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A REVIEW OF CREDIT AND MONETARY POLICY
by
M . S . SZYhCZAK
Member, Board of Governors
of the
Federal Reserve System
before the
J?Utli Annual Convention
of the
NATIONAL ASSOCIATION OF SUPERVISORS OF STATE BANKS-3

TjJ B R A l v Y

)

Drake Hotel,
Chicago, Illinois.
FOR RELEASE AT TIME OF DELIVERY

2:00 p.m. CDT
September 22, 1955

i

A_REVIEW QF

CRmiWi^OTm^POLICY

Today let me discuss with you the general question of money
and credit as I see it.
As you know, the Federal Reserve is concerned with influencing
the volume of credit and money.

This influence is brought about primarily

by affecting the reserve position of the banking system.

By adapting

credit and Monetary policy to the needs of the economy, the Federal
Reserve strives to make the maximum possible contribution to stable
economic growth.
You have all observed the effects of changing credit and
monetary policies on the positions of commercial banks. When policy
becomes restrictive, more banks will be in debt to the Federal Reserve
Banks, bank holdings of short-term securities will generally be
reduced, and the market values of long-term securities will be depreciated.

All of these developments tend to restrict the willingness

of banks to expand credit.

When credit and monetary policy becomes

easier, the opposite developments will take place.
Although Federal Reserve credit and monetary policy operates
through its influence on bank positions, these are only the initial
effects.

N o t only do Federal Reserve actions affect the terms on

which banks lend and invest, but indirectly they also affect the terms
on which nonbank investors lend and invest.

This influence results

from the highly developed character of the market for money and credit
and the fact that both banks and nonbank investors operate in many
segments of this market.

For example, if banks are selling Government

-

2

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Securities, or reducing their purchases, prices of these securities
VT

iU decline.

Other investors will therefore become more willing to

buy and less willing to sell.
G

Lower prices and higher yields on

overnment securities thus tend to restrict lending to other borrowers.
As you well know, the Federal Reserve has three major ways

of

influencing bank reserve positions.

One is open market operations

^ United States Government securities and bankers' acceptances.
Se

cond is changes in percentage reserve requirements.

A

A third is

Regulation of the discount mechanism through which the Federal Reserve
B

*nks lend to member banks; this includes changes in the discount rate.

Iri

recent years all of these instruments have been used flexibly to

influence bank reserve positions.
As you will recall, in early postwar years the use of open
£Sgket operations to affect bank reserve positions was hampered by
the policy of supporting the Government security market.
Ve

s

u

Securities

r e purchased by the Federal Reserve in order to peg Government

ecurity prices, and increases in reserve requirements were somotimes
sed to offset the effect of such purchases.

Because reserves were

Readily obtainable through sales of securities, the discount mechanism
^as largely inoperative.
Let me therefore repeat here what has often been said before,
th

a t since the Treasury-Federal Reserve Accord early in 1951 open

^ r k e t operations have been carried on primarily with regard to their
ef

fect on bank reserve positions.

Meanwhile, the role of the

discount mechanism has increased in importance.
The use of the various instruments of credit and monetary
ac

tion has been adapted to prevailing economic conditions, and some-

- 3

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times two or more of the instruments have been used together to bring
about the desired results.

The F'ed.eral Reserve has studied carefully

the operations of the various instruments in the postwar economic and
financial setting, and the experience gained has enabled it to adapt
the use of these instruments better to the needs of the banking system.
Open market operations are generally the instrument best
adapted to meeting changes in the needs for bank reserves as they
develop over time.

Typically, reserve needs can best be met by an

instrument that can supply or absorb funds in small amounts and that
can be reversed if necessary.

Open market operations are eminently

suited to fill this requirement.
Changes in economic conditions calling for changes in
credit policy are usually gradual.

At any time the need is not

likely to be for a drastic change in bank reserve positions, but
rather merely for somewhat tighter or somewhat easier positions.
Moreover, at times it is not clear what policy will be called for
several months in the future.

Open market operations are readily

adapted to meet these circumstances, since purchases or sales can be
in any amount and they can be readily reversed if necessary.
Open market operations are also used to meet changing reserve
needs associated with many developments other than changes in general
credit and monetary policy, and such operations in any period must be
interpreted with regard to these developments.

For example, a gold

inflow associated with a surplus in our international balance may
supply banks with reserves while a gold outflow may deprive them of
reserves.

Temporary changes in the Treasury balances at the Reserve

-

h-

Banks also affect bank reserve positions.
vised to offset these developments.

Open market operations may

In addition, the Federal

Henerve topically purchases securities in the second half of the calendar
and sells them in the first half in response to seasonal changes
in the demand for currency and credit.
e

Finally, the needs of a growing

Conomy require an increase in deposits and reserves from year to year.
From time to time the Federal Reserve

Government

securities from dealers

According to the
a

purchases U . S.

brokers under repurchase agreements.

these agreements, the dealers and brokers

gree to repurchase the securities at a fixed price, usually within

a

U

terms o f

arid

also

matter of a few davs.

Repurchase agreements have been found extremely

seful to supply bank reserves to the market at times of temporary

Portages for technical reasons.

For example, there are frequently

special needs for reserves near the end of the. year when banks are
Urn,T

illin£ to show indebtedness on the December 31 balance sheets 0
At times changes in reserve requirements have been used to

Provide banks with reserve funds or to absorb such funds.
Ine

nt can best be used when banks are faced with a large and long-run

change in their need for reserves.
13

This instru-

By its very nature, this instrument

not ordinarily suited to meeting gradual and short-run changes in

Reserve needs.
Reference thus far has been to the ways in which reserves
are supplied or absorbed at the initiative of the Federal Reserve,
Member banks can also obtain reserves at their own initiative by borrowing from their Reserve Banks.
ls

Regulation of the discount mechanism

the third way in which the 'Federal Reserve can affect bank reserve

positions.

Discounting tends to increase when open market and reserve

requirement actions of the Federal Reserve become more restrictive.
Since banks do not like to remain in debt, an increase in member bank
borrowing tends to restrict bank credit expansion.

In addition, when

a more restrictive credit policy is being followed, the Federal Reserve
Banks generally raise their discount rates, thus making borrowing more
expensive.

It is therefore evident that when Federal Reserve policy

eases, member bank indebtedness declines and excess reserves may
increase, thus encouraging bank credit expansion.

0

At such times reducti '

in Federal Reserve discount rates are customary.
These instruments of credit action have all been utilized
in recent years in response to economic developments,

Since mid-19^2

economic developments have included two periods of rapid expansion in
business activity and in the demand for credit as well as a period of
moderate business recession.
From mid-1952 until the spring of 1953 Federal Reserve
and monetary policy was directed toward preventing inflation.

credit

At this

time there was an increase in the demand for credit stemming from the
removal of selective credit controls, optimistic business expectations,
growth in inventories, and a Federal deficit.

Since the economy was

already fully employed, the extent to which production could increase
was limited, and it was necessary to take steps to restrict credit
expansion.

This was done largely by restricting Federal Reserve purchaS^

of securities in the open market.

Purchases over this period on

balance were more than offset by gold and currency outflows.

Member

bank discounts exceeded one billion dollars on the average in nearly

every month from July 1952 through April 191?3.

In January 1953 Federal

Reserve Bank discount rates were raised from 1-3/h to 2 per cent.
Respite the strong demand for credit, the rate of growth of bank
credit and money declined, and prices remained stable.
By the spring of 1953 it appeared that the existing degree
of restriction was no longer necessary, and after the middle of 1953
the demand for credit became less active, particularly for consumer
credit and short-term business credit.

Beginning in May, the Federal

°eserve acted to ease bank reserve positions, and from late 1953 until
late 195); it pursued a oolicy of active ease.

It purchased securities

in Vie open market beginning in May 1953, and in July additional
reserves were provided by a reduction in reserve requirements,

although

the reserves thus provided were used in part to meet seasonal needs,
they

permitted a reduction in member bank indebtedness to the Federal

Reserve Banks.

Discounting declined further early in 195li despite

seasonal sales of securities by the Federal Reserve.

Discount rates

Were reduced from 2 to 1-1/2 per cent in the period from February
through H a y .

In the summer of 1951 additional reserves were provided

through further reductions in bank reserve requirements.

Since these

were provided in part in anticipation of seasonal needs, they were
Partly offset by sales of securities in the open market.

As needs

developed, the Federal Reserve made reserves available by purchasing
s

ecuritjes e
The money supply increased slightly from mid-1053 to mid-195b,

in contrast with declines in some earlier business recessions.

After

mid-]951; it increased sharply, at a seasonally adjusted rate of about
5 per cent per year.

By late ±9%h it was clear that a policy of active ease was
no longer appropriate for prevailing economic circumstances.

There

was an increase in the demand for credit, especially consumer credit
and short-term business credit, and employment and production increased.
The Federal Reserve permitted bank reserve positions to tighten
in late

and early 1955.

somewhat

Although Federal Reserve sales of

securities early in 1955 were largely seasonal, bank discounting increased to an average of almost half a billion dollars in the second
quarter of 1955.

C

ince midyear the federal Reserve has jr e m i t t e d bank

reserve positions to tighten further, as employment and production
have reached record levels, but the demand for credit has continued to
grow.

Discount rates at the Reserve Banks have been raised from 1-1/2

to 2-1/h per cent by three separate steps.

In addition, the Board of

Governors has raised, margin requirements for purchasing or carrying
securities from 50 to 70 per cent by two separate actions in order to
help prevent the excessive use of credit for stock market trading.
It may now be of some interest to compare cur credit and
policies with those of seme other nations.

moneta

Needless to say there are

often differences between other countries and our country in
institutional structures as well as in economic and financial conditions*
Therefore, we must be extremely cautious if we try to apply our
experiences to other countries, or foreign experiences to our own
conditions,

Nevertheless, it seems to be significant that all

over the free world, and especially in Europe, there has been a
growing reliance on general credit and monetary policy.
therefore, briefly to review this development.

Permit me,

You know that ever since the end of the Second World War,
fcost foreign countries have been suffering from inflationary rather
than from deflationary pressures.

In the early postwar period,

these pressures originated primarily from the need for rapid rec

onstrvction of war damaged plant and equipment and depleted in-

ventories j the desire for a rapid restoration of prewar standards
°f livingj and the inability of countries with reduced foreign exchange holdings and impaired productive capacities to pay for the
hare minimum of producer and consumer goods imports, either out of
their reserves or by increased exports.
Monetary policies were little used.

At that time, anti-inflationary

Instead, reliance was placed on

direct controls, which aimed at channelling available resources to those
uses that the authorities, rather than the individual producer
a

nd consumer, believed to be most urgent.

The breakdoxm of the world

sconomy was avoided primarily by large-scale foreign assistance, most
of it (though by no means all) from the United States,
These initial pressures had largely disappeared when the
outbreak of hostilities in Korea gave inflation a new impetus.

Fears

°f a new world conflagration, exaggerating the rise in demand for raw
Materials and equipment needed for the war effort of the United Nations,
led to excessive spending in the industrialized countries; the inflow
°f an unprecedented amount of foreign exchange, reflecting the increase
in the volume as well as in the price of raw material exports, produced
similar excesses in many underdeveloped countries.

T

'hen the crisis

Passed, some industrialized countries experienced a slight recession,
hut in most of them the upward movement was soon resumed.

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By that time, however, recovery from the war had everywhere
proceeded far enough to raise production above the prewar level, and
to permit the restoration of economic flexibility in both domestic
and international transactions.

These changes made monetary policies

more practical, both politically and economically.

In 1951-52, there-

fore, all major industrial countries used monetary policies to reestablish
or maintain financial equilibrium.

Belgium, Italy, and Jermany had

already done so in earlier years; now they were joined by the Netherlands)
the United Kingdom, and France.

In no major country did wholesale prices

rise significantly between 1952 and 195U.
Stabilization was not jurchased at the price of economic
stagnation.

On the contrary, world production and world trade expanded

at record rates.

The physical volume of world exports rose in these

years by 13 per cent, dramatically refuting the idea of a continuous
decline in the importance of Internationa], commodity movements.

The

rise was even more rapid in the case of the European countries:

the

volume of exports of Western European countries (including the United
Kingdom) rose between 1952 and 195 h by 21 per cent.

The gold and doll3

r

holdings of these countries increased between the end of 1951 and the
end of the first ha]f of 1955 by 55 per cent.
in Western Europe rose in that period by 2h P
as fast as in the United States.

And industrial production
e r

c e n t

—

m o r e

twice

In some countries, such as Germany,

production has doubled since prewar days; in recent years, the countries
with the most rapid advance have been by and large those with the best
record of financial stability.
Such rapid progress, however, was bound sooner or later to
build up renewed pressures.

In contrast to the early postwar years,

- 10

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kut in line with post-Korean experiences, the Governments of most
European nations recently threatened by this kind of "prosperity inflation" promptly applied again anti-inflationary monetary policies,
Since the beginning of this calendar year, eight European countries
have increased their discount rates, and some of them also have used
other forms of monetary action.
In Germany, the central bank, in addition to I'aising the
discount rate, increased the reserve requirements for commercial banks
a

nd, for the first time in postwar German monetary history, used open

Market operations in Treasury bills to tighten the money market.
In the Scandinavian countries, where the danger of inflationary
developments was more urgent, the authorities used anti-inflationary
fiscal as well as monetary policies.

Denmark imposed a national sales

^ x , raised its excise taxes, and reduced housing subsidies; moreover,
the National Bank raised the discount rate, reduced its support price
Government bonds, and urged the commercial banks to be more restrictive in their lending policies.

Norway imposed taxes on investment;

H s monetary measures included a rise in the discount rate, the establishment of reserve requirements for commercial banks and of credit
filings for mortgage credit associations, and an increase in the interest
r

ates of Government bonds,

Sweden introduced a tax on business

construction and increased the rates of corporation taxes; in the
field of monetary policy, it raised the discount rate, stimulated
Savings by offering Government-financed premiums for long-term savings
deposits, increased interest rates of bonds issued by municipalities
a

n d public utilities, and induced the commercial banks to restrict their

- 11

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lending under the threat of introducing compulsory reserve

requirements.

The United Kingdom relied exclusively on weapons of credit
and monetary policy, and so far has not adopted anti-inflationary tax
measures.

Early this year, the Bank cf England raised its discount

rate in two steps from 3 to U-l/2 per cent.

This action led to a

general rise in the interest rate level and on the whole banks could
expand their loans only if they sold their investments at a loss.
The interest rates on Government loans to the local authorities,
which provide the bulk of housing and other public work finance,
were repeatedly increased.

Instalment credit was curbed.

Finally,

in July, the Bank of England used also the weapon of "moral suasion"
to induce the commercial banks to a^ree to a reduction by 10 per cent
in the total amount of their loans; "moral suasion" can be effective
under the British system of branch banking since lending policies
are determined by a handful of large banks which maintain the closest
ties with the monetary authorities.
This, then, is a short general review of credit and monetary
policy both here and abroad.

It is too early to judge the effects of

the policy actions undertaken in recent months.

On the whole, however,

the record of the past three years gives evidence that flexible

credit

and monetary policy has contributed to stable economic growth.

There

have been many other factors contributing to the generally high level
of production and employment, and to the stability of price levels.
However, the role played by the banking system should not be overlooked.

For this reason, a credit and monetary policy that enables the

banking system to fulfill its economic functions and thus helps to maintain economic equilibrium, is of vital interest to us all.