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·' I





MAY 6, 1954

The last time I appeared before the New Jersey Bankers Association was
at your mid-year Trust and Banking Conference in December 1946. I made what was
probably an overlong speech on Monetary Management and Credit Control. It was
an after dinner talk, and even now I seem to remember some glazed eyes in the
audience before I f'inished. To one less addicted to preaching the gospel than
I am, that experience might have suggested a more lively topic for this occasion.
I am going to risk talking on the same general theme, however, hoping that it
may seem less dull in the afternoon than it did in the evening.
In any case, I must assume that when you ask me to speak you want to
hear about some aspect of the work of the Federal Reserve System, and I continue
to believe that you as bankers, · and as citiz.ens, ought to know more about what
the System is doing. It is always sobering to me to realize how much economic
power has been put into the hands of those who manage the Federal Reserve System
and how little a~tention, proportionately, is paid to the quality of those who
control the System's operations and to the ~ay in which they perform their duties
and di.scharge their responsibilities. The fact that the System h as done its job
as well as it has, without abuse or misuse of power, is a tribute to the continuing high calibre of men who, inconspicuously, have made s.t aff careers within the
System, and to individuals _. who, from t✓ime to time, on the Board of Governors and
the directorates of the Federal Reserve Banks, have been willing to devote themselves to the policy aspects of a. wo:bthwhile public service.
Stimulated by this righteous appreciation of my own brotherhood, I
would like to say something, first, on recent credit policy and, second, on
certain particular aspects of' our recent open market operations.
As you all know, for the past nine or ten months we have been in a
period of declining economic activity, call it what you will. How has the Federal
Reserve System reacted to this development? Well, its reaction re~lly began in
the preceding period o.f nboom't when, during 1952 and the early months of 1953, it
applied monetary brakes to a situation which .s eemed to be call•i ng more credit into
use than was required to maintain our economic balance. That sort of situation,
if unchecked, breeds speculation and may .s pell inf lati.on and erosion of the purchasing power of the dollar. And it may alsu spell subsequent deflation; perhaps
severe deflation with its accompaniment of widespread human suffering. Helping
to prevent the formation of a speculati~e bubble on top of a boom is the most
effective action which the Federal Reserve System can take to make cumulative
deflation less likely. We have to try to see to it that, so far as monetary
policy is concerned, periods of economic advance are not distorted by speculative
excesses which lead to sharp and dis?rderly declines.
Federal Reserve Bank of St. Louis




Once the turn comes, however, or even when it seems to be coming, an
alert central banking system should relax whatever pressure it has put on the
reserve position of the commercial banks o Otherwise they may be forced or, at
least, influenced to restrict credit and to put pressure on borrowers to repay
outstanding loans o In f act it is largely true, I think, that if left to itself
the credit mechani.Sm may tend to aggr avate an economic downturn, as credit risks
rise and lenders become more cautious . The opjective of monetary management, in
the first phase of a directional change in policy, is t o try to prevent this
from happening.
If a decline in economic a ctivity persists, of course, the duty of the
Federal Reserve System goes well beyond checking the possible perverse action of
the private credit mechanism . The System can then see to it that a monetary
climate favorable to credit expansion and capital expenditures - is created. It
can see to it that commercial banks are amply supplied with reserves, and have
ample assurance of the continuing availability of reserves at low cost . It can
see to it that the cost of borrowed capita l turns in favor of the borrower.
Its policy becomes an affirmative aggressive policy which helps to remove deterrents to expenditure by individuals, by business, and by State and local governments .
The financial needs of the national Government must also be considered
in such circumstances , and not in a narrow or political sense . Government
deficits are likely to develop or increase in a period of economic decline, either
through reduced tax collections or increased expenditures, or both. New money
will have to be borrowed , and some of it will have to be and ought to be borrowed
from the banks . Unless the banks are provided with ample reserve funds, however,
the Treasury will be unable to do its necessitous financing without causing some
lessening of the availability of credit to private borrowersn The banks have to
be able to meet both private and public needs with some degree of assurance and
comfort, or the stimulating eff ect of Government spending of money borrowed from
banks will be offset by the restraint which Government borrowing has placed on
private credit»
The course of Federal Reserve policy during the past year has been
generally consistent with these objectivese The restrictive policy of 1952, and
the early months of 1953 , was reversed i n May 1953, when it was decided that inflationary pressures/ were no longer dominant in our economy, and when evidence of
constriction in the capital and mortgage markets made some reversal of policy a
monetary necessity . As evi dences of economic decline developed, we took the
offensive and supplied substantial amounts of reserves to the banking system somewhat in advance of actual need o And right up to the present moment there has
been assurance and re-assurance , t hrough open market operations and reductions
in the discount rate , that reserve fun ds are and will be readily and cheaply
available so long as the pre s ent economic situation per sists .
As a consequence,whatever tight spots there may have been in the money
and capital markets have been eased or eliminated, first by our action and later
by forces within the marketo Bank credit, corporate borrowing, mortgage borrowing, consumer credit, and borrowing by State and local authorities (if rightly
priced) have all beeµ freed of the restraints of the earlier period . Truly, as
is necessary in a period of economic de c line , monetary policy has gotten out of
the way of production, distribution, and spending ~ It has helped to clear the
way for e-conomic recovery .
Federal Reserve Bank of St. Louis




There are those, of course, many of whom usually sit facing backward it is slightly easier to see where you have been than where you are going - who
criticize our intervention., and particularly the steps we took to check credit
expansion in the boom period which preceded the present decline. Their thesis
seems to be that monetary action taken to check a boom will bring on a decline
which cannot then be checked. That is tantamount to saying you do not want a
central bank, although surprisingly these critics are often the same people who
favor a variety of Government i ntervention in economic affairs. I would not
claim for one instant t hat our recent performance has beeri perfect, that it has
been without mistakes. But I do claim that within the permissible range of human
error, in a field where there are no absolutely fixed points of reference, monetary policy has made its contribution to the protection of income, employment,
and the stability of purchasing pow~r of the dollar, in this period of transition
from a highly stimulated var economy to a predominantly peace economy.
The overtime economy, the hyper-activity economy of late 1950 to early
It bred the need for the
economic readjustment we are now going through . Monetary action can ' t stop a
decline in economic activity during such a period of transition, but it can help
substantially to keep the decline from over-reaching the real needs of economic
readjustment. That, I think, it has help~d to do in this instance. If the
economy now, or within the year, begins again to realize its potential for growth,
without too many injections of short-lived artificial stimulants, this country
will have given the world a heartening example of improved economic stability.

1953, did not bear the seeds of sustained prosperity.

Turning from t he general outlines of recent central banking performance
to particular details of policy execution, I now want to touch on certain aspects
of our open market operations du.ring this period. The skeleton of the discussion
of these operations has been published in the record of policy actions of the
Federal Open Market Committee which is printed with the Annual Report of the
Board of Governors of the Federal Reserve System for 1953, and there is some
further discussion in the body of the Board's report. So far as I am aware, very
little attention has been ~aid to this published record. Maybe that is as it
should be. Maybe our arguments over form and method were too fine-spun to ir-terest anyone but a central bank theologian. Maybe I should let the subject rest
in peace, since in the debate I was one of a small and diminishing minority. And
maybe the majority was right . As I said in the beginning, however, I think it is
important that there be a wider and better understanding of how the Federal
Reserve System performs its functions, and I believe that our present techniques
of open market operation are a matter of importance and, therefore, deserve more
banking and public scrutiny than they have had.
Let me emphasize immediately that there has been no division of opinion
among us as to the general aims and lines of credit policy during this period.
And let me also say that, given the general policies we ·unanimously adopted, our
differences as to techniques may not currently be of first importance. My concern is not with degrees of present importance. My concern is that there be
wider knowledge and understanding of what we are doing, and that it be critically
examined. We are then less likely to dig a groove which becomes a rut, making
change difficult if different circumstances make change more important .
Federal Reserve Bank of St. Louis




The main questions at issue, I think, are

Should Federal Reserve purchases and sales of Government
securities be made solely for the purpose of providing or
absorbing bank reserves? Among other things, this excludes
offsettipg purchases and sales (even swaps) of securities
which have the effect of altering the maturity pattern of
the System's portfolio, and excludes purchases (and sales)
which might be made at times of Treasury financing in direct
furtherance of an integrated program of debt management and
credit policy.

2 . n Should Federal Reserve open market operations be confined
to short term securities? In practice, as is shown by the
published statistics, this has meant confining operations
to transactions in Treasury bills o
It has been my view that a central banking system does not discharge
its responsibilities and. complete its functions in the best possible manner, in
our present day economy, by directing its open market operations : solely toward
putting reserves into or taking reserves out of the commercial banking system.
I believe that the central banking system should retain freedom of action to
assist or promote, directly and under appropriate circumstances, changes in the
availability and cost of funds throughout the money and capital markets, and
freedom of action to assist, directly and under appropriate circumstances, desirable debt management ·operations of the Treasury.
Those who espouse the opposite and presently prevailing view will have
little or none of this . They have emphasized the view that the Federal Open
Market Committee, except in the extraordinary circumstance of a "disorderly
market", shcn:1,ld limit its operations in Government securities solely to operations for the purpose of providing or absorbing reserves . They hope and expect,
as I understand it, that providing or absorbing reserves, by purchasing· or
selling Treasury bills, will quickly be reflected in the cost and availability
of all short term credit and, through arbitrage , will also be quickly reflected
out through the longer term markets where t he price and availability of mortgage
money, corporate funds, and funds for State and local improvements are determined.
They believe that, only when our open market operations are circumscribed in this
way, will the Government security market become freer and more self reliant, and,
therefore, help market forces to determine the most desirable allocation of all
available funds .
My own view is that just putting in and taking out reserves at the
short end of the market, is not always good enough or certain enough. I believe
that since this country has wisely rejected most direct controls of our economy,
and has placed its chief r e liance in the indir e ct and impersonal controls of
fiscal policy, debt management, and monetary policy, we should make the fullest
and best integrated use of these tools to contribute to sustained high levels of
production, employment and income, and to the stability of the dollar. Otherwise I fear that we shall not be able, at all times and under all circumstances,
to do the job we should do, and that our f ailure will not only lessen the prospects of economic stability, but might also increase the danger of being pushed
into d~rect controls which promise stability, but which really strangle enterprise, efficiency, freedom, and growth .
Federal Reserve Bank of St. Louis




I am not arguing here against the proposition that the primary purpose
of open market operations is to affect the volume of member bank reserves, nor
that this can best be accomplished, in many circumstances, by purchases and sales
of Treasury bills. I am arguing that putting in or taking out reserves is not
the sole purpose of open market operations. And I am arguing that there are
times and places when putting reserves in, or taking them out, by way of the
Treasury bill market may involve unnecessarily large purchases and sales, or may
not promptly find its best reflection in the credit and capital markets of the
country because of imperfect arbitrage within markets and between markets.
Finally, I am arguing that there have been and may be occasions when some direct
assistance to Treasury operations in ~he field of debt management, through open
market operations in securities other than Treasury bills, will be good economics
and good central banking.
It is illuminating and perhaps significant that in countries where
traditions are most similar to ours, and where the central banks have available
a broad market in Government securities in which to conduct operations, there is
no such squeamishness as we have exhibited in using that market to influence the
whole credit structure and level of interest rates. In a recent statment at a
hearing of the Standing Committee on Banking and Commerce of the House of Commons
in Canada, the Governor of the Bank of Canada said :
"As part of our programme to improve and broaden the
money market for the benefit of lenders and borrowers and of
our financial structure as a whole, the Bank of Canada has
been a constant trader in Government of Canada securities
since we opened our doors in 1935. While the total amount
of our .holdings of Government securities is necessarily
determined by considerations of monetary policy, we have endeavoured to help make a market for a l l Government issues
and have been very substantial buyers and sellers. In a
sense, we per~orm a jobbing °function, holding the inventories
which are indispensable to a good market. Investment dealers
and banks also operate in this way, although naturally on a
smaller scale. We would be glad to see both dealers and banks
extend their operations of this character, and have the Bank
of Canada play a smaller part, although we would always expect
to be a substantial participant in the market."
Each central bank, of course, has to fit itself into its own environment.
What others do may not suit our book. But I find it encouraging that such perceptive and knowledgeable lleople as the Canadians believe there is a middle ground
between the extremes of our present approach, on the one hand, and the extremes of
our war and immediate post --war approach of pegged prices and detailed control over
the whole interest rate curve, on the other. It illustrates the statement of a
colleague that there should b e plenty of useful scope for central bank action between the extremes of chilly indifference and constant intrusion o
Our present situation, in my opinion, provides the Federal Reserve System
and, therefore, the country with an opportunity for constructive action in the
search for economic stability, which did not exist when the System was est~blished
four decades ago. For better or worse we now have a large Federal debt, which
overshadows in magnitude all individual private debts and is roughly equal to
private debts in the aggregate. This large debt, representing various maturities,
Federal Reserve Bank of St. Louis




has given us a national homogeneous securities market, which to a considerable
extent conditions all other security markets (corporate securities, mortgages;: etc.).
The Federal Reserve System through its authority to engage in open market operations can, if it will, seek to ma ke its policies effective by operations anywhere
in the maturity range of thi 9 national market for Government securities. This
does not mean co~stant intervention in and manipulation of the market, and it
certainly does not mean pegging prices. But it does mean ~hat, if operations in
Treasury bills in appropriate amounts, and the subsequent arbitrage within and
between markets do not or cannot ach ieve the desired results, at all times and in
all circumstances, direct action b y the Federal Reserve may give the process a
desirable assist. Similarly, it means that if Treasury debt management operations
put a temporary but intense strain on the facilities of the market, in bringing
about adjustments in portfolios of thousands of investors in billions of securities, within a short period of time, the largest single portfolio of all should
not always stand aloof (except for the purchase or sale of Treasury bills). Direct
aid in helping to cushion the effect of massive maturities, new issues, or conversions of Treasury securities, at times when unavoidable Government financing
would otherwise disrupt, temporarily, the money and capital markets, would seem
to me to be wholly consistent with the primary demands and objectives of monetary
policy. The need for such action may be infrequent, but I question whether the
central bank spou ld publicl y renounce t he possibility of such action.
I must admit, though, that some very attractive labels have been put
on the bottle from which we are now dr inking. - "Free markets", "avoidance of price
pegging", and dealing in the "nearest thing to money" are examples. I like the
appearance and the sound of t hese labe lf?, but I want to··· t est the contents of the
bottle, further, before ac cepting t he promise of the labels.
So far as "free markets" are concerned, I think we are all attracted
by the phrase. It suits our habit of mind. But we haven't had a free market in
money and credit, at least since t he Federal Reserve System was established; and
we haven't had a free market in Government securities, and therefore a wholly
free securities market, since the Government debt climbed to the higher magnitudes, and open market operations by the Federal Reserve System came to be used
as a principal instrument of credit policy. We now have a market in which lenders
and borrowers have to and do ta ke account of action and possible action by the
Federal Reserve System to alter the supp ly, availability and cost of reserve funds;
a market which has to and does ta ke account of possible actions by the Treasury
with respect to debt manageme nt and of credit policy in relation to debt management. This will continue to be the situation in a mixed Government-private money
and capital mar ket such as we now have, and will continue to have for a long time
to come.
I t hink we should accommodate our ideas of "free markets" in the money
sector of the economy to present day conditions. I do not think t h is will do
violence to the "traditions 11 of centr al bank ing. Even in the "good old days" of
the nineteenth century, when social and economic conceptions were different, I
believe they were practical about such things. They did not suggest that any
supplier or user of f unds, so large that his every action necessarily affected
the anticipations and ac t ions of everyone else in the market, could pretend that
markets were made without him o So long as we have a central bank and a large
and constantly shifting public debt, both will be powerful and special market
influences. Our approach to credit policy, and to debt management as well,
should take these facts into account.
Federal Reserve Bank of St. Louis



I have already intimated that the approach I prefer has nothing to do
with price pegging, nor with trying to establish and maintain a particular
pattern of interest rates, nor with other practices which during the war and
earlier post war years destroyed or handicapped monetary policy. There is a
natural and justified aversion to these practices, but this aversion is quite
beside the point I am discussing. The issue is not whether to peg or not to
peg, but whether at all times and in all circumstances (except for disorderly
markets) the System should confine itself to shoving reserves in or taking them
out .at the bottom of the credit pile . The issue is whether there will not be
times when direct operations in other areas will be appropriate and more effective. Almost everyone is agreed, I think, that our intervention in the market
should not .be to impose a fixed pattern of prices and yields on the market.
Finally, dealing only in the "nearest thing to money" is something of
a throwback to a central banking concept of earlier days. Before it was applied
to open market operations in Tr easury bills this theory or label was applied to
the discount, rediscount and purchase of "self liquidating" prime commercial
paper. Even then, however, there was always the question of how fast, and how
well, and in what circumstances operations in such short term paper would
permeate all markets and all maturities. It may be that there is enough
fluidit y in t he Government security market, and between that market and other
markets, to solve this problem for us automatically now, but I doubt it. I do
not want to tie myself to that hypothesis. If we are going that far, why not
take the next step and, instead of dealing in the "nearest thing to money",
deal in money itself? Instead of shying away merely from influencing longer
term markets directly, why not shy away from influencing the short term market
directly? Our operations in Treasury bills can and have caused distortion in
the short term market and between short and long markets o In other words, we
might merely increase or decrease reserve requirements of particular banks or
groups of bank~ in order to affect reserves directly, without the intervention
of even Treasury bill.s . I introduce the idea only as a sort of reductio ad
.absurdum; I wouldn't suggest it.
The conflicting views on open market techniques which I have been discussing really do not come to a testing ground in a period such as the present,
when general credit policy is to maintain a substantial volume of readily available bank reserves at all times. The whole private market plus the Treasury's
debt management program can pretty mu ch float on a sea of reserves. This
obscures the view of things which might have been done better. It persuades the
advocates of the practices with which I take issue that we have come off pretty
well so far. And those who have been persuaded to support this position are
comforted by the statement that present practices can be changed at any time if
the need becomes apparent; that present policies are to be followed only until
such time as they may be superseded or modified by further action of the Federal
Open Market Committee. The tendency has been and , is, however, to fix these
practices as permanent rules of central banking, and- to display them to the
market as such. The inevitable consequence will be, I think, to make it difficult for men to open their minds to any o.ther mode of operation, ev'e n under
changing conditions, and to expose us to charges of having misled the market or
of violating "promises" to the market if we do change our methods. We could
have done about all that we have done, in practice, during the past year,
without trying ·to enshrine a new doctrine of central banking as a permanen~
"norm". We could have retained our freedom of action to meet changing _circumstances without endangering present policy, and without interfering ~ith the
proper freedom of our money and security markets a
Federal Reserve Bank of St. Louis



To sum up, then, I think the central bank should exert its influence
on the cost and availability of credit or capital, openly and directly as circumstances may require, in whatever areas of t he market it can reach. I think
the central bank should be free to aid the market directly in making its
adjustments to large scale Treasury financing, whenever such aid can be given
without permanently overriding credit po licy. I b elieve that trying always
to do these things indirect ly , through dealing only in the "nearest thing to
money", will not create a "free market", b ut will keep the central banking
system from realizing its full potentialo
It has b een said, perhaps unkindly, that Americans, in t he face of
the international responsibilities which have b een thrust upon them, are prone
to try to find a general formula which will spare them from having to make
individual decisions under changing circumstances. Moral pronouncements are
used to try to give an air of permanence to t hings which are essentially
impermanent o We want to lay out "rules of the game" wh ich will guide all the
players and, if the players are properly numbered, will also guide the s pectators. Maybe that is what we have been trying to do in the field of central
banking; to establish monetary "norms" in a world which is not normal. I
doubt if it can be done, but I think t hat when it is tried it should have the
serious attent ion of bankers and others who are interested in monetary policy.
Federal Reserve Bank of St. Louis