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Statement o f Thomas B. HcCc.be, Chairman o f t h e
Board o f Governors o f t h e Federal Reserve System
Before t h e Senate Banking exid Currency Committee

July 29, 194S
When Senator Tobey v e r y k i n d l y asked me yesterday a f t e r n o o n i f
I would appear before you t h i s morning, I requested t h a t he postpone any
appearance u n t i l a f t e r t h e scheduled meeting o f the Bop.rd o f Governors
tomorrow, as I had promised t h e Board t h a t I would submit t o them f o r approval
the statement t h a t I was p r e p a r i n g f o r the House Banking and Currency Committee
before whom I was p r e v i o u s l y requested t o appear.
On t h e urgent i n s i s t e n c e o f Senator Tobey, f o l l o w e d t y a s p e c i a l
request from t h e P r e s i d e n t , I prepared a condensed statement o f the o f f i c i a l
view o f the Board o f Governors and submitted i t f o r approval t o the i n d i v i d u a l
members by telephone l a s t n i g h t ,
I telephoned

Senator

i f t e r o b t a i n i n g t h e i r f a v o r a b l e approval,

Tobey about 10*00 p.m. and t o l d him t h a t X would be

pleased t o appear t h i s morning.
The statement o f t h e Board i s as f o l l o w s :
A n t i - I n f l a t i o n Act o f 19A&
The proposed " A n t i - I n f l a t i o n
o f 1948" i n c l u d e s two t i t l e s
r e l a t i n g t o c r e d i t c o n t r o l s . Both a r e , i n substance, p a r t o f the comprehensive a n t i - i n f l a t i o n a r y program which the Board o f Governors has
p r e v i o u s l y recommended t o Congress. T i t l e One r e l a t e s t o r e g u l a t i o n o f
consumer c r e d i t and T i t l e Two r e l a t e s t o bunk reserves, As you gentlemen
know, t h e proposed r e g u l a t i o n o f consumer c r e d i t i s i d e n t i c a l , except f o r
the date, w i t h t h e b i l l passed by t h e Senate, and acceptable t o the Board
o f Governors as one p a r t o f an o v e r a l l program.
The proposal w i t h respect t o bank reserves i s s i m i l a r t o t h a t
advanced by the Board i n A p r i l , except t h a t t h e increased requirements would
be a p p l i c a b l e o n l y t o member banks, whereas the Board had recoiamended t h a t
they be made a p p l i c a b l e t o a l l coxamereial bonks. T h i s i s a s i g n i f i c a n t
d i f f e r e n c e . We f e e l deeply t h a t i t i s n o t f a i r t o member banks i n t h e i r
c o m p e t i t i v e r e l a t i o n s t o non-member banks t o r e q u i r e t h a t they be s i n g l e d
o u t t o c a r r y the a d d i t i o n a l reserves t h a t may be necessary t o combat t h i s
i n f l a t i o n a r y s i t u a t i o n * As an emergency measure, however, the b i l l would
be adequate t o meet the immediate need f o r a d d i t i o n a l a u t h o r i t y t o d e a l
w i t h reserves.



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2

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I n thus s t r t i n g the views o f the Beard 011 these two t i t l e s
o f d i r e c t concern t o t h e System, I do n o t want t o create the impression
t h a t a c t i o n i n the c r e d i t f i e l d clone w i l l solve our i n f l a t i o n a r y problems , Other areas, p a r t i c u l a r l y a budgetary s u r p l u s , are more i m p o r t a n t .
Now, I w i l l g i v e you some o f ny personal observations conc e r n i n g the i m p r c t o f the i n f l a t i o n a r y f o r c e s on our c r e d i t
mechanism.




control

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Consideration of the pressures now a t work i n our economy
must be based on an understanding o f the f a c t t h a t the f i n a n c i a l f o r c e s
generated i n a great war are the most d i s r u p t i n g f a c t o r s t h a t can
a f f e c t the economic system* We are now d e a l i n g , and f o r years s h a l l be
f o r c e d t o d e a l , w i t h the monetary backwash o f the g r e a t e s t and most
c o s t l y war of a l l t i m e . We are f a c e d w i t h t h e problems of l i q u i d a t i n g
the e f f e c t s o f t h a t war upon our own economy, and indeed upon t h e
economy o f the w o r l d . I f h i s t o r y i s a g u i d e , we must r e a l i z e t h a t these
problems w i l l n o t be solved i n a day* They w i l l extend over a number of
years—how many depends upon how w i s e l y and how courageously we devote
ourselves t o the t a s k .
The f i n a n c i a l cost o f the l a s t war, i f a l l conceivable items of
cost were i n c l u d e d , perhaps c o u l d never be a c c u r a t e l y summed u p .
Suffice
i t t o say t h a t our n a t i o n a l debt rose t o approximately $280 b i l l i o n and
i s s t i l l above $2^0 b i l l i o n * The s o l u t i o n o f our present problems does
not r e q u i r e us t o determine whether the debt should have r i s e n so h i g h ,
whether we should have spent so much, whether we should have taxed o u r selves more and borrowed l e s s , o r whether t h e p a t t e r n o f our borrowing
was w e l l conceived* Yfoat has been done i s i n the realm of f a c t and the
consequences must be d e a l t w i t h a c c o r d i n g l y * One o f the important f a c t s
i s t h a t the c r e a t i o n of our n a t i o n a l debt r e s u l t e d i n a tremendous expansion
of the money supply* While the Government borrowed vast sums from nonbank
l e n d e r s , other vast sums were s u p p l i e d by the commercial banking system.
And l e t me say r i g h t here t h a t t h i b n a t i o n owes a debt of g r a t i t u d e t o
commercial bankers g e n e r a l l y f o r t h e i r s e r v i c e i n the task of f i n a n c i n g
the war* The r a p i d expansion o f the money supply which r e s u l t e d from
t h e i r c o n t r i b u t i o n s must not be p e r m i t t e d t o r i s e and plague them as i f
they had cunningly c o n t r i v e d i t f o r t h e i r own s e l f i s h ends.
Nevertheless, as a net r e s u l t of war f i n a n c i n g , t h e r e were
increases i n the p u b l i c ' s h o l d i n g s of demand d e p o s i t s and currency from
l e s s than U0 b i l l i o n i n 19^0 t o 110 b i l l i o n at p r e s e n t ; o f time deposits
from l e s s than 30 b i l l i o n t o n e a r l y 60 b i l l i o n ; of United States Government s e c u r i t i e s , which are r e a d i l y c o n v e r t i b l e i n t o money, from a few
b i l l i o n t o over 90 b i l l i o n * The t o t a l supply o f these forms of money and
p o t e n t i a l money i s now more than t h r e e times the prewar t o t a l *
The p r o d u c t i v e c a p a c i t y of the n a t i o n was l a r g e l y devoted t o
war purposes f o r almost f i v e years* At the peak more than $0 per cent
of our r e c o r d p r o d u c t i o n was f o r war use* While 1U0 m i l l i o n people
were coming i n t o possession o f more money than any people had ever had t o
spend and save, t h e r e was a s c a r c i t y o f t h i n g s t o spend i t f o r * Conseq u e n t l y two great backlogs r a p i d l y accumulated-^a backlog o f u n f i l l e d
wants and a backlog of money savings* With removal of c o n t r o l s t h i s
pent-up spending power p l u s an unprecedented volume of c u r r e n t income
were t u r n e d loose i n a market c h a r a c t e r i z e d by s c a r c i t i e s and shortages.
Prices rose r a p i d l y . Pressure on wages q u i c k l y ensued and the s p i r a l
o f price-wage i n f l a t i o n was on i t s way* At present t o t a l p h y s i c a l p r o d u c t i o n o f a l l goods and services i s probably n o t over t w o - t h i r d s
g r e a t e r than a t the prewar maximum, w h i l e p r i c e s have r i s e n by about t h r e e fourth sf



- 4 *
P u b l i c Debt Holdings Provide Basis f o r Postwar C r e d i t Expansion
I n h e l p i n g t o f i n a n c e the Government's l a r g e war expenditures
and t o provide the money supply demanded by the expanding and abnormal
war economy, the commercial banks o f the country and a l s o the Federal
Reserve Banks g r e a t l y expanded t h e i r holdings o f Government s e c u r i t i e s •
Commercial bank h o l d i n g s o f Government s e c u r i t i e s o f a l l types increased
from about 16 b i l l i o n i n 1940 t o a peak o f 90 b i l l i o n a t the end o f 1945
and then were reduced d u r i n g 1946 t o 70 b i l l i o n , l a r g e l y by Treasuryuse o f i t s excess bank deposits t o r e t i r e d e b t . To meet the demands
o f r a p i d l y expanding p r i v a t e economy i n the postwar p e r i o d banks have
f u r t h e r reduced t h e i r holdings o f Government s e c u r i t i e s , b u t they s t i l l
h o l d 65 b i l l i o n d o l l a r s o f them* Other i n v e s t o r s have a l s o sold or
redeemed some o f the holdings o f Government s e c u r i t i e s i n order t o obt a i n funds f o r other uses*
Sales o f U* S . Government s e c u r i t i e s i n the market by banks
and others have not been absorbed by purchases on the p £ r t o f other
i n v e s t o r s * I n order t o keep the p r i c e s o f Government s e c u r i t i e s from
d e c l i n i n g , the Federal Reserve System has continued t o c ^ r r y out i t s
wartime r e s p o n s i b i l i t y o f s u p p o r t i n g the market by buying a t r e l a t i v e l y
s t a b l e p r i c e s s e c u r i t i e s o f f e r e d f o r s a l e and not purchased by o t h e r s *
The r e s u l t o f these purchases by the Federal Reserve Banks i s t o supply
a d d i t i o n a l reserve funds t o banks» Because o f the f r a c t i o n a l system o f
reserve requirements, these new reserves i n t u r n p r o v i d e the basis f o r
an increase i n bank c r e d i t t h a t may be many times the amount o f new
reserves obtained*
I n the postwar p e r i o d these reserves supplied the basis f o r an
increase i n bank c r e d i t i n response t o an a c t i v e demand f o r loans t o
finance the operations and expansion o f the business system i n an era o f
h i g h demand, a c c e l e r a t e d a c t i v i t y , r i s i n g c o s t s , and r i s i n g p r i c e s . There
i s ample evidence t h a t bank c r e d i t i s a l s o being used f o r purposes
o r d i n a r i l y served by the c a p i t a l market* As a r e s u l t , d e s p i t e a reduct i o n o f $25 b i l l i o n i n the volume o f Government s e c u r i t i e s h e l d by comm e r i c a l banks, d e p o s i t s and currency h e l d by the p u b l i c have increased
by $15 b i l l i o n since the end o f 1945* This has been l a r g e l y the r e s u l t
o f an increase o f $15 b i l l i o n i n bank l o a n s . The Board o f Governors
has kept the Congress and the p u b l i c informed concerning these r e s u l t s
o f supporting the market f o r Government s e c u r i t i e s * I t has r e p e a t e d l y
p o i n t e d out t h a t the e f f e c t has been t o increase s i g n i f i c a n t l y , and i t
may be dangerously, the money s u p p l y .
P o l i c i e s Adopted t o R e s t r a i n I n f l a t i o n a r y C r e d i t Expansion
The Federal Reserve System and the Treasury have adopted
p o l i c i e s designed t o o f f s e t the expansive e f f e c t on bank reserves o f
market purchases o f Government s e c u r i t i e s by the Federal Reserve System*
The f i r s t and q u a n t i t a t i v e l y more e f f e c t i v e o f these measures has been the
use o f the Treasury surplus t o r e t i r e maturing s e c u r i t i e s , p a r t i c u l a r l y
those held by the Federal Reserve Banks* The debt r e t i r e m e n t program was
made p o s s i b l e f i r s t by a l a r g e cash balance b u i l t up by the Treasury i n the
V i c t o r y Loan d r i v e i n 1945 and l a t e r by a s u b s t a n t i a l surplus o f cash r e c e i p t s
over expenditures* I n paying out a l a r g e p a r t o f the excess cash c o l l e c t e d
from the p u b l i c t o the Federal Reserve f o r r e t i r e m e n t o f d e b t , t h a t amount
o f money was e l i m i n a t e d from the money supply and a l s o from bank reserves*



As a second measure of r e s t r a i n t , about a year ago the Federal
Reserve and the Treasury embarked upon a program of p e r m i t t i n g y i e l d
r a t e s on s h o r t - t e r m Government s e c u r i t i e s t o r i s e from the very low
l e v e l s a t which t h e y had been pegged d u r i n g the war* The purpose of t h i s
a c t i o n was t o encourage banks and o t h e r s t o i n v e s t a v a i l a b l e funds i n s h o r t term s e c u r i t i e s *
This enabled the Federal Reserve t o reduce i t s holdings
of s h o r t - t e r m s e c u r i t i e s and thus o f f s e t the e f f e c t on reserves of i t s
purchases o f longer term bonds* The r a t e on 90-day Treasury b i l l s rose
from 3/8 of one per cent t o about 1 per c e n t , and t h a t on one-year
Treasury c e r t i f i c a t e s from 7/8 t o 1 - 1 / 8 per c e n t * Late i n 19lt7, market
y i e l d s on Government bonds also r o s e , i . e . , p r i c e s of bonds d e c l i n e d i n the
market• This adjustment was i n l a r g e p a r t inaugurated by sales by f i n a n c i a l
i n s t i t u t i o n s t o o b t a i n funds t o i n v e s t i n corporate s e c u r i t i e s and mortgages, but i t was accelerated by sales made i n f e a r o f f u r t h e r d e c l i n e s i n
p r i c e s of bonds, which had been s e l l i n g a t s u b s t a n t i a l premiums* I n order
t o check t h i s d e c l i n e , the System adopted a p o l i c y of f r e e l y purchasing
bonds a t an e s t a b l i s h e d s e r i e s o f p r i c e s , which maintained y i e l d s i n
accordance w i t h a p a t t e r n r a n g i n g from 1 - 1 / 8 per cent f o r one-year issues
t o 2 - 1 / 2 per cent f o r t h e l o n g e s t - t e r m bonds•
I t may be of i n t e r e s t t o review c r e d i t developments and the
e f f e c t s o f these p o l i c i e s d u r i n g the past twelve months* I n t h e year
ending June 30, 19U8, as shown on the c h a r t s , commercial banks showed a small
increase i n t h e i r d e p o s i t s and t h e i r t o t a l loans and investments, although
t h e r e were some wide f l u c t u a t i o n s d u r i n g the period? I n the twelve
months, commercial banks increased t h e i r t o t a l loans and t h e i r h o l d i n g s
of corporate and State and l o c a l Government s e c u r i t i e s by a t o t a l of 7
b i l l i o n d o l l a r s * Most o f t h i s growth occurred i n the l a t t e r h a l f of
19k7 and was accompanied by an expansion i n bank deposits and reserves*
I n the e a r l y months of 191*8, however, d e p o s i t s were withdrawn t o make
seasonal heavy t a x payments, which were not o f f s e t by Treasury expenditures* Banks met the d r a i n by reducing t h e i r h o l d i n g s o f Treasury bonds.
Some maturing bonds were exchanged f o r c e r t i f i c a t e s or notes and a p a r t
of these issues were sold* At the same time banks i n general purchased
added amounts o f Treasury b i l l s , an i n d i c a t i o n of the e f f e c t of the
higher s h o r t - t e r m r a t e s i n a t t r a c t i n g a v a i l a b l e funds•
Banks also continued t o increase t h e i r loans i n the f i r s t h a l f
o f 19^8, by about 1*7 b i l l i o n , although at a somewhat slower r a t e o f
growth than i n 19U7» Most of the d o l l a r increase i n bank loans d u r i n g 19^7,
p a r t i c u l a r l y i n the l a s t h a l f , was i n commercial and i n d u s t r i a l l o a n s , but
the increases i n consumer loans and r e a l e s t a t e loans showed l a r g e r p e r c e n t ages i n 19h7 and have continued t o expand i n 19)48*
Savings i n s t i t u t i o n s , p a r t i c u l a r l y insurance companies, also
considerably expanded t h e i r h o l d i n g s o f mortgages and investments other
than United States Government s e c u r i t i e s d u r i n g the past year*
In
the aggregate, these assets of s e l e c t e d groups of f i n a n c i a l i n s t i t u t i o n s increased by 8*6 b i l l i o n d o l l a r s i n the p e r i o d , of which 6*1;
b i l l i o n was met by r e c e i p t s o f new savings from the p u b l i c and 2.2 b i l l i o n




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6

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a r e d u c t i o n i n t h e i r holdings of Government s e c u r i t i e s . Nonbanlc i n v e s t o r s , as a group, s o l d and redeemed bonds, but purchased c e r t i f i c a t e s
and b i l l s , r e f l e c t i n g increased p o p u l a r i t y of these issues w i t h the r i s e
i n r a t e s . Another c h a r t shows how l i f e insurance companies s u b s t a n t i a l l y
increased t h e i r holdings of Government s e c u r i t i e s during the war and then
i n the postwar p e r i o d reduced these holdings w h i l e i n c r e a s i n g t h e i r mortgages and other investments.
Sales of Treasury bonds by nonbank i n v e s t o r s and by banks i n
the past year have been l a r g e l y purchased by the Federal Reserve System.
The System purchased 5*7 b i l l i o n d o l l a r s of Treasury bonds i n the market
and a l s o purchased i n the market a net amount of about 2 . 6 b i l l i o n
d o l l a r s of notes and c e r t i f i c a t e s , but s o l d on balance n e a r l y U b i l l i o n
d o l l a r s of b i l l s t o banks and other i n v e s t o r s .
I n the same p e r i o d the
Treasury redeemed f o r cash about 5 b i l l i o n d o l l a r s of maturing issues
of v a r i o u s kinds h e l d by the Federal Reserve Banks. W i t h r a l l o f these
wide s h i f t s i n holdings o f d i f f e r e n t types o f s e c u r i t i e s , t h e r e was only
a small net d e c l i n e i n the System's aggregate holdings of government
s e c u r i t i e s , although the t o t a l f l u c t u a t e d considerably from time t o
time.
The purpose of t h i s d e t a i l e d survey of f i g u r e s i s t o i l l u s t r a t e how s h i f t s i n holdings of the p u b l i c debt are being used t o
finance i n f l a t i o n a r y spending, and how Federal Reserve and Treasury
p o l i c i e s endeavor t o o f f s e t these tendencies. Treasury use of surplus
funds t o r e t i r e s e c u r i t i e s h e l d by the Federal Reserve drains reserves
from banks and makes i t necessary f o r them t o s e l l s e c u r i t i e s i f they
wish to m a i n t a i n t h e i r loans, and even more so £f they want t o expand
credit.
The h i g h e r r a t e on Treasury b i l l s encourages banks and other
holders of l i q u i d funds t o buy b i l l s r a t h e r than i n v e s t i n other a s s e t s .
Since most of the b i l l s have been h e l d by the Federal Reserve, a reduct i o n i n System holdings i s made p o s s i b l e and bank reserves are thereby
absorbed. Nevertheless, sales of bonds t o t h e Federal Reserve, p r i m a r i l y
by nonbank i n v e s t o r s , have been so l a r g e t h a t the r e s t r i c t i v e e f f e c t of
the other p o l i c i e s has been f u l l y o f f s e t .
I t should be mentioned t h a t bank reserves have a l s o been supp l i e d i n the past year by an i n f l o w o f g o l d amounting t o 2 . 2 b i l l i o n
d o l l a r s and also by a decline of about h a l f a b i l l i o n i n currency i n
c i r c u l a t i o n . A temporary increase of 1.3 b i l l i o n i n Treasury deposits
a t the Federal Reserve o f f s e t i n p a r t these f a c t o r s .
The t o t a l growth
i n reserves was l . U b i l l i o n , s u f f i c i e n t t o cover increases of about a
b i l l i o n d o l l a r s i n reserve requirements a t c e n t r a l reserve c i t y banks
i n New York and Chicago, as "well as increased requirements r e s u l t i n g
from deposit growth.




- 7 *

Prospective Demands f o r C r e d i t
Economic prospects i n d i c a t e a c o n t i n u a t i o n of strong i n f l a t i o n ary pressures d u r i n g the next s e v e r a l months and perhaps f o r a much longer
p e r i o d . I n d i v i d u a l incomes have continued a t a h i g h l e v e l , w i t h a tendency
t o increase as p r i c e s and wages have r i s e n and employment has grown w i t h
the labor f o r c e . Consumer spending, based on c u r r e n t incomes, the use of
p a s t savings, and borrowing, a l s o has continued t o expand. C o n s t r u c t i o n
volumes seem l i k e l y t o remain f o r a w h i l e a t c a p a c i t y l e v e l s , w i t h poss i b l e f u r t h e r r i s e s i n p r i c e s . Business expenditures are a l s o expected
t o continue i n l a r g e volume. Government expenditures are i n c r e a s i n g ,
w h i l e the recent income t a x r e d u c t i o n w i l l lower r e c e i p t s .
C o n t i n u a t i o n o f these tendencies w i l l c a l l f o r t h f u r t h e r c r e d i t
expansion. Borrowing by consumers and homeowners w i l l n£ doubt continue
t o expand and thereby add t o consumer spending and t o demands f o r housing,
which are already excessive. Prospective l a r g e o u t l a y s by business f o r
expansion o f i n v e n t o r i e s end plants w i l l probably exceed i n t e r n a l funds
a v a i l a b l e and a l s o amounts obtained by f l o t a t i o n o f new s e c u r i t i e s .
O v e r - a l l demands f o r funds may continue i n excess o f the c u r r e n t volume
o f savings r e a d i l y a v a i l a b l e f o r l e n d i n g f o r such purposes. To help
meet the demands f o r c r e d i t and c a p i t a l , c o r p o r a t i o n s , i n d i v i d u a l s , and
f i n a n c i a l i n s t i t u t i o n s w i l l s e l l some o f t h e i r holdings o f Government
s e c u r i t i e s and a l s o increase t h e i r borrowings from banks.
I f these tendencies continue, sales o f Government s e c u r i t i e s
by nonbank i n v e s t o r s may exceed 1.5 b i l l i o n i n the l a s t h a l f of 19^8
and perhaps be much g r e a t e r e a r l y i n 19^9. These sales w i l l keep the
Government bond market under pressure and r e q u i r e support purchases by
t h e Federal Reserve, i f t h e p o l i c y of m a i n t a i n i n g the 2 - 1 ' 2 per cent
y i e l d l e v e l on l o n g - t e r m Treasury bonds i s continued. Thus a d d i t i o n a l
reserve funds would be made a v a i l a b l e t o banks which, unless otherwise
o f f s e t , could s u s t a i n a f u r t h e r v e r y l a r g e i n f l a t i o n a r y expansion o f
bank c r e d i t . A d d i t i o n a l reserves s u p p l i e d through the g o l d i n f l o w may
be approximately o f f s e t by the d r a i n r e s u l t i n g from seasonal currency
demands.
To a v o i d an abundance o f reserves, an easy s h o r t - t e r m money
market, and continued i n f l a t i o n a r y c r e d i t expansion, p o s i t i v e measures
t o absorb reserves w i l l be needed. I n view o f t h e pressure o f c u r r e n t
demands, the continued shortages o f many goods, the l i m i t e d c a p a c i t y
f o r increased o u t p u t , and the a v a i l a b l e accumulations o f l i q u i d assets,
f u r t h e r c r e d i t expansion w i l l add t o the pressure f o r r i s i n g p r i c e s .
Continued c r e d i t expansion w i l l s t o r e up t r o u b l e f o r t h e f u t u r e and make
t h e i n e v i t a b l e adjustment more dangerous f o r the s t a b i l i t y o f the economy.
This course o f economic and monetary developments has been
t h e source o f i n c r e a s i n g concern t o the Federal Reserve a u t h o r i t i e s .
We are convinced t h a t , so l o n g as the present s i t u a t i o n l a s t s , 1 i t i s
important t o r e s t r i c t f u r t h e r c r e d i t expansion and t o promote a psychology
o f r e s t r a i n t on t h e p a r t o f b o t h borrowers and l e n d e r s . To keep the




-

8

*

reserve p o s i t i o n o f "banks under pressure and discourage f u r t h e r
i n f l a t i o n a r y c r e d i t expansion w i l l r e q u i r e c a r e f u l l y coordinated o p e r a t i n g
measures on the p a r t o f b o t h the Treasury and the Federal Reserve
System.
Of t h e two sets o f measures used t o r e s t r a i n the growth o f
bank reserves d u r i n g the past year - - namely ( l ) use o f the Treasury cash
surplus t o r e t i r e F e d e r a l Reserve-held s e c u r i t i e s and (2) r e d u c t i o n i n
Federal Reserve h o l d i n g s o f Treasury b i l l s through a r i s e i n s h o r t - t e r m
r a t e s - - the f i r s t has been g r e a t l y reduced i n i t s potency. Whereas the
Treasury showed an excess o f cash income over cash outgo o f 9 b i l l i o n
d o l l a r s i n the f i s c a l year 19^7-48, the prospects f o r the c u r r e n t year
on the b a s i s o f v e r y t e n t a t i v e and u n o f f i c i a l estimates are f o r a cash
surplus o f o n l y about 3 b i l l i o n . T h i s d i f f e r e n c e reduces considerably
t h e most important a n t i - i n f l a t i o n a r y i n f l u e n c e i n the s i t u a t i o n d u r i n g
t h e past y e a r .
•

The Treasury cash surplus was a p a r t i c u l a r l y e f f e c t i v e device
because i t exercised a d r a i n on bank reserves. As a r e s u l t the banks
l o s i n g reserves had t o s e l l s e c u r i t i e s i n order t o m a i n t a i n t h e i r reserve
p o s i t i o n s . While under these pressures they are less l i k e l y t o be seeking
new loans and i n some cases l e s s w i l l i n g t o meet loan a p p l i c a t i o n s .




- 9 *
This b r i n g s us t o the v a r i o u s ways i n which* r e s t r a i n t may be exe r c i s e d over c r e d i t expansion.
The f i r s t means i s v o l u n t a r y s e l f r e s t r a i n t on the p a r t of b o r rowers and l e n d e r s . I am convinced t h a t the v o l u n t a r y program o r i g i n a t e d
ajid a c t i v e l y developed by the American Bankers A s s o c i a t i o n has had a s i g n i f i c a n t e f f e c t i n developing a more cautious and c r i t i c a l a t t i t u d e on the
p a r t o f bankers toward s o - c a l l e d unproductive or s p e c u l a t i v e l o a n s .
If
i n f l a t i o n a r y pressures were m i l d , v o l u n t a r y r e s t r a i n t might be adequate
t o h o l d them i n check. Continued and i n t e n s i f i e d v o l u n t a r y r e s t r a i n t w i l l
make our j o i n t t a s k e a s i e r .
There are a number o f reasons, however, why v o l u n t a r y r e s t r a i n t
cannot be expected t o do the whole j o b alone when i n f l a t i o n a r y pressures
are as s t r o n g as they are a t the present t i m e . Perhaps the most i m p o r t ant reason i s t h a t a l o a n which may appear p r o d u c t i v e wlxen viewed by i t s e l f
may n o t add t o the t o t a l output o f the economy as a whole. For example,
a customer may increase h i s p r o d u c t i o n by borrowing funds^ t o purchase
needed p a r t s t h a t are i n s h o r t supply. Such a l o a n would* appear t o be
p r o d u c t i v e from the i n d i v i d u a l p o i n t o f view o f both the borrower and the
l e n d e r . But w i l l the l o a n increase the supply o f the p a r t s or t o t a l
output? I f a l l resources are being used t o c a p a c i t y , the loan may merely
enable the borrower t o secure p a r t s t h a t otherwise would have been bought
by another f i r m . From the p o i n t o f view o f the economy as a whole, the
loan has increased the demand f o r goods b u t i t may n o t have increased
t o t a l supply a t a l l . B a s i c a l l y , t h a t i s why I b e l i e v e t h a t s e l f r e s t r a i n t ,
though i m p o r t a n t , i s inadequate t o check a s t r o n g i n f l a t i o n a r y development.
Another reason i s the f o r c e o f c o m p e t i t i o n n o t only among
banks but among a l l l e n d e r s . We have i n the U n i t e d States n o t only
14,000 commercial banks b u t a l s o many thousands o f o t h e r l e n d i n g agencies.
Because o f concern f o r the general i n t e r e s t a bank may r e f u s e t o l e n d
even t o a good customer. This does n o t mean t h a t the customer w i l l n o t
secure the funds. I t may merely r e s u l t i n a permanent l o s s o f the
customer t o the bank. And u n f o r t u n a t e l y the new l e n d e r may secure the
funds from sale o f Government s e c u r i t i e s , w i t h the r e s u l t t h a t the loan
may be j u s t as i n f l a t i o n a r y as i f the bank had mjade i t i n the f i r s t
instance.
I want t o emphasize t h a t I support s t r o n g l y the s e l f - r e s t r a i n t
program developed by the American Bankers A s s o c i a t i o n and would l i k e t o
see i t pursued a g g r e s s i v e l y , n o t only by banks but by a l l l e n d e r s . I t i s
an important step i n the r i g h t d i r e c t i o n . P r i m a r i l y f o r the reasons
I have mentioned, however, I do n o t t h i n k i t can do the j o b alone.
Another approach t o the problem i s through c o n t r o l over member
bank r e s e r v e s . Bank c r e d i t cannot expand unless banks acquire or have
reserves on which t j expand. One way i n which the System has supplied
reserves has been through purchases o f l o n g - t e r m Government s e c u r i t i e s .
A means o f r e s t r a i n t would be f o r the System t o l i m i t i t s purchases o f
such s e c u r i t i e s e i t h e r by r e f u s a l t o buy or by reducing i t s p r i c e s s u f -




- 10 *
f i c i e n t l y t o a t t r a c t o t h e r p u r c h a s e r s . As you know, t h e System has made
a p u b l i c commitment t o support t h e 2 - 1 / 2 per cent y i e l d l e v e l on l o n g - t e r m
Government b i n d s f o r the f o r e s e e a b l e f u t u r e . I gave my reasons f o r
s u b s c r i b i n g t o t h a t commitment when my c o n f i r m a t i o n was under c o n s i d e r a t i o n by t h e Senate Committee on Banking and Currency. Although t h a t
commitment s u b s t a n t i a l l y l i m i t s our freedom o f a c t i o n , I b e l i e v e t h e r e
i s a b e t t e r way t o operate a g a i n s t c r e d i t expansion t h a n now t o abandon
t h a t commitment.
Our b a s i c problem i s t o absorb r e s e r v e s . Increases i n reserves
may be a n t i c i p a t e d from thr.*e p r i n c i p a l sourcess (1) i m p o r t s o f g o l d ,
(2) r e t u r n o f c u r r e n c y f r o m c i r c u l a t i o n , and (3) purchases o f Government
s e c u r i t i e s by t h e F e d e r a l Reserve Banks t o support t h e l o n g - t e r m y i e l d
l e v e l . The p r i n c i p a l problem b e f o r e t h e Systexa i s t o absorb or o f f s e t
reserves a r i s i n g f r o m these sources. The o n l y way i t c o u l d do t h i s
e f f e c t i v e l y under p r e s e n t a u t h o r i t y i s t o l i q u i d a t e p a r t oT i t s h o l d i n g s
o f Government s e c u r i t i e s .
I t would be n e c e s s a r y , o f c o u r s e , t o s e l l them
a t p r i c e s t h e - m a r k e t would pay. The System has a l a r g e p o r t f o l i o o f b i l l s ,
c e r t i f i c a t e s , and o t h e r s h o r t m a t u r i t i e s t h a t i t c o u l d u s e . I f t h e
i n f l a t i o n a r y demand f o r bank c r e d i t i s s t r o n g , use o f these h o l d i n g s t o
absorb r e s e r v e s would r e s u l t i n a f u r t h e r s t i f f e n i n g o f s h o r t - t e r m i n t e r e s t
rates.
The Open Market Committee o f t h e F e d e r a l Reserve System f e e l
t h a t a r i s e i n s h o r t - t e r m r a t e s i s a necessary and d e s i r a b l e s t e p . An
increase i n t h e s h o r t r a t e w - u l d t e n d t o a t t r a c t funds f r o m o t h e r uses
t o investment i n s h o r t - t e r m Government s e c u r i t i e s . The p o l i c y o f a l l o w i n g
s h o r t - t e r m r a t e s t o r i s e was begun about a y e a r ago and has had some success.
A t t h i s p o i n t the n e c e s s i t y f o r teamwork between the Treasury
and the F e d e r a l Reserve becomes a p p a r e n t . I am k e e n l y s e n s i t i v e t o the
n e c e s s i t i e s o f t h e Treasury i n i t s t a s k o f managing t h e p u b l i c d e b t .
I
t h o r o u g h l y understand t h e T r e a s u r y 1 s r e s p o n s i b i l i t y t o keep the i n t e r e s t
c o s t o f the debt as low as p o s s i b l e c o n s i s t e n t w i t h a l l r e l e v a n t f a c t o r s .
I know t h a t t h e Treasury Department i s e q u a l l y s e n s i t i v e t o the respons i b i l i t i e s o f the F e d e r a l Reserve i n t h e f i e l d o f monetary and c r e d i t
p o l i c y . The problems o f mutual concern t o the Treasury and t h e Reserve
System i n t h e i r r e s p e c t i v e f i e l d are b e i n g approached i n a c o n t i n u e d
s p i r i t of cooperation.
The r e d i s c o u n t r a t e i s '.mother i n s t r u m e n t o f p o l i c y i n t h e
s h o r t - t e r m market. A l t h o u g h i t s e f f e c t i v e n e s s i s d i m i n i s h e d i n times l i k e
these when t h e volume o f member bank borrowings i s s m a l l , i t should n o t be
w r i t t e n o f f . I f , f o r example, t h e y i e l d on s h o r t - t e r m Governments r i s e s ,
i t migjht become a p p r o p r i a t e under these circumstances t o i n c r e a s e t h e d i s count r a t e . T h i s a c t i o n would discourage t h e market from r e - a c q u i r i n g
through the d i s c o u n t window the funds t h a t had been withdrawn through the
d i s p o s a l by t h e Reserve System o f s h o r t - t e r m Governments. An i n c r e a s e i n
t h e d i s c o u n t r a t e has g r e a t p s y c h o l o g i c a l e f f e c t . Each i n c r e a s e r e p e a t s




- l i -

the warning t h a t c r e d i t i s i n need o f continued r e s t r a i n t . Changes i n
the r a t e and open market operations supplement each other as necessary
p a r t s o f an o v e r - a l l c r e d i t p o l i c y .
These two r e l a t e d instruments i n f l u e n c e the volume o f reserves
o f member banks. The t h i r d general instrument—reserve requirements—
i s designed t o i n f l u e n c e the amount o f bank c r e d i t t h a t can be based on
a given volume of r e s e r v e s . An increase i n requirements immobilizes
reserves and makes them u n a v a i l a b l e f o r f u r t h e r l e n d i n g and .investing.
As you know, the Board o f Governors has presented v a r i o u s ways o f d e a l i n g
w i t h the problem o f reserves or i m m o b i l i z i n g c e r t a i n bank a s s e t s .
The method proposed i n the b i l l before you i s simple and d i r e c t ,
and i n v o l v e s no departures from e x i s t i n g p r i n c i p l e s . The b i l l would
increase by 10 and U percentage p o i n t s the reserves t h a t member banks
may be r e q u i r e d t o m a i n t a i n a g a i n s t t h e i r demand and tim£ d e p o s i t s ,
r e s p e c t i v e l y . The a u t h o r i z a t i o n would be granted f o r a p e r i o d o f two
y e a r s . We f e e l deeply t h a t i t i s not f a i r t o member banks' i n t h e i r
c o m p e t i t i v e r e l a t i o n s w i t h non-member banks t o r e q u i r e t h a t they be
s i n g l e d out t o c a r r y the a d d i t i o n a l reserves t h a t may be necessary
t o combat t h i s i n f l a t i o n a r y s i t u a t i o n . The Congress might w e l l find*
i t d e s i r a b l e d u r i n g t h i s i n t e r v a l t o reconsider the whole s t r u c t u r e o f
reserve requirements, p o s s i b l y along the l i n e s developed r e c e n t l y before
the J o i n t Committee on the Economic Report.
I should l i k e t o i n d i c a t e b r i e f l y what can and cannot be
accomplished through increasd reserve requirements. Changes i n r e q u i r e ments cannot, o f course, be considered i n i s o l a t i o n . They must be r e l a t e d
t o other instruments o f p o l i c y . I n p r a c t i c e they are c l o s e l y r e l a t e d t o open
market o p e r a t i o n s . One method t h a t banks use t o a d j u s t t h e i r p o s i t i o n s t o
the pressure exerted by an increase i n requirements i s t o s e l l Government
s e c u r i t i e s . To the e x t e n t t h a t these are purchased by the Federal Reserve,
new reserves are created which meet the h i g h e r requirements. This i s n o t
the whole s t o r y , nor does i t happen i n v a r i a b l y , b u t i t does i l l u s t r a t e the
complexity of our problem. An increase i n requirements, o f course, reduces
the m u l t i p l e c r e d i t expansion r a t i o as w e l l as t h e l i q u i d i t y o f banks.
Even when the Federal Reserve creates new r e s e r v e s , i t has a g r e a t e r
volume o f s e c u r i t i e s a v a i l a b l e f o r s a l e . The e x t e n t t o which i t could
use them, however, i n v o l v e s s i m i l a r c o n s i d e r a t i o n s t o those a r i s i n g i n
connection w i t h d i s p o s a l s from the present p o r t f o l i o , namely, the p r i c e
a t which they c o u l d be l i q u i d a t e d .
I n other words, the purpose o f i n c r e a s i n g a u t h o r i t y over
reserve requirements i s n o t t o o b v i a t e the p o s s i b l e need f o r i n c r e a s i n g
s h o r t - t e r m r a t e s . That problem would s t i l l be w i t h u s .
The basic purpose of i n c r e a s i n g the a u t h o r i t y over reserve r e q u i r e ments would be t o enable the System t o acquire m o r e — i f necessary many more—
l o n g - t e r m Government s e c u r i t i e s t o m a i n t a i n the l o n g - t e r m y i e l d l e v e l . New r e serves created by such System purchases—or i n other ways—could be absorbed
through increases i n reserve requirements and thus be made u n a v i l a b l e f o r mult i p l e c r e d i t expansion.