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STATEMENT BEFORE THE HOUSE BANKING AND CURRENCY COMMITTEE
AUGUST 2, 1948 *
Chairman Wolcott and Members of the Committee:
I deeply appreciate the consideration your Chairman has extended to me in making the time of my
appearance here as convenient as possible. Although
Congressman Wolcott had asked me to come before you earlier, he kindly consented in deference to
my request to wait until this morning. I therefore
acceded to the urgent request of Senator Tobey to
appear before the Senate Banking and Currency
Committee last Thursday morning. Since your
Committee has been fully occupied with the testimony of M r . Porter, I trust that the postponement
until this morning has not caused you inconvenience.
On the evening before going to the Senate Committee, I canvassed the members of the Board by
telephone to ascertain their views on the two titles
of the proposed anti-inflation bill which relate to
consumer credit and bank reserves. The members
of the Board agreed unanimously to the following
statement:
A N T I - I N F L A T I O N A C T OF 1 9 4 8
The proposed "Anti-Inflation Act of 1948" includes two titles relating to credit controls. Both
are, in substance, part of the comprehensive antiinflationary program which the Board of Governors has previously recommended to Congress.
Title One relates to regulation of consumer credit
and Title T w o relates to bank reserves. As you
gentlemen know, the proposed regulation of consumer credit is identical, except for the date, with
the bill passed by the Senate, and acceptable to
the Board of Governors as one part of an overall
program.
The proposal with respect to bank reserves is
similar to that advanced by the Board in April,
except that the increased requirements would be
applicable only to member banks, whereas the
Board had recommended that they be made
applicable to all commercial banks. This is a
significant difference. We feel deeply that it
is not fair to member banks in their competitive
relations to nonmember banks to require that
they be singled out to carry the additional re*
* Presented by Thomas 1?. McGabe, Chairman, Board of
Governors of the Federal Reserve System.
904
serves that may be necessary to combat this
inflationary situation. As an Emergency measure,
however, the bill would be adequate to meet the
immediate need for additional authority to deal
with reserves.
I n thus stating the views of the Board on these
two titles of direct concern to the System, I do
not want to create the impression that action
in the credit field alone will solve our inflationary
problems. Other areas, particularly a budgetary
surplus, are more important.
Since I presented that statement to the Senate
Committee, {he Board has this morning had an
opportunity to meet and to discuss the proposed
legislation at fength. The Board is agreed that
the inclusion of the nonmember banks is essential
to make the proposed legislation fully effective. I
have also been in touch with several of the Presidents of the Federal Reserve Banks, and others.
There is strong concurrence with the statement that
it would be very unfair to single out member banks
to carry the additional reserves to combat this
inflationary situation. This is particularly true of
the Presidents from those districts where there are
large numbers of nonmember banks, which would
be given a competitive advantage as against member banks. It might result in a serious loss of
membership in the System and weaken the effectiveness of its policies. As you know, the effective
reserve requirements in most states are substantially below those carried by member banks, and
thus nonmember banks have greater latitude and
earning power.
The question of the inclusion of nonmember .
banks is very important and we would appreciate
it greatly if the Committee would give this problem serious consideration. Unquestionably from
the point of view of effectiveness as well as equity
the proposed legislation should apply to all commercial banks.
Now, I would like to give you some of my personal observations concerning the impact of the
inflationary forces oh our credit control mechanism.
These remarks are substantially the same as those
I made last week before the Senate Banking and
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S T A T E M E N T BEFORE T H E HOUSE B A N K I N G A N D CURRENCY
Currency Committee, except for elaborations on a
few points on which questions were asked by the
Senators.
Consideration of the pressures now at work in
our cconomy must be based on an understanding of
the fact that the financial forces generated in a
great war are among the most disrupting factors
that can afTect the economic system. We are now
dealing, and for years shall be forced to deal, w i t h
the monetary backwash of the greatest and most
costly war of all time. W e are faced w i t h the
problems of liquidating the effects of that war upon
our own economy, and indeed upon the economy
of the world. If history is a guide, we must realize
that these problems w i l l not be solved in a day.
They w i l l extend over a number of years—how
many depends upon how wisely and how courageously we devote ourselves to the task.
The financial cost of the last war, if all conceivable items of cost were included,* perhaps
could never be accurately summed up. Suffice it to
say that our national debt rose to approximately
280 billion dollars and is still above 250 billion.
The solution of our present problems does not
require us to determine whether the debt should
have risen so high, whether we should have spent
so much, whether we should have taxed ourselves
more and borrowed less, or whether the pattern of
our borrowing was well conceived. What has been
done is in the realm of fact and the consequences
must be dealt with accordingly. One of the important facts is that the creation of our national
debt resulted in a tremendous expansion of the
money supply. While the Government borrowed
vast sums from nonbank lenders, other vast sums
were supplied by the commercial banking system.
A n d let me say right here that this nation owes
a debt of gratitude to commercial bankers generally
for their service in the task of financing the war.
The rapid expansion of the money supply which
resulted from their contributions must not be permitted to rise and plague them as if they had
cunningly contrived it for their own selfish ends.
Nevertheless, as a net result of war financing,
there were increases in the public's holdings of
demand deposits and currency from less than 40
billion in 1940 to 110 billion at present; of time
deposits from less than 30 billion to nearly 60
billion; of United States Government securities,
which are readily convertible into money, from a
few billion to over 90 billion. The total supply of
AUGUST 1948
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these forms of money and potential money is now
more than three times the prewar total.
•The productive capacity of the nation was largely
devoted to war purposes for almost five years. A t
the peak more than 50 per cent of our record production was for war use. While millions of people
were coming into possession of more money than
any people had ever had to spend and save, there
was a scarcity of things to spend it for. Consequently two great backlogs rapidly accumulated—a
backlog of unfilled wants and a backlog of money
savings. W i t h removal of controls this pent-up
spending power, plus an unprecedented volume of
current income were turned loose in a market
characterized by scarcities and shortages. Prices,
wages, and profits rose rapidly, and the spiral of
inflation was on its way.
A t present, w i t h a supply of money or potential
money readily available to buy the current output
of goods and services about three times the prewar
level, the overall physical volume of production
of goods and services, so far as it can be measured,
is probably little over a half larger than the prewar
maximum. Production, it is important to emphasize, is practically at capacity; there has been little
increase in its physical volume during the past
year and a half, notwithstanding the great pressure
of unsatisfied demands, expanding credit, and
rising prices.
Prices on the average have risen by nearly threefourths since before the war and two-thirds of this
increase has occurred in the past two years. The
dollar value of the total national product, at nearly
250 billion dollars a year, is over two and half
times the prewar maximum. On the basis of the
present volume of money, the turnover of which is
low relative to past periods of high activity and
could be greatly increased, prices could rise even
further. Further expansion of bank credit, the
capacity for which is tremendous, would add to the
already excessive money supply and could do little
to increase output.
PUBLIC D E B T
HOLDINGS PROVIDE BASIS FOR
POSTWAR CREDIT EXPANSION
Capacity for still further credit expansion also
grew out of war finance. In helping to finance the
Government's large war expenditures and to provide the money supply demanded by the expanding
and abnormal war economy, the commercial banks
of the country and also the Federal Reserve Banks
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S T A T E M E N T BEFORE T H E
HOUSE B A N K I N G A N D CURRENCY
greatly expanded their holdings of Government
securities. Commercial bank holdings of Government securities of all types increased from about 16
billion in 1940 to a peak of 90 billion at the end of
1945 and then were reduced during 1946 to 70
billion, largely by Treasury use of its excess bank
deposits to retire debt. Subsequently, to meet the
demands of rapidly expanding private economy in
the postwar period, banks have further reduced
their^holdings of Government securities, but they
still hold 65 billion dollars of them. Other investors have also sold or redeemed some of the
holdings of Government securities in order to obtain
funds for other uses.
Sales of U . S. Government securities in the market by banks and others have not been absorbed by
purchases on the part of other investors. I n order
to keep the prices of Government securities from
declining, the Federal Reserve System has continued to carry out its wartime responsibility of supporting the market by buying at relatively stable
prices securities offered for sale and not purchased
by others. The result of these purchases by the
Federal Reserve Banks is to supply additional reserve funds to banks. Because of the fractional
system of reserve requirements, these new reserves
in turn provide the basis for an increase in bank
credit that may be many times the amount of new
reserves obtained.
I n the postwar period these reserves supplied the
basis for an increase in bank credit in response to
an active demand for loans to finance the operations
and expansion of the business system in an era of
high demand, accelerated activity, rising costs, and
rising prices. There is ample evidence that bank
credit is also being used for purposes ordinarily
served by the capital market. As a result, despite a
reduction of 25 billion dollars in the volume of Government securities held by commercial banks, deposits and currency held by the public have increased by an additional 15 billion since the end of
1945. This has been largely the result of an increase of 15 billion in bank loans.
The Board of Governors has kept the Congress
and the public informed concerning these results
of supporting the market for Government securities.
I t has repeatedly pointed out that the effect has been
to increase significantly, and it may be dangerously,
the money supply. The need for market support
of Government securities has greatly increased the
problem faced by the System in adopting policies to
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regulate the supply of money and credit to the
justifiable needs of a stable, full-employment
economy. As long as various holders of Government securities endeavor to sell more of their holdings than other investors are willing to buy, the
Federal Reserve Banks must purchase the balance
and these purchases create bank reserves.
It is my view that the System is obligated to
maintain a market for Government securities and
to assure orderly conditions in that market, not
primarily because of an implied commitment to
wartime investors that their savings would be
protected, nor to aid the Treasury in refunding
maturing debt, but because of the widespread
repercussions^that would ensue throughout the
economy if the vast holdings of the public debt
were felt to be of unstable value.
POLICIES ADOPTED TO RESTRAIN
CREDIT
INFLATIONARY
EXPANSION
The Federal Reserve System and the Treasury
have, nevertheless, been able to adopt some policies
designed to offset the expansive effect on bank
reserves of market purchases of Government securities by the Federal Reserve System. The first
and quantitatively more effective of these measures
has been the use of the Treasury surplus to retire
maturing securities, particularly those held by the
Federal Reserve Banks. The debt retirement program was made possible first by a large cash balance built up by the Treasury in the Victory Loan
drive in 1945 and later by a substantial surplus of
cash receipts over expenditures. I n paying out a
large part of the excess cash collected from the public to the Federal Reserve for retirement of debt,
that amount of money was eliminated from the
money supply and also from bank reserves.
As a second measure of restraint, about a year
ago the Federal Reserve and the Treasury embarked upon a program of permitting yield rates
on short-term Government securities to rise from
the very low levels at which they had been pegged
during the war.. The purpose of this action was to
encourage banks and others to invest available funds
in short-term securities. This enabled the Federal
Reserve to reduce its holdings of short-term securities and thus offset the effect on reserves of its
purchases of longer term bonds. The rate on 90day Treasury bills rose from % of one per cent to
about 1 per cent, and that on one-year Treasury
certificates from % to \ % per cent. The Federal
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Reserve Banks early in 1948 raised their discount
rates from 1 per cent to 114 per cent.
Late in 1947, market yields on Government bonds
also rose, that is, prices of bonds, which had been
selling at large premiums, declined in the market.
This adjustment was in large part inaugurated by
sales by financial institutions to obtain funds to
invest in corporate securities and mortgages, but it
was accelerated by sales made in fear of further declines in prices of bonds from their high levels. I n
order to check this decline, the Federal Reserve
System adopted a policy of freely purchasing bonds
at an established series of prices, which maintained
yields in accordance w i t h a pattern ranging from
1 % per cent for one-year issues to 2 l /i per cent for
the longest-term bonds. This pattern kept the
prices of all except a few very short issues of securities at par or higher.
It may be of interest to review credit developments and the effects of these policies during the
past twelve months. I n the year ending June 30,
1948, commercial banks showed a small increase
in their deposits and their total loans and investments, although there were some wide fluctuations
during the period. I n the twelve months, commercial banks increased their total loans and their
holdings of corporate and State and local Government securities by a total of 7 billion dollars. Most
of this growth occurred in the latter half of 1947
and was accompanied by an expansion in bank deposits and reserves. I n the early months of 1948,
however, deposits were withdrawn to make seasonal
heavy tax payments, which were not offset by Treasury expenditures. Banks met these needs largely by
reducing their holdings of Treasury bonds. Some
maturing bonds were exchanged for certificates and
a part of these issues were sold. A t the same time
banks in general purchased added amounts of
Treasury bills, an indication of the effect of the
higher short-term rates in attracting available funds.
Banks also continued to increase their loans in the
first half of 1948 by about 1.7 billion dollars—a
somewhat slower rate of growth than in 1947.
Most of the dollar increase in bank loans during
1947, particularly in the last half, was in commercial
and industrial loans, but the increases in consumer
loans and real estate loans showed larger percentage
increases in 1947 and have continued to expand in
1948.
Savings institutions, particularly insurance companies, also considerably expanded their holdings of
AUGUST
1948
COMMITTEE
mortgages and investments other than U. S. Government securities during the past year. I n the
aggregate, these assets of selected groups of financial
institutions increased by 8.6 billion dollars in the
period, of which 6.4 billion was met by receipts of
new savings from the public and 2.2 billion by a
reduction in their holdings of Government securities. Nonbank investors, as a group, sold and redeemed bonds, but purchased certificates and bills,
reflecting increased popularity of these issues w i t h
the rise in rates. Life insurance companies substantially increased their h o l d i n g of Government
securities during the war and then in the postwar
period reduced these holdings while increasing
their mortgages and other investments.
Sales of Treasury bonds by nonbank investors
and by banks in the past year have been largely
purchased by the Federal Reserve System. The
System purchased 5.7 billion dollars of Treasury
bonds in the market and also purchased in the market a net amount of about 2.6 billion dollars of notes
and certificates, but sold on balance nearly 4 billion
dollars of bills to banks and other investors. I n the
same period the Treasury redeemed for cash about
5 billion dollars of maturing issues of various kinds
held by the Federal Reserve Banks. W i t h all of
these wide shifts in holdings of different types of
securities, there was only a small net decline in the
System's aggregate holdings of Government securities, although the total fluctuated considerably
from time to time.
The purpose of this detailed survey of figures is
to illustrate how shifts in holdings of the public
debt are being used to finance inflationary spending, and how Federal Reserve and Treasury policies
endeavor to offset these tendencies. Treasury use of
surplus funds to retire securities held by the Federal Reserve drains reserves from banks and makes
it necessary for them to sell securities if they wish
to maintain their loans, and even more so if they
want to expand credit. The higher rate on Treasury bills encourages banks and other holders of
liquid funds to buy bills rather than invest in other
assets. Since most of the bills have been held by
the Federal Reserve, a reduction in System holdings
is made possible and bank reserves are thereby
absorbed. Nevertheless, sales of bonds to the Federal Reserve, primarily by nonbank investors, have
been so large that* the restrictive effect of the other
policies has been fully offset.
A third method of restraint used by the Federal
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S T A T E M E N T BEFORE T H E HOUSE B A N K I N G A N D CURRENCY
Reserve authorities during the past year was to increase reserve requirements at central reserve city
banks in New York and Chicago by 2 per cent of
demand deposits in February and again in June.
This added about a billion dollars to member bank
required reserves and immobilized that amount of
bank assets. The effects of these changes, however,
were concentrated on New York City and Chicago
banks, where loan expansion has been less than
at other banks. Under existing law there is no
further power to increase requirements except in
central reserve cities.
I t should be mentioned that bank reserves have
been supplied in the past year by an inflow of gold
amounting to 2.2 billion dollars and also by a decline of about half a billion in currency in circulation. A temporary increase of 1.3 billion in Treasury deposits at the Federal Reserve offset i n part
these factors. The total growth i n reserves was 1.4
billion, sufficient to cover the increases in reserve
requirements at central reserve city banks and
also increased requirements resulting from deposit
growth. The Federal Reserve System was not able
through its policies to prevent some continued expansion of bank credit.
PROSPECTIVE D E M A N D S FOR C R E D I T
Economic prospects indicate a continuation of
strong inflationary pressures during the next several months and perhaps for a much longer period.
Individual incomes have continued at a high level,
w i t h a tendency to increase as prices and wages
have risen and employment has grown w i t h the
labor force. Consumer spending, based on current
incomes, the use of past savings, and borrowing,
also has continued to expand. Construction volumes seem likely to remain for a while at capacity
levels, w i t h possible further rises in prices. Business
expenditures are also expected to continue in large
volume. Government expenditures are increasing,
while the recent income tax reduction w i l l lower
receipts, thereby sharply reducing the Treasury
surplus.
Continuation of these tendencies w i l l call forth
further credit expansion. Borrowing by consumers
and home-owners w i l l no doubt continue to expand
and thereby add to consumer spending and to demands for housing, which are already excessive.
Prospective large outlays by business for expansion
of inventories and plants w i l l probably exceed internal funds available and also amounts obtained
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by flotation of new securities. Overall demands
for funds may continue in excess of the current
volume of savings readily available for lending for
such purposes. T o help meet the demands for
credit and capital, corporations, individuals, and
financial institutions w i l l sell some of their holdings
of Government securities and also increase their
borrowings from banks.
I f these tendencies continue, sales of Government
securities by nonbank investors may exceed 1.5 billion i n the last half of 1948 and perhaps be much
greater early i n 1949. These sales w i l l keep the
Government bond market under pressure and require support purchases by the Federal Reserve, if
the policy of maintaining the 2l/z per cent yield
level on long-jprm Treasury bonds is continued.
Thus additional reserve funds would be made available to banks which, unless otherwise offset, could
sustain a further very large inflationary expansion
of bank credit. Additional reserves supplied
through the gold inflow may be approximately offset by the drain resulting from seasonal currency
demands.
T o avoid an abundance of reserves, an easy shortterm money market, and continued inflationary
credit expansion, positive measures to absorb reserves w i l l be needed. I n view of the pressure of
current demands, the continued shortages of many
goods, the limited capacity for increased output, and
the available accumulations of liquid assets, further
credit expansion w i l l add to the pressure for rising
prices. Continued credit expansion w i l l store up
trouble for the future and make the inevitable adjustment more dangerous for the stability of the
economy.
This course of economic and monetary developments has been the source of increasing concern to
th Federal Reserve authorities. We are convinced
that, so long as the present situation lasts, it is important to restrict further credit expansion and to
promote a psychology of restraint on the part of
both borrowers and lenders. T o keep the reserve
position of banks under pressure and discourage
further inflationary credit expansion will require
carefully coordinated operating measures on the
part of both the Treasury and the Federal Reserve
System.
Of the three sets of measures used to restrain the
growth of bank reserves during the past year—
namely ( 1 ) use of the Treasury cash surplus to retire Federal Reserve-held securities, ( 2 ) reduction
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in Federal Reserve holdings of Treasury bills
through a rise in short-term rates, and ( 3 ) increases
in reserve requirements at central reserve city banks
—the first and most important has been greatly
reduced in its potency and the third has been almost
wholly exhausted.
Whereas the Treasury showed an excess of cash
income over cash outgo of 9 billion dollars in the
fiscal year 1947-48, the prospects for the current
year, on the basis of very tentative and unofficial
estimates, are for a cash surplus of only about 3
billion; most of which w i l l be concentrated in the
first quarter of 1949. This difference in the surplus reduces considerably the most important antiinflationary influence in the situation during the
past year. The Treasury cash surplus was a particularly effective device because it exercised a drain
on bank reserves. As a result the banks losing
reserves had to sell securities in order to maintain
their reserve positions. While under these pressures they are less likely to be seeking new loans
and in some cases less w i l l i n g to meet loan applications.
POSSIBLE MEASURES OF RESTRAINT
This brings us to the various ways in which restraint may be exercised over credit expansion.
The first means is voluntary self restraint on the
part of borrowers and lenders. I am convinced that
th.e voluntary program originated and actively developed by the American Bankers Association has
had a significant effect in developing a more
cautious and critical attitude on the part of bankers
toward so-called unproductive or speculative loans.
I f inflationary pressures were mild, voluntary restraint might be adequate to hold them in check.
Continued and intensified voluntary restraint w i l l
make our joint task easier.
There are a number of reasons, however, why
voluntary restraint cannot be relied upon to do the
whole job alone when inflationary pressures are as
strong as they are at the present time. Perhaps the
most important reason is that a loan which may appear productive when viewed by itself may not add
to the total output of the economy as a whole. For
example, a customer may increase his production by
borrowing funds to purchase needed parts that are
in short supply. Such a loan would appear to be
productive from the individual point of view of
both the borrower and the lender. But w i l l the
loan increase the supply of the parts or total output?
If all resources are being used to capacity, the loan
AUGUST 1948
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may merely enable the borrower to secure parts that
otherwise would have been bought by another firm.
From the point of view of the economy as a whole,
the loan has increased the demand for goods but it
may not have increased total supply at all, w i t h a
bidding up of prices as the only result. Basically,
that is why I believe that self restraint, though important, is inadequate to check a strong inflationary
development.
Another reason is the force of competition not
only among banks but among all lenders. We have
in the United States 14,000 commercial banks and
many thousands of other l e t t i n g agencies. If, because of concern for the general interest, a bank
should refuse to lend even to c^good customer, this
does not mean that the customer w i l l not secure the
funds. I t may merely result in a permanent loss of
the customer to some other lender. A n d unfortunately the new lender may secure the funds from
sale of Government securities, w i t h the result that
the loan may be just as inflationary as if the bank
had made it in the first instance.
I want to emphasize that I support strongly the
self-restraint program developed by the American
Bankers Association and would like to see it
pursued aggressively, not only by banks but by all
lenders. I t is an important step in the right direction. Primarily for the reasons I have mentioned,
however, I do not think it can do the joo alone.
Another approach to the problem is through control over member bank reserves. Bank credit carnot expand unless banks acquire or have reserves
on which to expand. One way in which the System
has supplied reserves has been through purchases
of long-term Government securities. A means of
restraint would be for the System to limit its purchases of such securities either by refusal to buy or
by reducing its prices sufficiently to attract other
purchasers. As you know, the System has made a
public commitment to support the 2l/2 per cent yield
level on long-term Government bonds for the foreseeable future. I gave my reasons for subscribing to
that commitment when my confirmation was under
consideration by the Senate Committee on Banking
and Currency. Although that commitment substantially limits our freedom of action, I believe
there is a better way to operate against credit expansion than now to abandon that commitment.
Our basic problem is to absorb reserves. Increases in reserves may be anticipated from three
principal sources: ( 1 ) imports of gold, ( 2 ) return
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S T A T E M E N T BEFORE T H E HOUSE B A N K I N G A N D CURRENCY
of currcncy from circulation, and ( 3 ) purchases of
Government bonds by the Federal Reserve Banks
to support the long-term yield level. The principal
problem before the System is to absorb or offset
reserves arising from these sources. The only way
it could do this effectively under present authority is
to liquidate part of its holdings of Government securities. I t would be necessary, of course, to sell them
at prices the market would pay.
The System has a large portfolio of bills, certificates, and other short maturities that it could
use. I f the inflationary demand for bank credit is
strong, sale of these holdings to absorb reserves
would result in a further stiffening of short-term
interest rates. The Open Market Committee of the
Federal Reserve System feel that a policy of endeavoring to sell short-term securities in order to
absorb any additions to reserves is a necessary and
desirable step. I f an increase in the short rate
should result, it would tend to attract funds from
other uses to investment in short-term Government
securities. As I have pointed out, the policy of
allowing short-term rates to rise was begun about
a year ago and has had some success.
A t this point the necessity for teamwork between
the Treasury and the Federal Reserve becomes apparent. I am keenly sensitive to the necessities of
the Treasury in its task of managing the public
debt. I thoroughly understand the Treasury's responsibility to keep the interest cost of the debt as
low as possible consistent w i t h all relevant factors.
I know that the Treasury Department is equally
sensitive to the responsibilities of the Federal Reserve in the field of monetary and credit policy.
The problems of mutual concern to the Treasury
and the Reserve System in their respective fields are
being approached in a continued spirit of cooperation.
The rediscount rate is another instrument of
policy in the short-term market. It should not be
written off. Although its effectiveness is diminished in times like these when the volume of member bank borrowings is small, and when banks can
readily obtain needed funds by selling some of their
large holdings of Governmnt securities, higher discount rates would have some restrictive effect. If,
for example, the yield on short-term Government
rises, it would become appropriate under these circumstances to increase the discount rate. This
action would discourage the market from reacquiring through the discount window any funds
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that had been withdrawn through the disposal by
the Reserve System of short-term Governments.
A n increase in the discount rate has great psychological effect. Each increase repeats the warning that credit is in need of continued restraint.
Changes in the Federal Reserve discount rate and
open market operations supplement each other as
necessary parts of an overall credit policy.
These two related instruments influence the total
volume of reserves of member banks. The third
general instrument—reserve requirements—is designed to influence the amount of bank credit that
can be based on a given volume of reserves. A n increase in requirements immobilizes reserves and
makes them unavailable for further lending and
investing. As you know, the Board of Governors
has on prevteus occasions presented various ways
of dealing w i t h the problem of reserves or immobilizing certain bank assets.
The method proposed in the bill before you is
simple and direct, and involves no departures from
existing principles. The bill would authorize the
Board of Governors to increase by 10 and 4 percentage points the reserves that member banks may
be required to maintain against their demand and
time deposits, respectively. The authorization
wpuld be granted for a period of two years. As I
have already explained, we feel deeply that it is
not fair to member banks in their competitive relations with nonmember banks to require that they
be singled out to carry the additional reserves that
may be necessary to combat this inflationary situation. I earnestly hope that Congress will, during
this interval, reconsider the whole structure of
reserve requirements, possibly along the lines developed recently before the Joint Committee on the
Economic Report.
I should like to indicate briefly what can and
cannot be accomplished through increases in reserve
requirements. Changes in requirements cannot, of
course, be considered in isolation. They must be
related to other instruments of policy. In practice
they are closely related to open market operations.
One method that banks use to adjust their positions
to the pressure exerted by an increase in requirements is to sell Government securities. To the extent that these are purchased by the Federal Reserve,
new reserves are created which meet the higher requirements. This is not the whole story, nor does
it happen invariably, but it does illustrate the complexity of our problem. A n increase in requireFEDERAL RESERVE
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S T A T E M E N T BEFORE T H E HOUSE B A N K I N G A N D CURRENCY
ments immobilizes a larger portion of the assets of
member banks and makes them unavailable for sale
in order to obtain funds to increase loans. It, therefore, reduces the licjuidity of banks and lowers the
ratio of multiple credit expansion that can occur
on the basis of any increase i n available reserves.
The purpose of increasing authority over reserve
requirements is not to obviate the possible need for
open market operations and a rise in short-term
rates. That problem would still be w i t h us.
CONCLUSION
" I n conclusion, I should like to state emphatically
the Board's view that the use of its powers over the
supply of reserves under present conditions should
be directed toward restraining further credit expansion and not toward forcing liquidation of the
outstanding volume of credit. The Federal Reserve
System was established to provide for flexibility in
our monetary system. I t was not designed to make
available any amount of money that borrowers
might demand without regard to the productive
capacity of the economy and the speculative nature
of the commitments. The System would be derelict
in its duty if it did not exercise a proper measure
of restraint.
Expansion of the public debt because of war and
the necessity of maintaining a degree of stability in
the value of the vast holdings of that debt by financial institutions and individuals has confronted the
System w i t h formidable difficulties in the exercise
AUGUST
1948
COMMITTEE
of restraint over credit expansion. The proper
handling of this problem requires the most careful
management. It can be facilitated by the extension
of the System's powers, as proposed in the bill before you, which extension is thoroughly consistent
with existing powers and traditional methods.
As I have pointed out, there are possibilities and
prospects for a continuation of inflationary pressures which w i l l call forth additional demands for
credit. I feel confident that the Federal Reserve
authorities w i l l use their existing powers to the
fullest extent possible to,restrain these tendencies
without depriving the ectfhomy of the credit needed
to maintain production and employment at the
highest sustainable levels. •We would endeavor to
use the additional powers proposed in the same way.
Finally, it should be emphasized as strongly as
possible that action in the monetary field alone
cannot readjust the unbalanced relationships w i t h i n
the economic structure which have already been
created by inflationary forces, and cannot check
further inflationary pressures arising from nonmonetary causes.
The additional powers sought would enable the
Reserve System to exert a very necessary degree of
restraint upon the now unrestrained expansion of
credit. For that reason they are urgently needed,
even though they are not and should not be regarded by the Congress or by the public generally
as a cure-all.
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