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STATEMENT OF THOMAS B. MCCABE CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BEFORE THE SUBCOMMITTEE ON MONETARY, CREDIT, AND FISCAL POLICIES OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT DECEMBER 3, 19h9 Now t h a t the hearings before t h i s subcommittee o f the J o i n t Committee on the Economic Report are coming t o a close* I w i s h t o commend most e n t h u s i a s t i c a l l y the o b j e c t i v e manner i n which you have addressed yourselves t o your i m p o r t a n t t a s k . I am sure t h a t the witnesses who have appeared b e f o r e you a l l a p p r e c i a t e , as I do, the earnestness, i m p a r t i a l i t y and d i l i g e n c e which you and your s t a f f have shown i n your search f o r l i g h t on some o f the most complex problems o f our t i m e s . You have been concerned, n o t w i t h any s p e c i f i c l e g i s l a t i v e p r o p o s a l , b u t r a t h e r w i t h the more fundamental questions o f the p r i n c i p l e s which should guide f u t u r e l e g i s l a t i o n * The r e p o r t o f t h i s committee, composed as i t is o f members o f b o t h Houses who are w e l l versed i n money and banking, can not f a i l t o have g r e a t i n f l u e n c e upon t h e d i r e c t i o n o f monetary, c r e d i t and f i s c a l p o l i c i e s i n the f u t u r e . The searching n a t u r e o f the q u e s t i o n n a i r e sent out t o q u a l i f i e d and i n t e r e s t e d i n d i v i d u a l s , and the way i n which you have brought o u t d i s i n t e r e s t e d p r o f e s s i o n a l o p i n i o n have c o n t r i b u t e d t o the sustained h i g h l e v e l o f d i s c u s s i o n t h a t has p r e v a i l e d d u r i n g the p a s t t h r e e weeks o f these hearings. The p r i n t e d r e c o r d w i t h the testimony o f men o f broad experience from business, f i n a n c e , and p u b l i c l i f e , t o g e t h e r w i t h the answers t o the q u e s t i o n n a i r e , c o n s t i t u t e a most i m p o r t a n t and c o n s t r u c t i v e volume — one t h a t w i l l be a "must" i n every l i b r a r y d e a l i n g w i t h problems o f money i n the w o r l d today. You are p r o b i n g i n t o a v e r y d e l i c a t e and v e r y c r u c i a l problem. I t i s no exaggeration t o say t h a t n o t h i n g more v i t a l l y a f f e c t s the w e l f a r e and d e s t i n y o f t h i s n a t i o n than the i n t e g r i t y o f i t s money and c r e d i t . The American d o l l a r commands the h i g h e s t confidence throughout the w o r l d . To m a i n t a i n t h a t confidence demands no l e s s v i g i l a n c e than l i b e r t y itself. The problems you have been e x p l o r i n g are a t t h e base o f t h a t i n t e g r i t y and confidence. A f r e e e n t e r p r i s e econoxiry can n o t e x i s t w i t h o u t appi-opriate c e n t r a l banking i n s t i t u t i o n s t o i n f l u e n c e the a v a i l a b i l i t y and cost o f credit. U n f o r t u n a t e l y t h i s p o i n t i s n o t g e n e r a l l y undei^stood and l a c k o f background i s n o t c o n f i n e d t o t h e general p u b l i c . The a t t i t u d e o f many business and f i n a n c i a l l e a d e r s , and o f some o f our banking leaders and s u p e r v i s o r y o f f i c i a l s , whose d e v o t i o n t o the p u b l i c w e l f a r e can n o t be doubted, i s e x p l a i n a b l e on no other grounds. Much o f the d i v e r s i t y i n the testimony b e f o r e you r e f l e c t s n o t so much basic disagreement as i t does d i f f e r e n c e s i n a p p r e c i a t i o n o f the importance o f the problem. I s h a l l address i r y s e l f d i r e c t l y t o the r o l e t o be expected o f c e n t r a l banking procedures i n the f u n c t i o n i n g o f the American economy. C e n t r a l banking i n s t i t u t i o n s have always been considered the necessary and e s s e n t i a l complement o f a f r e e e n t e r p r i s e economy. manage i t s e l f . Money does n o t Once commercial banking i n s t i t u t i o n s h o l d i n g demand deposits become i m p o r t a n t , c e n t r a l banking i n s t i t u t i o n s must be organized t o a v e r t money panics and t o m i t i g a t e booms and depressions. Although they have n e c e s s a r i l y been given wide d i s c r e t i o n a r y powers* they should i n no sense be regarded as an i n v e n t i o n o f or an a d j u n c t t o a "managed economy" or an "administered s t a t e " . I n s t e a d they are p a r t and p a r c e l o f a f r e e e n t e r p r i s e econony, designed t o m a i n t a i n f u l l and continuous use o f i t s human and - 3 m a t e r i a l resources. * I n modern terms t h i s means t h a t they are expected t o help m a i n t a i n a h i g h and s t a b l e l e v e l o f employment i n a f r e e e n t e r p r i s e economy* They endeavor tp' do t h i s by the prompt and f l e x i b l e use o f adequate d i s c r e t i o n a r y a u t h o r i t y over the cost and a v a i l a b i l i t y o f money and c r e d i t . As i n the case o f the Courts, they must be operated p u r e l y i n the i n t e r e s t s o f t h e p u b l i c b u t a t the same time they should be immune from p o l i t i c a l b i a s and c o n t r o l . That i s the t r a d i t i o n a l , ^ the c o n s e r v a t i v e , the c l a s s i c p o s i t i o n . I t i s the issue t h a t was d e a l t w i t h by C a r t e r Glass, among o t h e r s , when the Federal Reserve System was e s t a b l i s h e d * much o f the c r i t i c i s m o f our a c t i o n s . Misunderstanding about i t underlies I can n o t emphasize too s t r o n g l y the d i f f i c u l t i e s we are p l a c e d under when many o f the most v o c i f e r o u s supporters o f f r e e e n t e r p r i s e , businessmen and bankers, and t h e i r organizat i o n s c r i t i c i z e the possession and use by the F e d e r a l Reserve System o f necessary a u t h o r i t y over the c o s t and a v a i l a b i l i t y o f c r e d i t as i f the d e l e g a t i o n o f t h i s a u t h o r i t y t o the System were c h a r a c t e r i s t i c o f a "managed economy" or an " a d m i n i s t e r e d s t a t e " • I t i s e x a c t l y the o p p o s i t e . Otherwise I would n o t have been considered f o r my present p o s t . Nor would I have been disposed t o h o l d i t . Our main problems today have a r i s e n as an i n e v i t a b l e r e s u l t o f the huge volume o f war f i n a n c i n g . They r a i s e anew the question, "How should c e n t r a l bank procedures be r e l a t e d t o the f i s c a l f u n c t i o n o f the state?" The t r a d i t i o n a l p o s i t i o n was developed i n a w o r l d where p u b l i c expenditures c o n s t i t u t e d a low percentage o f the n a t i o n a l income, where budgets were expected t o be balanced a n n u a l l y , where the p u b l i c debt, - U - though i t m i g h t have seemed l a r g e a t the t i m e , was v e r y l o w i n comparison r a t h a n y t h i n g we f a c e t o d a y , and where, i n c i d e n t a l l y , o f c r e d i t by consumers had y e t t o t a k e r o o t * t h e widespread use I t is clear that this v e r y f a r f r o m t h e s i t u a t i o n w h i c h c o n f r o n t s us t o d a y . In this p u b l i c e x p e n d i t u r e s , i n c l u d i n g F e d e r a l , S t a t e , and l o c a l , is country a r e o f a magnitude t h a t approaches o n e - f o u r t h o f t h e gross n a t i o n a l p r o d u c t * Since t h e war, our F e d e r a l p u b l i c d e b t has been c o n s i d e r a b l y i n excess o f our e n t i r e annual n a t i o n a l income, even though t h e n a t i o n a l income i s a t r r e c o r d peacetime levels. P u b l i c d e b t now f a r exceeds t h e t o t a l o f a l l p r i v a t e d e b t . The v a r i e t y o f new c o n s i d e r a t i o n s t h a t have t o be t a k e n i n t o account i n t h e modern f o r m u l a t i o n o f f i s c a l p o l i c y i s i n d i c a t e d i n t h e r e p o r t o f t h e economists a t t h e i r c o n f e r e n c e on f i s c a l p o l i c i e s h e l d a t P r i n c e t o n . r e p o r t i s included i n the record of your Their committee. I t i s c l e a r t h a t we can no l o n g e r e x p e c t t h e w i s e e x e r c i s e o f t r a d i t i o n a l c e n t r a l b a n k i n g powers, unsupplemented by o t h e r p u b l i c policies, t o m a i n t a i n h i g h l e v e l s t a b i l i t y i n a f r e e e n t e r p r i s e economy t o t h e same e x t e n t as was t h o u g h t p o s s i b l e a g e n e r a t i o n ago. The i m p a c t o f o t h e r p u b l i c p o l i c i e s on t h e whole economy has grown t o o l a r g e i n t h e i n t e r v a l . Does t h i s mean t h a t an " a d m i n i s t e r e d economy" i s i n e s c a p a b l e and t h a t we must f r a n k l y accept t h e h a b i t u a l r e s o r t t o w i d e s p r e a d c o n t r o l s i n t h e f o r m o f price-fixing, stability? allocations, rationing, These a r e i n c o m p a t i b l e w i t h a l l o f o u r c o n c e p t i o n s o f a f r e e e n t e r p r i s e economy i n p e a c e t i m e . no. e t c . , i n order to maintain high l e v e l To t h i s q u e s t i o n t h e answer i s 7fe can and we must r e t a i n t h e dynamic s t i m u l u s o f f r e e institutions. unequivocally enterprise The course o f postwar e x p e r i e n c e , b o t h here and abroad, has demonstrated anew t h a t t h e s e i n s t i t u t i o n s need t o be p r o t e c t e d t h r o u g h t h e - 5 - e x e r c i s e o f c e n t r a l banking f u n c t i o n s a f f e c t i n g the c o s t and a v a i l a b i l i t y of credit. These are s t i l l powerful instruments i n the promotion o f h i g h l e v e l economic s t a b i l i t y . They must operate, however, i n close c o n j u n c t i o n w i t h a p p r o p r i a t e f i s c a l , debt management, and o t h e r governmental p o l i c i e s . The Committee f o r Economic Development has submitted t o you a most t h o u g h t f u l document addressed d i r e c t l y t o t h i s problem. I t deserves c a r e f u l consideration. VJhen I j o i n e d the Board o f Governors i n the s p f i n g o f 191$, the economy was s t i l l undergoing the t r i a l s o f the postwar i n f l a t i o n . Money and l i q u i d assets r e s u l t i n g from war f i n a n c i n g were i n o v e r - s u p p l y r e l a t i v e t o a v a i l a b l e goods and s e r v i c e s . This v a s t l y expanded money supply \?as supplemented by an i n c r e a s i n g volume o f commercial c r e d i t and consumer credit. T o t a l loans a t a l l commercial banks i n c r e a s e d by more than $16,000,000,000 between the end o f I9h$ and the end o f 19U8. There was f u l l employment, p o s s i b l y over f u l l employment, s c a r c i t i e s p r e v a i l e d i n the markets, our people were becoming r e s t i v e under the impact o f continuous increases i n the c o s t o f l i v i n g , and the o p e r a t i o n o f the wage-price s p i r a l t h a t i s c h a r a c t e r i s t i c o f mounting i n f l a t i o n was everywhere i n evidence. I n f l a t i o n i s a form o f i n t o x i c a t i o n i n which some groups g a i n a t the expense o f the r e s t o f the p o p u l a t i o n , p a r t i c u l a r l y people o f f i x e d incomes. F r e q u e n t l y i t accentuates s e l f i s h i n t e r e s t s . Many i n these groups t h i n k t h a t t h e i r f i n a n c i a l progress has been due s o l e l y to personal m e r i t . They are b l i n d t o the f a c t t h a t the g r e a t impersonal f o r c e s o f i n f l a t i o n "greased the way." I t ^vas our unpopular t a s k , t o g e t h e r w i t h the Treasury, t o counter- a c t these f o r c e s by monetary and f i s c a l measures under our r e s p e c t i v e o r j o i n t i n f l u e n c e s or c o n t r o l . - 6 - Let me enumerate the measures t h a t were adopted and comment b r i e f l y on each* By f a r the most p o w e r f u l measure of r e s t r a i n t was the use o f surplus Treasury funds t o r e t i r e bank-held d e b t , p a r t i c u l a r l y Fede r a l Reserve h e l d debt* The power of d e c i s i o n w i t h r e s p e c t t o t h i s measure l a y w h o l l y w i t h the Treasury, I doubt whether the p u b l i c in general appreciates how i m p o r t a n t t h i s was and the c r e d i t t h a t must be given Congress and t h e A d m i n i s t r a t i o n f o r making i t p o s s i b l e d u r i n g that period* There i s no a n t i d o t e t o i n f l a t i o n equal t o t h e develop- ment of a budget s u r p l u s and the use of t h a t surplus t o r r e t i r e debt a t the c e n t r a l bank. I t was endorsed and indeed recommended by the F e d e r a l Reserve System. The p o l i c y of r e s t r a i n t was a l s o f o r t i f i e d by the campaign undertaken by the American Bankers A s s o c i a t i o n t o encourage v o l u n t a r y r e s t r a i n t i n the e x t e n s i o n of c r e d i t . I have r e p e a t e d l y commended t h i s a c t i o n i n b o t h p u b l i c and p r i v a t e statements. T h i s cooperation on the p a r t of t h e commercial bankers e x e m p l i f i e s the f a c t t h a t we can a l l p u l l t o g e t h e r i n t h i s country t o achieve p u b l i c ends when l e a d e r s h i p has understanding and c o n v i c t i o n . Another r e s t r a i n i n g measure was the r e i m p o s i t i o n of R e g u l a t i o n W, e s t a b l i s h i n g l i m i t s t o t h e e x t e n s i o n of i n s t a l m e n t c r e d i t t o consumers. I t was r e i n s t a t e d and a d m i n i s t e r e d by t h e Board o f Governors of t h e Fede r a l Reserve System when Congress granted a temporary a u t h o r i t y i n the summer of 19U8. During t h e p e r i o d of the lapse of t h i s a u t h o r i t y , the t o t a l volume of t h i s c r e d i t o u t s t a n d i n g increased by two and a h a l f b i l l i o n dollars. Another measure, and one of t h e more c o n t r o v e r s i a l , was the d e c i s i o n of the Board of Governors, a f t e r r e c e i v i n g temporary a u t h o r i t y -7from Congress, t o increase reserve requirements o f a l l member banks by 2 per cent on demand d e p o s i t s and 1 - 1 / 2 per cent on time d e p o s i t s i n the e a r l y autumn o f 191$. The Treasury was informed of t h i s d e c i s i o n and o f f e r e d no o b j e c t i o n * During a l l of the p e r i o d of strong i n f l a t i o n a r y pressures, t h e r e were r e l a t e d and h i g h l y c o n t r o v e r s i a l questions i n r e g a r d t o r a i s i n g the cost of c r e d i t i n the money markets* These i n v o l v e d , on the p o s i t i v e s i d e , increases i n d i s c o u n t r a t e s made i n 19h& and i n 19j*8 by t h e F e d e r a l 4 Reserve, t h e d e c i s i o n s by the Treasury i n 19li7 and 19 U8 t o r a i s e its r a t e s on new issues of c e r t i f i c a t e s , and t h e accompanying r e s t r i c t i v e a c t i o n s i n the open market tsy t h e Federal Reserve a u t h o r i t i e s t o increase the rate's a t which Treasury b i l l s and c e r t i f i c a t e s were t r a d e d i n the market. They i n v o l v e d , on the n e g a t i v e s i d e , s u p p o r t i n g a c t i o n s i n t h e open market by t h e F e d e r a l Reserve a u t h o r i t i e s t o m a i n t a i n the 2 - 1 / 2 per cent r a t e on t h e l o n g - t e r m Treasury bonds, a f t e r p e r m i t t i n g p r i c e s of these bonds t o d e c l i n e f r o m h i g h premiums t h e y had reached. I would l i k e the committee, i n j u d g i n g t h i s c o n t r o v e r s i a l subj e c t , t o be i n possession of t h e f a c t s . I t has been s a i d t h a t t h e Open Market Committee o f t h e Federal Reserve System, which i s charged by Congress w i t h r e s p o n s i b i l i t y i n these m a t t e r s , d i d n o t w i s h t o continue t o support the 2 - 1 / 2 per cent l e v e l on l o n g - t e r m Treasury bonds b u t was induced t o continue t h i s p o l i c y by pressure from the Treasury. i s not t r u e . This There were w i d e l y v a r y i n g shades of judgment, n o t o n l y throughout the c o u n t r y and i n t h e Congress b u t w i t h i n the F e d e r a l Reserve System on the w i s e s t course of a c t i o n t o pursue. I t was my v i e w , s t a t e d a t t h e t i m e , t h a t the System was o b l i g a t e d t o m a i n t a i n a market -8f o r government s e c u r i t i e s and t o assure o r d e r l y c o a l i t i o n s i n t h a t market, n o t p r i m a r i l y because of an i m p l i e d commitment t o wartime i n vestors, t h a t t h e i r savinps would be p r o t e c t e d , nor t o a i d the Treasury i n r e f u n d i n g maturing d e b t , b u t because of the widespread repercussions t h a t would ensue throughout t h e economy i f the v a s t holdings of the publ i c debt were f e l t t o be of unstable value . I n any case t h e d e c i s i o n taken and executed was the d e c i s i o n of t h e Open Llarket Committee* I t represented t h e i r combined b e s t j u d g - ment and I was convinced t h e n as I am now, i n r e t r o s p e c t , t h a t t h e y were r i g h t . They wore concerned w i t h t h e huge s i z e of the F e d e r a l debt and w i t h i t s pervasive i n f l u e n c e throughout t h e f i n a n c i a l structure* I n view of the pervasive h o l d i n g s of these s e c u r i t i e s , of t h e continued unsettlement t h a t p r e v a i l e d i n t h e immediate circumstances of the p o s t war i n f l a t i o n , and of t h e f a c t t h a t i t had n o t y e t been demonstrated t h a t the great b u l k of these s e c u r i t i e s were s o l i d l y h e l d and t h a t the f l o a t i n g supply had been absorbed, the adoption of a support l e v e l below par was a r i s k which t h e Committee was n o t prepared t o ux^derwrite. Our most c o n t r o v e r s i a l a c t i o n d u r i n g t h i s p e r i o d was t o r a i s e the reserve requirements of member banks. This d e c i s i o n wac r e l a t e d t o , but by no means c o n d i t i o n e d s o l e l y on, the r e l u c t a n c e of t h e Treasury t o increase s h o r t - t e r m r a t e s on b i l l s and c e r t i f i c a t e s as e a r l y as was recommended by the Cpen l i a r k e t Committee. discuss these two s i t u a t i o n s together< I propose, t h e r e f o r e , t o I have s t a t e d above t h a t r i g h t l y or wrongly i t was t h e d e c i s i o n o f the Open l l a r k e t Committee on i t s own r e s p o n s i b i l i t y n o t t o r i s k a l o w e r i n g of t h e support l e v e l on long-* t«?rm Treasury bonds. -9This d e c i s i o n , i n i t s e l f , meant, of course, t h a t funds p a i d out by the Reserve Banks i n support of the l o n g - t e r m bond market added t o the bank reserves a v a i l a b l e f o r c r e d i t expansion. I t meant t h a t the System must depend m a i n l y , f o r whatever r e s t r a i n i n g i n f l u e n c e c o u l d be e x e r t e d , e i t h e r on i n c r e a s i n g s h o r t - t e r m r a t e s or on i n c r e a s i n g reserve r e q u i r e ments, or b o t h . E i t h e r or b o t h o f these a c t i o n s , r e s t r a i n i n g i n them- s e l v e s , were bound t o be p a r t l y n e g a t i v e d t o the e x t e n t t h a t support of t h e l o n g - t e r m market r e s u l t e d i n f u r n i s h i n g reserves t o t h e banks» I t h i n k i t i s t r u e t h a t the r e l u c t a n c e of the Treasury t o move as r a p i d l y as the Open Market Committee recommended r e i n f o r c e d t h e d i s p o s i t i o n of t h e Board of Governors t o make use of t h e power t o r a i s e reserve requirements* I d o u b t , however, whether the Board, under t h e circumstances then p r e v a i l i n g , would have r e f r a i n e d f r o m t h e use o f the power t o r a i s e reserve requirements even i f the Treasury had agreed e a r l i e r t o an increase i n r a t e s on s h o r t - t e r m b i l l s and c e r t i f i c a t e s . It i s d i f f i c u l t t o be c a t e g o r i c a l about t h i s p o i n t because i t involves an i n t e r p r e t a t i o n of what o f f i c i a l r e a c t i o n s would have been i n a hypothetical s i t u a t i on. There are some who f e l t t h a t n e i t h e r of these r e s t r a i n i n g moves would be e f f e c t i v e because t h e y would t e n d t o be o f f s e t by the funds t h a t would n e c e s s a r i l y be p u t out i n support of the l o n g - t e r m bond markets There are o t h e r s , p a r t i c u l a r l y among t h e member banks, who f e l t that the increase i n s h o r t - t e r m r a t e s on b i l l s and c e r t i f i c a t e s would be e f f e c t i v e b u t t h a t the increase i n r e s e r v e requirements w o u l d be comp l e t e l y o f f s e t by support purchases of bonds* We can now l o o k back and give d e f i n i t e answers t o some of these c o n s i d e r a t i o n s t h a t were Digitized for h iFRASER ghly conjectural a t the t i m e * I t i s a matter of r e c o r d t h a t t h e - 1 0 - combination of these moves d i d a c t u a l l y e x e r t a n e t r e s t r a i n t , t h a t s h o r t term money r a t e s d i d f i r m , t h a t l o a n expansion d i d s t o p , and t h a t this s i t u a t i o n p r e v a i l e d u n t i l the Federal Reserve r e v e r s e d i t s p o l i c i e s when the i n f l a t i o n abated. I do not p e r s o n a l l y subscribe t o t h e view h e l d by some t h a t t h i s a c t u a l r e s u l t r e f l e c t e d s o l e l y t h e increase i n r a t e s on s h o r t - t e r m b i l l s and c e r t i f i c a t e s supported by t h e v o l u n t a r y campaign of the American Bankers A s s o c i a t i o n t o r e s t r i c t c r e d i t advances t o e s s e n t i a l productive c r e d i t s . P e r s o n a l l y I b e l i e v e i t a l s o r e f l e c t e d the increase i n reserve r e q u i r e m e n t s , f o r one reason because t h i s increase d i m i n i s h e d the l i q u i d i t y of the member banks. I n r e t r o s p e c t , however, I would a l s o say t h a t my r e l u c t a n c e t o r e s o r t t o changes i n reserve requirements as a method of d e a l i n g w i t h an i n f l a t i o n a r y s i t u a t i o n has been increased, not d i m i n i s h e d , by the experience. As everyone knows, t h a t p a r t i c u l a r episode i n our economic h i s t o r y , the hangover of postwar i n f l a t i o n , had come t o an end by e a r l y 19i#» We can now l o o k back on t h e postwar p e r i o d as a whole, conse- q u e n t l y , w i t h some p e r s p e c t i v e and some of t h e advantages of h i n d s i g h t * I t i s my personal e v a l u a t i o n t h a t t h i s c o u n t r y , a l l t h i n g s considered, came through t h a t p e r i o d of t r i a l amazingly w e l l , b e t t e r t h a n any other major c o u n t r y and w i t h l e s s s o c i a l and economic d i s t o r t i o n . The amount of i n f l a t i o n t h a t a c t u a l l y occurred was l e s s t h a n t h e r e was reason t o fear. By t h i s I do n o t mean i n any sense t h a t no mistakes were made, or t h a t the i n f l a t i o n and d i s t o r t i o n s we have s u f f e r e d were unavoidable f Some i n f l a t i o n was i n e v i t a b l e , p r o b a b l y a considerable i n f l a t i o n , b u t could undoubtedly have been h e l d w i t h i n narrower l i m i t s . it Nevertheless, t a k i n g a l l the c o m p l e x i t i e s and p e r p l e x i t i e s of the problem i n t o conDigitized for s iFRASER d e r a t i o n and a l s o t h e necessary c o o r d i n a t i o n o f m i l l i o n s of i n d i v i d u a l -11w i l l s I f e e l t h a t i t w i l l be the v e r d i c t of h i s t o r y t h a t our combination o f democracy and f r e e e n t e r p r i s e which we e n j o y i n t h i s country gave a good account o f i t s e l f d u r i n g t h i s p e r i o d . The monetary and c r e d i t measures which we adopted played no small part i n that overall r e s u l t . Let me c i t e two s p e c i f i c i n s t a n c e s . One of our c o n t r o v e r s i a l a c t i o n s was the d e c i s i o n t o reimpose r e s t r i c t i o n s on the extension o f i n s t a l m e n t c r e d i t t o consumers. YJhen we r e i s s u e d Reg- u l a t i o n W i n the autumn o f 191*8, the automobile i n d u s t r y was producing cars t o the f u l l e x t e n t p e r m i t t e d by the a v i l a b i l i t y o f M a t e r i a l s . This p r o d u c t i o n was i n s u f f i c i e n t t o meet the demand, however, w i t h the r e s u l t t h a t s o - c a l l e d used cars commanded bonuses or premiums of as much as $500 or more i n the " g r e y " market. I t was p a r t of our o b j e c t i v e t o d e f e r some of t h i s excess demand u n t i l m a t e r i a l s became more f r e e l y a v a i l a b l e , t h a t i s t o a p e r i o d when the demand so d e f e r r e d would sust a i n employment and b u t t r e s s h i g h l e v e l s t a b i l i t y r a t h e r than augment t h e i n f l a t i o n and the wage-price s p i r a l . I t h i n k t h e r e c o r d shows t h a t these e x p e c t a t i o n s were on the whole borne out by the subsequent course of e v e n t s . Of c o u r s e , many f a c t o r s p l a y e d on the scene and subsequent events cannot be e x p l a i n e d i n terms o f any one f a c t o r alone. Neverthe- l e s s , i t remains t r u e t h a t t h e premium i n t h e grey market f o r automob i l e s disappeared s h o r t l y a f t e r the reissuance o f our r e g u l a t i o n , t h a t we were able i n March of 191*9 t o r e l a x t h e r e g u l a t i o n , and t h a t the automobile i n d u s t r y since t h a t time has been a bulwark t o employment d u r i n g t h e t r a n s i t i o n p e r i o d of i n v e n t o r y readjustment t h a t has p r e v a i l e d i n 191*90 W i t h m a t e r i a l s more f r e e l y a v a i l a b l e , the automobile i n d u s t r y has been able t o set new h i g h r e c o r d s i n p r o d u c t i o n and sales a t a time when t h i s p r o d u c t i o n was most e f f e c t i v e and most needed as a c oFRASER ntribution to Digitized for high l e v e l stability. -12iiy second i l l u s t r a t i o n i s from the f i e l d of mortgage f i n a n c i n g i n i t s r e l a t i o n s h i p t o home b u i l d i n g a c t i v i t y . l o u are a l l aware of the s p i r a l l i n g costs of housing c o n s t r u c t i o n d u r i n g the postwar p e r i o d when what seemed l i k e an almost u n l i m i t e d demand f o r s h e l t e r impinged on the l i m i t e d resources of the home b u i l d i n g i n d u s t r y . You are also aware of t h e turndown i n new housing s t a r t s t h a t occurred i n the autumn of 191*8, the subsequent r e d u c t i o n i n costs of new homes by $ per cent t o 10 per c e n t , and the renewed and sustained home b u i l d i n g a c t i v i t y a t new r e c o r d l e v e l s t h a t made i t s e l f f e l t d u r i n g the past summer. Performance o f the home b u i l d i n g i n d u s t r y was a p o w e r f u l f a c t o r i n the maintenance of employment a t h i g h l e v e l s and w i t h o u t renewed i n f l a t i o n of costs during t h i s p a s t y e a r . I t i s my personal judgment t h a t monetary and c r e d i t f a c t o r s p l a y e d a s i g n i f i c a n t r o l e i n these developments* The slow- i n g up of new s t a r t s t h a t made i t s e l f e v i d e n t i n the autumn and w i n t e r of 19U8 was n o t u n r e l a t e d t o the decreased a v a i l a b i l i t y of c r e d i t a t t h a t time. The subsequent upsurge of a c t i v i t y d u r i n g t h i s summer was r e l a t e d i n p a r t t o the e f f e c t on mortgage f i n a n c i n g o f our moves t o ease c r e d i t d u r i n g t h e s p r i n g of 19h9, as w e l l as t o o t h e r a c t i o n s by government t o ease mortgage c r e d i t s . So much f o r the postwar i n f l a t i o n a r y s i t u a t i o n from which we have now emerged, and t h e lessons t h a t the experience has brought t o us* I w i s h t o t u r n now t o the c u r r e n t p o s i t i o n of the F e d e r a l Reserve System i n i t s p o l i c y operations i n t h e money markets. That p o s i t i o n was announced by the Open l i a r k e t Committee on June 28. I w i l l quote t h a t announcement i n f u l l so t h a t you a l l may be f a m i l i a r w i t h i t * -13"The Federal Open Market Committee, a f t e r consulta~ t i o n w i t h t h e Treasury, announced today t h a t w i t h a view t o i n c r e a s i n g t h e supply of funds a v a i l a b l e i n the market t o meet the needs of commerce, b u s i n e s s , and a g r i c u l t u r e i t w i l l be the p o l i c y of t h e Committee t o d i r e c t purchases, s a l e s , and exchanges of Government s e c u r i t i e s by the Fede r a l Reserve Banks w i t h p r i m a r y r e g a r d t o the g e n e r a l b u s i ness and c r e d i t s i t u a t i o n . The p o l i c y of m a i n t a i n i n g o r d e r l y c o n d i t i o n s i n the Government s e c u r i t y market, and the conf i d e n c e of i n v e s t o r s i n Government bonds w i l l be c o n t i n u e d . Under present c o n d i t i o n s the maintenance of a r e l a t i v e l y f i x e d p a t t e r n o f r a t e s has the u n d e s i r a b l e e f f e c t o f absorbing reserves f r o m the market a t a time when the a v a i l a b i l i t y of c r e d i t should be i n c r e a s e d . ! t I r e g a r d the announcement as a s i g n i f i c a n t milestone because it r e f l e c t e d the j o i n t judgment o f the Treasury and o f t h e F e d e r a l Open Market Committee t h a t the postwar economic and f i n a n c i a l s i t u a t i o n had evolved t o a p o i n t where open market o p e r a t i o n s c o u l d s a f e l y be p e r m i t t e d t o p l a y a more orthodox r o l e i n our p o l i c i e s . Such operations w i l l , of course, continue t o be a f f e c t e d by concern f o r the s t a b i l i t y of the Federal debt and i t s repercussions upon t h e e n t i r e debt s t r u c t u r e . debt i s now a dominant p a r t of the f i n a n c i a l s t r u c t u r e . The p u b l i c No one informed on money market operations expects t h a t open market p o l i c i e s w i l l ignore this fact. The p u b l i c d e b t , however, huge as i t s t i l l i s , has become s u f f i c i e n t l y s e t t l e d i n the hands of s t a b l e holders t o p e r m i t open market p o l i c y t o be f o r m u l a t e d on a more f l e x i b l e b a s i s than f o r m e r l y . I regard June 28, 19U9, as a most i m p o r t a n t d a t e . I t s i g n i f i e d removal of the " s t r a i t j a c k e t " i n which monetary p o l i c y had been o p e r a t i n g f o r n e a r l y a decade, t h a t i s , since the beginning of the w a r . The r e c o r d t h a t I have c i t e d i l l u s t r a t e s how we have been comp e l l e d t o operate under u t t e r l y new c o n d i t i o n s , unprecedented i n modern times. What i s t h e i r s i g n i f i c a n c e w i t h respect t o f i s c a l p o l i c i e s , t o the r e l a t i o n s h i p s r e q u i r e d between c e n t r a l banking a u t h o r i t i e s and f i s c a l -1Ua u t h o r i t i e s , and t o the adequacy of t r a d i t i o n a l c e n t r a l banking powers? These questions are i m p l i c i t i n your i n q u i r y . of t h o u g h t f u l men everywhere. They demand the a t t e n t i o n Unless we f i n d the s o l u t i o n t o these p r o b - lems, our way of l i f e , which i s the way of the f r e e w o r l d , w i l l be i n jeopardy. Having spent t h i r t y - t h r e e years of my l i f e as a p r i v a t e e n t e r - p r i s e r , I want above a l l t o a v o i d a n y t h i n g t h a t e i t h e r weakens our economy or p u t s the f i s c a l s t r u c t u r e o f our government i n p e r i l . I approach these problems w i t h a f e e l i n g of h u m i j i t y which I am * sure you and many of the t h o u g h t f u l men who have appeared before you share. I t i s t h i s f e e l i n g t h a t makes me so sympathetic t o the study which you are conducting. Out of a l l of the d i s c u s s i o n s , we can, perhaps, achieve b e t - t e r understanding f o r our f i x t u r e guidance. I would be l e s s than f r a n k i f I l e f t you w i t h the impression t h a t the new p o s i t i o n which was i n i t i a t e d on June 28 had ended the need f o r coo r d i n a t i o n between debt management and money market p o l i c i e s . w i l l , of course, c o n t i n u e . That need Many suggestions have been advanced i n the answers t o your q u e s t i o n n a i r e and i n the t e s t i m o n y , suggesting f o r m a l p r o cedures t o assure a r e s u l t t h a t i s i n t h e l o n g r u n p u b l i c i n t e r e s t of our democracy. P e r s o n a l l y I am s k e p t i c a l o f the v a l u e of f o r m a l i z e d p r o c e - dures i n a s i t u a t i o n of t h i s k i n d . The t r u t h i s t h a t our problems a r i s e out o f t h e d i f f e r e n t c h a r a c t e r of the v e r y s e r i o u s r e s p o n s i b i l i t i e s that are borne by the Treasury on the one hand and t h e Federal Reserve System on the o t h e r . The r e c o r d of h i s t o r y i s c l e a r , t h a t the i n s t i t u t i o n s charged w i t h these r e s p o n s i b i l i t i e s should be m u t u a l l y independent of each o t h e r , f o r t h e s u b o r d i n a t i o n of e i t h e r might l e a d t o u n f o r t u n a t e r e s u l t s . T h i s seems t o me t o i m p l y t h a t we must r e l y on the men who c a r r y these -Irr e s p e c t i v e r e s p o n s i b i l i t i e s , on t h e i r good w i l l , c o n s t r u c t i v e v i s i o n , and s p i r i t of c o o p e r a t i o n . There i s no danger t h a t Treasury o f f i c i a l s and Federal Reserve o f f i c i a l s w i l l l a c k personal c o n t a c t . The nature of t h e i r d u t i e s i n s u r e s and w i l l continue t o i n s u r e t h a t they face these problems together. I took p a i n s t o p o i n t out i n my answer t o the q u e s t i o n n a i r e t h a t a s p l e n d i d degree of cooperation e x i s t s between the Treasury and the Federal Reserve. Reserve Requirements I propose now t o c l a r i f y s e v e r a l s p e c i f i c , but n o t n e c e s s a r i l y r e l a t e d , p o i n t s where t h e r e c o r d i n d i c a t e s c o n f u s i o n . the g e n e r a l problem o f reserve requirements. F i r s t of these i s Three r e l a t i v e l y distinct types of problems t h a t f a l l under t h i s heading have been d e a l t w i t h i n the r e c o r d , and I want t o d i s t i n g u i s h them and comment b r i e f l y on each. (1) To what e x t e n t should the F e d e r a l Reserve a u t h o r i t i e s have the power t o r a i s e or lower reserve requirements and under what c o n d i t i o n s should t h i s instrument be used? I am somewhat embarrassed i n answering t h i s q u e s t i o n . The Congress has n o t seen f i t i n the past t o delegate as broad a u t h o r i t y w i t h r e s p e c t t o t h i s instrument as i t has w i t h r e s p e c t t o other i n s t r u m e n t s . Only s i x months ago Congress r e f u s e d e x t e n s i o n of the temporary a u t h o r i t y t h a t then e x i s t e d . I am h o p e f u l t h a t as a r e s u l t o f t h i s committee ! s i n - t e r e s t the s u b j e c t might be reviewed i n broad p e r s p e c t i v e i n a study under a u t h o r i t y o f Congress* The Board has h e r e t o f o r e proposed t h a t a d d i t i o n a l a u t h o r i t y be granted so t h a t i t would be i n a p o s i t i o n t o absorb a d d i t i o n a l reserves -16t h a t might be made a v a i l a b l e i n excess of t h e c u r r e n t needs of the economy. I t has been recognized, and so s t a t e d , t h a t reserve requirements are n o t a f l e x i b l e i n s t r u m e n t , i n o t h e r words t h a t f r e q u e n t ments should be avoided. 11 j i g g l i n g 1 1 of the r e q u i r e - The p r i n c i p a l p o s s i b l e sources o f a d d i t i o n a l r e - serve funds are ( 1 ) i n f l o w of g o l d , ( 2 ) r e t u r n of currency f r o m c i r c u l a t i o n , and ( 3 ) F e d e r a l Reserve purchases of government s e c u r i t i e s . I t should be recognized t h a t f r o m a l o n g - r u n s t a n d p o i n t b a s i c adjustments i n reserve requirements may be needed from time t o time t o * a l l o w f o r fundamental changes i n t h e reserve s t r u c t u r e . An i n f l o w of g o l d of a b i l l i o n d o l l a r s a year f o r f i v e or t e n y e a r s , t o g e t h e r w i t h a r e t u r n f l o w of a moderate p o r t i o n o f the v e r y l a r g e wartime increase of currency i n c i r c u l a t i o n , c o u l d d e p l e t e the Federal Reserve Banks1 open market p o r t f o l i o below a reasonable o p e r a t i n g l e v e l . I t may a l s o be e s s e n t i a l a t times f o r t h e F e d e r a l Reserve t o purchase government bonds i n m a i n t a i n i n g o r d e r l y markets f o r these s e c u r i t i e s * An increase i n reserve requirements might be needed i n order t o immobilize any l a r g e amount of reserves created i n t h i s manner. As I s t a t e d i n my answer t o your q u e s t i o n n a i r e , the F e d e r a l Reserve should have a u t h o r i t y broad enough t o meet i t s r e s p o n s i b i l i t i e s under different situations. We have l e a r n e d from experience t h a t i f we should again be c o n f r o n t e d w i t h t h e problem of d e a l i n g w i t h a dangerous expansion of bank c r e d i t , f l e x i b l e open market and d i s c o u n t p o l i c i e s would be more e f f e c t i v e instruments than i n c r e a s i n g reserve requirements* (2) I s the e x i s t i n g system of reserve requirements f o r member banks e f f e c t i v e and e q u i t a b l e ? I t i s not necessary on t h i s occasion f o r me t o discuss a t l e n g t h e x i s t i n g methods of computing r e s e r v e requirements or why we b e l i e v e a change i n the methods i s worthy of c o n s i d e r a t i o n . These matters are t r e a t e d a t some l e n g t h i n the answers which the Reserve Bank Presidents and I have submitted i n answer t o your q u e s t i o n n a i r e . The problem has been s t u d i e d by v a r i o u s groups i n t h e Federal Reserve System almost from the time of i t s o r g a n i z a t i o n and many proposals have been made f o r i t s solution. We are convinced t h a t t h e e x i s t i n g system should and can be g r e a t l y improved. We are n o t , however, committed t o any? p a r t i c u l a r p r o - posal f o r change. Our s t a f f s a f t e r years of study have worked out a method which i s b e l i e v e d t o be workable and e q u i t a b l e and may be the best t h a t can be devised; i t has a l r e a d y been presented i n f o r m a l l y t o your committee. The problem i s a c o n t i n u i n g one and i n e q u i t i e s increase the longer i t remains unsolved. I t i s my view t h a t the problem should be s t u d i e d by the a p p r o p r i a t e committees of Congress, by banking groups, and o t h e r s , as w e l l as by the F e d e r a l Reserve. We w i l l be prepared t o present a d e f i n i t e recommendation a t the a p p r o p r i a t e t i m e . I f a National Monetary Commission i s set up t o study such q u e s t i o n s , t h i s would be one o f t h e most i m p o r t a n t f o r i t t o c o n s i d e r . (3) Should banks which are n o t members o f the Federal Reserve System be r e q u i r e d t o m a i n t a i n reserve requirements e s s e n t i a l l y the same as those r e q u i r e d of member banks? I have discussed a t some l e n g t h , i n the answers submitted t o your q u e s t i o n s , the d i f f i c u l t problem of the l i m i t a t i o n s t h a t the e x i s t ence of nonmember banks place on the e f f e c t i v e n e s s of Federal Reserve actions. The Reserve Bank P r e s i d e n t s , who are i n t i m a t e l y concerned w i t h - 18 * t h i s problem, have a l s o g i v e n y o u t h e i r views and so have many o t h e r s . D i f f e r e n c e s i n r e s e r v e r e q u i r e m e n t s a r e one o f t h e most i m p o r t a n t aspects o f t h e e f f e c t o f nonmember banks on t h e F e d e r a l Reserve System. Reserve r e q u i r e m e n t s f o r S t a t e banks w h i c h a r e n o t members o f t h e F e d e r a l Reserve System v a r y f r o m no s t a t u t o r y r e q u i r e m e n t s whatever i n the State o f I l l i n o i s to requirements which, i n percentages, h i g h e r t h a n t h o s e o f member banks i n a number o f S t a t e s . are The e s s e n t i a l * d i f f e r e n c e between r e s e r v e r e q u i r e m e n t s o f member and nonmember banks, however, i s n o t i n percentages b u t i n t h e c o m p o s i t i o n o f r e s e r v e s . Even where t h e p e r c e n t a g e s o f d e p o s i t s r e q u i r e d t o be h e l d as r e s e r v e s a r e t h e same a s , o r h i g h e r t h a n those f o r member banks, t h e nonmember bank s t i l l has an i m p o r t a n t advantage. Nonmember banks can meet t h e i r r e s e r v e r e q u i r e m e n t s t h r o u g h h o l d i n g s o f v a u l t cash and balances w i t h c o r r e s p o n d e n t banks, w h i l e member banks can c o u n t o n l y t h e i r balances w i t h t h e F e d e r a l Reserve as r e q u i r e d r e s e r v e s , and i n a d d i t i o n must h o l d f o r w o r k i n g purposes a c e r t a i n amount o f v a u l t cash and balances w i t h Member banks n o t i n r e s e r v e c i t i e s , correspondents. t h e s o - c a l l e d " c o u n t r y " banks, as a group have r e c e n t l y been m a i n t a i n i n g h o l d i n g s o f v a u l t cash and balances w i t h o t h e r banks amounting t o about 1$ p e r c e n t o f t h e i r gross demand d e p o s i t s , i n a d d i t i o n t o balances w i t h F e d e r a l Reserve Banks o f 12 p e r c e n t a g a i n s t n e t demand d e p o s i t s * and 5> p e r c e n t a g a i n s t t i m e d e p o s i t s . * N e t demand d e p o s i t s a r e computed by d e d u c t i n g h o l d i n g s o f balances w i t h c o r r e s p o n d e n t banks and o t h e r cash i t e m s f r o m gross demand d e p o s i t s . - 19 * The p r a c t i c e o f h o l d i n g balances w i t h correspondents i s c h a r a c t e r i s t i c o f our system o f u n i t banks. monetary and banking l e g i s l a t i o n , I n any i n q u i r y o f needed c o n s i d e r a t i o n should be given t o the p o s s i b i l i t y o f e v o l v i n g a system o f reserve requirements t h a t would make allowance f o r h o l d i n g s o f v a u l t cash and balances w i t h o t h e r banks i n such a way as t o minimize the e f f e c t o f d i f f e r e n c e s between member and nonmember banks. I n my answer t o your q u e s t i o n n a i r e , I have submitted some a l t e r n a t i v e s t h a t might be considered t o d e a l w i t h r t h i s problem. The Problem o f a D i v i d e d Banking S t r u c t u r e I t has been i n t i m a t e d t o the committee t h a t we i n the Federal Reserve are unduly alarmed by the problems presented by a d i v i d e d banki n g s t r u c t u r e since nonmember banks h o l d o n l y 15 per cent o f the t o t a l commercial bank d e p o s i t s i n t h e c o u n t r y . I want t o p o i n t out t h a t t h i s i s an o v e r a l l f i g u r e and can be v e r y m i s l e a d i n g i f n o t viewed on a geographical basis. The percentage o f deposits v a r i e s between H#5 per cent and 62 per cent from the lowest S t a t e t o the h i g h e s t . Correspondingly, the number o f nonmember banks v a r i e s between 13 per cent and 85 per cent o f a l l commercial banks. I need h a r d l y p o i n t o u t t o members o f Congress the a c t u a l i n f l u e n c e o f these 7*000 nonmember banks r e p r e s e n t i n g 50 per cent o f the banking c o n s t i t u e n c y . I emphasized s t r o n g l y i n ray answer t o your q u e s t i o n n a i r e my fundamental f a i t h i n the d u a l banking system. The g r e a t commercial ex- pansion o f t h i s c o u n t r y was v e n t u r e d under t h a t system, and I would be the l a s t t o advocate any p o l i c y t h a t supplants i t . I a l s o emphasized my great concern l e s t our d u a l banking system degenerate i n t o a h o p e l e s s l y d i v i d e d banking s t r u c t u r e , and I gave you what I consider some c o n s t r u c t i v e - 20 a l t e r n a t i v e s t o deal w i t h * it. My p r i m a r y aim i s t o c o n s o l i d a t e the e f f o r t s o f a l l forces concerned w i t h our f i n a n c i a l i n t e g r i t y to t h e g r e a t e s t e x t e n t p o s s i b l e i n order t o have t h i s c o u n t r y adequately armed, so f a r as our money mechanism can accomplish t h a t , t o prevent c r e d i t excesses i n an upswing and t o make Federal Reserve resources u n i v e r s a l l y a v a i l a b l e t o banks i f they need help i n stormy weather* Our banking and c r e d i t economy c o n s i s t s o f an i n c r e d i b l y complex s t r u c t u r e o f i n t e r l o c k e d assets and l i a b i l i t i e s . No bank can operate t h a t can n o t convert i t s assets q u i c k l y i n t o caSh when d e p o s i t o r s 1 use o f funds r e s u l t s i n a d r a i n * I n periods of f i n a n c i a l s t r a i n there i s no a l t e r n a t i v e b u t recourse t o the Reserve System. This recourse t o funds i s always a v a i l a b l e t o a member bank, w i t h f u l l assurance t h a t the Federal Reserve m i l be i n a p o s i t i o n t o meet i t s requirements, whatever they may be. I would l i k e t o see t h i s recourse open a l s o t o nonmember banks who c a r r y t h e i r reserves i n the Federal Reserve Banks. Objections r a i s e d a g a i n s t i n c l u s i o n o f a l l commercial banks i n common p r o t e c t i v e a c t i o n a g a i n s t i n f l a t i o n a r y excesses, do n o t o f course a r i s e when we t a l k o f making the resources of the Reserve System a v a i l a b l e t o a l l banks, regardless o f membership, when the going gets rough. Whether i t i s more v i t a l t o r e s t r a i n a boom or cushion a de- p r e s s i o n , i n e i t h e r case I have f e l t t h a t the Reserve System should be i n a p o s i t i o n t o use a l l i t s influence. I t h i n k t h i s should d i s p e l the f o g t h a t has spread over the q u e s t i o n o f whether nonmember banks should be on an equal f o o t i n g w i t h 21 member banks so f a r as reserve requirements are concerned. new s u b j e c t . This i s no I t i s as o l d as the Federal Reserve Act i t s e l f . Carter Glass was by* no means alone i n i n s i s t i n g t h a t l o g i c and simple f a i r n e s s c a l l e d f o r u n i v e r s a l membership. I can imagine no more vigorous a champion o f S t a t e s 1 r i g h t s than he was. I n the e a r l y and m i d - t h i r t i e s , Congress s p e c i f i c a l l y p r o v i d e d t h a t a l l i n s u r e d banks, a t l e a s t , be m e m b ^ o f the Reserve System. reversed, should True, t h a t d e c i s i o n was subsequently I mention t h i s o n l y t o p o i n t out t h a t t h e r e u i s n o t h i n g new o r novel, t h e r e i s no r e a c h i n g f o r more and more power, when we b r i n g t o your a t t e n t i o n the f a c t t h a t nonmembership d i l u t e s our a b i l i t y t o do our j o b — and t h a t i s a l l we are concerned w i t h . Carter Glass p u t i t i n f a r s t r o n g e r terms when he s a i d i t makes f o r c o m p e t i t i o n i n l a x i t y . As a businessman I n a t u r a l l y d i s l i k e r e s t r i c t i v e government a u t h o r i t y and c e n t r a l i z a t i o n o f power. Some o f the f o g t h a t surrounds the s u b j e c t o f the r o l e o f monetary p o l i c y a r i s e s because o f the erroneous b e l i e f t h a t the Federal Reserve System seeks t o p l a y a f a r g r e a t e r p a r t than was intended and t h a t i t i s r e a c h i n g f o r more power. I have t r i e d t o b r i n g out i n t h i s d i s c u s s i o n , on the c o n t r a r y , t h a t the dilemma we faced u n t i l t h i s year c o u l d n o t be r e s o l v e d adequately because, i n our considered judgment, we c o u l d n o t use the open market powers — undoubtedly v e r y g r e a t — which we a l r e a d y possessed w i t h o u t the l i k e l i h o o d o f doing more economic harm t h a n good. The suggestion has r e c e n t l y been made t o me by a v e r y competent observer t h a t one step f o r w a r d might be taken through s t r e n g t h e n i n g , in some a p p r o p r i a t e and acceptable way, the r e l a t i o n s h i p s between the Reserve System and the Supervisors o f S t a t e banks. I have n o t thought t h i s o u t -22completely, and I mention i t o n l y because t h i s i s one o f many cons t r u c t i v e thoughts t h a t we are e x p l o r i n g t o harmonize the p o l i c i e s o f a l l s u p e r v i s o r y a u t h o r i t i e s i n a t t a i n i n g our common o b j e c t i v e . With your permission, I w i l l i n t r o d u c e i n the r e c o r d a t a b l e which shows nonmembership by S t a t e s , b o t h as t o deposits and numbers o f banks• would a l s o l i k e t o i n t r o d u c e i n t o the r e c o r d excerpts from l e t t e r s I I have r e c e n t l y r e c e i v e d from the Presidents o f the Federal Reserve Banks o f Chicago, Minneapolis, and Kansas C i t y , commenting op t h i s s u b j e c t . Loans t o Business I y/ish p a r t i c u l a r l y a t t h i s p o i n t to c l a r i f y my response i n the q u e s t i o n n a i r e t h a t d e a l t w i t h the a u t h o r i t y o f the Federal Reserve Banks t o extend d i r e c t loans t o i n d u s t r y . The statement has been m i s - understood by some t o i n d i c a t e t h a t I requested new a u t h o r i t y t o compete w i t h the l e n d i n g a u t h o r i t y o f the R e c o n s t r u c t i o n Finance C o r p o r a t i o n . The f a c t i s t h a t the Federal Reserve Banks have l o n g had a u t h o r i t y under S e c t i o n 13b o f t h e Federal Reserve A c t t o make d i r e c t loans to i n d u s t r y . I was seeking i n my answer t o a v o i d c o n f l i c t between the l e n d i n g a c t i v i t i e s o f the Federal Reserve Banks and those o f the RFC* I s p e c i f i c a l l y s t a t e d t h a t i f Congress d i d n o t w i s h t o c l a r i f y the p o s i t i o n I would p r e f e r t h a t our a u t h o r i t y be repealed, and I w i s h t o reemphasize t h a t statement because the Federal Reserve System should n o t be l o o k i n g f o r new worlds t o conquer. Furthermore, the v e r y j u s t i f i a b l e question can be r a i s e d as t o the r o l e o f a c e n t r a l banking a u t h o r i t y i n the f i e l d of direct lending. I t i s p a r t o f my basic p h i l o s o p h y t o be wary o f the growth o f - 23 * government l o a n agencies t h a t i n t h e i r c o m p e t i t i o n w i t h p r i v a t e l e n d i n g i n s t i t u t i o n s may weaken these i n s t i t u t i o n s t o the p o i n t where they no l o n g e r p l a y a dynamic r o l e i n our economy* A t the same time, I recognize t h a t s i t u a t i o n s have a r i s e n , and may a r i s e again, p a r t i c u l a r l y i n periods o f emergency, when the a v a i l a b i l i t y o f p u b l i c f i n a n c i n g i s e s s e n t i a l t o the s u r v i v a l o f the economy. I recognize a l s o t h a t i n the area o f small business t h e r e may be f i n a n c i a l needs a t a l l times t h a t j u s t i f y d i r e c t government a t t e n t i o n and s u p p o r t . I n ny answer I t r i ^ d t o d e a l w i t h b o t h o f these needs. The b a s i c problem a r i s e s o u t o f the nature o f the c r e d i t r e l a t i o n s h i p between borrower and l e n d e r t h a t i s a p p r o p r i a t e t o a p r i v a t e e n t e r p r i s e economy. Though i t may n o t so appear on the balance sheet, a business c r e d i t or business l o a n i s n o t an i s o l a t e d t r a n s a c t i o n t h a t occurs once between a borrower and a l e n d e r and i s t e r m i n a t e d a t the time o f repayment. \Vhat a businessman needs, and what s m a l l businessmen need above a l l e l s e , i s a c r e d i t connection, a r e c u r r e n t source o f loans t o which he can t u r n p e r i o d i c a l l y t o f i n a n c e h i s seasonal needs, to t i d e him over emergencies, t o a d v i s e him on plans f o r expansion and t o help f i n a n c e h i s growth. I t i s o n l y v e r y l a r g e concerns, w i t h d i r e c t access t o the c e n t r a l money markets, t h a t can a f f o r d even t o contemplate operations w i t h o u t an e s t a b l i s h e d r e c u r r e n t source o f f i n a n c i a l accommodation. o f our s u c c e s s f u l business e n t e r p r i s e s , b o t h l a r g e and s m a l l , are meticulous t o c u l t i v a t e and m a i n t a i n customer r e l a t i o n s h i p s o f l o n g s t a n d i n g w i t h commercial banks and o t h e r f i n a n c i a l i n s t i t u t i o n s , vice versa. and Most - 2U ~ I t i s t h i s l o n g - t e r m n a t u r e o f business c r e d i t r e l a t i o n s h i p s t h a t makes me f e a r f u l o f government l e n d i n g a c t i v i t i e s . The danger i s t h a t such f i n a n c i a l r e l a t i o n s h i p s once e s t a b l i s h e d tend by t h e i r v e r y nature t o be maintained, and t h a t a growing s e c t o r o f our p r i v a t e b u s i ness economy may come t o depend f o r i t s c r e d i t advances on the p u b l i c credit. The suggestions I advanced i n my answer represented my b e s t thought on how we i n the Federal Reserve System might^meet these conf l i c t i n g o b j e c t i v e s c o n s t r u c t i v e l y , i f the Congress placed our a u t h o r i t y on a more e f f e c t i v e b a s i s . The advantages t o the economy, should Congress do so, are t h a t we are v e r y close t o banks and are f a m i l i a r w i t h t h e i r o p e r a t i o n s , t h a t we have adequate resources, and t h a t we have an experienced personnel capable o f g i v i n g considerate and c o n s t r u c t i v e a t t e n t i o n t o unusual c r e d i t s i t u a t i o n s , p a r t i c u l a r l y those t h a t are c l o s e l y associated w i t h the l e g i t i m a t e f i n a n c i a l needs o f s m a l l business. I t has been my o b s e r v a t i o n t h a t an i m p o r t a n t d i f f i c u l t y o f small business, p a r t i c u l a r l y o f r e l a t i v e l y new v e n t u r e s , t o secure f i n a n c i n g i s due t o the f a c t t h a t i t has no e s t a b l i s h e d banking Connection* I t i s my thought t h a t i f the Congress so d i r e c t s , we i n the Federal Reserve c o u l d p l a y a c o n s t r u c t i v e r o l e by d e v o t i n g ourselves t o the establishment o f sustained customer connections between small business u n i t s and t h e i r l o c a l banks. C l e a r l y , t h i s would be more welcome t o small business than the prospect o f continued dependence on p u b l i c l e n d i n g agencies. F r e q u e n t l y , these connections are n o t a u t o m a t i c a l l y e s t a b l i s h e d i n the marketplace, because a t y p i c a l s m a l l business w i t h no r e g u l a r - 2* - banking connection represents an "unusual c r e d i t r i s k t h a t does n o t conform t o t r a d i t i o n a l standards. I n such cases, the a p p l i c a t i o n may- be t u r n e d down by the l o c a l bank because i t has n o t the f a c i l i t i e s to make the i n v e s t i g a t i o n e s s e n t i a l to e s t a b l i s h whether or not the r i s k i s bankable* I t i s these s i t u a t i o n s where the Federal Reserve Banks could operate most e f f e c t i v e l y . W i t h t h e i r t r a i n e d personnel and f a c i l i t i e s they are i n a b e t t e r p o s i t i o n t o i n v e s t i g a t e unusual c r e d i t s i t u a t i o n s than many s m a l l l o c a l banks. I f they fourtfl such s i t u a t i o n s j u s t i f i e d the extension o f c r e d i t , they could make t h e * l o a n , subject always t o the safeguard t h a t the l o c a l i n s t i t u t i o n c a r r i e d a t l e a s t 10 per cent o f the r i s k * They would always be prepared t o s e l l back t o the l o c a l bank any or a l l o f t h e i r p a r t i c i p a t i o n and we would consider t h e i r j o b w e l l done when the borrower had a c q u i r e d an e s t a b l i s h e d l o c a l banking connection and no l o n g e r r e p a i r e d t o the Federal Reserve Bank f o r assistance. I am aware t h a t d i r e c t loans o f a customer nature t o industrial business u n i t s l i e o u t s i d e the main c r e d i t a c t i v i t i e s o f c e n t r a l banking institutions. I would n o t expect t h a t the d o l l a r volume o f such loans a t the Reserve Banks would ever be l a r g e . I would l o o k on i t as a p i l o t o p e r a t i o n designed t o e s t a b l i s h r e g u l a r customer r e l a t i o n s h i p s between l o c a l s m a l l businessmen and t h e i r l o c a l banks. I would judge i t s success n o t by the d o l l a r volume o f such loans o u t s t a n d i n g a t any one time b u t r a t h e r by the v i t a l i t y t h a t i t gave t o s m a l l business and t o commercial banking* I f Congress were t o request us t o do a j o b l i k e t h i s , I can assure you t h a t the Federal Reserve i s organized to do i t . As I - 26 * i n d i c a t e d i n my answer, I would want our e x i s t i n g a u t h o r i t y l i b e r a l i z e d and I would also want assurance t h a t the law be amended so t h a t we would n o t be i n a c o m p e t i t i v e p o s i t i o n w i t h the R e c o n s t r u c t i o n Finance Corporation. O r g a n i z a t i o n o f the System I t i s o f course v i t a l t h a t the Board o f Governors and the Open Market Committee be composed o f men o f the h i g h e s t c a l i b e r . T I whole- h e a r t e d l y agree w i t h the view which has s e v e r a l times been expressed here t h a t t h e best assurance t h a t the System w i l l continue t o be able t o a r r i v e a t informed and d i s i n t e r e s t e d judgment on a l l questions o f monetary p o l i c y i s a s t r o n g Board o f Governors. Only a Board made up o f men o f the h i g h e s t competence can discharge the heavy r e s p o n s i b i l i t i e s f o r monetary p o l i c y e n t r u s t e d t o i t . That i s why I f e e l so s t r o n g l y t h a t i t was a g r e a t mistake f o r the Congress under the r e c e n t executive pay l e g i s l a t i o n t o a l t e r the r e l a t i o n s h i p between the s a l a r i e s o f Board members and those o f the top executive o f f i c e r s o f the government, which was e s t a b l i s h e d when the Federal Reserve was founded. I t i s n o t the s a l a r y l e v e l as such so much as the i m p l i e d disparagement and reduced s t a t u s o f the Board which w i l l make i t extremely d i f f i c u l t i n the f u t u r e t o induce o u t s t a n d i n g men t o accept Board membership. The Board i s also p l a c e d a t a disadvantage i n i t s r e l a t i o n s h i p w i t h o t h e r agencies. The accusation has been made t h a t the Board operates i n an i v o r y tower, and t h a t i t s d e c i s i o n s are surrounded by n$rstery. v e r y f a r from the f a c t . This i s I doubt whether t h e r e i s any i n s t i t u t i o n , public o r p r i v a t e , anywhere i n t h e w o r l d whose operations are so f u l l y d i s c l o s e d - 27 * t o t h e p u b l i c as those o f the F e d e r a l Reserve System. I n the Federal Reserve B u l l e t i n , i n t h e annual r e p o r t s t o Congress - w h i c h i n c l u d e a l l p o l i c y a c t i o n s o f t h e Board and o f the Open Market Committee t o g e t h e r w i t h t h e reasons t h e r e f o r - i n r e g u l a r l y i s s u e d r e p o r t s o f d a y - t o - d a y o p e r a t i o n s , i n f r e q u e n t o t h e r p u b l i c a t i o n s b o t h o f t h e Board and o f the Reserve Banks, and i n p u b l i c d i s c u s s i o n s , the a c t i o n s and a c t i v i t i e s of t h e e n t i r e System a r e d i s p l a y e d as i n an open book. Yfe occupy no i v o r y tower. ^ We l i v e i n a g o l d f i s h bov<rl. The unique o r g a n i z a t i o n o f the F e d e r a l Reserve enables t h e System t o be e x t r e m e l y c l o s e t o t h e p u l s e o f the econony a t a l l Before coming t o d e c i s i o n s on a l l m a t t e r s o f p o l i c y , times. the Reserve Board has t h e i n e s t i m a b l e advantage o f b e i n g a b l e t o communicate w i t h and o b t a i n f a c t u a l i n f o r m a t i o n , as w e l l as o p i n i o n s , f r o m the twelve F e d e r a l Reserve Banks and t h e i r t w e n t y - f o u r branches t h r o u g h o u t the c o u n t r y , on whose boards are more t h a n 2^0 d i r e c t o r s , dravm n o t o n l y from b a n k i n g b u t from the w i d e l y d i v e r s i f i e d i n d u s t r i a l , professional p u r s u i t s of the n a t i o n . commercial, a g r i c u l t u r a l , The d i r e c t o r s , t h e o f f i c e r s , and and s t a f f s o f the Reserve Banks and the Board, the F e d e r a l A d v i s o r y C o u n c i l , and t h e member banks comprise t h e Reserve System. The Board has c o n s t a n t l y a v a i l a b l e c u r r e n t i n f o r m a t i o n , drawn f r o m t h i s g r e a t System, t o supplement the v a s t mass o f f a c t u a l and s t a t i s t i c a l d a t a gathered t h r o u g h o t h e r governmental s o u r c e s . occasion demands. Moreover, the System sponsors s p e c i a l s t u d i e s as I n a d d i t i o n , we a r e always a t p a i n s t o c o n s u l t w i t h r e p r e s e n t a t i v e businessmen, t h e s m a l l as w e l l as the l a r g e r ones, w i t h t r a d e a s s o c i a t i o n s and, i n f a c t , w i t h a l l who are a f f e c t e d by System - 28 operations. * We t r y t o weigh c a r e f u l l y t h e i r views and t o d i s t i n g u i s h broad n a t i o n a l c o n s i d e r a t i o n s from those r e f l e c t i n g narrower i n t e r e s t s . The a r t o f c e n t r a l banking i s f a r from simple, nor i s i t one o f the exact sciences. That i s why, as I have s t a t e d , I f e e l t h a t your committee i s doing such a u s e f u l e d u c a t i o n a l j o b i n b r i n g i n g these monetary, c r e d i t and f i s c a l problems t o t h e a t t e n t i o n o f the p u b l i c and g r a p p l i n g w i t h these problems. You can help g r e a t l y by such conclusions and recommendations as you may p u t i n your r e p o r t to ;bhart the f u t u r e course o f monetary and c r e d i t p o l i c y and enable i t to p l a y i t s p a r t towards a c h i e v i n g our goal o f steady economic p r o g r e s s . full
@FedFRASER