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FEDERAL RESERVE FOLICY SINCE 1953 K. S. SZYKCZAK, Member, Board of Governors of the Federal Reserve System, Washington, D« C. l,Before the FORTY-FIRST ANNUAL CONVENTION of the NATIONAL MORTGAGE BANKERS ASSOCIATION . \ r Conrad-Hilton nu ^ vjunrau-nxxL.ua Hotel. Chicago, Illinois 11:00 A.M. CST September 27, 19$k. For Release at time of Delivery FEDERAL RESERVE POLICY SINCE 1953 I saw many of you at the Texas Mortgage Bankers convention in Da Uas on May 7, 1953. Let me, please, take advantage of this opportunity talk about developments since that time. At that time it appeared and I said that, on the basis of first Quarter results, "the total number of new houses built in 1953 may not be far different from either 1951 or 1952, which despite many restrictions V ere ' both excellent construction years." As it turned out, the number was 1,101;,000, or 13,000 more houses than in 1951 Cf and 23,000 less than in 1952. It now appears that the number new houses built in 195U will surpass the 1952 mark, if the pace of the eight months is maintained. The record-making performance of the economic area in which you ^ ave a particular interest, real estate and building, has done much to c ^ange the course of the economy from decline to over-all stability in the •Ust Sj_x month3 or go. Without in any way minimizing the earlier decline, Su ggesting that stability at the present level is good enough, it is ^°ssible to say that the ability which our economy has shown in recent "kftths to adjust to and moderate forces of change should give us great hope r t r the economic future of our nation. In a cyclical economy like ours, however, the need to adjust to an §ing situations is a continuing one, and our ability to make the necesadjustments is always being tested. One of the important instruments f 0 Y> Achieving sustainable economic growth over the years with a minimum of Uc tuation, and one which has been significant in the recent short-term re- Juatment, is monetary and credit policy. I am sure you are all aware of -2the influence such policy has had and will probably continue to have on Mortgage markets. if you don't mind, recent Federal Reserve policy in the monetary and credit area as In my remarks today I should like to review with you, and attempt a tentative evaluation of its influence and effectiveness, dispassionately and as objectively as I know how. you too j . c . Please try to stay with me. ruh, V*- it agairst you. I hope my effort won't If you can't, I'll not Ix, has none of the warm oratorical appeal, to say the Ie asta Part of the effectiveness of Federal Reserve policy is the facility W l -th which it can be adapted to changing circumstances, as is evidenced by 4.1 ne events of the past couple of years. During late 1952 and early 1953, lriv entories were rising, capital outlays were being made on a large scale, ancl rising speculative interest was being manifested in many markets. These f o m e n t s constituted a threat to our objectives of long-term stability anci growth. Accordingly, Federal Reserve policy was directed toward exer- t i n g restraint upon inflationary developments as well as keeping the Su ttply of credit and money adjusted to the needs of a growing economy. In Notice, this meant permitting some expansion in bank credit and the money Su Pply, but limiting the degree of expansion in view of the large excess of ^ a n d for credit over the available supply of savings. neither stopped nor thrown into reverse. The credit machine It was simply held within a s Peed limit determined by considerations of safety, including the crowded of the highway at the time. In so far as savings provided banks with the necessary reserves, could expand loans freely. In so far as the banks had to sell securities " h Federal Reserve or borrow from it to obtain the necessary additional te -3feserves, the story was different. To prevent unlimited expansion of bank credit, the Federal Reserve refrained from open market purchases that would have supplied the necessary reserves. Member banks still had the privilege °f borrowing from their Reserve Banks, of course. But as the monthly average their borrowing mounted in late 19^2 and early 1953 to a range of one to °ne-and-a-half billion dollars, the discount rate was increased from 1- 3/U to 2 per cent. b The traditional reluctance of banks to borrow was fortified y the higher rate. Their resort to this method of temporary acquisition of additional reserves consequently was lessened. So was their extension of ^edit. These developments on the side of credit supply seemed to do no ^cre to diminish credit demand than storm warnings did to diminish the force the hurricane that recently struck New England. The rise of interest rates Under this pressure seemed in itself to impel borrox-jers to rush into the Market seeking to cover future financing requirements before the cost rose ^rther. You will recall, I am sure, some of the incidents of that period: th e breaking under par by the new 3-l/U per cent long-term Treasury bond, the sharp reaction that followed in the price of seasoned issues of corporate and municipal securities; the increasing difficulty of getting new ^rtgage commitments, the increasing availability of outstanding mortgages at rather large discounts, and the issuance of regulations raising the rates ° n FHA and VA mortgages. It was at about this time that it became apparent that the Federal cash deficit would be larger than had earlier been expected and that the Treasury would be a heavy borrower during the remainder of the year. An as surance that this additional Treasury borrowing would not be allowed to r educe the supply of credit available for other borrowers was quickly pro- v e d by the Federal Reserve's embarking upon substantial open market purchases of U. S. Government securities* dat From Me.y 7—the Dallas convention e I mentioned earlier—through July 8 the Federal Reserve supplied about 1,2 billion dollars of reserves to banks by these operations. These funds tabled member banks to pay off a substantial portion of their borrowing at ftfcserve Banks, and for the month of June excess reserves of member banks deeded their borrowing at the Reserve Banks by nearly hOO million dollars. '^Us credit conditions began to be eased at a time that was later to be pl '°VGd strategic from an economic standpoint, though those who chose to Cri Ucize the Federal Reserve's action as being inflationary could, and did, ba ck up their arguments with data showing production, employment, and incomes still at or close to record levels. Those data did not control Federal Reserve actions, but I must a(irn it, in justice to our critics at that time, that the data carried enough We ight with us to induce more caution than we would show now if we were , through the period again but aided this time by hindsight. For instance, the data obviously had an effect upon the decision s . of the Federal Open Market Committee at its meeting on June 11, 1953. Despite ( ^eloping doubts in the Committee about the strength of underlying business Editions, the directions it gave its Executive Committee for operations aime d at "avoiding deflationary tendencies" were tempered by a caution against e Hcouraging a renewal of inflationary tendencies." That action, with the various other steps in the transition to a of active credit ease, is set out frankly in the official policy record I 1 -5of the Open Market Conimittee as published in the Federal Reserve Board's Annual Report for 1953. As the record further shows, on the following September 2k, the Open Market Committee, influenced by softening tendencies in various sectors of the economy, revised its instructions to the Executive Committee. The re ference to avoiding a renewal of inflationary developments was deleted, having an unqualified instruction to operate with a view "to avoiding ^flationary tendencies." ln This implied that a more active policy of supply- S reserves was to be followed. During the last quarter of 1953, the decline in economic conditions th °Ugh moderate, became unmistakable. The December 15 directive of the Open ^rket Committee to the Executive Committee, therefore, was to operate with a Hew "to promoting growth and stability in the economy by actively maintain ln g a condition of ease in the money market." In accordance with those general policy objectives, the Board of G °vernors of the Federal Reserve System and the Open Market Committee took several specific actions to contribute to active ease in financial markets. 1 f eel compelled to recite them even at the risk of boring you. (1) A reduction in reserve requirements, effective in July 1953, Prevent an undue tightening of credit from developing out of a convergence Of seasonally expanding private demands for credit, and substantial financing ^ the Treasury to meet immediate needs. This freed an estimated 1.2 "^lion dollars of reserve funds. (2) Open market operations. This sphere provided a graphic demon- St *ation of flexible operations in execution of a policy of keeping reserves a high but stable level under varying conditions. Open market purchases -6s^pplied, between mid-August 1953 and the end of the year, 1.5 billion of reserves. However, part of these purchases were temporary, to meet the usual year-end tightness in the money market. For instance, 600 million dollars of Se curities were acquired near the close of the year from dealers, with agree- ments by the dealers to repurchase the securities after the turn of the year. In contrast, during the early months of 19$k the System sold another 700 on dollars of Government securities in the market in order to absorb Reserves which usually accumulate during that season of the year. Back on ^e other side, open market purchases were resumed in May and June this year in order to maintain a condition of ease in credit and capital markets. S ^ill later, sales were again made following a further reduction in reserve re( luirements this past summer, providing an example of close coordination the federal Reserve's reserve requirement and open market powers, first, release a large amount of reserves and assure availability of ample credit, anc *> second, to insure against "sloppiness" in c °urse of the release of these funds. financial markets during the More recently yet, purchases were undertaken in early September, as we approached the beginning of the demands for credit, to keep the volume of excess reserves stable at a ^Sh level. To be very frank with you, I expressed apprehension within the and the Open Market Committee about releasing reserves by a reduction Of reserve requirements and later absorbing some of these excess reserves V sales of Government securities in the open market, but this flexible ^°licy i n the use of our monetary and credit instruments has, up to novr at Xeas t, on the whole, it seems to me, worked well — in the interest of a level stable economy. (3) Reduction in discount rates. Discount rates remained at 2 per °ent throughout the last half of 1953, but were reduced to 1 - 3 A P e r in cent January and again to 1-1/2 per cent in April and May of this year. Both these changes followed a general lowering of interest rates in the money Markets and had the effect of restoring the discount rate to a more customary relationship to market interest rates. After these reductions, discount rates were at the level prevailing prior to the Korean outbreak. (U) Reduction in reserve requirements, July-August 195h» This further reduction in reserve requirements, to which I referred earlier in c °nnection with open market operations, was carefully timed to take effect ° Ve r a period of several weeks. hilars in reserves. It released a total of about 1.5 billion The reduction involved 2 percentage points on demand ^Posits at central reserve city banks; one percentage point on such deposits at reserve city and country banks; and one percentage point on time deposits at all member banks. bel These reductions brought requirements to levels at or ow those prevailing in late 19h9 and 1950. The reduction in reserve requirements at this time was made in an ticipation of demands on bank reserves during the summer and fall, taking account Treasury financing needs as well as probable private financing 3?ec luirements, including the marketing of crops and the replenishment of ^tail stocks in advance of the fall and Christmas sale seasons. Coordinating N a t i o n s in the open market followed, as I sketched them for you above. Reflecting the foregoing credit actions, bank reserve positions changed markedly since the spring of 1953. In April of last year, ^mber bank borrowing from the Reserve Banks averaged about 1 - l A billion ^ l a r s or about 3/li billion more than excess reserves. In July of this however, member bank borrowing averaged less than 100 million dollars -8ai r( 2 excess reserves more than 800 million. Free reserves—excess reserves •^ss borrowing at Reserve Banks—expanded progressively during this period °m a negative 3/h billion dollars to more than a positive 3 A billion . fr hilars. Having reviewed with you what has been done by the Federal Reserve 111 the field of credit and monetary policy in the recent past in order to c °Pe with conditions of sharp economic change, I should like to turn now to a ttoredifficult task; namely, that of attempting to appraise the results Of s uch policies. Bankers, businessmen, and economists are generally ^ainiliar with the way credit and monetary policies contribute to dampening and inflationary developments, but they are much less familiar with they contribute to stability when depression and deflation threatens. The matter can be clarified, I think, if it is kept in mind that i>e< the^it and monetary policy exerts an influence on economic conditions on both n. r U P and down sides, mainly through its effect on five factors: the volume of m ne ° y, the cost of borrowing, the availability of credit, capital values, and + k i n general liquidity of the economy. ^e These factors are closely inter- e -^ted but may be discussed separately for purposes of convenience and a ^ity, <phe following examination of financial developments over the past w to th it-h respect to each of these factors will help clarify judgments as contribution of recent Federal Reserve policy to economic stability. The money supply. Instead of contracting, the volume of money b y the public has expanded over the past eighteen months, though the Vth gl,Q •W 4, since the second quarter of last year has been a modest one. Consider. extent of the decline in over-all business activity since mid-1953, s s in the money supply has been a positive stabilizing force in the ~9~ economy. This contrasts with the early stages of a number of previous business declines, when the money supply contracted, reflecting significant credit liquidation as a factor of economic recession. At those times, consumers and businesses wanting to maintain their liquidity had to reduce their expenditures from time to time, cumulatively inducing additional Eductions in employment and incomes. Cost of borrowing. The cost of borrowing has declined sharoly °Ver the past year and a half, reflecting, besides the actions we have been discussing, a reduction in demands for funds and a continuing high rate money saving. The decline in rates has pervaded the entire credit market, Meeting all types of paper and securities, although, of course, in varyXn g degress• You have all been aware of the changes in nominal rates, in discounts, and in other terms of mortgage loans. These declines in interest *^tes have given a strong incentive for marginal borrowers in all credit aj?e as to raise funds through financial markets. The declines in interest rates have been as sharp and as wide- spread as in the comparable phase of any recession since World War I. As s Usual during a period of rapid movement in interest rates, yields on s hort-term securities have experienced the sharpest relative changes. aver The ag e yield on Treasury bills, for example, dropped almost 70 per cent mid-1953 through July of this year, and the rates on commercial paper Alined nearly 50 per cent. are These drops in yields on short-term paper close to the average for the corresponding phases of other recessions Sln ce the First World War. Rates charged by banks on short-term business ^°ans reacted more slowly than other short-term rates, but they also declined ^ i n g the first half of 195U. -10Yields on long-term securities, those used for financing capital ^vestments. have declined somewhat more over the past year than in corres P°ndj.ng phases of past recessions. For example, at the end of July yields long-term U. S. Government securities were down 20 per cent from mid-1953, ^ose on high-grade corporate bonds 15 per cent, and those on high-grade ^icipal securities 23 per cent. In the mortgage field, where your principal interest lies, the discounts that prevailed a year ago on U-l/2 per cent Federally insured ^ guaranteed home mortgages also have largely disappeared. In addition, r?l tes on conventional home mortgages seem to be down approximately 1/2 per from levels prevailing a year ago. Availability of credit. ari(i Changes in the availability of credit capital funds, as you can well imagine, are exceedingly difficult, if not ^Possible, to measure objectively. Suffice it to say that in the spring of year there were wide-spread reports about the shortage 0f of many types financing, with the stringency of funds in the mortgage market particularly Object to complaint. ai?e easy to arrange. Few such reports are heard today. Loan commitments Mortgage lending on small non-farm properties totaled ° V e r 12 billion dollars in the first 7 months of this year as compared with a kittle over 11 billion in the first 7 months of last year; and new securi- t:i e3 - issued by State and local governments for new capital amounted to about U b iUion in the more recent period compared with a little over 3 billion ear lier. The volume of corporate security issues for new capital, however, dropped from about 5 billion to U-l/2 billion over this period, due to ^ U c e d demand for outside funds by certain types of manufacturing corporal s . -11Gapital values. These values, in general, have risen since June of last year. Falling interest rates, in addition to meaning lower costs for borrowers, affect economic activity in the nation through raising the dollar value of existing assets, particularly long-lived assets. This comes about because the expected future returns from such assets a re recapitalized at the lower rates of interest. One example is in the stock market where, for instance, rising Prices for outstanding investment-type securities have registered the in fluence of falling interest rates as well as other factors. On the °ther hand, capital values have apparently not risen recently in the r cal estate area. Even here, however, the effect of lower interest rates ^ y have been to cushion a decline in values of existing property due to ^e sharply increased supply growing out of the recent high level of construction activity. General liquidity. as Higher values of existing assets, as well the maintenance of the money supply and other highly liquid assets, ^ave tended to maintain the liquidity of business and individuals and ^ake them more willing to spend and invest, ln They have also made financial stitutions more liquid and willing to lend. Commercial banks, for e Xample, have been able to increase greatly their holdings of short-term h ighly liquid securities as well as to repay a large part of their indebt- edness. Any attempt at over-all appraisal must take into consideration following factors: -12(1) The first, and foremost, difficulty in arriving at any °ver-all appraisal of the stabilizing effect of recent Federal Reserve action is that such action is only one of many factors, although an important one, influencing the general level of economic activity. Its success, moreover, is conditioned by various other policies, programs, ar *d activities of Government. To cite only a couple of illustrations, such built-in stabilizers as unemployment compensation and farm price supports, for example, have provided important cushions in the current readjustment. Tax reductions and public debt operations have also helped stabilize the economy. The success of Federal Reserve credit and monetary policy is also affected by a wide range of private activities and by the changing ^cods and impulses of businesses and the public generally with respect tn spending, borrowing, and saving. The manifold elements affecting Economic stability will each be influenced in some measure by credit and ^netary policy, but the degree of influence will vary considerably under different circumstances and the effects from any one element can never completely isolated and measured. (2) A second difficulty in appraising recent credit and ^ e t a r y actions is that their full impact cannot be determined for a Con siderable period of time. Accordingly, it is too early to appraise 01 lately the actions of the past year and a half. (3) Finally, difficult questions of judgment are involved in as seSsj.ng any given current economic situation. At any given time, the -13economy generally exhibits a mixture of tendencies toward expansion and contraction. An over-all appraisal of the effectiveness of a specific factor affecting general economic and business conditions, therefore, hinges to a large degree on one's judgment as to where we stand currently in so far as business conditions are concerned. Basically, of course, the question that one would have to answer in order to appraise the effects of Federal Reserve action with full assur- anc e is this: What would have happened to the general business and economic situation over the past eighteen months if such actions had been different? And that question, of course, is impossible to resolve. All in all, however, I think it is fair to say that recent Federal Reserve actions have been of significant benefit, first, in contributing to restraint of what threatened to be an unstable speculative boom, and, subsequently, in contributing to the moderation of the business downturn. In the past few years, we have had almost a classical business cycle situation to deal with as we moved through a period of record high activity under a Cor >stant threat of inflation and went from that into a period of a business extraction. In the earliest phase, credit restraints helped to discourage speculative excesses, restrain inventory accumulation, damp down undue e *Pansion in capital goods expenditures, and encourage saving. Subsequently, ^ d e r a l Reserve credit actions have helped to encourage business capital ° u U a y s , home construction, and State and local expenditures for construction anci of other improvements, as is indicated by the sustained if not growing volume activity in these areas. The pace of these activities is considerably * f f ected by ready availability of low-cost long-term financing, a condition recent System policy has had an important part in establishing. -lliInventory liquidation, moreover, has thus far been orderly, with no material Pressure arising from financing problems. Emerging economic developments will need to be scrutinized carefu U y and continuously in the period ahead, and Federal Reserve policies Promptly adjusted as required to contribute to the fullest to the promotion of sustainable economic growth. m One of the major virtues of credit and °netary policy in a period of readjustment like the present is its great flexibility, permitting quick adjustment to changing trends and the prompt a ^option of counterbalancing action to any unstabilizing developments that ^ay arise.
