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BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENT OF CHAIRMAN ECCLES BEFORE THE JOIFT COML'ITTEE ON THE E C W ^ U C REPORT 1'ffiDNESDAY, DECEIIBER 1 0 , 19kl FOR RELEASE ON DELIVERY Mr. Chairman and Members of the Committee: 'I appreciate the dpportunity to discuss further the problem of what might be done in the monetary and credit field to deal with inflationary forces. Since my previous appearance before this Committee, there has been considerable discussion of the Reserve Board's .proposal for a temporary special' reserve requirement. There is a good deal of misapprehension and misunderstanding about it. I should like, as briefly as possible, to put it in what appears to me to be the correct perspective. In my initial testimony before this Committee, I explicitly stated and I want to reemphasize that the proposed special reserve is only a part, though a necessary part, of any effective anti-inflationary program, and that the need for this authority would be less to the extent that appropriate action is taken on other fronts. By far the most important action is a continuing, vigorous fiscal policy. Because of that policy there is likely to be little need for the special reserve requirement during the next four months. In that period Treasury surplus funds, taken from the market through taxes, will be available to retire a substantial amount of bank-held public debt. However, after that period we may be exposed to an unbridled expansion of bank credit because the Reserve System's existing powers, in the face of its newly-acquired responsibilities for the Government security market and in the face of a continued inflow of gold, are insufficient to restrain further bank credit expansion. Considered in this light, our proposal is a precautionary measure to guard against possible disaster later. Many bankers find certainly .the, Federal Reserve people are agreed that the Government bond market must be supported and stabilized. There is agreement that thfe present progr&jn of the Federal Open Market Committee and the Treasury should >be vigorously prosecuted. There is agreement that supervisory policy and moral suasion on the bankers to avoid loans for nonproductive purposes should be aggressively pursued. There is agreement on fiscal policy and the need for maintaining as large a surplus in the Treasury's cash budget as possible in order to pay off bank-held debt* There is agreement as to the need for strengthening the savings bond program of the Treasury. These are important areas of agreement^ and they ought to be kept in the foreground of any further discussions of the use of monetary and credit policy as a brake upon further inflation. &t the same time, we should not fail to keep in mind the fundamental issu^:'4 Bank credit is still expanding, mainly because of loans, gold is flowing into the country, the money supply is still growing, inflation is continuing. The question is; What is the next step, if any is required, in doing something about it? Banking loaders who have already had some opportunity to study the proposed special reserve plan and have arrived ,at4opinions adverse to its adoption, voice this opposition along two lines of ,argum$nt. On the one hand, they contend that the plan is impractical, socialistic, and unnecessarily drastic. On the other hand, they assert that the plan i*s not strong enough to accomplish its expressed otjject^yes. The cojitrast between 'these two lines of argument is striking. Both cannot be correct. - 2 First, does the proposal mean regimentation of the banks; will it unduly interfere'with the operation of their business, and will it be a step toward socialization? *" ! * In the Board's judgment, the typfc of authority proposed is neither novel nor revolutionary. The'authority provided by the Banking Act of 1935 'to raise r^sertfe 'requirements of member banks to twice the then prevailing statutory level was similar. Except for a small margin applicable only to Hew York and Chicago banks, this authority to increase meifiber' bank required reserves has already been exhausted. In late December 19U0 the Reserve Board, the presidents of the Federal Reserve Banks, and the Federal Advisory Council unanimously joined in a special report to the Congress pointing out the inflationary dangers for theJ national economy inherent in the defense effort. This special report, recognizlrig that the authority of the Federal Reserve System was wholly inadequate to deal with the potential excess reserve problem of the banks, recommended that Congress — "(a) Increase the statutory reserve requirements for demand deposits in banks in central reserve cities to 26 per cent; £or demand deposits in banks in reserve cities to 20 per cent; far demand deposits in country banks to*lU per cent; and for time deposits in all banks to 6 per cent. "(b) Empower the F'ed&ral Opeh Market Committee to makfc further increases of reserve requirements sufficient to absorb excess reserves, subject to*the limitation that reserve requirements shall not be incrfeased to more than double the respective percentages specified in paragraph (a). "(c) Authorize the FeddY&l- Ofcen Market Committee to change reserve requirements for central ^reserve city banks, or for re* serve city banks, or for country banks, or for any combination of these three classes. Tf (d) Make reserve refquiregents applicable to all banks receiving demand deposits reg&r&le'ss of whether or not they are members of the Federal Reserve System." In addition to these major recommendations, the special report urged that the defense program be financed as far as possible from existing deposits and. from tax revenues rather than from inflationary borrowing from the banks. I submit for the record a copy of 'this special report, because it called for far more onerous and drastic powers than the special reserve plah. The special*reserve plan, however, is identical in purpose with an outright increase in regular reserve requirements. The plan, in'fact, - 3is no more than an adaptation of this familiar method of dealing with the volume of bank credit. The plan how proposed by the Board would enable the banks to retain the same volume of earning assets they now have, in place of makjng then reduce earning assets, as would an increase in regular reserve requirements, with adverse effects upon bank earnings* Is the Board's proposal unnecessarily drastic? • l Hi il i |B — »i • • H» i -II *< • I I I I •! i f riti •• m i l i • • • p ••• In pointing out the inflationary dangers that exist v/h^n the supply of money in the hands of people who seek to spend it greatly exceeds the volume of goods and services available, the Board in its Annual Report for 19U5 indicated that there were three alternative methods for dealing with the monetary aspects of the postwar inflatioiiary problem: First, a limitation on the Government bond holdings of banks; second, an increase in their regular reserve requirements; and, third, the holding of short-term Government securities or cash under a special reserve requirement. Our study of the problem led us to select the special reserve method as the lea?t onerous, the most equitable, and the most practicable method. These specifications for the proposal call for the immobilization, even at the maximum, of only a part of existing large holdings by commercial banks of Government securities. Less than half of the 70 billion dollars of Government securities held by the banks could be immobilized even if the entire authority were used. The special reserve could be imposed only gradually, and if inflationary bank credit expansion C8n be otherwise brought under check, the requirement would not be imposed at all. Under the plan suggested, the individual banker would be left in the same competitive position he is in today. Contrary to what has been stated by a recent National City Bank Letter, among others, banks would not be under legal compulsion ;bo buy Government bonds; the holding of Government securities in lieu of cash or balances with other banks to meet the special reserve requirement would be entirely optional v/ith the individual bank. The speciaj reserve plan is a middle-of-the-road proposal for helping to deal v/ith the credit and monetary aspects of the difficult and complex inflationary situation. The Board feels, however, that the purpose of restraining further inflationary expansion of bank credit can be adequately accomplished by the specifications it has drawn for the plan, if its use is. accompanied by appropriate fiscal and other policies. It v/ould seem that bankers would prefer this proposal to an increase in regular reserve requirements, which they recommended in 19U0 in anticipation of inflationary developments. Are existing powers adequate? The argument that the Board's proposal is unnecessarily drastic implies that the suggested special reserve requirement is not needed because -hthe System1 s existing powers are adequate to restrain credit expansion if the System would use them. Existing powers are beings and- will continue to be used to the fullest extent consistent with maintaining the market for Government securities. Under present conditions, howeVer, any further absorption of bank reserves is entirely dependent upon a continued surplus in the Federal budget that can be used to retire public debt held by banks. There -will be Little or no surplus, in 19U8 after March. Any subsequent surplus will depend on appropriations and tax legislation yet to be adopted* Sales of some of the large vplume of Government securities held by tha Federal Reserve System would, of course, absorb bahk reserves, but such sal.es, particularly when banks are-selling securities to expand other credit, would demoralize the market and cause a sharp break in Government bond prices. The discount rate should be kept high enough to discourage borrowing from the Federal Reserve Banks, but its effectiveness is limited as long as banks can obtain reserves by selling short-term Government securities. The only remaining power we havfc is to raise regular reserve requirements at New York City and Chicago banks, as I have indicated. This would be restrictive to a small degree, but would be met by sales of short•term securities by those banks to the Jteserve System. These particular banks, moreover, have shown relatively much less credit expansion than have other banks. • For some months the Reserve System and the Treasury have been carrying out a program combining monetary, fiscal, and debt-management restraint on current inflationary bank credit expansion. Some moderate, corrective rise has been permitted in wartime levels of interest rates on short-term Government securities, together with some adjustment in yields on long-tkrm issues from* very law levels. In addition, excess funds in Treasury,balances arising from*current budget surpluses have been applied to the retirement of maturing bank-held Government securities. The System has also urged all banks to maintain conservative standards in the extension of consumer instalment credit, and has joined with other Federal and State bank supervisory agencies in recommehding that all banks pursue conservative lending policies. This program of restraint has helped to reverse the processes that contributed so strongly to the wartime expansion of bank credit, and will be carried on as the proposed special reserve plan is not a substitute for this program, but may be necessary to- supplement and reinforce it. - 5Despite the pressures of fiscal policy during September and October, which drew upon bank deposits and permitted retirement of over one billion dollars of Government securities held by the banking system, deposits of businesses and individuals at commercial banks increased by 2.5 billion dollars, reflecting largely extension of bank loans to businesses, consumers and owners of re&X/estatet. Current reports indicate that the expansion of credit to these, groups-of bank, customers continues to be at an unduly rapid rate. Will the special reserve plan unduly restrict bank loans for productive purposes, handicap production in catching up with demandf and thereby defeat it's"anti-inflationary purpose7 The present situation, as the Board emphasized in its Annual Reports for 19U5 and 19U6 and has been reemphasized time and again in the Federal Reserve Bulletin, is one of effective demand in excess of available supplies of goods, and of effective demand being continuously fed by still further expansion of bank credit* There can be considerable reduction in the volume of demand without bringing it below available supplies of goods and upsetting production. Such a contraction of demand is essential to avoid further price increases* 1/Vhen a situation is finally reached where supply exceeds demaxid, that vail be the proper time to encourage credit expansion. The Board's proposal is not a one-way street. It would not prevent banks from making essential loans. It is designed, rather, to encourage banks to make loonb out of the existing supply of loanable funds, replacing one loan with another or selling securities vrtiicn the public or other banks will purchase* It would accept the present volume of outstanding bank loans, amounting to nearly 37 billion dollars, as a huge revolving credit pool for the financing of necessary production and permit banks to sell off other assets to make loans if this pool proved inadequate. V/hat it would not do is to permit banks to go on expanding the total volume of their loans by selling securities which only the Federal Reserve will buy, thereby creating additional reserves, which can be expanded by the banking system into loans and investments amounting to six or more times tneir amount. Some would argue that bank loans at this time which are accompanied by increased production are not inflationary or are even antiinflationary. This argument is of dubious validity because the money once created by loans and spent by tne borrower finds Subsequent uses which are beyond the control of the banker or the borrower and are highly inflationary in character." In describing the recent loan expansion and its inflationary effects, the November issue of the Federal Reserve Bulletin states: ,f. • . to the extent that tne loens have not facilitated increased production, loan expansion has accelerated inflation. In addition, the deposit funds Created in the first instance by loans, whether for production, consumption, or speculation purposes, have found many inflationary uses in subsequent transfers among holders.1' -6 What the plan cannot do is to reduce the existing volume of bank deposits. ' The only way this total<can be reduced«is by paying off in the aggregate i;he public and private debt held by the banks as assets against these deposits. This is inevitably a slow process <at best. Could the special reserve plan be applied without resulting in a violent upset in the Government securities market? There is no reason why the transition could not be accomplished in an entirely orderly manner. The introduction of the proposal would be gradual. v-Any bank that might not be able to meet the proposed special reserve requirement introduced in this gradual way on the basis of their present holdings of * short-term Government securities should get into a more liquid position. I should like to submit for the record a table showing for each major group of insured banks the relation of available special reserve assets on June 30, 19U7* to selected 1/evels for the proposed special reserve requirements, The table also shows the percentage holdings of short-term Government bonds which these groups of banks held at mid-year, which were available for sale in the market to obtain eligible as-s^ts. This table makes clear the feasibility of the plan from an operating standpoint. Of course, statistics for individual banks would show wider variations in holdings* of eligible assets than are indicated by the table for groups of banks, inasmuch as aggregates conceal individual bank variations. However, the tkble should allay fears that the plan would have disruptive effects. Would the imposition of the plan perhaps lead to deflation and depression? A fear expressed by some bankers who have discussed this Board's plan publicly — and they include those who are prepared to renounce the use of monetary and credit controls for anti-inflation purposes -- is that the use of this plan might upset the present state of high production and over-full employment ajad induce severe deflation and depression. The object of the plan is not to bring on deflation, but to minimize the- deflation that is, inevitable if we follow a let>~nature-take-it3v-*oourse policy. The Board recognizes that the proposal is no panacea and that there would be some risks in its use. But it would be< an impbrtant z-estraint available to be used, and to be used only, in the event of continued inflationary banking developments. Any anti-inflationary program involves some risk of precipitating a doimturn and readjustment in business conditions. It would have been better to have had the power available for use earlier. Had the Reserve System been gi«ven the additional power that was recommended in the special report in 191*0, it would no doubt have used it in view of developments during and since the war. •7 There itf some feeling within the Reserve System.that it will be held responsible for deflation if even the mildest use <of this requirement should happen to coincide with a deflationary readjustment* It is because of this possibility that the Board is not eager to have the grave responsibility for using the authority* Nevertheless, the Board feels that the System should not shrink from bearing its share of responsibility for restraint on further inflationary developments in the credit fieldt Is the special reserve plan strong enough to accomplish its expressed purposes? We have been at pains to draw a plan that would be moderate and equitable and at the same time capable, when applied in conjunction with other monetary and fiscal policies, of accomplishing the purpose of restraining further inflationary expansion of bank credit* This is the sole objective of the plan* We think the authority would prove adequate for the purpose in view* It would immobilise, at the maximum, about one-half of the war* time growth in bank holdings of Government securities whloh in turn equals about one-half of the total deposits of commercial banks. Since the immobilization of this volume of Government securities would greatly reduce the banks1 available secondary reserves, which they now feel free to draw upon, the plan would certainly make many banks more cautious about seeking or making new loans* It would end aggressive solicitation of new loan business in which a great many banks are actively engaged* Another source of pressure on the banks that would result from the plan is that most of the banks would have to sell higher-rate issues from their holdings of Government securities in order to expand loans and at the same time maintain reserve positions* This would be even more effective, from the standpoint of restraining banks# than would a rise in the discount rate* It would have this effect without causing a rise in interest rates on short-term Government securities* Thus* the proposed measure would be another step in a program of keeping the banks under constant pressure to restrain further credit expansion* It would not force liquidation or reduction in total bank credit outstanding* It would dls* courage expansion* Can the plan be effective without permitting or encouraging a . . Ifl m T • || n • > • || J-M. j • , » • ! ! iT III I I 1 1 1 ill •»•» rise in interest rates? Some bankers and others seem to believe that the only effective mechanism for the restraint of inflationary bank credit is a rise in the general level of interest rates* We doubt whether a reasonable rise in short-term interest rates under present conditions of business profitability - 8 would deter borrowers. We do not believe it would effectively deter lenders. Our plan places the restraint primarily on the lender. However, to the extent that the interest rate mechanism can have some effect, the Boardfs plan would not interfere, with it. Any increased cost resulting from the plan would be bprne by private borrowers who are increasing their indebtedness, and npt rby the .Government which is reducing its indebtedness. This i,$, the oply, reasonable solution to the interest rate problem. A general rise in interest; rates high enough to halt the current jnfla- • tionary expansion of bank credit would not only entail large added costs to the Government but would have a disastrous effect upon the Government bond market. RATIOS OF AVAILABLE SPECIAL RESERVE ASSETS AIJD SHORT-TEKH TREASURY BONDS TO GROSS DHMND DEPOSITS, ALL INSURED COMMERCIAL B^NKS, JUNE 3 0 , 19l*7 Percentage of gy*pss demand deposits Deficiency or excess Treasury bohds^ydue pf s p e c i a l reserve or c a l l a b l e ^ / Treasury assets if r e t b t a l imjfrement 6 are Mils, 10% of q e r t i f i - Excess f e c i a l ' 2 # / b f dfemand' demand cash reserve cates, a s s e t s ^ / assets" and and Within and Within h% of 1W of 1 year 1-5 years notes time time deposits deposits Central reserve city member banks New York Chicago 8.5 6,8 15.7 12,0 5.9 17.9 10.3 9.3 6.7 8.0 12*9 7.1 17.5 9.U 16.7 8.3 •U.9 U.U - 9.9 - 8.8 • 5.5 5.7 2r.8~ + 7.2 iu?- 2y;h. -8,6 -il,8 -11.3 + 7.1 + 6.5 + U.It • 3.0 + 9,'U +12.3 5.1 3.5 1.'5 18.3 31.7 22.6 33.7 Reserve city member banks Boston New Ifork Philadelphia Cleveland Richmond Atlanta Chicago St, t Louis Minneapolis Kansas CityDallas San Francisco Total 6.U 7.U 8.7 [20.3 '23.2 27*7 6.0 6.1 7.6 16,1 .22*7 19.1 30.5 - .7.0 ~3<9 -.2,7 -10,2 -10.7 n.3.7 - 7.1 * »9 15.2 7.2 22.U 12,6 12,7 18.7 17.8 17,0 19,7 21.6 21V7 23.8 26.1 21.3 6.It X-3 18.9 21,9 ' 28.8 28.9 S.5 5.1 10.5 3.8 6.U 25.5 2U.8 32.1 25.5 35.8 17.6 9.6 11.1 7.9 18.8 8.6 1U.U 20.6 10.3 8.8 16.8 13.3 22.9 7.1 6.3 •7.-3 16.6 +15.5 + 5.9 *'5.ti 7.1 2.5 3.5 5,9 5.1 3.7 32.5 20.0 36.9 2U.2 28.0 19.1 +12.2 + 8*8 +17.9 2.2 6.1 18.U 6.1 +11.0 U.9 27.8 -11,1 + 6.9 + 8,6 +15.5 >15.9 +13.8 +13.6 +19.5 +1U.0 +18,0 +25,2 +22«1 +13.3 5.0 37.3 U.3 5.0 U.8 U.3 U5.7 Ui.U U.O 7.3 3.2 2,9 6»9 U0.2 31.8 25.0 lil.8 28.7 39.8 18.8 16.7 33.9 +15.3 U.7 3U.3 U.8 31.3 Country member banks Boston New York Philadelphia Cleveland Richmond Atlanta. Chicago S t . Louis Minneapolis Kansas CityDallas San Francisco Total 10,1 11.1 32.li + .6 - 3.2 - .3 + 9.3 + 6,6 25.5 • .rvV? • 30.2 mum -ll,5 -'U.U - 3.5 - 3.9 * 3.3 ii n . 11 n »IIM» 27.U - 2.8 (Continued on next page) 3.9 5.9 RATIOS OF AVAILABLE' SPECIAL RESERVE ASSETS AIID 'EHORT-TERi: TREASURY B0KD5 TO GROSS DEMAND DEPOSITS^ ALL INSURED JJQMJl^ 19U7 Percentage of gross demiand deposits Deficiency or ej&gMT. o£' speciaF^resePEe fTj^fagwy bonds due Tr-easury '' or callable^/ assets if rebills, >tal quirements are Excess special , 25* of certi^ 10? of cates, casli reserve demand demand assets]*/ assets and and Within Within and notes 1056 of 1 year 1-5 years W of time time deposits •deposits. Nonmember insured Qommeycial^baak [s Boston New York Philadelphia Cleveland Richland Atlanta Chicago Sti.Louis Miriiieapolis Kansas City Dallap SanlFrancisco Total 1.2 1.7 19.2 15.1 20,9 22.0 20.U 25.2 29.0 25.0 39.6 28.0 16.5 19.6 3,9 7»3 10.U .6 2Uf7 U.U .3 U.8 .2 6,8 5.9 U.7 flte -15,8 -16.2 -11,1 -6,3 - 9.2 + 3,8 + 3.1 • 2.7 +12.8 + 8.6 + .8 -16.6 + S.9 + 3.6 + 8.3 •13.5 + 8.7 +20.7 +22.2 +18.9 +31.2 +2U.6 +16.5 29 A - 1.3 +16,9 20,3 16,8 21.2 26.8 20,6 32*0 3U.9 29«7 k3 J 35 O 2.7^0 + 5.5 5.6 U.5 3.8 U-6 5.8 3.0 35.6 37.6 29.5 £2.9 2.9 .9 7.7 39*8 22.5 '32.5 20.5 18,3 39.3 U.2 31.0 U.6 2.2 6.U . iil.5 39.9 a, 'Idtfel of t l ) balances Ttfith Federal"* Reserve Qanks, C?) excess of demand balances due from ov&r* demand dbjtosits duer^bq banksrfijb[ United States, (3) coin and currenby, and *(k} cash iAdmsr in process of aollection, l e s s (5) the sum of 20 per ceriVof demand ^deposits arid! 6 per fSopb of time deposits* b/ These r a t i a s are based t>n estimated holdings of sudfc^Treasujiy bonds •
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