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MAY 27, 1948
The Committee has requested rqy views concerning the adequacy of
Present powers of the Federal Reserve System to deal with the expansion
nd contraction of bank credit.
Shortly before I took office the Committee received the recommendations of the Board of Governors. It also has heard Mr. Allan Sproul,
•Resident of the Federal Reserve Bank of New York, express his views,
^"ich differ in some respects from those of the Board. Consequently, what
shall have to say should be taken as an expression of my own personal
iews% The Committee will appreciate that I have been inraypresent office
out a month and that I am only beginning to got ray feet wet. While I can
*}ot at this early date speak with precision upon some matters of technical
rtheless, I welcome this opportunity to state my position on
basic questions into which the Committee is inquiring.
Throughout my business experience I have operated under limitations and have had to know what those limitations were. Every executive
forced to make his plans as well as his day-to-day decisions within the
iraits imposed upon him by his authority and the resources at his command,
have long been resigned to the realization that increased authority and
^ of action are not easily obtainable. In fact I have frequently
in business that better results are obtained if our energies are
®cted to the most effective use of existing facilities.

I did not seek this position and I did not assume the office I
kold without searching appraisal of the responsibilities involved,
appraisal included the job the Federal Reserve System lias to perform
nd the adequacy of its tools. % appraisal convinced me that the job
could be done. I am still of that opinion.

Consideration of the pressures now at work in our economy must
based on an understanding of the fact that the financial forces gene
**ated in a great war are the most disrupting factors that can affect the
Economic system. We are now dealing, and for years shall be forced to
with the monetary backwash of the greatest and most costly war of all
line. We are faced with the problems of liquidating the effects of that
upon our own economy, and indeed upon the economy of the world. If
.^-story is a guide, we must realize that these problems will not be solved
a day. They will extend over a number of years—how many depends upon
wisely and how courageously we devote ourselves to the task.

The financial cost of the last war, if all conceivable items of
^ost were included, perhaps could never be accurately summed up. Suffice
"to say that our national debt rose to approximately $280 billion and is

-2still 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 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 nenbank
lenders, other vast sums were supplied by the commercial banking system.
And let me say right here that this nation owes a debt of gratitude to
commercial bankers for their patriotic 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.
The productive capacity of the nation was largely devoted to
war purposes for almost 5 years. At the peak more than 50 per cent of
our record production was for war use. While H O million 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. With 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 rose rapidly. Pressure on wages quickly ensued and the spiral
°f price-wage inflation was on its way.
One of the few controls that was not removed or immediately
Modified was the pattern of rates that was maintained by the Federal Reserve System in support of the Government securities market. This
Policy was deliberately adopted early in the war as essential to its
financing. Experience gained in the First World War had taught the
iscal and monetary authorities that without a fixed pattern of rates
which the money market could confidently expect to be maintained, interest
ates would tend to rise as the financing program proceeded. The inevitable results of such a tendency would have been to increase the interest
°ost of the debt, and, of even greater importance, to encourage the withholding of funds by investors awaiting anticipated higher rates. Moreover, the effects of an unstable and disorderly market in the postwar
Period would have greatly complicated the problems of reconversion. In
iew of these and other considerations the decision to maintain a pattern
°f rates was taken early in the financing program of World War II. It is
important to remember that the general characteristics of this pattern
resulted from the condition of monetary ease which developed in the 1930 s.
The support of the rate pattern had to come from the Federal
Reserve System. As the market became more and more convinced that the
Pattern would be maintained, it began to sell increasing amounts of shortterm securities to the System in order to secure funds for investment m



•long-term securities bearing higher rates. These support purchases by
the Reserve Banks increased the reserves of the commercial banking system and thus made possible a multiple expansion of bank credit.
In the postwar period these reserves supplied the basis for an
increase in bank credit in response to an active demand for loans to
•'nance the operations and expansion of the business system in an era of
demand, accelerated activity, rising costs, and rising prices. There
ample evidence that bank credit is also being used for purposes
ordinarily served by the capital market. As a result, despite a reduction of $20 billion in the volume of Government securities held by commercial banks, demand deposits and currency increased by §1.1 billion from
the end of 1 % 5 to the end of 1947. The Board of Governors has kept the
_°ngress and the public informed concerning these results of supporting
'he rate pattern. It has repeatedly pointed out that tho effect has been
increase significantly, and it may be dangerously, the money supply.
Our problem is to find a common ground on which all can unite
o avoici further inflation as a result of this swollen money supply. It
an objective which all recognize as essential to our well being. It is
% firm view that too much emphasis can not be placed upon the necessity
° r cooperative effort. The problems we now .face are not the exclusive
Problems of the Federal Reserve System, the commercial banking system, or
Government. There is grave responsibility also upon every citizen,
Pon every group or organization of citizens, upon labor, industry,
-iness, anrl agriculture. We must do all we can to increase the total
°utput of goods, especially those in short supply, by working as hard and
efficiently as possible. I think we shall fall into grievous error if
assume complete responsibility for the future is concentrated in any
° Place. Here is a crying need and a magnificent opportunity for team
m c emphasize that everybody is on the team.

I should now like to refer briefly and somewhat more specifically
the place on the team which the Federal Reserve System occupies.

Tho responsibilities of the Federal Reserve System are specified
basic objective toward which the System is required by
to direct its credit policies is perfectly clear. Under provisions
„ . F e d e r a l Reserve Act the System is required to fix rates of discount
view of accommodating commerce and business"; the power to change
-^erve requirements is required to be exorcised "in order to prevent
^Urious credit expansion or contraction"; and the power to conduct open
a *. ^ operations must be exercised "with a view to accommodating commerce
J business and with regard to their bearing upon the general credit
"tuation of the country." As a result of these powers and the standards
. g o v e r n their use, it is tho function of the Reserve System to proue the country with a supply of money tliat is appropriate to its needs,
"as just as much responsibility to prevent injurious credit expansion
to prevent injurious contraction.


The paramount consideration bearing upon the general credit
situation of the countiy during war times was the necessity to finance
the war. The use of open market operations tc support the rate pattern
as undertaken by the System in discharge of a responsibility to assist
in the mobilization of credit in the war effort. The effects of that
action on the monetary situation of the countiy were- of secondary
importance. Since the end of war financing, the Government's financial
needs, though still very large, have become less important than the need
°r dealing with inflationary forces originating largely during the war as
result of the Government's financial needs. Monetary considerations are
no longer of secondary importance.
A number of steps have been taken in recognition of this shift
in emphasis among objectives. After offerings of new issues of long-term
Government securities ceased with completion of the Victory Loan Drive,
investors forced down long term yields try bidding up the price for outstanding issues. This created further inflationary pressures, because
some of the bidding came from investors who sold short-term issues to buy
these bonds and the Reserve System purchased the short issues to support
the short end of the rate pattern. It was to discourage this practice
that short-term rates were permitted to move up after mid-1947. This had
very salutary effect.
Thus the pattern of rates maintained during the war was broken,
it was necessary to do this 'in order to discharge the duty of the Federal
Reserve System to prevent an injurious expansion of credit. At the same
time the System has always kept in mind its other important objective of
maintaining orderly and stable conditions in the Government securities
market. Although these twin objectives complicate the problems of the
central banking system, I am confident that our responsibilities in both
fields can and will be discharged in so far as one can now see.
What problems are involved in a policy directed toward these
ends? As I see it, they may be discussed under four heads. It might be
W e
H to enumerate them at the outset so that you will have an over-all

How to prevent further expansion in member bank


How to maintain the 2-1/2 per cent yield level for
the longest-term Government bonds for the forseeable future.


Whether funds should be absorbed from the market by
liquidating securities or by increasing reserve requirements.


How orderly conditions in the Government securities
market may best be maintained.

-5I should like to discuss briefly each of these components of a
comprehensive policy.
1. Control, of member bank reserves. Bank credit can not expand unless banks acquire or have reserves on which bo expand. That is
ky the volume of reserves can not be left to the determination of the
market if an inflationary development is to be halted. The time has come
the volume of reserves must again be given primary consideration in
° U r policy. As long as inflationary forcus are dominant there should be
strong brakes on further expansion of reserves. Indeed, if there should
a rise in the rapidity with which our existing stock of money is being
°P^nt, the existing volume of reserves may prove too high. It should be
^pha sized that preventing reserves from increasing does not Imply a conAction of bank credit. It will not force banks to stop lending as seems
to be alleged. Loans are being repaid continuously so that new loans
&ust be placed on the books with equal continuity simply to maintain a
-Loan portfolio.
2. Support of the 2-1/2 per cant Ions-term yield level. The
« stem has made a public commitment to support the 2-1/2 per cent rate on
°n8-term Government bonds for the forseeable future. I gave ny reasons
"~?r subscribing to that commitment when my confirmation was under consideration by the Senate Committee on Banking and Currency. Although that
^Oflimitment substantially limits our freedom of action, I am confident that
° r the present and under conditions as I now see them we can make good
° n that commitment and at the same time exercise an effective restraining
flucnce on further credit expansion.
3. Instruments of policy. Increases in reserve funds may be
ticipated from three principal sources? (1) imports of gold, (2) re, U r n of currency from circulation, and (3) purchases of Government securiles by the Federal Reserve Banks to support the 2-1/2 per cent long-term
The problem before the Reserve System, therefore, is to absorb
additions to the supply of reserves from these sources. The only way
can do this under present authority is to sell part of its holdings of
o^ernment securities. The System has an ample portfolio of bills,
^tificates and other short maturities. If the inflationary demand for
crcdit is strong, the use of these holdings to absorb additions to
k reserves will result in a further stiffening of short-term interest

At this point the necessity for teamwork between the Treasury
the Federal Reserve becomes apparent. The capacity of the Federal
oserve System to absorb reserves is limited only ty the size of its
and its willingness to part with them at prices the market will
for. The theoretical limitation imposed upon us ty the size of the
Portfolio is of no current practical importance. Ue have ample amrnuni^on, our freedom to use it is another matter since that may involve a
in short-term rates. I am keenly sensitive to the necessities of

-6the Treasury in its task of managing the public debt. I thoroughly understand the Treasury's responsibility to keep the interest cost of the debt
low as possible consistent with all relevent 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. I am confident that problems of mutual concern to the Treasury and the Reserve System in their respective fields will be approached and solved in a
Continued spirit of cooperation and that each, respecting the responsibilities of the other, will seek to unify their efforts in the public
The rediscount rate is another instrument of policy in the
short-term market. Although its effectiveness is diminished in times like
these when the volume of member bank borrowings is small, it should, not be
itten off. If, for example, the yield on short-term Governments rises,
it might become appropriate to increase the discount rate. This action
^ould prevent the market from reacquiring through the discount window the
that had been withdrawn through the disposal by the Reserve System
short-term Governments. An 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 rate and open-market operations supplement each other as necessary parts of an over-all credit
These two related instruments influence the volume of reserves
member banks. The third general instrument—reserve requirements—is
signec} to influence the amount of deposits that can be based on a given
°lume of reserves. An increase in requirements immobilizes reserves and
kes them unavailable for further lending and investing. An increase in
quirements is a powerful weapon for influencing the volume of deposits
Provided the total volume of reserves is not correspondingly increased and
,anks have little or no excess reserves when the action is taken. Changes
reserve requirements can not, however, be considered in isolation. In
Practice they are closely related to open market operations. One method
that banks use to adjust themselves 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
et the higher requirements. Even when this happens, however, some
^ostraint has been exercised because the increase in requirements reduces
the multiple credit expansion ratio as well as the liquidity of banks;
^nd i n addition the System has a greater volume of securities available
_sale. The extent to which it could use them, however, involves
S-Lmiiar considerations to those arising in connection with disposals from
the present portfolio, namely the price at which they could be liquidated.
4. Maintain orderly conditions in the Government securities
I have discussed reserves and the relation of reserves to dePosits because that is the heart of the System's statutoiy responsibiliXe
s. The control over reserves, however, is not an end in itself. It is

the means by which the volume of money and the flow of expenditures is
influenced. The ultimate goal is to contribute to the maintenance of high
levels of production and employment at reasonably stable prices. In view
of the huge size of the public debt resulting from the war and its
Preponderant position in the credit structure the Federal Reserve western
Nust place the maintenance of an orderly market for U. S. Government
securities among its primary obligations. We feel confident that we will
e able to continue to maintain orderly conditions without detriment to
the pursuit of broader objectives.
I assumed the grave responsibilities of my job with the firm
conviction that they could be discharged. I am still of that conviction.
course no one knows the strength of the forces that we must hold in
hock. Naturally the Board of Governors would be in a more comfortable
Position if it had greater authority over reserve requirements. Any public
body charged with such a grave responsibility desires all the authority
that may be necessary to cope with adverse developments. Opposition to
granting additional authority has been so widespread, however, that I
accepted appointment to the Board, resigned to the probability that no
additional authority would be granted at this session of the Congress.
appreciate also that an increase in reserve requirements, of itself, is
ot the sole answer, especially if it resulted only in transferring
Government securities from commercial banks to the Reserve Banks. An
increase in the rates on short-term Government securities might still be
necessary if the restraint is to be really effective.
Should the flow of funds into the market be stimulated beyond
our ability to absorb them in the ways that have been described, we shall,
course, need to ask for such remedial measures as may be required.
There is no other course but to go forward operating in the expectation
that Congress will deal promptly and appropriately with any emergency that
^ay develop.
Thus far- I have spoken mainly of the role of the Federal Reserve
Astern, one member of the team that must work together to achieve our
The cooperation of the public is likewise essential. All of us
ttust be educated to realize that each of us must exercise real restraint
in the use of money already in existence. All reasonable means should be
tilized to discourage consumer borrowing and consumer spending for nonessentials or for purposes which, even though at some sacrifice, can be
deferred until inflationaxy forces have subsided. Likewise capital expenditures of businesses should also be deferred except in the most
gent cases, such as investment necessary to eliminate bottlenecks in
ssontials. The purchase of Savings Bonds should be encouraged by all
Possible means. Local governmental expenditures are on the increase.
States, municipalities, and political subdivisions can join 111 the fight
against inflation by postponing expenditures for public improvements where

health and safety of their communities will not be jeopardized, We
nave seen the restraining effect of Treasury cash surpluses. Every
®ffort should be made to continue them and to that end the greatest
Possible economy should be practiced by the Government, not only in
direct spending but also in the extension of credit by or under
guaranties of Government agencies. We can not afford to forgot that
what we can do is limited by our real resources. The hard fact is that
° simply do not have enough real resources to provide all the things we
ould like to have. If we insist on trying to acquire them anyway, we
jall end by dissipating our resources through higher prices. The gospel
Restraint in the spending of money should be .taken to heart by every
^dividual and by every organized group, public or private.
Commercial banks have embarked on a program of voluntary restraint in the extension of credit, under the auspices of the American
inkers Association. This is an excellent example of team work and sets
t P ttern for cooperative effort which might be copied with profit by
m&ny other enterprises and organizations. The guiding principle of such
effort should be to avoid every deferable use of money or credit. It
^ould be emphasized again and again that the more effective such volun^
Policies are the less need there will be for stronger and more
direct controls.