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STATEMENT BEFORE SENATE BANKING & CURRENCY COMMITTEE - 3/2A/A7 MEMORANDUM OF CHAIRMAN ECCLES ON H*R* 2U13 The proposed b i l l would extend f o r 3 years the existing temporary authority, under the Second War Powers Act, whereby Federal Reserve Banks may purchase up to 5 b i l l i o n dollars of Government securities to meet temporary deficiencies in Treasury balances with the Reserve Banks. The b i l l would restore to a limited degree an authority which the Federal Reserve System had from i t s inception in 1914 until the Banking Act of 1935» A provision was inserted in that Act requiring all purchases of Government securities by Federal Reserve Banks to be made in the open market, which means purchased chiefly from dealers in Government bonds* Those who inserted this proviso were motivated by the mistaken theory that i t would help to prevent d e f i c i t financing. According to the theory, Government borrowing should be subject to the if test of the market.w The so-called "test" could only be applied to marketable securit i e s , and the test would be meaningless unless applied to them in an ent i r e l y regulated market« There could be no such market except at the risk of chaotic conditions in the bond market and incalculable added costs to the Government in managing the public debt. Congress vested in the Federal Reserve authority to create reserves f o r the banking system primarily by purchases of Government securities in the open market* Purchases as well as sales of Government securities are made by the Open Market Committee, established by Congress f o r that purpose. Policy governing these operations i s determined on the basis of the broad needs of the economy at any given time. Through these operations the Government bond market has been kept relatively stable, notwithstanding the vast increase in the public debt as a result of the war, and the Treasury has had an assured market f o r new as well as refunding issues at interest rates satisfactory to the Government* Nothing constructive would be accomplished by the proviso that the Reserve System must purchase Government securities exclusively in the open market. About a l l that such a ban means i s that in makiiig such purchases a commission has to be paid to Government bond dealers. The prohibition would not restrict the total amount of Government financing, nor would i t a f f e c t the general level of interest rates, and that is the only way in which the "test of the market'' could be manifested. Interest rates on Government securities have been and w i l l continue to be determined by the Open Market Committee in consultation with the Treasury. Finally, i t i s unrealistic to presume, as this theory does, that i f Congress votes f o r expenditures but does not vote f o r sufficient taxes to cover the expenditures, the money market should erect barriers to discourage the practice* The purpose f o r which the direct purchase authority has always been used in the past and would be used in the future is simply one of meeting temporary needs of the Treasury which, i f met in other ways, would entail either needless additional costs in managing the public debt or equally needless fluctuations in the securities and money markets f o r brief periods. "What i s involved in the proposed b i l l i s not a question of monetary theory or policy, but simply a question of e f f i c i e n t , economical and businesslike management of the public debt. - 2 - The direct purchase authority merely provides a line of available credit f o r use i f needed. Without i t , the Treasury would f e e l obliged to carry much larger cash balances, which means that i t would have to borrow more and thereby increase the amount and cost of the public debt* In other words, having the authority, even though there may be no need to use i t , enables the Treasury to carry smaller balances than would otherwise be possible and thus reduces interest charges» For every b i l l i o n dollars of Treasury balance that can be saved in this way, interest costs would be reduced by at least b million dollars. As the Committee knows, with a huge public debt, much of i t in short maturities,, frequent, periodic refunding operations are necessary» For example, more than 10 b i l l i o n dollars of Treasury b i l l s , certificates and notes f a l l due in March, some 8 billions in April, and so on through the year» The same will hold true f o r years to come — as long as we have a debt of this magnitude. To have an uncertain or periodically tightened money market in view of this situation would be as impracticable as i t is needless* I append to this statement a table which shows the number of occasions on which the direct purchase authority, granted temporarily in the Second War Powers Act of 19^2, has since been used* The table shows that in 19U2, 19U3 and again in 19U5 there were approximately 60 days, a l l of them falling at periods when the Treasury had to meet large payments, generally f o r interest or f o r redemption of maturing debt, a few days before large tax receipts were deposited* The Treasury temporarily borrowed from the Federal Reserve Banks f o r these few days when the Treasury balances at the Federal Reserve Banks were less than the amounts needed to meet withdrawals* Subsequently these deficiencies were overcome and the Treasury balances at the Reserve Banks were built up again as deposits were made to these accounts of tax payments received by Internal Revenue collectors* The temporary borrowing did not mean that the Treasury had no funds* It had large deposits in War Loan Accounts with commercial banks at a l l these periods» Sufficient funds could have been transferred from the War Loan Accounts to the Federal Reserve Banks to cover a l l expenditures* However, transfer of funds from the commercial banks to the Federal Reserve Banks f o r this purpose would have l e f t the Treasury, after the tax receipts had come in, with a much larger balance at the Reserve Banks than i t needed and thus would have unduly reduced bank reserves f o r an extended period* If commercial banks are faced at tax periods not only with deposit withdrawals to meet tax payments but also with drains on their War Loan Accounts, they would have to follow one of four courses: If they had sufficient excess reserves with the Federal Reserve Banks they could reduce their reserve balances to the extent necessary. If they did not have excess reserves — this normally is the case — they would have to s e l l sufficient securities to obtain the funds, or they could withdraw correspondent balances, or they could borrow from the Reserve Banks. All of these alternatives would tend to tighten money market conditions at a time when taxpayers would be drawing on their bank accounts to make their tax payments* In other words, i f the Treasury could not borrow temporarily from the Federal Reserve Banks at thsse tax payment periods, and in - 3 - this way avoid withdrawals from i t s War Loan Accounts to pay off maturing obligations, money conditions would unduly tighten and tend to unstabilize the money market and the Government securities market. This can be avoided by the temporary borrowing until the tax payments again build up Treasury accounts at the Reserve Banks and provide the Treasury with funds. The operation simply s t a b i l i z e s the market. That is a l l that happens. The amounts of special c e r t i f i c a t e s shown in the table are relatively small compared with the size of the public debt and the recurring maturities. For instance, on June 16, 19^4-2 and f o r four days thereafter, the Treasury had borrowings varying from 58 to 9U million dollars. The largest occurred in the middle of March of 19^3 > when the highest amount borrowed was $1,302,000,000 on March 15* The borrowing was entirely paid off by the end of the month. As I have indicated, the authority existed f o r more than twenty years prior to 1935* I t i s more needed than ever today because of the size of the debt and the refinancing operations. The f a c t that tax c o l lections are also very large, currently about ¡4O b i l l i o n s a year, means that quarterly withdrawals from the banking system are going to continue to be heavy, so that i t w i l l be desirable to have the authority to help in stabilizing the money market at tax dates. HOLDINGS OP SPECIAL SHORT-TERM TREASURY CERTIFICATES BY THE FEDERAL RESERVE BANKS, 19U2-1+5 (In millions of dollars) Amount Date Date June 16 19 20 22 23 hi 3b 9b 19U3 - Mar. 18 19 20 22 23 32U 189 26 76 53 27 29 30 58 70 Sept.15 16 17 18 19 286 Nov. 27 28 30 139 329 Dec. b22 1 10 15 98 16 li+5 191+3 - Jan. 29 30 115 202 Mar. 2 b 5 6 8 9 10 11 13 15 16 17 3 17U 35*+ 5U3 591 61+8 632 790 1.0Ì4.3 1,302 1,250 981 2b 25 June 15 16 17 18 19 Sept. 8 9 10 11 13 Amount 836 778 768 603 700 512 ¿+32 381+ 301+ 10b bo 805 659 350 256 212 11 126 2b3 21+6 21b lb 15 16 179 U21+ 258 19U5 - Mar. 15 1+ Deo. b 5 6 7 107 318 37U 1+81+ 10 202 8 1+81+
@FedFRASER