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Statement of
William McChesney Martin, Jr.
Chairman, Board of Governors of the Federal Reserve System

before the
Committee on Finance
United States Senate

April 22, 1958

The Battle Against Recession

Since my appearance before this Committee last August, the
United States economy has passed from an inflationary to a recessionary
phase of the "business cycle. For the third time since World War II the
strong growth trend in this country has been interrupted by a downturn.
The troubles now confronting us are traceable in many respects
to the excesses of the preceding three-year boon with its creeping inflation
Recession as an effect of boom
Between the summer of 1954 and the summer of 1957 real output
of goods and services in the United States increased about 12 per cent.
But prices also rose

Consequently, the dollar value of total output, or

gross national product, increased 22 per cent. This gap of 10 per cent
between the real and monetary increase in total product roughly gauges
the magnitude of the inflation in that period.
The three-year expansion of the economy represented at first
recovery from the 1953-54 recession, sparked by active consumer buying
of houses and automobiles. This surge of consumer buying, which was
encouraged by the ready availability of mortgage funds and consumer
instalment credit on sharply eased terms, was followed by a wave of
business spending for plant and equipment that transformed the 1954-55
upswing into a boom.

The classic acceleration principle of business cycle

history found confirmation once more.

In the process, inflationary

pressures were generated as aggregate demand came to press against
productive capacity.

The upward price movement so generated received

further impetus from the mutual interaction of prices and costs.

-2The current recession is a reaction to both the investment boom
and the inflation which accompanied it. The growth of business capital
spending beginning in early 1955 was at a rate that was unsustainable.
An economy with a long-run upward growth trend of about 3 or 4 per cent
per year cannot sustain for long an increase in business investment of
about 10 per cent per year in real terms, such as we experienced in 1955-56.
The investment spending, even if prolonged by inflationary trends, had at
some point to slow down.
Throughout our economic history, investment spending has tended
to come

in waves, closely associated with cyclical variations in over-all

economic activity.

These periods of rapid growth in our capacity to

produce have been followed by cutbacks in investment spending, usually
with secondary effects on total incomes and output. One of the goals of
stabilization policies is to attempt to mitigate the effects of such cycles
without inhibiting underlying growth forces.
In the 1955-57 investment boom, inflation aggravated the tendency
toward overexpansion as well as the subsequent decline.

Inflation, as I

have said, was the result of an excess of total demands at existing prices
over what the economy was producing, and apparently able to produce under
the existing organization and use of resources. But once prices started
up and expectations of additional price and cost increases were engendered,
spending was stimulated further. With prospective costs rising, business
had every incentive to enlarge its productive capacity at today's rather
than tomorrow's prices. And when investment plans are made on this basis,
a certain amount of uneconomic productive capacity is likely to be created;
that is to say, capacity which does not reflect a basic pattern of demands
undistorted by expectations of rising prices.

-3Monetary policy in the boom
In cyclical processes, monetary management has a responsibility
to use such powers as it possesses over economic events to dampen excesses
in economic activity.

If this responsibility is exercised wisely and

effectively, it should help to foster a relatively steady and sustainable
rate of economic growth and longer term price stability.

Perfection in

monetary management and economic stabilization, however diligently sought,
is unattainable.

Nevertheless, over the years progress has been made and

further progress will be made.
Last August monetary policy was in a restrictive posture, as
it had been for two years. As I stressed before this Committee at that
time, the inflationary pressures that had developed in the boom had also
given rise to the disturbing notion that creeping inflation had become
an inevitable condition of modern economic life. This idea took nourish¬
ment from the steady upward movement in consumer prices in 1956-57 as
well as from the substantial rise in all prices since prewar years. The
creeping inflation idea was, in turn, conspiciously reflected in the sharp
rise in prices of common stocks, the most popular hedge against inflation.
Thus in July 1957, for the first time in two decades, the average dividend
yield on stocks was bid below the average yield on high grade corporate
In that atmosphere, Federal Reserve discount rates were raised
one-half percentage point in August in order to relate them more closely
to market rates which had been rising for some time and in this way to
maintain their effectiveness in restraining bank credit and monetary

That action also served as an indication to the business and

investment community that the Federal Reserve rejected the idea that
creeping inflation was inevitable.

-4On the financial side, the three-year expansion under conditions
of monetary restraint had reduced markedly the liquidity of the "business
community and of the commercial banks. The money supply had increased
but little after 1955.

Its velocity of circulation, however, had

quickened appreciably; that is, money holdings had been lowered in
relation to the growing gross national product.

Indebtedness of consumers

and businesses had increased relative to incomes.
Inflationary sentiment was a factor not only in the domestic
economy but in other industrial economies as well. Widespread expecta¬
tions had developed in world markets that failure to arrest inflation in
key countries, especially in Europe, would result in important changes
in international currency values. Despite actions taken by various
countries over the summer to strengthen their anti-inflation programs,
speculative movements of funds continued to dominate exchange markets.
The crisis was not resolved until late September, after the Bank of
England raised its discount rate from 5 to 7 per cent and the German
Bundesbank, almost simultaneously, lowered its discount rate from 4-1/2
to 4 per cent, thereby lessening the incentive for short-term funds to
move from sterling into deutschemarks. These actions made it clear
that inflationary trends would be strongly resisted and that key foreign
currency values would be maintained.
We are now aware that the economy was to reach a cyclical
turning point in the fall.

This is not to say that there were no earlier

signs that the economy might be getting into an overextended position.
This was shown by a fall off in new orders for machinery and equipment

-5in the earlier months of 1957 and by the development of a margin of excess
capacity in some key industries.

In the spring, however, consumer buying

took on renewed strength as business investment was being maintained,
encouraging expectations of further economic expansion and of continued
upward price pressures. Consumer buying, particularly of nondurable goods
and services, rose through August.

On balance, it looked as if an extension

of rolling adjustments at a high level of activity would continue to be the
During the fall, expansive forces gave way and downturn set in.
Business inventory holdings had been at a high level for a long period in
which the price trend had been upward.

Hence, they were vulnerable to the

emergence either of eased conditions of supply or of relaxed market demands.
This occurred as Government defense orders, which had been expanding in
the spring, were cut back in the summer and fall to conform to the budget
program and the ceiling on public debt. At the same time a decline in
business spending for plant and equipment set in, in recognition that
productive capacity had risen more rapidly than final demand and output.
Monetary policy and recession
As evidences of downturn developed the Federal Reserve System
began to alter the course of its policies.

In the latter part of October

and early November, open market operations were used to relax somewhat
pressures on commercial bank reserve positions.

In mid-November, a one-

half point reduction in discount rates signaled a decisive change in
System policy.

From this point on, restraints on bank credit expansion

were progressively relaxed.

-6Through the first quarter of this year, as reserves were provided
through open market operations and by two reductions in reserve require¬
ments, member banks reduced their indebtedness at Reserve Banks and
accumulated some excess reserves. Between September and March, member
bank borrowing at the Reserve Banks declined from about $1 billion to
less than $150 million, while excess reserves rose more than $100 million.
Thus net reserve positions shifted by almost $1 billion.

Discount rates

were reduced in two further steps and at the end of the quarter stood at
2-1/1+ per cent, compared with 3-1/2 per cent in the autumn.
Just last week the System took additional action to ease credit
conditions. Reserve requirements were reduced further, releasing about
$450 million from required reserves. Discount rates were lowered an
additional l/2 percentage point, bringing them to 1-34 per cent at
seven Federal Reserve Banks.
The easing of bank reserve positions has been reflected in a
substantial expansion in bank credit and an exceptionally sharp drop in
interest rates. Over the six months ending in March, for example, the
total of bank loans and investments has increased almost $5 billion.
In the corresponding six-month period a year ago, the growth of bank
credit was less than $1 billion.

The expansion of bank credit has been

mainly in the form of Government security holdings, and the effect has
been to enlarge holdings of cash balances and to increase the economy's
over-all liquidity. Aside from temporary spurts of bank loans to business
in December and March, business loans outstanding at banks have tended to
decline with economic activity.

However, loans on securities which provide

important support to the capital markets have risen.

-7As Federal Reserve policy has shifted from restraint to ease over
the past six months, financial markets have reacted strongly.


interest rates fell more rapidly in the three months following the first
reduction in Federal Reserve discount rates than in six months following
the 1953 turning point. By mid-April, Treasury, bill yields, an indicator
of the availability of funds in the money market, had declined to about
1-1/4 per cent, compared with more than 3-1/2 per cent in October.
Longer term market yields are down about three-fourths of a
percentage point. This decline has met with remarkable demand response
in the long-term security markets and the total volume of corporate, State,
municipal, and foreign borrowing has reached record levels.

In the first

quarter of this year, State and local governments issued $2-l/4 billion of
new securities. This was almost 25 per cent more than in the same period
of 1957 and represented a new record high for the quarter.


business raised $3.1 billion in new capital through the securities markets.
Although smaller than a year ago when business investment outlays were
still rising, this volume of flotations exceeded that of any other first
quarter on record.

New issues of foreign and international borrowers

amounted to an estimated $360 million, twice as much as in the first
quarter of 1957.
It should be stressed that the Federal Reserve has been pursuing
an active, not a static, policy and using all its instruments in the process,
as indicated by the attached record of policy actions since last fall.
Banks have been expanding their assets and deposits. Their reserve needs
have increased, requiring that their reserve positions be strengthened.
This has been done by means of open market purchases, lower discount
rates, and reductions in reserve requirements.

-8Thus, monetary policy has contributed to an increase in the
availability and a reduction in the cost of borrowed funds. This has
permitted a sizable expansion in bank deposits.

In this way monetary

policy is helping to increase the liquidity of the economy, which is an
essential financial prerequisite to recovery and renewed economic growth.
The problem of public policy
No one can predict with certainty the course of the present

It is already deeper than the two which preceded it. Never¬

theless , experience over the long history of the United States supports
the belief that, except for occasional cyclical readjustments, our economy
is one of continuing long-run growth and strength.

Hence, governmental

measures to deal with such cyclical readjustments ought to be shaped so
as to be consistent also with the longer run trend.
This is not a prescription for inaction or immobility at times
of recession.

It is, rather, a recommendation for discretion and

flexibility in selecting and implementing stabilization policies so that
measures undertaken to deal with today's problem do not aggravate those
of tomorrow. At the same time, public policy needs to keep alert to any
tendency for downward movements to become cumulative.
A second observation relates to the use of resources. As I
have said earlier, a part of our present problem stems from overexpansion
or misdirection of investment in particular lines of industry.

In some

cases, excess capacity exists in part because producers have misjudged
the market or the long-run rate of growth of demand for their products.
To some degree, this is inevitable in a free market economy.

It can be

-9mitigated, however, to the extent the Government is able to stabilize
aggregate demand around a steady growth curve and thus to provide a
general economic climate that facilitates shifts in resource utilization
as these are dictated by free markets.
The human problem
In discussing economic problems, we should never forget that
what we are really dealing with are human problems--human problems of a
very important kind.

In combatting inflation and deflation, what we are

really doing is combatting human misery that springs from economic causes.
Every recession is serious: this one and all the others that
preceded it. The best time to recognize that fact is before a recession
starts, for the best way to prevent a recession is to forestall the
inflation that precedes it. When the next economic turn comes, as
assuredly it will, let us try harder to remember that--and act accordingly.
Today we are concerned, and properly so, with fostering the
recovery everyone wants from a recession that nobody wants. That's fine.
But let's also keep in mind that, vital as it is to achieve recovery, it
is also vital to insure that it will be a recovery that lasts; a recovery
that does not merely provide ephemeral jobs, but lasting jobs.
We must recognize that enduring prosperity is not a question
simply of the dollar volume of spending.

It is also a matter of

equilibrium and balance of costs and prices within the economy.


prosperity rests upon the efficient production and distribution of goods
and services at prices that people are willing and able to pay.
to be earned.
anyone else.

It has

It can't be provided as a gift, by the Government or


Concluding observations
By fostering conditions conducive to prosperity, the Government
can help a lot. But it can't do it all. That is why the Employment Act
of 1946 pledges the Government's efforts to create and maintain "conditions
under which there will "be afforded useful employment opportunities, including
self-employment, for those able, willing and seeking to work."

And it is

why the same Act says the Government's efforts to that end shall be applied
"in a manner calculated to foster free competitive enterprise and the
general welfare."
Monetary policy is undertaking, within its inherent limitations,
to provide such a climate for recovery.

It is not omnipotent, but I can

assure you that the System is approaching the problem of combatting recession
with just as much vigor as it exhibited in battling inflation.

On both the

up and the down side of the business cycle, the System is striving con¬
stantly to

promote economic stability and growth.




Purpose of Action

1957-Mid-Oct.-System holdings of U. S. Govern¬
To increase the availability of
bank reserves for seasonal
ment securities increased by
purposes and also to cushion
$1 billion, including substantial
adjustments and mitigate
amounts of securities held under
repurchase agreement. Member bank recessionary tendencies in
the economy.
borrowings declined from an
average of about $1 billion to
an average of less than
$750 million.
1957--Nov.-Dec.Reduced discount rates from 3-1/2
to 3 per cent at all Reserve

To reduce the cost of borrowing
from the Reserve Banks and
eliminate any undue restraint
on bank borrowing in view of
the decline in business
activity and evidences of
economic recession.


Limited net reduction in holdings
To ease reserve positions by
of U. S. Government securities
absorbing only part of .the
to $900 million, more than half
reserves made available by
of which represented securities
the seasonal return flow of
held under repurchase agreement
currency from circulation.
at end of year. Member bank
borrowings declined to an average
of $450 million.


Reduced margin requirements on
loans for purchasing or carrying
listed securities from 70 to
50 per cent of market value
of securities.

Stock prices and the volume
of credit in the stock market
had declined to levels near
or below those prevailing at
the time of the previous
increase in requirements.



Purpose of Action


1958--Jan.-Feb. Reduced discount rates from 3 to


2-3/4 per cent at 11 Reserve





Reduced reserve requirements on
demand deposits from 20 to 19-1/2 )
per cent at central reserve city )
banks; from 18 to 17-1/2 per cent )
at reserve city banks; and from )To reduce further the cost of
12 to 11-l/2 per cent at country ) borrowing from the Reserve
banks, thus freeing an estimated ) Banks and increase further
$500 million of reserves.
) the availability of bank
) reserves in order to
Reduced discount rates from 2-3/4 ) encourage monetary expansion
to 2-1/4 per cent at 11 Reserve ) conducive to resumed growth
Banks and from 3 to 2-1/4 per
) in economic activity.
cent at one Reserve Bank.
Reduced reserve requirements on
demand deposits from 19-1/2 to
19 per cent at central reserve
city banks; from 17-1/2 to 17
per cent at reserve city banks; )
and from 11-l/2 to 11 per cent
at country banks, thus freeing
an additional $500 million of
Purchased about $450 million of
U. S. Government securities.
Member bank borrowings declined
further to an average of about
$180 million.

To supplement reserve require¬
ment actions in further
increasing the availability
of bank reserves-


Reduced reserve requirements on
demand deposits from 19 to
18 per cent (in two stages) at
central reserve city banks and
from 17 to 16-1/2 per cent at
reserve city banks, thus freeing
a total of about $450 million
of reserves.


'To supplement previous actions
1 to encourage monetary expan1
sion and resumed growth in
economic activity and to
offset recent gold outflow.

Reduced discount rates from 2-1/4
to 1-3/4 per cent at seven
Reserve Banks.