and get all the gold they want, I believe in 3 hours why the gold supply would disappear. Some people do not agree with that, but I have asked some of the advocates of convertibility of gold what they would do if they had the right to convert their money into gold, and I think uniformly everyone has said, "Well, I would get all I could get and I would put it away in a good, safe place." I do not go along with any proposition at the present time under the present world conditions to make our gold supply convertible freely. Senator DOUGLAS . You do not agree with the apparent meaning, therefore, of an eminent candidate for the Presidency who declared that he wanted a solid American dollar with a modern gold standard . Representative PATMAN. I think you would have to define what is meant by a "modern gold standard . " Senator DOUGLAS . Strike my query from the record. Representative PATMAN. No, no. Well, thank you very kindly, Mr. Wiggins. Dr. Blough, we are glad to have you as our witness. Do you have a prepared statement ? STATEMENT OF ROY BLOUGH, MEMBER, COUNCIL OF ECONOMIC ADVISERS Mr. BLOUGH. Mr. Chairman , the opportunity which the committee gave the Council to respond to the committee's questionnaire has given me plenty of opportunity to explain my views on the subject under consideration. There is one point, however, I think on a rather central problem, that may not stand out as clearly as might be wished . I have prepared a statement on that point. If it meets with your approval, I would like to have that statement appear in the record, and to have the committee's indulgence for me to summarize very briefly the points involved , after which I shall be happy to address myself to whatever questions the committee may wish to ask me. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 249 Representative PATMAN. Without objection , that will be satisfactory, Mr. Blough. ( The prepared statement submitted by Mr. Blough is as follows :) THE DILEMMA OF MANAGING A LARGE PUBLIC DEBT IN A PERIOD OF INFLATION The hundreds of pages devoted by individuals and agencies to answering the questions submitted by your committee testify to the many facets that mark the relationship between monetary policy and the management of the public debt. It is obvious that I can deal with only a small segment. There would seem to be three general kinds of problems involved in this subject of the relationship between monetary policy and the management of the Federal debt. At the center is the economic problem of how to manage a very large Federal debt with the least harmful influence on the economy. This economic problem comprises several problems that are more specific, among them, how to manage the Federal debt without contributing to inflation , how to manage the Federal debt without contributing to deflation and depression, and how to manage the Federal debt without causing a monetary crisis . A second kind of problem might be designated the problem of policy, or more specifically, the problem of choosing among desirable objectives. There are many desirable objectives for the Nation, among them being the promotion of the defense program, the expansion of production and productive capacity, the maintenance of a relatively stable price level, the achievement of a fair distribution of income and wealth, the promotion of individual freedom, and the advancement of the economic security of our citizens. To some extent, these objectives can be advanced simultaneously. Often, however, it is necessary to choose among them-to weigh the advantages of a little more of one against the disadvantage of a little less of another. A rapid shift from a civilian economy to a mobilization economy, for example, might have been difficult to achieve without some increase in prices. The third kind of problem may be designated the organizational problem. This is the problem of how to allocate the powers of Government in such a manner that the economic methods used and the policy decisions made will to the greatest extent possible promote the national interest. The problem to which I wish to direct my remarks is the first of these three, namely, the economic problem of how the public debt can be managed with the least harmful and most beneficial results for the economy. More specifically, I wish to deal with the problem of managing the Federal debt without contributing to inflation. PROBLEMS PRESENTED BY A LARGE PUBLIC DEBT The Federal debt, which on December 31 , 1951 , totaled $259.5 billion, is one of the most important economic facts of our time. This Federal debt is 45 percent of the total net debt, public and private, outstanding in the United States today. The largest debt owed by any other governmental agency is $3.2 billion of gross. debt owed by the city of New York. The largest debt of any business organization to come to my attention is $3.6 billion. During the year 1952, it will probably be necessary for the Federal Government to refinance over $35 billion of the Federal debt in addition to the $15.6 billion of Treasury bills which are turned over four times a year. The Secretary of the Treasury has indicated that because of the Federal deficit, it may be necessary, in addition , to borrow from the public as much as $10 billion in new funds during the calendar year 1952. The magnitudes of these operations are so much vaster than those involved in private financing, and the Federal Government is so different from a private business, that there is no reason to believe that all the rules applicable to private financing can or should be applied to Federal debt management. The Federal debt is a stubborn fact that has a bearing on all economic policies. We cannot get rid of the debt, at least not in our lifetimes, so we must learn to live with it. A basic fact in considering problems of monetary policy and debt management is that every dollar of the Federal debt at all times must be held by someone. The amount of the debt may be reduced by increasing revenues or reducing expenditures, but the remaining debt is going to be held in some fashion whether by individual investors , corporate investors, commercial banks, or Federal Reserve banks. 250 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Under most economic conditions, a large public debt presents no problem for monetary policy ; indeed, under some conditions, the debt can serve as a useful tool. Under the following circumstances, however, a difficult problem arises in using monetary policy to stabilize the economy while managing the public debt : (1 ) When there are substantial issues maturing currently that require refunding, or when additional borrowing is necessary because revenues are insufficient to cover expenditures ; and ( 2 ) when demand for goods and services has pushed employment and production to so high a level that any additions to demand will not result in greater production but will give rise to inflationary pressure ; and (3) when the combined total of demands for loanable funds by Government and private borrowers is in excess of the supply of loanable funds available from the voluntary savings of individuals and corporations. Conditions of this character have existed during much of the time since the Korean attack in June 1950. They exist in the main today and they promise to become accentuated over the next 12 months or so because of the large Federal deficit which we shall soon be incurring. It is well to bear in mind that it is the relation of spending ( including consumer spending, business spending, and Government spending ) for goods and services to the supply of goods and services which is the biggest factor determining prices. All kinds of financial transactions , including the increase in the money supply ( of which a minor fraction is currency and the major fraction is bank deposits ) affect prices only as they result in a an increase or decrease in spending or a decrease or increase in the supply of goods and services. For example, the effect on prices of an increase in bank reserves cannot be accurately forecast either as to amount or as to time. The result depends on many other economic steps. The results can be more readily forecast in a period of inflation than in one of deflation , when there may be no further steps at all, at least not for months or years, but even in a period of inflation the timing and amount of the consequences are uncertain . In all discussions of the effect of monetary and debt transactions, it is necessary to follow through to the effects on actual spending and on the actual supply of goods and services. The economic dilemma that is presented when the demands for loanable funds exceed the supply in a period of full employment is suggestive of the parlor game of musical chairs , in which there are less chairs than people. In musical chairs, there would be no game if the number of people and the number of chairs were the same, but in the situation just described regarding the Federal debt, the number of players and the number of chairs must in some manner be made the same. The problem is how to restore equilibrium between the supply and demand of loanable funds while maintaining price stability in maximum degree. Either an equilibrium must be achieved between the supply of loanable funds and the demand for loanable funds, or some kind of rationing of loanable funds will have to be carried on by action of either the lenders or the Government. INCREASING THE SUPPLY OF LOANABLE FUNDS To achieve an equilibrium between the supply of loanable funds and the demand for loanable funds, it is obviously necessary either to increase the supply or decrease the demand. The supply of loanable funds can be increased by persons and corporations increasing their savings. Since the spending of the loan is offset by reduction in spending by the saver of the money, the result is not inflationary. Another method of increasing the supply of loanable funds is for persons and corporations to loan funds which they formerly held idle. In this way, the velocity of circulation is increased and spending is increased ; the result is inflationary. The lending power of banks can be increased by enlarging commercial bank reserves through an inflow of gold, rediscounting with Federal Reserve banks, or the purchase of Government securities by Federal Reserve banks. The lending power conferred by bank reserves can be increased by reducing reserve requirements. Lending power can be decreased, of course, in the reverse ways by raising reserve requirements, by an outflow of gold, by paying off rediscounts, and by the sale of securities by Federal Reserve banks. There are conditions under which an expansion in the supply of loanable funds is not inflationary. As just mentioned, if savings are being simultaneously increased, an increase in spending growing out of increased loans will not create additional inflationary pressures. Moreover, to the extent that the economy is growing with respect to the physical volume of production or trade, a larger supply of money is required to carry on the increased volume of business at the existing price level. Expansion in the supply of money or increase in the velocity MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 251 of its use that is not in excess of such additional needs does not increase inflationary pressures. Otherwise, however, if an increase in lending power is actually followed by an increase in loans and if this, in turn, is followed by an increase in spending by consumers or businesses for goods and services, inflationary pressures are added to the economy. Whether price increases will actually result depends on what measures are taken to hold down spending elsewhere in the economy through such measures as taxes, rationing, priorities, and allocations, and so on. The fact that inflationary pressures are increased at one point or from one cause, therefore, does not mean that actual inflation must result. However, it is clear that bringing about an equilibrium between the demand and the supply of loanable funds by increasing the supply of loanable funds through the expansion of bank reserves is likely to add to inflationary pressure and thereby to make the problem of preventing inflation more difficult to solve. It is for these reasons, of course, that stress is placed on the desirablity of avoiding the indefinite expansion of the holdings of Government securities by the Federal Reserve banks. But Government spending financed by selling securities to the public in exchange for idle funds also is inflationary. The hope of achieving an equilibrium between the supply of and demand for loanable funds through an increase in the supply of funds lies in the increase in real savings. To increase real savings is, of course, easier said than done. EFFECTS OF A RISING INTEREST RATE The second method of bringing equilibrium between the supply and demand of, loanable funds is to decrease the demand for such funds. One way to do this is to permit the interest rate to rise. The chief way in which permitting the interest rate to rise brings about equilibrium between the supply of and demand for loanable funds is by causing some prospective borrowers to drop out because of the increase in the cost of the loans to them. Clearly, as the cost becomes higher and higher, more and more borrowers will find the expense of borrowing too great for them to undertake. Many persons have taken the position that the problem of the public debt is solved when the Federal Reserve System ceases to buy Government securities . In fact, however, this is only the beginning of the problem. It is all very well to say that the Federal Reserve must not buy the securities, but the stubborn fact is that it is absolutely necessary that someone buy them. How is this to be done when there is a bigger demand than supply for loanable funds ? Presumably, the Federal Government can, if it will, outbid other borrowers of funds who do not have the same imperative necessity to borrow, by offering high enough interest rates . Clearly, if only the interest rate is to be used to cut down the private demand for loans, the Federal Government cannot stop short of outbidding other borrowers. This might be a serious matter, since the highest marginal rate which the Treasury had to pay on the last dollar it borrowed would tend to set the rate pattern for the whole of the Federal debt, which, as previously noted, is nearly as large as all the private debt put together. Thus, the interest rate paid on this tremendous volume of debt obligations would tend to be determined by how rapidly a rise in the rate of interest drove other borrowers out of the market or discouraged lenders from loaning to the other borrowers. If this course is to be followed, it becomes very important to know whether the Federal Government will have to bid very high to refinance its loans and to borrow what new money it will need . I do not know how high the interest rate would need to go, but several factors may be indicated. A rise in interest rates may affect the market for loanable funds by affecting the supply and by affecting the demand. As previously indicated , only increases in the supply of funds that result from increased saving avoid being inflationary. It is not generally believed by economists that moderate increases in rates of interest have a substantial stimulating effect on the level of saving. There are forces working in both directions that tend to offset each other. The second effect of rising rates of interest is on the demand for loans. This is a very crucial question, since if the demand for loans is very elastic in relation to interest changes , a small rise in interest rates may suffice to restore equilibrium between the supply and demand of loanable funds, while if the demand is very inelastic, a very large rise in interest rates might be necessary to reduce demand sufficiently to bring about an equilibrium. When demand for loanable funds is decreased by an increase in the rate of interest, it is of course 97308-52-17 252 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT important that this decrease not be in those sectors that are vital for the promotion of the defense effort. We cannot approach the present situation as a normal one in which only traditional economic techniques will be sufficient to meet the problem. The expansion and diversion required by the defense program, the tremendous volume of private capital formation, and the heavy anticipated Federal deficit combine to make this a special situation which may call for special measures. It may be useful to run over briefly the different demands for loans. As previously stressed, Government loans cannot be reduced at all by debt management ; somehow or other, Government must get the money and, unless other measures are to be used to prevent the market from being entirely "free," the Government must be prepared to outbid the interest rates that other borrowers would pay. The demand for speculative loans would be very slow to drop out, because the interest cost is a very small element among the factors determining speculative purchases. The demand for loans to carry inventories would also be very slow to decrease as interest rates rose, because again the rate of interest is a very small part of total cost, especially when the risks of the operation are considered part of the cost. The demand for loans to finance the purchase and production of machinery, tools, and equipment would be relatively slow to respond, because again interest is a small proportion of cost for items of equipment which are written off or depreciated at a relatively fast rate of speed. The demand for loans to finance industrial and commercial construction would presumably be reduced to a greater extent, since the interest rate is a relatively important factor in determining the profitability of the operation. This is true also of residential construction, since the amount of rents that home owners can pay is dependent on their wages and other income, and as interest rates rose, demand would fall off. It should be pointed out, however, that with respect to the present situation the limits on the amount of construction ( industrial, commercial, and residential ) have been set in recent months not by the aggregate demand of borrowers but by the supply of scarce materials. Even at higher interest rates the demand of borrowers would likely have continued sufficiently great to take up all of the available supplies of materials. It is not clear how long this will continue. On the basis of the above analysis, there is good reason to conclude that it might very possibly happen that an increase in interest rates of a moderate character would have an insufficient effect in reducing the private demand for loans. In that case, the Federal Government would be obliged to face the prospect of outbidding private demand for loans with even higher rates of interest. It may be urged that although an increase in the rate of interest would have relatively little effect in reducing the demands of borrowers for loanable funds, the lenders would ration their supplies of funds in such a way that the Government would receive what it required . The argument has been made that an important reason why insurance companies, for example, have been loaning money in the private market instead of to the Federal Government is that the companies have certain contracts which they must fulfill, and that the rate of interest offered by the Government is not enough to satisfy the needs of the companies in fulfilling these contracts. It has been argued that a small increase in the rate of interest on Government securities would make them attractive to the insurance companies, which under those circumstances would be willing to buy from the Government instead of loaning money in the private market. Likewise, it has been said that banks have certain earnings expectations , and that when these are satisfied, the banks will be willing to lend to the Government instead of lending the funds to private borrowers . While it may be granted that there is a short lag while the appetites of lenders are temporarily satisfied by an increase in the rate of interest, it is not human nature for this satiation of appetite to continue. As a matter of fact, the rates of interest which some observers said last winter would be satisfactory for insurance companies are being said now not to be satisfactory. An increase in interest stimulates the appetite instead of satisfying it. If private borrowers are willing to pay more for their loans, I can see no reason to expect that private lenders will not take advantage of the higher interest rates and force the Federal Government to keep raising its bid in order to place its securities in the hands of private holders . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 253 DISADVANTAGES OF LARGE INCREASES IN INTEREST RATES The point may be made that there should be no objection to the Federal Government increasing its interest rate bids as high as may be necessary to outbid enough of the private borrowers to assure that the Federal debt will be held without inflationary consequences. Can this view be accepted ? If the interest rate necessary for the Federal Government to outbid private borrowers were a permanent equilibrium interest rate, there might be little objection to the Federal Government engaging in such competitive bidding. But this means that we would expect the country for a long time to come to be in an inflationary situation. We would expect the rate of demand for loanable funds to be so much in excess of the supply of saving that the cutting off of demand for construction and for machinery, tools, and equipment for the longer run would be desirable. There are countries where this is, indeed, the outlook, and where a rising interest rate is a recognition that capital investment must be slowed down regardless of the desirability of industrial expansion, simply because the rate of saving is too small. But this is not the outlook in the United States. This Nation has a tremendous capacity for saving. It does not have the capital shortages that a war-ravaged Europe or an underdeveloped Asia, Africa, or South America may have. Already financial writers are professing to see deflationary dangers ahead after 1 , 2, or 3 years. Over the longer run, in my opinion, this is a high-saving economy and a low-interest-rate economy. That is, savings will be made in large volume, in my opinion, and to keep them invested in real capital, as they must be if unemployment and depression are not to threaten us, the interest rate that is paid for the use of savings will have to be to a relatively low one. If this be the case, the problem is not one of seeking a long-term equilibrium rate of interest but of achieving a short-term equilibrium ( which in the absence of other action might require a high rate of interest ) followed by a long-term equilibrium which would require a low rate of interest. But why is this situation a matter of any concern ? Why not have high interest rates now and low interest rates when we need them ? The difficulty is that interest rates in the past have not adjusted downward with sufficient rapidity to meet the changing needs. That adjustment requires a process of reeducation to a lower interest rate standard. The average yield of Aaa corporate bonds in 1932 was higher than in 1929. It took a long time after 1932 for interest rates to fall substantially, and positive action on the part of the Government was involved . Do we want to educate lenders to a high interest rate only to have to go through another slow process of reeducation to lower rates? Of course, the Government could engage in direct lending at such a time and thus break the interest rate structure. But most of us, I am sure, would like to minimize such activities by Government. We shall be much surer of having the needed lower interest rates when they are required for a healthy economy if they do not rise too high during the intervening period. Another reason for avoiding high-interest rates is that the continually rising interest rate which might be necessary for the Government to outbid the market might result in placing actually less securities in the hands of the public than if a lower interest rate had been maintained . This might happen for two reasons. First, the declining value of Government securities might cause investors to avoid investing in Government securities for the future, because of the capital losses suffered in the past and present. Second , investors might reason that an increase in the rate of interest would be followed by still further increases and that therefore they might as well wait until later before buying any intermediate or long-term securities. Relatively little is known about the probable behavior of Government security holders under various possible circumstances. The situation is not one, however, in which bold experimentation can be lightly undertaken. With about half of the total debt of the Nation in the form of Federal securities, the development of a disorganized market could be a major disruptive force. The action which then might be required by the Federal Reserve to restore financial order might involve larger purchases of Government securities than a flexible support program to maintain stability. It is not convincing to argue that market supports were discontinued and that the fear of security market disorganization proved to be a bogey. Support was not discontinued, and was handled with great care and skill. Moreover, the more difficult financing problems have not yet been faced. 254 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Another result of higher interest rates would be, of course, that the cost of servicing the public debt would rise. No one will question the undesirability of unnecessarily increasing the tax burden on the public. On the other hand, no one will question that if the only way to maintain stability is through a higher rate of interest on the Federal debt, it would be far cheaper for the country to pay the higher taxes than to experience the inflation . But in view of the uncertain effects of rising interest rates and the possibility that other methods can be used to prevent inflation, it is understandable that a substantial increase in the interest rate is not to be viewed wtih complacency . It should also be mentioned that much of American financial strength rests on a foundation of the values of Federal securities. The substantial declines in the values of those securities that would accompany substantial increases in interest rates might have very repressing effects on types of financial and business operations necessary for the sound functioning of the economy especially in the defense mobilization period. OTHER METHODS OF RESTRAINING PRIVATE DEMAND FOR LOANS I want to make it clear that I do not defend any particular level of interest rates as being the correct level. It may be, moreover, that under the circumstances we face, the equilibrium level will not involve much if any increase in interest rates. But for the reasons mentioned , large increases in interest rates would have undesirable effects, and it is necessary accordingly to review other possible ways of reducing the demand for loanable funds and of inducing lenders to prefer Government securities to private loans. The problem in short is one of finding ways to reduce private loans in order that the Government's debt may be held without undesirable increases in the rate of interest and without an inflationary expansion of credit. easy comprehensive way of achieving this result, but there are a number of different methods which, when combined, may add up to a considerable total. Allocations and cut-backs in materials available for civilian use, restrictions on commercial construction , and other methods of reducing activity operate to cut down the need for borrowing. Specific credit controls by reducing the amount loaned and speeding up repayments operate to cut down the demand for loanable funds with respect to purchases of consumer durable goods and of houses. Willingness of banks and other institutions to lend has been diminished through voluntary credit-restraint programs that bring the social and moral pressure of the whole industry to bear on its individual members. Price controls reduce the desire to engage in speculative transactions and help to hold down the requirements for working capital. In the actual management of the public debt, it should not be assumed that any one of the methods of achieving an equilibrium between the supply and demand of loanable funds must be or should be followed to the exclusion of the others. In practice, it may be found necessary and desirable to make some use of all of the methods, and possible to do so without inflationary pressures resulting. The policy of supporting the market for Government securities that seems to me best suited for the uncertain type of situation we face is the flexible policy of the type which I understand is being followed by the Federal Reserve System. This kind of support keeps large holders from readily monetizing their holdings ; it does not preclude active support of the market when this seems necessary or desirable ; it helps prevent the kinds of fluctuations in Government security prices that would make difficult the sale of future issues ; and it should prevent seriously hurtful market confusion and economic disruption. In closing, I would like to repeat that monetary policy and debt management are by no means all there is to the problem of economic stabilization or its solution. The inflationary problem is one of holding down total spending, not simply that relatively small part which is financed by increases in debt, public and private. A well-balanced stabilization program using all the other measures at the disposal of the Government should go along with a monetary and debt management policy that itself should be to the largest practicable extent noninflationary, despite the handicap placed upon it by that basic inflationary influence, too little revenue to match expenditures. Mr. BLOUGH. The problem with which my statement is concerned is the dilemma for policy that arises in a certain combination of circumstances. The circumstances are : MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 255 1. An economy experiencing full employment or under inflationary pressures . 2. A large Federal debt . 3. A considerable volume of refinancing or, what is worse, new borrowing to be undertaken. 4. An excess of demands for loanable funds over the supply of loanable funds available from the voluntary saving of individuals and corporations. Now under those circumstances we have a situation much like the parlor game of musical chairs in which there are more players than there are chairs. There is more demand for loanable funds than there is supply from the voluntary savings of individuals and corporations. The difference is this : That in musical chairs there would be no game unless there were more players than chairs, while in monetary policy and debt management, the number of chairs and players must be made equal by some method. The central requirement in any solution to this problem is that all of the Federal debt must be held by someone at all times, whether by individual investors , corporate investors, institutional investors, commercial banks, or Federal Reserve banks. That is a very vital necessity in any thinking about this subject. One method for achieving the equilibrium between the supply and demand of loanable funds is to increase the supply. Any method of increasing the supply of loanable funds, assuming a strong demand for funds, increases inflationary pressures unless it is accompanied by an addition to saving through contraction of spending. This increase is greatest of course when new money that is bank deposits, is created to increase the supply. This is the reason for concern about the purchase of Government securities by the Federal Reserve System, since this may add to the reserves of the banking system and permit the expansion of bank deposits and the money supply by several times the amount of the increase in reserves. Since I am very deeply concerned with the problem of inflation, I believe it is important to avoid the expansion of the supply of loanable funds as much as possible consistent with a high level of production, but I would like to stress the point that to say that the Federal Reserve should not buy Government securities is no solution to the problem, but only a way of raising the problem, because someone must hold the securities. The second method of bringing about an equilibrium between the supply and demand of loanable funds is to allow interest rates to rise . It may be presumed that at some point an increase in the rates of interest will cause enough demand for loanable funds to drop out so that the securities of the Government can be placed without requiring an expansion of loanable funds through the increase in bank reserves or otherwise. There are two major questions here . One question concerns how high the interest rate would have to go in order to cut down the private demand for loanable funds by a sufficient amount to produce an equilibrium. I explain in my statement why I am rather skeptical about the effectiveness a moderate increase in interest rates would have in reducing the private demand for loanable funds. 256 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT The second major question is what harm a high interest rate would do. These matters are discussed in the statement, and I will simply refer to them in the summary. A third method of bringing about an equilibrium in the supply and demand of loanable funds is to reduce their demand in other ways than through higher interest rates. The allocations and restrictions in connection with the shortages of material imposed on civilian production , especially investment, when combined with price control may cut down the demand for loans to an important degree. Price control itself, if effective, reduces the desire for speculative activity and the need for large working capital. Voluntary creditrestraint programs bring the moral pressure of the whole industry to bear on individual bankers and other lenders in holding down their loans. And there are no doubt other methods of achieving this result. In practice it seems likely that all three of these methods will be used to bring about the equilibrium of supply and demand . Some expansion in the bank loans and money supply can take place without actual inflationary results. Moreover, to the extent that inflationary pressures may develop because of the difficulties of financing a large deficit in completely noninflationary ways, it is possible to use the various other elements in a general stabilization program to prevent inflation from actually occurring. The most helpful step, which would not solve the problem but would be very helpful , would of course be to eliminate the deficit and to achieve a budget surplus. Mr. Chairman, that is the end of the summary of the statement which I have filed with the committee, and in order to expedite the work of the committee, I am ready for any questions that you may wish to ask. Representative PATMAN. Mr. Wolcott, would you like to ask any questions ? Representative WOLCOTT. No, thank you. Representative PATMAN. Senator Douglas ? Senator DOUGLAS. Not at the moment. Representative PATMAN. Mr. Bolling ? Representative BOLLING. Mr. Blough, I would like to get clear in my own mind what would happen if the Treasury faced a substantial refinancing or new issue if a percentage of that issue found no market whatsoever . Mr. BLOUGH. What has always happened in the past under those circumstances is that the Federal Reserve System has come to the rescue and has taken up the part of the issue which found no placement anywhere else. Representative BOLLING. What I would be interested in is what you feel could happen if the Federal Reserve refused to move in and take up that part of the issue. Mr. BLOUGH. That would depend on the Congress. My own judgment would be that in an aggravated case the independent Federal Reserve System might very shortly thereafter lose its independence through adverse congressional reaction. Representative BOLLING. You arrive at that conclusion very rapidly but what I am trying to do is to clear in my mind the dilemma that MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 257 would be faced . It is entirely a theoretical question because, as I understand it, it has never happened, but what would the alternative be? Mr. BLOUGH. To answer your question I would like to refer to the developments between June of 1950 and March of 1951. While I could approach your question without doing so , I believe it may be helpful to deal with that period, since the same general problem is involved, although of course that is not the question you asked. Representative PATMAN . It was going to be asked anyway. Dr. Murphy expected to ask you that question, so you may go ahead. Mr. BLOUGH. It is the same point, one difference being that at that time there was no new financing going on. There was, however, a considerable amount of refinancing, with a weekly turn-over of bills, of something in the neighborhood of $1 billion a week, and certain other refinancing. We had a balanced budget, so the situation was in that respect easier than it will likely be later on. On the other hand, people were in the grip of a very powerful urge to buy things. I can't stress that point too much ; there was a fear that we were going into an all - out war, and a widespread desire to buy things before supplies became short and prices rose. Individuals and businesses bought in advance for later use, hoarding in some cases. Businesses stepped up production and sought to increase their inventories. There was really a very tremendous pressure to buy things and to get the funds with which to buy. Now how could businesses and people get funds with which to buy things under these circumstances ? Well, in the first place many of them had their own funds. They had currency and bank accounts which they could draw on. The economy was very liquid. The velocity of circulation increased substantially during this period. That increase in velocity might have been considerably greater than it was if funds could not have been secured by borrowing. In the second place, it was possible to borrow from the banks, thus adding to spendable funds through increasing the supply of money. It is at this point that Federal Reserve action becomes important. Suppose that the Federal Reserve had during that period refused to buy any securiites from the banks. What might have happened ? I would like to use a rather homely illustration which I hope will clarify rather than obscure my point . Suppose a thousand people urgently desired to go from Washington to Baltimore. This represents the powerful effort to buy goods, which I have mentioned . There are several roads to Baltimore . One of the roads that enables people to go to Baltimore-to spend in buying goods-is the action of the Federal Reserve in buying Government securities. This gives people spendable funds and at the same time enlarges bank reserves, thus increasing the lending power of the banks . We might say well, we will stop that road to Baltimore. But that does not necessarily mean that the thousand people are not going to get to Baltimore, because, in the second place , there would be the possibility that the banks, if they wanted to increase loans, would discount their paper with the Federal Reserve , that is, borrow from the Federal Reserve . Senator DOUGLAS. Short-term Government bonds ? 258 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Mr. BLOUGH. I am thinking of any of those kinds of assets which the Federal Reserve will take for rediscount. I am not at this time thinking about short-term Government securities but of any assets of the bank on which the Federal Reserve bank will lend its money, thereby increasing bank reserves and expanding the lending power of the banks. But the Federal Reserve does not have to discount this paper, as I understand it. It could either say no to the member bank or raise the discount rate to a prohibitive level . While that is quite possible so far as abstract economics is concerned, we must not forget that in setting up the mechanism of rediscounting Congress indicated that the purpose was to accommodate the needs of commerce and business. Senator DOUGLAS. Yes, but Dr. Blough, I want to point out that this might apply in the case of commercial paper but the Federal Reserve was certainly not set up in order to provide a dumping ground for short-term Government securities . Carter Glass was very specific on that point in the debates. Mr. BLOUGH. I have not said anything about short-term Government securities , Senator. Senator DOUGLAS . As a matter of fact isn't it true from the testimony that Mr. Martin gave I think, that the increase in discounts by the Federal Reserve had been discounts of short-term Governments, not commercial paper. I believe he said that discounting of commercial paper had fallen into disuse more than he would like. Mr. BLOUGH. That as a matter of fact I think is correct , but I believe most of the banks hold adequate short-term commercial paper if they wanted to use it as backing for their discounts, so that there certainly is this possibility. But whether or not the basis for the discount is the short-term paper or the short-term Government security, my point is this : That the loans which were being demanded at that time were business loans and that under the statute, an important function of the Federal Reserve is to accommodate commerce and business. I am simply suggesting the heavy pressures from the business community that would be brought to bear upon the Federal Reserve if it refused to accommodate commerce and business by discounting paper presented to it by member banks. But suppose the Federal Reserve was adamant and refused to discount the paper. Well, there is still another road to Baltimore, to continue the illustration. The banks were holding then, as they are now, large quantities of short-term Government securities, some of which were maturing almost continuously. The banks could have allowed these short-term securities to run off, demanding cash instead of resubscribing, thereby increasing the amount of their cash. Now that in itself would not increase their reserves , to be sure, but it would increase the cash assets of the owners of the securities. Senator DOUGLAS . How would the Treasury pay for these shortterm securities ? Mr. BLOUGH. The Treasury would in that case be obliged to get the funds wherever it could get them. Senator DOUGLAS. Where would it get them? Mr. BLOUGH. It could get them from one of two sources. It could attempt in this period of tremendous pressure on the part of all bor- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 259 rowers for funds, to outbid the market for them and thereby get the funds and pay them to the holders of the maturing securities. Senator DOUGLAS . It would raise the interest rate? Mr. BLOUGH. Whatever interest rate was necessary and under those circumstances I suggest the interest rate might have been very high. Or the Federal Reserve might take the short terms off the Treasury's hands, in which case the Federal Reserve would be again adding to the reserves of the member banks. Suppose the Federal Reserve refused to take any of the short-term securities ? So far as I know this has never happened, but suppose it did happen. Then , at last, all of the roads to Baltimore have been closed except the one road of using the funds that people already have, with greater velocity. There is no way the Federal Reserve or anyone else can stop that. Now, perhaps the existing funds at the higher velocity would meet the need for spending power, in which case, perhaps, there would be no problem. But to carry my illustration to the end, it seems to me very likely that on this road, which might be much too narrow, the thousand people could become so involved in trying to get ahead of each other as to cause a riot. In other words, if the Federal Reserve had been adamant at all points, it may well be that a major financial and monetary crisis would have arisen. And if a major financial and monetary crisis arose under those circumstances , either the Federal Reserve would come to the rescue and straighten things out again as best it could at that late date, or, to repeat my earlier thought, I wonder how long the independence of the Federal Reserve System would be permitted to continue by the Congress of the United States . This does not mean that Federal Reserve open-market operations cannot be used with considerable effect, or that the earlier adoption of the accord would have made no difference in the inflationary movement. My point is that shutting off expansions in the supply and velocity of money is not an easy or simple matter. The same general line of reasoning can be applied to the kind of situation which we might expect to face in the future, but with several changes in the circumstances. On the one hand, we probably would not have that tremendous pressure for funds to support spending that we had during the months from July 1950 to March 1951 . I certainly hope that we do not enter a period of that kind again. If we do not, that will be a change on the good side. The situation would be more orderly and more capable of being handled . On the other hand, of course, a large deficit is anticipated . If that deficit is realized , the problem on the financing side will be much bigger than it was in 1950. I do not think the dire possibilities that I have mentioned are at all likely to occur, but to be logically complete we must consider them. Representative BOLLING. As a matter of fact in this case all roads do not lead to Baltimore. They lead to the Federal Reserve. Mr. BLOUGH. All but one, and that is the road of increasing the velocity of circulation . I do not think that road should be underestimated in an economy as liquid as our economy is with its tremendous volume of currency and bank deposits, and the large amounts of near moneys that are available. I do not think we should underesti- 260 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT mate the effects of increases in velocity that might occur under the pressure of tremendous desire for increased funds. Representative BOLLING. Mr. Chairman, I have another question which stems from that, but since this is a whole in itself, if any of the other members had questions on this, I would like to see them have the opportunity to present them at this time. Representative PATMAN. Any comments ? Representative WOLCOTT. I have a general question. I do not know whether they want to answer it offhand or not, but I found myself the day before yesterday at a loss in what I think Senator Douglas characterized as a semantic wilderness . I am just a plain unadulterated Member of Congress here without too much knowledge of economics, and most of the people's representatives are not educated in economics and financial matters . I would hesitate to go back to my people and try to explain to them the recommendations of the Council of Economic Advisers as to just what we can do to stop inflation . Now can somebody, either you or Mr. Keyserling or somebody representing the Council, in very brief understandable language give the recommendations of the Council of Economic Advisers as to what must be done to prevent further inflation, recognizing I think as we all do that we do have inflation . Mr. BLOUGH. Congressman, I would be glad to try. These comments represent my personal views, but I believe they are also the views of the Council. We look upon inflation as a problem of spending against supply, spending being Government spending, consumer spending and business spending for goods and services, including building up inventories, buying new equipment and new construction, and so on. When the spending is in excess of theRepresentative WOLCOTT. Wait just a minute. Let's not go into that any further. I think we all recognize that as the problem. You have stated in your last paragraph as follows : In closing, I would like to repeat that monetary policy and debt management are by no means all there is to the problem of economic stabilization or its solution. The inflationary problem is one of holding down total spending, not simply that relatively small part which is financed by increases in debt, public and private. A well-balanced stabilization program using all the other measures at the disposal of the Government should go along with a monetary and debtmanagement policy that itself should be to the largest practicable extent noninflationary, despite the handicap placed upon it by that basic inflationary influence, too little revenue to match expenditures. That to me is a statement of our problem . Now I want to know what the Council suggests as a remedy, as a solution to the problem. Mr. BLOUGH. I see I started my answer at too basic a level. Representative WOLCOTT. Is it more taxes, is it less spending, and in what fields can there be less spending and how can we increase taxes, if that is the position ? I would like to have you put one, two, three in simple terms your recommendations as to what we might recommend to the Congress, what we should do here as a matter of administration that will solve this problem . Mr. BLOUGH. I think you will find, Congressman Wolcott, that the views of the Council have been expressed in the reviews of 6-month periods, and they involve the following points in the program. First, MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 261 there is spending. Obviously Government spending is very largely the genesis of the problem at the present time. Representative WOLCOTT. Why should it be ? Please explain how Government spending affects the value of money? Mr. BLOUGH. All the different kinds of spending put together—if the total is in excess of the supply of goods when people are fully employed, the demand being in excess of the supply drives prices up. Representative WOLCOTT. Again, can we have an answer to the question as to why spending on the part of the Government or why deficit financing results in inflation ? Mr. BLOUGH. I think that what happens is this. Suppose you had a fully employed economy with the Government spending $40,000 ,000,000. Then with the Government spending $40 billion , and with business spending and consumer spending-all the spending added together is taking all of the goods and services which all of the people are producing working at a high level of employment and a high level of plant operations. Now suppose that the Government undertakes an additional program, that involves, let us say $20 billion additional spending. This $20 billion is used to buy goods and services of various kinds. It is used to pay military personnel, to buy tanks, planes , food , clothing, build military bases, and so forth . That $20 billion is added to the spending that is already taking place by the Government and business and consumers. But there is no increase or very little increase in the supply of goods to meet this increase in demand of $20 billion on the part of the Government . Unless some way is found either to increase the supply of goods without also increasing consumer and business spending or to decrease such spending, we will inevitably get an inflationary pressure. Representative WOLCOTT. That is fundamental . Now what do you suggest is the remedy ? Mr. BLOUGH. Since increased expenditures give rise to the problem, if it were possible to reduce expenditures, as I said beforeRepresentative WOLCOTT. What does the Council recommend by way of reducing expenses ? In what field do we reduce expenses ? Senator Douglas has said every time we try to cut expenses, from the White House down we have a barrage of protests, so that apparently is not the practical solution so long as we are going to be faced with executive opposition, that probably is not the practical way of solving this problem . Mr. BLOUGH. There has been a good deal of reduction of nondefense expenditure in the past 2 or 3 years. It is possible there could be more. The very large part of this problem, however, is in the military side. Representative WOLCOTT. You say it is possible. What can you recommend in that field to us ? Mr. BLOUGH. I am not qualified to make recommendations in the military field . I am sure you will find plenty of people who will recommend specific points to cut. Representative WOLCOTT. People in Government ? Mr. BLOUGH. Some people in Government but no doubt mostly people outside of Government. The budget process, Congressman Wolcott, as you know cuts down the request for appropriations and expenditures by many billions of 262 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT dollars before these programs ever get to the Congress, so that all of the work which has gone before to cut down and hold down expenditures never is observed by the general public, which sees only the figure that is presented to Congress, and which always looks larger in total than anyone would wish. Representative WOLCOTT. It is getting larger and larger all the time. Mr. BLOUGH. The only figures that are getting larger and larger are the military expenditure figures. Even the military appropriation request figures are lower this year than they were last year. Representative WOLCOTT. But still we have inflation . Mr. BLOUGH . We have inflation because Representative WOLCOTT. We are raising more money than we ever raised before. Mr. BLOUGH. But we are not raising enough to meet Representative WOLCOTT. Is that your point, you have got to raise more by taxes ? In other words, have we got to continue throughout the next 8 or 10 years to siphon off inflation through taxation , and if so where do we reach the saturation point ? Mr. BLOUGH. My point is that the source of the problem is in military expenditures, and the amount of those expenditures is determined to an overwhelming extent by forces pretty much outside our control. Representative WOLCOTT. That contemplates a continuance of debtMr. BLOUGH. Not necessarily, sir. Higher taxes can prevent an increase in debt and also reduce inflationary pressures . In order to cut down private demand , the most positive way is of course to take funds out of the private economy through taxation. This has the advantages that it pays the cost directly , immediately through taxes, does not add to the debt, and does not give rise to some of the problems we have been talking about. It cuts down on private spending, and that is the natural and normal way for cutting down inflationary pressures growing out of governmental spending. It has been the accepted way used in the United States throughout our history. Representative WOLCOTT. Now at what point in this tax structure do we arrive at the floor of diminishing returns due to a discouragement of production expansion to keep pace with our expanding economy? That is the problem and the thing that has bothered me. If industry, individuals, agriculture have to get their capital out of earnings, how much of their earnings can we take before we destroy the capital structure which is the foundation that has built this production expansion, which we all agree is necessary to keep pace with an ever expanding economy ? Mr. BLOUGH. You ask for the point of diminishing returns for the tax system as a whole. I don't know the answer to that. Representative WOLCOTT. I think you should find the answer. Unless we just give encouragement to a lot of the platitudes in respect to the desirability of siphoning off this inflation through taxation , I think we had better find out before we go any further as to whether we perhaps have not reached the point now where we are discouraging production expansion to keep pace with our expanding economy, because if we have done that then, of course, any increases that we have legislated in taxes last year and in the future under your recom- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 263 mendation might be inflationary, by prohibiting us from producing sufficiently to meet the demand occasioned by the increase in savings and purchasing power. Mr. BLOUGH. Congressman Wolcott, perhaps I might have been better advised to say what I think we do know about tax limits rather than to start out by saying that I don't know what the specific point is. Representative WOLCOTT. I want to get away from that idea. I think the Council of Economic Advisers should put in a very orderly manner and very simple terms their recommendations as to what the Congress, what the Federal Reserve, what the Treasury and all the rest of them, should do to prevent inflation . I think that is what we are here for. Mr. BLOUGH. I would like to follow up on the point about the limit of taxes. I said I do not know where that limit is, but I intended to go on immediately to say that there is no evidence that I can observe at the present time that during this period of very large Government spending we have reached or in any way closely approached the limit with regard to the burden of taxes in general . There are two kinds of problems. One is the distribution of the burden, the other is the total burden. Neither the distribution nor the total burden seems at the present time to be interfering with the accumulation of large amounts of funds by businesses, the reinvestment of those funds in businesses , and a very high level of industrial growth and expansion . The signs are not there that taxes are interfering with the growth of the economy. Now, certainly we must have in mind the danger that they might interfere with the growth of the economy, and I am not saying that if the expenditures were to be greatly reduced the present level of taxes would not interfere with the growth of the economy. Representative WOLCOTT. Do you think we are getting enough production now to meet nondefense demands and the military demands ? Mr. BLOUGH. The increase in production is not being limited by the willingness or financial ability of business to expand. There are always exceptions, of course. In the soft-goods industries there could be somewhat greater production if consumer spending were higher. In the hard-goods industries materials also are an important factor limiting production . In the defense industries there could be a somewhat larger and more rapid increase of production if plants and facilities were more quickly available. They have to be constructed . There are some important shortages. Representative WOLCOTT. You have got facilities in the automotive industry to produce at least 40 percent more than they are producing now. You have a very serious unemployment situation in Detroit and in some other areas in the United States. We can't convince any of the members of the CIO or the AFL out in Detroit that something serious is not happening to them . Mr. BLOUGH. Congressman Wolcott, until we have reached the point where we have an adequate supply of these materials, we will have to shut down somewhere. In other words, this is a process of diverting-Representative WOLCOTT. Now you bring up the availability of materials. We are told repeatedly that the big bottleneck is in cop- 264 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT per and there isn't any particular shortage of sheet and wrought steel. Warehouses are so full of it that they have difficulty finding places to store it. Mr. BLOUGH. It seems to have been discovered only in the last couple of weeks, and only in some specific items. Representative WOLCOTT. It was discovered by me last fall. A Toledo warehouseman came to me and said, "We don't know where we are going to put another ton of steel. We can't dispose of it. " There are a lot of steel warehousemen out there who are finding it difficult to warehouse this steel. They would like to move it into industry, and the men employed in industry would like to have this steel moving into industry, but that is an entirely different situation . It is a little outside the scope of our discussion here, perhaps , but you haven't come up with a suggestion yet. What is the one phase of your program that you would recommend to stop inflation ? Mr. BLOUGH. I have already talked about two methods that are involved in inflation . Representative WOLCOTT. Taxation ? Mr. BLOUGH. That, of course, is a very fundamental method, and some people think it would be enough all by itself. We have recommended credit restraints ; both the general control of credit and specific methods of restricting the use of credit in purchasing durable goods and new houses and in stock market operation . Representative WOLCOTT. As to discounting, the Federal Reserve has all the authority it needs in that field, and they have not been able to agree yet on recommendations with respect to increasing bank reserves . As a matter of fact, I think Mr. Martin indicated that increased reserve authority probably would not be advisable. I know here a few months ago when we asked him about the reserve situation, whether they needed any additional legislation, they could not agree as to the advisability of it or how much, so it seems as though somebody has abandoned the idea of shutting off credit by either arranging rediscount rates, reserve requirements, and yet they all admit that the pressures on inflation have been lessened by the actions taken in firming up our money policy. And I think it is quite generally agreed that if we do not do something to firm up the dollar here, pretty soon it is going to have an effect upon the world economy, and I might say, to be a little dramatic about it, this world has no hope of peace unless the American dollar is firmed up pretty quickly. Mr. BLOUGH. Let me proceed with the list that you have asked for. Firming up the American dollar is stopping inflation, that is all. One of the methods of credit control is the increase in reserve requirements. The Council has favored an increase in reserve requirements. Another method is the allocation of materials to those needs which are most important. Such allocation is desirable not only for promoting the defense effort and for building up the productive power of the economy but it is desirable also to prevent the pressure of competing demands in the markets by businesses trying to get these materials and bidding the prices way up. So allocation and priorities is an important anti-inflationary method. Another method of restraining inflation, of course, is the direct controls, price control and wage controls, which were put into effect a MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 265 year ago this last January, and which were, I think the turning point in this inflationary movement. Representative WOLCOTT. You say that the Federal Reserve takes the attitude that bonds issued ought no longer be monetized, increased its rediscount rates, and discovery that to support the Government bond market above par was inflationary, so they discontinued that. They maintained that that was the cause, but you fellows in government, if you can't get together on the causes of inflation, how do we in Congress expect to solve the problem ? Mr BLOUGH. I don't think there is any inconsistency. Representative WOLCOTT. We have had this controversy between the White House and the Treasury on one side, and the Federal Reserve on the other, as long ago as the Douglas committee met . We got together, I thought, in a pretty good way. As a matter of fact, Senator Douglas surprises me. When he first came into the Senate here I had some pretty crazy ideas, I find now, about what his policies might be. Senator DOUGLAS . You are becoming a better Democrat every day. Representative WOLCOTT. We are getting so close together that I am either becoming a better Democrat or you are becoming a better Republican . Anyway, we found ourselves so closely together in that report that instead of filing a minority report I just dissented to some minor technicalities in a few footnotes. Yet we recognized this same problem 21½ years ago. We thought that by cracking some heads together we might be able to get somewhere, and I do think we had some executive sessions between the Treasury and Federal Reserve, and two years afterward they met their accord. I would like to think that the accord machinery was started at that time. Two years afterward they met in this " accord." What further should be done in addition to that accord to stabilize our economy, stabilize our money ? Mr. BLOUGH. May I clean up one or two loose ends that have gotten away in the previous discussion ? I said I thought it was the imposition of the wage and price controls in January of 1951 that was the turning point. Before that time there was a tremendous psychological churning, a mass movement of demand for goods. People had been talking about price and wage controls . There was an expectation that they would be put on. Prices were being pushed up, not only because of demand and supply factors, but in order to get ahead of whatever the control would be. Wages had been pushed up also for the same reasons. There was a fever in the air. The price and wage freeze did , I think, put a psychological freeze on the public mind. It was then discovered that inventories had been built up very rapidly, that war shortages were not going to be felt as soon as had been anticipated, and that instead of shortages there were plenty of things to be bought . The Federal Reserve action, which came about the same time, unsettled the investment side of the market, and I think all of it worked together toward quieting down the inflationary movement. 266 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT In my opinion, the turning point in this movement was the freeze of prices and wages in January, but I do not think that view is inconsistent with recognizing a measure of benefit from the action which took place a little later on by the Federal Reserve . Representative WOLCOTT. I do not want to take any more of the time of the committee, but I do wish that I could have an answer to my questions. This committee is trying to work very closely with the Council of Economic Advisers. Make some definite suggestions as to what we might recommend to the Congress in our report by way of a program which will stop this inflation. If you do not, the value of the dollar having already dropped 6 percent in the last 18 months, with the impact on defense spending coming up sometime in the next couple of years, we can anticipate over the next 3 years a further drop in the value of the dollar of about 12 percent, bringing the value of the dollar down to 40 cents . That is the problem we are confronted with here and we have to find a solution to it. I think you owe it to us members who are not ecoonmists who find it rather difficult to understand what you are talking about, to put in very simple terms what we can do to stop inflation . Mr. BLOUGH. May I say that I do not share alarmist expectations about further rises in prices. It seems to me our adjustment to the military program is fairly nearly completed. I do not anticipate the kind of increases you have suggested. Representative WOLCOTT. Right there, do you think that in the next 2 or 3 years that we are not going to have any more inflationary pressure than we are having at the present time ? Mr. BLOUGH. I did not say that. Representative WOLCOTT. What was the import of your remark ? Mr. BLOUGH. The import of my remarks was that my hope, my expectation is that we will not have serious inflationary pressure. Representative WOLCOTT. What is your opinion ? Mr. BLOUGH. My opinion is of course no one knows what is going to happen - we will not have nearly as strong inflationary pressures over the next 2 years as we have had in the last 2, assuming no international flare-up . Representative WOLCOTT. Are the pressures going to be greater or less than they are at the present time ? Mr. BLOUGH. At the present time we are in a rather-the word "lull" has been used. I have used it myself. There is a sideward movement in business. I am somewhat disturbed about the impact of the deficit which will begin to show up in new borrowing before very long. Representative WOLCOTT. That is what I had in mind. If we continue this policy tying the value of our money to debt, we might expect we will have to indulge in deficit financing between $10 and $20 billion in the next 3 years, with the influence deficit financing has had on the dollar, then how can we avoid further depreciation in the value of the dollar ? Mr. BLOUGH. In the relation to the total budget, those amounts will not be nearly as large as they may seem in absolute terms. But the Council has indicated the desirability of higher taxes. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 267 Representative WOLCOTT. You recommend that we raise taxes by $10 billion ?. Mr. BLOUGH. No. If I recall correctly , we recommended that taxes be raised by about $ 5 billion at this time. There can be some noninflationary borrowing. Representative WOLCOTT. You would still have deficit financing by $5 or $6 billion . Mr. BLOUGH. Suppose the deficit should amount to as much as $142 billion, which is the figure in the budget . I don't know how much it will be ; that is pretty far ahead to look. The budget has to look far ahead. Suppose the deficit amounted to $ 14½ billion . About $4½ to $5 billion is received by the trust funds in excess of the payments from the trust funds. That leaves roughly $ 10 billion. If Congress accepted the President's recommendation for an increase in taxes of $5 billion , that would leave $5 billion to be borrowed in the open market. Senator DOUGLAS. Why not cut expenditures by $5 billion ? Mr. BLOUGH. If Congress decides that can safely be done, I would not object. Senator DOUGLAS. What I very frankly object to in the report of the Council of Economic Advisers is that it did not indicate the need for cutting expenditures. I know it is difficult for one branch of the executive to criticize the actions of another branch of the executive, and so I can quite well understand the difficult position in which the Council was placed. But if you offered advice to Congress as well as to the Executive, which I understood Mr. Keyserling said he regarded as a proper function of the Council, we would like to have you offer advice to us with that same degree of frankness which you undoubtedly exhibit to the Executive. Representative WOLCOTT. Will you put in the record language which I can understand as to your recommendations ? Mr. BLOUGH. We can try again, if you wish, Congressman Wolcott, but I think if you will examine the answers I have given to your questions during the last few minutes, you will find that I have given a list of measures which, if adequately followed through, would bring this inflationary pressure under adequate control. Senator DOUGLAS. Is this a cruel question ? In your capacity as an adviser to Congress now, do you advise Congress to cut expenditures by $5 billion or would you prefer not to answer ? Mr. BLOUGH. I always like to answer your questions, Senator, whenever I can. Let me say that I consider myself completely at liberty to discuss with Congress economic trends and developments, the effects and implications of governmental policies, and the different ways in which various policy objectives can be achieved. I am very pleased to have an opportunity to do this, and I try to do it in as objective a manner as my basic attitudes permit. However, in view of the budgetmaking process, a definite recommendation on expenditures, it seems to me, is advice that I can more properly give to the Executive than to Congress. Senator DOUGLAS . I want to say there is no moral wrong attached to your not advising us on this matter. 97308-52-18 268 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT I would like to point out moreover that this is the situation which we are placed in : that the Council of Economic Advisers when it offers advice to the Congress does not ever feel it can offer advice contrary to the recommendations of the Executive . I think we have now put our thinking on an extremely important point of Government structure, which means that once the decision is made by the Executive, the Council of Economic Advisers, whatever advice it may have previously offered, the Executive then cannot go contrary to the decision which the Executive has taken and Congress therefore has to proceed on its own. Representative BOLLING. Isn't there another factor involved there ? The Council of Economic Advisers is not the agency that advises the Executive as to the level that is necessary for military expenditures. Yet its problem when that level is in its judgment going to have the effect of seriously damaging the economy , it then would come within its perview to indicate that the level of expenditures was damaging to the economy, but to that degree they are not the agency that makes the decision by any means. Senator DOUGLAS . That is correct, it is the President who makes the decision. My point is that once the decision is made, then the Council of Economic Advisers apparently cannot offer to us the same frank advice which I hope they offer to the President. Representative BOLLING. But they could be considered to be in a position of having indicated implicitly that they did not think that the economy was going to be damaged by a controlled deficit of $5 billion. There could be very serious areas of disagreement in that. Senator DOUGLAS. That is right. Mr. BLOUGH. I am prepared to say that I think there is no serious problem in managing a cash deficit of $5 billion under these circumstances. Representative WOLCOTT. They should be a little more explicit in their recommendations . Senator DOUGLAS . Well, Congressman, as you know, Senator Benton and I have prepared a supplemental opinion to the report of the congressional committee proposing a reduction in expenditures of 7.6 billions and an increase in revenues of 2.4 billions to balance the budget. I hope we can get your support. Representative WOLCOTT. You surely can on the reduction of expenditures. I might have to take another look at your recommendations to increase taxes. Senator DOUGLAS. With the reduction in expenditures that would leave a deficit of about 212 billion, and if a deficit of 5 billion does not seem too serious to Mr. Blough, I am sure a deficit of 2.5 billion is only half as serious. Mr. BLOUGH. It is less than half as serious in my judgment. Senator DOUGLAS. This is a very grave question . I do not know that it is the fault of the Council, but I think it indicates that the Council in the political nature of events becomes primarily an adviser to the President, and cannot be as frank an adviser to the Congress . Representative BOLLING. Perhaps, Mr. Chairman , it would not be inappropriate to suggest that the chairman of the Council comment on that. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 269 Representative PATMAN. Yes ; I think it would be a fine thing. Would you like to, Mr. Keyserling ? Mr. KEYSERLING. Yes ; I would like to comment. Representative PATMAN. Suppose you pull your chair up next to Dr. Blough. We would like to have your comments. STATEMENT OF LEON H. KEYSERLING- Resumed Mr. KEYSERLING. Yes, I want to comment on two things. First, on the question that Senator Douglas has raised as to the role of the Council, and whether or not it is in a position to express itself frankly. Senator DOUGLAS . Frankly to the Congress that is. Mr. KEYSERLING. Tothe Congress, and second on the question raised by Congressman Wolcott, which I think is very pertinent. As to the first question , I have always felt that I should comment as frankly to the Congress as to the President. I have always felt that if the President on any fundamental matter of economic policy which as a public servant of integrity I felt departed from my-I am using the personal pronoun here because I do not want to involve my colleagues in this-I have always felt that if the President in any recomendations which he made to the Congress on economic policy departed from the advice that we gave to him to the point where a public servant of integrity felt that he was fundamentally repudiated, that such public servant ought to resign and not give the color of his approval to the recommendations of the President. Now of course that involves questions of degree. Nobody would claim that a man of integrity in the Government service resigns every time the President adopts some variation from his suggestion, because that is the proper nature of the Presidential office. But I have felt that basically on major matters people in our position are really in no different position from an adviser in another field , in the field of international policy, in the field of what is needed to protect the country , and that we should stand before the Congress in the same light that we stand before the President as men of integrity willing to support anywhere advise that we give anywhere, insofar as it does not violate confidence. Now coming to the second point—if I have not covered that point fullySenator DOUGLAS. Let me listen before I ask a question. Mr. KEYSERLING. Now coming to the second point, the second point has to do with the Economic Report submitted to the Congress in January which set up certain proposals with respect to the disposition of our resources between public spending and private endeavor, and that gets into the substantial question, Senator and I will try to be very frank with you on that the question of public spending and the deficit. My view is that an inflationary situation is caused when an effort is made to use our total resources more rapidly than resources are available for their use. That effort is made through spending. Consequently the inflationary pressures increase as the effort to spend increases faster than production increases, and I think that this is implicit in the general definition here of inflation , trying to do too 270 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT much too fast, trying to take more out of the economy by way of enjoyments than the economy is producing by way of goods and services. And that is why I have always believed, and I think Congressman Wolcott would agree, that in the long run the solution to the inflationary problem is to do as much as you can to expand your output, use your technology and not cramp it through excessive controls . Now in the short run, after the middle of 1950 , I would say that the inflationary situation rose for these reasons, and I covered them in the beginning of my prepared statement : The Nation was trying to do three things , three basic things : Use resources for the building of capital equipment by private industry. That is what I refer to as investment in the broad sense. Use resources for consumption, which is the second great purpose, and use resources for Government outlays, including an expanding security program, which is the third great purpose. I think the inflation occurred because the Nation was trying to use resources for the total of those three purposes in excess of what the economy would support at its then available productive capacity and , consequently, well, there are lots of ways you can state it. You can say demand exceeded the supply, or the effort to spend money exceeded the available flow of goods, and that caused the inflation . Now the way to deal with that situation in the final analysis gets down to one thing. Until you can solve the problem through production, which you can't in the short run, you must cut the demand. Now the next question is where do you cut the demand, and it is in the approach to that question of where you cut the demand that I begin to make some suggestions which are rather novel to some phases of economic thought, although they are I at least think sound. When a government undertakes through a series of policies to cut demand, it must consider national priorities. That is the essence of it. When the Government is undertaking to cut demand, whether through a cut in public demand through the reduction of public outlays, or through a cut in private demand through higher taxes, or through a cut in private demand through reducing the volume of house construction, it must consider national priorities. In other words, it can't say that as a matter of national priority the appropriate first cut in demand is always public outlays. Now I think as a general statement this is self-evident, because otherwise you would say we should cut the defense program to zero before we attempted to make any cut in private demand through national policy, and nobody would say that. So it comes down to a matter of the priorities which the Congress as the ultimate arbiter of national policy wants to apply in cutting down demand. It has been my personal view that far from-I do not want to introduce a political note in this far from cutting Government spending being a hard thing, I think there are some harder things politically than cutting public outlays for national defense , and I think personally that some of those harder things are what might well be considered in this situation . For example, it seems to me that the level of general consumption by the American people in 1950 and 1951 was too high as measured against our resources and what it seems to me we need to do to help make our contribution to world security. Therefore, since you asked for frank advice and it may be wrong-I will give it to you. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 271 I think the first thing that should have been considered constantly from 1950 until the current time is whether there should not have been more of a cut in the level of consumption . Now, that is not politically easy to do, and I am not giving youSenator DOUGLAS. How would you do that, through an increase in taxes ? Mr. KEYSERLING. A variety of ways. I think an increase in taxes is very important if the taxes are imposed at the right points. Representative WOLCOTT. Rationing? Mr. KEYSERLING. I do not think the shortages were great enough to entail the administrative difficulties of rationing. If the shortages were great enough, yes, but I do not think they were. Representative WOLCOTT. They have not developed yet ? Mr. KEYSERLING. No, sir, not to that extent but I would say that the first thing that I would advise you-of course, that is predicated on a judgment noneconomic in character as to whether the world situation calls for a big security program. Senator DOUGLAS . Dr. Keyserling, what about the possibility of a reduction in governmental expenditures ? Can you say that every dollar is necessary to national security ? What about wastes in the civilian branch and what about wastes in the military branch ? Mr. KEYSERLING. I think I am addressing myself to that problem and will cover it a little more fully, but I am saying one cannot automatically say, since the problem is one of national priorities-and I think that proposition is incontestable-that by definition you should make all of the reduction to the level of total demand which can be supported by the output of the economy in reduced public outlays before you consider reduced private outlays. Now, if you have an economy which is producing $320 billion of goods and services and $200 billion of that, roughly, is in personal consumption and $60 billion of it or $70 billion of it, roughly, is in public outlays, and $50 billion or $60 billion of it, roughly, is in private gross capital formation, I think you have to look at all three of them and to say in terms of the priority of our national purposes, admitting that you have got to cut somewhere and probably cut everywhere, what types of cuts will do us the most good and the least damage in the long run. Now, by those criteria-and I do not think the criteria can be seriously challenged-I would say where we have made our greatest error thus far is in trying to be too easy on cuts in consumption. And that I would feel that we were safer as a nation and still adequately supplied with the good things of life if we cut a little more heavily on that before we cut too heavily on foreign aid and the defense program. Senator DOUGLAS. You would favor an increase in taxes more than a reduction in expenditures ? Mr. KEYSERLING. I would not automatically assume in terms of true economic and national security that a cut in the amount of our resources going into security was preferable to a diminution of our resources going into consumption. Senator DOUGLAS. Are you defending the position that there is no waste in Government ? Mr. KEYSERLING. No, but I think there is waste also in private outlays. 272 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. I understand, but we have little control over private outlays and lots of control overMr. KEYSERLING . You have tremendous control over private outlays .. Take the question of capital formation. Now, as a matter of fact, Senator, when you identify as one of the main areas for economic policy this monetary policy, that is directed toward contracting the availability of funds for private outlays. It does not affect the volume of public expenditures. The volume of public expenditures is determined by appropriations and authorizations by the Congress, so you yourself have identified the importance of private outlays in this inflationary situation. Now I am saying this Senator DOUGLAS. I do not want to use this verb, but why do you move attention to everybody except the governmental budget which is before us ? Mr. KEYSERLING . I am not moving attention awayRepresentative BOLLING. Mr. Keyserling, before you proceed , I would like to interject at that point. I do feel very strongly a rather exaggerated amount of attention is paid to Government expenditures as opposed to the attention paid to these other approaches. Mr. KEYSERLING. I want to carry it a little further, Senator , and I do not think that either my originally prepared statement or what I want to say now goes against the point that you should attempt to squeeze waste out of Government outlays, and I want to say a little bit more about that. But I am trying frankly to answer Congressman Wolcott's question. I am saying that , begining in the middle of 1950 we had an inflationary situation because we were trying to do three things in total too fast against our resources. The total of business invesment, of public spending, and of consumption was too high, and the only way you could have avoided the inflation and the only way you can avoid its recurrence is not letting the total of those three things get higher than our resources can support. And you have got to face that problem. Representative WOLCOTT. Wasn't the overproduction between Korea and 1951 due largely to the threat of allocations ? Mr. KEYSERLING. I did not indicate an overproduction. Representative WOLCOTT. I thought you did. Mr. KEYSERLING . Overbuying . Representative WOLCOTT. I have been under the impression that you have all agreed more or less there was an overproduction in the first 8 months succeeding Korea, which filled up our inventories and filled up the pipelines to the point where the impact of defense spending was not felt. Mr. KEYSERLING. I think there was an overaccumulation of inventories, certainly. Representative WOLCOTT. Then there was an overproduction, wasn't there ? Mr. KEYSERLING . Well, there was an overultilization of resources for that purpose. I think if those resources had been used instead to build more plant capacity or to build more end fighting weapons, we would have been better off, yes. But the point I am making is, let us take the business investment as one example of it. One of the very important factors in the inflation MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 273 during the time that prices were moving upward-and I would like to say something about the question of whether we are still in that situation—we had in the first half of 1950 a $44 billion level of business investment. We had in the second half of 1950 , as I recall , a $54 billion annual rate. Now, of that $54 billion in business investment, $512 billion was net inventory accumulation, which was too high. You take that off, you have still got $481 / 2 billion, which was very high. Now I say that one part of the problem of controlling inflation was to consider as a matter of national policy whether the allocation of resources to that purpose, which I consider one of the three sides of the triangle, was too high on some scale of national priorities. I think you have to have a scale of priorities whenever you start cutting anything. I am inclined to think it was. In other words, I think for example that a million and a quarter houses in 1950 , 1,100,000 houses in 1951nobody knows better than Congressman Wolcott that I am a housing enthusiast, but I think measured against our total resources in that period, that it was too much, and I say that I would rather see that cut some more than to see our defense build -up cut. Representative WOLCOTT. Yet you found in the economic report that we would have to produce , what was it , a million and a quarter houses for the next 10 years to meet the normalMr. KEYSERLING. That was an estimate of the need for high-level employment prior to the emergence of this new defense situation , Congressman . Representative WOLCOTT. You found also it should be cut to 800,000 or 850,000 this year, but you insisted - talking now about cutting Government expenses-that the same number of public housing units be constructed under an 800,000 unit program that you built last year under 1,100,000 . Mr. KEYSERLING. As I recall, Congressman , the number of publichousing units per year is somewhere in the neighborhood of 50,000 or less, and the very point I would make on this is that as you cut the total product, you have to consider more closely the priorities of national need. Representative WOLCOTT. Wait, we should not have gotten into this, but do you think the Government can build houses with less material than private enterprise ? Mr. KEYSERLING. I think when you cut the housing output from a million and a quarter a year to 850,000 a year or 600,000 a year, you have got to be even more careful that the very limited supply goes where it is needed most. Representative WOLCOTT. You say it is needed most in public housing or private housing ? Mr. KEYSERLING. I would say that workers moving into crowded defense areas are less likely to be suitable to home ownership and to paying the current costs of home ownership and current rentals of privately built housing than the mass of the population which is necessary to consume a million and a quarter units of housing. Representative WOLCOTT. I wish you had not brought up this question of housing. 274 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT Senator DOUGLAS. I was just about to say that this beautiful friendship which has been sprouting between us is now being strained to its very limits. We will give a little relief to the hard pressed Keyserling for a moment to say we contemplated the level of public housing for the slums a little over 200,000, and the total housing production of 1,250,000 units . Now we have accepted a cut to 50,000, one- fourth of this figure, when the total number of private units goes down from 1,000,000 to 750,000 . We have accepted a cut of 80 percent where there has only been a cut of 25 percent on private housing. Now you would like to abolish this completely. You live in a beautiful residential city in between the Lakes there at Port Huron, but you go into any major city in the country and you will find the slums rocking the population away, so on this point please , Jesse, don't disturb this new found alliance between us. Representative WOLCOTT. I want to mention that this mansion in that very beautiful city is almost a mile away from the river, and it probably would be comparable to many of the slums in other cities. I find it difficult to maintain a $5,500 valuation on it. Senator DOUGLAS . I would suggest, Jesse, if we want to keep in closs alliance on this matter, don't push Mr. Keyserling too far on this public housing. Representative WOLCOTT. He says in his economic report there were 75,000 started last year and there should be the same number of public housing start this year, although he is cutting the over-all production of housing units from 1,100,00 to 800,000 . I can't reconcile the fact that percentagewise it should be a greater percentage of public housing units this year than there was last year. Mr. KEYSERLING. Congressman Wolcott, I have been talking about the allocation of scant resources, and for the benefit of some of the Members of Congress who have not been here as long as you have, I just want them to know that you and I discussed this housing question at considerable length at various times. Representative WOLCOTT. 1937, 1939, and then it went to sleep until the Eightieth Congress came in. Mr. KEYSERLING. I will come back to the housing thing, but I would like to spend a minute on the general idea I was developing and addressing to the Congressman's question. I am simply saying that, when we found we had a new security burden, the size of the security burden, the pace at which our private capital formation was proceeding, and the pace at which consumption was proceeding, was during that inflationary period higher than we could support. We could not do all those things at once so fully. Now I think that insofar as the Congress is dealing with national policy, is has to decide on a basis of priorities which things it is best to cut first or to exercise pressure to cut first in the interest of the Nation. Now I am perfectly willing to admit, as a believer in the enterprise system, that where other things are equal, you should cut Government spending first, because other things being equal, if you can accomplish result A through private spending or through public spending, you cut the public spending first. But all public spending is based on the theory that you are accomplishing certain things in that way that you can't accomplish through MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 275 private spending. That is the only justification for any public spending. Therefore I say the basic question that has to be decided is what do you think we can better afford to cut, the amount of resources being consumed by the security program, the amount of resources being consumed by the industrial build-up, or the amount of resources being consumed by 155,000,000 consumers generally. That is the first issue of national policy. Now when you address yourself to that issue, then you have the next question : How do you do it ? And that is where you get to the tools. Now I happen to think we should have placed more restraint upon $54 billion of capital formation, for one thing.. What are the tools available for that purpose ? Well, taxation is a general tool that helps to do that, and consequently we were in favor of higher taxes. Specifically, the so-called selective controls are another method of doing it, and that is why we were for some of the selective controls to cut down on the volume of housing. Allocation of materials is another way to do it, and that is why we were for some of the allocation controls, again to cut down on the volume of housing and some other nonessential things. So much for the business side. You have taxation, you have allocations, you have limitations on the use of materials, and you have this tool on which Senator Douglas has placed emphasis, and I want to say again that I think that is a tool that can be used in moderation to cut down on excessive business boom. The only point I made about it is that if you push it too far, you are likely to cut down on the general increase of production or the general expansion of productive facilities on a nondiscriminating basis. Senator DOUGLAS . Is this a cruel question, Mr. Keyserling ? If so , I do not wish to play the part of Torquemada, but do you advise reduction in the total expenditures of the Federal Government ? Mr. KEYSERLING. Let us take that bit by bit. Senator, one of the thingsRepresentative WOLCOTT. You mean these are the trees in the semantic wilderness now ? Mr. KEYSERLING . No. One of the things that stirs me on this is • that I read with enormous admiration the Senator's article in the New York Times of a few weeks ago, and and first few pages of that particularly, pointing out the size and pace of the Russian military build-up. The more recent figures which have come out point to the fact that they are putting 30 percent of their more limited resources into a military build-up, and all the cogent arguments which you there advanced make me feel that the allocation of our resources to national security is not too high against our wealth and strength as a nation. Now think that is a separate question from the question of waste. I think that if by specific examination you can find that the amount of national security which is being produced for $ 50,000,000,000 or $55,000,000,000 can be produced for $40,000,000,000 or $45,000,000,000 , of course that should be done, and I commend the Senator and I commend Congress and I commend anybody who is trying to do that. But I do not think that this is the same thing as saying that we can get along with less security or that automatically a reduction of 276 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT funds allocated for security from fifty or fifty-five to forty or fortyfive is going to produce that kind of economy. It may just produce less security . I think they are two separate questions in the field of national security just the same as in the field of private outlays. My basic position is that I do agree that through better procurement policies, better scheduling policies, and more intense pressure on the part of the Congress, which I applaud, that the military can get a lot more per dollar spent, and that if they got a lot more per dollar spent, they could get a given volume of security with several billion dollars less. But that seems to me to be confused with the quite separate question of whether we are allocating too much of our productive resources to national defense. There you can't apply an economic judgment. You might call it a policy judgment, you might call is a subjective judgment. There I happen to feel that we are not ; and that, on the contrary, what we are not foregoing enough of is in civilian enjoyments on a lush level and all kinds of private capital formation , and I would regard that as a very important guide to policies in these times. I would like to see more efficiency and competence in the security outlays combined with a larger net allocation of our resources to security in the broader sense, because I think we can do that without carrying the consumption level of 155,000,000 people below very wellsustainable levels, and without carrying business development below levels very consistent with building up our productive strength and our tools and our equipment . Now, of course, that is a noneconomic judgment, but the Senator asked me to express frankly my views on this subject. Representative PATMAN. Do you have any other questions, Mr. Bolling? Representative BOLLING. I think mine have been covered. Representative PATMAN. Mr. Douglas ? Senator DOUGLAS . No. Representative PATMAN. Mr. Wolcott ? Representative WOLCOTT. No. Senator DOUGLAS . Senator Flanders could not be here today. He asked that it be stated for the record he has read your statement , Dr. Blough, and he commends it. I don't believe I have any further questions. We want to thank you very much for your attendance and your answers to our questions and for the statement that you have filed for the record ; and we thank you, too, Mr. Keyserling. (The statement referred to is as follows :) SUPPLEMENTARY STATEMENT BY LEON H. KEYSERLING Although the subcommittee was most generous in the time allotted to me in my appearance before it on March 12, 13, and 14, I find upon reading the record that a further amplification of my views may be helpful to the subcommittee, to the Joint Committee on the Economic Report as a whole, and to other interested parties. Consequently, I have prepared this supplementary statement for insertion in the record at the end of my testimony . Limited scope of issues raised during my testimony During my 3 days of testimony before the subcommittee on March 12-14, practically no questions were asked me covering the whole range of credit and monetary policy. Consequently, my views were not elicited concerning the important role of monetary and credit policy in general ; and my testimony should not be construed to minimize this role. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 277 Instead, the central question placed before me was how much importance should be attached to the particular and limited change in monetary policy represented by the accord of March 1951 between the Treasury and the Federal Reserve Board, specifically with reference to its effect upon prices. My testimony before the subcommittee was addressed to the assertion, or at least the intimation , that it was the absence of the policy represented by this accord that was largely or mainly responsible for the serious price inflation between the Korean aggression in mid-1950 and March 1951, and that it was the presence of the accord of March 1951 that was largely or mainly responsible for price stability thereafter. My testimony converged upon the point that I do not believe that this particular accord device, to the extent that it was actually used, was among the more important factors explaining the shift from inflation to stability. The main line of questioning directed to me was based, as I understand it, upon this thesis : That the Federal Reserve Board's support of Treasury obligations on an inflexible basis during the period between the Korean aggression and March 1951 , prior to the accord, made possible and resulted in a large increase in bank reserves ; that this large increase in bank reserves in turn made possible and was responsible for a many times larger increase in bank loans ; and that this large expansion of loans correlated almost exactly with and was mainly responsible for the increase in prices. This thesis, as I understand it, holds that much or most of the inflation during this period would not have taken place if the accord had then been in effect, and similarly that the adoption of the accord in March 1951 has been a powerful or predominant factor in the maintenance of price stability since then. In disagreeing with this thesis, I have not taken and do not take the position that sufficiently drastic use of monetary policy does not importantly affect the price level. Clearly, it does. Further, I agree that the Federal Reserve Board during this period between the Korean aggression and March 1951 could have departed sufficiently drastically from the policy of purchasing Treasury obligations to have drastically affected the volume of bank loans and thus to have reduced business spending and attempted spending sufficiently to have had a very important effect upon the restraint of price inflation. For example, if the Federal Reserve Board had refused absolutely to purchase Government bonds, it would have had an enormous effect upon the whole economy and upon the price level, until that policy was reversed. However, my position in my testimony was based upon my belief that, if the accord between the Federal Reserve Board and the Treasury had taken effect immediately after the Korean aggression, it would not have operated under all the conditions then prevailing in the economy to have changed the degree or nature of Federal Reserve Board purchases of Treasury obligations sufficiently to have affected bank reserves enough to have restrained the volume of loans enough to have had much effect upon business spending and attempted spending. And as the effect upon business spending and upon the amount of funds that business would have had available to try to spend (i. e., competitive bidding for scarce goods ) would in my judgment have been slight, the effect upon total inflationary pressures at that time would have been very slight because inflationary pressures were coming also from intensified consumer buying and from the prospect of rapidly accelerating Government spending. Correspondingly, my belief that the accord of March 1951 has been far less responsible than other factors for the price stability since that date, is not based upon the idea that a drastic contraction of the money supply or of bank reserves or of loans does not affect prices. It is based instead upon the belief that the variant between what the Federal Reserve Board did during this latter period under the accord, and what it would have done in the absence of the accord, did not under all the factors then pertaining have an important enough influence upon bank reserves or loans to affect prices substantially. I ascribe the price stability since February 1951 predominantly to factors other than this accord. This appraisal on my part that the mild variant in Federal Reserve policy has not been the basic factor in the sharp inflationary movement after the Korean aggression, or in the price stability since March 1951 , should not be equated with an assertion that drastic changes in monetary policy or in bank reserves or loans would not substantially affect the price level . I have made no such assertion. I do believe that a change in monetary policy, drastic enough to have had a substantial effect upon price inflation during the period from the Korean aggression to March 1951, would have had damaging effects outweighing the beneficial effects, as I shall subsequently develop in this supplementary statement. But I 278 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT do not believe that there would have been such a drastic change in monetary policy immediately after the Korean aggression even if the accord had been put into effect at that time, and I do not believe that the accord has represented any such drastic change in monetary policy since it has been put into effect. This should not be taken to mean that I condone the price inflation between the Korean aggression and March 1951. I deplore this price inflation as much as anyone else, and believe that more effective measures could have been taken, and should have been taken, to restrain it. But I believe that the measures which would have accomplished this restraint, without damaging consequences outweighing the beneficial consequences, are predominantly outside of the mild variant in monetary policy represented by the accord. It is on this narrow ground that I disagree with the thesis that the absence of the accord was basically responsible for the price inflation between the Korean aggression and March 1951 , or that the adoption of the accord has been basically responsible for the price stability since that time. Other factors seem to me to have been predominantly responsible for the price situation in both periods. Reasons why I do not believe that the accord, as actually employed, has had much effect upon prices I conceded in my testimony that the adoption of the accord in March 1951 may have had some slight effect upon the control of inflation since then, but a lesser effect than a number of other factors. Correspondingly, I stated the view that the absence of the accord was not an important factor in the sharp price inflation during the months immediately following the Korean aggression , and particularly the Chinese intervention. My reasons for believing that the absence of the accord had little to do with the price inflation during the earlier period are as follows : The inflationary pressures between the Korean assault and March 1951 were caused by a total of spending and effort to spend available funds, by business , by consumers, and by Government, in excess of our productive capacity to try to satisfy all these demands without price inflation . The price inflation arose in response to all of these sources of demand, and not just from one of them. To have avoided the price inflation, it would have been necessary to reduce the total demand, and probably to reduce each of the three main segments of demand to which I have referred. If the accord had been in effect between the Korean assault and March 1951 , it would not have reduced Government spending, or consumer spending by much. The main issue is whether it would have reduced business spending and efforts to spend (i . e., use of available funds for competitive bidding) . I do not believe that it would have reduced business spending or efforts to spend by much, because even with the accord business in the main would have found the funds under the circumstances then prevailing to capitalize upon the economic outlook as it was then appraised by business . Of course, there is a correlation between business loans and business spending and efforts to spend ; there is a correlation between business loans and bank reserves ; and there is a correlation between bank reserves and Federal Reserve Board purchases of Treasury obligations. But establishing this correlation does not give the whole picture, because many other factors were at work in the total situation. If the accord had been in effect in late 1950 and early 1951 , the Federal Reserve Board might have purchased less Treasury obligations, but nonetheless the rate of purchase would have had to be very high. If the Federal Reserve Board had purchased less Treasury obligations there would have been a smaller expansion of bank reserves, but not correspondingly smaller, because reserves could be created in other ways. If there had been a smaller expansion of bank reserves than actually took place, there might have been a smaller amount of loans , but not as much smaller, partly because business could have procured some loan funds in other ways. If there had been a contraction of total loans to business, business: spending might have been somewhat reduced, but I do not think it would have been reduced very much because of the amplitude of business financial resources and because of the great incentives to business at that time to exploit the prospects offered by the emerging defense program. And if business spending and attempts to spend had been lower, the inflationary pressures would have been less, but not correspondingly less, because of the importance of other types of spending. Taking all of these factors into account, it seems to me that the inflationary pressures would not have been greatly different during the period under consideration if the support policy of the Federal Reserve Board had then been MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 279 modified to the slight degree that it was in fact modified by the accord of March 1951. My belief that the accord, if it had been in effect in late 1950, would not have been a powerful deterrent upon the over-all level of business activity and spending is supported by the fact that the expansion of bank loans and of business spending, particularly for plant and equipment, continued after the accord. Correspondingly, I do not believe that the adoption of the accord in March 1951 ranks high on the list of factors which have contributed to price stability since that time. After the accord, as I have stated , bank loans and business investment continued to expand, and it is not ascertainable whether they would have expanded at a much more rapid rate if the accord had not been put into effect. The fundamental business outlook, and trends of the defense program, particularly the expansion programs, have primarily conditioned the level of business investment and other spending. As I said in my testimony, I would rate the accord as being less responsible for the past year of price stability than the expansion of production , the rephasing of the defense program, the higher rates of taxation, the increase in voluntary savings, the selective credit restraints, and the price and wage stabilization program. Further, let us not confuse monetary policy in general with the particular device represented by the accord . Certainly monetary policy could be so drastically used as to affect the price level profoundly. The only point I am making is that one particular monetary device, namely, the accord, has not been the main reason for price stability since March 1951 , and its absence was not the main reason for price instability before then. Clearly the accord has had no appreciable effect upon the level of Government spending or upon the size of the Federal deficit, and yet at times some ascribe to these two factors the controlling effect upon the degree of inflation . I have rarely seen an economic analysis which ascribed either the inflation from late 1950 to early 1951, or the stability since March 1951 to the particular monetary device represented by the accord. Most of the analyses which I have seen, made by economists and others, tend to enumerate about the same causal factors as I do, in about the proportion and blend that I have stated them. Significance of correlation between bank loans and price trends between Korean aggression and March 1951 For the reasons which I have indicated above, I do not believe that bank loans would have been sufficiently affected during this period to have had an important effect upon prices even if the accord policy had then been in effect. I think that even if the accord had been in effect under all of the powerful economic forces then prevailing , the Federal Reserve Board policy of supporting Treasury obligations and its consequences upon bank reserves would not have been changed drastically enough to affect bank loans very much, and that consequently the effect upon business spending and attempts to spend would not have been substantial enough to have substantially altered inflationary pressures. A separate and distinct question raised during my testimony was whether, because in this particular period there was an increase of 18 percent in bank loans and an increase of 16 or 17 percent in prices, the conclusion should be drawn that the increase in bank loans was almost the entire explanation of the increase in prices, and that an exact correlation between the two is established as a guide to national policy. I do not accept this conclusion . The fact that A and B took place in approximately the same quantitative degree during a short space of time is not sufficient to establish a theory of cause and effect or to derive national policy. During the period running from 1946 to 1951 there were times when a rapid expansion in bank loans and in the monetary supply was not accompanied by a rise in prices, and also periods when a rise in prices was not accompanied by an expansion in bank loans and in the money supply. Sometimes, in fact, the trends moved in opposite directions. For example, the upward sweep of bank loans during 1951, and particularly the second half of 1951 , was about as steep as during 1950, although 1950 wholesale prices rose very sharply and during most of 1951 wholesale prices moved moderately downward. To take another example, there was an upward movement of the money supply during the last three quarters of 1949, and a downward movement of wholesale prices. To take still another example, bank loans increased enormously from the beginning to the end of 1948 while the money supply was approximately the same at the end of that year as at the beginning of the year. From the third quarter of 1946 to the second quarter of 1947 280 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT wholesale prices increased enormously while the money supply changed very little. From the middle of 1946 to the end of 1951 the money supply, with the 1946 average as the base, increased from a little over 100 to about 115, while bank loans increased from a little over 100 to about 210. I do not cite these figures to establish any particular theory of cause and effect, but merely to show the danger of oversimplification . If someone wanted to ascribe cause and effect predominantly to a different set of factors , one could show that the stabilization of prices started with the price and wage freeze of February 1951 and has been maintained since then ... An overenthusiast for price and wage controls could make the argument that the price inflation from late 1950 to early 1951 was caused predominantly by the absence of price and wage controls, and that the stability thereafter was: caused predominantly by the existence of price and wage controls. I do not ascribe the change-over from inflation to stability to price and wage controls , or to any other single factor. Many factors were at work in both periods . It is intellectually possible to prove almost any causal relationship that someone has made a predetermination to prove, because in our changing and flexible economy some period of time can be found when there is a coexistence of almost any A and almost any B. The fact that there is no clear and precise correlation between the expansion of bank loans and rising prices, especially in the short run , strengthens my belief that the minor change in the volume of bank loans which might have resulted if the accord had been adopted right after the Korean aggression would not have had much effect upon the resulting inflationary price trends. Would it have been desirable, and by what means, to reduce the volume of business spending and attempted spending during the months immediately following the Korean aggression? It seems to me to be skipping a step to consider how business spending and attempted spending might have been reduced during the inflationary period. under discussion , without first asking the question as to how much it would have been desirable to reduce business spending during that period, as against the alternative of reducing other types of spending such as consumption. My own: view is that more stress should have been placed upon the reduction of consumer buying, because much of the business spending was necessary to build up our productive strength. In short, we should analyze what kind of spending it would have been desirable to reduce, before appraising the relative worth of various measures. I readily admit that it would have been desirable during the period under discussion to have had a somewhat lower level of total business spending, since some of that spending was excessive and not necessary to the build-up of our productive strength. For example, there was excessive inventory accumulation .. But here also the analysis to be meaningful must ask what kind of measures should then have been used more extensively than they were in fact used to reduce business spending. On this question, I make these three points : ( 1 ) That the mild variant in Federal Reserve policy represented by the accord of March 1951 , if it had been adopted in the fall of 1950, would not have reduced business 'spending very much for reasons that I have stated above ; ( 2 ) that if the particular monetary device reflected by this accord had been pushed far enough to have had a profound effect upon business spending under the conditions then prevailing, it would undesirably have upset debt management and the general economy, and impaired essential production without being selective enough to weed out the undesirable rather than the desirable types of investment ; and (3 ) that the measures which would have been desirable somewhat to reduce the level of business spending and attempted spending during this period would have fallen mainly outside of the device represented by the later accord . Still more use of higher taxation , selective controls, allocation of materials, limitation. orders upon inventory accumulation and upon nonessential construction , would have been essential to repress further the level of business investment ; and price control would have tended to reduce speculative inventory accumulation. Limitations on drastic use of monetary policy during early stages of defense build-up While I have expressed my belief that the Federal Reserve Board would not under any circumstances have altered the monetary policy sufficiently to have had a major effect upon price inflation in the period immediately after the Korean aggression, I of course admit that a drastic variant in that policy would have affected not only the price structure but also the whole economy very MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 281. greatly. But it is my view that so drastic a policy, if it had been countenanced ,. would have had disadvantages far outweighing its advantages. Such a drastic policy would have thrown confusion into the financial markets,. impaired confidence on the part of ordinary holders of Government bonds, and. raised most difficult problems of debt management. Perhaps more important, for such a drastic policy to have impacted greatly upon the price level, it would have had to exercise a repressive effect upon the general level of production. and employment. This would have run counter to the prime objective of a rapid build-up of our productive strength, which I have regarded as absolutely essential to meet the burdens imposed upon us by the international situation .. Further, I believe that this impact upon production and employment would. not have been selective enough to repress the nonessential or wasteful types of private economic activity, consistent with retaining stimulae to the essential or desirable types of expansion. The general use of monetary policy to fight inflation through the process of general economic contraction, whatever might be said for it under different circumstances, is not suitable to the economic strategy of the mobilization program . That strategy has been based upon rapid expansion of certain vital productive facilities, accompanied by counter-balancing contraction in other areas, and combined with the general purpose of expanding the total production of the economy as the labor force grows and as technology and productivity advance. To reconcile this sound strategy with the containment of inflation requires a much more highly selective variety of restraints upon the economy than are consistent with the generally repressive effects of monetary contraction along theoretical or classical lines. General monetary policy , to be sure, can be used mildly to take the edge off excessive ebullience of inflationary sentiment. But it cannot be used drastically without taking the edge off essential productive advance. The basic weapons for fighting inflation in a mobilization period should be consistent with the accomplishment of mobilization . Nor is it at all clear that drastic restraints upon the money supply, which would have forced prices downward or prevented them from rising, would have had a beneficial effect upon the general standard of living or upon income distribution, even if we conceded these to be desirable or attainable objectives during the early defense period. Not nearly enough analysis has been devoted to this question by economists and others. If drastic restraints on the money supply affected the price level without disturbing maximum production and employment, it could have little effect upon the general standard of living, unless it resulted in a higher level of consumption by diverting more resources away from the defense build-up and from the business build-up. I do not know that it would accomplish this diversionary effect upon resources, and if it did, I would question the desirability under current conditions for reasons which I have already stated fully. On the other hand, if a drastic repression of the money supply reduced production and employment, which it is at least arguable that it might do, then I believe that it would reduce the general standard of living, and, based upon past experience, I think that it would also have an unfavorable impact upon the distribution of income. That is why it seems to me inadequate to try to appraise the economic significance of a trend upward of the money supply or of prices , or a repression of the money supply or of prices, without tracing through to the ultimate effect of these trends upon our economy and our people . The ultimate effect depends upon the level of production and employment, and upon the distribution of resources and of incomes at any given level of production and employment. That is why I believe that the most fruitful economic analysis should commence by looking at these considerations, and then appraise various economic tools, monetary and otherwise, in terms of their impact upon these considerations. In appraising economic developments, price trends should be evaluated in the context of other trends Just as insufficient analysis has been directed to the ultimate effects upon the economy of a drastic monetary policy, I likewise believe that there is a strong tendency to evaluate economic developments excessively in terms of price trends, to the neglect of other very important matters. There has in general been a rising price level for a considerable number of years. During this period, as shown recently by a study of the National Bureau of Economic Research, published in part in the New York Times, there has been a distinct trend toward a larger portion of the national income in real terms: going to those in the lower parts of the income structure. As national production and productivity have expanded greatly, these groups have benefited most,. 282 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT not by dragging others downward, but by they, themselves, moving upward. It seems, also, that this change in the income structure, aside from its effect upon the reduction of poverty and hardship, has helped to make the economy more stable with respect to the maintenance of high levels of employment and production. It may well be argued that it would have been still better if the great advance in total production and employment, and in per capita productivity and standards of living, which has occurred generally during the past 20 years, had been accompanied by a stable price level rather than by a generally rising price level. But this argument does not meet the question of whether, in the dynamics of the American economy, a stable rather than a rising price level would have been consistent with the great productive advances which have taken place. Economists may range themselves on either side of this question ; but the established fact in any event is that we have had a rising price level, and that this has been compatible not only with productive advances which have exceeded the most sanguine expectations, but also with improvements in the income structure from the viewpoint of equity and the reduction of poverty and hardship. It is true that the fixed -income groups have been adversely affected by rising prices. For this reason among others, I have always favored vigorous programs to prevent rapid price inflation. But even on this question of the fixed-income groups, there has been insufficient analysis of the actual situation by economists and others. How many people are in the fixed -income groups in the sense of not having shared in the rising standard of living over a long span of years ? Insofar as they have not shared, would it be more feasible to improve their lot by supplementing their money incomes, and would this cost the economy more or less than the steps which would have to be taken to raise their standards of living by forcing a decline in prices ? And if the price level were forced downward by drastic monetary or other measures, what proportion of the fixed-income groups would be more hurt by such a deflationary policy, through unemployment or otherwise, than other income groups would be hurt? In short, what would be the net effect upon the economy ? I am inclined strongly toward the view that a reasonably stable price level should be the objective of national policy, with advances in national production equitably reflected by increases in money incomes. But while a stable price level seems to me highly desirable, we should guard against the easy assumption that it should always be maintained regardless of other economic objectives ; and we should certainly be on our guard against measuring the desirability or undesirability of economic trends and developments as a whole solely by whether the price level is stable or moving upward or downward. This problem now seems to be very important, because there is evidence that the popular tendency to rivet attention upon price trends has tended to distract attention from other vitally important factors in the economy. For example, I believe that, in the current world situation, we would do better to place relatively more emphasis upon marshaling our productive strength and keeping it fully active, and relatively less emphasis upon controlled stabilization, although both are important. In the long run, I think this change in emphasis would result not only in a richer and stronger economy, but also in a more stable economy. It would also result in a more effective release of the peculiarly dynamic energies of the American enterprise system, and would provide a basis for more unity and less discord and friction among the great functioning groups in the economy with respect both to private and public economic policies. Further, I would not accept without a great deal of qualification any statement that it was the rising price level after the Korean aggression which depressed the standard of living of most of the American people since the defense program started. We have been operating at relatively full employment, and relatively full utilization of our current resources. If the general standard of living has been reduced, or prevented from rising as it otherwise might, it has been because the defense program and the business build-up have commanded a larger share of our total production than they would in more normal times. There is no monetary device or anything else which can provide for the people as high a standard of living as they would be able to have, at full employment, if the defense program and the business build-up took a smaller proportion of our resources. I think the proper thing is to tell this to the American people, so that they will not labor under the illusion that they can have their cake and eat it, too. Considering the importance of the business build-up, and the importance of the security program, I think that the American people should be told that their standard of living has been kept remarkably high during the past 2 years, and not MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 283 that it has been excessively reduced . Measured against the world situation, the American people in the main have not had great sacrifices imposed upon them. Further, I think it in the interest of the American people in the long run to put relatively more resources for a time into the business build-up, and relatively less into the expansion of consumption. By increasing our productive strength, we shall in the long run be able to support and enlarge our current standard of living even if the defense burden remains high. There is no other way to do it. This is not an argument in favor of price inflation. The point I am making is that the general standard of living could not be higher without sacrifice of the defense program or of the business build-up, because our resources are not limitless and they have been used fairly fully during the past 2 years. And of course, I agree that a rapid upward sweep of prices, particularly when it runs ahead of increases in production, is highly undesirable by almost any test. The rapid upsweep of prices in the period after the Korean aggression was clearly undesirable. The Council of Economic Advisers, and I personally, have constantly urged a strong and comprehensive anti-inflationary program whenever the country has been confronted with current or prospective inflationary pressures, because there are many valid and necessary objectives which such a program can well serve. The economics of public spending under current conditions I should like to amplify my testimony with respect to my attitude toward the size and character of public spending during the defense emergency. This involves also the question of balancing the budget, and of the Federal deficit. There are really two issues involved here : First, what economic activities we conduct as a Nation , and second, the method we use to finance these activities. There is a relationship between these two issues, but they need to be analyzed separately for the sake of clarity. I believe that in the United States, with our abundant resources, our maximum economic strength and progress depend primarily on how we use these resources. We should use these resources to maximize production and employment, without excessive strain, because the more we produce the more we have. In order to do this, we must allocate resources sensibly among three great purposes , which are ( 1 ) capital formation and development by business of our productive facilities through the investment process, ( 2 ) immediate consumption by 155 million people, and (3 ) Government programs, mostly national defense under current conditions . If any of these three uses gets seriously out of balance with the others, the economy is weakened. Practically all Government spending, aside from when it is spent in a period of depression to enlarge the total of economic activity, is based upon the idea that utilization of a part of our resources through this degree of Government spending is of a higher order of national priority than if these resources were utilized through business spending or through consumer spending. If the judgment is correct that the Government spending serves a higher priority of national need than would otherwise be served, then as a generalization the spending is justified. Otherwise, and to the extent that it fails to meet this test, it is unjustified. The question of whether Government spending since the Korean outbreak has employed resources which it would have been in the Nation's interest to employ through private spending, turns primarily upon whether the resources absorbed through Government spending have cut excessively into the resources and incentives available for private business activity, or cut excessively into the resources available for immediate consumer use or into the funds that consumers have had available with which to obtain goods and services. I shall not repeat here the facts cited at length in my opening prepared testimony. These facts seem to me to demonstrate conclusively that, in 1950 and 1951 , and prospectively for the years immediately ahead , diversion of resources through Government spending has neither deprived business of the ability and the desire to build up our productive facilities and perform its other functions at an extraordinarily high rate of growth, nor deprived consumers in 1950 and 1951 or prospectively in the years immediately ahead of a very high standard of living indeed. In fact, if world conditions should necessitate a larger security program short of total war, the facts show clearly that even that large a program could be well reconciled with a very healthy allotment of resources both for business development and for .consumer satisfactions. So, by this basic test, I think that the level of public spending predominately for national defense, is consistent with the maintenance of a strong economy, 97308-52-19 284 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT and with the achievement year by year of an even more productive and therefore even stronger economy. There remains, of course, the question of whether the level of public programs, including national defense, is so high as to perform functions which have a lower order of priority than would be served by the private use of the same resources. This, necessarily, is a matter of judgment and not subject to much qualitative analysis. All I can say here is that it is my belief that the security program is not absorbing more of our resources than would be prudent in view of world conditions, and, consequently, since there is also the fact that our economy is being kept strong despite the security program, I would not now favor a sizable reduction of the security program. As to public programs other than national security, I incline to the belief that in the main they are serving needs of the Nation and of our people of at least as high an order of priority as the needs that would be served if the resources were used in some other way. Obviously , there will be wide varieties of opinion about this . There is also the question of whether the size of public outlays contributes to inflationary pressures . Manifestly, there is such a contributtion, because the inflationary pressures have resulted from excess demand at given times relative to available supplies, and Government spending has been a large part of this demand. But that only brings us to the point of deciding what types of demand should be cut first, and in what amounts, to avoid or reduce the inflationary pressures . This again, at least insofar as national policies are involved, is a matter of national priorities. My own reasoning is that it would have been better for us as a Nation, during the inflationary pressures augmenting from the Korean aggression to early 1951 , to have cut back more on private business outlays for nonessentials and on consumer outlays than to have had a slower security build-up which would have been the main way to cut back much on public outlays. The same criteria would apply to consideration of how to reduce inflationary pressures in the future as they may appear, until the defense build-up reaches a point which gives us a larger measure of security in a troubled world than we have thus far attained. As a matter of fact, not enough attention has been paid to the relative magnitudes of private and public spending, and to the relative size of he changes in these magnitudes, in connection with the inflationary problem. For example, comparing the second quarter of 1950 with the first quarter of 1951 , personal consumption expenditures rose from an annual rate of $188 billion to an annual rate of 208 billion ; gross private domestic investment rose from an annual rate of 48 billion to an annual rate of 60 billion ; and purchases of goods and services by the Federal Government rose from an annual rate of 21 billion to an annual rate of 32.4 billion, with expenditures for national security rising from an annual rate of 17 billion to an annual rate of 28.8 billion. It should be clear from these figures, quite aside from the question of national priorities on which I have placed so much stress above, that restraints upon the use of resources by others than the Federal Government is quite as important to the inflationary problem as the restraint of Federal outlays . Yet one would think, from some discussion in some quarters, that attention should be directed almost solely to the matter of Federal outlays. Moreover, there is need for closer analysis of how much of a cut in Federal outlays, or in fact in total outlays throughout the economy, would be necessary even if the avoidance of inflation were our only national problem. I submit that the events of recent months have tended to vindicate the views I expressed much earlier, that the American economy had the productive power in the long run to carry the kind of security program being contemplated without great or excessive inflationary or other strain. Price stability has been maintained for more than a year, and both wholesale and retail prices are now tending downward . Employment is not too high, and unemployment is by no means too low. There is definite slack in some parts of the economy, and many businessmen fear , I believe erroneously, that a general slack will become pronounced before very long. Through the productive expansion programs, many of the basic material shortages of not long ago have practically been overcome. The effective workweek is relatively low, certainly as contrasted with the World War II situation. The technology and other resources available for the further expansion of production lead to the conclusion that, unless the economy gets excessively slack, we will increase our total output by well over 5 percent per annum during the next few years short of a total war. All in all, I cannot see anything in the current economic situation or outlook to justify the conclusion that the security program must be slashed in order to MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 285 avoid dangerous inflation. On the contrary, I believe that the now proposed security program can be fully maintained consistently with the maintenance of price stability, if we hold on to and keep in good working order the variety of anti-inflationary tools which are now in active use. I think it would be most imprudent now to get rid of these tools , because some new international incident or some other cause for a change in the psychology of businessmen or consumers. could result in a new wave of buying similar to that which took place after the Chinese intervention. In summary or this phase of my argument, of course Federal spending and security outlays should be reduced if they are serving needs which as a Nation we should be serving on a smaller scale. But the proposition that, independently of this, or even recognizing the magnitude of the international danger, we should reduce our own defense build-up or the Mutual Security Program in order to protect our economy from danger, is a proposition to which I cannot subscribe. Since we clearly have the productive resources to support what we are now trying to do, this brings me to the second phase of the analysis : How should what we are trying to do be financed ? In other words, what would be preferable, a reduction in expenditures or an increase in taxes? I believe that an increase in taxes of about $5 billion at this time could be imposed, if wisely apportioned , without having a dampening effect upon the level of business investment and the level of consumer enjoyments which we ought to try to sustain during the defense emergency. I will not labor this point, because it seems clear that for all practical purposes the Congress has already arrived at a decision not to increase taxes along these lines. I yield to this decision, because the Congress is the appropriate body to decide such ultimate issues of national economic policy. But it does not automatically follow, even assuming no increase in taxes, that such inflationary pressures upon the economy as would result from the size of the deficit created by the expenditure program recommended by the President, would outweight the dangers involved in slashing our own defense program or the Mutual S. curity Program. The size of the Federal deficit is not the only factor bearing upon the degree of inflationary pressures. Based upon the analysis of the whole economic outlook which I have made above, it seems to me that a deficit of the size in prospect, if taxes are not raised and expenditures not cut appreciably, would not be inconsistent with the maintenance of a stable price level through the antiinflationary program now in effect. This conclusion is based in part on the fact that developments since January would indicate now a smaller estimate as to the size of the prospective deficit than the estimate which was made in early January. The conclusion is also based in part upon the fact that, even at current tax rates, a budget balance could be achieved within a year or two when the defense build-up will have passed its peak and when the productive output of the economy at reasonably full employment will have further increased a great deal. It is based also upon the observation that many other factors besides the budget affect the degree of inflationary pressures. There remains, finally, the question of the size of the national debt. If other things were equal, it would be desirable to reduce that debt. But the world situation being what it is , I cannot reach the conclusion that an increase in the national debt by 5 to 10 billion dollars a year, or even somewhat more, would confront us with unmanageable problems , in view of the fact that we have the resources to increase our national product by about $20 billion a year without strain, and in view of the fact that such an annual increase in productive output would be about three times the total annual carrying charges on the national debt. None of what I have said should be taken to minimize the seriousness of a deficit or of an expanding national debt, but merely to set these factors in the perspective of the whole economy and all of the urgent problems with which we must deal. Interest manifested by the Council in Government economy A question raised during my testimony as to whether those members of the Council appearing before the subcommittee had any recommendations to make to the subcommittee as to how or where the budget submitted by the President might be cut, prompts me to the following clarification of my position. The Council of Economic Advisers as a whole, and I as well, have constantly emphasized that the outlays of the Federal Government in these times should be held to the lowest levels consistent with the hard effort we are now making 286 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT to improve the security position of the free world, and with other essential national purposes. It would not be correct to assume, because I did not urge before the subcommittee that the President's budget as submitted to the Congress be cut drastically, that I have not been interested or active in trying to help to hold down Federal outlays to the lowest safe and prudent levels in these times. Before the President submits his budget to the Congress, there are months of detailed and searching study, examination, consultation, and advice. In this process, the Council of Economic Advisers participates. And in this process, huge cuts have taken place in the estimates made by various departments and agencies. It is a matter of common knowledge, for example, that the estimates for defense outlays contained in the President's budget as sent to the Congress are tens of billions of dollars lower than the estimates made by some defense officials. I would make a rough calculation that the total of the estimates originally submitted to the Bureau of the Budget and to the President by all the agencies and departments of the Government were many tens of billions of dollars higher than the total in the final budget as submitted by the President to the Congress. In this budget-making process, the Council of Economic Advisers has had its chance to exercise, and has exercised, its influence in the direction of economy. The proper time for us to exercise this influence is before the President submits his budget to the Congress, rather than to come before congressional committees and take issue with the President's budget in open hearings. This is true for reasons that I try to set forth fully in this statement, in my discussion of the relationship of the Council of Economic Advisers to the President and to the Congress. So I hope the subcommittee will not think that the members of the Council and I, personally, are not interested in proper economy, and have not exerted great efforts to help achieve it, just because I have not responded to the invitation to point out to the subcommittee how much or where the President's budget could or should be cut. But I would not be frank if I left the idea, by way of indirect intimation, that I think the budget ought to be slashed but am not in a position to say so here. Broadly speaking, I have already participated in the considerations leading to the formulation of the budget, and, broadly speaking, I think that it is not out of line with our national needs and our economic ability to serve these needs without weakening our economy. This issue turns primarily upon the size and pace of our security program , both domestic and international. I read with enormous admiration Senator Douglas' article in the New York Times of a few weeks ago, particularly the first part of it which pointed to the size and pace of the Russian build-up of their offensive striking forces. The most recent figures which have come out indicate that the Russians are putting above 30 percent of their resources, which are much more limited than ours, into their military build-up. I cannot bring myself to believe that the proportion of our total productive resources which the budget proposes that we allocate to national security is too high , measured against our wealth and strength as a Nation and our further productive capacity. The dollars requested for national defense are one measurement of the size and pace of the program. Relationship of the Council to congressional committees Senator Douglas raised certain questions concerning the degree of freedom with which members of the Council of Economic Advisers can express their views to congressional committees, since the Council is advisory to the President. The Council of Economic Advisers is established by law in the executive branch of the Government, in fact in the Executive Office of the President, and its members are appointed by the President and confirmed by the Senate. The main duties of the Council, as defined by the Employment Act of 1946, are to study economic trends and the economic outlook and also national economic policies and programs, to advise the President with respect to these matters, and to assist the President in the preparation of his Economic Reports to the Congress which deal with these matters and contain a comprehensive program of specific recommendations to encourage the stability and growth of the economy under a system of free competitive enterprise. The phrasing of the statute also set forth for the Nation as an objective the promotion of maximum employment, production and purchasing power. It is thus clear that the members of the Council are employees of and advisers to the President, and that they are not employees of and advisers to the Congress in the same sense. But this does not mean, in my opinion, that the members of the Council cannot or should not testify before, cooperate and consult with, and in a sense MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 287 give advice to, committees of the Congress, just as this is done by heads of other agencies in the executive branch, and even other agencies in the Executive Office of the President such as the National Security Resources Board, who are appointed by the President and confirmed by the Senate under statutes defining their functions and responsibilities, and who are employees of and advisers to the President in the sense that they work under his direction as members of his "official family” and may, of course, be dismissed by him . The Economic Report of the President to the Congress is prepared by the President with the assistance and advice of the Council of Economic Advisers, just as presumably a message appraising the international situation and recommending international policies is prepared and transmitted to the Congress by the President with the assistance and advice of the Secretary of State and his staff ; just as presumably a message appraising our security needs and making recommendations for defense outlays is prepared and transmitted by the President to the Congress with the assistance and advice of the Secretary of Defense and other people in the Defense Establishment ; and just as presumably heads of other agencies not of Cabinet rank advise and assist the President in the same way when he sends appraisals and recommendations to the Congress in the field designated for the operations of these other officials by statute. In all of these cases, under the way our Government now operates and has generally operated , none of these officials except in rare instances makes available to the public or to the Congress the nature of the advice he gives to the President while he is assisting and advising the President in the preparation of such Presidential messages and the recommendations contained therein ; and likewise, it is only in rare instances that such officials make it known to the public or even to the Congress if there is a variance between the advice they give to the President and the extent to which the President follows that advice and conforms to the recommendations contained therein in the messages sent by the President to the Congress after getting that assistance and advice. Nonetheless, after the Presidential message in question and the recommendations contained therein are sent to the Congress and to the congressional committee or committees concerned therewith, it has been practically the universal custom and is entirely appropriate for those officials whose statutory responsibilities make it clear that they have been advisers to the President in the field covered by such Presidential message and recommendations to appear before such congressional committees, to discuss and analyze the matters involved, and in fact to amplify and support the recommendations made by the President and the analysis underlying them. In addition, it has been the almost universal custom and entirely appropriate for such officials to appear before congressional committees and to make analyses and give advice in the fields in which they operate under statute, even when this has not been preceded by a Presidential message covering the specific matters before the committee. In appearing before committees of the Congress in this role, I cannot see where the Council of Economic Advisers is doing any different or appearing in any different light from what is done by heads of other agencies working in different fields. And I have never seen any valid reason why the members of the Council, in view of the statute under which they operate and the nature of their role, should follow a contrary course or differentiate between themselves and the heads of the other agencies to whom I have referred above. Certainly, the distinction cannot be that the members of the Council deal with economic problems, because many heads of many other agencies deal with economic problems, or even predominately with economic problems. That this construction of the Council's role is correct is supported by the legislative history of the Employment Act, by the expressed views of some of the legislative sponsors of the act, by the fact that the Joint Committee on the Economic Report and other congressional committees have frequently invited the members of the Council to appear before them for this purpose, and by the fact that doing so is in accord with the Council's responsibilities as defined by the President. More important, it is in accord with the whole tenor of the American system of Government, and I believe it a good and healthy thing that public officials should be subjected to the questioning and testing of their views by congressional committees, particularly when these public officials have been appointed and confirmed under acts of Congress to deal with the very subject matters which these committees are considering and to help in the preparation of the very reports and recommendations which the President sends to these committees. 288 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT The next phase of the question is whether the members of the Council are in a position to express themselves frankly and fully to congressional committees, in view of the fact that they are advisers to the President, and in view of the fact that the advice and recommendations that they give to the President may at times not be exactly the same as the advice and recommendations which the President transmits to the Congress. There has been considerable interest in this subject, and I am glad of this opportunity to express my views. I believe that members of the Council of Economic Advisers are in exactly the same position, with respect to expressing themselves frankly and fully before congressional committees, as any other agency heads of integrity who have advised the President in important fields in which the President makes recommendations to the Congress. Under our system, no responsible official in such a position, while working for the President, parades before the public or before congressional committees the differences of viewpoint that there may be between himself and the President on matters under consideration by the Congress . If these differences are minor in character, the responsible public official does not feel entitled to the luxury or self-satisfaction of having the President agree with him in every detail ; Government could not function if that were expected. But if the President, in his recommendations to the Congress, were to depart from the analysis and advice given him by the official in question to the extent that it could be regarded as a fundamental repudiation of that official's views, the official of integrity should resign where under all the circumstances he believes it in the national interest to do so . But it seems to me incorrect to say that a public official in this kind of job can place himself in open conflict with the President for whom he works, and at the same time stay on the job. Obviously, also , a man of integrity should resign if the President for whom he works should ask him to go before a congressional committee or anywhere else and stultify himself by making analyses or supporting policies which this official believes to be against the national interest. The view has been expressed in some quarters , that members of the Council of Economic Advisers, in order never to be faced with a choice based upon the situations described above, should solve the problem by advising the President but by refusing to appear before congressional committees to analyze and support those recommendations by the President to the Congress which are in accord with the advice they have given him. I can see no more reason why the members of the Council should duck their basic responsibilities by so doing than why other officials should thus avoid their responsibilities . Under our system, if it is to function and if congressional committees are intelligently to process reports and recommendations sent to them by the President, there must be and there always has been someone from the executive branch available and ready to come before the congressional committees and to work with them in the customary fashion. With respect to analyses and recommendations sent by the President to the Congress in those areas of economic policy which are the province of the Council as defined by statute, if the members of the Council are not the proper persons to come before the congressional committees for this purpose, then who are the proper persons ? If my analysis is at all correct, it seems to me that for a member of a congressional committee to raise a question about my freedom to be frank, or whether I agree with recommendations made by the President, or whether after the President has sent up recommendations I am estopped from expressing my own views, is the same as asking that question of the head of some other statutory agency of Government appearing before a congressional committee. My own answer to the question is as follows : I always have and always will try to speak frankly and deal fairly with congressional committees. I ask the subcommittee to assume what is in fact the truth, that the analyses and recommendations which I make to it are consistent with the analyses and recommendations which I make to the President. So long as the recommendations made by the President to the Congress conform in the main to the recommendations which I have given him, I feel privileged and duty-bound in appearing before a congressional committee to give my reasons for supporting those recommendations . If the President were to fundamentally repudiate my views as to what is in the Nation's economic interest, and were to send recommendations to the Congress in basic conflict with them, then I would resign. That situation has not arisen. At all times, consequently, I hope this subcommittee will feel that the analyses and recommendations I present to it represent my honest convictions. I would not present them if they did not. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 289 I hope that the subcommittee will excuse the length at which I have covered this subject, but it goes to the heart of the relationship between the Joint Committee on the Economic Report and the Council of Economic Advisers, and I feel strongly about it. Representative WOLCOTT. Mr. Chairman, I will not be able to be here next week, but I assure you that I will follow the hearings . Representative PATMAN. Next week we will have our hearings in 362 Old House Office Building. That is the caucus room, the third floor of the Old House Office Building. Our session will commence at 10 o'clock in the morning. The first day, March 17, we will have Mr. Marion B. Folsom and Mr. J. Cameron Thompson, of the Committee for Economic Development ; Mr. W. L. Hemingway, of the American Bankers ' Association ; and Mr. John F. Fennelly, of the Investment Bankers' Association. That is for Monday. We will stand in recess until Monday morning at 10 o'clock. (Whereupon, at 1:05 p. m. , the subcommittee recessed to reconvene at 10 a. m. Monday, March 17, 1952. ) MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT MONDAY, MARCH 17, 1952 CONGRESS OF THE UNITED STATES, SUBCOMMITTEE ON GENERAL CREDIT CONTROL AND DEBT MANAGEMENT OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, Washington, D. C. The subcommittee met, pursuant to recess, at 10:10 a . m. , in the caucus room, Old House Office Building, Representative Wright Patman (chairman of the subcommittee) presiding. Present : Representative Patman , Senators Douglas and Flanders, and Representative Bolling. Also present : Grover W. Ensley, staff director ; Henry Murphy, economist for the subcommittee ; and John W. Lehman, clerk to the full committee. Representative PATMAN. The committee will please come to order. We will hear first from Mr. Marion B. Folsom, representing the Committee for Economic Development. Mr. Folsom is chairman of the board of trustees of the Committee for Economic Development, treasurer of the Eastman Kodak Co. , a member of the Board of Directors of the Federal Reserve Bank of New York, formerly a member of the board of directors of the Buffalo branch of that bank, and a member of the Advisory Committee on Social Security, which advised the Social Security Board and the Senate Finance Committee in connection with the comprehensive revision of the Social Security Act in 1939. Mr. Folsom, we will be very glad to hear from you. The statement which you furnished the committee last Thursday or Friday has been furnished to each member of our committee-I went over the statement myself yesterday. You may proceed . STATEMENT OF MARION B. FOLSOM, CHAIRMAN, BOARD TRUSTEES, COMMITTEE FOR ECONOMIC DEVELOPMENT OF Mr. FOLSOM. Mr. Chairman , Mr. Thomson is also appearing with me today, and I would appreciate it if the committee would give us an opportunity to go through our statement, both, first, and then you can question us later, because many of the questions you might ask me will probably be answered in Mr. Thomson's statement. Senator DOUGLAS . That is probably a wise request. Mr. FOLSOM. I am appearing this morning in my capacity as Chairman of the Committee for Economic Development. 291 292 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT The Committee for Economic Development is an organization of businessmen and educators formed to study and report on the problems of achieving and maintaining a high level of employment and production within a free economy. Its research and policy committee issues from time to time statements of national policy containing recommendations for action which, in the committee's judgment, will contribute to maintaining productive employment and a rising standard of living. I am pleased to have the opportunity to appear here, along with Mr. Thomson, to discuss CED's views on monetary policy at the request of your committee. CED has regarded the problem of monetary policy as one of the four or five basic problems involved in the efficient operation of a free society. In 1948 the committee issued a statement entitled "Monetary and Fiscal Policy for Greater Economic Stability," in which we presented our general recommendations in this field. We have also published two research reports by Dr. E. A. Goldenweiser, who was Director of Research of the Federal Reserve Board from 1926 to 1945. We are submitting copies of our policy statement and Dr. Goldenweiser's books for the use of the subcommittee and its staff. For the past 2 years a CED subcommittee under the chairmanship of Mr. Thomson has been studying the difficult problems of monetary policy in an attempt to make our recommendations more complete and definite. We hope to issue a policy statement on this subject later this year. Pending issuance of that statement our remarks here must be regarded to some extent as our individual views, although I believe we can represent fairly accurately the current thinking of our committee members. In our work we have consistently approached the problem of monetary policy as part of the problem of maintaining economic stabilityof avoiding serious depressions and serious inflations. Certainly before this committee I do not need to elaborate the tremendous importance of economic stability to the welfare of the American people and to the survival of the American free society. The Joint Committee on the Economic Report, like the other mechanisms of the Employment Act, was created because of the great national concern over instability of our economy. Since the end of the war we have escaped serious unemployment- the aspect of the instability problem that was most feared 6 or 7 years ago. But we have had enough recent experience with inflation-the other aspect of the instability problemto remind us that the problem has not been solved . We have found, in CED , that whenever we approach the problem of economic stability, and from whatever angle we approach the problem we come quickly to the question "What can monetary policy do ?" The fact that your committee has twice undertaken to study monetary policy suggests that you also have found monetary policy to lie close to the heart of the stabilization problem. The national interest in monetary problems, so much in evidence in the past few years, is not a theoretical or academic interest. It is a practical interest in the problem of stabilization-specifically in the problem of inflation. I suppose this is obvious. But I point it out because unless we remember what our practical interest is we are in danger of getting off the track in an area that is the subject of so many traditional slogans and so much subtle theorizing. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 293 Reasonable judgments about monetary policy for economic stability cannot be reached by looking at monetary policy alone. Monetary policy is, of course, not the only instrument of national policy that affects and can be used to promote economic stabilization . Each of these instruments has certain difficulties and limitations. If any one of these instruments is examined by itself these difficulties are likely to appear overwhelming. The conclusion is likely to be that the difficulties of this particular instrument are so great that we had better seek stability by other means-that is, by means whose difficulties we have not explored . Specifically, if we look at monetary restriction alone as a means of preventing inflation we see certain difficulties : (a ) There is considerable disagreement among experts about the effectiveness of monetary restriction in preventing inflation ; (b ) Monetary restriction may have unsettling effects upon capital markets ; (c) Monetary restriction is likely to raise the interest charge on the Federal debt . These difficulties might lead one to the conclusion that monetary restriction should play only a minor part in the restraint of inflation , and that reliance should be placed instead on other measures , such as budget policy or direct controls. This conclusion would be unjustified. The alternative to monetary restriction also involves real costs and risks, which must be considered in deciding on the role of monetary restriction . One alternative is higher taxes. But there is uncertainty as to how effective higher taxes above the present level would be in restraining inflation . The taxes might be passed on in higher prices or might simply reduce saving. Higher taxes will weaken incentives to produce and may cause serious inequities. Moreover, it is only realistic to recognize that higher taxes are unlikely to be adopted. Another alternative is reduction of Government expenditures . I am confident that Government economy should and can make a great contribution to economic stability in present circumstances. But here again action to the extent needed is difficult to achieve. A third alternative is direct Government controls over prices, wage rates, investment, and production. How much contribution such controls can make to stability is uncertain . Direct controls are difficult to administer at best, and would be likely to break down if unrestricted credit expansion were permitted greatly to increase the purchasing power of businesses and consumers. In any event , I am certain that whatever is accomplished by these controls will be purchased at great cost to efficiency and economic growth and to the freedom of our economic system . And so we come back to monetary restriction , not because it is easy or without costs but because its difficulties look less formidable when compared with the alternatives. The stabilization problem is a problem of getting a reasonably adequate result out of the use of a number of imperfect instruments in a balanced combination. It is our belief that in such a combination monetary policy will always have an important role to play. The relative emphasis to be placed on different instruments depends upon the circumstances. Considering only inflationary situations, the 294 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT reliance upon direct controls should probably be greater in a time of complete mobilization than in a period of limited mobilization like the present. Also we should probably rely more on budget policy, specifically on budget surpluses , in a period of normal budgets than in a period of extraordinarily large budgets. I should like to indicate briefly what seems to us a balanced combination of instruments to be used to prevent further inflation during the present defense program . First, we believe that direct price and wage controls have only a stop-gap function in the present situation. They can help us temporarily to avoid some of the consequences of failure to use other measures adequately. Such support as there is for direct price and wage controls stems from the belief that they are necessary, not from the belief that they are good. But surely whether or not such controls are necessary depends upon what is done by other means-notably by fiscal and monetary policy. It is the function of these other means to create a situation in which we are reasonably safeguarded against serious inflation. It is the function of direct price and wage controls to disappear when that situation has been created. Second, we believe that balancing the cash budget is a desirable and achievable goal of fiscal policy. A balanced cash budget would make an important contribution to the avoidance of further inflation . It does not, of course, provide a guarantee against inflation ; much depends on the type of taxes imposed , the size of the tax burden , and the strength of the inflationary forces. In addition to its anti -inflationary effect, we believe that adherence to the pay- as-you-go principle is desirable in order to preserve one of the few forces now working in the direction of Government economy . The real question in most people's minds is whether the budget can be balanced. It appears to us realistic to estimate that on a cash basis revenues from present taxes would fall about $7 billion short of expenditures for the programs proposed in the fiscal 1953 budget. We believe that approximately this amount could probably be cut from the proposed expenditures without reducing the real content of the security programs or interfering with other essential Government functions. We have tentatively estimated that about 4 billion of this total saving could be achieved by more rigorous screening of military requirements and specifications and by more efficient military procurement. Senator DOUGLAS . Mr. Folsom, I must ask pardon for breaking the rule which you wanted to lay down at the beginning, to say that great minds move in the same channel. It so happens that in the economic report of our Joint Congressional Committee on the Economic Report I make an identical estimate of $4 billion to be saved out of the military budget, so I am delighted that we move together. Mr. FOLSOM. I might say, sir, that we originally had ourselves set at 6 billion, but upon further study we had to raise it up to 7 billion. As I say, we believe that the fiscal 1953 cash budget could be balanced without a tax increase. However, we do not have sufficient information about the military programs, which are the core of the problem, to be sure that this is the case. By the time the hearings on the military appropriations are completed Congress should have a much firmer judgment on how much can be saved. If it should be the judgment of Congress that an amount large enough to balance the MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 295 budget cannot be saved , consideration should be given to the enactment of a broad-based consumption tax. Given a balanced cash budget, it should be the function of monetary policy to prevent the existence of any significant excess of total demand for goods over the supply. In case the cash budget is not balanced , monetary restraint will become more difficult but may be even more important. Under the head of monetary policy I include not only the use of the Federal Reserve's powers but also the management of the Federal debt and other steps taken by the Government to promote saving. It will be noted that the function assigned to monetary policy is a residual one, and the precise degree of monetary restriction called for is uncertain . No one can tell just how strong inflationary pressure will be in the next year or 18 months. Therefore no one can tell just how much anti -inflationary action is required. It is necessary and proper that this uncertainty should be concentrated on monetary policy. One of the great advantages of monetary policy is that it can be flexibly adapted to changing economic conditions. Tax rates and expenditure programs, on the other hand, must be decided for a period at least 12 months ahead, and after a considerable period of deliberation. It is an efficient division of labor between monetary policy and budget policy to plan in advance for a balanced budget and to leave to monetary policy the task of shorter-period adjustment to variable and unforeseeable economic conditions. We believe that this task, of working alongside a balanced budget to prevent further serious inflation , is within the capacity of monetary policy. More important we believe that the costs of such a policy will be less than the costs of the alternatives-which are more inflation, more taxes, or more reliance upon a price- wage control system working against strong pressure. The costs of monetary restriction are usually thought of in terms of the effects upon interest rates. These costs are not likely to be large unless the inflationary pressure is great-greater than now seems probable. But if the inflationary pressure is great, the value of a restrictive monetary policy, and the costs of the alternatives, will be correspondingly great. In his reply to this subcommittee's question about the economic objectives of the Treasury, Secretary Snyder listed as number 7 "to hold down the interest cost of the public debt to the extent that this is consistent with the foregoing objectives," and included among the foregoing objectives "to use debt policy cooperatively with monetarycredit policy to contribute toward healthy economic growth and reasonable stability in the value of the dollar." I think this is a sound appraisal of the position of low interest costs among the objectives of national policy. Also it is important to note that we have now crossed the bridge of allowing Government bonds to fall below par. During the past year we have demonstrated that it was not necessary for the Federal Reserve to peg prices at some predetermined level, that Government bonds can stand on their own feet, and that we can have a genuine market in Government securities with none of the catastrophic consequences that were once predicted . It seems probable that financial markets and investors are fairly well adjusted to the prospect of some variation in the prices of Government securities. If anti -inflationary monetary 296 MONETARY POLICY AND MANAGEMEN MANA T OF PUBLIC DEBT policy should result in some further decline of bond prices this is less likely to produce a financial panic or similarly extreme result than was the first drop below 100 a year ago-assuming, of course, that care is taken to maintain orderly market conditions . This means that we can carry on a flexible monetary policy with more confidence . Mr. Thomson will discuss the problem of carrying out an effective monetary policy, and I want to make only one general observation on that subject. We believe that the existing powers, techniques and organizational arrangements are adequate for the performance of the function of monetary policy. This does not mean that improvements may not be possible. We should keep an open mind on that subject. But it means that deficiencies in powers, techniques and organization have not been the main cause of inadequacies in monetary policy in the past and are unlikely to be the main cause in the future. The main problem is to get a wider agreed understanding of the potentialities, functions, and methods of monetary policy. Without such an understanding no changes of techniques or organizations can prevent a vacillating and ineffective policy. With such an understanding, present arrangements can work very well. Forward steps in money and debt policy during the past year have been due to improved appreciation of the fundamental issues. The investigation conducted by the subcommittee under Senator Douglas made a major contribution to this improvement. We are confident that the present investigation will make a similarly important contribution to better understanding and thereby to better policy. Thank you, Mr. Chairman. Now, if Mr. Thomson can present his statement. Representative PATMAN. We shall be very glad to accede to your request that the two of you be heard before yielding to questions. Our next witness is Mr. J. Cameron Thomson, also representing the Committee for Economic Development. He is chairman of the Committee for Economic Development's committee on monetary, fiscal, and debt policy, and president of the Northwest Bancorporation of Minneapolis. Mr. Thomson, we shall be very glad to hear from you. STATEMENT OF J. CAMERON THOMSON, CHAIRMAN, COMMITTEE ON MONETARY, FISCAL AND DEBT POLICY, COMMITTEE FOR ECONOMIC DEVELOPMENT Mr. THOMSON. Thank you, Mr. Chairman. I would like to throw in one sentence at the beginning and say that I appear here with a lot of humility and a desire to be helpful, and I hope we can do that. It is a pleasure to accept your invitation to appear before this committee on behalf of CED. As Marion Folsom has indicated, we have found the problems of monetary policy exceedingly difficult . The materials you have already published have demonstrated that the work of your committee will contribute a great deal to our study, and we are happy to participate in your investigation . Mr. Folsom has described our general approach to the problem of monetary policy. I should like to comment on three critical aspects of this problem : MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 297 1. The effectiveness of monetary restraint, possible limitations on monetary restraint set by the existence of a large public debt, and the possible use of new tools to surmount these limits. 2. The implications of a flexible monetary policy for public debt policy. 3. The position of the Federal Reserve System within the Government. In the light of these things, I also should like to say something about the problems of the next 2 years. Before I turn to these specific points may I make one general observation. The question before your committee is not one of disagreement on technical points of interest only to scholars or of disputes between Government agencies. The question is the survival of our free society. Can we be confident of the survival power of our free society if we cannot control inflation without authoritarian methods ? And can we be confident of our ability to control inflation without authoritarian methods if we are not able to control our monetary system effectively ? We believe that monetary restraint can make an important, even indispensable, contribution to preventing inflation . The methods by which monetary restraint operates have been explained in many of the replies to your questionnaires. Banks and other financial institutions find it more difficult or more expensive to obtain funds to lend . The availability of credit to borrowers from these financial institutions is reduced, which may involve an increase of interest rates. Some of these borrowers become unable or in some cases unwilling to carry out expenditures they had planned. Even individuals and businesses who are not borrowers are affected. They find that the market value of assets they hold , such as bonds, is lower and the inflow of cash to them is reduced by the indirect effects of the restraints on bank lending . It becomes more difficult or expensive for these individuals and businesses to finance expenditures out of their own funds, even if they had not planned to borrow . I believe it is generally agreed that this process goes on. However it is sometimes argued that the effects are marginal, applying to only a small fringe of transactions, and therefore the conclusion is that they are unimportant . In my opinion this conclusion is mistaken. If we look at the $350 billion of expenditures that buy the gross national product we see relatively little of it that would be directly affected by monetary restraint. But the problem of inflation is not the whole of this $350 billion . The problem is in an unsatisfied margin of demand, usually relatively small. We can have inflation when the gross national output is $350 billion and the demand for output is $355 billion . This gap of $5 billion can produce a large inflation as the excess expenditures produce larger incomes that produce larger expenditures , and so on. The effectiveness of monetary policy must be judged in relation to this unsatisfied margin . Judged in this way, I believe it is very important. It is sometimes maintained that while this may all have been very true in the past it is no longer true, chiefly because of the large size of the public debt. 298 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT It is said that their holdings of public debt give the great lending institutions so much liquidity that they are largely protected against the Federal Reserve's monetary restraints. I think this is a mistaken conclusion. The fact is that our lending institutions have become more closely concerned with the Government bond market because of their large holdings of Government's. This would mean, and I believe it to be true, that they are increasingly sensitive to the changes in the market that the Federal Reserve can bring about. In the second place, it is argued that not only the lending institutions, but people and business generally have acquired such large amounts of liquid assets that for the most part they are in no need to borrow. They seem to be beyond the reach of credit restraint . Again there is an element of truth. But it is true also that while some parts of the economy have become less dependent upon outside financing, others have come to rely on credit to an increasing degree . Installment credit and housing credit, for instance, are much more important today than formerly. Also, as a banker I know that even though a business may have no need to borrow, it usually still has to watch out for its liquidity. A tightening of credit makes itself felt not only among borrowers, but all over. And , finally, I cannot see how one can conclude, from the high degree of liquidity that the public debt has provided, that credit restraint should be abandoned . If the danger of inflation is greater owing to the debt and greater liquidity, credit control would seem the most natural means of dealing with the situation . I could go on citing still further arguments that have been put forward to show that credit policy today cannot work. But to all. of them my reaction is the same as to those already mentioned . They point to something that is quite true in itself, but they do not draw what seems to me the proper conclusion . What all those arguments show, and what I think is undeniable, is that the circumstances under which monetary policy must work have altered very much during the last 20 years. But they quite fail to show, in my view, that it is any less essential today than it used to be, and they overlook the new opportunities for its success that have arisen . The main argument usually advanced against monetary restriction is not that it will not work but that in the process of working it will do serious damage. Therefore it is said that monetary restriction must be stopped short of the point to which it might be effectively pushed in the interest of curbing inflation . I am pleased to note in the replies to your questionnaires that there is no longer much sentiment for rigid pegging of bond prices. Some people may think that abandoning par support for 22 percent bonds a year ago didn't do much good ; but no one can say that it did any serious damage. And now that par has been left behind, no one is urging that we go back to it. Par has lost whatever symbolic value it may have had. Moreover no one is suggesting a new peg at 98 or 968. The whole idea that one could say that there is one best interest rate that will continue to be best forever has been seen to be irrational ; and beyond, of course, you affect all lenders, including the banks, as well . However, I think I see in some of the replies to your questions the development of a new philosophy. This is the philosophy of the What this seems to imply is that monetary stable bond market. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 299 restraint can be used in a period of inflation provided it does not involve allowing bond prices to fall below the bottom of some predetermined range. Such a policy becomes important only if an inflationary situation arises in which anti -inflationary monetary policy would involve a decline of bond prices below the predetermined bottom. But if such a situation does arise we would find ourselves back in the same old box- unable to make a free decision about how far to pursue monetary restriction and finding monetary policy locked in more and more securely the longer we stay in that position . If this is what is meant by a stable bond market policy, I do not believe it solves the problem of orderly adjustment of monetary policy to changing economic conditions . I think the answer to the question "How far should we go with monetary policy ? " is like Abraham Lincoln's answer to the question about how long a man's legs should be. Monetary restriction , in combination with budget policy, savings policy, and other appropriate measures, should be adequate to prevent inflation . The problem, as Mr. Folsom has pointed out, is the problem of the right combination. When in an inflationary situation we decide not to push monetary restriction further we should be deciding to do more of something else. The right combination will vary from time to time and can only be judged by evaluating costs and benefits. Beyond this I can only urge that in appraising the costs of monetary restriction we should not be frightened by bogeymen. We should not exaggerate the fragility of our financial system. It is sensitive but sturdy. We should not exaggerate the difficulties of Treasury financing in a moving bond market. It has been done before and the Treasury is doing it successfully now. We should not exaggerate the significance of the interest burden. The Secretary of the Treasury has clarified this matter in his reply to the committee . We should not fear that secular stagniation is around the corner, requiring perpetually low or zero interest rates. We should not think that persons who receive interest are less entitled to their incomes than those who receive other shares in the national income. I think that if these considerations are borne in mind we will find an important and active role for general credit policy. If we do not follow this course, if we soft-pedal credit control , we probably shall have to put up either with more inflation, or with more direct controls over prices, wages, and materials. Quite likely we shall have to put up with more of both. I think we are all agreed that inflation is a great evil , and that direct controls are alien to our way of life and should be used as little as possible. This is one of the reasons why I think it is so important for us in our present situation to make vigorous use of credit policy, particularly those instruments usually referred to as "general credit policies," that is, open market operations, discount rate, and flexible reserve requirements. These tools of policy, though they may sometimes hit hard, do so through the process of the market. They do not involve direct interference with the actions of individuals and businesses . The same cannot altogether be said of the so -called "selective" instruments of credit policy chiefly over consumer and housing credit under regulations W and X. These do involve some interference , even though of a rather impersonal kind. For this reason they should , in my opinion, be regarded as subsidiary devices upon which we do not 97308-52-20 300 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT want to rely too heavily or too long. In our present defense economy, however , there is special need to guide credit and resources to the most important users and to limit their use by others . Under these unusual conditions, the selective instruments can usefully complement our general credit policies. The use of these powers must be flexibly adapted to changing conditions and the Federal Reserve should have sufficient authority to operate in this flexible way. As times change, supplementary tools of credit policy may need to be added . The Federal Reserve in effect now has several new tools. Among them are regulation X, which relates to construction credit, and the revived regulation W, relating to installment purchase credit . For further powers I see no urgent need at this time. I think so particularly because open market operations have now been revitalized through the removal of the peg. I do not favor, therefore , proposals made in recent years for secondary reserve requirements in the form of Government securities, nor for reserves against different types of assets. The main goal of these devices was to insulate the Government securities market to some extent against a tightening of credit for private borrowers. It was thought that this might be a way of getting back to a flexible rate policy in the private money and capital market, without causing equal fluctuations in Treasury obligations. In my opinion it is doubtful that such devices could have been effective so long as the bond market was pegged. Meanwhile, the policy of par support for Government securities has been abandoned . No extreme repercussions have been felt, as had been feared by many. There seems to be less need now for adopting such protective devices, even though the principle of seeking to insulate the Government market has some merit, as I explain later. Both the securities reserve requirement and the asset reserve plan would mean a major change in our credit system. They would make it less flexible and less well able to serve the needs of our growing economy . And the compulsory holding of Government securities under such plans might well have a bad effect upon people's attitude toward the public debt in general. The voluntary credit restraint program is, as its name implies, a voluntary organization of our private financial institutions aiming to hold down the use of funds for nondefense purposes . It operates under standards set by the Federal Reserve, and represents something quite new on our financial horizon. Its efforts in fighting inflation are a real contribution. But beyond that, it has done something else that is very worth while. Through its work, the financial sector has come into close working contact with monetary policy. Perhaps this will mark the beginning, in this country, of the closer relationship between the market and the monetary authorities, that has proved so fruitful in some foreign countries. I should now like to turn to the relations of debt management to a flexible monetary policy. That the debt, and decisions about its rates, maturities, and related factors play a very powerful role in the market is obvious. This influence results, in the first place, from the sheer size of the debt. The Federal debt now amounts to close to 50 percent of the sum total of all public and private debt in this country. It further results from the fact that refunding operations keep the Treasury almost constantly in the market for large amounts. MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 301 Finally, the debt's influence results from the fact that the Federal Reserve must , if unsettlement and conflict are to be avoided, create market conditions that will put the market in line with the decisions made about the debt. This calls for the closest cooperation between the Treasury and the Federal Reserve . Their cooperation must be of a kind that does not infringe upon the Treasury's primary responsibility for the public credit. It must insure, at the same time, that the Federal Reserve can carry out its statutory obligations in the regulation of money and credit. In this joint venture of the two agencies, it seems to me that the main burden of day-to-day cooperation falls mainly upon the Federal Reserve. It must maintain an orderly market for Government securities. It must also maintain conditions in the market that permit the Treasury to raise the funds it needs. The burden of cooperation for the longer run, on the other hand, rests more heavily with the Treasury. It must shape its financing decisions in the light of market trends and in harmony with the monetary and credit policies of the Federal Reserve . I do not believe that in adapting itself to the market and taking account of the Federal Reserve's policies , the Treasury would be in conflict with its duty to protect the public credit. The public credit does not depend upon the market quotation of Government bonds. Neither does it rest upon anything so changeable as the current interest of investors in buying these bonds. This is largely a matter of market trends and of the comparative attraction of other investments . If any single thing can be regarded as the outstanding symbol of the soundness of the public credit, it is the value of the dollar. A flexible debt policy does not by itself guarantee the value of the dollar, but without it we shall surely suffer inflation . The interests of the Treasury and the Federal Reserve might be easier to reconcile if the Government securities market could be insulated to some extent against the fluctuations that a flexible credit policy produces. I do not believe that we can accomplish anything like complete insulation . Nor do I favor those methods of insulation that would involve compulsory holding of securities by banks or other holders. But some progress can perhaps be made by the use of nonmarketable issues. An example of this was the offer of 234 percent nonmarketable bonds in exchange for long-term marketables that the Treasury made as part of the unpegging operation . Study by the Treasury of what more could be done in this direction without unduly restricting the flexibility of monetary policy, seems to me worth while. Finally, it seems to me that the coordination of debt policy with monetary and credit management would benefit if the Treasury would give its principle of " tailoring issues to the needs of investors" a broader meaning. As it is now, the Treasury seems to feel that it cannot sell long-term bonds because there is no demand for them at the rates it would be willing to offer. Other competing investments, it is said, are too attractive. But this policy may have a very unfortunate consequence . It almost inevitably leads to concentration on short-term financing at a time when it is important to sell long- term bonds in order to absorb some of the investment funds that feed the inflation . The expansion of short- term debt , even though it 302 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT may not immediately increase bank-held debt, does carry a greater threat of inflation . The CED has gone on record as to the importance of a proper countercyclical debt policy. In our view, the aim should be to shift debt out of the banks during times of expansion , thereby reducing the volume of money. In times of contraction, the opposite should be done. An effort to sell long-term Government bonds now would work in this direction and would be well worth while. With adequate. preparation, and at competitive interest rates, I think such an issue would have good prospects of success. What I have to say on this question of how the Federal Reserve System should be related to other parts of the Government, and the internal structure of the system, is brief. I do not think it any less important for that. On the contrary, it is the heart of the matter. It is not a matter of technical points, but primarily one of principles and convictions. The basic issue obviously is the independence of the Federal Reserve System. The Federal Reserve System is exercising a governmental power-the power to issue and regulate money. This power is given to Congress by the Constitution, and certain parts of that power have been delegated by Congress to the Federal Reserve. The nature of the power is such that Congress has had to give the Federal Reserve a large measure of discretion . The problem then arises of assuring that this great power is exercised in the general public interest and is not used to serve shortrun, sectional, departmental, or personal interests . This is what I mean by the independence of the Federal Reserve System-the maximum insulation from short-run and narrow pressures. The most important aspect of this problem is inflation, which has been the bane of monetary systems that are not sufficiently insulated from such pressures. There is agreement that inflation is contrary to the general public interest. But at least in the short-run, policies that lead to inflation or permit inflation are convenient for many people or groups. A major reason for the independence of the Federal Reserve System is to insulate it from pressures for inflationary policy. The Federal Reserve System as now organized is, in our opinion, an effective way of achieving responsible independence of monetary policy. The authority is lodged in a Board, to reduce the possibility of domination by the special viewpoint of any one person . The Board members are given a long term of office to reduce the possibility of domination by the appointing power. At the same time the public character of the Board is well established , basically by the fact that the system is the agent of the Congress and can be abolished or altered in any way by Congress. I think the present fact is that the Federal Reserve System cannot follow a policy that runs counter to any generally held public belief about what monetary policy should be. If anything, the Federal Reserve has been unduly sensitive to opposing views that do not really represent any widely held conception of the public interest . The Federal Reserve began to exercise its independence only when it became clear that the course it wished to follow had a large measure of public support. We consider it of the utmost importance not to reduce the independence of the Federal Reserve System. More than that, we be- MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 303 lieve it important to encourage the Federal Reserve in the exercise of its independence . This is not to deny in the least the need for cooperation and consistent action by the Federal Reserve and the Treasury. But this cooperation should not be sought by subordinating the indpendence of the Federal Reserve in the exercise of the responsibilities granted to it by Congress . It should be sought in a more general understanding of the common objectives of monetary policy and debt management and by continuous interchange of ideas between the two agencies. In the last analysis, if there are differences of opinion , the Federal Reserve must exercise its own best judgment, constantly recognizing that it is responsible to the public, through the Congress, for the wisdom of that judgment. There have been a number of suggestions for the establishment of an interagency council to coordinate monetary policy and debt-management policy and possibly other aspects of economic or financial policy. As usually proposed the council would include the Chairman of the Board of Governors of the Federal Reserve System, the Secretary of the Treasury, and the heads of the Budget Bureau, the Council of Economic Advisers, and perhaps other agencies such as the Securities and Exchange Commission. It is difficult for me to see what useful purpose would be served by such a council and I can see a possible danger arising from it. Every agency will naturally wish to consult with other agencies whose work is closely related to its own. Opportunities for such consultation already exist and are used without the necessity for a formal council. In view of this fact, what would be the function of the council ? It would be difficult to escape the interpretation that establishment of a council by statute or Executive order was intended to achieve something beyond consultation—namely, the subordination of each member's responsibility to the consensus of the members of the council. This would be inconsistent with the independent responsibility properly assigned to the Federal Reserve by the Congress . Two other suggestions in this area I also view with skepticism. These proposals aim, respectively, to place the Secretary of the Treasury on the Board of Governors of the Federal Reserve, and the Chairman of the Board in the Cabinet. Although the goal is better cooperation and a higher status for the top man in the system, the result would , I fear, be a loss of independence for the Federal Reserve not compensated by real advantages. The Treasury and the Federal Reserve have ample opportunity for close contact . I do not see much benefit in formulating this at the top level, but I do see the dangers. What is needed, it seems to me, is more intimate and frequent contact particularly at the staff level . Cabinet status would involve the risk of converting the chairmanship into a political office. This would be too high a price to pay for closer contact with the "inner circle." Access to this circle is important, but a man of standing and ability, I believe, can usually create this contact in his own way. The suggestions I have mentioned so far, even though in most cases I question their merit, do point up one important need. That is the need for strengthening the Federal Reserve System inwardly, in order to make it more effective in its outward relations . The most effective means to that end, in my view, is the reduction in the number 304 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT of members of the Board of Governors, from their present seven to five. That would make the Board a more effective body, and would give it a better chance of attracting and holding top- caliber men. Whatever else can be done to make Board membership more tempting-including salaries less out of line with what good men can earn elsewhere-would also help . There are two more proposals for streamlining the system, each the opposite of the other. One suggests that the power of the openmarket committee , which handles open-market operations, should be transferred to the Board. The Board would then have in its hands all the monetary powers of the system. The other proposes that all the powers of the system be concentrated in the committee. Since the majority control of the committee rests with the members of the Board- the minority membership consists of Federal Reserve bank presidents the change would be one of emphasis rather than of substance. I believe that the existing division of functions, which is based on historical development, has worked well. It gives representation to a wide variety of views and experience. It is not particularly logical, but it has the weight of tradition and experience on its side. There seems to be no strong reason for changing it. The next 2 years may present a severe test of our ability to manage our financial affairs. A sizable deficit threatens. While CED believes that the deficit can and should be avoided , there is danger that it will not. If it is not, then the extent of the damage will depend largely on the manner in which the deficit is financed. This will pose once more in severe form the problem of Treasury- Federal Reserve cooperation. A few words about the financial outlook are, therefore, very much to the point in this discussion. If the budget is not balanced, we shall have to look for the least harmful means of financing a deficit. In addition to the deficit, we shall in any case have to finance the seasonal swing in tax revenues, which will hit a low during the second half of each calendar year. We shall further have to finance the "attrition " in the outstanding debt, that is, the cashing in of maturing securities whose holders reject the usual exchange into new securities. The seasonal swing can probably best be financed by sale of tax-anticipation notes or bills, a device successfully used by the Treasury so far. The attrition will probably be heaviest in maturing savings bonds. I believe that a savings-bond program better adapted to the current situation could materially reduce this attrition and make an important contribution to Treasury financing and economic stability. One need is for a new educational program, more fundamental and more intensive than the present effort. Another need is for a new bond, which should reflect the rise of interest rates that has occurred since the present savings bonds were devised. A new model bond is essential if a new savings program is to arouse public interest, and an increase of rates would help to demonstrate the renewed importance that the Government attaches to saving. The step taken last year to offer more attractive terms for continued holding of savings bonds beyond their 10-year maturity was in the right direction, but did not go far enough. The overriding principle in financing in this period should be that on no account must we go back to the practice of pegging the market . MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT 305 I would not be too concerned over a limited amount of financing through banks, and about some expansion of Federal Reserve credit to make this possible , so long as the Federal Reserve retains control over the amount . But to peg the market means to give control over bank reserves and money supply to the holders of securities. We must not again put ourselves in that position . In addition to this main principle of obstaining from pegging the market our aim should be to get as much of the money as we can from nonbank lenders, and as much of it as possible for medium and long-term periods. I am happy to note that the Treasury has made a move in the direction of longer maturities with its recent offer of a 7-year bond. To obtain long-term money in larger amounts it may be necessary for the Treasury to put in its bid well ahead of the actual date of financing. Many of the big institutional investors now commit their funds far in advance. I believe it would be sound policy for the Treasury to make arrangements right now that would assure the placement of a long-term issue this fall. At a competitive interest rate such an issue should offer good promise of success. In addition, the coming financing will no doubt call for a welldiversified offering of securities. As I stated earlier, I am in accord with the Treasury's policy of tailoring its offerings to fit the needs of investors. But this tailoring should mean that rates as well as types and maturities are set in line with the market. The principles that I have suggested for any financing that may be ahead will have the effect, I believe , of keeping down inflationary pressures. They will involve a somewhat higher interest cost, at least for a time, than would short-term financing relying mainly on bank credit. But the cost is small compared to what we would stand to lose through inflation . Our general position may be briefly summarized . We believe that a flexible monetary policy operated by an independent Federal Reserve System can make a major contribution to reducing economic instability. This important instrument cannot be effectively used unless all branches of the Government and the public understand in general how monetary policy works. We are confident that the work of your subcommittee, like the work of its predecessor subcommittee under the chairmanship of Senator Douglas, will be a major step in the development of a successful program for the avoidance of serious inflation or depression . Thank you. Representative PATMAN. Thank you, Mr. Thomson. Senator Flanders has been identified with the Committee for Economic Development since it was organized, I believe , back in 1942. Was it not 1942 when it was organized ? Mr. THOMSON . Correct. Representative PATMAN. Senator Flanders, of course, is a very valuable member of our committee. I wonder if you wanted to ask any questions, Senator Flanders , of either or both of these gentlemen , who will yield to questions at this time ? Senator FLANDERS . I do not know which one of the two to address myself to. In these hearings so far, I have been trying, among other things, to formalize, at least in my own mind, the new relationships between 306 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT the Treasury and the Federal Reserve Board. About as far as I can get is that it depends on the personal ability of the Board, whose policies now find expression in Mr. Martin, and the personal ability of the Secretary of the Treasury, whose staff and other policy bodies find expression in the personality of Secretary Snyder to get along with each other. That is not anything that seems quite satisfactory to depend upon for times in which either of those gentlemen might be somewhere else, either above or below. Is there anything that you could suggest for putting that policy in some more definite form for the guidance of future generations ? Mr. FOLSOM. Well, I will attempt to briefly answer that and see if Mr. Thomson has anything to add. I do not see how you can legislate on the matter any more than you can legislate on the question of forcing cooperation between the executive department and Congress. You have separate agencies, and a lot depends upon the personalities involved. I think we are building up an experience though which certainly should be a guide in the future, to help these two organizations work more closely together, but I do not see any way in which you can build up any rigid set of rules forcing them to do it. I think, as we go along, you will find the staffs down the line in the Treasury and Federal Reserve working together more closely than they have in the past. I think if you do that you can get away somewhat from the personal element of the two top people involved. Mr. THOMSON. My answer, Senator, is by way of emphasis of what we have said. We have been gradually evolving our system of monetary controls. There has not been as much understanding even upon the part of the banking fraternity as there ought to be. These hearings on the controversy over the Federal Treasury accord have materially increased the understanding. As we have gone along in this defense program, we have seen the dangers of resorting to totalitarian methods to accomplish things, and we have seen that there is an alternative. I think the public has become better informed as to the choices there are. Now, with that better education and with the statements here by the two men involved , the record has been made, and I think that you do not need any statutory powers. I agree with Mr. Folsom on that. I think furthermore that those organizations are going to be more alert to meeting their own responsibilities, and yet cooperating, and I think that the public is going to be more alert to make sure that if they do not agree that the Congress or the public make itself felt. Senator FLANDERS. You are saying then that there is no chance at the present of developing a manual and that, perhaps, no manual for these operations could ever be written ; is that what you are saying ? Mr. THOMSON. I agree with that, and I think if I could ask you a question from your experience as head of the Federal Reserve Bank of Boston, you would probably agree. Senator FLANDERS. Well, that definitely limits the preciseness of any report that w
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