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Summary of Remarks

JHomer Jones
Chief, Division of Research and Statistics

EDIC Supervising Examiners

Washington, D. C,

April 22, 1946

By Homer Jones

Bank supervisors are greatly interested in the future of "bank deposits.
They are interested in whether the total volume of deposits will decline,
will greatly expand or will remain approximately as at present.

They are

also interested in what will happen to the distribution of deposits among
the regions of the country and among various banks.
To a very considerable extent government policy and action determine
the volume of deposits and the price level.

If the government maintains

certain practices with respect to taxation, expenditures, bank reserves
and the management of the government debt, we may have declining deposits
or falling prices.

If certain other policies in these various fields_ are

followed, we may very likely experience still further increases in deposits
and higher and higher prices.

Control of the volume of deposits is a major

factor in determining the price level.

A great increase in the volume of

deposits tends to produce price inflation, while a great reduction in the
volume of deposits tends to induce price deflation.

Thus the volume of

deposits and the price level are not something like the weather to which
we must adjust ourselves but about which as such we can do nothing.
contrary they are greatly affected by government practices.

On the




Since 1939 the practice of this government has "been such as to permit
and increase hank deposit inflation.

Prom December 31, 1939 to December 31,

1945 bank assets increased 131 percent and bank deposits increased 130 per­

The increase in deposits was the direct result of the increase in


The banks purchased government securities and gave the government

credit in the banks’ books in the form of deposits*

The government in «urn

paid for what it needed with these deposits and the deposits flowed into the
hands of the general public*

Along with this great increase in deposits

there was a still greater increase in money in circulation, amounting to

over 300 percent.

The increase in deposits and, to a considerable extent,

the increase in money was primarily a result of deficit financing by the
Federal Government.

If higher taxes had been levied, the government could

have avoided the creation of so great a volume of deposits.

Very likely

somewhat different borrowing policies could also have assured that a greater
volume of the financing of the government would have been out of the savings
of the public and less by the creation of bank credit,
Some increase in deposits during the war was probably desirable and

To the extent that there was more business to be done and to

the extent to which the public chose to save in the form of cash, it was
appropriate that more deposits and money be created.

However, deposits

were created in an additional volume such that prices rose substantially.
Since the end of 1939 an index of the cost of living has risen 30 percent,
wholesale prices 35 percent, construction costs 38 percent, the stock market

- 3 ~

45 percent, and farm land prices 71 percent,

Indeed it is possible that

these indicators do not show the entire increase in prices and that when
consideration is given to the "black market, deterioration in quality, and
other factors, prices have risen much more.


if we had not insti­

tuted a system of price control and rationing, it is very likely that prices
would have risen much more than has "been the case.
large measure an alternative to deposit limitation.

Price control was in
If less deposits had

"been created, price control in considerable measure would have had less to
do and could have done that which it did have to accomplish more effectively.
In any case we are left with a large volume of deposits and money which
threaten to result in a further great increase in prices whenever control
may he lifted.

Our problem now is to so adjust the volume of deposits and

money that we can dispense with price control without a great price rise.
There is every indication at the present time that we need to prevent any
further increase in bank deposits and very possibly that we need to induce
a contraction.

Preventing an increase in deposits means that banks must

not expand their total assets.

Such expansion might come through deficit

financing, through transfer of government debt from the public to the banks
or through increasing other bank assets, particularly loans.
Present indications are that the government will not have occasion to
finance a deficit through borrowing from the banks.

While the last quarter

of this fiscal year is expected to show a slight deficit, the cash now held
by the Treasury is so great that it can not only provide for this deficit

- 4 -

hut also for some retirement of outstanding debt.

Banks will consequently

not expand in the near future by financing government deficit, but in sub­
sequent periods such expansion might take place if taxes were reduced or
government expenditures not kept under control.

A prime key to any possible

contraction of bank deposits would be a large excess of government receipts
over government expenditures.

For the immediate future this would seem to

be a most desirable procedure.
To the extent that the banks may in the future take over government
debt now held by the public, inflation will be promoted.

On the other hand

for government debt to move from the hands of the banks to the general pub­
lic'would be an anti-inflationary influence.

Generally speaking, a strength­

ening of interest rates would be conducive to the movement of debt to the
public, while any softening of interest rates would be an inducement to the
movement of that debt into the banks.

To the extent that we are at any

moment experiencing a substantial rise in prices, this factor in itself will
tend to cause the debt to move toward the banks, thus increasing the money
supply and still further promoting price increases.

To the extent to which

the public may be very optimistic about the future of employment and believe
there will be future price rises, the debt will move from the public to the

Contrarywise, stability of prices and confidence in stability of

prices will be conducive to a movement of debt into the hands of the public.
If the Treasury can issue more long term securities attractive to others
than the banks, price stability will be promoted.


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Expansion of bank loans is an inflationary influence.

In the last half

of 1945 the business loans of insured commercial banks rose 25 percent.


this movement should be resumed, a still further impetus would be given to
purchasing power in relation to goods available and inflation would be pro­

Consumer credit controls, stock market controls, and comparable de­

vices are, within limits, useful in preventing inflation,
When prices are rising, borrowing from the banks will expand in order
to carry on business activity at higher and higher price levels.

This bor­

rowing will result in the creation of further deposits and thus contribute
still further to price rises.

On the other hand, under stability of prices

business can, for the most part, be financed out of funds now held by busi­
ness and consumers and by the sale of securities to investors.
The basic device for preventing unlimited expansion of bank deposits
and unlimited inflation is batik reserves.
very old fashioned one.

This is not a new concept but a

Under the gold standard, particularly as it existed

before World War I, reserve requirements in the form of gold prevented, in
a crude way, unlimited bank expansion.

Under the federal Reserve System

requirements for reserves in the form of deposits in the federal Reserve
banks have served a comparable function.

The federal Reserve System has

prevented unlimited expansion of such reserves by limiting the expansion
of federal Reserve credit.

The important question now is whether the federal

Reserve can, consistent with the present low level of interest rates, ade­
quately limit expansion of federal Reserve credit.

If the commercial banks




see fit to expand their credit through e:npansion of loans or through acqui­
sition of additional securities, they are in a position to expand their
reserves to the degree necessary "by disposing of government securities which
they nay hold so long as the Federal Reserve is committed to maintaining
the prices of government bonds at their present levels and keeping down the
interest rate,

The traditional Federal Reserve devices of selling govern­

ments or raising rediscount rates are not effective or their application is
not consistent with maintenance of the current low cost of servicing the
Federal debt,

Government bonds held by the commercial banks, expecially

the short terms, can be turned into reserves if the Federal Reserve System
supports the bond market.
If the Federal Reserve System did not support the market or supported
it at lower levels, the Treasury would have to refinance at higher interest

Would this be an undue price for inflation controlt

There is a

popular opinion that aside from the increased cost of servicing the Federal
debt, a rise in interest rates and a fall in the price of government securi­
ties would have a bad effect upon investors in government securities, par­
ticularly financial institutions such as the banks and the insurance com­

A fall in the price of government securities would be harmful to

these institutions only on the assumption that it would be necessary for
them to sell their holdings*

While this would be true in some cases, gen­

erally speaking there would be no need for taking such a loss except when
it was anticipated that the higher yields on new investments would more


than compensate for the loss incurred.

Generally speaking, financial insti­

tutions would profit from the rise in interest rates, since their new in­
vestments would “bring them higher returns,

The institutions which currently

hold relatively large amounts of cash and of short-term securities would
of course benefit more from the change than would the institutions which
hold large amounts of long term securities.
While relaxation of support for the securities markets would be the
most orthodox method of limiting bank reserves, there are alternative sug­
gestions for limiting the reserves of the banks while permitting the Fed­
eral Reserve System to continue to support the market and maintain low
interest rates.

The simplest or most obvious of these methods would be to

raise the required ratio of deposits in the Federal Reserve banks to the
deposit liabilities in .the commercial banks.

The banks would have to sell

some or all of their government securities to the Federal Reserve banks in
order to bring up their deposits with those banks.

This procedure would

lower bank income unless interest were paid on deposits with the Federal
Reserve banks#

Such a policy would be consistent with a view held by some

people that bank income is currently unreasonably high.
The second possibility is to require the banks to keep a supplementary
reserve in the form of special non-negotiable government bonds»
would find the adjustment difficult.
higher deposit requirements.

Some banks

This is also true in the case of




There is a widespread view that the cure for the present inflation
potentialities is not so much/monetary or fiscal problem as it is a problem
of securing full employment and maximum production.

However, it is not cer­

tain that a condition of full production, desirable as it is, may not be
more inflationary than a condition of ««Srpro duct ion if fiscal and monetary
matters are not properly handled.

When there is full production the recip­

ients of income equivalent to the production may feel so optimistic that
they are not only willing to spend the entire income received, an amount
just sufficient to buy the production of the country, but they may also
attempt to reduce their accumulated savings and borrow newly created credit
from the banks, thus attempting to spend an amount more than equal to the
goods produced and consequently create inflation.

On the other hand,'when

production is somewhat less than full production and unemployment prevails,
the recipients of income may be so pessimistic that they will not spend
their entire incomes, will attempt to build up their accumulated savings,
will pay off their bank loans, and consequently demand will not be so great
as production, even though that production is low.

Thus while every attempt

should be made to achieve full production, such a goal is not a cure for
the inflation problem*
In conclusion, the current situation seems to be such that we must
choose between (1) inflation (2) indefinitely extended price controls and
rationing, and (3) preventing bank expansion.

If the third policy is fol­

lowed, we must choose (l) higher interest rates or (2) higher reserve
requirements of the banks.