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\tr, Braddock Hickrnan
Elfun Society of G. E.
May 5, L966
Cleveland, Ohio
THE T'EDERAL RESERVE AND MONETARY POLTCY
Our discussion this evening centers on the Federal Reserve Systern and
its role in shaping national rnonetary policy. Before talking about rnonetary
policy, however, I'd like to give you a glirnpse of the structure of the Federal
Reserve, then a vignette of the rnen who serve as Directors of our Bank, and
finally
a
bit about the service functions we perforrn for mernber banks and the
public.
The Fed.eral Reserve Bank of Cleveland.
is part of the central banking
systern of the United States. Along with the eleven other Reserve banks it
functions in part as a service institution, and in part as the rnonetary authority
of the United States,
The Federal Reserve Systern was created 52 years ago by an Act of
Congress to provide an elastic currency and to prevent period.ic panics which
resulted frorn the perverse elasticity of the m.oney supply under the old national
banking systern.
At the apex of the Systern stands the Board of Governors of the Federal
Reserve Systern -- a Governrnent agency appointed by the President with the
advice and consent of the Senate. The Board is independent of the Executive,
but is responsible in a broad general way to Congress. The Congress has
delegated to the Federal Reserve the day-to-day responsibility
for regulating
the rnoney supply, which was delegated to the Congress by the Constitution,
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-zNext in the hierarchy stand the twelve regional Federal Reserve banks,
which are half public, half private. Their stock is owned by the 6, 000 rnernber
banks of the Systern. The rnernber banks receive fixed dividends of six percent
on non-transferable capital
stock, They do not have a proprietary interest in
the Reserve banks, and do not have a residual clairn on the Reserve banksl
earnings or assets. They do, however, have the right to elect six of the nine
directors of their Federal Reserve bank.
I should like to talk a little about our Board of Directors, its rnajor
responsibilities and how its rnembers are chosen, and to indicate the caliber
of the rnen who serve as directors.
Our directors rneet on the second Thursday of each rnonth to review
business and credit conditions and to take such action as is necessary in
connection with the affairs of the bank. They establish the discount rate of our
bank (the rate paid by rnernber banks who borrow frorn us), subject to the review
and deterrnination of the Board of Governors of the Federal Reserve Systern in
\4rashington. The directors advise the presidents of the twelve Reserve banks
on national credit policies and thereby perforrn an irnportant public service,
Like
each of the eleven other Federal Reserve banks we have nine
directors, divided into three classes, designated A, B, and C. The CIass A
and B Directors are elected by mernber banks
CIass
A Directors are usually bankers,
for three-year terrns, The three
and by law can be
officers in a bank
and
hold bank stock. The three Class B Directors are actively engaged in cornrnerce,
agriculture or industry, and by law can hold bank stock but cannot be bankers.
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3-
The Board of Governors appoints the three Class C Directors who are
regarded as therrpublic'r rnernbers. The Governors designate one of thern as
Chairman and tr'ederal Reserve Agent and another as Deputy Chairrnan, Class
C
Directors can neither hold bank stock nor be bank officers. In effect, Class A
Directors are lenders, Class B Directors are borrowers,
and.
Class C Directors
represent the general public. Now for the introductions, beginning with the
Class C Directors:
JOSEPH
B. HALL, Director
and
forrner Chairrnan of the Board of The
Kroger Co., Cincinnati, is our Chairrnan and Federal Reserve Agent for the
Fourth Federal Reserve District.
LOGAN T' JOHNSTON' Chairrnan of the Board of the Arrnco Steel
Corporation at Middletown, Ohio, is our Deputy Chairrnan.
The
third Class C Director is ALBERT G. CLAY, President of the Clay
Tobacco Cornpany of Mt. Sterling, Kentucky.
The CIass B Directors are:
ItÀfALTER
K. BAILEY, Chairrnan of the Board of 'Warner & Swasey here
in Cleveland.
DAVID A. MEEKER, Chairrnan of the Board and Chief Executive Officer
of Hobart Manufacturing Cornpany of Troy, Ohio, and
ED'WIN
J. THOMAS, Chairrnan of the Executive and tr'inance Cornrnittee of
Goodyear Tire & Rubber Company of Akron.
The Class A Directors, all of whorn are bankers, are;
RICHARD R. HOLLINGTON, President of The Ohio Bank and Savings
Cornpany in Findlay, Ohio, and also a member of a Cleveland law firrn.
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-
-4EVERETT D.' REESE, Chairrnan of the Board of The City National Bank
& Trust Cornpany of Columbus, who is the newest rnernber of the Board, and
SE\^/ARD D.' SCHOOLER, President of the Coshocton National Bank,
Coshocton, Ohio.
I rnight add that ïve have two branches -- one in Cincinnati and one in
Pittsburgh -- and each of these has its own board of directors, Once each
quarter all of us get together and exchange views and opinions - - rnuch as you
do
in the Elfun Society.
'we are
all justifiably proud of the rnen on our Board,
and we are
indebted to the rnany fine cornrnunities in the Fourth District that supply men of
such high character and accornplishrnent who serve so well the banking business
and the public.
The Federal Reserve Systern is not dependent upon the Congress for
appropriations. The Reserve banks rnake a huge profit, rnost of which, after
operating expenses and rnodest dividend and surplus requirernents, is turned
over to the United States Treasury, Last year our bank earned over $110 rnillion,
paid dividends of about fi?,9 rnillion, transferred $2.6 rnillion to surplus and
paid the rernaining $105 million over to the U. S, Treasury. The comparable
figures for all twelve Reserve banks are: earnings, $I.35 billion; divid.end.s,
$32
rnillion; transferred to surplus,
$27
rnillion,
about $1,3 billion.
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and paid to the
U. S. Treasury,
-5-
The assets of the tr'ederal Reserve Bank of Cleveland at the close of last
yeat totaled about $5.4 billion, and the total assets of the twelve banks in the
Systern aggregated $63
billion, Thus, our District represents about eíght percent
of the Systern totaL, We are the largest financial organizatíon in the District.
You rnight wonder where the rnoney cofiLes frorn that we operate on and
pay to the Governrnent. Only a very srnall fraction -- about 1.3 percent -con).es
from interest on loans we make to rnernber banks. The great bulk of it
coTnes
frorn interest on Governrnent securities that the tr'ederal Reserve banks,
operating as a Systern, have purchased in order to supply reserves to rnernber
banks,
Before I get into the techniques of rnonetary policy, I should like to
outline briefly sorne of the service functions perforrned by our bank for rnernber
banks, the U. S. Treasury, businesses and individuals. Most of the 1,435
ernployees at our rnain office and branches are engaged
in service operations.
Arnong these service departrnents are:
(l) Our Check Collection departrnent, which last year processed
4LZ rníLlion
iterns, with a face arnount totaling rrlore than $13I billion --
an
all-tirne high.
(Zl Our Cash departrnent, which in
and over $2.3
1965 paid out 4,500 tons
of coin,
billion in currency.
(3) Our Fiscal Agent departrnent, which perforrns rnany services for
the U. S. Treasury, including the issuance of E bonds for payroll plan savers,
the issuance and redernption of other Treasury issues, payñrent of coupons on
U. S. Treasury bonds, the collection of withheld taxes frorn ernployers,
the destruction of unfit Treasury currency.
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and
-6(41 The transfer of funds and U, S, Governrnent securities over private
wires of the Systern at a saving in tirne and cost to all.
(5) The safekeeping of securities owned by rnernber banks, and the
purchase and sale of Governrnent securities for rnernber banks and public bodies.
(6) The rnaintenance
of.
a
stafî. of
trained exarniners who rnake unannounced
detailed exarninations of state rnernber banks at least once a yeal , and
(7) The collection and distribution of research and statistical inforrnation
concerning industry and agriculture in the District.
So rnuch
Systern and our
for general background inforrnation about the Federal Reserve
bank. Now letrs turn to rnonetary policy - - the prirnary
responsibility of the Systern. We have three rnain tools as instrurnents for
irnpl ernenting rnonetary policy:
(l) Required reserve ratios, set by the Board of Governors in lü'ashington,
These are the percentages of their deposits that rnember banks rnust keep on
deposit with their Federal Reserve bank as reserves. The pïesent ratios for
dernand deposits
-- that is, checking account rnoney -- are 16 llZ percent for
large city banks and
12
percent for other banks (so-called country banks), and
4 percent of savings and tirne deposits,
for all banks. Any change in
the
required reserve ratios is a very rrbluntrr instrurnent. A change of one percentage
point, for instance, provides the basis for expansion or contraction of bank
credit of several billions of dollars. This tool, because it is so blunt, is used
very infrequently.
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1(Zl The discount rate, which is the rate of interest rnernber banks rnust
pay when they borrow frorn the
Fed. This rate is set by the directors of
each
of the twelve Federal Reserve banks every two weeks, subject to approval by
the Board of Governors. The present rate of.4lf 2 percent has been in effect
since Decernber, when it was raised frorn 4 percent.
(3)
Open
Market Operations. This is by far the rnost flexible and
frequently used tool for irnplernenting rnonetary policy. First I want to give
you a birdrs-eye view of the overall operation, and then, in sorne detail, give
you a tvorrnrs-eye view of what goes on behind the scenes in this irnportant
phase of policy rnaking.
Open rnarket operations are conducted by the Federal Open Market
Cornrnittee, which rneets in 'W'ashington every three weeks to deterrnine rnonetary
policy for the next three weeks. The Cornmittee is composed of the seven
rnernbers of the Board of Governors and five tr'ederal Reserve bank presid.ents.
The president of the New York bank
is a perrnanent rnember;
Chicago tr-eds alternate every other year -- currently, I
and the other nine banks rotate every three years,
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aryL
Cleveland. and
a voting rnernber --
8-
At
each rneeting the Board rnembers and Federal Reserve bank presidents
summarize the credit needs of the econorrry as seen frorn their respective areas
and vantage
points, A consensus is then agreed
upon by the voting mernbers and.
a directive is given to the Manager of the System Open Market Account, who
operates frorn New
York. To ease credit he buys Governrnent gecurities in
the open market, thus increasing bank reserves; to tighten credit he sells
securities, thus decreasing bank reserves, Each $l million of Governrnent
securities purchased in the open rnarket provides a reserve base for an
expansion of about $7
million in demand deposits, or for about $25 rniltion in
time deposits. Because of these high
e>rpansion
ratios, deposits held at the
Federal Reserve banks by member banks are called "high-poweredrr money.
The CommitteerE work iE basic to the main task of the Federal Reserve
System, which iE to establieh money and credit conditions that will help to
achieve the broad economic goals of our country, These goals are a healthy
expandlng economy' etable
prices, maximum employment, and a favorable
balance of paymente,
I would llke now to give you
Eome idea of how we do the
job -- how we
formulate moRetary policy to achieve national goals, and then how we implement
It. I wtll
toueh upon the framework of policy making, how decÍsione are made,
the flow of lnformatlon that aupports the policy-making proceBs, the role of
decentrallzatlon or reglonallam, and how I, ae preaident of the Cleveland bank,
flt into the general plcture,
Although my role seeme important to me, I am
actually a very emall part of a very large organization. ürhat I am about to telt
you can thereforo beet be interpreted ae a'JyormrE-eye view of central banking.
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At the center of the policy-rnaking process, as I have indicated, is
the
Federal Open Market Cornmittee, cornrnonly called the FOMC. ïrhile only five
of the Reserve bank presidents are voting rnernbers at any one tirne, all twelve
of the presidents are expected to attend the tri-weekly rneetings of the Cornrnittee
for two reasons: First, to keep the Cornrnittee fully inforrned. of what is
on in the various
going
Districts and, second, to assure that the Cornrnittee will
have
the rnost cornpetent regional thinking on the forrnulation of rnonetary policy.
Each president cornes to the rneetings
fully briefed by his research
staÍ.Î; each president has tapped the knowledge and judgrnent of rnernbers of his
board of directors and of his branch boards of directors; each president, in
addition, regularly talks to business and banking leaders in his area, who often
contribute irnportant insights into business and financial developrnents as they
occur, and sornetirnes
even before they
occur -- in either event, well before
they are reported in the national statistics cornpiled in 'Washington.
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The presidents thus bring a wide variety of background inforrnation to the
FOMC rneetings, where this rnaterial
is fused with other rnore global, or
aggregative data, to serve as a basis for official policy. I rnight add that each
president has his own point of view -- whether it is in interpreting current
developrnents
or in judging what policy ought to be.
lü'hen the FOMC
finally
reaches a consensus -- after all the presidents, the governors, and the
official staff have had their say -- it is, in rny opinion, a reasonable
and
balanced judgrnent, based on the very latest and rnost detailed inforrnation
available throughout the nation. Also, in rny opinion, the functioning of the
FOMC'is an outstanding exarnple of how a decentralized and regional systen). can
contribute to sound and balanced policy rnaking for our vast and cornplex nation.
The presidents are close to the grass roots and have a close feel of the local
situation, The national board in
lvV'ashington
is near the processing centers
for the preparation of broad aggregative data, and is adept in interpreting
these m.easures. Thus, policy is forrnulated on the basis of both local and
national inforrnation, of both specific and general data, On the whole, this
systern has worked well and has contributed irnportantLy to our countryrs growth
and stability,
Frorn rny own personal standpoint, I feel strongly that I have a very
serious responsibility as a rnernber of the f'OMC -- as do the other presidents,
and, of course, the rnernbers of the Board of Governors. I feel it is rny duty to
go
to l{ashington as futly inforrned and as well prepared as possible, within rny
physical and rnental lirnitations.
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-11The focus of
all this rnight be clearer to you if I told you how we at the
Cleveland bank prepare f.or a rneeting of the FOMC. Our procedures here are
really quite sirnple to describe. Although we continuously study the course of
econornic events, about a week before each F OMC rneeting
\áe
rnove into high
gear. The research staff prepares a conrprehensive, up-to-date background
report on econornic developrnents - - locally, nationally, and internationally.
The essence of all of this is sirnmered down and distilled into a fifteen-page
surlrm.ary, which rny staff has dubbed the rrtri-weekly" (to reflect the frequency
with which they have to prepare it), Special mernoranda are also prepared by
individual staff rnernbers on topics that appear to be of overriding and tirnely
significance, for exarnple, on prices, quality of credit, and so forth. In
addition, the staffs of the Board of Governors in lü'ashington and of the New
York Reserve Bank send us reports on significant econornic developrnents at
horne and
abroad, Thus we have a cornprehensive evaluation of national
and
international developrnents, and a close reading of regional developrnents as
well. Our research departrnent rnakes a particularly detailed analysis of
regional industries that are of rnajor significance in interpreting national
developrnents; for exarnple, steel, autos, rnachine tools, and the like,
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_LZ_
The staff is always trying to develop new techniques of analysis and
special or
ne\á
kinds of data to irnprove our evaluations -- sornetirnes as
a
result of rnyrrneedlingrr, but more often on their o\Mn. For exarnple, they
have developed, with the cooperation of rnajor steel producers in our district,
a special series on new orders for steel. This gives us advance inforrnation
as to what steel production and shiprnents will be in the rnonths to corne; and
you know how important the steel industry is in explaining cyclical swings in
the econorny, as well as for the health of our part of the country,
In addition to these intensive studies within our shop, rnernbers of our
staff rnaintain close contacts and have rnany discussions with business and
banking people outside of our organization, other econornists, rnarket research
analysts, and the like, Our senior staff rnernberg, in particular, attend many
rneetings with their counterparts in other organizations. Once a week they
lunch with l5 or Z0 other Cleveland econornists, to exchange views on current
developrnents and trends; once a rnonth the five
or six cornrnercial bank
econornists in Cleveland corne to our bank to exchange views on financial and
banking developrnents; once every quarter Fourth District industrial econornists
spend
a day at the bank reviewing in depth developrnents throughout the region
and the
nation. There are firany other contacts too nurnerous to rnention.
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All of these bits and pieces flow together in
a m.ore
or less steady
strearn to provide a deep reservoir of inforrnation that goes into the rnaking
of rnonetary policy. The various and sundry parts are put into a cornprehensive
whole, usually beginning on the Thursday prior to the FOMC rneeting, when I
sit
down with the
First Vice President and senior research officers to focus
on the rnaterial that we have at
on
hand. I have fiÌy own views, which I test
thern, And, of course, I listen to others in the group. In effect,
we
harnrner out (and I use the wordrrharnrnerrradvisedly) a point of view -- a
consensus
-- of what we think the econorny is doing and what we feel would be
appropriate rnonetary policy, In the end, of course, I arn the responsible
party, but I donrt reach rny conclusions alone,
After the Thursday rneeting, a draft of a position paper is prepared.
lffe then reconvene on Friday and work on the draft, arriving at what we hope
is a cogent, well-reasoned and analytically
sound position paper to be used
at the FOMC rneeting on the following Tuesday. If new or different inforrnation
becornes available before then, appropriate changes
are, of course, rnade in
the docurnent, sornetirnes late into the evening of the night preceding the
rne eting.
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-14-
I have discussed our procedures in
soñLe
detail because they convey,
to me at least, the true strength of the Federal Reserve Systern -- the fact
that we are dealing with Í.act, not fancy or fiction. Our procedures allow us
to check, to review, and to assess, not only what is happening in the
econorrry,
but as well, the irnpact of Federal Reserve policy on business, banks, and
other financial institutions. The lateness of the publication dates of rnost
national statistics is reason enough for us to operate as we do -- we need to
know about things prornptly as they unfold
-- in î.act, even before they unfold,
if at all possible. Also, we need much rrlore detail than is provided by the
national statistics.
With sirnilar procedures being followed at other Reserve banks and at
the Board of Governors, it is not surprising that the deliberations of the
Fed.eral Open Market Cornrnittee are detailed and enlightening. In rny own
case, I feel strongly that I arn contributing to these deliberations on policy
rnaking, If I didn't, I would not be at the Cleveland bank. It is the very nature
of what I have described that convinces rne of the strength of our regional
dec
entralized systern.
In a sirnilar sense, the case is very strong for keeping the Federal
Reserve independent. Independence of the Federal Reserve is essential to
keeping policy rnaking outside of the political arena. Moreover, the cornplexity
of our econornic affairs argues strongly for the type of objective process that
we have.
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-15 -
lllndependence,
llof course, does not m.eanrlaloofness.rr The tr'ederal
Reserve is not independent of the Federal Governrnent -- but is only independent
within the Governrnent. The Federal Reserve has been delegated the responsi-
bility for carrying out rnonetary policy by the Congress; but that delegation
does not cover
all phases of governnì.ental activity affecting the econornic and
financial clirnate. For exarnple, the Treasury has vast pov/ers in the international field and it is absolutely essential that the Federal Reserve and the
Treasury work closely together on rnatters affecting international finance, the
international balance of payrnents, and our gold position. Furtherrnore, it
is essential that the Federal Reserve
and the Treasury both conforrn to the
requirernents of the foreign policy of the United States as established by the
President of the United States and his Secretary of State. The Treasury is
also the biggest borrower in our country, and in our operations in the money
rnarket we can no ñrore ignore the needs of the Treasury than a cornrnercial
bank can ignore the needs of its irnportant custorners.
The independence that we have in the Federal Reserve Systern, our
regional structure, and the heavy and sobering responsibilities which the
Systern bears, account
5Z years
for a large part of the successful record of the past
-- and our healthy influence on the nationrs economic life. It also
helps to explain the fundarnental strength and resilience of the Federal Reserve
Systern as well as the high caliber of the people who serve
Thank you all very rnuch.
it.
@FedFRASER