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

before the
Joint Economic Committee

February 6, 1958

As always, Mr. Chairman, the Board of Governors welcomes these
discussions with your Committee.
Only five years ago, we were exploring the role of credit and
monetary policy in some detail and at some length with a subcommittee of
this Committee charged with making an inquiry into "Monetary Policy and
the Management of the Public Debt: Their Role in Achieving Price
Stability and High Level Employment."

You will recall that one of the

issues was the potential contribution of flexible monetary policy in
fostering balanced and orderly economic growth.

In our presentation,

we emphasized that flexible monetary policy could make a positive con¬
tribution to stable economic growth, indeed was indispensable to it,
though it could not do the whole job. Although monetary policy was only
one of the instruments available to Government policy to help carry out
the objectives of the Employment Act of 1946, it needed to be used if
we were to have tolerable success in meeting those objectives.
In administering our responsibilities since that inquiry we
have endeavored at all times to adjust our policies affirmatively and
promptly to the changing economic situation. We have consistently acted
to encourage such credit and monetary expansion as would be needed by a
growing economy without inflation. We have resisted inflationary
pressures by credit and monetary restraints whenever such pressures
have mounted. We have relaxed restraints and made bank credit more
available and eased credit conditions generally whenever inflationary
tendencies have abated.


Anti-inflationary policies and anti-deflationary policies are
inseparably linked.

To achieve maximum success in contributing to

stability, Federal Reserve policies, and indeed all types of government,
as well as private, actions, must resist excesses on the upside if they
are not to complicate the adjustment process on the downside.

On the

other hand, excessive stimulus during recession can jeopardize long-run
Throughout the period since flexible credit and monetary
operations were resumed in early 1951, we have endeavored to shape our
policies continuously in accordance with basic economic forces and
conditions. The economic situation, to be sure, has been influenced in
some degree by our policies, but it has not been created by them.


other forces are also at work in a dynamic enterprise economy.
This background is relevant to an understanding of more recent
developments. A year ago when I testified before your Committee,
economic conditions were characterized by strong inflationary pressures.
This was exemplified by the substantial rise that was occurring in gross
national product measured in current dollars compared with the relatively
modest increase that was being experienced in product measured in constant

In spite of the preceding credit and monetary actions that had

been taken, money was losing its value at a pace that was a matter of
deep concern to all.
Inflationary excesses had clearly gotten ahead of us and the
economy stood in danger of an inflation crisis. The adjustment problems
that the economy Is confronting today are the aftermath of those excesses.

-3In retrospect, none of us participating in economic decision-making
adequately appraised the speed and force of inflationary boom.
credit rose substantially in 1955•


Businesses vastly increased their

expenditures for plant and equipment in 1956 and 1957•

Bankers and

other lenders greatly expanded their commitments to lend.

Labor unions

sought current wage increases—and commitments for future increases-that pressed against or exceeded gains in productivity.


inflationary trends seem to have halted before creating maladjustments
of such severity to lead to a protracted period of liquidation and
structural realignment in the economy.
Inflationary trends continued through the summer months of
last year. There was an alarming spread of the belief, not only in
this country but also abroad, that creeping inflation under modern
economic conditions was to be a chronic and unavoidable condition.
Reflecting this view, common stocks, the most popular hedge against
inflation, rose sharply in price in July to a level where for the
first time in two decades their yields fell below the yields on
high-grade bonds. Also, credit demands generally continued to show
great strength, and interest rates were rising.

Large city banks

on August 7 raised their lending rate to prime business borrowers
from 4 to 4-1/2 per cent.

In this situation, Federal Reserve Bank

discount rates, which were below market rates by a widening margin,
were raised from 3 to 3-1/2 per cent, thus increasing member bank
costs of operating on the basis of borrowed reserves.

In late summer and early autumn, however, developing
uncertainties here and abroad began to affect the short-term economic

In European exchange markets, widespread expectations of

changes in exchange rates fostered large speculative movements of funds
between European centers. These expectations in part reflected further
accentuation of inflationary developments in some key countries,
despite actions to tighten credit that were taken in various countries
during the summer.

It was not until late September, after the Bank of

England established a 7 per cent discount rate, that it became clear
that key foreign currency values would be maintained and that inflation
would be strongly resisted.
In this country, the unexpected curtailment in defense payments
and changes in procurement policies that were inaugurated during the
summer, to avoid breaking through the debt ceiling, had an unsettling
effect on business.

In September, retail trade, which had been at

record levels in July and August, began to show signs of sluggishness
and this continued.

Partly as a result of all of these developments,

common stock prices, which had already begun to react from their
extremely low yield relationships to bonds reached in July, broke
further and passed in late September through the lower edge of the
trading range that had prevailed during the past two years. With
changing attitudes toward the economic outlook, adjustments that had
been occurring for some months in various lines of activity, including
some capital goods lines, came to be reappraised by businessmen,
investors, and the public generally.

In contrast to earlier indications

-5of strong credit demands, bank loans to "business during early autumn
decreased contrary to usual seasonal tendencies.
The pace of business was maintained for a time despite these
uncertainties, with employment and industrial output continuing at
relatively high levels in August and September. By late October,
the composite of most recent economic information suggested that
inflationary pressures might be abating, and open market operations
were modified to lessen restraint on bank credit and monetary expansion.
By mid-November, information becoming available, incomplete though it
was, indicated that general downward adjustment was setting in.


response to this evident change in basic economic conditions, Federal
Reserve Bank discount rates were reduced from 3-1/2 to 3 per cent.
Since that time, other successive System actions were taken
in accordance with information increasingly indicative of the emergence
of recessionary trends. Thus, monetary policy contributed to a marked
easing in the credit and capital markets. This is illustrated most
dramatically by the very sharp drop in market rates of interest, the
sharpest drop for any comparable period of which I have knowledge.
This adjustment in credit and capital markets is helping to facilitate
and cushion other adjustments in the economy as well as to strengthen
demands in important areas dependent on credit financing.

It is thus

helping to set the stage for recovery in activity and employment as
soon as other developments contribute to revival.

-6History shows that cur market economy has cyclical characteristics,
and the consequences of this irregularity in terms of hardship and un¬
employment are a matter of deep concern to everyone. When downward
readjustment becomes unavoidable, it is incumbent on business enter¬
prises, financial institutions, and labor organizations, as well as
Government generally, to adjust policies and programs to foster recovery.
We have been concerned, for example, at the decline in output and
employment while prices generally have been maintained and some prices
even have risen further. How soon recession is checked and recovery
is resumed will depend in some part at least on the speed with which
economic corrections and adaptations are made in factors beyond the
province of monetary policy, that is to say, in business pricing,
other selling practices and efficiency, in wage bargaining, in various
financing arrangements, and in the incentives to consumers to buy.
These general remarks are by way of introduction, for you
have requested in advance that I address myself today to four major
questions. The balance of this statement is concerned with answers
to these questions, but I have rearranged the order in which I will
take them up.


"What is the current policy of the monetary authorities?"
In recent months, the Federal Reserve System has operated to

make bank and other credit more available and cheaper.
Over this period, open market and discount policies were used
in a complementary fashion.

Open market operations provided sufficient

reserves to permit member banks not only to repay a substantial portion
of their indebtedness to the Reserve Banks, but also to accumulate some
addition to reserves available for bank credit expansion.


rates were lowered on two occasions, mid-November and mid-January, from
3-1/2 to 2-3/4 per cent. These reductions in discount rates assured
member banks that, if loan operations should require temporary borrowing
of Federal Reserve credit for reserve purposes, its cost would be cheaper.
As a result of these developments, bank credit, capital market
credit, and mortgage credit, have become more readily available to
borrowers who have delayed or postponed financing as well as to borrowers
seeking to finance new projects. Furthermore, the cost of credit has
been reduced as a result both of lower rates of interest and more
favorable terms of borrowing.

These conditions are favorable to

monetary expansion.
At the end of 1957, total customer credit for purchasing and
carrying securities was 10 per cent less than the amount outstanding at
midyear and back to the level of early 1955. Thus, the need for pre¬
venting an excessive expansion of stock market credit through the higher
level of margin requirements had abated.

The Board of Governors in

mid-January reduced margin requirments for purchasing or carrying listed
securities from 70 to 50 per cent.


"What would you regard as the proper division of labor between tax
policy and monetary policy as instruments of economic stabilization
during the coining year?"
From the standpoint of economic stabilization, tax policy needs

to be reviewed in relation to expenditure requirements. Therefore, it
is appropriate to consider monetary actions in the perspective of general
fiscal policy rather than just tax policy.
The combination of fiscal and monetary policies that are appro¬
priate at any particular time depends upon the circumstances prevailing
and upon the feasibility of action in one field or the other. These
policies are most effective in achieving their purposes when utilized
in a complementary fashion. Yet, to an extent, each can be used in
varying degrees independently of the other.
Fiscal policy is less flexible than monetary policy. Never¬
theless, the so-called built-in stabilizers in the Federal Budget do
come into operation promptly. As personal income and corporate profits
decline, tax collections relatively decline more sharply. At the same
time, unemployment insurance payments increase. These features of the
budget and fiscal system are already operating to cushion the reduction
in private incomes and expenditures.
Whether further action is desirable in either or both of these
fields depends on the unfolding economic and financial picture. As of
the present, the division of labor between monetary and fiscal policy
is about as follows. Through the automatic stabilizers, fiscal operations
have provided some offset to the decline in incomes and expenditures.
Monetary policy has actively increased the availability and lowered the
cost of credit, thereby encouraging loan-financed expenditures, raising
capital values, and enhancing liquidity throughout the economy.



"What, if any, elements exist in the current situation which suggest
or might permit a resurgence of inflationary forces in the next 12
or 15 months?"
In retrospect, it is now clear that economic activity in the

United States reached a peak in the third quarter of 1957 and that it
has been receding since then. Thus far, the downward movement has been
reminiscent in many ways of the declines that occurred in 1948-49 and
in 1953-54. The early stages of all three postwar cyclical contractions
have been marked by rather rapid declines in output and employment in
industrial sectors.

It may be remembered that the two preceding

contractions were moderate and short-lived.
Resurgence of inflationary forces in the next 12 or 15 months
is contingent on general revival of demands, output, and employment; on
the vigor of such a revival; on institutional forces such as wage
bargaining, cost plus purchasing practices, and easy credit terms that
may foster price advances; on market pressures of demand in relation to
supply in particularly strategic areas; and, finally, on the nature and
timing of governmental actions to deal with the developing economic
situation generally or with key sectors of it.
No one can speak with certainty about the future course of
economic activity.

There is, in fact, a range of views currently held

regarding the duration and extent of this recession and of the timing
and vigor of the ensuing recovery.

In my own view, the underlying

strengths of the economy are many. After not too long a period of
readjustment and realignment of activities, healthy revival should set
in, progressing to new records of economic performance and new high

-10levels of national well "being. But everything depends upon the speed with
which needed readjustments and realignments of activities are made.
We are all, of course, well aware that reasoning by analogy
may be misleading and that history does not repeat itself.

In the two

preceding postwar recessions, lows in activity were reached in less than
a year from the cyclical peak and recovery to new high levels of output,
demands, and employment was rapid and substantial. With the exception
of the catastrophic depression of the early 1930 ! s, the downward phase
of every cycle since World War I has been over or virtually over in the
course of a year.
As in our other postwar recessions, many basic forces are
present in the situation favorable to recovery.

(1) For instance, as I have already mentioned, credit and
capital market conditions have already responded to
relaxed monetary policy and are much easier than they
were a few months ago. Important financial adjustments
also have already been started. By borrowing from the
capital market, business firms have been able to repay
bank debt, thus rebuilding the liquidity positions of both
financing institutions and business enterprise.
(2) Consumer incentives to achieve still higher standards
of living are strong, and research continues to provide
new products of wide consumer appeal. As a group,
businessmen and consumers continue to have confidence
in the long-term growth prospects for our economy.

-11(3) Population increase has been maintained at a rapid
pace--the rise of 1.8 per cent in 1957 compares with
a postwar average of 1.7 per cent, and hence the market
is expanding steadily.
(4) Consumer incomes have shown some cyclical decline
recently, but the decline has been small and moderated
by unemployment compensation benefits. Consumer
demands are supported by a record volume of financial
assets, the ownership of which is widely distributed.
Growth in such assets was rapid in 1956 and 1957, while
growth in consumer instalment and mortgage debt, though
not small, was at a much slower rate than in 1955. The
availability and terms of mortgage credit have recently
become more favorable to borrowers.
(5) At the State and local government level, community
demands for schools and teachers, for roads, public
buildings, and other community facilities are continuing
large and insistent.
(6) For the Federal Government, postwar budgets have been

dominated by the need to cope with critical international
stresses and tensions and to provide an adequate defense
under conditions of major scientific advance and rapid
technological change. National security and related
problems continue to be urgent.


(7) Insofar

as international economic developments are con¬

cerned, Western Europe still shows considerable strength.
Industrial activity, while no longer expanding, has
generally been maintained at or close to record levels.
In general, balance of payments positions have improved
although in several countries reserves of gold and
foreign exchange are not as large as might be desired.
Outside Europe, however, raw materials producing
countries are facing difficulties because of declines
in prices or volume of their exports.
A primary uncertainty with respect to the timing and pace of
economic revival and renewed growth relates to the course of business
outlays for new plant and equipment. Some observers view the business
capital goods boom of the past three years as having provided a margin
of industrial capacity over prospective demands greater than can be
absorbed quickly.

These observers tend to expect a more protracted

period of adjustment than took place in the two preceding cycles.
This concern may turn out to have been well founded, but it
may be noted that capacity never appears more excessive than in the
midst of recession.

Cyclical recovery, in due course, can certainly

be expected to be accompanied by effective and profitable use of the
economy's capacity to produce and by still further additions to
capacity. The important factors working to expand business capital
investment in the period ahead should not be minimized.

The advance

in the technology of production, in part the result of the huge

-13investment in research of recent years, has been rapid and can be
expected to continue.

Incentives to reduce costs, to meet competition,

and to sustain or improve profitability, are strong.
If revival in over-all economic activity becomes vigorous,
there will be, of course, the accompanying possibility of resurgence
of inflationary pressures. Postwar experience has demonstrated that,
in a period of expanding demand, upward pressures on prices and costs
can develop quickly.

Once under way, inflationary movements tend to

spread themselves throughout the economy, not only because of normal
market reactions, but also because of a variety of institutional arrange¬
ments such as cost-of-living clauses in wage contracts and cost-plus
arrangements in business or Government procurement contracts, in part
designed to protect one group or another from the ill effects of

Currently, it may be noted, consumer prices reached a new

high in November and remained at that high in December, notwithstanding
significant declines in activity and employment.
As I said earlier, those charged with responsibility for
national economic policies must at all times reckon with the dangers
both of inflation and of deflation. The central policy problem, in
one sense, is to prevent either inflationary trends or deflationary
trends from becoming dominant. Public policies for one objective
or another can have effects that go far beyond those that are intended.
Both fiscal and monetary policies must be carefully formulated to
exert enough pressure but not too much. That is a difficult task.


"If the inflationary forces continue to abate during the year, what
program would you recommend as to priority and specific actions in
the fiscal and monetary fields?"
Everyone hopes that any recession will "be moderate and short¬

One possibility for the year ahead is that revival may
develop without renewed inflation, at least in its early stages.
Under such circumstances, the task of monetary policy would be to
foster revival and resumed growth, but to be ever alert to the
potentials of inflationary pressures and to take prompt action should
they recur.
Another possibility is that recession may be deeper and more
protracted than many now anticipate, with a greater degree of underutilization of manpower and industrial resources and with manifest
deflationary tendencies.

In such an eventuality, further monetary

action would need to be considered, both to increase the liquidity of
the economy and to encourage expansion of spending financed by credit.
Monetary policy by itself, however, cannot assure resumption of highlevel employment and sustainable economic growth, although ready
availability of credit at reasonable cost is an essential condition
for recovery.
This country is now in the process of re-evaluating what
share of its potential productive capacity to devote to current con¬
sumption and what share to devote to investment in its future—in the
form of outlays not only for defense and capital equipment but also
for research, education, and foreign assistance.

This process of

-15reappraisal will continue for some time and in our thinking we ought
not to forget the enormous growth potential that we have over the
longer run and the need that we shall have for an adequate volume of
savings to finance it.
With respect to fiscal policy, should the present recession
appear to justify some action in this field, I should like to emphasize
that we should weigh carefully both the need to meet the challenge to
our defensive strength and the need to keep our economy strong and