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PRESS RELEASE To morning newspapers Wednesday, November 16, 1960 In connection with Remarks by M . S. Szymczak Member of the Board of Governors of the Federal Reserve System before the Chesapeake Chapter, Robert Morris Associates Washington, D. C. Shoreham Hotel, Washington, D. C. Tuesday, 6:15 p.m. November 15, 1960 The Federal Reserve System has been delegated responsibility by the Congress for monetary policy. In carrying out this responsi- bility, one main objective is to moderate short run swings in economic activity, checking inflationary excesses and moving promptly against recessions. Another important objective is to accommodate the forces making for high-level employment and long run growth of the economy without permitting inflationary erosion of the dollar. The commercial banking system is the principal avenue for carrying out monetary policy. This is done mainly through regulation of the availability of member bank reserves, which in turn influence the supply of bank credit and money and ultimately the level of business and consumer spending. While somewhat less than half of the more than 13,000 commercial banks in the United States are members of the System, these members collectively hold nearly 85 per cent of total commercial bank deposits. The Federal Reserve System has three basic instruments which it uses to influence the reserve positions of member banks. The most used and perhaps the least understood of these instruments is open market operations, the purchase or sale of government securities in the open market. Such operations affect directly the volume of bank deposits, but their most important impact is upon the reserve levels of member banks. By changing the supply of reserve funds, the Federal Reserve in- fluences the ability and willingness of commercial banks to extend credit to prospective borrowers or to add to their holdings of securities. - 2 - Owing to our system of fractional reserve requirements, the banking system can expand total loans and investments and deposits by more than six times the amount of any addition to reserve funds. Most open market operations of the System are for the purpose of offsetting short-run fluctuations in the volume of bank reserves due to seasonal changes in currency in circulation and Reserve Bank "float" i i j or to other factors, such as gold flows and changes in Treasury balance* at the Reserve Banks, These fluctuations are so large that in the abse** of offsetting action, they would Create serious disturbances in the m o ^ market and cause large fluctuations in short-term interest rates. In making these adjustments, the System can simultaneously alter the avail' ability of reserves as needed to achieve longer-run objectives of ere dif and monetary restraint or expansion. The fact that member banks in need of funds to meet large temporary reserve drains may borrow from Federal Reserve Banks brings into play the second instrument of credit policy, changes in the disco^ rate. This is the rate of interest charged member banks Wiho borrow at Federal Reserve Banks to meet temporary reserve deficiencies. During periods of strong credit demands, when market rates of interest are rising and credit restraint is required, the Federal Reserve may raise the discount rate and thus help to discourage excessive borrowing, Whe11 the System is pursuing a policy of monetary ease, the rate is reduced facilitate necessary borrowing. t<? - 3 - This is a supplemental instrument, however, since the regulations against continuous borrowing at the Federal Reserve and the reluctance of many banks to be in debt to the Reserve Bank are also powerful deterrents to excessive borrowing. Thus when reserves provided through open market operations are restricted and banks find it increasingly necessary to borrow from time to time at the Federal Reserve/ they under pressure to curb their lending arad investing activities. On the other hand, as reserves become increasingly available in a period of monetary ease, banks tend first to pay off borrowings at the Federal Reserve before expanding outstanding credit. A third policy instrument is exercise of the Board's authority to change reserve requirements of member banks. Such action affects the volume of reserves that banks are required to hold in support of their deposits, in contract with the previous instruments, which influence the volume of reserves available. Under present law, the Board may establish reserve requirements against net demand deposits anywhere between 7 cand 14 Per cent at country banks and 10 and 22 per cent at city banks, and against time deposits, between 3 and 6 per cent at all classes of banks. Thus, an increase in requirements raises required reserves in relation to the volume of reserves available and is restrictive while a decrease in requirements has the opposite effect. Partly for reasons of convenience in bank administration, changes in requirements generally have been reserved for occasions when instantaneous and wide-spread impact on credit availability is needed or when a longer-run structural adjustment in the level of requirements appears desirable. - 4 - Federal Reserve Policy in I960 At the turn of the year, monetary policy was restrictive, as it had been during most of 1959* After settlement of the steel strike late in 1959, the level of economic activity quickly regained and moved ahead of pre-strike levels, and inflationary expectations were widespread. During the early months of I960, credit demands eased considerably and inflationary psychology moderated. A major factor in this transi- tion w a s the shift in the Federal budget from a large deficit in 1959 to what will apparently be a small surplus for 1960. In addition, business, consumer, and State and local government demands for credit slackened, As a result, market rates of interest declined. The Federal Reserve responded to these developments by permitting reserve positions of member banks to ease considerably, Member bank borrowing at the Reserve Banks, which had averaged close to $900 million in late 1959, fell to about $600 million by March. To pay off borrowing, member banks had reduced their holdings of U . S. Government securities, and this was accompanied by a more than seasonal decline in bank credit and the money supply. Beginning in the spring, when the economic outlook became more uncertain, the System stepped up action to ease bank reserves. Since that time, borrowings declined f.urther to a low level of about $150 million in October and excess reserves rose. Reflecting the continued downward course of interest rates, the discount rate was reduced on two occasions, in early June and in August and early September, by one-half percentage point each time, - 5 - In late August the System released $600 million of reserves by a change in the regulations applicable to vault cash, and a reduction in reserve requirements at central reserve city banks. Banks responded to these actions by making substantial, acquisitions of U . S. Government securities, particularly during periods of Treasury financings in July and October, Loan demands weakened in the meantime, and total loans outstanding at all commercial banks in late October were little changed from the level at the end of June. Because the increase in investments, however, total commercial bank credit has increased in the past four months by a record amount for these months in any postwar year. This has been accompanied by sharp growth in time deposits and a more than seasonal increase in the money supply. It goes without saying that in formulating policies designed to provide adequate reserves for healthy credit growth in the United States, the System has endeavored, at the same time, to avoid actions w h i c h would have an adverse effect on our balance of payments or on o u r international economic and monetary relationships. Banks are now fr.cing the usual strong fourth-quarter reserve drai ns associated with holiday currency needs and inventory accumulation a n d a variety of year-end credit demands. Part of these needs have already been met through open-market operations. Also, the System again recently announced several actions to release in the aggregate, about $1.3 billion of additional reserves to help in meeting these large reserve drains. Effective November 24, member banks will be authorized to count all their vault cash in meeting reserve requirements. A partial offset to this action in the case of country banks, where holdings of vault cash have been greater than at city banks, is a simultaneous increase in reserve requirements against net demand deposits from 11 per cent to 12 per cent. Effective December 1, reserve requirements of central reserve city banks against net demand deposits will be reduced from 17-1/2 per cent to 16-1/2 per cent. This change is in accordance with a provision of a 1959 Act that would have had the effect of eliminating the differential in requirements.for central reserve and reserve city banks by mid-1962. Thus, over recent months, the System has taken extensive actions to facilitate ample provision for the credit needs of the economy. These actions have already given rise to a substantililimeasure of bank credit and deposit expansion.
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