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TESTIMONY OF CHAIRMAN MARTIN B E F O R E THE JOINT COMMITTEE ON THE ECONOMIC R E P O R T , .. F e b r u a r y 7, 1956 On behalf of the Board of G o v e r n o r s , I should like to e x p r e s s a p p r e c i a t i o n of this opportunity to r e p o r t to you on the nation' s c r e d i t and m o n e t a r y developments during 1955. The P r e s i d e n t ' s Economic Report d e s c r i b e s in detail the g e n e r a l l y gratifying p e r f o r m a n c e of the nation's economy, except for a g r i c u l t u r e , over the p a s t y e a r and you have a l r e a d y had t e s t i m o n y dealing with i m p o r t a n t p h a s e s of the s u b ject. The only supplement I will offer for your background i n f o r m a - tion is a s m a l l c h a r t book of key s t a t i s t i c a l information on d o m e s t i c and international economic developments over the p a s t y e a r . My p r e p a r e d s t a t e m e n t will r e l a t e mainly to adaptations in F e d e r a l R e s e r v e o p e r a t i o n s in r e s p o n s e to the changing economic situation. In 1955 F e d e r a l R e s e r v e policy shifted from m a i n t e n a n c e of ease in the money m a r k e t to r e s t r a i n t of inflationary d e v e l o p m e n t s . During J a n u a r y , S y s t e m policy continued to be d i r e c t e d toward fostering r e c o v e r y , while maintaining conditions in c r e d i t m a r k e t s that would avoid u n s u s t a i n a b l e expansion. Beginning in F e b r u a r y , however, and for the r e m a i n d e r of the y e a r , a s o v e r - a l l d e m a n d s mounted, as i n d u s t r i a l output approached capacity and inflationary p r e s s u r e s a p p e a r e d , m e a s u r e s w e r e adopted to m o d e r a t e the pace of c r e d i t expansion. F e d e r a l R e s e r v e action sought to k e e p growth -2in bank c r e d i t c o n s i s t e n t with growth in employment and production. I n c r e a s e d c r e d i t demands e x e r t e d i n c r e a s i n g p r e s s u r e on bank r e s e r v e positions; b o r r o w e d funds b e c a m e l e s s r e a d i l y available to m a r g i n a l u s e r s , and i n t e r e s t r a t e s r o s e . In p u r s u a n c e of this policy of r e s t r a i n t on bank c r e d i t expansion, the R e s e r v e System reduced slightly over the y e a r its portfolio of United States G o v e r n m e n t s e c u r i t i e s . Commercial banks, in o r d e r to m e e t growing loan demands from t h e i r c u s t o m e r s , had to sell a l a r g e amount of Government s e c u r i t i e s to nonbank h o l d e r s . These banks a l s o i n c r e a s e d both the frequency and magnitude of their b o r r o w i n g from the R e s e r v e Banks* The fact that the banks found it n e c e s s a r y to b o r r o w did, in itself, i m p o s e some r e s t r a i n t on t h e i r lending activity. This r e s t r a i n t was r e i n f o r c e d by s u c c e s s i v e i n c r e a s e s in the discount r a t e s c h a r g e d by F e d e r a l R e s e r v e Banks on m e m b e r bank b o r r o w i n g . F o r the y e a r 1955 a s a whole, the r i s e in total loans and i n v e s t m e n t s of c o m m e r c i a l banks amounted to a p p r o x i m a t e l y $5 billion or about 3 p e r c e n t - - a s m a l l e r expansion than in 1954. L o a n s and i n v e s t m e n t s , excluding United States G o v e r n m e n t s e c u r i t i e s , r o s e by $12 billion or 15 p e r cent—the l a r g e s t growth of any y e a r since 1950, Through s a l e s and run-offs at m a t u r i t y , bank holdings of Government s e c u r i t i e s w e r e reduced by $7 billion, m a i n l y in s h o r t term issues. This shift from Government s e c u r i t i e s to b u s i n e s s and -3consumer loans caused bank liquidity to decline, which in turn worked to restrain bank lending. Like the increase in total bank credit, the rise in the .active money supply, namely, the demand deposit and currency holdings of consumers and b u s i n e s s e s , was moderate. For the year, the money supply rose about $3, 5 billion or l e s s than 3 per cent. The turnover of demand deposits outside leading financial c e n t e r s , however, rose from 19. 2 times a year in 1954 to 20. 4 t i m e s , or by 6 per cent reflecting more active use of existing money. Deposit turnover in financial centers was also faster than in 1954. As compared with 1954, the increase in time deposits in 1955 was much l e s s at c o m mercial banks and about the same at mutual savings banks. Growth in savings and loan shares was somewhat greater than in the preceding year. Nonbank sectors of the community, particularly business corporations, State and local governments, pension and trust funds, and individuals, added substantially to their holdings of United States Government s e c u r i t i e s , including the short-term i s s u e s sold by banks. This shift in ownership of Government s e c u r i t i e s represented a reversal of developments in 1954 when commercial banks added appreciably to their holdings of Government securities by market purchases from nonbank holders while increasing loans only slightly, Nonbank lenders also extended more credit to private borrowers in 1955 than in previous y e a r s . mortgage and Especially sharp was the rise in consumer credit. -4- Although policy actions of the Federal Reserve in 1955 tended to produce a gradually increasing degree of restraint over much of the year, most of the System's open market operations, including repurchase agreements with dealers in Government s e c u r i t i e s , sought to moderate the impact of seasonal factors on the money market. In January and February the System sold, or allowed to mature without replacement, $ 1 . 3 billion of United States Government securities. This was mainly for the purpose of absorbing r e s e r v e s made available by the seasonal return of currency from circulation and the reduction in required r e s e r v e s associated with the seasonal deposit decline. Since the declines both in currency demands and required r e s e r v e s were l e s s than usual for the season, some additional member bank borrowing from the Reserve Banks resulted. Borrowings, which averaged about $300 million in December 1954 and January 1955, increased to $500 million in March and April 1955. This change marked a shift in the emphasis of Federal Reserve operations from ease toward moderate restraint. During the second quarter of the year Federal Reserve operations in the Government securities market were small, and there was little net change in commercial bank r e s e r v e positions. In recognition of the rise in market rates of interest that had been occurring since the summer of 1954, the Federal Reserve Banks raised their discount rates in April from 1-1/2 to 1 - 3 / 4 per cent. -5The Board of Governors raised margin requirements for purchasing and carrying listed securities from 50 to 60 per cent in early January and again to 70 per cent in late April. The volume of stock market credit, which had risen sharply from early 1954 through the spring of 1955, thereafter expanded but little. In the early part of July, the System purchased Government securities to supply banks with r e s e r v e s to meet temporary seasonal needs, including Treasury borrowing in the market.. From mid-July to late September, the System's holdings of securities declined and member bank borrowing from the Reserve Banks rose in September to a daily average level of about $850 million, as compared with an average of $400 million in June. Interbank borrowing also increased during this period. In early August, discount rates were raised from 1-3/4 to 2 per cent at 11 Reserve Banks and to 2-1/4 per cent at the Federal Reserve Bank of Cleveland. The 2-1/4 per cent rate was established at all Reserve Banks by early September. Thus in this period, restraint on bank credit expansion was firmed. In late September, the System resumed purchases of Government securities. Between that time and the year-end more than $1 billion had been added to the Federal Reserve portfolio of securities, of which about $350 million were securities acquired under repurchase agreements. These operations offset seasonal drains on bank reserves and did not ease the money market. In mid-November, restraint on bank credit expansion was again strengthened by a further -6increase in discount rates to 2 - 1 / 2 per cent at all Federal R e s e r v e Banks, During the year, outright purchases of Government s e c u r i ties by the Federal Reserve were confined almost entirely to Treasury b i l l s . At the end of November, however, the System entered into commitments to purchase $167 million of new certificates when issued on December 8. The specific occasion for an acquisition of certificates rather than Treasury bills was to facilitate a l a r g e - s c a l e Treasury refunding operation in the face of a more stringent money market than was foreseen when the t e r m s of the Treasury refunding were decided upon. Another unforeseen circumstance was an unusually large volume of maturing i s s u e s held by investors desiring rash, which made them indifferent to the t e r m s of the exchange offering. Toward the close of the year, as is usual, additions to the System's portfolio consisted of temporary purchases of securities under repurchase agreements with dealers in Government s e c u r i t i e s . The purpose of these purchases was to moderate the effect on the money market of the exceptionally heavy volume of business and financial payments at the year-end. R e s e r v e s a l s o became available about this time through an unusually large and sustained seasonal increase in Federal Reserve float, which reflects the volume of credits to the depositing banks' r e s e r v e accounts for checks still in p r o c e s s of collection through the Reserve Banks. -7- At the year-end, the money market continued firm in tone because of the large demands for liquidity, the temporary nature of some of the r e s e r v e funds available to the market, and the effect of higher discount rates in keeping down member bank borrowings. In summary, the year 1955 was marked by the flexibility and adaptability that are essential in the administration of monetary policy if it is to play its proper role. Above all, t i m e l i n e s s is vital. In restrospect I think it fair to say that the transition of monetary policy from ease to restraint in 1955 was effected promptly as economic recovery was achieved and capacity output, accompanied by inflationary tendencies, was approached. I did not take part a year ago in your hearings on the Economic Report but the preceding February of 1954 I emphasized in my statement to you that the objective of Federal Reserve policy and action is to make available a volume of bank r e s e r v e s that will safeguard the economy from the over supply that makes for inflation or the under supply that makes for deflation. The exact amount of r e s e r v e s needed for this purpose is difficult to measure with fine precision ahead of t i m e . The goal is a growing economy and a rising standard of living for the nation. Monetary policy, closely coordinated with debt management, can contribute to the attainment of that objective but cannot by itself maintain the steady and sustainable economic p r o g r e s s we all wish -8to have. Responsibility for continued p r o g r e s s r e s t s not alone on Government, but upon the p r a c t i c e of prudence and self r e s t r a i n t on the p a r t of l e a d e r s h i p in b u s i n e s s and finance, in l a b o r , and in agriculture. The operation of free m a r k e t s m a y be counted upon to bring about many e s s e n t i a l a d j u s t m e n t s without the d i r e c t intervention of G o v e r n m e n t . The p e r f o r m a n c e of the economy in the l a s t few y e a r s j u s t i f i e s , I b e l i e v e , renewal of faith in m o n e t a r y action a s an i n d i s p e n s a b l e , though by no m e a n s omnipotent f a c t o r , in the o r d e r l y development of the economy under p r i v a t e e n t e r p r i s e i n s t i t u t i o n s . I continue to have that cautious o p t i m i s m about the future which I e x p r e s s e d h e r e two y e a r s ago. F o r your convenient r e f e r e n c e , I a m attaching to m y s t a t e ment a digest review of the P r i n c i p a l F e d e r a l R e s e r v e P o l i c y A c t i o n s , D e c e m b e r 1954 through D e c e m b e r 1955. P r i n c i p a l F e d e r a l R e s e r v e Policy Actions D e c e m b e r 1 9 5 4 - D e c e m b e r 1955 Date Action P u r p o s e of Action D e c e m b e r 1954 Made net p u r c h a s e s of U. S. Government s e c u r i t i e s in open m a r ket of l e s s than $50 million, all under r e purchase agreements with d e a l e r s and b r o k e r s . Member bank b o r r o w i n g i n c r e a s e d to an a v e r a g e of 250 million in December, To m e e t p a r t of the t e m p o r a r y e n d - o f - y e a r needs of banks for r e s e r v e funds, but in view of r i s i n g c r e d i t d e m a n d s , to p e r m i t t h e s e needs to be reflected in p a r t in slightly less easy reserve positions, January-June 1955 Sold in the open m a r k e t or r e d e e m e d U. S. Government s e c u r i t i e s totaling $ 1 . 3 billion. Member bank b o r r o w ing i n c r e a s e d to an a v e r a g e of m o r e than 400 million in the second q u a r t e r , To offset effects of s e a s o n a l f a c t o r s affecting bank r e s e r v e positions and, in view of strong c r e d i t d e m a n d s , to b r i n g about somewhat g r e a t e r m e m b e r bank b o r r o w i n g from Federal Reserve Banks. January 1955 Raised m a r g i n r e q u i r e m e n t s on loans for p u r chasing or c a r r y i n g listed s e c u r i t i e s f r o m 50 to 60 p e r cent of m a r k e t value of securities. Raised m a r g i n r e q u i r e m e n t s on loans for p u r cashing or c a r r y i n g listed s e c u r i t i e s from 60 to 70 p e r cent of m a r k e t value of securities. April 1955 April 1955 Raised discount r a t e s from 1-1/2 to 1-3/4 p e r cent. To help p r e v e n t an e x c e s s i v e use of c r e d i t for p u r c h a s i n g or c a r r y i n g s e c u r i t i e s in a period of i n c r e a s i n g u s e of c r e d i t for c a r r y i n g s e c u r i t i e s , To b r i n g discount r a t e s into c l o s e r alignment with open m a r k e t money r a t e s and make b o r r o w i n g by individual banks more expensive. -2- Date Action P u r p o s e of Action MarchDecember 1955 Made net p u r c h a s e of bankers' acceptances in open m a r k e t totaling $28 million. To r e c o g n i z e i n c r e a s e d u s e of b a n k e r s ' a c c e p t a n c e s by b u s i n e s s a s a m e a n s of financing international t r a d e . JulyDecember 1955 Made outright p u r c h a s e s of T r e a s u r y bills in the open m a r k e t totaling $700 million net and i n creased repurchase a g r e e m e n t s with d e a l e r s and b r o k e r s by 300 m i l lion. Member bank b o r rowing i n c r e a s e d to an a v e r a g e of about $850 million in S e p t e m b e r and m o r e than $ 1 . 0 b i l lion in November but declined to about $850 million in D e c e m b e r , To m e e t p a r t of r e s e r v e n e e d s a s s o c i a t e d with s e a s o n a l f a c t o r s , thus r e q u i r i n g banking s y s t e m to m e e t needs in p a r t by further i n c r e a s i n g i n d e b t e d n e s s . This action was taken with a view to p r o viding for s e a s o n a l needs while limiting undue expansion of bank c r e d i t . November December 1955 Purchased when-issued T r e a s u r y c e r t i f i c a t e s of indebtedness totaling $167 m i l l i o n . To facilitate T r e a s u r y refunding in period of money m a r k e t s t r i n g e n c y . Supply of r e s e r v e s was c o n s i s t e n t with o v e r - a l l open m a r k e t policy at t i m e . AugustSeptember 1955 I n c r e a s e d discount r a t e s from 1-3/4 to 2 - 1 / 4 p e r cent. This i n c r e a s e was made in two steps at all R e s e r v e Banks except Cleveland. November 1955 I n c r e a s e d discount r a t e s from 2 - 1 / 4 to 2 - 1 / 2 p e r cent. To k e e p discount r a t e s in an a p p r o p r i a t e r e l a t i o n s h i p with m a r k e t r a t e s of i n t e r e s t and thus m a i n t a i n a d e t e r r e n t on e x c e s s i v e b o r r o w i n g by individual banks at the R e s e r v e Banks,
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