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> FEDERAL RESERVE DECISION MAKING (Remarks of C9 Canby Balderston, Vice Chairman, Board of Governors of the Federal Reserve System, before the Financial Analysts of Philadelphia, on Friday, April 12, 1957o) Tight money, so-called, has moved the Federal Reserve from the fil i a l page to the front page. 8ha Since the Fed works full-time to do its re to protect the purchasing power of the dollar, it is important that the na t,ure of the System and of its decision making should be understood. liy first point is that the central bank in this country is a sysnot a sinple bank. It is a system whose structure or design balances Centralization and centralization. st ii, . It is a Federal system with a basic ^cture and checks and balances akin to those of o u r ^ e r a l Government. My second point is that its monetary policy decisions are not ^ e suddenly or arbitrarily, but are the result of long consideration and H u s s i o n to which many minds contribute. as Federal Reserve decisions evolve one phase of the economy fades into another. S^own They do not spring full- Athena from the brow of Zeus. It is especially appropriate to be discussing the Federal nature °ur central banking system in the city which was the home of the First ana Second Banks of the United States0 The First Bank was chartered by the a[ Ve ° rnment to issue paper currency. Essentially it was a private central ^ though its ownership was divided: **ivate> one-fifth governmental, four-fifths - 2 The charter of the First Bank lapsed during the administration of Resident Madison; the function of issuing currency was returned to state ba nks exclusively. These state bank notes lacked 100 per cent metallic Peking and many of them declined in value substantially. Five years after the First Bank expired, Congress gave birth to Second Bank of the United States, Five of the directors were appointed V the President of the United States and 20 by private stockholders. Its ^in office was here in Philadelphia, but it had over two dozen branches Mattered from Maine to Louisiana,, Through these branches Nicholas Biddle contract and expand the currency. Bray Hammond indicates that its pov 'er to regulate came from the fact that it held the deposits of the U. S. T ^asury, the largest depositor in the country, bar ^s were deposited with it, Biddle gave the Treasury immediate availability arici 8pe f When checks of the local then pressed the local banks to make settlement in specie. cie> W e t h e i r povjer to lend was reduced, As they lost The Second Bank exerted strong in- upon both industry end agriculture. But once again the central bank under political attack because it was looked upon as the tool of the power. aft And so, President Jackson vetoed the renewal of its charter er Congress had voted its renewal. 0f Once more the control of the issuance currency was returned to the state banks. And this country continued to upon state banks for the issuance of notes until the establishment of the National Banking System in 1863. Both credit and currency inflation again without restraint even though Nicholas Biddle had been demonstrates real insight into the methods by which a central bank could keep the ^ y supply attuned to the needs of the economy* Subsequent to the demise the Second Bank, the currencies were neither dependable nor elastic. In the long decades that intervened before the Federal Reserve Astern was created, this country suffered a series of monetary afflictions. C hief among them was the Civil 1/ar inflation that culminated in the polit- *Cally attractive greenback movement. This destruction of values was fol- d e d by the free silver agitation. The silver purchase legislation in efect - from 1878 to 1893 resulted in increased currency issues and a gold °utflow which endangered the maintenance of the gold standard, but the free s Uver group wanted to go still further and substitute free coinage of silver clt • X. old price. ^Um So much for a currency that was unreliable both as a me- exchange and as a store of value. But the panics of the 1870's and 1890's and 1907 demonstrated the ot her weakness of our currency: Qls 'oQ for secular growths its inelasticity not only seasonally, but There was no central bank to provide for an elastic CUr and tofrom serve"runs" as a bank of them last or resort when individual commercial k ^*'ency s suffered against to supply the expanding monetary 3e essential for a growing economy. While gold discoveries around the turn of the century supplied the asis for monetary growth—perhaps too rapid expansion—provision for ad- Stiri g money supply flexibly to the varying needs of the economy waited 1913 w h e n congress determined upon a central bank in the form of a federal system. Its structure consisted of a central Board with 12 Mortal banks, to which there have since been added 2.4 branches. th ^ Each of banks has 9 directors of which 3 represent lenders, borrowers and at large, respectively. The first 6 are elected by the commercial that hold Federal Reserve stock. Of these 3 are bankers and 3 are businessmen or farmers who are not bankers. The remaining 3 public repre- sentatives are appointed by the Federal Reserve Board. Altogether the Fed- er al Reserve Banks and their branches have 260 directors who represent a c ross..section of American businessmen. At the hub of this Federal Reserve wheel are the Federal Reserve Boa rd and the Open Market Committee. The first, consisting of 7 members ap- pointed by the President for staggered terms of 14 years each and confirmed ^ the Senate, may be described as a coordinating body, with the general 0v ersight of the several Banks and branches, and the authority to administer ^rgin requirements, and to review and determine discount rates. It has the res Ponsibility also for examining the Federal Reserve Banks and Branches, and though these Banks to examine the member banks. The Open Market Committee consists of the 7 members of the Board Governors plus 5 Presidents in rotation and has the responsibility for ^ g i n g the System's portfolio of United States Government securities, the la ^ s t portfolio in the world. yst em. This Committee is the clearing house for the its direct responsibility is to control the use of the most delicate the monetary instruments, namely, open market operations. ^crease bank reserves by buying or selling securities. the It can increase Recently, however Committee has come to be a forum for corralling the knowledge and thinking the entire System, and for exchanging views as to the shifts in our dyna- 11110 economy. Not only is it the focal point of the System's intelligence U n t i e s , it is a mechanism for determining the consensus of Sjrstem thinkEach individual member is responsible for judging the trend of events in e ^ Pendently and for reaching his own conclusions; he is also responsible, - 5 as a member of the Committee, for making his contribution to its joint pro- duc t. Over a period of time it is a fair assumption that the consensus of a dumber of informed opinions is a safer guide to policy making than that of a sin gle individual, however correct he may be at a particular moment. To a ccomplish these ends, the Open Market Committee now meets about every three *eeks. The 7 Presidents who at a given time are not members under the sj'stem of rotation also attend; except for voting, they participate in all other Aspects as if they were members0 What I am suggesting is that it is a mistake to think of shifts in F ederal Reserve policy as being the result of abrupt or arbitrary actions. The general monetary policy for which the Federal Reserve is responsible is f<3a tured by flexibility. t34ea . It shifts with the ebb and flow of the economic Just as businessmen seek to determine business trends by observing the s igns and portents that have been found historically to have some meaning, S ° Monetary authorities appraise business tendencies by the same signs and accordingly. The problem of judging the state of business, as you have discovered, is ^o-fold. One is the time-lag before business data become available. The is the low visibility during certain phases of the cycle. For monetary authorities, the most fundamental problem of timing is ° Recast changes in the business climate in order to take compensatory before the figures actually prove its necessity. Promptness of action 4 5 operative if the anticipated results are not to be reduced unduly by the tlrn ^lag between changes in monetary policy and their effect on business ac• If the authorities wait until the figures demonstrate beyond question - 6 that further credit restraint or stimulation is needed, the action may lose lts effectiveness, in whole or in part. But the perils of action based on 3udgments in advance of confirmatory information are obvious! Another timing difficulty stems from the integration of monetary au 3 fiscal policy. Actions by either the Fed or the Treasury may create ^fficulties for the other one, however firmly these two agencies resolve to V;or For instance, take the problem posed for both the Treasury aU(i the Federal Reserve at the time the discount rate was raised in November k in concert. ^55. For some months, business confidence had been mounting,, It was evi- n c e d by the rise of industrial orders and of loans, by rising stock prices, business plant expansion, by a scarcity of steel, cement, and glass, and V increasing prices of many important industrial materials and products. The count action that such a situation might have indicated was delayed by the ec nor ° nic uncertainties stemming from President Eisenhower's illness in late s Member. That these uncertaintj.es dissolved in the sober reflections of ^Usinessmen was indicated by the McGraw-Hill survey of capital additions forecast an overall increase in 1956 plans over 1955 of 13 per cent, e Return of ebullience plus high seasonal demand for loans caused the FedReserve Banks, with the approval of the Board of Governors, to raise ^ir rediscount rates in November even though the Treasury faced a refundln S in December of over $12 billion. L The Federal Reserve action, necessary ^as, increased the Treasury's difficulties in refinancing its maturing ^•^gations the following month. The action had to be taken at the time despite some risk of unsettling the market for both Government P^vate securities. - 7 Monetary policy should be adapted to future contours that can be discerned only dimly and for a short distance ahead. Consequently, shifts business outlook are rarely so definite and clear-cut that monetary authorities can decide abruptly to shift credit policy from restraint to ease, 0i> vice versa. Nor is a shift in policy emphasis usually decided suddenly Without extended consideration. Just as a paddler guides his canoe through the ever-changing currents of a swift-flowing river, so must monetary authorises use as much foresight as possible in adapting their policies to changes ln direction and condition. Sometimes, of course, crises develop suddenly, X95 In the spring of 3, ebullience was high, plant expansion was rapid, inventory accumulation V,as large, and credit demands were strong with prospects for large Treasury l o w i n g ahead. The monetary authorities met this situation by maintaining res traint on bank credit expansion. Suddenly, in a matter of days, as heavy b °rrovdng demand hit the market, money became tighter than it had been for 50 years. There developed fears that this tightness might endanger the conduct of business, particularly in view of the usual seasonal exPans ion in demands then beginning, and the restraints were eased. In retro- Spe °t, it appears that the subsequent decline in activity is to be attributed ln Part to curtailment of governmental defense expenditures—a curtailment that had not been scheduled when the monetary restraints were imposed,, However, typical changes in the use of open market operations, Cha *ges in discount rate and reserve requirements evolve gradually from a V,hol -e sequence of developments in manufacturing, in commerce, in finance, ^ in the markets of the world. A striking example happened in the middle - 8 of 1956 when the Minneapolis and San Francisco Banks used discount rates different from the rest of the Reserve Banks. The commercial banks in those districts were experiencing such loan demand as to cause them to borrow ^avily from their respective Federal Reserve Banks. The Federal Reserve directors of those two districts felt that the business sentiment reflected b y this loan demand was sufficiently exuberant to require curbing. Accord- they decided to increase their discount rates, subject to review and termination by the Federal Reserve Board. The Federal Reserve Board, like- ^i36, was watching with concern the expansionist tendencies of that period, ana it approved the changes in these two districts even though the other ten districts did not all follow suit for over four months. There is ample evidence to indicate that neither monetary policy n °r fiscal policy, nor the two in concert, can provide growth and economic e W i b r i u m in the face of either general despair or speculative exuberance. 0f these two products of group psychology, despair and ebullience, there is aiso evidence in the history of previous booms and busts to demonstrate their Pov:e r. 19301 eVen the Take the impact of the widespread destruction of equities in the s upon the initiative of executives and their willingness to venture if they were credit-worthy,, At the other end of the spectrum observe speculative fever that has so often weakened the economy during boom Pe riocis% There was the inventory expansion culminating in 1920, the Florida estate boom culminating in 1926, and the inflation of security prices 6nc5ir ig in 1929 that was inspired by the belief in a "new era" and was sup- p e d by an abnormal flow of credit into the stock market. Dr. Riefler has observed that "a business situation is no sounder tha n the quality of its business decisions." Their quality, however, has two - 9 as pects# One aspect is the soundness of the decision itself. To base a deci- sion upon an objective appraisal of such facts as are available does not, of course, insure that it will subsequently prove to be correct. But is the de- cision not more likely to prove imprudent if it is based upon the desire to chase the "fast buck" or upon sales projections that are inflated by price dances? The second aspect is that there are times in the business cycle Vj hen business decisions may cause aggregate demand to outrun supply even th °ugh most of the decisions may have been made prudently* the Even if all of demand arising from speculative and imprudent decisions were eliminated, lt is conceivable that the remaining ones might create so much demand for Scar> ce materials, labor and credit as to prove inflationary* Hence, it is not realistic to assume that prudent decisions alone are a solution without the overall control exerted by the central bank over the total supply of c *eciit. The question is frequently raised as to whether monetary and fis- Cal controls can prevent creeping inflation,, Professor Sumner Slichter has fl?e quently written upon this subject. He has recently observed that points v iew concerning it fall into three categories. First, there are the pes simi3ts who argue that no government dares to resist the demand for more ancl more credit because of the popularity of inflation with employers; trade Zionists and the growing number of debtors. The second group he describes c autious optimists, typified by Dr. Arthur F. Burns, who argue that the S0?a -s of stable prices and of high and rising employment are broadly com- Pat ible, the The third group he describes as optimistic skeptics who hold that long-run price movement is determined largely by influences over which ~ 10 * have only very incomplete control. These skeptics feel that there is not much that any one can do about the rapidly growing need for metals and oil unless one can halt industrialization and check population growth. Morethey hold that the country is not prepared to accept either of the two Kftovjn methods of control—sufficient credit restraint to create enough une:a Ployment to halt the rise in labor cost or drastic government controls of Wa £es and prices. There is no evidence from the experience of any country, even ^Ussia, that direct controls over prices and wages, however drastic, can C nt ° ain inflation*, It is my own belief, however, that with general monetary and sound fiscal policies orderly economic growth and reasonably Sta ble p r i c e s are compatible. not <s I decline to accept the doctrine that we can have p r i c e stability without heavy unemployment. My principal argument that excess capacity tends to depress prices and to curb price rises. As opacity catches up with demand, prices recede. Witness the record in C tt,0 ° n spinning, the production of rayon and acetate, and the weaving of C tt,0 ° n and synthetic fabrics. In the last of these, the data suggest that Vh Productivity and wage rates have increased about one-third since 1947 M m . iabric prices have fallen,, My second observation is that the belief that creeping inflation is • inevitable is both self-defeating and dangerousa SCaUs It is self-defeating e one group after another seeks to protect itself by devices such as clauses that tend to bring on the very malady it dreads; danger- e by v cause it has an insidious effect upon the quality of decision making DUs inessmen who feel (perhaps unconsciously) that if they err on the side Of ^Prudence j in plant expansion and inventory building, the anticipated ~ 11 ris - e of costs and prices will validate their blunders. Such a belief threat- ens the continuance of the orderly rolling adjustment that seems now to be in pr °gress. The wide belief that inflation is not only inevitable, but in fact ^sirable to sustain high employment, would accentuate the ebullience that has already caused investment demand to outrun savings. It leads to the ef- of too many people to buy too much too fast. If the value of money is to be stable and to assist the economy to 111076 anci steadily upward, its supply must be harmonized with the flow of goods with market competition. ec °nomy i s so The impact of the general money supply upon the great as to make it of prime concern to citizens generally. supervision and control by governmental authority is required. as As far the total supply of money and credit is concerned, we have a managed curThe apportionment of this supply among individual borrowers, however, is nno t primarily a matter for Government but for private lenders operating th free markets. 6 to The selection of the particular customer to whom loans be made is and should be left to the discretion of commercial institu- Only if the allocation is the result of the operation of a free market Mjj . . . . ^ be as impersonal as is desirable. This is not to say that it is m Ppr °P*late to intervene to further the general public welfare. 001 Our public system is a classic example of the social gains from such intervenIn war or other extreme emergencies involving severe social hardship, * Whe n there is undue restraint of trade, the Government should interfere ^ te n ° allocative function of prices and markets. But when the Government does intervene in the process of allocato take care of especially sheltered groups through subsidies, guarantees, direct loans, it should remember that it is increasing the difficulties those not so sheltered. Under the free enterprise system it is axiomatic that not all groups can be thus protected. Currently, with the widespread feeling that continued inflation is inevitable, consideration of the public welfare calls primarily for measures to bring savings into balance with investment demand. Confidence that we Possess and will pass on to our children a stable dollar is more important to groups in the country than further attempts to shelter some of these ^oups from inflation. I turn now to the philosophy that pervades the Federal Reserve Astern and guides its methods. tha The point has been made by Chairman Martin t the philosophy of the System may be likened to the concept of trustee- Shi P. Trusteeship involves obligations that extend beyond mere legality. ^ involves the highest ethical and moral standards in the carrying out of the mandate issued to the trustee. While that mandate is in force, it im- p iies the courage to take actions, however unpopular they may be at the that the trustee believes to be best for the country and its economy, ^turally, the "trust indenture" of which we are speaking, that is the FedReserve Act, is not irrevocable because it may be changed at the will the Congress. In bringing about this trustee arrangement to deal with the highly c °%>lex problems faced by a central banking system, the Congress is to be Cj?e ^ited with foresight in the degree of independence with which it has surthe System. The nuances of independence are not easily spelled out. -involve an opportunity, like that of the judiciary, to act objectively - 13 without favor and without fear, free of private pressures on the one side partisan political pressures on the othera Such objective action re- tires full recognition of the real needs and interests of all concerned, alc >ng vath recognition of their important roles in a properly functioning e conomy0
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