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REMARKS OF ALLAN SJ>ROUL, PRESIDENT,
FEDERAL RESERVE BANK OF NEW YORK,
AT THE MID-WINTER MEETING
NEW YORK STATE BANKERS ASSOCIATION,
JANUARY 25, 1954
RARY
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Independence of the Federal Reserve System-. ·
I hope that you will not hold me too closely to the assigned topic
of my talk this evening. I intend to weave in and out around it, but I am
not going to try to give you an historical and philosophical dissertation on
the independence of central banks. Even if such a task were not beyond my
powers of exposition, it would probably be beyond your powers of endurance.
The subject is continuously interesting to central bankers, however,
and it may be that by relating it to banking discussions and credit policy in
recent years and months, I can make it of some interest to you. It is important, I think, that neither frozen attitudes of mind concerning the past independence of central banks, nor misconceptions of the present situation of
the Federal Reserve System, be allowed to jeopardize a position which, even
though it be confirmed from time to time, is never free from attack. The possibility that there might be a "money power" able and willing to flout the
economic policies of elected Government, or exposed to the coercion of special
private interests, disturbs many men and attracts demagogic assault o
When your President asked me to speak tonight, I told him that I
thought the bankers of New York State, and of the Second Federal Reserve
: District, have a special call upon my time and energies. This could be seized
upon by those who hold that the Federal Reserve System is banker-dominated,
and banker-oriented in its attitudes and actions, but it carries no such implication. Our relations with you are close to be sure, but this is necessary
both as a matter of law and as an aid to the proper functioning of our money
economy. In the performance of our primary duty of relating the supply of
money to the needs of agriculture, commerce, and industry, and of our secondary
duties such as supplying coin and currency, collecting checks, and supervising
member banks, we necessarily work with and through the private banking system.
Our objective in both areas, however, is to meet a public need. In
the first instance it is to provide, to the fullest extent permitted by actions
of Government and the private economy, over which we do not have control, a
money supply which has reasonably stable purchasing power and which will contribute to the steady growth of the economy. In the s~cond instance, it is to
promote the improvement of our banking facilities for the benefit of every
citizen, whether or not he ever borrows from a bank or makes or withdraws a
deposit.
One line of criticism of the Federal Reserve System, which during
the past year has made ominous forays into the public prints, is that the
Federal Reserve Banks perform all sorts of free services for the commercial
banks of the country, while charging the Federal Government for many services
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performed for it. We are accused of favoring private institutions as against
the Government and of using funds, which otherwise would revert to the
Government, to consummate this favoritism. As a consequence it is sometimes
suggested that the Federal Reserve System be brought within the budget-making
orbit of the Congress, and be subjected to the general accounting procedures
of the Government, presumably so that thes e twin 11 evils 11 may be curbed or
eliminated.
It is a narrow and myopic view, I think, to look upon the services
we perform for our member banks as subsidies to the banking businesso If
there are such subsidies, as distinguished from services that we can' and should
perform at no cost or low cost, as part of our job of providing efficient monetary :-,ar;rangeme:gts for the nation, th~y should be eliminated. But the r ·e al and
overriding purpose of these services, when wisely conceived and economically
performed, is the provision of that better banking system, which the original
Federal Reserve Act envisaged, and which is a necessary part of the proper
functioning of our economy. Banking i~ this country is a highly regulated
public utility. Individual banks are operated for the profit of their stockholders, but the banking system as a whole operates for the benefit of the
community. And it is the Federal Reserve System which, nationally and in
collaboration with the Comptroller of the Currency and the Federal Deposit
Insurance Corporation, draws all of these private units together, and with
them and through them tries to see to it that the public is provided with
efficient and effective banking facilities, in the form and at the place where
these facilities will be most useful. The expenses which we absorb in pursuit
of this objective are not subsidies to the private banking system. They represent a service to everyone in the country who depends on the proper function=
ing of our monetary system. And that means everyone .
Reasonable men and friendly critics are somewhat attracted, nevertheless, by the idea that these expenditures of the Federal Reserve Banks should
be brought under the budgetary control of the Congress, and the subsequent
review of the General Accounting Office. If there were real abuses to be corrected, this might be one solution, albeit one which would introduce the
unfortunate but probably inescapable element of rigidity of "Big Government"
and bureaucracy into operations which, both on behalf of the Government, as
its fiscal agent, and on .behalf of the public, through the member banks, require
a high degree of flexibility in the allocation and uses of funds o For myself,
I do not believe there exists any possibility of abuse which cannot be detected
and eliminated under present procedures, or improvement s in those procedures.
The facts as to the earnings and expenses of_ the Federal Reserve Banks are
readily available. The efficiency of operations of the Federal Reserve Banks
is open to the daily observation of all who have dealings with them. Their
operations are under the immediate scrutiny of boards of directors performing
a public service but, in most cases, used to the compulsions of operating a
private business for profit. And the banks are subject to the check and audit .
of the Board of Governors of the Federal Reserve System at Washington o There
is no lack of control of the financial affairs of the Federal Reserve Banks.
On the question of the services which, as fiscal agents, the . Federal
Reserve Banks perform for the Government, and for some of which a charge is
made, I am inclined to believe that both the public and the Congress would
look with a jaundiced eye on a broad extension of the free list. The net cost
to the Government, in any case, is a small one, since the charges made for
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fiscal agency operations prevent erosion of the net earnings of the Federal
Reserve Banks, approximately 90% of which are now paid to the Treasury. And
there are dangers as well as costs to be considered o The first danger here
is that extravagant Government departments and bureaus, or economy-minded
agencies, depending on which way the wind is blowing, would find this a convenient way to improve their own budgetary position, and to escape some of the
controls of the Congressional appropriation procedure. There must be literally
hundreds of financial housekeeping jobs, I suppose, which Government departments might seek to have performed free of charge by the Federal Reserve Banks,
as fiscal agents of the Government, if the doors were opened to this sort of
thing o The final danger would then be that the Federal Reserve Banks would
become swamped with these incidental, mechanical functions to the detriment
of the performance of their primary' duties as central banks.
It is no help in the resolution of questions such as these, of course,
to find that there are many bankers who still think that the Federal Reserve
Banks are "making money" out of member bank reserves and who do not realize
that, on the contrary, the Reserve Banks have for a long time been creating
reserves to provide the basis for present day deposit banking. These bankers
are inclined to argue that the Federal Reserve Banks are making large profits
out of the use of the reserves deposited with them by their member banks,
and that these earnings should be used to provide more "free services" for the
member banks, instead of being paid over, in large part, to ·the Federal
Government. Such argument not only gives support to those who see in this
matter only a question of division of spoils between private banking institutions and the Government, it also indicates a tenacious misunderstanding of
how our reserve deposit banking system really works. The reserves originally
paid into the Reserve Banks by their member banks were not, of course, earning
assets and did not become such by this shift from one vault to another. And
over the years these reserves have long since been submerged under a thick
layer of reserves -created by the Federal Reserve Banks, using the powers
granted to them by the Congress. The reserves which you paid into the Reserve
Banks could be put back into your own vaults, and they would be there just as .
inert as they now lie in the vaults or, better, on the books of the Reserve
Banks. The reserves which we created, primarily by buying Government securities during the war, now find a reflection in the substantial earnings wtich
we report each year. And similarly created reserves will be a similar source
of earnings for the Federal Reserve Banks, if the reserve base needs of a
growing banking system in a growing economy continue to be met in this way.
We do not live on the reserves which you once placed with us.
This has nothing to do, of course, with the level of reserves which
different classes of banks are required to keep with the Federal Reserve Banks.
If the percentage amount of your required reserves is increased there will be,
in effect, a transfer of earning assets from the member banks to the Reserve
Banks o And if the percentage amount of your required reserves is reduced,
there would be a reverse movement of such earning assets. Perhaps this has
helped to confuse· the picture. The way to get at this situation, however, is
not to demand free services from the Federal Reserve Banks, but to examine the
history and effect of present reserve requirements, to see if some more up-todate and more equitable method of fixing reserve requirements cannot be devised.
The Federal Reserve System has made studies of this problem, and it is one which
will have to be solved at some time if our fractional reserve banking system
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is to keep in step with changing conditions ~ But so far the interest which
the banking community has shown in the problem has been small, sporadic, and
perhaps, too much tinged with the particular interests of particular groups
of banks.
Well, you now have a right to ask, what has all this got to do with
the independence of ··the Federal Reserve System? Only this. If the charge
can be made to stick that the Federal Reserve Banks now serve primarily the
selfish and pecuniary interests of the private banks, the independence of the
Federal Reserve System will be in danger. Whether the attack be a frontal
one, involving so-called nationalization of the Federal Reserve Banks, or
whether it be an encircling movement p~tting the Federal Reserve System in
with sprawling Government departments, subject to stereotyped Governmental
budget and accounting procedures, the independence and the regional character
of the Federal Reserve System~-and, I believe, its effectiveness--will be
undermined. It can happen here, particularly if bankers themselves do not
take the trouble to broaden public understanding of the basic principles and
the organizational advantages of the central banking system which have evolved
in this country.
In defending what we have, however, and in trying to improve it as
we go along, we may be in danger at the hands of friends as well as critics.
Here I have in mind some of the fiction which, it seems to me, is getting
mixed up with the facts about our experiencesduring the war and post-war
period, and some of the loose language which is being used to describe our.
recent adaptations of flexible credit policy.
I shall refer to the earlier period only briefly. It is becoming
part of the legend that during the war, and during he post-war years until
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March 1951, the Federal Reserve System was the upine servant of the Treasury.
The demands of capsule . treatment of a difficult period in credit policy and
debt management seem to make for . such easy generalization. So far as the war
period is concerned, I think it is closer to the facts to say that the Treasury
and the Federal Reserve System reached an agreement, with some compromises
along the way, as to war financing and credit policy. It is quite true that
we lost our "independence", but we lost it to the inexorable demands o
It was not meekly handed over to the Treasury in abdication of our
bilities.
The long post-war delay in dismantling war financing policies is
less defensible. Our problem was to recapture from the commercial banks of
the country, and other holders of Government securities, the initiative with
respect to the creation of reserve credit, and to restore the ability of the
Federal Reserve Banks to vary the availability and the price of such credit
to meet changing economic conditions. The problem was complicated by the fact
that the Treasury faced, during these years, an unprecedented job of funding
and refunding an enormous mass of public debt, and by the fact that large
segments of that debt had not yet settled into firm hands. The bases for
strong differences of op:i.nion existed even though we and the Treasury professed
the same ultimate objectives. The result of our debates was a policy so
cautious, so hesitant, so distrustful of general credit measures, that credit
policy lost much of its effectiveness. It is worth remembering, though, that
during much of the early post-war period the Treasury was drawing in cash surpluses which were used, to a significant extent, to reduce bank reserves, and
thus to offset much of whatever harm was done by our release of reserves in
support of Government security prices.
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Here again, however, there was no meek surrender of independence;
this time it was a runni ng fight all the way. And we did accomp·lish something
as early as 1947 with the unfreezing of short-term interest rates, which enabled us to offset with one hand, by sales of short-term Government securities,
what we:.were doing with the other, in support of the long-term market~ But
despite such qualifications, those who hold that we should have acted sooner
than we did to restore our freedom of act i on probably express the majority
opinion. But to tmpute our fa i lure to a lack of courage, in defense of our
independence, is like sitting in the bleachers and demanding more courage of
some young men who are hav~ng all they can do to stay in the game.
There is one prime fact to be remembered, also. A more independent,
more effective monetary policy could not have prevented the post-war inflation;
at best it could only have slowed it down. The big damage had already been
done. The money supply of the country had been increased from $36 billion to
$102 billion during the war, without any similar increase in civilian goods
and services. The inflationary effects of this warborn development were suppressed but not eliminated by direct controls. They were bound to break out,
unless we were ready and able to embark on a drastic program of deflation
which would have resulted in a decline in production, a decline in employme~t,
a decline in income, and a decline in consumption. I did not then and I do
not now believe that this would have been the right prescri~tion for the
troubled post-war world, when so much depended on this country's economic
strength. A credit policy so drastic as to erase the inflationary effects
of war financing was not the answer. We had to grow up to the wartime expansion of the money supply through an increase in production and prices, moderated by increases in productivity. Perhaps we could have prevented some of
the increase of $10 or $11 billiqn in the money supply which took place in
1946 and 1947, but the money and credit requirements of a massive readjustment
from a war economy to a primarily civilian economy would have made even this
doubtful.
When our economy had pretty well grown up to the new .m onetary magnitudes decreed by war and when, after the mild recession of 1949, the outbreak
of hostilities in Korea set off a new spiral of inflation, we did act promptly
and vigorously. This involved us, in August 1950, in a publi~_lmockdown and
drago~t fight with the Treasury, which we had been trying to avoid for so long,
in what we conceived to be the national interest. The independence we then
asserted was broadened and affirmed in the "accord" of March 1951, with growing support of banking and public opinion .
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That support has been evident ever since, and has found ~xpression
in the findings of two Congressional committees charged with looki~g into our
actions and status. What we have to guard against now is renewed erosion of
our independence.
To illustrate this danger, I might quote from a weekly magazine of
enormous circulation. In a recent issue it published a picture of the Council
of Economic Advisers with the caption "President's Prophets" and then indulged
in some prophecy of its own ab.out the anti-depression planning of the present
Adm:lnistration. One section of this statement said that "the 'tight money'
policy, which has already been liberalized, would quickly be switched to fast
expansion of credit by decreasing Federal Reserve margins, resuming the price~
pegging of government bonds, and stimulating instalment buying." The implication was that this remarkable hodge-podge is part of the Administration's
anti-depression planning, an~ tAat the Federal Reserve System is in the
Administration's pocket so far as the implementation of such a program is concerned.
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Or take another example from a banking magazine published in London.
"The attempt of the Republicans to go back to Coolidge and 'sound money' has
failed before it started. At the first whiff of deflation Mr. Randolph Burgess
and Mre Humphrey, the big battalions of the dear money and ' putting value into
the dollar' school, broke and fled, leaving the rearguard action to the hastily
organized open market operations of the Federal Reserve." Here we are tied in
with the monetary ideas of President Coolidge, and charged with being used as
expendables by the present Administration, when all the time we thought we were
acting on our own non-political initiative to accommodate credit policy to the
needs of~ changing economic situation.
An erudite domestic critic puts it more subtly . He says we have
again become subordinated to the Treasury by a process of intellectual osmosis.
It all seems to add up to the charge that the independence we achieved in 1951
was given up again in 1953.
Now what exactly have we done during the past year? I shall leave
out the way we have done it, which has caused some intra-mural debate, and
confine my discussion to broad policies and broad objectives . The story cannot
be definitive, of courseJ because to a certain extent we have been pioneering,
and we shall need later judgments properly to assess the results • .. If we had
only to work by the book, we should not have had to cope with, first, inflationary excesses and then with deflationary dangers, while the Treasury was
almost continuously a borrower or prospective borrower of new money to meet
cash deficits.
My outline, ·then, will be just a broad sketch of policies as they
appeared at the time . In January 1953, there was considerable general or nonstatistical evidence of some revival of boom psychology in business, supported
to some extent by the statistics of November and December 1952. On the other
hand, in the critical area of prices there was little· confirmation and some
deni~l of the emergence of inflationary forces. We were · concerned, however,
about consumer spending increasing faster than consumer _income, the increasing
investment in inventories, and the possible consequences of the prospective
removal of remaining price and wage controls. The situation was characterized
as precarious balance at high levels. In such circumstances a continued policy
of mild restraint of credit expansion seemed indicated. In keeping with such
a policy and consistent with previous open market operations, the discount rate
was increased in January from 1 3/4% to 2%, and gains in banking reserves, resulting largely from the return flow of currency from hand to hand use, were
offset or slightly more tnan offset by reductions in our holdings of Government
securities. As an indication of the mildness of this holding action, the
member banks gained about $1,200 million in reserve funds from January 1, 1953
to mid-March, through the return flow of currency and a decline in required
reserves, and lost a little over $1,300 million through gold and foreign account
transactions and a reduction in the Government security holdings of the Federal
Reserve Banks.
As we came into the spring season, however, the need for alertness to
signs of possible declines in economic activity increased, highlighted by the
decline in farm prices and farm income and the then unpredictable economic consequences of the cessation of fighting in Korea. At the same time, the pressure
of an unusually sustained private demand for bank credit was augmented by the
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emergence of Treasury needs for new money, some of which would have to come
from the banks. These cumulating pressures, operating against a policy of
mild restraint on the part of the Federal Reserve System, converted that policy
into one of more severe restraint than the economic situation seemed to justify.
The risk of giving a final fillip to unwholesome inflationary developments, of
creating a bubbie on top of a boom, had receded.
Taking cognizance of this situation the Federal Reserve Banks began
buying Government securities in the open market during the week ending May 13
and, before the month was out, a total of $157 million of Treasury bills had
been purchased. In addition the amount of reserve credit in the market was
increased by $125 million through repurchase agreements made with non-bank
dealers in Government securities. A net increase of $282 million in reserve
funds available to the market is no small chunk. It might have been considered
as a significant sign of a change in policy and of a prospective easing of
credit availability. But markets are creatures of expectations as well as
events, and the money market and capital market had become disturbed and
jittery, in the face of what they thought would be normal increases in private
demands for funds during the second half of the year, accompanied by Treasury
demands which seemed to grow in size with each new estimate. There was no
immediate reaction to our relaxation of credit restraint during M~y. We were
up against the fact that, at best, central banking is an art, not an exact
science, that there are lags of unpredictable duration between action and
reaction, and that our problems are still quite largely problems of human
behavior.
The market had to be shaken out of the view that credit would not
be readily available during the second half of the year, if we were not to
run the risk of giving deflationary influencesa hard shove into the foreground, by reason of faulty market assumptions concerning future credit
policy. The action the System then took was precipitated in timing and
form--but not in substance--by the needs of the Treasury. Our open market
operations were_ stepped up in June, and lower bank reserves were announced
to take effect early in July. The cynic or the skeptic can say that this
reduction in reserve requirements coincided too neatly, in timing and amount,
with the reserve needs of the banks, as related to Treasury borrowing, to
pass muster as an act of credit policy. The alternative, however, in the
face of the necessitous borrowing of the Treasury, was to allow that borrowing to press hard on bank reserves and on private financing, at a time when
the economy was no longer balanced between inflation and stability, but
between stability and deflation. It seemed to me then, and it seems to me
now, that it would have been economically unjustified to run the risk of
tipping the balance toward deflation.
From early July until early September, we followed pretty much a
hands-off policy while the economy moved sidewise at high levels and with
stability in the broader price indices. We had become convinced, however,
that it was safe to make our errors on the side of credit ease and, during
September, we began to anticipate the expected increase in demand for credit
during the last quarter of the year. The fact that private demands for
credit did not come up to seasonal expectations made it look · as if we had
overshot the mark by our purchase of $359 million of Government securities
during September and the first week of October, and this exposed us again
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to the charge that we had become creatures of the Treasury's needs. I have
no hesitancy in saying, however, that our policies were dictated primarily by
economic factors, other than the Treasury's debt management problems, and
that whatever mistakes we made were not dictated mistakes.
It is an unfortunate fact that our estimates of what may happen to
bank reserves from day to day and even from week to week, as a result of
ordinary market factors, are not too accurate. Over a longer period they
come out pretty well, but the intervening swings may be wide. If we were
going to give the business community and the money market a lead as to credit
policy during the last quarter of the year, when it seemed necessary that
there be no question of the continued availability of reserve funds, we had
to run the risk of overshooting our immediate objective in order .to achieve
the longer term result.
When the demand for reserve funds again began to catch up with the
supply at the end of October we resumed open market purchases of Government
securities and carried on through the year-end. And, as the special demands
of the year-end began to impinge on the central money markets, while the reserve position of the rest of the country remained easy, we gave special
relief to the money market by reducing from 2 to 1 3/4 per cent the rate
applying to repurchase agreements with non-bank dealers in Government securities. In this way the dealers were enabled to supply a temporary home for
short -term Treasury securities which corporations and others wished to convert into cash in connection with year-end adjustments, and the banks were
provided with additional reserves with which to meet seasonal demands.
There, in brief, is the story. We have been trying to do- what it
is possible for monetary management to do in helping to maintain a high
level of production and employment without encouraging inflation or deflation. In the process we have moved from a policy of mild restraint, when
the business situation still had some aspects of a "boom", through a brief
-Period when market expectations induced more vigorous restraint than we had
contemplated, to a policy of increasing ease, as signs of a modest and
gradual downturn in the economy became more and more evidento At no time .
since last June has there been any real concern about the ready availability
· of reserve funds needed to support the credit requirements of the economy.
On the record, therefore, and without claiming too much credit for
what has happened, because monetary policy, at best, is only one part of the
picture, I would say we have been reasonably successful. Up to the end of
1953 adjustments which were taking place in the economy proceeded gradually,
without setting off a chain reaction of downward movements. If this continues, present policies plus the normal forces of growth in our .economy,
which are very strong, should be sufficient to reverse the movement before
it has gone too far, too fasto If a cumulative decline should appear to be
getting under way--if this seconq. transition from "war 1 ' to "peace" should
show signs of economic breakdown--it would be necessary to try to check the
movement with more positive measureso
I now submit that the record of the Federal Reserve System during
the past year has been the record of an independent central banking system,
performing its functions within the framework of the American political
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system, and in the light of the economic conditions with which it was confronted. It is less than accurate, and less· than fair, to try to shove it
back into a niche at the Treasury . To be sure our policies have been consistent with the over-all economic policies ·or the Government, and have
coordinated well with the debt .management policies of the Treasury. That is
what you would expect when reasonable men have the same objectives and are
working from the same set of facts in formulating their policies and programs.
We do not seek to use our independence to oppose Government, merely for the
sake of showing our independence. That would be . intolerable and impossible.
As I have said before, our ind~pendence is within the Government of the day;
we cannot be independent of the Government. But neither can we afford to
be--even be suspected of being--independent within the Government when it is
of one complexion, and subservient when ·it is of another. If that should
happen, our independence would be a sham, and would be destroyed with the
next turn of the political wheel of fortune.
That is why I have taken your time and tried your patience with
this review of our policies during the past year. It is important that they
be understood, if we are not to begin to slip again into a situation which,
eventually, would bring the independence of the Federal Reserve System into
jeopardy.
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