The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
UNITED STATES MONETARY POLICY: RECENT THINKING AND EXPERIENCE HEARINGS BEFORE THE SUBCOMMIITEE ON ECONOMIC STABILIZATION OP THE JOINT COMMITTEE ON THE ECONOMIC EEPOET CONGRESS OF THE UNITED STATES EIGHTY-THIRD CONGRESS SECOND SESSION PURSUANT TO Sec. 5 (a) of Public Law 304 (79ttt Congress) DECEMBER 6 AND 7, 1954 Printed for the use of the Joint Committee on the Economic Report .-mil UNITED STATES GOVERNMENT PRINTING OFFICE WASHINGTON : 1054 JOINT COMMITTEE ON THE ECONOMIC REPORT (Created pursuant to sec. 5 (a) of Public Law 304, 79th Cong.) JESSE P. WOLCOTT, Michigan, Chairman RALPH E. FLANDERS, Vermont, Vice Chairman RICHARD M. SIMPSON, Pennsylvania ARTHUR V. WATKINS, Utah HENRY O. TALLE, Iowa BARRY GOLDWATER, Arizona GEORGE H. BENDER, Ohio FRANK CARLSON, Kansas EDWARD J. BART, New Jersey JOHN SPARKMAN, Alabama WRIGHT PATMAN, Texas PAUL H. DOUGLAS, Illinois RICHARD BOLLING, Missouri J. WILLIAM FULBRIGHT, Arkansas GROVER W. ENSLEY, Staff Director JOHN W. LEHMAN, Clerk SUBCOMMITTEE ON ECONOMIC STABILIZATION RALPH E. FLANDERS, Vermont, Chairman UNITED STATES SENATE BARRY GOLDWATER, Arizona J. WILLIAM FULBRIGHT, Arkansas U HOUSE OF REPRESENTATIVES RICHARD M. SIMPSON, Pennsylvania WRIGHT PATMAN, Texa* CONTENTS Statement of— Pa*« Chandler, Lester V., professor of economics, Princeton University 44 Clark, John D., director, American National Bank, Cheyenne, Wyo. former member of Council of Economic Advisers. 47 Harris, Seymour, professor of economics, Harvard University 51 Prepared statement . 54 Supplementary statement-._ 59 Humphrey, Hon. ueorp:e M., Secretary of the Treasury; accompanied by W. Randolph Burgess, Under Secretary for Monetary Affairs; David M. Kennedy, Assistant to the Secretary; Edward F. Bartelt, Fiscal Assistant Secretary; and Robert P. Mayo, chief, analysis staff Debt Division _>160 Land, James N., senior vice president, Mellon National Bank Trust Co., Pittsburgh, Pa _ 60 Lahston, Aubrey G., Aubrey G. Lanston & Co., Inc., New York, N. Y_ 102 Martin, William McChesney, Jr., Chairman, Board of Governors, Federal Reserve System; accompanied by members of the Board of Governors of the Federal Reserve System and Reserve Bank Presidents 218 Mitchell, C. Clydu, Jr., chairman, department of agricultural economics, University of Nebraska 62 Prepared statement . 66 Shaw, Edward S., the Brookings Institution 73 Simmons, Edward C , professor of economics, Duke University 253 Smutny, Rudolf, senior partner, Salomon Bros. & Hutzler, New York. 76 Sproul, Allan, President, Federal Reserve Bank of New York and vice chairman, Federal Open Market Committee 223 Upgren, Arthur R., dean, The Amos Tuck School of Business Administration, Dartmouth College 254 Wilde, Frazar B., president, Connecticut General Life Insurance Co., and chairman, Research and Policy committee, Committee for Economic Development -87 Prepared statement89 Additional information submitted for the record: Background information on the appearance of the Open Market Committee of the Federal Reserve System before the Joint Committee on the Economic Report, December 7,1954 89 Correspondence between the staff director of the Joint Committee on the Economic Report and the Chairman of the Council of Economic Advisers 37 Federal Open Market Committee report of ad hoc Subcommittee of the Government Securities Market L 257 Analysis of discussions on scope and adequacy of the Government securities market 292 Call-money facilities , 305 Chairmen of the Federal Reserve banks, members of the Federal Advisory Committee 291 Comments of the Federal Reserve Bank of New York on report of the ad hoc Subcommittee on the Government Securities Market307 Findings and recommendations 264 Government securities market 260 Ground rules 299 Individuals and organizations which received a note enclosing copies of the letter and outline of study for their information 290 Individuals who received, as addressees, the explanatory letter and outline of study 291 Introduction 260 in IV CONTENTS Additional information submitted for the record—Continued Page Federal Open Market Committee, etc.—Continued Open-market account transactions in United States Government securities July 1,1951-September 30,1952 235 Outline of study 286 Preface— 257 Summary of conclusions and recommendations 284 Membership of Federal Advisory Council 222 Membership of Federal Open Market Committee, 195J through 1954—. 220-223 Memorandum by Congressman Patman from Secretary Humphrey on history of depository practice of the Treasury Department 184 Membership of the Board 220 Present members of the Federal Open Market Committee 221 Present membership of executive committee of Federal Open Market Committee, 1951 through 1954 222 Questions by the subcommittee transmitted to the Treasury and the Board of Governors of the Federal Reserve System 2 Replies to questions addressed to the Treasury and the Board of Governors of the Federal Reserve System 3,30 Reserve bank presidents, list of 220 Statement on action on ad hoc subcommittee report, December 9,1954- 257 Stimulus to Economic Growth, article by John D. Clark, in Washington Post and Times Herald, December 6,1954 50 UNITED STATES MONETARY POLICY: RECENT THINKING AND EXPERIENCE MONDAY, DECEMBER 6, 1954 CONGRESS OF THE UNITED STATES, JOINT COMMITTEE ON THE ECONOMIC REPORT, SUBCOMMITTEE ON ECONOMIC STABILIZATION, Washington^ B. C. The subcommittee met, pursuant to notice, at 10:05 a. m., in room 318, Senate Office Building, Senator Ralph E. Flanders (chairman of the subcommittee) presiding. Present: Senators Flanders, Goldwater, Sparkman and Douglas; Representatives Talle, Patman, and Boiling. Also present: Grover W, Ensley, staff director, and John W. Lehman, clerk. Senator FLANDERS. I would like first to say I am glad to see you here. I am glad that our panel is here. I am glad that the attendance in the uncomfortable chairs in the rear of the room indicates a lively interest, and I am glad that there are other members of the Joint Committee on the Economic Report here besides the members of the subcommittee. The Subcommittee on Economic Stabilization was appointed by Chairman Jesse P. Wolcott on April 16, 1954, pursuant to the report of the Joint Committee on the Economic Report filed with the Senate and House of Representatives on February 26,1954 (H. Rept. 1256). The committee report set forth the functions of the Subcommittee on Economic Stabilization in the following words : Subcommittee on Economio Stabilization.—The economic situation is obviously very dynamic. The committee and staff will follow economic trends and developments from day to day to make sure that stabilizing action on the part of Government and business is effective. To facilitate expeditious study and action in this field the chairman will appoint a Subcommittee on Economic Stabilization. The subcommittee will hold hearings and conduct meetings as frequently as it deems necessary and desirable, and will report from time to time to the full committee on employment, production, and purchasing power trends. It will follow particularly the role of fiscal and monetary policy in dealing with the current recession. Tho subcommittee and the committee staff have followed the current economic trends carefully during the past year. . The staff has met frequently with economic analysts of the executive agencies, of business, labor, agriculture, and consumer groups, and the universities. Members of the committee have joined in a number of these meetings. As customary, the staff has reported these happenings and developments to all members of the committee. The subcommittee, in its executive meetings during the course of the past year, felt that recent economic developments did not warrant a material change in appraisal l 2 UNITED STATES MONETARY POLICY of the outlook from that presented by the witnesses at the committee's hearings last February, and set forth in the committee's report of February 26. We have consequently not seen the need for subcommittee hearings or special public reports during the recent session of the Congress. We have reported to the full committee. During the last 3 years much reliance has been placed on monetary policy in carrying out the objectives of the Employment Act of 1946. The Joint Economic Committee has actively studied the objectives and workings of the United States monetary policy. Thorough studies were made by subcommittees in 1949-50 and again in 1951-52 under the chairmanships of Senator Paul Douglas and Representative Wright Patman, respectively. Since the inquiry in 1951-52 there have been significant changes in the national economy and in the use of monetary instruments. I t seems appropriate, therefore, and in compliance with announced intentions of the committee in its report to the Congress last February (II. Rept. 1256), to review recent thinking and experience with monetary policy. The use of the term "monetary policy" in this study is intended to include Federal debt management policy. The study will try to avoid covering the ground of the earlier committee studies, and will postpone discussion of the immediate economic outlook and the program to be submitted to the Congress by the President next January. The subcommittee, in October, asked the Secretary of the Treasury and the Chairman of the Board of Governors of the Federal Reserve System to submit in writing their judgments relating to a number of questions by November 20 for review by the subcommittee, the committee staff, the panel participants, in advance of today's and tomorrow's hearings. I will insert at this point in the record the list of questions that were transmitted to Secretary Humphrey and Chairman Martin. We asked Secretary Humphrey to give his judgments on questions 1 and questions 6, 7, and 8; we asked Chairman Martin to comment on questions 1 through 5. (The questions referred to above are as follows:) 1. What role did monetary policy play in the period of relative stability following the Treasury-Federal Reserve "accord" in 1951, in the months of boom late in 1952 and earlv 1953, and in the recession of 1953-54? 2. How has the emphasis in the use of monetary instruments changed during the period since mid*1952? For example, how have the various instruments— oi>en market operations, discount rates and administration of discount operations, and reserve requirement—been used under varying conditions? Has there been any reliance on moral suasion during this period? 3. What is the practical significance of shifting policy emphasis from the view of "maintaining orderly conditions" to the view of "correcting disorderly situations" in the security market? What were the considerations leading the Open Market Committee to confine its operations to the short end of the market (not including correction of disorderly markets) ? What has been the experience with operations under this decision? 4. What is the,policy with respect to the volume of money? 5. Has monetary machinery (a) worked flexibly, and (b) has the market demonstrated flexibility in its responses to changes in policy? For example, how has the policy of "active ease" been reflected in the level and structure of interest rate, the volrme of credit, and. the r les of various types of lenders? 6. Has the debt m* lagement policy of the Treasury—both as to objectives and techniques—been consistent with the monetary policy of the Federal Reserve throughout the period since mid-1952? UNITED STATES MONETARY POLICY 3 7. What considerations should dictate the maturity distribution schedule of the Federal debt, first, as to the long-run ideal to be pursued and, second, as a practical operating matter, giving weight to timing and contemporary conditions? 8. Are the benefits ?nd costs to commercial banks of handling Government transactions clear enough, or can they be made clearer, to determine whether or not the banking system is being excessively compensated or undercompensated? What about the Treasury cash balance—its size and management? Should the Government receive interest on its deposits with commercial banks? Senator FLANDERS. Without objection there will also be inserted in the record the replies of these two officials. (The documents above referred to are as follows:) BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, Washington, Hon. November 26, 195%. R A L P H E. FLANDERS, Chairman, Subcommittee on Economic' Stabilization, Joint Committee on the Economic Report, Washington, D. C. DEAR SENATOR FLANDERS: In accordance with the request contained in your letter of October 2G and with subsequent conversations between members of your staff and the staff of the Board, there are attached copies of the Board's answers-to questions 1 through 5 contained in your press release of November 12, 1054. Sincerely yours, WM. M C C . MARTIN, J r . REPLIES OF THE CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM TO QUESTIONS SUBMITTED BY THE SUBCOMMITTEE ON ECONOMIC STABILIZATION OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT IN CONNECTION W I T H SUBCOMMITTEE HEARINGS OF DECEMBER 7, 1954 (1) What role did monetary policy play in the period of relative stability following the Treasury-Federal Reserve accord in 1951, in the months of boom late in 1952 and early 1953, and in the recession of 1953-54? Inflationary dangers in prospect in 1951 made essential a shift in credit and monetary policies of the sort envisaged in the Treasury-Federal Reserve accord. Review of subsequent developments supi>orts the conclusion that the policies pursued were helpful in bringing about and maintaining a reasonable degree of both stability and growth in the economy. The country encountered an economic problem of unprecedented nature, namely, carrying out, with no further price inflation after the 1950-51 spurt, a defense program of exceptional magnitude short of war while permitting moderate expansion in private expenditures. Private demands for goods and services were still in the process of overcoming the effects of war and postwar scarcities. Credit and monetary measures, together with fiscal and debt-management policies, helped to make it possible to cope with this situation through the mechanism of competitive markets and a free price system. As a result, the various direct controls imposed early in' the defense period could be eliminated, thus relieving markets of the rigidities and inefficiencies inherent in such controls. The Treasury-Federal Reserve accord was reached after an earlier inflationary outburst of overbuying, overborrowing, and overpricing in the private economy. In the first year after its adoption, private spending and borrowing moderated while the defense program expanded. In the second year, however, from the spring of 1952 to the late spring of 1953, there was a vigorous expansion in private spending and in private credit demands, just as defense expenditures were reaching a peak and the Federal Government faced the need for heavy borrowing to meet a deficit. Large capital expenditures, inventory accumulation, and heavy consumer purchases of durable goods—all financed to a large extent by credit— together with overtime operations in industry and exceptionally full utilization of resources generally, threatened to develop into an unsustainable boom. Credit restraints helped to keep total demands within the limits of the capacity of the economy to produce and to spread the volume of spending over a longer period. The boom was checked without collapse and was followed by an orderly and moderate downward adjustment in activity. The adjustment was cushioned by progressive action to ease credit markets, as well as by tax reductions and other 4 UNITED STATES MONETARY POLICY fiscal measures. It has not developed into a disastrous depression, as many quite reasonably feared. The defense program has now been curtailed to a level more likely to be sustained over an extended period. Many of the more urgent domestic and foreign shortages resulting from war destruction and postwar reconstruction have been satisfied. Inventories have been reduced appreciably, and current production is moie nearly in balance with demand. The problem of economic policy has thus become one of facilitating, yet keeping within sustainable bounds, the normal growth forces of a free enterprise, competitive economy. In the remainder of this answer, credit and related economic developments in the 1951-54 period are described and analyzed in some detail. Treasury-Federal Reserve accord When the Korean outbreak occurred, the financial policies of this country were hampered by problems and methods of operation inherited from the Second World War and its aftermath. Federal Reserve credit policies for many years had been handicapped by trying to combine appropriate credit action with the support of Government securities prices. These practices, which were adopted to meet wartime conditions, contributed in the early postwar period to an inflation that had raised the price level to almost double the prewar average before it came to an end in 1949. Following the Korean outbreak and adoption of a greatly enlarged defense program, inflation resumed. Various attempts to restrain credit expansion while continuing to support prices of Government securities had unsatisfactory and diminishing results as mounting sales of securities to the Federal Reserve by banks and other holders made funds abundantly and cheaply available for spending, investing, and speculation. In a move to correct this situation, on March 4, 1951,.the Secretary of the Treasury and the Chairman of the Board of Governors of. the Federal Reserve System announced that "the Treasury and the Federal Reserve System have reached full accord with respect to debt management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government's requirements and, at the same time, to minimize monetization of the public d e b t " Following this accord, monetary policies were reoriented. Open market operations were altered o**er a period so as to adjust the supply of bank reserves to levels consistent with stable economic growth rather than to support prices of Government securities. The discount mechanism through which member commercial banks borrow from the Federal Reserve banks was gradually restored to an effective instrument of credit regulation. Various selective regulatory and voluntary means for restraining credit extensions in particular areas were utilized for a time, but to an increasing extent reliance came to be placed upon the more general measures that operate through the quantity of bank reserves and through flexible interest-rate movements. Imposition of credit restraints—Spring of 1051 to spring of 1052 Following the accord, Federal Reserve operations in the short-term Government securities market, except for limited purchases during periods of Treasury refunding, were only for the purpose of influencing the volume of bank reserves in accordance with the broad objectives of Federal Reserve policy, namely, to contribute to stable economic growth. Purchases of long-term securities by the Federal Reserve were continued in diminishing volume for a number of weeks following the accord, but after mid-1951 the Federal Reserve bought practically no long-term bonds. Under these policies, any bank or other investor wishing to sell Government securities generally had to depend on buyers in the market, and the free play of market forces resulted in some fluctuation as well as some rise in rates. Such price and interest-rate fluctuations perform impr . ^ t functions of a selfcorrective and stabilizing nature, as is explained *• .*.< fully in the answers to questions 3 and 5. It had been widely feared thnt because of the m a / r ^ , of the public debt the removal of pegs on prices of Government securities \, :ild leav* the market with insufficient buyers and holders to carry the .debt, and thus would produce a catastrophic decline in bond values and panic conditions in the Government bend market. These fears proved unfounded. Would-be sellers either found buyers at prices they were willing to accept or refrained from selling. New issues were offered at yields which attracted sufficient buyers. Until late 1952, market yields on long-term bonds averaged less than 2% percent, with prices fluctuating UNITED STATES MONETARY POLICY 5 between 95 and 99. The rate on Treasury bills gradually increased, but until 1952 remained generally below the Federal Reserve discount rate of 1% percent. The Federal Reserve purchased short-term securities at times of Treasury refunding operations in order to steady the market. During periods of peak seasonal needs for reserves by the banking system, the Federal Reserve bought securities either outright in the market or from dealers under repurchase agreements for limited periods. At other times, however, System holdings of securities were reduced in order to absorb reserves in excess of current needs. For the year ending April 30,1952, although there were wide variations during the period, total Federal Reserve holdings of United States Government securities declined slightly as shown in table I. During this period banks were supplied with some reserves on balance by other factors, primarily a gold inflow, offset in part by a growing currency demand. To obtain additional reserves, banks resorted increasingly to borrowing at the Federal Reserve banks; these borrowings fluctuated considerably in response to temporary needs for reserves and showed a gradual rising tendency. This was the first time banks had had to borrow to any significant extent since the early thirties. Since banks are generally averse to borrowing steadily and the Federal Reserve banks endeavor to discourage continuous borrowing by individual members, the result of such a situation was to exert restraint on bank credit extension and thus on growth of deposits. Federal Reserve credit and hank reserves, changes from April 1951 to April 1952 * [In billions of dollars] Federal Reserve credit: United States securities Discounts and advances Other factors affecting reserves (sign indicates effect on reserves) : Gold stock and foreign balances at Federal Reserve banks Currency in circulation Other, net Member bank reserve balances, total Required reserves Excess reserves —0.5 +• 2 +1. 8 —1.3 -f. 3 +.5 +.6 t 2 1 Changes derived from monthly averages of daily figures for the 2 months indicated. Figures may not balance because of rounding. In addition to the adoption of more restrictive monetary measures following the Treasury-Federal Reserve accord, direct controls were imposed on prices early in 1951 and the allocation of materials in short supply was made more rigorous. A general reaction set in from the overbuying, overpricing, and ove*> borrowing of the previous months. In the following 12 months, Government expenditures for defense increased sharply, but expansion in business and consumer expenditures for durable goods halted, and the rate of accumulation of business inventories was reduced. Consumer expenditures for nondurable goods and services continued to increase moderately. Private credit expansion slackened. Prices in general showed little change. Some prices that had previously risen most sharply declined, while some other prices advanced moderately. Private credit expansion continued in this period, but the rate of growth was much slower than immediately after the outbreak in Korea. Commercial banks, while slowing down their loan increases, added somewhat to their holdings of short-term Government securities, being motivated to do so by the attraction of higher rates and by the fact that their longer-term holdings were less liquid than they had been under the bond support policy. Credit developments in this and other periods are indicated in table II, which shows changes in outstanding amounts of selected types of credit and also by selected groups of lenders or investors for years ending June 30, 1950 to 1954. Although corporate security issues increased from mid-1951 to mid-1952, as a result especially of needs to finance expanding defense activities, the rate of expansion in bank loans to businesses and in mortgage credits slackened considerably. Increases in consumer credit and in borrowing by State and local governments were kept within moderate limits, notwithstanding continuing strong demands. The moderation in credit growth was due in part to regulation 6 UNITED STATES MONETARY POLICY of consumer and mortgage credit terms and to the voluntary credit restraint program cp.rried on by lending institutions. To a considerable extent, however, th* slackened pace in making loans and investments resulted from the limitation on the availability of bank reserves, higher interest rates, and the reluctance of lenders and oih rs to sell Government securities at the lower prices then prevailing. TAfctE II.- -Growth in major types of debt and equity financing [Net increase in amounts outstanding, in billions of dollars] 1 12 months ending June 30— Distribution of growth b y 1954 1953 ! 1952 Major types: ! 1951 2.2 5.5 9.9 6.7 -1.3 .4 2.4 2.9 3.1 9.4 7.7 2.0 4.9 .2 -0.5 2.6 8.2 7.C 1.5 2.3 1.4 •-5.8 2.S 11.3 4.7 a 5 1.8 1.0 25.8 30.2 22.8 22.3 .3 8.2 1.8 3.5 -.1 8.4 4.7 4.0 4.9 3.3 -2.5 6.0 2.7 5.7 -7.2 11.2 -- 1.9 3.9 4.5 2.0 4.0 5.2 1.4 2.4 3.7 .9 2.1 3.7 .. .. -2.5 ! ,«. o i 1.5 - ? 1.2 -.9 -1.1 .9 -2.0 1.6 1.0 Total holdings of above financing types accounted for b y selected holders . . .. 17.5 * 39.0 14.7 16.0 State and local government issues Real-estate mortgages ... Corporate bond and stock Issues ... Bunk loans to business Consumer credit bv banks and other lenders Bank credit not included above . , Total, major types of financing Selected holders: Federal Reserve b a n k s : . Commercial banking system - - ... 1 United States securities . Other loans and i n v e s t m e n t s . . . . . . . . . . . .............. Xonbank holders: Mutual savings banks ...... ................. Savings and loan associations.... ...... ... . Life-insurance companies ... . Others, U. S. Government securities only: CorporatioLS Miscellaneous investors .... . . .. .. . *: '• NOTE.—Table shows net changes in selected types of loan extensions and new equity financing. Among types not included are trade credit other than consumer credit; interbank loans; security issues by foreign agencies, international organizations, nonprofit and eleemosynary institutions; nonbank loans for purchasIUK securities; and claims such as shares, passbooks, and insurance policies issued byfinancialorganizations. Among holders, the most important exclusions are nonfinanclal corporations, trusts, governments, and individual, except for U. S. Government bonds. These latter changes constituted in effect a decrease in liquidity and resulted in an increased demand for cash balances, The changed liquidity needs and the expanding volume of economic activity made possible a further substantial growth in bank credit and the money supply without generating inflationary pressures. Demand deposits and currency showed a further expansion of about $7 billion, or 6 percent, in the 12 months ending April 1952. Savings deposits, which had actually contracted following the Korean outbreak, increased substantially, a s did savings in other forms. In summary, it may be said that after the Treasury-Federal Reserve accord the Federal Reserve endeavored to adjust its policies so as to influence the level of bank reserves and the money supply in accordance with seasonal requirements, the capacity of the economy to produce goods and services, and sustainable economic growth in the economy. The discount function was restored as a means of supplying temporary needs for Federal Reserve credit in a manner that exerted restraint on unwarranted uses of such credit, thereby complementing open market operations in influencing the availability of credit at member banks. Discontinuation of rigid pegging of Government security prices removed the possibility of monetizing the public debt through sale to the Federal Reserve System at the initiative of the holders, nonbank as well as bank, and without loss to them. The excess liquidity of the economy was thereby removed. UNITEr STATES MONETARY POLICY 7 Resumption of expansionary tendencies—spring of 1952 to spring of X958 Beginning in the spring of 1952 the rate of increase in defense spending slack* ened, but there was a renewed expansion of private expenditures and private credit demands became more vigorous. Around the middle of that year direct regulation of consumer installment and real-estate credit and the voluntary credit-restraint programs were discontinued. These actions increased the dependence on general credit measures for restraining excessive credit and monetaryexpansion. Total national product increased in the following year as a result of growing private expenditures both for consumption and investment, including a building up of inventories. By late 1952 the economy generally was operating on an overtime basis. Wage rates again rose substantially and consumer prices advanced slightly; at the same time, however, wholesale prices continued to show more declines than advances. All major kinds of credit increased more sharply in the 12 months ending June 1953 than in the preceding 12 months, as shown in table II. The biggest change was in consumer credit, which increased $5 billion as compared with only little change during most of the previous year. The United States Government became a net borrower of about $3 billion from the public, as compared with a reduction in its indebtedness in the previous year. The volume of mortgage loans completed and of corporate and State and local government securities issued was moderately larger than in the preceding year. ank loans to businesses, reflecting inventory accumulation, expanded very sharply in late 1952 and failed to show the usual seasonal decline in early 1953. A significant characteristic of this period was the amount of credit demands met from the genuine savings of the public. The net expansion in credit supplied by nonbank lenders was much greater than in the preceding year, while bank credit showed a smaller rate of increase. Furthermore, a larger portion of the bank credit represented the investment of savings deposits, which increased by 7 percent. Demand deposits and currency continued to expand but the annual rate of growth declined from G to 3 percent. The Federal Keserve occasionally bought Government securities in this period but the objective of monetary policy continued to be restraint on undue credit and monetary expansion. Purchases were made at times of Treasury ref undings during 1952 and subsequently offset in part by sales. Open market operations' were also undertaken in response to seasonal influences affecting bank-reserve needs. Over the whole period April 1952 to April 1953, as shown in table III, not purchases were less than enough to cover the drains on bank reserves resulting from gold outflow and larger currency demands. Banks had to borrow substantial amounts from the Federal Keserve in order to meet growing demands for credit. Discounts and advances at Federal Reserve banks generally exceeded a billion dollars from July 1952 to May 1953, and they averaged $1.6 billion ih. December 1952. This made banks much more restrained in their willingness to supply these demands. To make the policy of restraint more effective, the Federal Reserve discount rate was raised from 1% to 2 percent in January 1953. TABLE III.—Federal Reserve credit and bank reserves, changes from April 1952 to April 1953 l [In billions of dollars] Federal Reserve credit: United States securities -f 1.4 Discounts and advances + »8 Other factors affecting reserves (sign indicates effect on reserves) : Gold stock and foreign balances at Federal Reserve banks — .7 Currency in circulation —1.3 Other, net + .1 Member bank reserve balances, total 4- «2 Required reserves + •3 Excess reserves — .1 1 Changes derived from monthly averages of daily figures for the 2 months indicated. Figures may not balance because of rounding. 8 UNITED STATES MONETARY POLICY The restraints did not stop credit and monetary growth. The growth that occurred apparently corresponded closely to the capacity of the economy to absorb more money without inflation. Since the resources of the economy were generally fully utilized, any more credit might have resulted in inflationary price rises and moreover might have built up an unsustainable debt structure. Inflation was prevented, notwithstanding strong pressures of demand for more credit, and prices remained relatively stable. In some lines, particularly installment loans to consumers and inventory loans to business, the rate of expansion was apparently more rapid than could be sustained. The money market showed a marked response to (he strong demand for credit and the restraints on its availability. Interest rates rose during the period, reflecting the pressures of credit demand in excess of the available supply. The rise in interest rates was particularly great in the spring of 1.953 when yields on high-grade securities and loans generally reached the highest levels for 15 to 20 years. Treasury bill rates approached 2% percent, the average yield on long-term Treasury bonds rose above 3 percent, and a small new issue of 30-year Treasury bonds bore a coupon rate of 3VL percent. Rates on new issues of high-grade corporate bonds exceeded 3% percent, and federally guaranteed mortgages sold at discounts in the secondary market. By May 1953 the market developed a condition of tension that threatened to become unduly severe. This reflected a number of converging factors. Apprehension arose regarding the ability of the credit market to meet borrowing demands of the State and local governments, consumers, home buyers, and business corporations, together with rising Treasury financing needs. The combination of a Government deficit and large private credit demands is exceptional for a period other than one of active war and it was difficult to gage the problems that it might present. At that time the Treasury made its offer on a $1 billion issue of 30-year ZlA percent bonds to raise new money from nonbank investors. This offering gave probably the first tangible evidence of a striking nature, not only of the fact that the Treasury had to borrow substantial amounts, but also that it had to compete against large private borrowing demands for the available supply of sa^ ings ac competitive rates if resort to the creation of an undue volume of new money through the banking system were to be avoided. In addition to Treasury borrowing, private credit demands of various sorts were exceptionally large. New security issues by corporations and State and local governments exceeded $7 billion in the first haif of the year—larger than in any previous half-year, and the amount of future issues scheduled was still large. Some of this borrowing was in anticipation of further stringency. About this time, also, the ceiling rates on the FHA and VA mortgages were raised after months of consideration, and a large volume of mortgages which had been held back pending the authorization of higher rates suddenly came on the market. The new rates, however, proved low relative to the tight market at the time, and such mortgages sold at discounts in the secondary market. The continued high level of member bank borrowing from the Federal Reserve and the limited availability of reserve funds were keeping banks under pressure. The effect on the money market was a marked rise in interest rates, which exerted a considerable amount of restraint on private credit demands. The heavy pressures on the market were due to the growing demand for credit. The supply of credit actually increased substantially but did not meet all demands. Slackening of activity after spring of 1953 Early in May 1053 Federal Reserve officials recognized that as a result of a combination of circumstances, some of which were unexpected, undue tension was developing in the credit market. They concluded that steps should be taken*to temper restraints curently imposed on member banks, particularly in view of prospective seasonal credit and currency demands. The Open Market Committee began early in May to supply reserves by purchasing Government securities and by midyear about $1 billion of securities had been acquired. Early in July some $1.2 billion of reserves were released to the banking system by a reduction in member bank reserve requirements. These actions made if possible for banks to decrease their borrowings sharply and to subscribe for a new issue of short-term Government securities early in July, as well as to meet seasonal credit and currency demands around the midyear. Inflationary forces abated after the spring of 1953 and economic activity commenced to recede from the all-time high level reached in the second quarter of that year. Business inventory expansion slackened and subsequently contraction 9 UNITED STATES MONETARY POLICY in inventories set in. Home building plans were temporarily held up because of financing difficulties. Substantial cutbacks in defense expenditures began to be made by the Government. As these evidences of business slackening became clearer, the Federal Reserve further eased credit conditions by purchasing additional securities in the market. Reserves thus made available were enough to cover the effects of a gold outflow and the customary seasonal rise in currency and credit demands, but the increases that actually occurred in currency and required reserves were smaller than expected. Member banks were thus able to use a part of the reserves made available to them to reduce their borrowings at the Federal Reserve banks. In February 1954 the Federal Reserve discount rate was reduced to 1% percent. Developments for the first 12 months following the change in policy are summarized in table IV. In that period the reduction in reserve requirements of $1.2 billion and Federal Reserve purchases of securities of $1.3 billion enabled member banks to meet a small further gold outflow, to decrease appreciably their borrowings at the Reserve banks, and to obtain reserves needed to cover further deposit expansion. TABLE IV.--Federal reserve credit and bank reserves [Changes in billions of dollars l] April 1953 to April 1954 to April 1954 October 1954 Federal Reserve credit: United States securities , Discounts and advances Other factors affecting reserves (sign indicates effect on reserve): Gold stock and foreign balances at Federal Reserve banks Currency in circulation 1 Other Member bank reserve balance*, total r fc Required reserves, due to— Reduction in requirements Growth in deposits Excess reserves 2+1.3 -1.0 »-.4 -.0 -1.2 +.4 +.2 -0.2 +.1 —.3 0 -.5 -1.6- +1.1 0 1 Changes derived from monthly averages of daily figures for the 2 month.* indicated. Figures may not balance because of rounding. 2 Exclude effect of $500 million sale oi Government securities to Treasury in exchange for free gold carried in Treasury cash balance. Since April 1054 reserves needed for customary seasonal and other purposes have been supplied largely by a further reduction of about $1.6 billion in member bank reserve requirements. Reserves were supplied at limes by Federal Reserve purchases of Treasury bills, while at other times to absorb redundant reserves bills were sold or not replaced at maturity. Thus banks have been able to meet seasonal credit and monetary demands and also to purchase new issues of Treasury securities with little borrowing. Total credit demands, particularly for long-term purposes, continued substantial during the latter part of 1953 and in 11)54, although less than in the preceding year. There was a decline in bank loans to business and consumer credit showed little increase from the middle of 1953 until recently. Mortgage lending began to pick up in the autumn of 1953 and has since been in record volume, stimulated in part by considerably liberalized downpayment and maturity terms, especially under Government mortgage programs. New security issues by corporations were slightly less than in the preceding year but those of State and local governments were much larger. The Federal Government remained a substantial net borrower. Savings continued to meet a large portion of total credit demands as reflected in the figures of. insurance companies, savings and loan associations, and mutual savings banks as wTeli as in time deposits of commercial banks. The total of demand deposits and currency, which changed little from the spring of 1953 to the spring of 1954, except for normal seasonal movements, showed a more than seasonal increase after mid-1954. As a result of the increased availability of funds and the slackened credit demands, yields on short-term Treasury securities declined by the summer of 1954 to the lowest level since 1949. Since the spring of 1954 yields on long-term Government securities and those on high-grade corporate bonds have been gen 10 UNITED STATES MONETARY POLICY erally at the lowest level since the Treasury-Federal Reserve accord. Rates charged by banks on customer loans remained at about last year's higher levels until mid-March, when the rate to prime borrowers was reduced. Mortgage interest rates declined somewhat and discounts on guaranteed and insured mortgages were reduced substantially, with small premiums appearing in some areas. Summary and conclusion The role and objective of the Federal Reserve in the defense-mobilization period have been to make possible the provision of adequate credit and money for full utilization of, and growth in, the country's economic resources. At the same time, policy endeavored to prevent excessive credit and monetary expansion beyond the limits of productive capacity that would lead to inflationary developments and threaten the maintenance of stable growth. During the period of restraint in 1952-53, Federal Reserve policy looked toward the avoidance of credit excesses which could cause real trouble once a downturn, had come. This policy sought to even out the flow of capital investment by fostering deferment of some projects until slack had developed in the economy. During the period of ease since May 1953, the major contribution has been to facilitate as large a volume of bank lending as the economy required, and to provide support for mortgage lending and utility and State and municipal financing which has had its counterpart in a higli volume of construction of residential property, utilities installations, public buildings, and road construction. These activities have been a substantial offset to declines in defense expenditures and in business inventories. (2) How has the emphasis in the use of monetary instruments changed during the period since mid-1952? For example, how have the various instruments—open-market operations, discount policy, and reserve-requirement changes—been used under varying conditions? Has there been any reliance on moral suasion during this period? At any given time, the Federal Reserve System pursues the policy it believes appropriate for the credit and economic situation. It has three major instruments available for effectuating iis policy—open-market operations, discount policy, and changes in reserve requirements. These instruments are complementary find mutually reenforcing. Extent of reliance on any one of the instruments depends upon the System's judgment as to what may be most appropriate under the circumstances to further the general credit policy being pursued. Description of the instruments Open-market operations are carried out at the initiative of the System by making purchases or sales of Government securities in the market. Purchases of securities supply reserves to member banks. Sales of securities absorb or extinguish member bank reserves. These operations can be used to offset losses or gains in reserves from changes in such factors as currency in circulation or gold stock or to expand or reduce the volume of bank reserves. Discount policy relates to Federal Reserve bank lending to member banks. The initiative in such credit extensions is taken by individual member banks when it is necessary for them to build up their reserve positions to required levels. The discount rates at which the Federal Reserve banks will lend to member banks are established by each Reserve bank from time to time, subject to review and determination by the Board of Governors, in accordance with the credit and economic situation. Member banks, as a matter of well-established banking practice, are generally reluctant to operate on borrowed funds, or to stay long in debt. Therefore, under ordinary circumstances, borrowing at the Federal Reserve by individual banks is usually on a temrorary, short-term basis, tn unusual or emergency situations, of course, Federal Reserve discount credit may be outstanding to individual banks for longer periods. The general principles governing Reserve bank administration of the discount window arise out of law, regulation, and Federal Reserve discount experience. By raising or lowering reserve requirements of the various reserve classes of member banks—within specified limits for each class as permitted by law—the Federal Reserve at its initiative may diminish or enlarge the volume of funds which member banks have available for lending. Action of this type thus influences the liquidity position of banks and their ability to expand deposits in relation to their reserves. By their nature, changes in reserve requirements affect at the same time and to the same extent all member banks within each reserve class subject to the action. UNITED STATES MONETARY POLICY 11 Jnterrelationship of the instruments Although any one of these three major instruments will tighten or ease credit conditions, each of them has a somewhat unique role in carrying out System credit arid monetary policy. Open-market operations have become the chief instrument by which the System influences on a current basis the volume of unborrowed reserves of member banks. Such operations are also actively used to exert important restrictive or expansive pressure on bank credit conditions when the economic situation calls for fundamental change in these conditions. Since a purchase or sale of Government securities by the System adds to or substracts from the reserves of the member banks, it will be reflected initially, other things unchanged, in the volume of excess reserves held by member banks or in the volume of reserves that member banks need to obtain by borrowing at the Federal Reserve banks. Reflecting the reluctance of member banks to incur indebtedness or remain long in debt, changes in the volume of member bank excess reserves or borrowing are promptly reflected in conditions of credit availthe Federal Reserve banks. Rejecting the reluctance of member banks to incur become increasingly indebted and eased as the volume of that indebtedness is diminished or the amount of excess reserves is increased. Open-market operations are thus a flexible means for helping to achieve whatever condition of credit tightness, ease, or moderation may be appropriate. The Federal Reserve discount rate is a pivotal interest rate in the credit market. In particular, short-term open-market rates tend to array themselves in relationship to the Federal Reserve discount rate, except in a period when the reserve positions of member banks are so easy as to obviate the need for borrowing at the Reserve banks. When through open-market operations bank reserve positions have been put under pressure (or have been allowed to get under pressure as bank credit and deposits expand), money rates will tend to range higher in their relationship to the discount rate. Conversely, as bank reserve positions ease, they will be lower in relation to that rate. In a period, for example, when restraint on bank credit and monetary expansion is needed, open market operations and changes in the discount rate need to be used to reinforce each other. In-the first instance, increasing pressure on bank reserve positions (increased need for borrowing) may be developed through use of the open-market instrument alone. At a point, however, it will become appropriate to support the effectiveness of this open-market action by an increase in the discount rate, strengthening the reluctance of member banks to remain indebted to the Federal Reserve by making borrowing more expensive as a means of adjusting bank reserve positions. Such discount rate adjustments tend to lag behind adjustments in market rates in a tightening credit situation. With an upward adjustment of the discount rate, market rates may shift further upward over a period of time as they re-form around the new and higher discount rate. In a period when it is appropriate to ease credit conditions, open-market operations may be undertaken to supply reserve funds. Member banks may use these funds initially to reduce their borrow/ng. Since this action will put banks in a stronger position to increase their lending and investing activities, it will tend to be reflected in a stronger tone in money markets and in lower market rates in relation to the discount rate. To reinforce this credit-easing action, it may be appropriate at some stage to lower the discount rate, thereby keeping the. cost of using this avenue for the temporary adjustment of bank reserve positions more nearly in line with the cost of making these adjustments through the sale and subsequent repurchase of market paper or securities. Changes in reserve requirements can be used, like open-market operations, to tighten or ease bank reserve positions. As with open-market operations, the effect shows up initially in changes in the volume of member bank excess reserves find borrowing at the Reserve banks. Its impact on the money market and the availability of bank credit is, therefore, similar, in many respects to that of a comparable open-market action. The reserve-requirement instrument, however, is not interchangeable with the open-market instrument. Unlike open-market operations, the results affect immediately and simultaneously all banks in each reserve class. Changes in requirements, moreover, cannot be made frequently—especially on the up s i d e without unduly disturbing the operations of individual banks, since in our country adherence to reserve requirements is a basic rule to be observed in conducting a banking business. Changes in reserve requirements are, therefore, made infrequently and typically involve a fairly sizable volume of funds. The effects tend to be large and concentrated within a short period of time. The instrument 12 UNITED STATES MONETARY POLICY is more appropriate for making a major change in the volume of available bank reserves than it is for short-run adjustments. It is not adaptable to affecting bank reserve positions on a day-to-day and week-to-week basis, as are openmarket operations. Nor is the instrument as sensitive and flexible a means of affecting general credit conditions as is the combined use of open market and discount operations. In fact, it may be desirable to engage in partially offsetting open-market actions in order to cushion the impact of reserve requirement cnanges in credit markets. Use of the instruments since mid-1952 In an api>ended tabulation, exhibit A, the various credit actions taken by the Federal Reserve after mid-1952 are set forth, together with a summary of the surrounding credit and economic circumstances. ' A chart, exhibit B, shows the interrelated effects of these actions on member bank borrowings and excess reserves. iSxamina tion of these measures will make clear the interaction and interrelation of tne major instruments following a pattern similar to that described above. As may be seen from the accompanying chart, the System did not fully meet through open-market operations the heavy demands of banks for reserves in the fall of 1952, with the result that there was a buildup in the volume of discounts. This pressure on bank reserves was reflected in a rise in interest rates, particularly in the short-term sector. The restrictiveness of this development was reinforced in early 1953 by an increase in the discount rates of the Reserve banks from 1% to 2 percent. Restraint on bank reserve positions was maintained over the first several months of 1953. Reflecting the very strong demand for credit from a variety of sources, interest rates, both long- and shortterm, rose further. The revival in this period in the use of the discount instrument, little used since the early 1930's, raised some problems of discount administration for the System. Through a lapse of time some member banks had lost familiarity with the principles of law and regulation relating to the appropriate occasions for borrowing at the Reserve banks. Under the excess-profits-tax law then in effect, it was profitable for member banks in excess-profits-tax brackets to borrow to increase their tax base, and, in order to improve their tax situations, a few of these banks began to rely on borrowing at the Reserve bank rather than adjustments in asset positions in maintaining their reserve positions. Some other banks seemed willing to remain indebted a t the Reserve banks for extended periods in order to profit from differentials between market rates.of interest and the discount rate. As these developments became apparent, they were dealt with administratively by the Reserve banks on a case by-case basis. With signs of an abatement of the inflationary threat in the spring of 3953. the Federal Reserve modified its credit policy. Easing actions were first undertaken through the open-market purchases begun in early May and made on an increasing scale through June. These open-market purchases were supplemented at mid-1953 by a reduction in reserve requirements. Taken together these actions made available sufficient-reserve-funds to meet seasonal reserve drains and credit needs a t the midyear, including large Treasury needs, and at the same time greatly to ease pressures on bank reserve positions and to reduce member bank borrowing needs. Additional open-market actions were taken over the second half of 1953 toexpand further the supply of reserves available to member banks in accordance with usual seasonal factors. Actual credit demands vUd not come up to seasonal expectations, however, and member banks used surplus reserve funds to reduce their borrowings ai the Reserve banks. By early 1954 banks were largely out of debt to the Reserve banks and over the first half of the year excess reserves increased steadily, largely reflecting seasonal factors. Easing actions by the open-market instrument were supported by reductions in .the discount rates of the Reserve banks first in February * id again in April and May. Interest rates declined sharply over the period in resfxmse to this combination of actions and the reduced demand for short-term credit. UNITED STATES MONETARY POLICY 13 In May of 1954 the Federal Reserve again began to supply bank reserves through open-market operations and around midyear reserve requirements of member banks were further reduced. This action was taken in order to promote further bank credit and monetary expansion and to make available funds to meet seasonal reserve drains and credit needs, including those of the Treasury. It was foreseen that the action would supply more reserves than were called for at the time and accordingly open-market sales were made to absorb a part of the funds. It was anticipated that these funds would be released to the market over the fall months as needed by open-market purchases and this was done. Theh dovetailing of reserve requirements and open-market actions in the summer of 1054 illustrates how the impact of a change in reserve requirements may be cushioned and spread over time by temporarily offsetting open-market measures. Selective credit actions 1 In addition to its general credit instruments, the System had during this period one continuing instrument of selective credit action, namely, margin requirements on stock market credit. Margin requirements established by the Board of Governors limit the amount which brokers, dealers, and banks may lend to customers in order to purchase or carry securities. Their statutory purpose is to prevent undue use of credit for stock market transactions. From the standpoint of credit and monetary administration, margin requirement regulation serves to minimize the bearing that stock speculation might have on the use of the general instruments of System policy discussed above. In February 1953 margin requirements on stock market credit were reduced from 75 to 50 percent. The 75 percent margin requirement had been set in January 1951 as a preventative measure during that inflationary period. The action in early 1953 was taken in the judgment that a 50 percent requirement would be adequate to prevent an excessive use of credit for purchasing and carrying securities. Use of moral suasion Moral suasion is generally taken to refer to oral or written statements, appeals, or warnings made by the banking and monetary authorities to all or special groups of lenders with the intent of influencing their credit extension activities. During the period under review only minor use was made of this instrument within the Federal Reserve System.2 The term "moral suasion" is sometimes given a broader meaning to include any public or private statements made by Federal Reserve officials in the discharge of their responsibilities. As so defined it would include statements made to promote awareness and understanding of current credit and monetary problems on the part of the public and the financial community. It would also include conferences with member banks, individually and in groups, and with others in connection with the administration of various System functions, including particularly the discount function. On the basis of this broader definition, it may be said that moral suasion is constantly being employed by the System to promote public understanding of System actions and to ensure compliance with the law and with regulations issued pursuant to the law. * At times during the past the Board has also had temporary authority to regulate the terms of consumer and real-estate credit. Most recently, for example, regulation of consumer credit was undertaken in the early fall of 1950 under temporary authority granted by the Defense Production Act. The Board suspended such regulation in May 1952, and in the Defense Production Act amendments approved June 30, 1952, Congress repealed the authority to regulate consumer credit. In the fall of 1950 the Board was also given temporary authority to regulate real-estate credit terms. Such regulation was begun in midfall of that year and suspended in September 1952 to conform with the provisions of the Defense Production Act as amended. That act continued the authority for real-estate credit regulation until mid-1953, but required that the regulation be relaxed earlier If the estimated number of dwelling units started in each of 3 successive months was below a seasonally adjusted annual rate of 1.2 million. 3 For example, the Fedex*al Reserve Bank of Boston, on May 15, 1953. addressed a letter to all commercial banks in the First Federal Reserve District calling attention to. relaxation of credit standards taking place in the market for installment credit. 55314—54 14 UNITED STATES MONETARY POLICY EXHIBIT A.—Use of Federal reserve instruments, July 1952-October 1954 Purpose of action Intent with respect to effect on credit and money Date September 1952. Suspension of regulation of real-estate credit. None. July-December 1952. Limited net purchases of VIS. Restrictive Government securities in open market to $1.8 billion. January-April 1953. Sold or redeemed $800 million net of U. 8. ^Government securities. do- January 1953... Raised discount rates from \H to 2 percent and buying rates on 90-day bankers' acceptances from lji to 2H percent. February 1953. Reduced margin requirements None.. on loans for purchasing or carrying listed securities from 75 to 50 percent of market value of securities. May-June 1953. Purchased in open market about $900 million U. S. Government securities. do Relief of credit market tensions. Reduced reserve requirements Expansive on net demand deposits by 2 percentage points at ceutral Reserve city bunks and by 1 percentage point at Reserve city and country banks, thus freeing an estimated 1.2 billion or reserves. do July-December 1953. Made net purchases in open market of U. S. Government securities totaling $1.7 billion. July 1953 January-June 1954— Limited net sales to about $90C million of U. 8. Government securities m open markoc. February 1954. April-May 1954 Reduced discount rates from 2 to \y* percent and buying rates on 90-day bankers' acceptances from 2±b to in percent. deduced discount rates from 1H to l\i percent and buying rates on 90-day bankers' acceptances from IH to 1# percent. do .do.. Explanation To conform with the terms of the Defense Production Act, as amended, requiring suspension of regulation if housing starts in each of 3 consecutive months fell short of an annual rate of 1,200,000 units, seasonally adjusted. To meet seasonal and other reserve drains only in part, requiring banks to borrow some of the reserves needed so as to restrain bank credit and deposit expansion at a time when credit demand was very large and the economy was fully employed. Purchases in August and September were made primarily at times of Treasury refunding operations and were offset in part by subsequent sales. To offset seasonal changes in factors affecting reserves and thur to maintain pressure on member bank reserve positions. To bring discount rates as well as buying rates on acceptances into closer alinement with open-market money rates and to provido an additional deterrent to member bank borrowing from the Reserve banks. To reduce margin requirements from the high level imposed early in 1951, in the judgment that the lower requirement would be adequate to prevent excessive use of credit for purchasing and carrying stocks. To provido banks with reserves and to permit a reduction of member bank borrowing from the Reserve bunks at a time when such borrowing was high, credit and capital markets were showing strain, and seasonal needs for funds were imminent. To free additional bank reserves for meeting expected seasonal and growth credit denial .ds, including Treasury financing needs, and to further reduce the pressure on member bank reserve positions. To provide banks with reserves to meet seasonal and growth needs and to offset a continuirg gold outflow with little or no additional recourse to borrowing. This action and the one below were taken in pursuance of a policy oi active ease adopted in view of the business downturn. To absorb only part of the reserves made available by the seasonal deposit contraction and return flow of currency thereby further easing bank reserve positions. To bring discount rates as well as buying rates on bankers' acceptances into closer alinement with market rates of interest and to eliminate any undue deterrent to bank borrowing from the Reserve banks for making temporary reserve adjustments. UNITED STATES MONETARY POLICY ^EXHIBIT 15 A.—Use of Federal reserve instruments, July 1952-Octooer 1954—Con. Purpose of action Action Date Intent with respect to effect on credit and money Explanation June-October 1954.. Reduced reserve requirements Expansive. To supply the banking system on net demand deposits by 2 with reserves to meet expected percentage points at central growth and seasonal demands for Reserve city banks and by 1 credit and money, including percentage point at Reserve Treasuryfinancingneeds. city and country banks, and requirements on time deposits by 1 percentage point at all member banks, thus freeing about $1.5 billion of reserves in the period June lfr-Aug. 1. Sold or redeemed U. S. Gov- Cushioning... ernment securities totaling about $1 billion in July and August. Reductions In reserve requirements Made net purchases in open market of about $400 million were offset in part by temporary sales of securities in order to preIn September and October. vent excess reserves from increasing unduly at the time, but security purchases were resumed as need for funds developed. MEMBER BANKS <3) What is the practical significance of shifting policy emphasis from the view of "maintaining orderly conditions" to the view of "correcting disorderly situations" in the security market? What were the considerations leading the Open Market Committee to confine its operations to the short end of the market (not including correction of disorderly markets) ? What has been the experience with operations under this decision? The matters referred to in this question relate to changes in techniques of System open market operations adopted in the spring of 1953. At that time, the full Federal Open Market Committee decided to amend its directive to the •executive committee by dropping the clause authorizing operations to maintain orderly conditions in the market for United States securities and by substituting therefor a clause authorizing operations to correct a "disorderly situation" in the securities market At the same time, the executive committee was instructed to confine its operations to the short end of the market. Closely associated was a decision taken earlier to discontinue direct supporting operations during periods of Treasury refinancing with respect both to maturing issues and to new issues being offered, as well as issues comparable to those being offered in exchange. These three decisions did not change basic policy objectives. They were taken .after intensive reexamination in 1952 of the techniques then employed in System 16 UNITED STATES MONETARY POLICY open market operations with particular reference to the potential impact of such techniques on market behavior. Their purpose was to foster a stronger, more self-reliant market for Government securities. Improvement in this market was desired (1) in order that the Federal Reserve might better implement flexible monetary and credit policies, (2) to facilitate Treasury debt management operations, ind (3) to encourage broader private investor participation in the Government securities market. The decisions were taken to remove a disconcerting degree of uncertainty that existed at that time among market intermediaries and financial specialists. The marke:: was uncertain, first, with respect to the limits the Federal Open Market Committee had in mind in its directive to "maintain an orderly market in Government securities.'* A second uncertainty pertained to the occasions when the System might decide to operate directly in the intermediate and longterm sectors of the market to further its basic monetary policy objectives, i. e., to ease intermediate and long-term interest rates in periods of economic slack or to firm these rates in periods of exuberance. Both of these uncertainties related solely to transactions initiated by the System outside the short end of the market, transactions which had as their immediate objective results other than a desire to add to or absorb reserves from the market. The effect, however, was to limit significantly the disposition of market intermediaries and financial specialists to take jx>sitions, make continuous markets, or engage in arbitrage in issues outside the short end of the market. The constant possibility of official action, which from the standpoint of investors and market intermediaries would often seem capricious, c nstituted a market risk which private investors could in no reasonable way ant *ipate and evaluate in formulating their advance judgment about market prospects. Even a financial intermediary who appraised correctly the emergence of a situation, where the Committee might decide to intervene, would have, little basis for estimating the exact timing of that intervention, the issues in which it might be concentrated or the levels at which it might take place. Such estimates are important to the sensitive rapid trading at very small spreads that is characteristic of a self-reliant securities market. Inability to make them may add a degree-of risk that is more than financial intermediaries are willing to accept. It became apparent that these uncertainties, so long as they persisted, would tend to perpetuate a condition of thin markets and sluggish adjustment as between sectors of the market. This impaired the attraction of Government securities as a medium of investment, since tlieir very high status with investors rests on ready salability as -well as on credit quality. Froir the point of view of the Federal Reserve System, such uncertainties might increase the probabality of situations arising in which the Open Market Committee would be forced to intervene in various sectors of the market, either to prevent disorderly situations from arising or to see to it that funds it added to or absorbed from bank reserves in the pursuit of monetary policies found effective and appropriate response throughout the credit structure. In taking these decisions, the Federal Open Market Committee is not absolving itself from concern with developments in the longer-term sector of the market. I t is particularly concerned that its policies shall be reflected in the cost and availability of credit in those markets. In the case of all three decisions, subsequent experience with actual operating results has, on the whole, tended increasingly to substantiate the judgments that led to their adoption. This is particularly true of operating experience since June 1953. Wihout any intervention from the Federal Open Market account, except in the short end, the market for United States Government securities has become progressively broader, stronger, and more resilient throughout all maturity ranges. Experience during April and May 1953, just after the new techniques were adopted, and before their import was understood, is less clear. This was the period of mounting tension in the credit and capital markets analyzed in the answer to question 1. In the 20 months' period of operations under these decisions, the economic climate has changed from one of boom to one of reduced* levels of activity. Accordingly, Federal Reserve policies have been shifted from restraint against inflation to the active promotion of ease in the credit markets. Ease in the longterm markets, as well as the short-term money market, has been an iinportant objective of these policies. Although all open-market operations, for technical reasons cited below, have been confined to the. short end of the market, there appears to be no example that can be cited from Federal Reserve history where *h« cost and availability of credit in all sectors of the securities market has been UNITED STATES MONETARY FOLICY 17 more sensitively responsive to shifts in Federal Reserve policy than during these months. This applies as fully to the market for long-term funds as for short-term funds; to the market for mortgage money, for business and industrial, State, municipal and public financing. It is important to keep in mind the scope of the decisions relating to the new open-market techniques. They are decisions of the full Open Market Committee .adopted for the guidance of its executive committee and the manager of the openmarket account. They do not mean that no operations wil be undertaken henceforth outside the short end of the market. They do mean, unless modified by the Committee, that operations in other than the short end of the market will have to be specifically authorized by the full Open Market Committee, except operations to correct a disorderly situation. In that case the executive committee, which can be convened quickly by telephone if necessary, is empowered to authorize such corrective operations. Background of new techniques These three interrelated decisions are designed to hold to a minimum the technical market repercussions that result in some degree from any operation on the part of the Federal open market account. In one sense it may be said that any purchase or sale in a market by any party, private as well as public, .small as well as large, disturbs the market in that it results in a change in demand and supply conditions in that market. The new operating techniques are not designed to prevent this type of repercussion. Such market response is necessary and desirable if a market is to perform efficiently the function of continuously equilibrating changes in demand with changes in supply. On the contrary, it is the primary objective of the techniques to contribute, so far as possible, to the development of such responsiveness in the market for United States Government securities. For this end to be realized, the market must be able to translate swiftly an increase in the availability of funds in any one sector of the market to increased availability in all sectors, and to soften the impact of decreased .availability of funds on any one sector by spreading that impact over other sectors of the market. In a well functioning market capable of such resilient response. Federal Keserve policies can make their greatest contribution to economic stability and growth. Technical characteristics peculiar to system transactions.—The danger that operations by the Federal open market account may, if executed through faulty techniques, exert an unduly disturbing or even disruptive effect upon the market for United States Government securities arises from four characteristics of these operations by which they are differentiated from purchases and sales of securities for the account of private firms and individuals. First, the dollar amounts of reserve funds that are required to be injected into or withdrawn from the markets in the course of ordinary day-to-day operations are likely to be quite large, much larger than the average amounts bought or sold in the course of a day for any individual private account. This naturally puts some strain on the market mechanism which is likely to function most effectively when the aggregate of its transactions is made up of numerous individual transactions of relatively small magnitude. Second, the open market account deals in reserve funds which provide a basis for a multiple expansion of credit. This means that when it buys it does more than merely add to the demand side of the market, as do other purchasers. The account pays for its purchases with a check on the Reserve banks. Consequently, it simultaneously adds to the reserve base sufficient buying power to absorb a much larger volume of securities. Conversely, when the open market account sells a Government security, the problem of the market is more than finding a buyer for that issue, as it must in the case of sales of securities by others. The purchasers must simultaneously pay for the security with commercial bank reserve funds which will be subtracted from the reserve base. This withdrawal of reserve funds will affect positively the supply of securities offered for sale. Third, transacrions by the open market account are not motivated by profit or loss considerations. They differ, consequently, from private purchases and sales which are so motivated. Private firms or individuals motivated by profit and loss considerations will riot pursue purchases when prices rise or yields fall to levels that appear less remunerative than comparable alternative outlets for their funds, neither will they press sales and take losses with respect to either price or yield when alternative courses of action open to them appear Jess costly. The result of these motivations in a market with large numbers of participants is to generate forces that tend to slow down, or counteract, or limit 18 UNITED STATES MONETARY POLICY movements in either direction. The importance of these counteracting forces was effectively illustrated after the accord when the unwillingness of investors to take losses reduced offerings in the market for United States securities. This restrained expenditures and helped materially to prevent a continuation o r resumption of the Korean inflation. These same motives do not govern transactions initiated by the Federal open market account, which are undertaken for policy reasons, and pursued, until policy goals are achieved, without regard totheir effect upon the earnings of the Reserve banks. Fourth, the Federal open market account is the largest portfolio of United States securities under single control. Its holdings of marketable United States securities approximate $25 billion or nearly 1 out of 6 of all such securities outstanding with the public. Its' potential buying power is also very large. Transactions initiated by the Federal open market account differ, therefore, from privately initiated transactions not only with respect to their motivation but also with respect to the potential financial power that lies back of them. Role of financial intermediaries.—These four basic respects in which transactions in United States Government securities initiated by the Federal open market account differ from privately initiated transactions find a reflection in the technical organization of the market for United States securities. They are particularly Important in circumscribing the role which primary dealers in United States Government securities and other professional intermediaries a r e willing to assume in that market. In general, a market such as the market for United States Government securities achieves depth, breadth, and resiliency when there are active within it, at all times, professional and intsrmediaries alert and willing, on their own capital and risk, to make continuous markets and to engage in arbitrage. To make continuing markets, they must stand willing continuously to quote firm prices at which they will buy reasonably large quantities of securities from any and all sellers, including each other. They must be prepared, if necessary, to hold such securities in their portfolio, pending subsequent resale. Similarly, a professional intermediary must stand ready to quote firm prices at which he wilt sell securities in reasonably large quantities to any and all purchasers, and must be prepared to enter into such contracts for sale even if the particular issues in demand are not in his portfolio a t the time but must subsequently be purchased from others. To make continuous markets successfully with his own capital and at his own risk, the professional intermediary must be alert to possibilities for arbitrage, i. e., he must sense when various issues are offered for sale or sought for purchase at prices which are mutually inconsistent with each other in terms of price relationships which may be expected to prevail in the near future. In such cases, the professional intermediary seeks to sell the issue that is overvalued and simultaneously to purchase the issue for which there is momentarily less demand. This requires a keen sense of values, and has the effect of keeping market quotations for comparable values in close alinement with each other. The sensing of such minor inconsistencies is less difficult when the two issues are in the same maturity sector of the market. It requires great skill, however, when they lie in different maturity sectors, for then the professional intermediary must stake his capital on a judgment a s to price and interest rate relationships that may be expected to emerge as between the various maturity sectors of the list. When the financial intermediary, alert to possibilities for arbitrage as between the various maturity sectors, is able to make such judgments successfully, and is willing to act on them aggressively, the effect is to impart continuity and responsiveness to the whole market. Continuity exists wrhen variations in quotations as between successive transactions are minor. Responsiveness obtains when the impact of sales in any particular sector, instead of being concentrated in that sector, is cushioned and dispersed in greater or less degree throughout all maturity sectors. Technical repercussions of transactions for system account.—These technical factors, taken in conjunction, pose the problem dealt with in the decisions discussed in this answer. Since transactions in United States securities initiated by the Federal open market account differ in important respects from similar tiansactions for private account, there is.a danger that they may set off adverse repercussions that impair the efficiency of the market as an equilibrating factor in the economy. The nature of these repercussions may be illustrated by analysis of a sales transaction initiated by the Federal, open market account. In any market, a transaction initiated by the seller is likely to have as one effect a lowering of price for the commodity sold. In the market for Government UNITED STATES MONETAKY POLICY 19 securities, this means that sales initiated by any seller are likely to find their first expression in a softening of quotations for the particular security offered for sale. The softening is likely ^o be larger, the larger the amount that is offered. It is also likely to be larger if there is ground to expect that the specific offer for sale is only the first of a series of further offers. In the case of offers from the Federal open market account, these typical reactions and expectations are likely to be accentuated because such sales not only supply issues to the market for which purchasers must be found but also withdraw reserve funds from the market and diminish its ability to carry securities. They are made, furthermore, from the largest portfolio of the United States Government securities available for sale in the market. For all the market knows, they may be the forerunner of many more sales to come. Since they are not motivated by the twin incentives of maximizing gains or minimizing losses that motivate most other offers that appear in the market, but are made solely in the execution of monetary policy, they are properly regarded as a possible signal of the attitude of the monetary authorities with respect to the state of the economy. These reactions acquire peculiar significance when transactions are initiated outside the short end of the market because prices fluctuate most widely in these sectors in response to changes in the availability of securities relative to the demand for them. This imposes a handicap upon private dealers and other professional Intermediaries in the market whose function it is, first, to provide continuous markets by carrying portfolios and taking positions throughout all maturity sectors of the list, and, second, to maintain a consistent relationship between prices of different individual securities by being alert to possibilities for arbitrage. The ^ross operations of these professional elements are very large relative to their capital at risk. They maintain markets by trading at very small spreads. If they are alert, they can function effectively when variations in price from one transaction to the next are small, as they are likely to be when selling and buying is on private account, limited in volume by the needs of private investors for outlets for funds on the one hand, or for cash on the other. Private professional intermediaries face a very different problem when prices in any group of securities vary sharply between transactions. Then the risk of making continuous markets and of engaging in arbitrage becomes too great. They tend to retire to the sidelines, so far as putting their own capital at risk is concerned. They cease, under these conditions, to make continuous markets, and confine their activities mainly to acting as brokers. As a result, the market for issues characterized by such risks becomes thin and moves over a relatively wider range between transactions. Such a market reacts sharply to relatively small bids or offers, and quotations that characterize an individual transaction become a poor guide to the values that would prevail on normal volume. Technical advantages of operations in the short end of the market.—The danger that transactions initiated by the open market account may unduly disturb the efficient functioning of the market is much less acute when they are confined to the short end of the market There are three main considerations which contribute to this result. In the first place, the risk assumed by professional intermediaries when they trade in bills is much less than when they trade in longer term securities. Bills are traded on a discount basis, and the great preponderance of bills outstanding at any one time have a maturity of less than 3 months. This means they will always appreciate to par within that period. Bills are ideal collateral, furthermore, and can always be used as security for loans. It is not toe difficult, therefore, to hold them to maturity. The main financial hazard attending professional operations in bills is that the holder will have to pay more in interest when he borrows to carry them than they gain in price as they approach maturity. Another reason is that the bill market is accustomed to relatively large transactions such as the open market account must undertake in absorbing and releasing reserves. It is the market in which all financial institutions typically adjust their day-to-day positions. »Trading is continuous and the market is accustomed to a large volume of individual transactions. Finally, the financial markets do not attach the same significance to System operations when they are transacted in bills as they do to transactions in other sectors of the market, Financial experts know that the Federal Open-Market Committee is more or less continuously engaged in putting funds into or absorbing funds from this market as it compensates for large day-to-day fluctuations in t h e amount of float, in Treasury balances, in the demand for currency, and in other factors. The appearance in the bill market of purchase or sell orders initiated by 20 UNITED STATES MONETARY POLICY the Federal open market account has no general long-term policy significance In the great majority of cases, and therefore does not so readily give rise to apprehensions that a change in policy is imminent Summary of technical conHidcrations.—To'summarize, transactions initiated by the Federal open market account, particularly transactions in intermediate and long-term issues, may seriously affect the efficiency of the market. The initial impact of such transactions falls first on the professional intermediaries of the market whose willingness to take positions gives continuity to the market and whose willingness to engage in arbitrage works to cushion a concentrated impact of such sales on part of the price structure by spreading their effect in greater or less degree throughout all maturity sectors. These intermediaries confront great difficulty in estimating how large transactions for the Federal open market account may be, how long they may continue, or how large are the losses the seller may be willing to absorb. Such estimates, iiowever, are essential to the efficient performance of the professional intermediary whose operations make continuous sensitive markets possible. Without them, dealers and other professional intermediaries have less basis for decision as to the amounts of securities they can afford to take into portfolio, or the points at which they can undertake an arbitrage operation. The ability to make such supply and demand estimates correctly on the average is a rare skill which a professional intermediary in the market must possess in high degree to survive. When market conditions are such that approximate supply and demand estimates cannot be made, the continuity and sensitiveness of the market is seriously impaired. Dealers and other professional intermediaries in the market become reluctant to take positions and to undertake arbitrage. Instead, they tend to confine their role to that of brokers, operating mainly on a commission basis. In this role, they offer to find buyers for issues pressed for sale, and other sellers for issues in demand, but they do not themselves purchase or sell securities at their own risk. They do not. therefore, perform the function of giving breadth and continuity to the market by.their willingness to take securities into position. This situation presents a very real dilemma to the monetary authorities. Monetary policy is most effective and can make its maximum contribution to economic stability arid growth without inflation at high levels of output and employment when the entire credit structure is sensitively responsive to its operations. Federal Reserve operations exert their constructive influence most effectively when they affect the cost and availability of credit throughout all sectors of the market. This is particularly true of the long-term market where the rate of saving and the cost and availability of funds register on capital formation. The effectiveness of monetary policies is definitely hampered when markets are thin-. Hiziorical background of new techniques Market conditions, adverse to the proper functioning of dealers and other professionals in the market for Government securities, were strongly in evidence during the period of pegging prior to the Treasury-Federal Reserve accord of March 1951. Dealers in United States Government securities tended to confine their operations to the broker function, coming to the Federal open market account for securities when they were in demand in Tthe market and disposing of securities to the Federal open market account w hen they were in supply. Under these conditions, the account itself performed the function of making continuous markets for most maturity sectors even including the very short end of the market. It did so, of course, at the expense of monetary policies appropriate to the stability of the economy. The reserve funds that were made available almost automatically under the technique of pegging operated to augment the availability of credit and thus to increase the demand for commodities to a volume that was in excess of what could be supplied. Vne result was to incorporate into the base of the price structure a spiral of risi:og costs and prices. This inflationary process was stopped early in 1951 when the Federal Open Market Committee discontinued pegging the prices of United States Government securities. Thereafter, as is brought out in the reply to question 1, the reserve funds released or absorbed througn open-market operations n.»re adjusted more closely to the needs of a growing economy operating wV.houti inflation at high levels of activity. The market for United Slates Government securities showed its basic strength at that time by adjusting to the new situation with much less disturbance than many close and informed observers had UNITED STATES MONETAE" POLICY 21 expected, and within a few months the operations of the open market account were almost wholly confined in practice to the short end of the market. The Federal open market account continued during this period, however, to engage in operations in support of Treasury refinancing. The volume of reserve funds released in these supporting operations became, as time passed, a matter of increasing concern to the Federal Open Market Committee. They were large in volume and had later to be recovered by offsetting sales if the fueling of inflationary forces was to be avoided. Concurrently, there was increasing concern at the failure of certain sectors of the market, particularly the long-term sectors, to develop the degree of depth, breadth, and resiliency that would be desirable from the point of view (1) of effective refinancing of the public debt, (2) of the effective execution of monetary policies, and (3) of the effective operation of the market in shifting or allocating funds among various users. Specifically, following the accord, the long end of the market was described by competent observers as "thin." This was illustrated by the fact that prices of long-term Government bonds fluctuated over a relatively wide range In response to the appearance of relatively small buying or sales orders. I t indicated that, so far as the longer sectors of the market were concerned, dealers and other professional intermediaries still tended, on the whole, to confine their operations to the broker function. Operations undertaken at their own risk, c.ither to maintain continuous markets or for arbitrage, remained limited on the whole to relatively small commitments, too small to give the market a desirable degree of selfreliance." It was in this setting that the Federal Open Market Committee undertook, in 1952, to reexamine intensively the techniques employed by the System itself in its contacts with the market for United States Government securities to seewhether any changes could be made in those techniques that would contribute to a stronger, more smoothly functioning market. This examination led, among other things, to the three interrelated decisions that are dealt with in this reply. These decisions have fostered a more effective and efiicient market for United States Government securities in two ways: First, by reducing to a minimum the direct disturbing or disruptive impacts on the market of transactions initiated by the System; and, second, by establishing a climaie of expectations in the market that would encourage private operators to engage more actively in making continuous markets and in arbitrage. The accomplishment of these results has had beneficial effects on System openmarket operations from a monetary point of view. These operations are now confined to the amounts necessary to effectuate basic monetary policies—that is to say, they have come to be limited to providing or withdrawing reserve funds in amounts and at times appropriate to the general economic situation. Decision to discontinue support of Treasury refinancing The decision to discontinue support operations during periods of Treasury refinancing was mainly important in improving the timing, reducing the volume and minimizing the disturbing or disruptive effects of System operations on the market. Its importance in minimizing the volume of operations initiated by the open-market account and in improving their timing shows up stri^'tigly in the record of System operations between July 1, 1951; i. e., after the market had adjusted itself to the accord; and September 30, 1952, the last month in which direct support was given to a Treasury refunding issue. During these 15 months, direct operations for System account put reserve funds into the market amounting to $2,418 million net, during periods when the Treasury was refinancing. During the same 15 months the net effect 6f all open-market operations initiated by the System in t he intervals between these periods of refinancing was to withdraw $1,G58 million. In other words, during those 15 months, a large volume of sales from System account were made solely to absorb reserve funds in excess of basic needs that had previously been put into the market to support Treasury refundings. This phenomenon has entirely disappeared since the autumn of 1952 when the practice of giving direct support to Treasury refinancing was discontinued. At the same time, the rate of attrition incident to Treasury refunding operations, i. e., the relative proportion of maturing Treasury securities that have been presented for cash payment at maturity, has averaged lower than it d»d in the period when such direct support was given. This wholly satisfactory result reflects, of course, the nature and pricing of new securities offered by the Treasury since supporting operations were discontinued as well as improved performance on the part of the market under the new operating techniques. 22 UNITED STATES MONETARY POLICY Decision to confine operations to the short end of the market The technical considerations that account for the decision to confine operations to the short end of the market have already been discussed. The decision was taken to remove an obstacle that appeared to account, in part at least, for an undesirable degree of "thinness" in the intermediate and long-term sectors of the United States Government securities market after the accord. It was not taken without consideration of alternative techniques from the point of view both of the possible effects of these techniques on market behavior and of their implications in the development and effectuation of credit and monetary policy. Alternative to operations at the short end of the market.—The problem of how to deal with the effects of central bank transactions on market behavior are not confined to this country. They are present in greater or less degree in all countries with highly developed credit structures where open market operations are used as a principal means of effectuating monetary policies. Some monetary authorities have tried to meet the problem by themselves assuming primary responsibility for making continuous markets and for arbitrage. They do this by being themselves prepared to buy or sell in all maturity sectors of the Government securities market. When a particular issue in demand is in relatively scarce supply in the market, the monetary authority is prepared to make the desired securities available from its own portfolio. It may then have to purchase other securities from other sectors of the list to offset the effect of the sale upon bank reserves, if the basic objectives of monetary policy do not justify an absorption of reserves from the credit base. This procedure resembles in many respects that which was employed by the Federal Reserve System when it was engaged in pegging the prices of Government securities prior to the accord and for a period afterward during periods of Treasury refinancing; It has the important difference that no attempt is made to perpetuate any particular price level for Government securities. Rather, when this is done, the monetary authority comes to a judgment not only as to the general interest rate level but also as to what structure of rates would be most appropriate in the various maturity sectors of the market and is prepared in its operations to make these levels effective. As economic conditions change, requiring a different level of interest rates or a different structure of rates as between the various maturities, the monetary authority uses its own operations to move the prices of secU/ ities quoted in the market and market rates of interest to levels it rgards as more appropriate to the new situation. When monetary authorities adopt this technique, the problem of thin markets and sluggish arbitrage is in a sense- eliminated, since the monetary authority is itself prepared to maintain continuous markets and to establish directly and to change from time to time the levels of prices and of interest rates which it regards as appropriate to the various maturity sectors of the market. The various securities in its portfolio become part of the potential market supply and it takes over the role of primary jobber to the market. At the same time, for reasons already noted, dealers and other professional middlemen operating on their own capital and at their own risk tend to confine their activities to that of brokerage. I t has been recognized within the Federal Reserve System since the accord that the technique described above not only had intrinsic defects but was inapplicable to the American economy. Considerable thought has, however, been given to a variant of this approach, namely, one in which the Federal Open Market Committee would normally permit the interplay of market forces to register on prices and rates in all the various maturity sectors of the market out would stand ready to intervene with direct purchases, sales, or swaps in any sector where market developments took a trend that the Committee considered was.adverse to high level economic stability. It will be readily appreciated that this variant differs decisively from that •described above. Instead of taking affirmative responsibility to make continuous markets and to establish interest rates and prices in all the various sectorsof the list, the Committee under this variant would operate normally in the short end of the market, absorbing or releasing reserve funds from day to day in accordance with general policy directives. It would stand continuously ready, however, to intervene in a r y sector of the list when it considered such intervention might further the objectives of monetary policy, Such intervention would not necessarily have to be decisive. The fact t h a t t h e Committee purchased or sold securities at any given quotation would not mean that it was prepared to engage in similar subsequent transactions to maintain the same price. Rather, i* would seek, by occasional purchases and sales UNITED STATES MONETARY POLICY 23 a t the fringe of the market, to cushion or reverse declines or advances at some times and to accelerate them at others. In each case of intervention, the decision whether to accelerate or cushion would be based on an evaluation of what was considered most appropriate at the time to the achievement of the objectives •of monetary policy. This variant, which paralleled closely the actual pattern of System operations during the period following the accord up to the spring of 11)53, was not adopted because it did not appear to offer real promise of removing obstacles to improvement in the technical behavior of the market. System open market experience from the accord to March 1953.—During the greater part, of the first 2 years after the accord, the great bulk of transactions actually undertaken by the System was confined, in fact, to the short end of the market. These included purchases to support Treasury refinancings, most of which were executed in the short end of the market. At the same time, the policy statement of the Federal Open Market Committee directed the executive committee to maintain orderly conditions in the market for United States Government securities. It was generally understood during this period, both within the System and in informed market quarters, that it was the policy and desire" of the System that a free ,narket for United States Government securities should develop and be permitted to make its maximum contribution to economic stability both in the sense of equating the demand for funds for investment with the supply of savings (with due allowance for the growth factor in the money supply) and of being permitted to allocate these demands and supplies as between the various sectors of the market. At the same time, it was understood that the System stood ready through open market operations, without restriction as to maturity, to check undesirable movements in prices and interest rates. In comparison with the preceding period in which the practice of pegging prices and yields contributed to the inflationary potential, this shift in policy and technique was in the right direction. Despite the forebodings of many who prophesied that the dropping of the pegs would be followed by chaos, a free market did develop when the pegs were dropped and did play a major role in stopping the inflation and in sustaining the economy at high levels of activity. There was no catastrophic shift in prices of Government securities. There was no panic. Confidence in the stability of the dollar wTas restored. The results of the action in all major respects, except one, corroborated the judgment of those who took the responsibility for its initiation. The exception, already noted, was the thinness that continued to characterize the intermediate sector and the long-end of the market for United States Government securities. At first, this was generally explained by the fact that a return to a free market after so long an interval would necessarily be accompanied by some frictions. It would necessarily take time, it was felt, for appropriate mechanisms to develop in the market before it could perform its normal functions at high efficiency. As time went on. however, these mechanisms failed to develop adequately and the problem of thin long-term markets continued to exist. It was in this setting and, in part, to consider how to deal with this problem, that the Federal Open Market Committee in 1052 undertook the studies that led to the three decisions treated in this question. Decision to change directive xoith respect to orderly markets During the period from the accord to March 1053 there was considerable misapprehension and confusion with respect to the interpretation of the phrase "orderly markets," a situation which in many respects was justified. The clause in the directive requiring the executive committee to maintain orderly markets was in the directive prior to the accord and was the authority under which many stabilizing operations were taken at that time. The fact that the phrase had not been changed after the accord but instead had been interpreted less restrictively left legitimate grounds for uncertainty with respect to the interpretation that might be placed upon it in future operations. The decision to change the directive to the executive committee "to maintain oiderly markets for United States Government securities" to read "to correct a disorderly situation in the Government securities market" was made to remedy this misapprehension and confusion. This gave notice that the Federal Open Market Committee would not intervene to prevent fluctuations of prices and yields such as normally and necessarily occur as markets seek to establish equilibrium between supply and demand factors and to allocate savings as between the different maturity sectors. Instead, it indicated that the market would have to be clearly disorderly before such intervention would occur. 24 UNITED STATES MONETARY POLICY The primary aim of this shift in operating objectives was to foster in themarket a climate of expectation with respect to System intervention that would encourage maximum private participation in market activities. In combination, with confinement of operations to the short end oJ the market, the shift also contributed to minimizing the disturbing or disruptive effects of System operations. Experience with the new techniques These decisions were taken in March of 1953 in the hope and expectation, that they would provide an environment in which professional intermediaries in the market would begin to broaden the scope of their operations in a way that would give greater depth, breadth, and resiliency to the intermediate and longer sectors. Specifically, it was hoped that these intermediaries, faced mainly by business and market risks wThich they were in a position to evaluate and freed from the risk of disturbing or disruptive repercussions arising from direct intervention by the Federal Open Market Committee, would begin to make more continuous markets and engage more promptly in arbitrage through all maturity sectors. I t was hoped that they would sufficiently improve the market so as tominimize the occasions for direct System intervention in these sectors of themarket, intervention either to correct the development of a disorderly situation or intervention to hasten the market's response to changes in credit and monetary policy. These expectations to date have been on the whole fulfilled, although, of course, it is recognized that this approach is still experimental and that insufficient time has elapsed to draw firm conclusions. The first and most difficult test came in the spring of 1953, within a very short time after the new techniques were adopted, and before their impact had been evaluated or understood. This was the period described in the answer to question 1 when great tension developed in the long-term investment market, sufficient tension to require vigorous offsetting action by the Federal Reserve System. There were many at that time who felt that direct System intervention in the longtorni money market was the only remedy that wTouId relieve the situation. This view gained adherents when the first purchases of bills, initiated by the System early in May 1953, found relatively small immediate response in relieving tension in the long-term sector of the market even though the Treasury with its own funds made some purchases in that sector during this period. Finally, as the Treasury made larger purchases and the open-market account undertook to supply reserves in large volume through an aggresive purchase of bills, the tension began to Subside. Subsequently, all sectors of the market, long, intermediate, and short, have been characterized by great improvement with respect to their depth, breadth, and resiliency. Private arbitrage has brought about a sensitive response to the System's monetary policy in the long-term sectors of the market. The ease that for some time has pervaded the money and credit markets may account for part, but it does not by any means account for all, of these results. It has been a primary objective of System credit and monetary policy during this, period to encourage an expansion in private activity financed by long-term funds. This has also been a main objective of Treasury debt management policy which has refrained from competing with mortgage borrowers and other potential users of long-term savings. While, under the new techniques, openmarket operations to help effectuate this policy objective have been confined entirely to putting, reserves into the short market, the response in the form of increased availability of funds in the ? ng-term capital markets, including even the semi-isolated mortgage market, ha.j been gratifying. The recession of industrial activity during this period has been exceptionally mild as compared to other periods, even milder than the recession of 1949 when United States security prices were pegged. It would.be very difficult to make a case that direct intervention in the long-term markets during this period would have induced an even better response. Such is the experience with the new techniques to date. As previously pointed out, it remains for them to be tested in other more normal periods of Federal Reserve operations. Only time and further experience\vill tell whether problems not now foreseen will or will not emerge. If thej do, it will be the duty of *he Federal Open Market Committee to deal with them in the light of its accumulated experience. Conclusion The formulation of appropriate credit and monetary policy is., a t best, difficultI t requires, first, painstaking search for all the relevant facts that may bear on UNITED STATES MONETARY POLICY 25 the economic and financial outlook; second, all the wisdom and insight that experience and operating contacts can bring to the interpretation of those facts, and, finally, and perhaps most important, humility with respect to any emerging situation. There are relatively few occasions when the meaning of developing events is so clear that the monetary authorities can say, "As of today, our policy should be changed from restraint to ease." A shift in policy emphasis more typically emerges from a succession of market developments and administrative decisions in which the range for variation needed in pursuit of any particular policy gradually shifts from the side of ease to the side of restraint or vice versa. The various factors that exert an impact on bank reserve positions are at best difficult to forecast in advance. There is a considerable margin of uncertainly in any forecast of factors absorbing or supplying reserves. Yet the.se forecasts or projections must be made in planning open-market operations. In consequence, there is frequently much discussion, when prosi>ective purchases or sales are authorized, of whether it would be wiser to deal with the area of uncertainty in the forecast in the direction of restraint or in the direction of ease. These changing shifts in emphasis do not necessarily mean that a new policy direction is emerging. Usually, however, by the time the facts of the economic situation are sufficiently clear to lead to the adoption of a changed policy directive, it will be found that these day-to-day allowances for uncertainties in the forecasts of reserve availabilities have begun to be increasingly resolved on the side later indicated by the new policy directive. Such-tentative testing and probing of the responsiveness of the economy to monetary actions would be much more difficult if the Federal Reserve were to make itself responsible not only for adding to and withdrawing marginal amounts of reserve funds from the money market but also for making continuous markets and establishing interest rates and prices prevailing in all sectors of the security markets. Then any changes in such interest rates and prices could result only from direct administrative decisions. Such decisions would carry considerable significance in themselves and would require adequate justification. Such justification might not be too. difficult to find if the American economy customarily relied on the import of capital for its development. In that case, the necessary signals would usually be furnished by movements of prices and interest rates in the various sectors of the foreign financial market from which the capital was imported. In fact, however, the American economy is a highsaving economy that exports rather than imports capital. In this country if the structure of interest rates were too closely controlled, it would be difficult to tell from the character of the u a r k e t response whether and when new trends were developing within the economy. The allocation functions of the market place in determining relationships between the cost and availability of funds in the various sectors of the market, short-term, intermediate, and long-term, would be in abeyance, and responsibility for efficient performance of these important economic functions would be transferred to the area of official discretionary action. In conclusion, it needs to be emphasized once more that it is not contemplated that these new techniques will never be changed. The Federal openmarket committee must always be prepared to tailor the techniques of its operations to the requirements of the economy. In the development of those techniques, situations may well arise when the Federal Open Market Committee will want to operate directly outside the short end of the market. I t must also be emphasized that the new techniques do not.imply that the Federal Open Market Committee is unconcerned about developments throughout the securities market or that it is committed to dealing only in he short end of the market whatever may happen to prices and yields of Jong-term securities. The Federal Open Market Committee directive specifically and positively enjoins the executive committee to operate to correct a disorderly situation in the market for United States Government securities if one develops. Such situations rarely do develop in efficiently functioning markets. History indicates, however, that there are occasions when a market becomes clearly disorderly and in itself threatens economic stability. This happens when a selling or buying movement feeds on itself so rapidly and so menacingly as to prevent counteracting forces from developing within the market mechanism. Usually, these situations reflect a serious deficiency or excess of reserve funds and can be corrected by 26 UNITED STATES MONETARY POLICY operating to adjust the volume of reserves to the requirements of the economy. Sometimes, however, they occur in response to other factors. Under the Federal Open Market Committee's present directive, the executive committee is responsible for diagnosing such a situation if one develops and for dealing with it decisively without any restriction whatever as to sectors of the market in which transactions are initiated. (4) What is the policy with respect to volume of money? The policy of the Federal Reserve System with respect to the vol lime of money is to provide as nearly as possible a money supply which is neither so large that it will induce inflationary pressure nor so small that it will stifle initiative and growth. P u t another way, the policy is to help maintain a volume of money sufficient to facilitate the consumption and investment outlays necessary to sustain a high level of production and employment, without leading to spending and investing at a rate which would outstrip the supply of available goods at prevailing prices and generate speculative conditions. Judged from this standpoint, the amount of money required varies with such factors a s : the productive capacity of the economy; the state of business expectations; economic dislocations of various kinds; seasonal fluctuations; and changes in money turnover or velocity reflecting variations in liquidity and the demand for liquidity on the part of businesses and consumers. In the past, the monetary supply has shown considerable fluctuation over the course of business cycles. It is the policy of the Federal Reserve System to counteract, insofar as possible, the tendency for excessive cyclical swings in the volume of money. An economy which is expanding requires an increasing supply of money to facilitate its growing volume of transactions. Additions to population and productive capacity and a growing complexity of economic organization give rise to increased needs for cash balances. It is the policy of the Federal Reserve System to foster growth in the money supply in accordance with these needs. Like any other modern monetary system, the monetary system of the United States is complex. In view of its complexities, it is not feasible to rely upon any mechanical formula for the determination of the volume of money appropriate to a given economic situation. This subject is one requiring continuous examination and study—historically, currently, and prospectively—of the various changing forces affecting the economy's need for money. Our monetary organization and its complexities were discussed at considerable length in the reply of the Chairman of the Board of Governors to question 28 of the questionnaire addressed to him in 1951 by tue Subcommittee on General Credit Control and Debt Management, under the chairmanship of Representative Patman. They were also treated again in an article under the title "The Monetary System of the United States" published in the Federal Reserve Bulletin for February 1953. (5) Has monetary machinery fa) worked flexibly, and (b) has the market demonstrated flexibility in its responses to changes in policy? For example, how has the policy of "active ease" been reflected in the level and structure of interest rates, the volume of credit, and the roles of various types of lenders? The monetary machinery since mid-1952 has worked flexibly, and the market has responded flexibly to changes in credit and monetary, policy. The effectiveness of credit and monetary policy is due in part to its adaptability to changing economic circumstances. During late 1952 and early 1953, inventories were rising, the Federal cash deficit was increasing sharply, consumer installment indebtedness was-growing rapidly, capital outlays were being made on a large scale, credit demands generally were very strong, and forward commitments were taking on a speculative hue. With the economy already operating at virtually full capacity and producing in excess of final takings from the market, these developments constituted a threat to long-term stability and growth. Accordingly, Federal Reserve policy from mid-1952, to late spring 1953 was directed toward restraint of further increases in spending financed by bank credit. With abatement of inflationary pressures in the late spring of 1953, the Federal Reserve readapted its policies to promote orderly realinement of activities and to foster a climate favorable to resumption ol economic growth. UNITED STATES MONETAHY POLICY 27 The influence of credit and monetary policy can be traced through observations of changes in five interrelated factors: the availability of credit relative to demand, the volume of money, the cost of borrowing, capital values, and the general liquidity of the economy. Examination of each of these factors helps to illustrate the points of "flexibility'* and "responsiveness" raised in this question. In considering these factors it is important to keep in mind that credit and •monetary action is only one of the many factors, although an important one, affecting the general level of economic activity. The influence of credit and monetary policy in any period is necessarily conditioned by various other policies and programs of the Federal Government, by economic and political developments abroad, and by public responses to a variety of unpredictable events. Also, the effectiveness of credit and monetary policy in a particular period needs to be judged in the light of broad experience and observation. One of the difficulties with such judgments is that financial and institutional practices are constantly changing so that close comparison with past periods may not be entirely appropriate. These changes result in financial adjustments which differ in responsiveness and degree of lag from one period to another. Availability of credit Changes in the availability of credit, while not subject to statistical documentation, may be observed in a general way from the terms and conditions which lenders require in granting credit, from their passivity or aggressiveness in seeking out new outlets for loan funds, and by the response that borrowers experience to their applications for credit. During the period of credit tightening through late spring of 1053, for example, the very large demands for credit exceeded the substantial volume of funds available for lending and lenders had to adjust their operations to this fact. Some lenders, particularly banks, tended to favor short-term credits and reduced their longer term lending. Other actions to discourage undue borrowing were adopted by various lenders. Commercial banks tended to require larger minimum deposit balances from borrowers. Insurance companies tended to write more restrictive call provisions and other features into their'private-placement agreements. Mortgage lenders generally tended to favor paper with shorter terms and to require larger downpayments. Also, lenders cut back their activities for developing new credit outlets, became reluctant in many cases to accept new borrowing customers, and reduced the volume of their lending to borrowers who were marginal in terms of risk and longrun profitability. These tendencies became more pronounced as the tightening movement progressed. With credit easing after the late spring of 1953, these developments were reversed. In general, lenders found themselves with more funds available relative to the demand than earlier, and were under pressure to keep such funds fully invested.' As a result, uses of credit were promoted that under tighter money conditions had been postponed or curtailed. The volume of new security issues was maintained at a very high level throughout the period of business decline, and a number of these issues, particularly State and local government revenue issues, were of a type that would not have been brought out in the earlier period of restraint. Mortgage credit became available on more liberal terms with respect to downpayment and maturity, and lending commitments to builders again came to be readily arranged. Consumer credit standards and terras also eased, although with more lag than in the case of mortgage credit. Commercial banks, moreover, became more aggressive in term.lending and tended to lengthen somewhat the maturities of their investment portfolios as well as to widen the area of their investment interest. In some cases these liberalizations went further than had been attained in the preceding period of credit ease. Volume of money The accompanying chart shows the movement in demand deposits adjusted plus currency in circulation, seasonally adjusted, since mid-1952. Federal Reserve restraints on the expansion of bank credit during the period of inflationary threat from mid-1952 to late spring of 1953 were effective in curbing growth in the money supply at a time when pressures for bank credit and monetary expansion were very strong. During this period, the demand deposit and currency holdings 28 UNITED STATES MONETARY POLICY of individuals and businesses increased by $3 billion, or about 2M? percent. This compares with a growth of over 6 percent in each of the preceding 2 years. Over the past year and a half, the money supply increased further even though business activity declined ov^r the first half of that period. Demand deposits and currency of businesses arid individuals leveled off during the second and third quarters of 1953, after allowances for usual seasonal movement, rose moderately thereafter through mid-1954, and subsequently increased sharply. Over the year ending September 1954, the money supply expanded by $3 billion, or approximately 2% percent. This expansion, which reflected primarily an increase in bank holdings of Government securities, is in contrast to the behavior of the money supply in most previous periods of business decline. In some previous recession periods the money supply contracted, reflecting a significant liquidation of bank credit as a factor of economic recession. Under such circumstances, curtailed liquidity put consumers and businesses under pressure to reduce their spending, thus contributing to further recession in activity. DEMAND DEPOSITS Cost of borrowing The accompanying table of selected market interest rates since mid-1952 shows the changes that have taken place in the cost of borrowing. Reflecting the combined influence of heavy credit demands and restrictive Federal Reserve policy, interest rates began a general advance in the second half of 1952. The advance accelerated in early 1953, with peaks for this movement reached in June. Thereafter, the interest rate movement was reversed as Federal Reserve policy shifted from one of restraint to one of actively fostering credit ease. Market interest rates declined appreciably through the early part of 1954 and subsequently have $hown Htt3e change. The movement in interest rates spread throughout the credit market, affecting all types of credit paper and securities, although in different degree. For example, rates charged by banks on customer loans were more sluggish in their response on the downside than were open market rates. However, the responsiveness of market interest rates to the policy of "active ease" was very marked; the decline in money and capital market rates after mid-1953 was as sharp and widespread as in the comparable phase of any other business downturn since World War I. 29 UNITED STATES MONETARY POLICY Selected money rates [Monthly averages] XJ. S. Government securities Bills 1.700 1.824 1.876 1.786 1.783 1.862 2.126 2.042 2.018 2.082 2.177 2.200 2.231 Long3 to 5. term old years series 2.04 2.14 2.29 2.28 2.26 2.25 2.30 2.39 2.42 2.46 2.61 2.86 2.92 2.61 2.61 2.70 2.71 2.74 2.71 2.75 2.80 2.83 2.89 2.97 3.09 3.09 +.531 4-. 88 2.101 2.72 2.77 2. OSS 2.69 1.876 2.36 1.402 2.36 1.427 2.22 December --_1.630 1954—Januarv - .. 2.04 1.214 1.84 February ----.984 March 1.80 1.053 1.71 1.011 April 1.78 May .782 1.79 June . 650 1.69 .710 July 1.74 August .892 1.80 September 1.007 1.85 .987 October Change: June 1953 to October 1954 -1.244 - 1 . 0 7 +.48 2.99 3.00 2.97 2.83 2.85 2.79 2.68 2.60 2. 51 2.47 2.52 2.54 2.47 2.48 2.51 2.52 1952—June———— --July Aupust - --.-September..----*----October November - -. December -------1958—January -_ February March - - - - - - - April May Change: June 1952 to June 1953 1953—July August September October -.57 Prime commercial paper Bank rates to customers Corporate bonds Aaa A Baa Municipal bonds 2.31 3.51 2.31 2.31 2.31 3.49 2.31 2.31 2.31 3.51 2.31 2.31 2.36 3.54 2.44 2.67 2.75 "~Z~72>~ 2.94 2.95 2.94 2.95 3.01 2.98 2.97 3.02 3.07 3.12 3.23 3.34 3.40 3.20 3.19 3.21 3.22 3.24 3.24 3.22 3.25 3.30 3.36 3.44 3.58 3.67 3.50 3.50 3.51 3. 52 3.54 3.53 3.51 3.51 3.53 3.57 3.65 3.78 3.86 2.10 2.12 2.22 2.33 2.42 2 40 2 40 2 47 2.54 2.61 2.63 2.73 2.99 +.22 +.46 3.28 3.24 3.29 3.16 3.11 3.13 3.06 2.95 2.86 2.85 2.88 2.90 2.89 2.87 2.89 2.87 +.47 3.62 3.56 3.56 3.47 3.40 3.40 3.35 3.25 3.16 3.15 3.15 3.18 3.17 3.15 3.13 3.14 + . 3 7; 3.8< 3.85 3.88 3.32 3.75 3.74 3.71 3.61 3.51 3.47 3.47 3.49 3.50 3.4« 3.47 3.46 +.89 2.99 2.88 2.88 2.72 2.62 2.59 2.50 2.39 2.38 2.47 2.49 2.'*8 2.31 2,23 2.29 2.32 -.53 -.53 -.40 -.67 +.44 2.75 2.75 2.74 2.55 2.31 2.25 2.11 2.00 2.00 1.76 1.58 1.56 1.45 1.33 1.31 1.31 -1.44 '"z'H" ""T76~ 3.72 3.60 -.17 Capital values Changing interest rates have also affected the economy through the recapitalization of future income, that is, through lowering or raising the dollar value of existing capital assets, particularly long-lived assets. This response has been especially noteworthy in the securities markets where prices of outstanding bonds and investment-type stocks have registered the influence of interest rate movements as well as, of course, of other factors. The attached table shows the percentage changes in values in selected types of capital asset over the past 2% years. From mid-1952 to mid-1953, the increase in yields and consequent decline in prices of United States Government securities and corporate and municipal bonds reduced significantly the market value of investors' portfolios of such securities. Stock prices also showed moderate decline over this period despite prosperous business conditions. These developments were an influence helping to damp down the boom in capital outlays in this period. Since mid-1953, rising prices of bonds and stocks have reflected in part the influence of falling interest rates. This movement in values has tended to help sustain private rcapital expenditures during the period when business activity in other lines w as receding somewhat in consequence of the work-off of excess inventories and reduced defense expenditures following the settlement in Korea. 55314—54 3 30 UNITED STATES MONETARY POLICY In some investment areas, such as the farm and existing residential real estate areas, values declined somewhat despite falling interest rates. These declines reflected the overriding effect of other factors, for example, the reduction in agricultural income in the case of farm real estate values and the increasing supply of new homes in the case of residential real estate values. Even in these areas, however, there is reason to believe that the higher capitalization factor helped to cushion the decline in market values. Percentage changes in selected capital values June 1952June 1953 Government bonds (long-term) Corporate bonds (high-grade) Preferred stocks l(high-grade) Common stocks (Standard & Poor's series) - June 1953October 1954 +9 +8 -7 -6 -12 -9 -3 +10 +14 +33 1 Values of common stocks are, of course, particularly affected by important variables other than the capitalization factor. These include, for example, changes in earnings and dividends and changes in expectations as to general business developments. General liquidity of the economy Changes in the volume of money and other highly liquid assets and in the value of existing assets affect the liquidity of businesses and individuals and influence their willingness to spend and invest They also affect the liquidity of financial institutions and their willingness to lend and invest The restrictive credit policy from mid-1952 to last spring 1953 caused existing assets to decline in liquidity. This development influenced consumers and businesses to screen expenditures more carefully either because they were reluctant to dispose of interest-bearing securities at the prices currently prevailing, or because they were encouraged by rising yields to save and invest in securities or other savings forms. Also, the desire for liquidity was heightened by the fact that access to credit was not as assured as it had been earlier. This put a greater premium on holding cash balances and other liquid assets rather than spending. The relative stability of prices over this period, moreover, fostered confidence in the value of the dollar so that holders of deposits and currency did not feel pressed to make expenditures immediately in anticipation of higher prices. In contrast, falling interest rates in the recent period of monetary ease tended to make individuals and businesses, as well as financial institutions, more liquid and increased the proportion of their assets that could be sold at cost or profit This is particularly true of investment portfolios where the rise in prices of marketable United States Government bonds, corporate bonds, State arid local government bonds, and corporate stocks made holders more willing to lend and to spend. The fact of ready availability of credit, furthermore, reduced the requirements of businesses and individuals generally for liquidity. Concluding comment Viewed as a whole it appears that credit and monetary policy exerted a wholesome restrictive influence in the 1952-53 period of boom and a desirable cushioning and sustaining influence in the economic decline which followed. In so doing, it made a necessary and positive contribution to stable economic growth. UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS, Washington, November Hon. 26,1954. RALPH E. FLANDERS, Chairman, Subcommittee on Economic Stabilisation of the Joint Committee on the Economic Report, Congress of the United States, Washington, D. C. M Y DEAR MR, CHAIRMAN: For Secretary Humphrey, I am transmitting the Treasury's replies to the questions your subcommittee directed to us on October 26, 1954, with respect to United States monetary policy and debt management in recent periods. Both Secretary Humphrey and I are pleased to participate in your subcommittee's review of recent thinking and experience in this important field. The 31 UNITED STATES MONETARY POLICY past 2 years have given us our first real test in a long time of the contribution that a flexible money and credit policy can make to economic stability and growth. As you knowr, the Secretary is currently attending the Conference of Ministers of Finance or Economy in Rio de Janeiro, but he still hopes to attend your subcommittee's hearings on December 7. In any event, I shall be there. Sincerely yours, W. RANDOLPH BURGESS, Under Secretary for Monetary Affairs. Enclosures. MONETARY POLICY AND DEBT MANAGEMENT REPLIES BY THE TREASURY DEPARTMENT TO QUESTIONS SUBMITTED BY THE SUBCOMMITTEE ON ECONOMIC STABILIZATION OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT, NOVEMBER 1054 Question 1. What role did monetary policy play in the period of relative stability following the Treasury-Federal Reserve accord in 1951, in the months of boom late in 1952 and early 1953, and in the recession of 1953-54? This question is being answered fully by Chairman Martin of the Federal Reserve Board, in his reply to the same inquiry. On the debt-management aspect of your question, however, we are glad to add a few comments from our own experience since this is the area where final responsibility lies with the Treasury, rather than with the Federal Reserve. Early 1958 When we came to the Treasury in January 1953, we were faced with the problem of developing a constructive program for the effective management of a public debt of more than $205 billion in an economic environment during the early months of 1953 where inflationary pressures were still running high. Production was at a record high in the spring of 1953 and was exceeding sales, causing a threatening accumulation of inventories in the hands of manufacturers and distributors. Defense expenditures "were high and plant and equipment expenditures were setting new records. Unemployment was at extremely low levels and industry was spending large amounts for overtime employment. The Nation's resources were fully utilized and any further sizable expansion of credit could result only in uneconomic competition for scarce labor and materials at the risk of further price rises. At this time, consumer credit was expanding rapidly and business loans were continuing to increase as compared with the normal expectation of seasonal contraction. New corporate and municipal security issues were at a record high and new mortgage financing was running ahead of previous years. Together with the prospect of a large Federal deficit, all of these factors .created inflationary pressures. In addition, controls over prices and wages had just been lifted. This was a situation that called for monetary and credit restraint, and that is exactly what the Federal Reserve was applying. Treasury action in debt management in the first half of 1953 wras carefully planned so as to tie in with a Federal Reserve monetary policy of credit r e s t r a i n t Debt-management decisions in this period were geared to a program designed to offer securities attractive to nonbank investors and by so doing avoid the inflationary potential of increased bank ownership of Government securities. In February, instead of offering investors who held a maturing certificate merely an exchange into another 1-year certificate, the Treasury gave investors the opportunity to go into a 5-year 10-month bond. The market response to the bond offering was encouraging and indicated that there was demand for securities beyond the 1-year area. As the Treasury approached its spring financing and realized that more money was needed than had previously been expected, the Treasury offered a billion dollars of 3 %-percent 25- to 30-year marketable bonds for cash—the first longterm marketable securities issued since the end of World WTar I I financing. In addition, close to half a billion dollars of the 3}4's were issued in exchange for those series F and G savings bonds which matured in the calendar year 1953. The Federal Reserve policy of credit restraint, together with these debt-management actions, permitted the heavy credit demands I~ the market to make a natural correction through the operation of a rising level of interest rates> continuing the trend of 1951 and 1952. The Treasury, in doing its borrowing, paid the rates required by the market in recognition of the principle t h a t the Federal Reserve should be free to exercise appropriate monetary and credit Digitizedpolicy. for FRASER 32 UNITED STATES MONETARY POLICY Monetary and debt-management policy in the first part of 1953 played an important part in checking the inflationary ground swell. The period mice May 1953 By the early summer of 1953 the situation changed. Business demand for funds lessened and inflationary pressures receded. There were some evidences of slowing business activity. In this new environment monetary and debt-management policies were directed toward increased availability of credit for appropriate business demands. As a result of the successful use of these policies, inventory liquidation was able to proceed in an orderly fashion without fear of a tightening up on loans and capital expansion was encouraged/- Interest rates fell and the path of legitimate credit growth was smoothed. In its refunding operations in June, and again in August, the Treasury issued only 1-year certificates in exchange for maturing issues to avoid any tightening effect on the money market as it adjusted to its new environment. The only major Treasury cash financing in that period was an offering of $5.9 billion 8-month tax-anticipation certificates to cover the seasonal low in Treasury receipts during the second half of the calendar year. Monetary policy during the late months of 1953 and during 1954 has stressed active ease in the money market. The Treasury, therefore, has refrained in the past year and a half from issuing long-term securities. It has purposely done its financing so as not to compete for or reduce the long-term money available for private capital investment or for State and local highway, school, and other construction projects, lids policy has contributed appreciably to maintaining a high level of economic activity during the last year or so. Treasury debt management policy, therefore, has been tied in very closely with monetary policy throughout the last 2 years, first in helping to restrain inflation and then in helping to avoid deflation. The successful restraint of inflationary forces eased the task of monetary and debt management policy in avoiding deflation. The Federal Reserve and Treasury actions of these past 2 years have conformed to the principles stated by your own Joint Committee on the.Economic Report, through Senator Douglas* subcommittee in 1950 and Representative Patman's subcommittee in 1952, which concluded that "* * * we believe that the advantages of avoiding inflation are so great and that a restrictive monetary policy can contribute so much to this end that the freedom of the Federal Reserve to restrict credit and raise interest rates for general stabilization purposes should be restored even if the cost should prove to be a significant increase in service charges on the Federal debt and a greater inconvenience to the Treasury in its sale of securities for new financing and refunding purposes." That freedom has been restored, just as President Eisenhower promised it would be in his first state of the Union message in early 1953: "Past differences in policy between the Treasury and the Federal Reserve Board have helped to encourage inflation. Henceforth, I expect that their single purpose shall be to serve the whole Nation by policies designed to stabilize the economy and encourage the free play of our people's genius for individual initiative." Long-run debt management objectives In the same date of the Union message, President Eisenhower also suggested that the long-run objective of Treasury debt-management policy was to "properly handle the burden of our inheritance of debt and obligations." At the same time that we have been working closely with the Federal Reserve in pursuing policies which would lean against inflation or deflation, the Treasury has also made progress toward its long-term objective of working toward a better balanced maturity structure of the public debt—one that will contribute, along with budgetary and monetary policies, to high employment, rising production, and a stable dollar. When the present administration came to the Treasury in January 1953, the debt was too heavily weighted in the short,-term area. Short-term securities tend, by their very nature, to be very liquid—almost like money. When they are relied upon too heavily, they can add substantially to inflationary pressures. A large volume of short-term debt also means that the Treasury has to be almost continuously in the market refunding short-term securities. When the Treasury has to engage in so many financings every year, it means that the Treasury's impact on the money market is almost continuous, either through the UNITED STATES MONETARY POLICY 33 planning of a new financing, the financing itself, or the secondary market response to it. This tends to limit the effectiveness of Federal Reserve credit control operations. The greater the space between Treasury financings, the lesa will be the likelihood of this sort of interference. In addition, Federal debt ownership should be broadly distributed among the various investor groups in the economy—and within those groups as well. I n a democracy like ours, it is important that citizens participate in its responsibilities as well as its benefits. With a direct stake in their Government's financial operations, either through individual or group investments in Government securities, they will tend to take a more active part in seeing that the Nation's affairs are managed in their best interests. That is one of the most valuable functions that the Treasury savings bond program is performing today. A widespread debt—in terms of maturities as well as holders—contributes to the effectiveness of monetary policy aimed a t promoting economic stability. When the Federal debt is widely distributed, action taken by the Federal Reserve to tighten credit during inflationary periods or to ease credit during deflationary periods will tend to be more effective as its impact is transmitted through all parts of the money market. Improvement in debt structure The Treasury has made progress in improving the structure of the.debt during the past 2 years, although improvement has at times been slow because of the need for adjusting our financing to the economic situation of the moment. The first step in spreading out the debt was taken in the February 1953 refunding, but a more important step was the issuance of the 3VA percent longterm bond in May. Treasury debt extension was postponed temporarily in the summer of 1953 as the market was unreceptive and short-term bank financing contributed to maintaining the volume of money. In the later months of 1953, however, the Treasury was able to make several modest moves toward lengthening the debt. On three occasions securities were offered which were attractive principally to commercial banks who were interested in lengthening out their own portfolios of intermediate-term Government securities. In this way, $7 billion of the debt was extended for periods ranging from 3V2 to nearly 8 years. Debt extension of this type was neutral with respect to Federal Reserve monetary policy. No useful purpose would have been served in flooding the commercial banks with more short-term securities than they wanted. Yet through issuance of intermediate-term securities, tUe Treasury was able to improve the maturity structure of the debt without competing directly in the long-term market for funds that were needed to support a high level of capital expansion in the economjr. The record of debt management in 1954 follows essentially this same pattern. Commercial banks again expressed interest in lengthening out their portfolios and this gave the Treasury the opportunity to spread the debt further through, the use of intermediate-term securities. In February 1954 investors exchanged $11 billion of maturing issues into 7-year-9-month bonds. In May, August, and October, a total of §13 billion more intermediate-term bonds and notes were issued—partly for cash and partly in exchange for maturing securities. The Treasury's latest refunding offer of 8-year-8-month bonds in its December financing has just been announced (November 18) and we have every reason to expect that the new bond will be well received. This is the longest bond offered since the SV^s in the spring of 1953. Even before we include the new December bond, the Treasury has issued $33% billionof securities in 1953 and 1954 which were beyond the 1-year area. As a result of these operations from January 1953 through November 1954; the Treasury reduced the amount of marketable debt maturing or callable withim 1 year from $74 billion to $63 billion—a decline of $11 billion. The Treasurydebt in the over-5-year category rose by about $8% billion during this period,, and will increase again in December. Furthermore, the average length of t h e marketable debt has risen in 1954, marking the end of a steady 6-year decline which virtually ended in 1952 and leveled out in 1953. It is also significant that during 10 out of 12 major financings during 1953 and 1954 (excluding seasonal borrowing in anticipation of tax receipts), t h e Treasury offered investors securities longer than 1-year certificates. This is quite a contrast to the 2 preceding years, when on only 2 occasions out of 13 were marketable issues offered outside the 1-year area. 34 UNITED STATES MONETARY POLICY Question 6* Has the debt management policy of the Treasury—both as to objectives and techniques—been consistent with the monetary policy of the Federal Reserve throughout the period since mid-1952? In the reply to question 1, we have already discussed the role that debt management has played in the past 2 years to complement monetary and credit-control action token by the Federal Reserve, first in the period through the spring of 1953—when inflationary pressures were still running strong and credit restraint was appropriate—and then later as the inflationary tide turned and an easier Federal Reserve money policy encouraged the free availability of credit for legiti • mate needs. Fiscal and monetary policy—with an independent Federal Reserve working in harmony with effective budgetary, tax, and debt policy—is the mainstay of our program for sound money in America. This is a major plank in the program of the Eisenhower administration. It is not surprising that it was also a major plank in the reports of both of your predecessor subcommittees studying these matters. It is a fundamental of good government. In 1950 your Subcommittee on Monetary, Credit, and Fiscal Policies, headed by Senator Douglas, concluded that— "We recommend not only that appropriate, vigorous, and coordinated monetary, credit, and fiscal policies be employed to promote the purposes of the Employment Act, but also that such policies constitute the Governments primary and principal method of promoting those purposes." And again in 1952 your Subcommittee on General Credit Control and Debt Management, headed by Representative Patman, agreed in these words: "We believe that general monetary, credit, and fiscal policies should be the Government's primary and principal means of promoting the ends of price stability and high-level employment and that whenever possible reliance should be placed on these means in preference to devices such as price, wage, and allocation controls and, to a lesser extent, selective credit controls—all of which involve intervention in particular markets * * V We believe in this policy. Under the present administration, the Federal Reserve has been free to pursue a flexible credit policy conducive to stability and economic growth. Independence does not mean isolation. We have worked very closely with the Federal Reserve Board, with the Federal Reserve bank officials, and with their staffs all along the line. We know of no occasion in the past 2 years when debt management decisions were not completely consistent with Federal Reserve monetary policy. Question 7, What considerations should dictate the maturity distribution schedule of the Federal debt, first, as to the long-run ideal to be pursued and, second, as a practical operating matter, giving weight to timing and contemporary conditions? In the reply to question 1, we discussed our long-term objectives of gradually moving more of the debt out of short-term securities into the hands of long-term savers. In the.same reply, we also discussed our shorter-run objectives in terms of managing the debt in a way that was consistent with monetary policy. A few additional comments here are in order. The Treasury's long-term objective of achieving a better debt distribution cannot—and should not—be defined In terms of any specific maturity pattern. Changing economic.conditions require changing perspectives, and debt-management policies, like budgetary and monetary policies, can best serve the Nation's interests if they are flexible. Aji ideal maturity structure of the debt cannot lie suddenly achieved or rigidly maintained. Improvement in the maturity structure of the debt is the composite result of a l ltltude of financing decisions over the years. We are working with a complicated debt structure which is already in existence. We do not have the opportunity to set up an entirely new debt structure, so progress must necessarily seem slow at times. As President Woodrow Wilson said in his first inaugural address: "We shall deal with our economic system as it is and as it may be modified, not as it might be if we had a clean sheet of paper to write upon; and st^p by step we shall make it what it should be * * *" In the attainment of an improTed debt structure, the Treasury cannot arbit trarily set the maturity distribution of the debt by dictating the terms under which it will borrow. The market for Government securities is to a large extent compartmentalized. Many investors are interested only in short-term securities, UNITED STATES MONETARY POLICY 35 others prefer long-terra securities, and still others want a more diversified portfolio. The market expression of demand for various types of securities from a wide variety of buyers has a powerful effect on the maturity structure of the debt. Like other borrowers, the Treasury mast meet the test of a free money market. The success of Treasury financings is dependent on its ability to offer attractive securities at those times and in those areas where market demand exists. The Treasury may be able to encourage investors to lengthen or to shorten their portfolios by offering them a choice of two issues, one of which may be a little more attractive to some investors than the other. But it is the investor who makes the ultimate decision as to which security he will take. He may decide not to take either one. There are many ways in which the problem of improving the structure of the debt may be approached. For example, the average maturity of the debt can be lengthened by the same amount by putting out a billion dollars of a 30-year bond or a larger amount of a shorter bond. Yet the particular economic circumstances of the moment may make the shorter alternative an obvious choice if the long bond would work against Federal Reserve monetary policy rather than complement it. The experience of the last year and a half is again a case in point. During the transition to a lower level of Government spending, it has been important to economic stability that the Treasury not put out any long-term bonds which would interfere with the availability of long-term funds for capital investment. Under circumstances such as these, improvement of the structure of the debt may be slowed temporarily. Obviously, an ideal debt structure must achieve proper balance between short, intermediate, and long-term debt. A certain amount of short-term debt is necessary and desirable to meet basic liquidity needs of commercial banks and for tionfinancial corporations, who are building up reserves for taxes and other short-term, needs. But the amount of short-term debt should be kept low enough so that it does not undermine action taken by the monetary authorities to restrain undue credit expansion. Furthermore, a high level of short-term debt already outstanding could create difficulties for the Treasury in an emergency requiring a substantial expansion of short-term debt. Question 8. Are the benefits and costs to commercial banks of handling Government transactions clear enough, or can they be made clearer, to determine whether or not the banking system is being excessively compensated or undercompensated? What about the Treasury cash balance—its size and management? Should the Government receive interest on its deposits with commercial banks? This question calls for a brief description of the Treasury depositary system. The Treasury doesn't make deposits in its tax and loan accounts in commercial banks in the same way that the individual goes into a bank and deposits money. What the Treasury does is to authorize the banks to act on its behalf as a system of pipelines through which taxpayments and the proceeds from the sale of Government securities flow from the public on their way to Treasury accounts at the Federal Reserve banks, against which checks are drawn to meet Government expenses. Most of the money that follows this route starts as a deposit in the commercial banks in their customers' accounts. The payment of taxes or the purchase of Government securities thus involves the transfer of a deposit from the account of an individual or corporation to a Government account. Some Treasury deposits in the banks are new deposits, which are created when a bank buys Government securities from the Treasury and pays for them by giving the Treasury a deposit in the bank. But the newly created deposits don't stay in the banks very long, because the Treasury begins to draw them out after a'few days to pay its bills. When the Treasury pays its bills, the people and business concerns who get the chocks deposit them in their banks and thus restore to the bankings system the funds withdrawn by the Treasury. The round trip is completed. Treasury deposits in commercial banks from these two sources are almost continually on the move. Semiweekly calls for withdrawal of Treasury balances in the larger accounts, for example, frequently run 25 percent to 50 percent of the outstanding balance. The average balance of almost $4 billion in these tax and loan accounts last year looks like a great deal of money—and it is. But it doesn't 36 UNITED STATES MONETARY POLICY seem quite as big when you compare it with the more than $5 billion of budget expenditures the Treasury has to meet each month. The extensive use of this commercial bank pipelina system provides the most effective method yet devised for maintaining a smooth flow of funds from the public to the Treasury and back again into the channels of trade through Government disbursements with a minimum of economic disturbance. Whenever the Treasury calls in money from the commercial banks and puts it in the Federal Reserve banks, bank reserves are reduced. Then r s the Treasury spends the money, the disbursement • t of the Federal Reserve causes bank reserves to go up again. By leaving most of our money on deposit in commercial banks rather than at the Federal Reserve, the amount of time between the withdrawal and the restoring of bank reserves is narrowed to a practical minimum. If the uneven flow of Treasury receipts were permitted to go directly to the Federal Reserve, the banks would have to maintain enough idle reserves to stand the load of tl^ese heavy withdrawals. Their lending capacity would, therefore, be reduced and interest rates would tend to rise. As it is, the general public and the whole economy benefit from the more efficient use of these Government funds! The principal reason, therefore, why the Treasury carries deposits in commercial banks is to assure an orderly flow of funds through the financial community and avoid jolts and jars. I t is in the public interest. Bank services The banks perform a great many services for the Treasury. They sell a large proportion of Treasury savings bonds; they service many of the E-bond payroll savings plans; they receive subscriptions for marketable Government securities and handle maturing issues presented for redemption or exchange. Banks participate in the weekly sale and distribution of short-term Treasury bills. In fact, the banks are the principal salesmen for all the vast billions of Treasury securities. The deposits they thus retain (even briefly) are their incentive for a vigorous sales effort. Without this arrangement the Treasury could have to pay commissions for selling its securities. Banks also handle remittances accompanying employers' withheld tax receipts when they are deposited in the Government's account. These and many other services are performed by the banks without compensation other than the value of the Treasury deposit. I t should be emphasized that the size of the Treasury^ deposit in any given bank is the result of that bank's own activities in selling and buying Treasury bonds, handling the flow of taxes, etc. Interest on demand deposits The question whether or not the Government should receive interest on its demand deposits with commercial banks is related* to the broader question of interef l on all demand deposits. The payment of interest on demand deposits was specifically prohibited by the Banking Act of 1933. This applies to Federal Government tax and loan deposits, which average around $4 billion, and to the $*/£ billion balances that the Treasury carries in general bank depositaries. I t also applies to the $10 billion of State and local government demand deposits, and to the $100 billion demand deposits of individuals and businesses. The prohibition of payment of interest on demand deposits was partly due to the belief that some of the serious bank failures of the twenties and early thirties resulted to a considerable extent from the weakening effect of excessive interest payments by banks for competitive reasons. At the time of the Banking Act of 1933, an added burden was also being placed on the banks in the form of assessments for Federal deposit insurance. More important still, interest payments on deposits forced the banks to charge higher rates for loans in order to cover their costs. A resumption of interest on demand deposits would exert pressure on banks to charge higher loan rates. It is almost impossible to make a useful analysis of the cost and income of the banks at f ributable to Government operations; they fluctuate widely, differ from bank to bank, and involve such a large part of bank activities. Bank profits have not been high, however, compared with other kinds ;of business and compared with the need to build up capital funds to protect their customers' funds. Senator FLANDEKS. Following the announcement of these hearings on November 12, the subcommittee was asked:rras to whether or not the Council of Economic Advisers had been g en an opportunity to 37 UNITED STATES MONETARY POLICY present its views on this important subject. The Council was given an opportunity, but declined at this time. In order that the record may be clear on this subject, however, I will insert at this point, without objection, correspondence between the stall* director of the Joint Committee on the Economic Report and the Chairman of the Council of Economic Advisers. Without objection, that will be inserted. (The correspondence above referred to is as follows:) OCTOBER 1, 1954. Dr. ARTHUR F. BURNS, Chairman, Council of Economic Advisers, Washington 25, D. 0. DEAR ARTHUR: Before Senator Flanders left for California last week he asked me to explore the possibilities of 2 or 3 days of hearings in early December on United States monetary policy—recent thinking and experience. There has been a desire on the part of some members of the subcommittee to meet with the Federal Reserve Board of Governors and the Federal Reserve bank presidents more or less informally to discuss monetary policy. This could be arranged with convenience in early December during the fourth quarterly meeting of the Board and bank presidents here in Washington. I have prepared the attached very preliminary and very confidential plan for 3 days of hearings along the lines expressed to me by Senator Flanders. As always on such studies we like to give the Council of Economic Advisers an opportunity to be heard either in executive or open session on the subject under consideration. You will note that on the attached plan we have tentatively reserved time to hear from you. We would, of course, lik^ to hear you but will be guided by your wishes as to (1) whether you appear or not and (2) whether you wish a closed session or an open session. In addition to your letting me Know your desires in this connection as soon as possible, we would appreciate any suggestions or observations which you may have a t this time with respect to the questions that will be considered in the study and the first-day panel participants. We will welcome any and all of your suggestions. With best regards. Sincerely yours, GROVER W. ENSLEY, Staff Director. T H E CHAIRMAN OF THE COUNCIL OF ECONOMIC ADVISERS, Washington, October 11,1954- Mr. GBOVER W. ENSLEY, Staff Director, Joint Committee on the Economic Report, Congress of the United States, Washington 25, D. C. DEAR GROVER : Thank you for your letter of October 1, in which you set out tentative plans for hearings by the joint committee, to be held early in December, on recent monetary happenings and policies in the United States. I appreciate the position taken by the joint committee in leaving it up to the Council to decide whether or not to testify. Tbe month of December is going to be an especially busy time for the Council, and after weighing all sides of the question I have reached the conclusion that it would be best for me not to appear during the December hearings. My conclusion is reinforced by two facts: First, that the Economic Report is likely to convey the Council's general thinking on monetary policy; second, that any questions that members of the joint committee may have about the Council's stand could be cleared up if I testify next year, as I did this year, at the hearings dealing with the Economic Report. Sincerely yours, ARTHUR F. BURNS. Senator FLANDERS. I regret that Congressman Richard M. Simpson, a member of this subcommittee, is unable to attend these hearings; he is in Geneva participating in the General Agreement on Tariffs and Trade Conference. Senator Fulbright, another member of this 38 UNITED STATES MONETARY POLICY subcommittee, also is participating in international discussions at the United Nations in New York and it is unfortunate that he, too, can't be with us. They both have expressed interest in the subcommittee'sinquiry, however, and I am sure will look forward to reading the hearings and the summary of this proceeding. I do not view these hearings as resulting in .a special subcommittee report but subject to the will of the subcommittee will view them as part of the educational functions of this committee. The hearings will be published, and I am sure will take the same place on this subject of monetary policies and debt control that the previous hearingshave taken in colleges, on the shelves of economists^ on the shelves of others who are technically interested and technically concerned with the problems that we are discussing today. I am sure that these hearings also will assist the committee in the formulation of the committee's annual report to the Congress which is due on March 1. The plan of the hearings was set forth in the announcement of November 12. I t includes a panel discussion today composed of recognized monetary technicians and, I might add, of widely varying points of view, from universities and from financial institutions. Tomorrow morning we will hear from Secretary of the Treasury Humphrey and W. Randolph Burgess, Deputy to the Secretary of the Treasury. Tomorrow afternoon we will have a roundtable discussion on monetary policy questions with the six members of the Board of Governors of the Federal Reserve System and the presidents of the 12 Federal Reserve banks participating. They'are holding their regular fourth quarterly meeting in Washington the first part of this week, and it seemed advisable, in view of the interest we have in getting their opinions, not to ask them to make a separate trip to Washington when they were coming anyway, at a time which seemed convenient to the members of the committee. Before getting into the panel discussion this morning, I wonder if other members of the subcommittee wish to make any introductory remarks. There is one other matter before I ask for preliminary comments from other members of the committee. With the approval of the subcommittee it would be my plan, unless other plans and better plans are suggested, to hold this session until 12:30, to meet again at 2 and continue in session until about 4. I would hope that the presentations of the panel could be completed this morning, with perhaps a little time left for discussion, and that we could spend the afternoon in discussion, particularly of the members of the panel with each other with such observation, comment, and questioning as the members of the committee, both the subcommittee and the main committee, may see fit to interpose. Is there any suggestion from other members of the committee or the subcommittee with regard to the procedure or by way of introductory remarks? Representative PATMAN. May I say a word, Mr. Chairman ? Senator FLANDERS. Yes. Representative PATMAN. First, I commend the chairman for calling this meeting. I think it is a very fine thing. I think it is well arranged, and I am particularly glad that the Open Market Committee.will be with us tomorrow afternoon. UNITED STATES MONETARY POLICY 39 I assume that is what he had in mind in suggesting that all the presidents of the Federal Reserve banks be here along with the members of the Federal Reserve Board. All the presidents are either now or have been or will soon be members of the Open Market Committee, and for all practical purpose they are functioning as members of the Open Market Committee. Senator FLANDERS. That is true. Representative PATMAN. And I assume that we will be privileged to ask these distinguished gentlemen questions after they have finished, and that they will return this afternoon for any further questioning that we desire. Senator FLANDERS. That is the plan. The plan is to have the Treasury represented tomorrow morning, and in the afternoon we will have as long a session as may be necessary. I wouldn't call it off at 4 o'clock if the discussion is still lively. Let's keep going tomorrow afternoon until we have made a good try at clearing up the various points of interest in open market operations. Representative PATMAN. Tomorrow seems to be a very crowded day, with Mr; Burgess and Mr. Humphrey being heard in the morning. If we are crowded in the afternoon, wTill there be an opportunity to have the members of the Open Market Committee back on Wednesday ? Senator FLANDERS. I think we might even run through into the evening if that seems necessary. Representative PATMAN. Mr. Chairman, I ask unanimous consent at this point to put in the record excerpts from our hearings in the past in which I have made request, representing the democratic members, for the personal appearance of the Open Market Committee before the Joint Committee on the Economic Report. Senptor FLANDERS. That we will be glad to do. (The documents above referred to are as follows:) BACKGROUND INFORSIATION ON THE APPEARANCE OF THE OPEN MARKET COMMITTEE OF THE FEDERAL RESERVE SYSTEM BEFORE THE JOINT COMMITTEE QN THE ECONOMIC REPORT, SENATE OFFICE BUILDING, WASHINGTON, D. C , DECEMBER 7,1954 JANUARY 1954 ECONOMIC REPORT OP THE PRESIDENT CONGRESS OP THE UNITED STATES, JOINT COMMITTEE ON THE ECONOMIC REPORT, Tuesday, February 2, 1954, Washington, D. C. The joint committee met, pursuant to notice, at 10:20 a. m., in room 1301, New House Office Building, Representative Jesse P. Wolcott (chairman), presiding. Present: Representative Wolcott (chairman), Senators Flanders (vice chairm a n ) , Carlson, Sparkman, Douglas, Fulbright; Representatives Simpson (Pennsylvania), Talle, Bender, Patman, and Boiling. Also present: Grover W. Ensley, staff director; John W. Lehman, clerk. * * * * * * * STATEMENT OF HON. GEORGE M. HUMPHREY, SECRETARY OF THE TREASURY, ACCOMPANIED BY HON, MARION B. FOLSOM, THE UNDER SECRETARY OF THE TREASURY ; AND HON. W. RANDOLPH BURGESS, DEPUTY TO THE SECRETARY * * * * * * * Representative PATMAN. NOW, then, Mr. Chairman, I want to make a request that we invite the entire Open Market Committee before this committee. Tomorrow, I understand from the agenda, we have Mr. Martin. Of course, Mr. Martin 40 UNITED STATES MONETARY POLICY is the Chairman of the Federal Reserve Board. But Mr. Martin is just the head of one group that is part of the Open Market Committee. The Open Market Committee, under the laws passed by Congress, has tremendous power. It is composed of the Board members of the Federal Reserve System, and five Presidents of Federal Reserve banks. I believe that this is worthy of the serious consideration by the chairman and should be granted for several reasons. No. 1, the five Federal Reserve bank presidents that a r e on this Committee a r e selected by the private banks. They are not directly under obligation to the Government a t all. They are constituents, we can almost say, of the private bankers in the district where they operate. There are five of them. To have just the Chairman of the Federal Reserve Board here, I think is incomplete. I do not think that he is in a position to answer. Particularly is that true now when the Board has only six members. Chairman WOLCOTT. Mr. Patman, I wonder if you would withhold your request until you have, heard Mr. Martin tomorrow, and ask the chairman of the committee to give further consideration to your request, following that, if you still think it is necessary. Representative PATMAN. I shall be very glad to yield to the request of the chairman, but I know now, Mr. Chairman, that he cannot speak for the five presidents of the Federal Reserve banks. He does not have the power to do so. And since we know that he does not have this power, I would just suggest that it might be a fine thing to have all the members of the Board of Governors and t h e five presidents of the bank here for a panel discussion. Chairman WOLCOTT. Would it not be better if we delayed any decision in that matter until after he testifies? Representative PATMAN. Certainly. Thank you very much, Mr. Chairman. I will propound the other questions to him in writing. CONGRESS OF THE UNITED STATES, JOINT COMMITTEE ON T H E ECONOMIC REPORT, Wednesday, February 8, 1954, Chairman WOLCOTT. The committee will come to order. We have with us this morning William McChesney Martin, the Chairman of the Board of Governors of the Federal Reserve System, and with him are Mr. Young and Counselor Cherry. * * * * * * * Representative PATMAN. I will defer as usual to the judgment of the chairman. Now, one other line of questioning which I hope will be brief, and I will be through. I notice you state here on page 11 that— " I t is and must be closely coordinated with debt management. * * * "But, so far as credit and monetary policy is concerned, we a r e on our own in t h e Federal Reserve System." What do you mean there, that you are on your own? That you are kind of footloose and fancy free and the System can do anything it wants to do, and nobody is the master except the Federal Reserve System? I s that the reasoning, Mr. Martin? Mr. MARTIN. NO. That is what I commented on earlier. I think that we have the sole responsibility for monetary and credit policy, and we have to exercise our own judgment. Now, the monetary function is like the function of the judiciary, as I answered a t the yme of your questionnaire, Mr. Patman, and I could do no better than a t t h a t time. I t requires objective judgment free of private pressures and free of political pressures. Representative PATMAN. Or presidential pressure or congressional pressure? Mr. MARTIN. Exactly. Representative PATMAN. All of them? Mr. MARTIN. All of them. Representative PATMAN. In other words, you are .free, almost another branch of the Government? Mr. MARTIN. NO. You have delegated to us Representative PATMAN. The Congress has. Mr. MARTIN. The Congress has delegated this to us. Representative PATMAN. That is the reason I asked the chairman yesterday, and I hope he does not talk me out of this one—I asked that the Open Market UNITED STATES MONETARY POLICY 41 Committee appear before our committee, because we ought to be able to see one time in our lives the people who are actually running the monetary credit policy of the Government. Chairman WOLCOTT. I am afraid I am going to have to Representative PATMAN. The Congress has delegated the power to the Open Market Committee, which you state here, and correctly so. Since we have delegated that power, which the one-hundred-and-sixty-million-and-some-odd people gave to the 531 Members of Congress, to 12 people, I would just kind of like to see them at one time. I make the request, Mr. Chairman, again, that we call them before this committee. Chairman WOLCOTT. YOU said you would like to see them a t one time. Representative PATMAN. I would like to see them before this committee. Chairman WOLCOTT. We have a problem with respect to the witnesses. We have a tentative program right up through the lGth. and then the staff and the members are going to have a terrific job to do to ge, this report out by March 1. That is what has been bothering me. Representative PATMAN. Don't you think this is more important than everything? Chairman WOLCOTT. I do not agree with you that the presence of the Open Market Committee is more important than the present study during which we will have other witnesses on the economic report. As I see it now, we would have to cancel some of these very important panel discussions which we are going to have next week to make room for the Open Market Committee. I think that perhaps the presence of these panels representing labor and agriculture and business and industry and finance generally—I thought, anyway, that their presencewould be of more help to us than the Open Market Committee. That is what isbothering me right now. As for myself, I have not made any definite commitmentRepresentative PATMAN. Ail right. I will not insist on it now, but I do w a n t you to consider it, because they are "it." CONGRESS OF THE UNITED STATES, JOINT COMMITTEE ON THE ECONOMIC REPORT, Friday, February 5, 195/f. Chairman WOLCOTT. The committee will come to order. Representative PATMAN. Mr. Chairman, may I make a request at this time? On behalf of the Democratic members of the Joint Committee on the Economic Report, Senators Sparkman, Douglas, Fulbright, and Representatives Hart, Boiling, and myself, it is requested that the chairman call before this group the Open Market Committee of the Federal Reserve System for questioning. Chairman WOLCOTT. Well, the chairman will give consideration to the request. Senator DOUGLAS. The chairman will, of course, with his customary fairness, hold a meeting of the committee to decide? Chairman WOLCOTT. I do not see any reason why we should not hold any meetings. If we can get the committee together for that purpose, I don't see any reason why we should not hold a meeting. But today, you know, we are running a little short because of the committee hearings in the Senate on several matters before committees of which members of this committee are members. Banking and Currency, for example, in the Senate this morning, is working on confirmation of members of the President's Advisory Council. Representative PATMAN. May I supplement that, Mr. Chairman, with one brief statement: Mr. Sproul, in making a speech last Monday a week, I believe it was January 25, emphasized the fact that the Open Market Committee of the Federal Reserve System are on their own; that they are almost a separate branch of Government; t h a t they are entitled to any credit for good that is done, and they should be charged with the responsibility of anything that is not good. He rhade a very courageous statement of his viewpoint, and on the day before yesterday, when Mr. Martin was before this group, he stated emphatically t h a t the Open Market Committee was responsible for anything that has happened; ini other words, and with reference to any change of hard money and high interest policy, they accepted ail responsibility for it. Since they consider themselves kind of off to themselves they have complete charge, according to their own statements, of the financial and monetary policy of our Government, we are just spinning our wheels talking to anybody else* They are the people we should talk to. 42 UNITED STATES MONETARY POLICY Chairman WOLCOTT. I want to say that there is perhaps no reason why the Open Market Committee should not come before this committee. But, as I s a i l the other day, I do not want that subject to get to be a disproportionate problem before the committee in the study that we making. Now, we are up against time. We are expecting to devote the next 2 weeks to open hearings, principally panel discussions, on these problems that the President has raised in his economic report. There will be then not more than a week in which the staff of this committee will have to get to do some very intensive work on the report if we are going to meet the deadline by March 1, and I hope we can meet that deadline. Now, I am certain that there will be no opportunity in the mornings to get the Open Market Committee or any other witnesses, in addition to those which we have set out in the agenda, to appear before this committee. I thought that, perhaps, if it was convenient to the committee, if we could work it in on an afternoon, that we might try to do it. But we have got to take into consideration, of course, the fact that the House and the Senate will be in session in the afternoon. I, frankly, do not look forward with any pleasure to evening sessions, and I am going to try to avoid as many evening sessions as I can before this committee at all times. Now, if we can get a reasonable number of members of the committee here on some afternoon, as far as it is convenient, where it does not interfere with their work on the floors, then we can give consideration to it. But I think it would be a grave mistake to interrupt the continuity of this schedule that has been set up, with the hope of an entire morning, as we would have to give to the Open Market Committee, because I think you would put a disproportionate weight on the testimony that they would give. I think we all know about what they would testify to anyway. But that is a matter that the committee can decide when we have a substantial number of the committee here, and I will be very glad to take it up then and see what they want to do. CONGRESS OP THE UNITED STATES, JOINT COMMITTEE ON THE ECONOMIC REPORT, Thursday, February IS, 1954, Chairnan WOLCOTT. The committee will come to order. We are continuing the discussion of the President's economic message, and this morning, as a summary, we have with us three outstanding economists: Edwin G. Nourse, Martin Gainsbrugh, and Alvin H. Hansen. Representative PATMAN. Mr. Chairman, may I propound a parliamentary inquiry? Chairman WOLCOTT. Mr. Patman. Representative PATMAN. In behalf of the Democratic members, I wanted to ask the chairman if he could give us an idea about our request to have the Open Market Committee before this committee. Chairman WOLCOTT. As far as the chairman is concerned, he has not changed his mind with respect to i t He still has the same doubts that he has already expressed. I shall put it this way: The question of open-market operations seems to me a little disproportionate for us to devote an entire day or 2 days to that question. We have to get this report out by March 1; We have to do a very quick job if we are going to do i t Personally, it is my ambition that in this respect we break precedent, or sot a record. As far as I know, this committee has never gotten out its report by March 1 even though the statute requires it. I though that possibly we might be able to establish precedent this year for future reports and get it out by March 1. We have made such good progress so far toward that end that I would be reluctant to suggest that we devote another 2 days to a subject which, as I said, has become disproportionate to the whole subject So, I would prefer that we wait until such time as # we can take a little time with them. I might say to members of the committee that whatever loose ends there are which we will not be able to pick up in working on this report, we might as well continue with a subcommittee. If such a subcommittee thinks it is advisable or essential that we have the Open Market Committee before us, then they may do so. We know also that the makeup of the Open Market Committee will change materially on March 1. I don't know whether we should have the present Open UNITED STATES MONETAKY POLICY 43 Market Committee down here only to have a new committee come in on March 1 or whether we should wait until March 1 to have the new committee. Representative PATMAN. May I suggest that I am in accord with the chairman's views on getting out the report, and I shall not do anything to deter him in that respect. I know that I am speaking the wishes and will of the other Democratic members in saying that. But a t the same time, it is not necessary that we hear from the Open Market Committee before we get out the report. We shall have a reasonable time after we get out the report. I am not suggesting that it is necessary to have them to get out this report. Chairman WOLCOTT. I might suggest, Mr. Patman, that a very short time after we get out this report, you and I are going to be busy with the Commodity Credit Corporation and the new housing bill. We have hearings on the Credit Corporation bill next Wednesday and immediately following that, hearings on the housing bill. Representative PATMAN. I realize that, Mr. Chairman. Chairman WOLCOTT. SO, I wonder if you and I want to devote that much time to the Open Market Committee during the House committee hearings on commodity credit and housing. Representative PATMAN. I think the Open Market Committee has much to do with the credit situation. In other words, the Congress has delegated to them important powers, and I do not believe it would be bad to have them appear at least once before a congressional committee that has never seen them to my knowledge. Chairman WOLCOTT. May we leave it this way, that at the first opportunity when the committee thinks it advisable we will have the Open Market Committee down here. Representative PATMAN. Does that mean within the next month or so, or eomething like that? Chairman WOLCOTT. If we were to set up a subcommittee following these hearings to pick up what loose ends we have, then the subcommittee can have them before them. Representative PATMAN. We do not Want to withdraw our request. We still want to urge the chairman at the earliest opportunity to have the Open Market Committee before this committee. Chairman WOLCOTT. DO you not think perhaps it might be better to await the new board? Representative PATMAN. That new board, Mr. Chairman, is somewhat of a fiction. I t is kind of one-third of a member each time. Chairman WOLCOTT. Maybe it is an important one-third. Senator FLANDERS. This morning we have eight economists drawn from universities and financial institutions. They were supplied a week ago with the Treasury and Federal Reserve replies to our questions. We would like each member of the panel to give a summary of his views on monetary policy during the past 3 years, this summary not to exceed 10 minutes. Now, there are 8 of you—8 times 10 is 80 minutes or an hour and •20 minutes. Two of these documents are a little lengthy. They cannot be disposed of in 10 minutes, and I am wondering whether the members of the committee present would feel like going through with these, even the longer ones, without much interruption, so that we can have the documents all presented during this morning's time. I will leave that to the desires of the committee. Representative PATMAN. We will leave it to the chairman. Senator FLANDERS. I think, then, perhaps we might well do that. And if either of those with the two longer documents feel that they can shorten them in any way by giving a synopsis^ of certain paragraphs or pages, it may leave time for discussion this morning. ^ Following the opening presentation, we will proceed more informally, giving individual panelists an opportunity to expand their 44 UNITED STATES MONETARY POLICY remarks or to raise questions with respect to other views and to give subcommittee members an opportunity to question the panel. I may say that individual members of the panel may insert in the record that portion of their prepared statements which they did not have time to present orally today. Xow these panel members will be called on alphabetically. I don't know of any fairer way to arrange that, whether it will present the proper contrasts or opinion, I am not sure, but we will proceed alphabetically. I will list them first and then call on them in turn. The first is Mr. Lester V. Chandler, professor of economics at Princeton University, in Princeton. I may say parenthetically that he was the economist for the Douglas subcommittee. John D. Clark, director of the American National Bank, Cheyenne, Wyo., former member of the Council of Economic Advisers. Seymour Harris, professor of economics, Harvard University, Cambridge. James N. Land, senior vice president, Mellon National Bank & Trust Co., Pittsburgh. C. Clyde Mitchell, Jr., chairman, department of agricultural economics, University of Nebraska, at Lincoln. Edward S. Shaw, economist, the Brookings Institution, Washington, D. C , oh leave from Stanford University, Palo Alto. Rudolf Smutny, senior partner, Salomon Bros. & Hutzler, New York. Frazar B. Wilde, president, Connecticut General Life Insurance Co., Hartford. Now,, bearing in mind the desirability of getting this all in during this morning?s session, and hoping to have a little time to spare for discussion, I would urge those reading their documents to take advantage of the provision for putting the whole statement in the record, and where it seems possible, summarizing passages or pages. The first one in the list alphabetically is Prof. Lester V. Chandler, professor of economics at Princeton. STATEMENT OF LESTER V. CHANDLER, PROFESSOR OF ECONOMICS, PRINCETON UNIVERSITY Mr. CHANDLER. Monetary and debt management policies since the Federal Reserve-Treasury accord of March 1951, may be evaluated on two different planes. One plane might be called that of "grand strategy"—the selection of major objectives and the formulation of general programs of action for the attainment of those objectives. The other plane would be that of "tactics"; this would call for an evaluation of the many individaul actions taken—the accuracy of the analysis of current economic conditions, the accuracy of economic forecasts, and the timeliness and appropriateness of each policy action. In the short time available for this opening presentation, I shall confine my remarks to a few aspects of what I have called the grand strategy level. As is well known, the outstanding event during this.period was a change in monetary objectives, which necessitated the development of new action programs appropriate to the new objectives. For nearly a decade prior to March 1951, the dominant objective of our national monetary policy had been to stabilize interest rates, or at UNITED STATES MONETARY POLICY 45 least to hold their fluctuations within very narrow limits, This was a demanding objective which at times forced the neglect of all others. Any tendency toward higher interest rates forced the Federal Reserve to create enough new money to prevent the rise, no matter how inflationary the injection of the new money and loan funds might be. Conversely, this objective called for a reduction of the money supply whenever interest rates tended to decline, whatever' might be the effects on employment, production, and price levels. The most important thing that has happened since March 1951, has been that considerations relating to the behavior of employment, production, and price levels have replaced interest rate stability as the dominant determinants of monetary and debt management policy. This does not mean that the behavior of interest rates is unimportant; it means only that interest rates should be allowed to change—and be forced by a positive monetary policy to behave— in a way that will contribute most to attaining the desired behavior of employment, production, and price levels. I t follows, of course, that the monetary and debt management policies followed since the "accord" must be disapproved by those who believe that the dominant objective of monetary policy should be stability of interest rates, whatever else may be happening in the economy. Their criticisms need- not be based on any real or alleged errors in tactics by the Federal Reserve or the Treasury; these critics must necessarily disapprove the shift of basic objectives. Those who insist on desirability of perpetually low interest rates must disapprove of all restrictive policies, no matter-how well justified by other considerations. And those who advocate stable interest rates at a high level must surely disapprove of the actively easy money policy which has been in effect for well over a year. For my part, I approve of the shift of objectives that has occurred since March 1951. This is not because I believe that monetary and debt-management policies can alone assure the attainment and maintenance of a satisfactory behavior of the economy. I t is only because I think that flexible monetary policies can make important contributions, whereas a policy dominated by the objective of stabilizing interest rates will often, if not usually, accentuate instability of business activity and prices. I t may be in order to make a few comments concerning the types of policies that would be appropriate to the new objectives. A shift to the objective of promoting economic stability and growth does not .imply any decrease in Federal Reserve responsibility for developments in the money market; nor does it imply that Federal Reserve policies should be any less active. I t is necessary to make this point because of some puzzling official statements during the period which created confusion and left the impx^ession that the official policy was to be one of passivity—of allowing the forces of private supply and private demand to determine conditions in the money market. High officials in the Treasury Department have at times suggested that interest rates should be determined by the market forces of demand and supply, and the Chairman of the Board of Governors made a memorable speech describing the transition to "free markets," which was to include a "free money market." This was, in my opinion, an unfortunate choice of words. There are some respects in which the money market should probably be largely free of continuing official 55314—54 4 46 UNITED STATES MONETARY POLICY control. For example, most of us would prefer to rely largely on competitive market processes to ration and allocate the supply of credit among th* arious competing demanders. But to allow the total supply o~ money and loans, and the price of loans, to be determined by p r r ate demand and private supply would negate the very idea of cen** dl banking. Central banks exist because we are not willing to allow the total supply of money and credit, and the cost of credit, to be determined by the unregulated forces of private supply and demand. The basic function of a central bank is to regulate the total supply of money and credit and the terms on which they are made available. I t should be clear that the Federal Reserve can make its maximum contribution to economic stability and growth onljr by recognizing its continuous responsibility for money market conditions, and by taking whatever positive actions that may appear conducive to the attainment of its objectives. There will, of course, be times when the forces of private demand and private supply will produce in the money market exactly those conditions that seem most desirable, and when no current Federal Reserve action will be required. But there will probably be many more occasions when the forces of private demand and supply will produce inappropriate conditions so that an active, and perhaps even an aggressive, Federal Reserve policy will be required. A successful policy of economic stabilization cannot be a passive policy. I t also needs to be emphasized that a shift to the objective of promoting economic stability and growth does not mean that the Federal Reserve should cease to be concerned about the behavior of interest rates, nor that its control of interest rates should be any less precise than was its control during the pegging period. The Federal Reserve's mistake during the pegging period was not that it controlled interest rates; the mistake was in stabilizing interest rates— in making stability of interest rates an overriding objective and in sacrificing all other objectives. To be successful in promoting economic stability and growth the Federal Reserve should use its power to control interest rates, but use the power to bring about those changes in interest rates which will best promote its purposes. Chairman Martin quite properly emphasized, in his answer to your questionnaire, that the effectiveness of Federal Reserve policy does notrely solely on interest rate behavior. When the Federal Reserve increases or decreases the fr^e reserves of the banking system, the supply of money may be increased or decreased in many ways other than by a reduction or rise of interest rates—by more restrictive or less restrictive rationing of credit by lenders, by changing standards of creditworthiness, and so on. Yet, interest rate behavior is important, and the Federal Reserve should take the responsibility of forcing the interest rates to behave in a desirable way. In some cases it may succeed in doing this solely by regulating the volume and cost of bank reserves; in others it may need to exert a direct effect on the prices and yields of long-term securities by purchasing or selling them. For example, there may be times when long-term yields remain undesirably nigh despite large, excess reserves in the banking system. At such times the Federal Reserve may usefully buy long-term bonds, thereby tending directly to drive their prices up and their yields down. Chairman Martin may be right in arguing that technical considerations relating to the broadening and deepening of the long-term .market for Government securities justified the policy of confining UNITED STATES MONETARY POLICY 47 open-market operations to the short maturities during the transition period. I t was, however, reassuring to note in his answer to your questions that this is not necessarily a permanent policy, and that we may hope that in the future the Federal Reserve will feel free to buy and sell long-term governments when such operations promise to be useful in promoting economic stabilization. Senator FLANDERS. Thank you, Professor Chandler. The next on the list is our old friend, Dr. John D. Clark, who was a former member of the Council of Economic Advisers, and appeared many times before us in that capacity. Dr. Clark. STATEMENT OP JOHN D. CLARK, DIRECTOR, AMERICAN NATIONAL BANK, CHEYENNE, WYO.; FORMER MEMBER OF COUNCIL OF ECONOMIC ADVISERS Mr. CLARK. Thank you, Mr. Chairman. We now have three official descriptions of the economic situation when our monetary authorities undertook their unhappy experiment with a repressive monetary policy in the spring of 1953. Two come to this committee from the Treasury Department and the Federal Reserve Board. The third is the statement of the President himself, in the White House release of August 12. The Treasury says that in the early months of 1953 inflationary pressures were "running high." In the next paragraph it says that production was exceeding sales, a condition which hardly fits into the description of inflation. Otherwise, in its reply to the committee as "well as in the many self-approving statements issued by the Secretary, the Treasury sticks to its story that in the first quarter of 1953 we faced inflation pressures serious enough to require the action which halted economic expansion. The Federal Reserve Board gives only faltering support to this rationalization of fiscal and monetary policy in the spring of 1953. I t opens its resj)onse with the statement that a series of circumstances "threatened to develop into an unsustainable boom." This is indeed a new standard of an economic situation requiring rigorous antiinflationary action. Later in its report, the Federal Reserve discredits its own speculative fears about economic stability early in 1953. Reviewing conditions in the period April 1952 to April 1953, the Board finds that credit and monetary growth "corresponded closely to the capacity of the economy to absoib more money without inflation." Then comes the flat statement that "inflation was prevented" and that "prices remained relatively stable." So there was neither monetary inflation nor price inflation in the spring of 1953, according to the Federal Reserve, but only a fear that things were too good to last. To the President, the first half of 1953. represents "the greatest prosperity we have yet known," and he does not conceal his yearning for a return to the happy economic conditions to which he fell heir. Neither the Tx^easury's sense of present danger nor the Federal Reserve pessimism about a coming storm clouded his assurance that our prosperity was real. These conflicting evaluations of economic conditions in early 1953 iail to explain why our new fiscal manager's set out to upset the 48 UNITED STATES MONETARY POLICY business boom as soon (is they entered office in January X953, An extraordinarily stable price level certified to the soundness of a condition of rising employment, production, and consumer buying. Yet men who 2 months before Inauguration Day were advertising their intention to use fiscal and monetary policies as antiinflationary instruments would not look at the real economic facts when they came to power. They found eager collaborators in the Federal Reserve Board, which had read the election reports. Xever since the war, and for a long time before, had the Federal Reserve failed to assist an important Treasury offering by supporting the market. This continued to be its policy even after it had discontinued steady pegging of the market price of Government bonds in 1951. But November 1952 changed all that. The large refunding operation on December 1 wras givdn no support. The market, thus advised that the monetary authorities were not averse to and would not act to halt the rise in interest rates for which the financial district had long hungered, promptly started the upward rush of rates which did not end until the crisis in the following June.. To keep it going until the new team taking over the Treasury could swing into action, the Federal Reserve raised discount rates in January. The tiny increase of one-fourth of 1 percent could itself have little effect upon credit. Its purpose was to show that the Federal Reserve intended to follow the market, not lead it as it had been doing^ for years. Experience with fiscal and monetary policy in the last 2 years has not taught us much that we did not know. The tightening of credit and increasing interest rates smothered a business boom, as such policy is intended and expected to do. The quick reversal of that policy and the return to one of low interest failed to forestall the induced recession. For a long time cheap and easy credit has had no effect in inducing economic expansion, as the Federal Reserve learned 20 years ago, and so reported. The fundamental issue between the supporters of monetary policy as a prime anti-inflationary instrument and the old Council of Economic Advisers still remains. In November 1950, we placed before the joint committee our view, in which President Truman concurred, that an important inflationary movement should be met by increasing the facilities and volume of production. This process requires cheap and ample credit, and until the volume of output increases, inflationary pressure will increase and must be curbed by other than monetary measures of the kind which increase the cost of capital. Our objection to the use of monetary policy was, of course, that theone and only way it reduces prices is by bringing about less employment, less output, and less demand for goods and services than would otherwise exist. This characteristic of monetary policy as an anti-inflationary instrument can hardly be denied, but advocates of that policy believe that, the monetary authorities can use their power %vith such finesse that the inflationary movement is stopped but no real damage is done. Our view was that gentle measures are futile, and strong action is dangerous. Very great damage has been done this time, and it is clear that the President is unhappy over the economic decline, quite apart from the fact that it has cost his party the control of Congress. But the Treas UNITED STATES MONETARY POLICY 49 ury and the Federal Reserve seem to be complacent. They do not quite subject us to the stupid and once common argument that the recession is a "healthy corrective movement," but they seem to feel that way and they constantly compliment themselves that they have done well in not bringing on a real depression. It seems that no lessons have been learned by the monetary authorities and that we must expect that unless the Congress intervenes they will continue to yield to the obsession with the danger of inflation which sticks out of this and every other Federal Reserve report and is shared by the officers currently in control of the Treasury. They have shown a willingness to bring economic expansion to an «ncl when there is no inflation and they only fear inflation may be coming. But even when they acknowledge that business needs to be invigorated, they are willing to engage in only meager action because they are forever beset by the fear that they will find inflation creeping into the economy. This haunting fear of inflation will foreclose resort by them to the only remaining recovery action in the field of monetary policy—a return to the normal legal requirements for bank reserves. The recent grudging decreases even when all public officials were eager to induce greater economic activity illustrate the deep reluctance of the Board to restore the normal legal reserve requirements and its determination to hang on to the extra requirements despite the passing of all circumstances which would justify their imposition. The Board is not even moved by the fact that if normal reserve requirements are restored, the Board will have a much wider-margin within which to maneuver whenever the new inflation it is always expecting does arrive. I do not know whether restoring normal legal reserve limits and the freeing of 40 percent of the large sums now in reserves would furnish the extra push to the economy which has been needed since the business slide-off ended 10 months ago. But the other possible sources of a major and quick-acting push upon the economy require legislative action in the very fields where legislation moves most slowly. Restoration of normal legal reserve requirements is the only program which can be adopted overnight. I t is the one program in the field of monetary policy which can add to the fresh stimulus to economic expansion which is coming right now from the resumption of full-scale automobile production and the collateral improvement in the steel industry. Above all, it is a program which can bring trouble only if it first produces great benefit, and if inflationary trouble does then develop, the program can be quickly reversed. By this I mean that reducing reserve requirements can bring inflation only if it first brings about larger employment, higher personal income, and greater demand for goods. Even then, there need be no increase in price levels if freer and cheaper credit has induced the necessary increase in the output of goods. A final word about recent developments which indicate the passing of the illusion that the Federal Reserve and other so-called independent commissions are not subject to executive control. If orders can be given to the Tennes^e Valley Authority and the Atomic Energy Commission, even to the point of forcing reversal of commission action, we may be sure that the Federal Reserve Board will be forced, if necessary, to fall in line with any national economic policy 50 UNITED STATES MONETARY POLICY which the President determines upon. I t may be, Mr. Chairman,, that with a little urging from this committee he will tell the Federal Reserve to give the economy a real shot in the arm, and he will take his chance with a little inflation for a change. Representative PATINIAN. Mr. Chairman, I ask unanimous consent to insert in the record at this point a letter from Dr. Clark that waspublished in the Washington Post this morning, • Senator FLANDERS. Without objection, it is so ordered. (The letter above referred to is as follows:) STIMULUS TO ECONOMIC GROWTH For the fifth time in a few years, the Joint Congressional Committee on the Economic Report is today beginning an inquiry into the usefulness of monetary policy as a method to stabilize the economy. This indicates a precarious status for a policy which only a few years ago seemed to be thoroughly accredited, and less than 2 years ago was the most loudly proclaimed of all of the policies of the new team then taking over theTreasury. The joint committee has become increasingly cool to the idea t h a t the way to halt inflation is to choke oft a business boom by making credit tight and costly. The study by the Douglas subcommittee led to a unanimous recommendation in January 1050 that vigorous use of monetary policy should be "the Government's primary and principal method of promoting" the economic stabilization which is the purpose of the Employment -Act of 1946. The more ambitious inquiry by the Patman subcommittee, with much the same membership, brought a divided report in June 1052 with the majority nodding approval of monetary policy in theory, but sharply criticizing its practical operation. When the full committee concluded its study in February 1954 of the actual use of restrictive monetary policy to smother the line business boom which the new administration inherited in the first quarter of 1953, the majority report did not have one word to say about monetary policy or about the most dramatic and important economic experiment of the preceding year. In separate statements,, several of the minority members challenged Treasury and Federal Reserve policies. Now that unemployment, the normal result of the successful use of monetary policy as an anti-inflationary instrument, has brought about the loss of administration control of the Congress, it will be interesting to observe where the joint committee goes. I t will be unfortunate if the new subcommittee holds to its agenda and postpones discussion of the current economic situation and of appropriate recovery programs until after the annual economic report of the President has been received late in Januaiy. The historical survey it proposes is important, because^ history is being distorted, but of far greater immediate importance is the problem of getting the economy off the dead center upon which it has stuck since last January. In the 1949 recession, the downward slide of industrial production from October 1948 to July 1949 was immediately followed by a recovery movement which with, almost no hesitation persisted until industrial production reached a new postwar high in June 1950, before the Korean outbreak. In the current recession,, the drop in industrial production continued from July 1953 to January 1954. T h e January 1954 index figure was 125, in October last it was 125, and in the intervening months it was either 125 or slightly lower. Why this difference in the course of the economy, and what does it portend? May we, like the Government officials who each month assure us that recovery is just around the corner, be complacent, confident that* if we are patient the normal and powerful forces of expansion which are inherent in our economy will sooner or later carry us off the economic plateau and in the right direction? Or should we fear that the stalemate is permitting the process of progressive deterioration which used to turn recession into depression to overcome the potency of the new stabilization policies which have twice since the war sustained the economy against forces of deflation? UNITED STATES MONETARY POLICY 51 Experience in the postwar economy is too limited to enable the joint committee to find wholly satisfactory answers to these questions, but the committee can reach a conclusion about the wisdom of national action without further delay. For the third time this year, a powerful stimulus to economic expansion h a s appeared. Neither the substantial reduction in personal income taxes nor t h e extraordinarily liberal credit program for housing proved to be strong enough, by itself, to give the economy the necessary push. We did not supplement either of these stimuli, when it was new and most powerful, with additional impulses toward recovery. Now we have the entire automobile industry joining in a full production program, with a corollary expansion of steel production and with three weeks of Christmas shopping upon us. We cannot know whether this combination of powerful forces will itself get the economy into forward stride again. That depends largely upon the consumer, and his verdict on the strange new car models has not yet been given. But we do know that this is the last occasion for months to come, when private enterprise will be developing powerful new stimuli to economic activity. After 3 weeks of Christmas shopping we will face a season of declining employment, of heavy t a x payments, of decreasing money supply, and of declining business borrowing. The Federal Government will then have to carry the full burden of formulating and supporting recovery programs, if recovery is still around the corner. Surely, it is the part of wisdom and prudence to exploit the fine opportunity we now have to join the impetus arising from potent Government action to powerful forces' of recovery in the private economy. That opportunity will be lost if we await the annual economic report of the President. J O H N D. CLARK, Waahhigton. (Mr. Clark formerly was vice chairman of the Council of Economic Advisers.) Senator FLANDERS. The next speaker is Prof. Seymour Harris of Harvard. Mr. Harris. STATEMENT OF SEYMOUR HARRIS, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY, CAMBRIDGE, MASS. Mr. HARRIS. Mr. Chairman, since my paper is one of the longer ones, I shall spare you the dull period of listening to it. 1 would like to summarize my position and save you some time, if that is agreeable, and put my paper into the record. I s that agreeable, Mr. Chairman ? Senator FLANDERS. I am very glad that you feel able to do that, Professor Harris; Mr. HARRIS. Let me begin by saying that in the last few years it seems to me that the Federal Reserve has had inflationary jitters, the Treasury has had a strong inflationary neurosis. Now, I say that this is true, both in 1952-53, and 1953-54. In ,the first place,there was no price decline in 1951,1952,1953, after March 1951, and therefore one could very well argue that there was no case for an anti-inflationary policy. I n the first half of 1953 there was a cash surplus for the Government. There was no evidence at all of inflationary pressures, with the possible exception of the rise in inventories. Despite that fact, in the first half of 1953 the Treasury raised its rates to such an extent that within a period of 5 months the rate of interest rose on long-term Government securities as much as they had risen in the preceding 7 years. Now, I will say possibly the Federal Reserve's bark is worse than its bite. If you IOOK at the total policy, there were a number of antiinflationary policies during this period. For example, they related on borrowing by the Federal Reserve on securities and real estate credit, and they did not reduce the excess reserves of member banks, and 52 UNITED STATES MONETARY POLICY for this reason, though the Federal Reserves were claiming a strong anti-inflationary policy, actually it wasn't quite so strong as claimed and did less damage, therefore. Now, when we look at the antirecession policy which began in about May 1953, what do we find? We find that there was a reversal of policy, and for this both the Treasury Reserve and the Federal Reserve deserve credit. They acknowledged their sins and are ready to give us an expansionary policy; but unfortunately again they are too fearful of inflation. ^ For example, in the year ending September 1953 there was a rise of deposits of | l billioiv_or less than 1 percent, in the period when the GNP dropped by 3 percent, and relative to a full employment economy by 6 percent. During this same period we had a fall in the annual rate of Government spending of $9 billion, and we have also since the peak had a fall in private investment of $10 billion. To offset that, we have a reduction of taxes with a lag at an annual rate of about $9 billion. In March 1951 we reached a peak of 3.7 million unemployed, which is roughly equivalent to 5 million in my own accounting of unemployment. Now, during this period of inclusion of hourly cuts and those unemployed but not so counted concern about the economic situation, the Federal Reserve gave us an average excess reserve in 1954 of $700 million. I would like to compare this figure with the more than 5 billions of excess reserves in 1939, when required reserves were only one-third as large. In other words, relatively speaking, the Federal Reserve gave us one-twentieth as large excess reserves as compared to the 1939 situation. Now, some may say, of course, that monetary policy doesn't do much good in recession, and I think that there is probably a good deal of truth to this, but the Federal Reserve makes no such claim, and if they are really using monetary policy, why don't they give us a couple billion dollars of excess reserves. Again the chairman made a point that I would also like to make very strongly, namely, there is an awful lot of nonsense in the Treasury and Federal Reserve statements about the free market. There is no such thing as a free market in money. As a matter of fact, where would our monetary system be without the $24 billion of earning assets of the Federal Reserve. Total member bank reserves are only $19 billion. Yon can imagine where our monetary system would be without the $24 billion of earning assets of our central bank. Now, you may ask: Why does the System fear to such an extent controlling the rate of interest? Because actually this seems to be their great fear. They are afraid to control the rate of interest. Note their statement on intermediaries when they seem so willing to relinquish much of their control over the rate of interest. Modern theory of employment and output holds that above all the authorities should control the rate of interest, and by controlling that they control, to some extent, the total amount of investment, and if the authorities control the total amount of investment, to that extent they stabilize the economy and allow it to grow, and if they do not do this, then they endanger all other markets, and if we want freedom UNITED STATES MONETARY POLICY 53 in all markets we don't want freedom in the rate of interest, the money market. In relation to this point, there seems to be a general view in recent years that the main objective of controlling the price of Government securities has been to maintain the price of Government securities. Now, this, to some extent, has been true and particularly from 1945 on we experienced some inflation that we might not have had if this policy had not been carried through. But I think it is a great mistake to assume that our major objective was to control the price of Government securities. The major objective was to control the rate of interest, and the way to control the rate of interest w^as to control the Government security market, and if you control the rate of interest then, of course, you also to some extent control investments. I t is a great mistake also to assume that there was a miraculous' change in policy in 1951, because, as a matter of fact, in the preceding year the Government was just as much interested in employment and output as was any other government. I am not trying to make this a political speech. The only point I am trying to make is that Government also, for many years, had been interested in employment and output, and we might criticize the administration on the grounds that before 1953 they gave us a little more inflation than we might have had, but not on the grounds that they wrere not interested in maintaining employment and output. I am very much surprised to hear the Federal Keserve announce that they are no longer interested in the long-term rate of interest. At least, what they are telling us is that what they are really trying to do is to control the short term of interest, and hoping that mis will in turn control the long rate of interest and that they do not generally intend to deal in long-term Government securities any more. This is a surprising position. I am very much pleased that Mr. Smutny also made a point of the difficulties involved for the dealers of Government securities resulting from the concentration on the shortterm rate. There also seems to be a theory held by these authorities that it is almost immoral for banks to hold Government securities. This is .certainly not my theory, and anybody who has studied American economic history knows this is the most absurd theory, because if you go back, for example, to the 1940's and take the situation in the early 1950's, you would find there has been a tremendous increase in the supply of money. That has made a rise possible and was a condition for the national income of 8 times and real national economic income of 4 to 5 times. Now, what made this possible? What made this possible was the purchase of Government securities by the banks, because of the total rise of earning assets by banks during this period, two-thirds were in public securities. And I would also like to point out that there it is not immoral for the banks to hold short-term issues or is it unwise to allow a large amount of short-term issues to be outstanding because, as a matter of fact, one of the great revolutions in the Government market has been the increase in short-term issues, which has been going on ever since the twenties, and this has been one of the great contributions to bring 54 UNITED STATES MONETARY POLICY ing the rate of interest down from 4 percent in the twenties to 3 percent in the thirties and 2 percent in the forties. This also has been a revolution and has had a great effect on our economy, and I think has made capitalism stronger since it reduced what Lord Kej'nes used to call the dead hand of debt. When we consider the objectives of the authorities, the Treasury objectives, for example, what were they going to do early in. 1953? Actually what these people were trying to do was to get Government bonds out of the banks, and I would like to suggest this is a silly policy. At any rate, what did they accomplish? From 1945 to 1952 Government bonds held by banks declined by 30 percent. From the end of 1952 to the latest month that I could get figures for, the amount of Government bonds in the banks increased by G percent, so they obviously failed here. • The Treasury also wanted to lengthen the average maturity of debt. I don't have the latest figures, but I wanted to point out that, as a matter of fact, the short-term securities held by the banks are as large, that is, securities less than 1 year, than they were at the end of 1952, and the average maturity of the entire debt actually increased in 1953, though there might have been some reduction in 1954. So, in a general way, Mr. Chairman, may I conclude, and within 10 minutes, may I say that I believe that to some extent the Treasury was responsible for our recession. To a smaller extent, the Federal Reserve was. Now, I think there are some extenuating circumstances. The Treasury was new at this job, and I think they were a little too anxious and ambitious to bring us back to a free market. I do hope that they will learn their lesson and learn this is not a free market. I also want to agree with the point that somebody else is going to make presently, namely, that the Treasury policy is going to increase the cost of financing the debt, and this is a dubious policy for a Treasury that is so strong for balancing the budget. And one final point, namely, when you look at the total volume of earning assets for 1952 to 1953, for example (fiscal year), you find actually the Federal Reserve, and luckily, policy failed because of an increase in earning assets of $30 billion, only $3 billion were commercial bank assets, and this suggests the Federal Reserve has a job to do in trying to control the policies of noncommercial banks. (The prepared statement submitted by Mr. Harris is as follows:) SUMMARY STATEMENT OF SEYMOUR E. HARRIS, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY, ON MONETARY AND FISCAL POLICY SINCE THE MIDDLE OF 1952 (Comments on the statements of Secretary Humphrey and the Federal Reserve Board) SUMMARY OF bUMMARY Whereas, in the first half of 1953, the Federal Reserve suffered from inflationary jitters, the Treasury seems to have contracted a genuine inflationary neurosis. Whereas the Federal Reserve attacked the mythical inflation with a scalpel, the Treasury used a sledge hammer. Whereas the Reserve authorities neutralized their anti-inflationary policies to some extent by recourse to modest inflationary policies, the Treasury within a period of less than 6 months raised the rate of interest by as much as it has risen in the preceding 7 years. Whereas throughout the years 1953 and 1954 the Reserve authorities carried through their UNIT 3D STATES MONETARY POLICY 55 .policies with due humility and expression of the uncertainty of results, the Treasury expressed no such doubts. The Treasury, much more than the Reserve, can therefore be held responsible for the rise of rates in 1953, for the imposition of an anti-inflationary policy in the midst of a period of price stability and even price declines, in a period of Treasury cash surpluses, and hence can be blamed to some extent for the insuing recession. In the period of antirecession policy beginning in May 1953, both the Reserve authorities and the Treasury wisely reversed their policies. And they deserve credit for doing so. But their policies were not sufficiently bold. By March 1954, the official unemployment had reached 3.7 millions and an accurate estimate cf total unemployment would be at least 5 niiiUons. Yet the Reserve authorities provided an increase of excess reserves of but a few hundred million dollars, and excess reserves averaged but $700 million iu the first 10 months of 1954. What danger would be involved in raising the excess* even to .$2 billion? (Compare the •excess reserves of $5.2 billion in 1939, when required reserves were but one-third those of 1953-54 and hence relatively the excess reserves were 20 times as large as in 1954. Commercial bank deposits in the year ending September 1954 had increased by but $1 billion, or less than 1 percent, and GNP had fallen by 3 percent in the first 9 months of 1954. Yet here where a sledge hammer should have been used, a scalpel was applied. There was still too much fear of inflation. With GNP 5 to G percent ($38 to $21 billion) below the full employment level, the authorities provided us with $1 billion more of bank deposits. Fortunately a reduction of $3 billion in personal taxes in 9 months (annual rate) prevented a more serious drop. The reduced taxes at least in part offset a decline of $9 billion in Government purchases (annual rates). In part the trouble seems to lie in a fear on the part of the Federal Reserve (and Treasury) to control the rate of interest aggressively. Rather the Reserve authorities insist that they merely-offset undesirable movements in r a t e s ; and they restrict themselves even within these narrow limits to influencing the shortterm rate. Modern developments in the theory of money and output seem largely to have escaped those responsible for monetary and debt policy. They seem to consider the control of the rate of interest on Government securities merely as an attempt to raise artificially the price of these assets rather than (as they should) consider the control on this rate as a means of determining the rate of interest generally and hence influencing investment and output and thus increasing the probability of freedom in all markets. The Treasury started with a bang. They were going to reintroduce the free m a r k e t ; to raise interest rates so that banks would dispose of securities and other purchasers would be attracted; and they wouid increase the maturities of .securities. There seemed to be no realization in their repeated statements of the association of bank purchases of Government securities and the required provision of adequate supplies of money. For example from 1914 to 1951, issues of $66 billion of Government securities to the banks were twice as important as new loans in contributing towards a rise of $132 billion in bank deposits, in turn •contributing toward a rise of national income of 8.6 times (4 times in real income). 1 At any rate the policies of the Treasury failed. There is no evidence that the Jligher rates increased the market for Government securities net. (The reduced income accompanying higher rates would tend ultimately to have the opposite effect.) Whereas banks disposed of 30 percent of these Government securities from 1945 to 1952, from 1952 to 1954 they actually increased their holdings. Even the program of converting short-term into long-term securities was not clearly •successful. The percentage of issues maturing in 1 year actually rose. Unfortunately the Treasury does not seem to be aware of the revolutionary changes in rates, with their significance for economic output and Government finance—a decline from 4 percent in the twenties, to 3 percent in the thirties and 2 percent in the forties. This is intimately tied to increased needs of liquidity and the great rise in popularity of short-term issues. I . ROLE OF MONETARY POLICY SINCE BOOM OF 1 9 5 2 July 1952-Aprtt 1958 The Federal Reserve claims that its policy was a restrictive one from the middle of 1952 to April 1953. Evidence of restrictive policies is to be found, according 1 See my statement in the 1952 hearings on Monetary Policy and the Management of the Public Debt, pp. 380-389. 56 UNITED STATES MONETARY POLICY to the Reserve authorities (statement of November 20), in the limitation of open market purchases of Government securities to $1.8 billion in the second half of 1952 to meet seasonal needs of banks; the sale of $800 million net of United States Government securities in January-April 1953 to keep member banks in debt to reserve banks and hence force banks to be more cautious in lending; and a rise in discount rates and buying rates on bankers' acceptances in January 1952. This policy of the Federal Reserve raises certain questions. One, was there a boom the premise upon which this policy was based? In 1951, the wholesale price level was 114.8; in June 1952, 111.2; by April 1953, 109.4. The cost of living, was also remarkably stable. In fiscal year 1952 (ending June 30), the Government's operations were not inflationary. Its cash budget was in balance; and in the first half of calendar year 1953 there was a cash surplus of $2 billion. There was also little evidence of inflation on the stock market. Then where was the boom? Indeed, the index of industrial production had risen from a low of 193 in July 1952 to 235 in December 1952 and 243 in March 1953. But surely a rise of output accompanied by stable or declining prices is no evidence of a boom. The Federal Reserve and the Treasury seemed to have had inflationary jitters. Second, fortunately despite its large claims of an antiboom policy, it is not at all clear that Reserve policy conformed to its professions. Perhaps the best test of effectiveness of Federal Reserve policy lies in its effects on member bank reserves and notably on excess reserves. Excess reserves in June 1952 amounted to minus $192 million (deficiency of reserves), but ranged (average daily figures) from a minimum of $535 million (April 1952) to a maximum of $778 million (September 195?) from July 1952 to April 1953. That the policy (fortunately) was not as restrictive as claimed is evident in the continued rise of bank deposits (demand), a rise of $7 billion in the second half of 1952. A seasonal decline followed in the first half of 1 -53. It is also of some interest that in September 1952 the Board suspended regulation of real-estate credit and in February 1953 reduced margin requirements for purchasing or carrying.securities from 75 to 50 percent—these are scarcely restrictive policies. May 1953-October 1954 In this period the Federal Reserve's objective was to treat an expected recession by introducing monetary case. In May-June 1953, the System purchased $900 million United States securities and in July-December 1953, $1.7 billion; in July 1953, through a reduction of reserve requirements, the Reserve authorities freed an estimated $1.2 billion of reserves and in the summer of 1954, an additional $1.5 billion of reserves were freed. (Though the latter was offset to some extent by sales of securities.) Clearly the policy of the Reserve System was in the right direction at this time and carried tnrough with adequate humility and admission of uncertainties of effects of policies. The only criticism I can make at this time is, was it enough? By March 1954, unemployment had risen to 3.7 million (more than 2 millions above the 1952 minimum) ; and if allowance were made for cuts in hours, the partially unemployed, those with jobs but unemployed (not counted as unemployed), the total might well be over 5 million. Member bank reserves were allowed to decline during most of 1953, though this was offset by relaxation of reserve requirements; and after a rise of reserves in the latter part of 1953 they moved downward again in 1954. The important variable to watch is excess reserves. They fluctuated very little from May 1953 to October 1954 ($591 million in May 1953 to a peak of $936 million in January 1954 and generally around $700 million; $705 million average in first 10 months of 1954). Indeed, member banks' borrowing declined to some extent, though this writer believes the Federal Reserve exaggerates the significance of this factor as a contractionist force. Total Federal Reserve credit changed insignificantly net over the 10 months ending October 1954. It is well to compare the excess reserves of $700 million in 1954 with the $5.2 billion in 1939, the $3.1 billion in 1941, and amounts substantially in excess of $1 billion during the was. Was not the Federal Reserve again excessively fearful of inflation and, therefore, inadequately concerned with unemployment? n . POLICY RESPECTING VOLUME OF MONEY In the opening paragraph of its reply to question.4 (Memo of November 23, 1954), the Federal Reserve presents an admirable statement of the objectives of monetary policy: to provide a supply of money "which is neither so large t h a t it will induce inflationary pressure nor so small that it will stifle initiative and UNITED STATES MONETARY POLICY 57 growth * * * sufficient to facilitate * * * outlays necessary to sustain a high level of production and employment * * *." This statement marks a great advance over the theory upon which the System was established, namely, accommodate credit to the needs of trade or even over the objective of the 1920's, (though not often publicly admitted) of stabilizing prices. 2 But some questions may be raised concerning policies pursued or even avowed in the light of this admirable objective. Thus in the year ending September 30., 1054, demand deposits rose by but $1 billion, or less than 1 percent. Is this sufficient to match expected annual growth of 3 percent? That GNP declined by 3 percent in the first three quarters of 1954 vis-a-vis the corresponding period in 1953, is all the more reason for making the most effective use of monetary policy. Would it hurt to raise excess reserves to $2 billion? Control the rate of interest? The Federal Reserve response to question 3 (why the shift of emphasis "from maintaining orderly conditions to the view of correcting disorderly situations?") is disturbing to this reviewer of Federal Reserve policy. It is a widely accepted view today that the fundamental job of the central banking system is to influence the total supply of money as a means of determining the rate of interest. Moreover, this indirect method of control should be implemented by direct purchase and sales of long-term Government securities— we cannot depend merely on the interrelations of short- and long-term rates to accomplish our objectives. Then here are our objections to the Federal Reserve policy as suggested by the reply to question 3 : 1. The Reserve wrongly fears a control by the monetary authority in cooperation with the Treasury of the return on Government securities (question 3, pp. 1-3, 22-24). They seem to lose sight of the fact that control of the return on Government securities is not only a means of pegging the price of these assets but, more important, it is a means of controlling prices of all long-term assets and hence influencing investment and contributing toward freedom in all other markets. Free markets are not likely to persist without adequate output, in turn dependent on rates of interest and investment. The primary objective is to control the rate of interest, not to depress rates of interest on Government securities. But I hasten to add that the monetary authority also has some responsibility for maintaining prices of Government securities in a world where Government finance is of fi^st-rate importance—though this objective should be related to other objectives of monetary policy. 2. It is absurd to assume that the money market is a free market. The Federal Reserve has created $24 billion of reserves primarily through the purchase of securities. This has provided not only the cash required to put money into circulation but has contributed in an important way toward the $19 billion of member-bank reserves which are the basis of the deposits of the country. Where would we be without the Federal Reserve and without the Federal Reserve determination of monetary supplies ? 3. It is difficult to understand why, out of deference to the intermediaries in the Government security market who are supposed to give the market breath and stability and who through arbitage operations are supposed to assure a consistency of prices of different issues of Government securities, the Federal Reserve should sacrifice its initiative and control of the market. The major objective is to determine interest rates, not merely offset undesirable changes in rates as is proposed at one point (question 4, pp. 20-21), and the way to do this is through Federal Reserve operations. 4. At :*ast we can say for the Federal Reserve that, though it disclaims any intention to take the initiative, nevertheless through purchases and sales it sometimes does. Moreover, in its statement of,policy with respect to the volume of money, the authorities say they take into account such factors as productive capacity, state of business expectations, and "changes in money turnover or velocity reflecting variations in liquidity and the demand for liquidity on the part of business and consumers" (question 4, p. 1). No better intent to influence the rate of interest could be found than a determination to offset increased liquidity by the creation of additional money. I I I . TREASURY DEBT FINANCING Apparently the Treasury moved in at the beginning of 1953 even more convinced than the Federal Reserve that inflation was the great danger. It made * See my Twenty Years of Federal lieseve Policy, 1933, especially vol. 1. 58 UNITED STATES MONETARY POLICY clear its objectives at the outset: (1) Free the Government bond market, with rates of interest to be determined by the free market; (2) the resultant higher rates would move securities out of the banks into the hands of the public and thus destroy deposits and cut inflationary pressures; (3) there would follow a great lengthening in the maturity of the Federal debt. The Treasury showed little of the humility of ihe Federal Keserve. At the very outset a spectacular rise in short-terra rates was put into effect. T h e famous April 3*4-percent bond issue followed, an issue which for a.while demoralized the bond market. Indeed, whereas the Federal Reserve used a scalpel, the Treasury had produced a sledge hammer. The resultant rise in interest rates contributed to the recession which followed. (A supplementary statement to be submitted to the Joint Committee of announced objectives of theTreasury should be compared with Secretary Humphrey's statement of November 1954.) Treasury policy was based on certain misapprehensions. First, the threat of inflation was not serious if present at a l l ; and hence t h e economy should not have been jeopardized by a sudden major rise in rates. Second, the response of additional purchases of securities to any practical rise of rates is not likely to be large. (Purchases depend on alternative attractions, for example, the pull of the stock market, which the authorities stimulated by reducing margins and, in 1054, by reducing interest r a t e s ; and purchases seem to depend on income even more than upon rates of interest. But higher rates cut income.) Third, the vogue of short-term securities is explained by the vest expansion of deposits, the need of tax anticipation securities, etc. Though at one point the Treasury pays lip service to this need of tailoring securities to market needs, the general meaning gleaned from Treasury statement of policy is that short•term issues are dangerous. The fact is that, in the last generation, adapting securities to market needs has brought a large rise in the proportion of shortterm securities and contributed greatly toward reducing rates of interest from the 4 percent level in the twenties, to 3 percent in the thirties, and to 2 percent in the forties. The resultant savings on Federal Government interest payments a r e about $3 billion yearly. Let us see how much the Treasury has accomplished. 1. Has the Treasury succeeded in forcing Government securities out of t h e banks (and thus deflating deposits)? The answer is no. In fact the record from 1952 to 1954 is much worse than from 1945 through 1952. U. &. Government securities held by commercial bnnks f Billion dollars] Change End 1952, 6 3 . 4 . . . August 1954, 67.0. End 1945, 90.8 End 1952, 63.4 -27.4 +3.6 Percent change -3Q> +6- Source: Federal Reserve Bulletin, November 1954. What is more, other borrowers were apparently not influenced g-eatly by higher rates. For example, here is the percentage of Government securities held by insurance companies, and savings and loan associations (latest figures available,. Federal Reserve. Bulletin, November 1954) : Securities held as percent of assets December 1952 Life-insurance companies Savings and loan associations „ 14.0 7.9 June 1953 13.3 8.1 August 1954 11.2" 6,8- 2. Has the Treasury succeeded in achieving substantial lengthening of maturities? The answer is "No." (Again, I rely on the last published figures, exclusive of the late November refunding.) 59 UNITED STATES MONETARY POLICY Major changes in Federal securities, 1945-54 [Billion dollars] December 1945December 1952 Short-term bills and certificates Intermediate notes Marketable bonds . Special issues ... December 1952October 1954 Petcent change -30.0 +33.0 -37.4 +16.0 +96.0 -16.7 +7.5 -40.7 +9.1 +19.15 -0.8 +5.9 +4.4 -.9 +3.1 Percent change —2 +20 +6 -1 +a Source: Federal Reserve Bulletin, November 1954. In making this comparison we should allow for the fact that the first period covers 7 years, the second only 21 months (one-quarter as long). But it is clear t h a t the Treasury in reducing short-term issues has not been as successful as the previous administration. In fact the short-term issues were 19.8 percent of the debt outstanding in 1945, 14.4 percent at the end of 1952, and 13.5 percent a t the end of October 1954. Against this it should be noted in favor of the Treasury that there was a rise in the marketable bonds outstanding (but contrary to objectives, in the hands of banks). But also note the large rise in notes outstanding. The average maturity, however, declined from 8 10.77 years in 1946 to 6.77 years in 1953; but there was no improvement in 1953. Finally, the Treasury had to yield on its objective of raising rates. Here it had a large success in the first half of 1953, though unfortunately a success in a mistaken policy; but it had to retrace its steps and help depress rates in 1954. Instead of seeking to issue long-term securities at higher rates of interest, the Treasury now introduced a new policy, and a much improved one: they would not issue long-term securities which might compete with the long-term private issues. Before the issue of April 1953 of 3^4-percent 30-year bonds, the Treasury had issued a 6-year 2%-percent bond in July 1952 and a 5-year 2%-percent bond. The 3%-percent issue marked a dramatic rise in rates. Interest rates moved as follows: Taxable Treasury bonds Average 1945 December 1952 237 2 75 i (a) 12-20 years J u n e 1953 3.09 Moody's AAA corporate bonds 283 297 (6) 20 years and after 3.29 3.40 Source: Treasury Bulletin. I t will be noted that whereas the yield of taxable Treasury bonds rose by 0.38 percent in 7 years, 1945 to 1952, aside from the additional rise associated with the rate on long-term bonds, the rise in the 6 months, December 1952 %o June 1953, was 0.34 percent, or almost as much as in the preceding 7 years. The later rise in corporate bonds was even more spectacular. (The following statement was submitted in response to the chairman's invitation to the panelists* to extend their remarks in the record.) SUPPLEMENTARY STATEMENT BY SEYMOUR E. HARRIS On the invitation of Senator Flanders, I make the following comments (unfortunately, 1 have not had the time to prepare an additional statement promised in my written evidence); 1. I emphasize again that what monetary policy can do in a depression is distinctly limited. But in a boom more may be attained. Hence I suggest that • CBD, Managing the Federal Debt, 1954, p. 10. 60 UNITED STATES MONETARY POLICY excess reserves should be increased. Not as much as Dr. Clark proposed, but a t least enough to increase purchases of assets. If the banVs then purchase more Government securities, they will then move on to other assets as the price of Government securities rises; that is, the return declines. But what of the stock market? asks Senator Goldwater. The market may be rising too much. If this is so by all means deal with the market directly. Why are margins 50 percent now? 2. I stress again the point that continued rises of output are likely to mean some inflation. Bottlenecks, wage inflation, other factors raising short-period real costs are relevant. In periods of 15 million unemployed or even 4 million, the effect of rising output is likely to be some increase of prices—more in the latter condition. Those responsible for policy have to weigh the gains against the losses. Our objective should be growth and stability; but we are likely to be confronted with some inflation as we grow. I doubt that any fiscal or monetary policy of 1955 vintage will stop the small but steady inflation except at the exj>ense of material unemployment. Is it worth the risk? 3. Then note that the major expansion of loaning assets by far in 1952-53 and 1953-54 (fiscal years) was made by noncommercial banks—not really under Federal Reserve control. They saved us from a much greater recession—and saved us from excessive caution of the monetary and Treasury authorities. 4. Much was said about the importance of the rate of interest. Mr. Wilde argued it did not m a t t e r ; Mr. Smutny that it did. In my opinion, it depends. I t is important for long-term contracts (e. g., housing) and can be decisive when there is not too much pessimism around (e. g., 1954-55). 5. Indeed, as Professor Chandler says, monetary policy should not be used to correct structural maladjustments. But it is also well to remember that structural maladjustments are associated with price-cost relationships. And when prices exceed costs (in, say, slightly inflationary periods) t^e same industries that would have been considered structurally maladjusted now become adjusted. Senator FLAXDERS. YOU did well, Professor Harris, and we appreciate it. The next speake£J*L Mr. James Land, senior vice president of the Mellon National Bank & Trust Co. of Pittsburgh. Mr. Land. STATEMENT OF JAMES N. LAND, SENIOR VICE PRESIDENT, MELLON NATIONAL BANK & TRUST CO., PITTSBURGH, PA. Mr. LAXD. Monetary policy since mid-1952 has made significant contributions to economic stability. I t is clear that the measures of monetary restraint taken in the latter part of 1952 and the first part of 1953 had a retarding effect on the volume of residential construction, and it is equally clear that the policy of active ease in the money market which was initiated in June 1953 has stimulated residential construction. In the field of State and local public construction, there have been somewhat similar results. Some projects were postponed or delayed during the period of relatively tight money because of the difficulty of financing under the conditions then prevailing. The advent of easier and" more readily available money turned the tide the other way and the volume of State and local public construction is now rising at a faster rate. Money conditions also probably influenced the timing of business expenditures for new plant and equipment, although to a lesser extent than in the case of residential and. public construction. In these various areas of the economy, particularly in residential construction, monetary regulations cut something off the peak of the boom which culminated in the spring of 1953 and helped to some extent to fill in the succeeding valley. UNITED STATE. MONETARY POLICY 61 Twenty years ago easy money was largely ineffective in stimulating business. Water was put before the horse, but the horse would not drink. This time the horse has been drinking. Throughout the recent period of changing business conditions, commodity prices on the whole have been unusually stable. Monetary regulation undoubtedly contributed to this stability. Those who are directing monetary and related fiscal policy are entitled to a large measure of satisfaction over the results they have been able to achieve through the application of such policy. From the standpoint of the future, however, there is cause for grave concern in some of the difficulties which were encountered in applying n policy of monetary restraint. In its efforts to acquire greater freedom to restrain monetary expansion, the Federal Reserve, late in 1952 and during the first several months of 1953, modified its policies with respect to United States Government securities, seeking only to prevent disorderly markets rather than to maintain orderly markets. Among other things, it abandoned the practice it had previously followed of assisting in the United States Treasury's refunding operations by bidding a small premium in the market for each maturing issue (other than bills) and exchanging all of the securities so purchased for the new refunding issue. The Treasury was confronted with several large refunding operations in the latter part of 1952 and the first part of 1953" and in addition it had to raise a considerable amount of cash. This financing was accomplished under increasingly difficult conditions, reflected in declining prices for Government securities, including new issues. The relative aloofness of the Federal Reserve, the record over several months of new issues successively selling below their issue prices and the prospect of heavy seasonal deficit financing by the Treasury combined to produce on the 1st day of June 195.3 a near panic in the Government securities market. It was only with considerable difficulty that the Treasury was able to sell an issue of bills on that date. Ill part the market disturbance was an overreaction by the public to various policy statements made by Federal Reserve and Treasury officials in preceding months. The public would have had a better balanced viewpoint if it had attached more importance to the fact that the Federal Reserve had begun to buy moderate amounts of Government securities in May 1953. The unfortunate events of June 1, 1953, made drastic action necessary, and this took the form of heavy open-market purchases of Treasury bills by the Federal Reserve during June, followed in July by reductions in the percentage reserve requirements of member banks. In early July the Treasury was able,to sell quite successfully a certificate issue of nearly $6 billion. The change in Federal Reserve policy which was made largely under the compulsion of the crisis of June 1, 1953, coincided fairly closely with a downturn in business, and this made continuation of an easy money policy appropriate. But suppose the boom had gone on unabated. Would the Federal Reserve have been able to reinstate an adequately effective policy of monetary restraint? I doubt that it would, in view of the con55314—54 5 62 UNITED STATES MONETARY POLICY tinuing large financing needs of the Treasury. ^ In my opinion, the events which culminated on June 1, 1953, indicate that monetary regulation by the Federal Reserve must be to a very substantial extent the prisoner of the Treasury's necessities when the Treasury is compelled to engage in large and frequent operations to refund maturities and finance deficits. I t is cause for satisfaction that the present Treasury administration regards lengthening of the debt as one of its primary objectives. The issues which it has put out for this purpose have been limited largely to the 2 ^ - to 9-year range, but refundings of this character can accomplish a great deal in the way of reducing the number of maturities per annum. We have apparently learned to use the accelerator of easy money quite successfully. What we now need to do is to create the conditions under which the brake of monetary restraint can be more successfully applied in the future when appropriate. If we use the accelerator too much, and the brake not enough, we shall drift into renewed inflation. Senator FLANDERS. Thank you, Mr. Land. Now we have C. Clyde Mitchell, Jr., chairman of the department of agricultural economics at the University of Nebraska, in Lincoln. I may remark that the University of Nebraska has a wonderful collection of elephant fossils, and if anyone is driving through Lincoln, Nebr., I urge them to stop and see two things : One is the wonderful State capitol, built without debt, and the other is that marvelous collection of elephant fossils. They show the growth of the elephants in the first period of a kind of a long-noSed thing which apparently grubbed in the mud in the Nile Delta, up to the present magnificent specimens which now roam the earth. Now we will return to our order of the day. Senator DOUGLAS. Mr. Chairman, wTould you forgive a question. I have not had the privilege of inspecting this collection of elephant fossils, but do they show the reason for'the decline and disappearance of the elephant from North America ? Senator FLANDERS. They, sir, give no untrue record of history. Mr. MITCHELL. We suspect it is the Nebraska winter, Senator Douglas. Senator FLANDERS. NOW, Mr. Mitchell. STATEMENT OF C. CLYDE MITCHELL, JR., CHAIRMAN, DEPARTMENT OF AGRICULTURAL ECONOMICS, UNIVERSITY OF NEBRASKA, LINCOLN, NEBR. Mr. MITCHELL. I n agriculture the American ideal of the expanding, prosperous economy is failing in the most obvious fashion. Monetary policy of the past 3 years must bear a great deal of the blame. While objecting to the restrictive monetary policy of*the immediate past, however, I desire to expand my objections to a broader subject—the economic theory of which monetary policy is only a p a r t - — Senator FLANDERS. Excuse me just a moment. 1 note that yours is one of the longer presentations. Mr. MITCHELL. YOU can trust me, Senator, to keep it to 10 minutes. Senator FLANDERS. I am sure I can trust anyone from Nebraska. UNITED STATES MONETARY POLICY 63 Mr. MITCHELL. Thank you. Continuing my statement: I desire to expand my objections to a broader subject—the economic theory of which monetary policy is only a part—concepts accepted by the^Fedei 1 Rese* re Board and the administration—concepts of capital formation and economic growth which are entirely unsuited to our Nation. If America intends to make a national policy of full-employment work, wTe are going to have to revise some widely accepted but highly unrealistic ideas about our economic system. One of them is a belief that underlies all the opinions presented by the Federal Reserve and Treasury officials, a belief that something called the free market rate of interest should be a major factor in determining when and how much our Nation should expand its economic growth. Monetary policy is too important to be entrusted to the market. There are three good reasons for this statement, either one of which Avon Id be sufficient to justify it. In the first place, it is quite certain that the real world does not fulfill the conditions necessary to create the type of free market in which the traditional economic theory would haye meaning; the theory, that is, of capital formation through prior saving and its regulation through the interest rate. There is thus no valid justification in economics for preferring the so-called free price rather than a controlled price for capital funds. In the second place, the traditional idea that a modern nation's capital-goods expansion is brought about through prior saving is incorrect, both in theory and in the actual history of modern .civilization. In truth, for society to plan and govern its capital formation in essential lines, and to set whatever rates of rental it desires for such funds, are completely sensible politico-economic behavior. Third, we have discovered, particularly since 1951, that whenever we attempt to use the so-called indirect methods of control on capital formation, they either do not work or work badly. This is particularly true with regard to agriculture. National welfare demands that there be made available to agriculture within the next few years, at low interest rates, very large increments of capital funds. Other industries whose rapid capital growth is also essential are in the same position. These essential industries should not have been penalized with higher interest and curtailed fund availability in the past 3 years, and should not in the foreseeable future. To develop these arguments in any detail wrould require far more time than is at my disposal. In this brief argument and in the longer paper you have before you, therefore, I am devoting major attention to arguments that seem to me to have been not so often presented. Last February, before this committee, I objected to tlie administration's proposal for agriculture on the grounds that it was based on unrealistic economic theory and that it was not designed to fulfill the responsibilities placed upon the administration by the.term of section 2 of the Employment Act of 1946. My criticism of our Nation's monetary policy since the accord of 1951 follows identical lines. This policy has been based on the same incorrect economic reasoning and likewise is not consistent with the aims of an expanding economy. The accord of 1951 placed the power of decision over an important factor of economic growth in the hands of men and institutions 64 UNITED STATES MONETARY POLICY devoted to the belief that there is something deeply significant and valuable in the way the price of rented money is set in the market. This belief led these men and these institutions to take action which struck hard at two classes of citizens—farmers, and low- to middleincome home builders. The excuse for this widely advertised hard money policy was twofold: (1) that we were in. an inflationary period, (2) that the so-called indirect methods, particularly those resulting in across-the-board curtailment of investment funds and in higher interest, are the best way to slow down inflation. Underlying these two was the implicit assumption that inflation is unquestionably something we must prevent. I should like to object to these two excuses and to the underlying assumption: (1) Whether we were in an inflationary period or merely a period of healthy prosperity consistent with reasonably full employment is a highly debatable subject. The definition of the terms "prosperity" and "controlled inflation" are practically indention!. People who would benefit from a stable or falling price level considered the situation inflationary, whereas people who would benefit from reasonably full employment and a generally bullish economy considered it healthy prosperity. Certainly for agriculture, the past 3 years have brought severe losses. Farmers will never agree with administration spokesmen that we have, to use their words "shifted from unsustainable inflation to stability." For farmers, the shift has been from moderate prosperity to depression. There is no other word that can describe a drop of 14 percent in net income from 1951 to 1954 (from 14.5 to 12.5 billion'dollars), (2) My objection to the second excuse (that "indirect methods" should be used) is one with which your committee is familiar; I shall merely summarize it. Indirect methods to control capital formation work badly, bearing particularly hard upon some of the most essential and "conservative" industries in society, for example, farming and home construction. For our Nation to follow an expanding— economy goal and carry out the ambitious terms of the Employment Act demands that interest rates for capital-goods formation in worthy industries remain at low level, preferably trending downward, but certainly never rising. If speculative and too-rapid capital formation in certain lines ever needs to be curbed, for example, the building of race tracks, Mr. Chairman, let it be curbed by direct means, such as materials rationing, instalment-credit curbs, and other selective controls. On the developmental side, capital funds for the things which America urgently needs may often have to be directed positively and selectively. This-is consistent with the social and economic planning which is normal in our complex society. That capital funds for such essential purposes should be rationed through the.supposed impersonal operation of something called the free-price system is not an inevitable, nor even a necessary rule of our society. Yet our present national monetary policy assumes, first, that ours is a free-price regulated economy and, second, that interest, the price for which money is rented, must be set by the impersonal market. UNITED STATES MONETARY POLICY 65 I suggest that we look at the world around us—that we recognize that through political action our society itself decides (or condones the decision by various private groups) upon many prices and production decisions—perhaps most of them. Our general policy—if there be one—is something like this: We leave many decisions to private interests, of course, but we do so not becouse of any basic trust in the "natural laws" which force private interests to decide correctly. We do so mainly because most of these decisions left to private interests do not impress us as being important enough, or tho private controls obnoxious enough, to warrant intervention. Whenever society decides that intervention is necessary in any case, there is no valid appeal from this decision, certainly not to anybody of absolute principles with which economics can supply us. Whenever we are faced with a serious situation that demands the creation of new capital goods, we create those goods. Whenever institutional rearrangements are necessary, to print money or expand credit to aid in construction, we make them. Because our Nation, and indeed all modern technological civilizations, always have a great deal of underutilized capacity within them, even in wartime, this can customarily be done with little or no increase in prices. In the material in appendix I, below, I suggest that the process of capital growth in our economy, and particularly in agriculture, needs to be understood and used in the national interest to achieve plailned expansion of our economy. I object also to the underlying assumption that inflation must always be prevented. There are two friain types of inflation: (1) That with rather full employment, as in the United States during recent periods, and (2) that with unemployment—like the Chinese type. I take it for granted that most economists now recognize that the only type we could have in this country is the former, the best answer to which always lies in increasing production, and in increasing capital funds available to the specific lines in which production must be most rapidly increased. I t is unfortunate that the same word, "inflation," is also used to describe the wild price flight that takes place when the technological productive capacity of a country has been wrecked by physical means. Most economic textbooks, failing to recognize the reasons for the Chinese type, imply that it will come about as an inevitable result of letting the United States type "go too far." Nothing could be further from the truth. The only plausible objection to the full-employment type of inflation in this country is that it can bring about changes in the distributive shares.going to various classes of our people, particularly upsetting to persons and institutions on pensions and other fixed incomes. I have discussed this problem at greater length in appendix I I , below. I can summarize by saying that our society, if it decides that mild, controlled inflation is a safer policy for implementing the Employment Act than rigid price stability, is perfectly capable of handling the problems such a policy creates, including the problems that prosperity creates for fixed-income classes. 66 UNITED STATES MONETARY POLICY (The unread portion of the statement submitted by Mr. Mitchell is as follows:) APPENDIX I. T H E ROLE OF CREDIT IN AN EXPANDING ECONOMY, W I T H PARTICULAR REFERENCE TO AGRICULTURAL CREDIT I. SUMMARY OF THIS APPENDIX 1. Economic progress in welfare terras (goods and services), is assumed to be the goal toward which, social planning is directed.- The United States has expressed in the Employment Act of 1046 the intention to pursue a course of economic progress in an expanding economy. 2. Such progress will continue to result, as it has in the past, mainly from the association of more (and more efficient) capital equipment with the factors of labor and management. 3. Productive credit assists in bringing about that association (of more capital equipment with the labor and management factors). Availability and use of credit which facilitates the creation of more capital equipment is therefore a condition of progress. 4. Serious deficiency in credit availability to various people engaged in agriculture is one important factor standing in the way of efficient production. If the United States is successfully to maintain an expanding economy, these deficiencies must be made up rather rapidly. 5. Tentative suggestions are made in this article that new and different methods of supplying credit to agricultural producers will be needed in the next few years. These methods at first glance appear to be radically different from those employed by agricultural credit institutions, particularly before 1033. They are different from those envisioned in traditional economic theory which frowns on capital goods accretion in the absence of prior moneysaving. However, a closer examination indicates that with regard to capital goods formation: (1) the areas of the American economy which have made the most progress have benefited from considerable cultural fiat and social action with regard to production credit, and (2) the traditional theory of capital goods formation contains basic logical faults and probably never deserved the adherence of economists in the first place. In short, it is possible that these suggestions are realistic rather than radical and involve only the extension to agriculture of ideas long accepted in industrial production. 6. More rapid progress in the field of agricultural capital formation will probably result from social action programs additional to and of a more comprehensive nature than have been tried in the past 20 years. Methods should be found to establish.competent farm producers in a well-equipped productive operation at the time in their lives at which it is most likely that they will be able to produce efficiently. 7. If plans along the lines of these suggestions are put into effect, they will change the nature of the obligations which the farm producer owes to the rest of the community. A tentative exploration is made in this article into the nature of these changes. II. A SHORT EXCURSION INTO TRADITIONAL IDEAS OF CAPITAL GOODS FOllMATION A, Robinson Crusoe and his fish net The earliest economic thinkers were impressed with the way in which division of labor and specialization could increase the production of any group of workers dramatically, beyond that amount the workers might contrive without specialization. These theorists recognized the influence of capital goods upon increased productive efficiency, and correctly reasoned that an increase in the production of capital goods was a necessary condition of economic progress. For various reasons, the fathers of economic thought devoted far less attention to the technological conditions of capital goods creation than they did to economic Conditions, rather narrowly defined. In the famous story of Robinson Crusoe, who built a fish net to increase his haul of fish beyond the amounts he could catch with his bare hands, theory took what is perhaps a wrong turn. I n order to feed himself while he spent 2 or 3 weeks weaving the net, Crusoe first needed a supply of food. He saved berries. Saving thus appeared to the theorists to be necessaryprior to the construction of capital goods. UNITED STATES MONETARY POLICY 67 B. Capital goods formation limited by savings From this interpretation of fishing technology grew the idea that capital goods formation is limited by money savings. Basic to the theory of capital goods formation are the assumptions of the logical system in which capital goods formation is only one p a r t : The laissez-faire system of distribution, in which prices serve as the directing force for economic decisions and bring about both efficiency in production and equity in distribution of the products of man's work. These assumptions can be summarized in the phrase "perfect competition in a perfect market," and include, subsidiarily, mobility of factors of production, and the economic man. Given these assumptions, in a free society, full and efficient employment of all factors of production would be assured as if by an unseen hard. For society to progress, new capital goods needed to be introduced into the system. Such introductions could be made only by those who could save money. Capital goods formation was therefore conceived to be limited by moneysaving. Moneysavers were changed from the usurious devils of a slightly earlier age into benefactors of society, by the writings of Adam Smith and his followers. C. Forced savings If money means benefaction, then could a ruler, by printing a great deal of money, become a great benefactor? For a long time the people in charge of printing paper money have been intrigued by the tremendous power in the finger with which they push the starting button of the printing press. I t appeared that a t a motion of this finger they could bring into being great warships, buildings, dams, highways, and national monuments. But simple intelligence convinced almost everyone that such magic could not possibly be t r u e ; that these impressive accomplishments were the product of artisans and laborers and engineers rather than the button-pushers in the printshop. In fact, the button-pushers, toiling not and sweating not, were deemed to be n rather irresponsible crew in aspiring to perforin magic feats. Economic logicians took pains to point out the danger of letting the printing-press operators direct such important human activities as catling forth warships and buildings. Given the assumptions of tiie economic system which the theoreticians believed described our world, of course, the printing-press operators were positively dangerous. Although they might print money which called forth in the construction of capital goods, their action took the entire matter of saving out of the hands of those fortunate members of society who could save, and forced everyone, particularly the poor people, to save whether they wanted to or not, or whether they could spare anything from their meager existence or not. The printing-press money forced savings by pushing prices up, particularly of the things that the poor people have to buy. This early discovery that money printing might get new industries built was therefore never given adequate study because it was almost from the start believed to be irresponsible and sinful. 1). Capital goods formation in an underemployed economy However, the theoreticians discovered that in the real world, money can sometimes be printed and put into circulation to build new capital equipment without raising prices or forcing anyone to save. This can happen whenever there are resources which are not being fully utilized in the economy. If the amount of underutilized resources is large, governments can print large amounts of money, or credit-creating institutions can create large amounts of credit, and large amounts of new capital goods can be built, using the slack resources. The admission by present-day economists educated in the classical tradition that it is j>osstbIe to bring about the creation of new capital goods by social aetioi* (printing money or expanding credit) without prior moneysaving by capitalists and without forced saving by consumers generally, points out a serious limitation in the usefulness of traditional theory. It constitutes an admission that society, acting through laws and other institutional factors, can direct our economy and do it well. Society can do it better in the real world, from a goods and services standpoint, that the automatic and impersonal forces of price and competition which (by the theoreticians at least) have been depended upon for 200 years. The theoreticians excuse themselves by admitting that the real world exhibits underemployment of resources, which the theoretical world ruled out. However, a few modern economists are reexamining the original idea, and ask if the building of the first fish net did not itself require underemployed resources. How did Robinson Crusoe manager to store up enough 68 UNITED STATES MONETARY POLICY berries for his 3 weeks of net-making? He must have lived in a surplus-producing area—a partially underemployed economy. In a society fulfilling rigorously the assumptions of the classical theory, it is entirely possible that there never could have been any capital-goods creation. I t is probable that in every society, everywhere, enough underemployed resources exist (or can be freed by adoption of new techniques) to allow great amounts of progress through social redirection of resources. 1 j£. Capital formation ly social dictate Whether or not we believe that the theory of capital-goods formation through prior-savings was faulty from its beginning, most economists today acknowledge that society quite properly engages in the process of dictating a great part of the capital-goods formation that now takes place. Whenever our society makes the decision that certain things must imperatively be built, those things a r e built, whether or not anyone had previously saved enough money to build them. The wartime expansion of our Nation's capital equipment is an excellent example, of course. The doubling of capital equipment in the last 15 years has occurred mainly because of social direction. That social direction included the creation of funds, the allocation of scarce materials, Government construction of plants, guaranteed or supported prices, preferential tax treatment, and many other similar measures. An exact measurement is impossible of the extent to which America's capital goods have increased due directly and indirectly to social action. The chief economist with a large American corporation argued that I was wrong, in an article I wrote in 1933 in which I said that "more than half, and perhaps almost all" of America's doubling of capital goods has occurred because of social action. He conceded the war plants had been built with RFC and other direct Federal money, but concluded that the balance, much more than half, was expansion from private funds. But that misses tne point. Those private funds, profits Of American business, were as large as they were because of definite decisions made by the American people. The decision to fight the war and to build war-related industry was a social decision. Once that decision had been made, most profits became automatically guaranteed for some years to come, not only in the war industries but also in all the less- and non-essential industries. Practically all of these industries enjoyed the most tremendous prosperity they had ever known. Savings from the net profits of private corporations did of course finance a great deal of the growth, but most of these net profits resulted directly from social decisions completely outside of the realm of a society governed by the laissez-faire doctrine. There can be no doubt that a great deal of such net profits resulted from the existence of patents, trade-marks, price fixing, and other modifications of pure competition which society has decreed or acquiesced in. There can be no doubt that rapid tax,writeoffs, coupled with the fact that the Government directly influences about one-fourth of the total income flow in the Nation, now guarantee business stability at a high-profit level for much of the so-called private enterprise sector. I should like to repeat my 1953 statement to which the aforementioned business economist objected: "The doubling of capital equipment that has taken place in the past 14 years h a s occurred very greatly (more than half, and perhaps almost all) because of the creation of funds beyond the amounts saved by capitalists, and certainly beyond the amounts capitalists could have saved had our economy been competitive in the classical sense." In other words, the funds for capital-goods creation were funds created by society, or allowed to be created because society has not thought it wise to force business to be classically competitive. In other words, the United States h a s through social programs directly created or has underwritten the- creation of most of our capital goods. The effect of this great increase in capital equipment has been a tremendous increase in physical productivity, in goods and services, of the American economy. The results are undoubtedly better, in the physical-productivity sense, than a purely competitive society could have achieved. III. THE CHANGING EATIO OF CAPITAL VALUE TO LAKOR IN THE 20TH CENTURY During the course of the industrial development of modern society, the money investment in capital equipment per worker has of course increased greatly. The average cost of capital equipment associated with each worker in American industry is more than $10,000; it is almost twice this amount in railroads and utilities. *A better understanding of these factors can enable us to do a more realistic job in aiding the underdeveloped areas of the world to industrialize themselves. UNITED STATES MONETARY POLICY 69 Investment in capital goods per worker has increased greatly in the past half century as the size and complexity of industrial operations have increased. The worlds of finance and industry have long been organized in such a way as to provide these large amounts of capital equipment without requiring either the laborer or the entrepreneur to make prior savings of large amounts of money funds. Indeed it is almost an axiom of business that new industrial enterprises be started with little or no money. (The entrepreneurs are expected to have production ability, but even that is not necessary—engineers can be hired.) Promotional ability is perhaps the main requisite to starting industrial enterprises, and on so precarious a basis (in the technological sense) funds are raised from investors. The promoters usually receive no-value common stock for their promotional efforts; the cost of physical plant and working funds are supplied by investors in preferred stocks and bonds. Competent studies, such as were made by Berle and Means and others, have shown that complete control, i. e. ownership of all common stocks, of America's largest industries w.as achieved with an investment of only about 7 percent of the real construction cost of the industries—the other 03 percent was furnished by investors who received'securities bearing little or no right of control over the industries. Great physical performance of the American industrial system has characterized past years, and profitable financial performance has characterized most of them. These two factors have adequately justified the optimistic hopes of an institutional system that permits entrepreneurs and laborers with ideas and abilities, but without money, to associate themselves with thousands of dollars worth of capital equipment during the best and most productive periods,of their lives. To take the different course suggested by Robinson Crusoe economics would be unthinkable—to require an industrial entrepreneur to work up the ladder from a common laborer to a skilled laborer to a small backyard shop to a larger shop to a small factory to a larger factory, buying the more expensive equipment in each case from the money savings he had made by abstaining from spending part of his income in the prior stage. He would be senile before he had saved the price of one forging hammer. America's Horatio Alger, folklore to the contrary notwithstanding, that is not the way an industrial economy makes progress. Progress is made because society has made a complex chain of decisions, some legal, some institutional, which bring entrepreneurs and workmen together to work, during the most productive period of their lives, with capital goods which society has decreed shall be created. Modern societies have learned, though most elementary economics texts avoid this fact, that economic growth is self-financing. As the conservative London Economist editorialized, in discussing the "lessons of the war," we have learned that "anything that is possible physically is possible financially." This is true because in modern societies, there are always rather highly flexible elements of underemployment of many resources, even in the times of greatest emergency, and further because when banks and governments create funds the prospect of economic growth so increases property values as to justify the creation of the funds. Of course a recognition of this process does not mean that governments or banks can safely create money by whim. If the new money is not matched by real physical growth and productivity increase, inflation results. In some cases of forced-draft increases, as in war, considerable effort must be expended in areas of stress by controlling some prices, allocating some materials, and altering some of labor's mobility. However, the generalization is a safe one that our technological ability to increase our capital equipment (and therefore our productivity) makes it possible for us to finance the increases. This is the exact reverse of the teaching of. traditional economics. Acceptance of this more modern way of looking at the problem of progress and growth underlies the Employment Act of 1946. That act expresses with the highest ceremony possible in our society, formal act of Congress signed by the President, and implemented by a top-rank professional staff, that we have to a large extent adopted a new theory of economic development, that we as a sovereign Nation will do whatever is necessary to maintain an expanding, growing economy. IV. CAPITAL GOODS FOR AMERICAN AGRICULTURE IN T H E FUTURE If this is a realistic picture of the changed and more realistic explanation of the tremendous technological progress made in the Western World, and in the United States in particular, to what extent has agriculture shared in these 70 UNITED STATES MONETARY POLICY changed concepts? As compared with industry,. agriculture has shared very little. This generalization is not intended to belittle the great significance of the social action programs of the last 20 years. Price supports, incentive payments, farm credit at reasonable rates, supervised credit of FSA-FHA, road building and the REA's—all of these have helped many farm producers to adopt new methods, invest in new capital equipment, and greatly increase their productivity. However, as between industry and agriculture, with regard to their ability to do an adequate job of meeting the challenge of an expanding economy for the next 2 or 3 decades, the gap is still great. In considering how to improve the physical efficiency and productivity of American farms in the future, I should like to direct attention to some new methods of expanding the amount of capital equipment available to farmers. 2 Agriculture is the main residual area in which the "save first before building" idea prevails. Twenty years of social and political concern with the farm problem has partially changed this idea, but in the main too many people still think that there is an agricultural ladder, and that the task of climbing it need not be materially eased by Government. I submit t h a t the same general type of technological and financial revolution that has brought our industrial society to the place it is today needs to take place in agriculture. On the most successful farms the physical revolution has already taken place. The farm that can support a family in decent middle-class living now requires an investment of more than $40,000. About the maximum t h a t a farmer can borrow for such an enterprise, without parental or other family assistance, is 50 percent. Raising $20,000, or even $10,000, is a difficult matter for most American farmers. For the young farmer it is usually impossible. To improve agricultural productive efficiency for the America of the future will require that methods be found to enable competent farm producers to associate themselves with adequate capital equipment early in life, when their vigor and ambition are highest. As in the case of industrial America, the association should prove successful. A farmer who can thus associate himself should ordinarily achieve physical productivity high enough to pay his initial loan off within about 20 years. In such cases, the increased productivity has amply justified the loan. If, however, the prevailing farm-finance pattern of today is continued, those 20 years of highest physical ability must often be partially wasted on inadequate and illequipped farm enterprises. V. IF SOCIETY TAKES A HAND American planners should consider whether or not we should participate in the process of making capital funds available to increase farming efficiency in an expanding economy to an.extent beyond anything contemplated in present laws and institutions. To.this end, capital funds up to 90 or 100 percent may need to be supplied to farmers who give evidence of being good entrepreneurs. Implicit in this proposal is, of course, the proposal that some measure of competence be devised and applied to applicants for funds. 3 Much of the new investment funds thus made available wpuld be from sources outside of agriculture. Whether the loans come from private financial institutions, private institutions with Government guaranties, or Government lending agencies, they will inevitably be more impersonal than is customary in present farmer-country banker relationships. Outside credit will probably require, and probably should receive, considerable guarantee of stability, as far as interest and principal payments are concerned. This stability feature in industry has been important in the wide acceptance of the principal of outsiders furnishing capital funds. If the principle is extended to agriculture, income stability of farmers becomes a- very important factor. Incomes in agriculture need to be made more stable from two standpoints: (1) The quality of the entrepreneural decisions needs to be kept high to insr»:e productive efficiency on the individual farm, and (2) farm incomes need to be stabilized to avoid £rea*t variations. 2 Although "equity" to farm people in access to social capital Is important, productive efficiency is the matter here under consideration. 3 Lest this be considered too radical a departure from American practice, we should remember that society through both public and private action has often furnished 100 percent of the capital funds required by promoters to set up new industries. Those promoters very often would not have been able to Rive oven a fraction of the evidence of tochnical ability that we have customarily required for the smallest rehabilitation loan of the Furmers Home Administration. UNITED STATES MONETARY POLICY 71 If society takes a hand in the provision of capital funds for agriculture, it will undoubtedly demand a hand in the selection of the farm enterpreneurs and in periodic examination to see how they are discharging their stewardship.* Furthermore, if society takes a hand in the selection and examination of farm enterpreneurs, we will need to devote considerable study and understanding to the problem of keeping social participation democratically responsive and maintaining the greatest possible decentralization of authority and freedom of action of the individuals concerned. Finally, if society decides to take a hand in such matters, it will have to safeguard itself from possible adverse consequences of its action. For example, stability in land prices and proper land use would undoubtedly need to be achieved through legal action—otherwise easing of agricultural credit could result iu wild bidding.up of land prices, or land might be ill used for one short-run purpose when social considerations would require it to be used differently for longrun conservation ends. CONCLUSION TO APPENDIX I If agricultural productive efficiency is to keep up with the demands of our expanding economy, entirely new arrangements must be devised for providing capital funds to farm operators. The point has been made here that the prospects for growth justify the creation of capital funds by the Government and by banks, in much the same manner as the capital funds have been created for America's industrial growth. Both the amount of funds created and the interest rate charged for the rent of these funds are subjects for social decision. There is no valid reason for letting either of them fluctuate adversely as long as capital growth is needed in important industries. APPENDIX II. PRICE STABILITY AS A GOAL? We economists are almost all honest men; we all are sincere in our quest for roughly the same goals (adequate production, decent income, and maximum possible individual freedom) ; why is it then that/vve arrive at such widely different recommendations? One of the main reasons is that we start with completely different assumptions as to the nature of man and society, and we inevitably arrive at different answeis. For example, if we start with an assumption t h a t is implicit in the work of most American economists that prices are the proper governor for most economic decisions, the conclusion is bound to follow that a policy which promises more price freedom at any point is always better than a policy which promises less. This is a common feeling of economists, whether they are discussing farm prices or the price at which money is loaned. I think it is only fair to point out that even though the overwhelming majority of professional economists probably believe such things, they are not true. 5 In our complex society decisions are made under the influence of a number of forces other than price; most of the prices which show up as a part of America's economic transactions are themselves influenced by forces which are either modifications or violations of, or excluded by definition from, the free market as it must be defined by traditional economic theory. American political reality has agreed with the foregoing analysis as to the factors that should influence economic production and distribution for many decades—not just since 19.'W. The economists have ordinarily disagreed. Who has been more nearly right, the American governmental processes, or the economists? Economists should at least keep their minds open. The prima facie case for a self-regulated society whose major activities are directed by free market prices has been wrecked both by logic and by experience. * In industry, society has In some cases demanded such a hand, and in some cases not. SEC regulations, public-utility regulations, wage-and-hour laws, and hundreds of other welfare measures are examples of society taking a direct hand in management. An indirect hand is taken in the many cases in which some businesses are assisted, others inhibited, by tariffs, patents, and various other oligopoly positions allowed or condoned by5 society. Most of the economists have invested many years of their lives in learning the analytical tools of the pure competitive, laissez-faire, price-regulated economic systein. They are undoubtedly swayed by the fact that retooling would be BO costly for themselves that it would be personally cheaper for them to try to change the rules under which the American economic system operates. Furthermore, the alternative tools of the more realistic sociopolitico-economic theories' are usually ill regarded by economists—they are full of inexactness, psychology, sociology, political science, and other social ideas not nearly so clean and sharp as economics, which deals precisely with prices and quantities and uses calculus and geometry. So most economists prefer to hold on to the beautifully embellished but highly unrealistic theory based on the free-market assumptions. 72 UNITED STATES MONETARY POLICY Another questionable assumption most economic writers make is to assume that our national economic policy should be aimed at price stability. Again we find that economists and America have disagreed for well over a hundred years. America's political activities are influenced to a great extent by segments and groups in our population, some inflationary in their demands; some deflationary. In general, farmers, laborers, and entrepreneurs have been in the former category ; in the latter have been white-collarT wrorkers, pensioners, and annuitants, both individuals and institutions whose w ealth or income wras measured in fixed dollar amounts.' Any time a discussion of American policy begins with the assumption t h a t a stable price level is a major goal of society, it is bound to conclude that any policy that does not work against inflation is an incorrect policy. Yet it is quite possible that America's physical production increases most dramatically in times of controlled but nevertheless continual mild inflation, with tremendous increments of created capital funds pumped into the system at specific points. Certainly the inflationist idea wins in the political arena every time it is clearly presented. The S5 percent of our people (approximately) 7 included in the segments which seem to prefer a little bit of inflation have in recent years been able (aided by the overriding urgency of depression and war) to stack the deck sometimes against the 15 percent who would have profited by stability or deflation.8 Again, we must face the question: Who is right, the majority of the economists-or the4 majority of the American people? Of course, stacking the deck against the 15 percent is to be regretted. There have been various practical suggestions in their behalf. For example, school teachers and other future pensioners are now encouraged to put half their ravings into common stocks and real property. Some people suggest t h a t insurance companies should do the same. (None of these suggestions is helpful to low-income people who have no savings aside from their interest in retirement or social-security funds.) Some economists nowadays sincerely believe that to attempt to maintain a stable price level is potentially very dangerous to our economy, and that the welfare of the So percent should not be tied inflexibly to a stability fetish to guarantee the purchasing power of bonds and retirement funds owned by the smaller group.- The ease for controlled inflation has not yet been proved, of course. A number of great problems (in addition to those of the endowed universities and pensioners) remains to be solved. But the case against controlled inflation has not been proved either. In the stable-price economy beloved by the traditional economists, private decisions would govern where to, whether to, and how fast to expand America's industrial economy, i t is ordinarily admitted by such economists that periods of stagnation and contraction might.occur; but freedom from socialistic control has always assumed to be a benefit sufficient to offset a growth rate considerably below the feasible and desirable. If we intend to keep America fully employed, it is my opinion that we should maintain a slightly bullish pressure on price levels. This, interestingly enough, will probably make governmental intervention in capital growth less necessary, simply because it should minimize the occurrence of the types of crisis in which the Government is called on "to do something." There are numerous other good reasons for this expansive policy; for example, foreign trade expansion probably depends on it—imports will be received in America with far less business anguish in times of steady upward movements. Even in an economy of controlled inflation, a large amount of decision making as to investment will nevertheless be retained in private hands. However, the total of all investment decision making will be kept expansionist, led by easy credit and such incentives a& rapid tax writeoffs in specified lines, and pushed by Government contracts. In a stable-price economy, reluctant, nonexpansive corporate managers feel they cannot be badly hurt because of their reluctance, and might, if depression ensues, prove to be men of great wisdom and parsimony. In an economy of controlled inflation, such men are fools, and become less and less important as their neighbors seize the torch of industrial progress and development. The American people have recognized the truly Incredible rate • Here, too, we must recognize that economists have a vested Interest in the traditional assumption. They customarily fall into one or more of the deflation-oriented groups because of fixed salaries and institutional jobs. 7 This is. of course, an oversimplification, inasmuch as there are many people who have interests in both categories. Primary interest is the point here, however. 8 In all modesty, this minority never publicly professes to want anything better than stability. UNITED STATES MONETARY POLICY 73 at which our industrial economy has developed under controlled inflation. They apparently do not feel that their personal freedoms have suffered too much in the process. When truly great performance is urgently needed, even imperative as in the case of war, there is never a serious question of whether to use controlled inflation; it is only a question of where to set the controls and where to pump in the incentives. CONCLUSION TO APPENDIX I I At least two factors will press America in peacetime to continue mild inflationism : (1) The belief that the free world must dramatically outproduce the Soviet's rising industrial might; to do this, investment decision making needs a shove toward expansionism comparable in scope with what it got in the war. (2) The acceptance, both popularly and in law (the Employment Act), of the idea that the American economy is badly managed if it does not produce in peacetime for peaceful purposes the expanding volume of goods and services of which three wars have shown us capable. One of the main—perhaps the main—argument of the Federal lteserve System and the Treasury for raising the general structure of interest rates is that such a policy is required "to fight inflation." This appendix has suggested that these institutions were probably lighting the wrong thing. Senator FLANDERS. Thank you, sir. You have kept within the normal time; you have propounded a number of questions which I find it difficult to keep, from pursuing myself, but since we have agreed to go through the lifct, we will wait until later. The next one in alphabetical order is Mr. Edward S. Shaw, of the Brookings Institution, on leave from Stanford University. Mr. Shaw. STATEMENT OF EDWARD S. SHAW, THE BROOKINGS INSTITUTION Mr. SHAW. I t would take more courage and wisdom than I can muster to answer question I confidently and explicitly. So I take some comfort from the fact that official answers from the Treasury and thfc Federal Reserve are neither complete nor quite complimentary. The Treasury view seems to be that restraint was necessary in early 1953 and that the May issue of 3% percent bonds was a salutary measure of restraint. I understand the Federal Reserve to say that excess liquidity was removed after April 1951 and that monetary growth balanced real growth until "unduly severe" tensions developed in May 1953. In this view the 3*4 percent issue was a tension that needed.offset by a roughly equivalent open-market-buying operation. Neither of these views recurs to the theme of the Council of Economic Advisers, i n i t s report of last January, that signs of impending deflation were evident at the turn of 1952 to 1953. My own ill-defined impression is that monetary restraint was skillfully balanced against forces of expansion in 1951-52; that monetary and debt restraints were pressed too hard and too long in early 1953; and that subsequent easy finance was at least congenial to the "specific pattern taken by the late recovery. I t is still too early for the casual observer to guess whether restraint has been renewed too quickly. The reply of the Federal Reserve to question I I is generally very lucid and instructive. I have a single quibble. The reply tells us wThy changes in. legal reserve requirements are a defective instrument of control. I t does not tell why so defective an instrument is used so frequently. There must, under some circumstances, be merits to balance the defects. 74 UXITED STATES MONETARY POLICY One does gain the impression that, in taking so skeptical a view o f both variable reserve requirements and operations in long-term securities, our central bank is tending toward an immaculate, highchurch, and 19th century view of its responsibilities. One defect allegedly is that "* * * the results [of a change in requirements] affect simultaneously and immediately all banks in each reserve class." In many instances results so> widespread would appear desirable on a money market as extensive as ours. ]S"ow that the Federal Reserve has denied itself access to the long-term market^ the pervasive effects of change in reserve requirements may be especially valuable. The large and infrequent changes in reserve ratios, which the Federal Reserve takes to be the result of defects ib the instrument, may instead be responsible for those defects. Open-market operations of comparable magnitude can also be a shock to the markets. Question I I I and the Federal Reserve's reply to it touch on fundamental issues in central banking theory. The Federal Reserve has made this decision: to deal only on the short end of the market; to lend no support during Treasury operations;* to intervene in disorderly markets. The result, it is said, shouH be to develop a private middlemen's inventory of Government securities that will absorb minor market disturbances. Private enterprise will preserve orderly markets. Then long rates may vary less in short periods, reducing market risks for all investors in long-term securities. This shoctld mean an improved market for Treasury long debt. Changes in long-term rates should become a more reliable index of changes in the terms of trade between savers and investors and, hence, a more reliable guide for monetary policy. Other advantages to the Federal Reserve may be expected", including a reduction in the turnover of its portfolio. The Federal Reserve has bowed off on the long market. I t will no longer manipulate relative market supplies of long-term and sbortterm securities. That function passes to the Treasury. The Treasury proposes to push out long securities, at relatively high rates of interest, when excess liquidity is contributing to cyclical boom. I t will borrow short, at low rates of interest, when more liquidity may soften a cyclical recession. Debt management is stepping into the market arena from which the Federal Reserve has withdrawn. The Treasury, with a new look, to be sure, has apparently gained in a new accord, prestige lost in the accord of 1951. There are disadvantages in this particular way of dividing responsibility between monetary action and debt management which are, after all,_different techniques for attaining identical results. It raises interest costs on the public debt, because long borrowing is done when long borrowing is dear. These extra costs appear to be in part a social cost of reviving the middleman function on the Government security market. The new technique may mean higher costs, too, because the Treasury, without central banking support, may need to put more favorable prices on its long-term issues. Final* ly, Treasury techniques for managing the rate structure are less agile than central banking techniques, so that the range of fluctuations in rates may not be reduced after all. In recent years commercial banking has lost ground to other institutional channels for lending and investing. Money has become less UNITSD STATES MONETARY POLICY 75 important among the financial assets that feed inflation. I t is being superseded to a degree by savings deposits, savings and loan shares, insurance policies, and other vehicles of saving. Control by direct or indirect means of the institutions that create and issue these media is increasingly vital to economic stability. There has been some reason to believe in recent years that the Federal Reserve was developing indirect controls over nonmonetary financial institutions through its operations in long-term Treasury issues. Now it appears that the Federal Reserve has abandoned the experiment and is limiting its area of responsibility to the traditional commercial banking field. Comments by the Federal Reserve on question IV and comments in other connections by the Treasury supply a clean-cut statement of national monetai^y and debt policy. Within the business cycle the range of fluctuation in interest rates is to be increased, by Federal Reserve action to stabilize the money supply and by Treasury policy of refunding on the cyclical rise. Over longer periods, the money supply is to grow along the narrow line that separates inflation from unemployment while the public debt is to be dispersed largely in funded form to investment-type portfolios. The policy of cyclically variable interest rates is correct if it does not jeopardize the recoveries that constitute economic growth. I object only to refunding when it is most expensive. It should be the central bank, not the Treasury, that sells long-term securities in cyclical recoveries. Refunding ideally should occur in recession when a successful operation, supported by the banking system, can assist in reducing long-term rates of interest. In response to question V, the Federal Reserve indicates gratification that the money supply did not contract in the recent recession. I t traces monetary stability primarily to bank purchases of Government securities and suggests that hereafter the substitution of Government issues for private securities in bank portfolios will brace the money supply against the contractive forces of recession. My own impression is that the money supply held firm in part because the recession has been so mild. Private borrowing at banks continued strong. With incomes still high, the public continued to want large money balances. We should not be. surprised in a more decisive recession if the public insists on economy in its cash balances, as it did in 1948-49. Xor should we be worried about a contraction in money balances if it is voluntary on the public's part and if, hence, it coincides with falling interest rates. Two queries come to mind in connection with the Treasury reply to question VI. . First, issue of a 5-year, 10-month bond in February 1953 is said.to have been a measure of restraint on inflation, yet issues of comparable maturity in late 195& are said to have been neutral with respect to Federal Reserve monetary policy. I t is not clear why lengthening of the debt is at times a restraint and at other times neutral in the monetary sphere. Second, if the explanation for this anomaly is that the intermediate securities are placed away from banks in booms but in* banks during recessions, one wonders whether it is necessary to pay the banks so well for lending capacity that would otherwise be idle. In general, question y i l has elicited a most helpful response from the Treasury. The doctrine officially laid down is a quite remarkable advance over traditional dogma that the only good debt at any time 76 UNITED STATES MONETARY POLICY js either long or long dead, I wish to question only the Treasury's excessive friodesty in claiming that it must cope with a free money market. The bulk of official testimony in these replies has been that the money markets, short and long, are not free and cannot safely be left free. They are the segment of the economy that must be so controlled as to communicate to other segments the signals that inflation or deflation have gone too far. These markets cannot be regarded as free in any important sense when they are managed and manipulated by the instrumentalities of the central bank and the public debt. The final question barely touches on the fringes of vital and highly disputatious issues. I t has to do with a minor aspect of the relationship between banking and government* The maintenance of Treasury balances with commercial banks and the various agency services that the banks perform for the Treasury should be considered in the broader context. Securities of the Federal Government were over 40 percent of all commercial-bank earning assets in mid-1954. Earnings and sale profits on Government securities approximated 30 percent of member-bank earnings in the first half of 1954, significantly more than enough to cover all taxes on all banking operations. The banks are deep in the business of monetizing public debt, and they are paid well for it. Private assets in their portfolios are sheltered by Government guaranties; excessive competition is restricted by Government authority ; expensive services are provided by an independent agency of Government. The banks, in return, provide an efficient payments mechanism and a principal channel for allocation of the community's savings. My judgment is that such minor aspects of bank-Government relationships as are suggested in question V I I I cannot be considered judiciously apart from aspects of much deeper significance. Senator FLANDERS. Thank you, Mr. Shaw. Our next witness is Mr. Itudolf Smutny t senior partner of Salomon Bros. & Hutzler, New York. I take it, sir, your firm deals actively in Government securities? Itir. SMUTNY. Mr. Chairman, that is correct. Senator FJLANDER3. Thank you; you may proceed. STATEMENT OF RUDOLF SMTTTNY, SENIOR PARTNER, SALOMON BROS. & HUTZLER Mr* SMUTKT. I would also like to say, Mr. Chairman, it is the first time in 38 years in Wall Street that I have been called an economist. My approach to the problems here under discussion is that of the bond dealer who specializes in the institutional investment market, of which United States Treasury obligations constitute so large a part. The unpegging of Government securities prices in March 1951, was long overdue. Pegged prices, being economically unsound, simply did not work. They destroyed the freedom of the market and made buyers and sellers largely dependent on the Federal Reserve banks. They encouraged some institutional investors to put short-term funds to work in the long-term market. They tended to lodge the initiative in the creation of reserve balances with the holders of Treasury securities, and, as a corollary, to deprive the Reserve authorities from UNITED STATES MONETARY „ POLICY 77 exercising their proper influence on the availability and cost of credit. I n the "pegged" market dealers were many times, for all practical purposes, merely messengers. At such times all market decisions rested with the Federal Reserve authorities. "Unpegging" the market restored its freedom of action, and broadened the scope of trading activity. I t seems to me that debt management and credit control policies during the past 2 years have, on the whole, been sound, My only criticism is that, during the transition period in the early part of 1953, the Government bond market was left without even interim token support from the monetary authorities. Moreover, and more important, it was needlessly subjected to many utterances regarding future financing policy which tended to upset market stability. I t seems evident, too, that the price decline in Government securities at that time was sharper than was waiTanted by supply-and-demand factors. For example, during the period January-May 1953 Treasury 2% percents ot\19G7-72 declined by 5.8 percent while high-grade corporate bond prices decreased by about 4.875 percent. The sharp break in prices of Government obligations naturally had an unsettling effect on the entire money and capital market. Fortunately the situation was soon rectified, and from mid-1953 to the present time, the debt management policies of the Treasury and the credit policies of the Federal Reserve have been handled with consummate skill. They have been geared to assist the money and capital markets and to help direct the flow of capital into corporate securities and mortgages so that corporate capital expenditures, and business and residential construction might be stimulated. While the supply of Government securities is very large, the present demand for long-term Government bonds is not impressive. There is, however, a very strong demand for short-term Government obligations with maturities of not more than 1 year. This is illustrated by the fact that from the beginning of 1954 through the first week in November, 40 major life-insurance companies, the leading institutional investors, purchased United States Treasury bonds to the extent of $360 million, which figure came to only 3.5 percent of their total investments of $10.5 billion. On the other hand, they acquired bills and certificates of indebtedness to an amount of $2,132 million, or 20.3 percent of the total. The incidence of greatest demand, therefore, is in the short-term, market, and a major sector of that market, United States Treasury bills, in the chosen medium in which the Open Market Committee operates to influence the reserves of the member banks, a factor which, from time to time, greately intensifies demand-supply ratios in this short-term area. So long as the economy is as active as it is today, and building construction continues at a high level, it is doubtful whether institutions, other than banks, will be large investors in long-term Government bonds. Rather, they will endeavor, as in the immediate past, to acquire high-grade bonds and mortgages which afford a better return than that obtainable on United States Government obligations. The fact that, early in 1953, Government bonds decreased considerably in price and that their marketability was materially reduced has also lessened their popularity to some extent. 65314—54 6 78 UNITED STATES MONETARY POLICY However, I believe we should not overlook even a minor opportunity for issuing long-term bonds and lengthening the average maturity of the Federal debt. We know that many smaller institutional investors, such as public and private pension funds, and a wide variety of local governmental and labor-union funds are always in the market for offerings of the highest yielding marketable Treasury security, regardless of maturity. Over the period of time under discussion a moderate amount of long-term bonds could have been placed with such relatively small institutional buyers. And, I think, that had public offerings of even lesser amounts of long bonds been made they would undoubtedly have served to cushion the pronounced price markup in the general bond market which has since occurred as a result of the actions of the monetary authorities. Xow I should like to turn to the problem of reserve balances and Open Market Committee operations. The reserve balances of the commercial banks are the basis of our credit system. The most important factors which increase or reduce reserve balances and thus expand or contract credit are: Changes in reserve requirements by the Federal Reserve Board, borrowing by the member banks from the Federal Reserve, and open-market operations by the Federal Reserve banks. Right now, I believe, open-market operations ought to be reexamined in the light of recent experience. As previously indicated the Federal Reserve banks in conducting open-market operations now deal exclusively in Treasury bills. Now the bill market is one of the most important segments of the money market. Through it financial institutions and industrial corporations provide for their liquidity. Banks must, of necessity, keep a large volume of bills on hand in order to cope with their daily cash swings. Many corporations keep their tax accruals in bills and use them to maintain their liquid assets. As a result of this pressing financial need for short-term paper there is a large and constant demand for Treasury bills. Hence, when the Federal Reserve conducts openmarket operations in the bill market it can have a pronounced effect on yields. This reliance on bills as the sole vehicle for open-market operations is doubtless due to respect for the traditional Anglo-American central banking practice of operating exclusively in "the nearest thing to money' ; also, perhaps to a fear of even seeming to sponsor anything remotely reserhbling the discarded "pegs." However, under present circumstances open-market operations do not appear fully to be achieving the desired objectives. The volume of bank loans has consistently lagged, and the level of bank rates has remained unchanged. Many corporations have cut down on bank loans and built up their emissions, of short-term paper. Therefore, wThen "the nearest thing to money" is in persistent and relatively short supply, and when openmarket operations in bills in pursuit of a policy of "active ease" have merely resulted in declines in bill and commercial paper yields while leaving the volume of loans unchanged, it may be surmised that something more than operating in the bill market is needed. UNITED STATES MONETARY POLICY 79 An arbitrary increase in the supply of bills is not the answer. I think, rather, that it is to be sought in widening the scope of openmarket operations to include securities other than Treasury bills. To this end the Federal Reserve should use its authority to buy and sell in the open market Treasury obligations with maturities, in the first instance, of up to 1 year, and should this prove ineffective, after suitable trial, then be authorized to operate up to 3 years. After all, the amount of Treasury securities due within 1 year, other than bills, is far larger than the entire Federal Reserve portfolio of Treasury securities. I do not believe such a liberalization of open-market operations would do violence to the traditional central banking practice of operating solely in "the nearest thing to money." At the same time it would reduce undue pressure on the bill rate. I think we must all concede that, thus far, the policy of "active ease" has had a much more pronounced effect on the level of bond prices and the yields on short-term paper than it has had on the volume of commercial loans and the level of bank rates. I do not believe that the modest increase in the area of open-market operations here proposed would have any significant effect whatever on the long-term Government market. Certainly it could hardly be construed as a return to the unsound practice of pegging the prices of long-term bonds. I would like to comment on just one more point, which, while not covered in the questionnaire, is, nevertheless, germane to this discussion. All of us—businessmen, bankers, economists, and public officials—have our jobs to do. We are all concerned, of course, with the overall well-being of the national economy. However, those of us engaged in the rugged competition of private enterprise have to think first of making a living and keeping solvent. We have to keep our eyes on the main objective, and, it must be confessed, the national economy is apt to become a rather remote concern. This is only natural. Nevertheless, I think we would all agree that concern for the well-being of the national economy is not the job of our public officials alone. Our own actions, therefore, ought, at all times, to take into account the public interest in our activities. I t is now amply evident, for example, that committing short-term funds in the long-term Government market did not, in the long run, serve the best interests of all concerned. Turning to more recent events, it now seems apparent that raising the prime rate at a time when conditions in the bond market were extremely critical was not the wisest course of action. I am proud to recall that, at that time, when Treasury 3*4 percents of 1938-78 fell to a discount while still "when issued," we at Salomon Bros. & Hutzler, and many other investment firms as well, ran advertisements in nationally circulated newspapers unequivocally recommending their purchase. The lesson in recent financial history is clear for all to see. The job of managing the national economy is not solely that of the monetary authorities. I t is our job, too. .To do it well we must learn to practice the art of financial statesmanship and to conduct our private activities within the moral as well as the legal boundaries set by our public responsibilities. 80 UNITED STATES MONETARY POLICY (The tables and advertisement referred to in Mr. Smutny's statement follow:) TABLE I.—Life-insurance company investments (based on reports from 40 major companies) Year 1954 through week ended Nov. 6 Mortgage loans: Farm loans —,... Loans on dwellings and business property... Real estate: Real estate acquired for investment Railroad securities: Bonds Stocks Public utilities: Bonds ... Stocks... Industrials: Bonds «. * Stocks Governments: U. S. Treasury bonds U. S. Treasury bills V. S. Treasury certificates XT. S. Treasury notes Canadian Government bonds., Other foreign governments State, county, municipal Miscellaneous: Bonds Stocks.— $274,689,200 3,370,030, 554 117,897,175 - —— 2.6 32.1 1.1 235,625,813 11,612,312 Total Recapitulation: Mortgages Real estate Bonds... Stocks Percent of total — Total 861,345,066 220,103,326 8.2 2.1 l,733r065,752 86,980,818 16.5 .8 361,662,104 2,065,136,032 67,097,253 62,545,477 108,572,375 16,162,554 432,825,176 .3.5 19.7 .6 .6 1.0 .2 4.1 458,338,238 25,571,199 4.4 .2 10,509,350,424 100.0 3,644,719,754 117,897,175 6,402,375,840 344,357,655 34.7 1.1 60.93.3 10,509,350,424 100.0 TABLE II.—Market yield on Treasury bills percent per annum 1953 January. . . „ . . . . . — - • - - - — - - - » - - - - - - . 1.96 1.97 2.01 April - . . . . . . _ . . - . . . • . . - . - - . - - - - - 2.19 2.16 2.11 1953 1954 J 1 July 2.04 2.04 1.79 1.38 .'. 1.44 1.60 1.18 j . 9 7 1 August.... September 1.03 October...i .96 November .76 December.. .64 1954 .72 .92 1.01 .98 TABLE III.—Interest-bearing marketable public debt of the V. S. Govei*nment of selected maturities (as of Dec. 15,1954—000,000) Up to 1 year inclusive of Dec. 15,1955 (excludes Treasury bills .Treasury bills) Percent Treasury bills Certificates of Indebtedness Treasury notes Treasury bonds Total $28,382 12,218 a 2,611 65.7 2? 3 6.0 43,211 100.0 $19,509 1 to 3 years Percent 100.0 Percent »$10,063 * 7,176 19,509 100.0 3 to 5 years 17,239 Percent 58.4 $5,728 41.6 »16,271 100.0 1 to 5 years 21,999 Percent" 26.0 1 $15,791 74.0 «23,447 100.0 39,238 40.2 59.8 100.0 1 Includes4 issues of IH percent notes amounting to $2,911,000,000 of which the Federal Reserve System owns all but about $200,000,000 thereof. 3 Includes all Treasury bonds with afirstredemption date within this period. 81 UNITED STATES MONETARY POLICY Holdings of U. 8. Government securities, including guaranteed securities, of the Federal Reserve banks (as of Nov. 2//, 195J>—000,000) Amount L'p to I vear 1 to b years 5 vears and over... * . . .. Total Percent $15,804 6,321 2,428 64.4 25.7 9.9 24r553 100.0 [This advertisement appeared in the New York Times, New York Herald Tribune, the Wall Street Journal, and the New York World-Telegram and Sun on April 20, 1953] UNITED STATES TREASURY S ^ - P E R C E N T BONDS, DUE J U N E 15, 1083 (noncallable prior to June 15, 1978) We consider these Bonds most attractive for all investors where the maturity meets their requirements. We recommend that holders of Series F and G United States Savings Bonds, maturing this year, exchange them for the new United States Treasury 3*4Pereent Bonds. This exchange privilege expires April 30,1953. SALOMON BROS. & HUTZLER Members New York Stock Exchange SIXTY WALL STREET, NEW YORK 5 , N . Y. Boston; Cleveland; Chicago; San'Francisco Mr. SMUTNY. Mr. Chairman, I would like to request that my detailed answers to the eight questions be made a permanent part of the record. Senator FLANDERS. Thsnk you, sir. (The answers previously referred to follow:) ANSWERS BY RUDOLF SMUTNY, SENIOR PARTNER, SALOMON BROS. & HUTZLER, TO THE QUESTIONS PROPOUNDED BY THE SUBCOMMITTEE ON ECONOMIC STABILIZATION OF THE JOINT COMMITTEE ON THE ECONOMIC REPORT OF THE CONGRESS OF THE UNITED STATES 1. W h a t ' r o l e did monetary policy play in the period of relative stability following the Treasury-Federal Reserve accord in 1051, in the months of boom late in 1952 and early in 1953, and in the recession of 1953-54? Answer: The 1951 accord between the Treasury and the Federal Reserve System paved the way for the effective employment of monetary policy, first, to combat the threat of further inflation; second, to promote economic stability; and third, to head off unduly deflationary tendencies in the economy. Pegged prices for Government bonds had a number of undesirable effects. They encouraged commitment of short-term funds in the long-term market. They promoted monetization of long-term debt, thus adding to inflationary trends. They tended to lodge the initiative in the creation of reserve balances with the holders of Treasury obligations rather than with the Federal Reserve authorities. They helped to make economic policy unwarrantedly subservient to Treasury finance. T h e y deprived the market of freedom of action. At the time of the accord we were still in a shooting war in Korea, and our -economy was under severe pressure. Not only was there a considerable demand for goods and manpower on the part of the Federal Government for building up the Nation's defenses, but there was also a strong demand for capital and labor from the private sector of the economy to meet civilian requirements as •well as to construct defense plants. After the outbreak of the Korean war ^wholesale prices rose by 17 percent from June 1950 to March 1951. For a few months following the accord the Federal Reserve policy continued t o be one of restraint. Thereafter, however, the policy might'be termed one of 82 UNITED STATES MONETARY POLICY neutrality, since the authorities realized that to restrict the availability of bank credit might interfere with defense efforts. Approximately the same policy was followed by the Federal Reserve during 1952. Toward the end of 1952, and particularly m the early part of 1953, the policies of the Reserve authorities underwent a considerable change. The policy of neutrality was again changed to one of restraint. In January 1953 the discount rate was raised from 1% to 2 percent, the first change in nearly 2% years. Member-bank indebtedness increased from a general level of under $500 million in the first half of 1952 to over a billion dollars in the second half of 1952 and the first few months of 1953. These changes were accompanied by a considerable increase in money rates and a correspondingly sharp decline in prices of Government securities. The Treasury bill rate on new issues rose from 1.78 percent in October to 2.13 percent in December and 2.23 percent in June 1953. The price of the 2%-percent Victory bonds witnessed a decline of 5.8 percent from the end of 1952 to the begining of June 1953, one of the sharpest drops on record. The credit policy followed by the Federal Reserve also led to a decline in the availability of bank credit. As the member banks became more heavily indebted to the Reserve banks, they became more hesitant to extend credit. Coupled with aggressive borrowing by the Treasury in active competition with private borrowers, this had a decided effect on the capital market. Rates of interest on mortgages increased. FHA-insured mortgages sold at substantial discounts and the flow of capital into private securities and mortgages was reduced. While it is my opinion that the Federal Reserve authorities and the Treasury went perhaps a little too far and too fast in restraining credit expansion, their objectives were achieved. The forces of inflation were brought to a halt by the middle of 1953. This experience seems to demonstrate that if interest rates go high enough, and portfolio depreciation in financial institutions becomes sufficiently severe, inflationary booms can be halted. When the Federal Reserve and the Treasury realized that the inflationary forces had run their course and that some deflationary pressures were becoming apparent, their policies were quickly changed. Member bank reserve requirements were lowered in July 1953 and again a year later. Open-market purchases were carried out on a large scale, with the result that holdings of Government securities of the Federal Reserve banks increased by over $2 billion from April to December 1953. Excess reserves increased by $333 million from the end of April 1953 to the end of April 1054 and by $656 million to the end of September. Prices of Government obligations, long term as well as short term, increased considerably. The Treasury restricted its borrowing and refunding operations to securities which did not compete with private borrowers, and hence stimulated the flow of funds into the building industry and capital investments by corporations. While, of course, other factors and governmental measures also played an important role, the changed credit- and debt-management policies of the Reserve authorities and the Treasury contributed materially to the fact that the readjustment, despite the decline of $4.6 billion in national-security expenditures in fiscal 1954 and a reduction of $4 billion in business inventories in 1 year, did not go very far. The index of industrial production decreased by 10 percent from its peak in July 1953 to the lowest point reached in 1954. Unemployment did not exceed 3,725,000. Commoditv prices, on the whole, remained stable and disposable personal income actually increased. The credit policies of the Reserve authorities and the debt-management policy of the Treasury, from the middle of 1953 to the present time, have been skillfully handled. Reserve requirement changes have been used sparingly and banks have been encouraged to use their discount privileges freely. In so doing they have apparently been brought into direct touch with Federal Reserve thinking concerning general economic conditions and the banking policy appropriate to such conditions. If any criticism is to be made, it is that the change in policy in 1953 might have taken place a month or two earlier, and that some intervention by the monetary authorities in the Government bond market would have prevented such a drastic decline as took place. * 2. How has the emphasis in the use of monetary instruments changed during the period since mid-1952? For example, how have the various instruments— open market operations, discount rates, and administration of discount operations, and reserve requirements—been used under varying conditions? Has there been any reliance on moral suasion during this period? Answer. AH the credit instruments at the disposal of the Reserve authorities have been used during the period since mid-1952. However, increasing use has been made of the discount mechanism, while open-market operations have been UNITED STATES MONETARY POLICY 83 used less actively. Similarly, changes in Reserve requirements were used only to supplement the policy of ease in 1953 and 1954. In the early part of 1953, when inflationary pressures were rather strong, the Federal Reserve followed a policy of restraint. I t made net sales of $900 million of Government securities in the first 3 months and raised the discount rate to 2 percent. During this period, considerable reliance was placed on moral suasion. Various utterances were made by high officials of the Federal Reserve System and the Treasury, all of which tended to depress the Government bond market and to curb the willingness of the banks to extend credit. In my opinion, the moral suasion, if anything, went too far, and at times did more harm than good. If any lesson is to be learned from the experience of the early part of 1953, it is that the Federal Reserve and the Treasury should rely more on action and less on pronouncements. The actions can be* studied and their consequences ascertained. The utterances are at times enigmatic in character and may be—and often are—misinterpreted. The moment the inflationary pressures began to disappear and signs of an economic decline set in, the credit and debt management policies of the authorities underwent a considerable change. Reserve requirements were lowered in July 1953 and also in June-August 1954. The Reserve banks began to buy large amounts of Treasury bills in the open market, thereby enabling the member banks not only to repay their indebtedness to the Reserve banks but also to increase their excess reserves materially. Since the middle of 1953 the policies of the Reserve authorities and of the Treasury have been handled with skill, and both have contributed materially to the stability of the economy. 3. What is the practical significance of shifting policy emphasis from the view of maintaining orderly conditions to the view of correcting disorderly situations in the security market? What were the considerations leading the Open Market Committee to confine its oi>erations to the short end of the market (not including correction of disorderly markets) ? What has been the experience with operations under this decision? Answer: So long as the policy of the Reserve authorities was to maintain orderly conditions in the Government bond market, dealers and investors more or less knew what actions to anticipate on the part of the Federal Reserve. So far, nobody in authority has described what the term "correcting disorderly situations" means. The fact of the matter is that the Reserve banks have not intervened in the market for quite some time. Even in the first half of 1953, when prices of Government bonds declined sharply and their marketability was materially reduced, the.authorities did not find it advisable to intervene. Apparently, they did not consider the Government bond market disorderly at that time. I t would be helpful if some explanation were to be forthcoming from the monetary authorities as to what comprises a disorderly situation in the bond market. Although the Federal Reserve Board in its annual reports makes public the deliberations of the Open Market Committee, it is extremely difficult for an outsider to analyze the considerations which led the Committee to confine its operations to the short end of the market. This answer can best be given by those responsible for the decision. The exj>erience wTith operations under this decision, in my opinion, has not been entirely satisfactory. As I stated in my opening statement to the committee,, the policy of the Federal Open Market Committee of operating only in Treasury bills has caused bills to fluctuate widely at times, and has induced corporations to turn more to the commercial paper market than formerly, which has not helped to increase the volume of loans. Because the bill rate has fluctuated so extensively, bills have become a less desirable investment instrument for corporations, institutional, investors and banks. This has also tended to reduce the earnings of the commercial banks. While it is evident that Federal Reserve policy should not concern itself with earnings of member banks, it must be borne in mind that the cost of doing business for banks has increased considerably and that a sound banking system is essential to the Nation's economy. The large commercial banks, in particular, play an important role in the money and capital markets. The operations in bills imply that consideration about total bank reserves is sufficient; if does not recognize that such open-market operations have a magnified impact initially on a limited number of the (larger) banks, particularly those in New York City. Geographical differences are ignored, as well as differences between bank and nonbank buyers and sellers. Since, in my opinion; the experience with Federal Reserve open-market operations confined exclusively to Treasury bills has not been satisfactory, I believe that the Federal Open Market Committee should be given the power to operate in all 84 UNITED STATES MONETARY POLICf Treasury obligations with, in the first instance, a maturity up to 1 year and then, if need be, up to 3 years. This would have a stabilizing effect not only on Treasury bills but also on the entire financial m a r k e t It would enable the Reserve banks to assist the Treasury more effectively, if necessary, in its refunding and borrowing operations. 4. What is the policy with respect to the volume of money? Answer: As far as I can judge, from the point of view of an investment house actively engaged in the money and capital markets, the supply of money is ample. Since the middle of 1953, the Reserve authorities have followed a consistent policy of providing the member banks with adequate reserves to enable them to meet all the legitimate requirements of industry and trade and the Government. Money rates, on the whole, are easy. With the exception of fluctuations brought about, by the flow of funds and the movement of gold and currency, money rates have been relatively low and have stimulated the flotation of a large volume of tax-exempt securities, as well as the sale of mortgages. 5. Has monetary machinery (a) worked flexibly, and (6) has the market demonstrated flexibility in its responses to changes in policy? For example, how has the policy of active ease been reflected in the level and structure of interest rates, the volume of credit, and the roles of various types of lenders? Answer: The policies of the Reserve authorities and the Treasury have been highly* flexible. During the first few months after the accord, and f^a'n in the latter part of 1952 and the first half of 1953, measures were taken to tig.'iten the money market and to reduce the availability of bank credit. These measures were reflected fairly promptly in the movement of interest rates, as may be seen from the following figures. Movement of money rates and bond yields, January J951-^1une 1953 [Percent] Treasury bills (now Issues) 1951—January, April... July.... October. 1952—January. April... July.... October. 19.13—January, April... May.... June..*. 1.39 1.52 1.59 1.61 1.69 1.62 1.82 1.78 2,04 2.18 2.20 2.23 Prime Long-term commercial Government's paper (4*6 months) 1.80 2.13 2.31 2.21 2.38 2.35 2.31 2.31 2.31 2.44 2.68 2.75 2.39 2.56 2.63 2.61 2.74 2.64 2.61 2.74 2.80 2.97 3.09 3.09 During the middle of 1953, the policies underwent a change and were directed toward easing the money market. The lowering of reserve requirements and Federal Reserve open-market purchases increased materially the volume of excess reserves. Money rates went down, as may be seen from the following figures: Movement of money rates and bond yields, June 1958-October 1954 [Percent! Treasury bills (new-issues) 1953—June August......... December 1954—January.-March.. . . - July September..October ... - . * 2.23 2.09 1.40 1.63 1.21 1.05 .78 .71 1.011.03 Prime LonR-term commercial Government's paper (2H's) (4-6 months) 2.75 2.75 2. 55 2.25 2.13 2.00 1.59 1.43 1.31 1.31 3.09 3.00 2.83 2.79 2.68 2.51 2.52 2.47 2.51 2.52 UNITED STATES MONETARY POLICY 85 Lower interest rates and increased availability of bank credit, as well as the changed debt-management policy of the Treasury, have had a favorable effect on the capital market. The volume of securities offered, particularly tax-exempts, has increased considerably, the: mortgage market has improved, and lower interest rates on mortgages have helped to stimulate building activity. G. Has the debt-management policy of the Treasury—both as to objectives and techniques—been consistent with the monetary policy of the Federal Reserve throughout the period since mid-1952? Answer: The debt-management policy of the Treasury has been closely coordinated with the policies of the Reserve authorities. For example, when the policy was one of restraint, the Treasury cooperated by floating longer term issues (to mid-1953). Later, when active ease was desired, the Treasury shortened its new issues and made them more attractive to banks, thus aiding an increase in the money supply. The use of tax-anticipation series reduced the impact of seasonal changes in tax receipts on the money market. Up to the middle of 1953 both were endeavoring, to the best of their ability, to tighten money. Since the middle of 1953 the policies of both have been geared to make money easy and to stimulate the flow of capital into corporate securities and mortgages. The cooperation between the Treasury and the Reserve authorities seems to have been carefully thought out and well handled. However, I do think greater boldness in the issuance of long-term bonds, such as the Treasury 3%s, might well have been consistently undertaken. As a general thing, whenever a change in any matter of policy is contemplated, there is always a temptation to avoid action on the plea that "the time is not ripe." Since the end of the war there have been several periods during which truly long-term Treasury bonds could have been issued. Even during the period of time since mid-1953 the Treasury could, at each financing period, have offered a basket of issues which included, in each instance, a long-term bond whose dollar amount could have been left to the discretion of the market place. Doubtless there would have been very little interest in such a long bond on the part of commercial banks, savings banks, and insurance companies. But pension funds, both public and private, and a wide variety of local governmental and labor-union funds are always in the market for offerings of the highest yielding marketable Treasury security, regardless of maturity, and it is conceivable that, over a period of time, a moderately large amount of long-term bonds could thus have been marketed. In addition, if such offerings had been made, a psychological check on the pronounced markup in the general level of bond prices which has since occurred would have been set. Violent swings in the bond market are not beneficial to overall economic stability and impose, besides, undesirable burdens on the long-term institutional investor. 7. What considerations should dictate the maturity distribution schedule of the Federal debt—first, as to the long-run ideal to be pursued; and, second, as a practical operating matter—giving weight to timing and contemporary conditions? Answer:. The long-run ideal in maturity distribution of the Federal debt would be, briefly,- as follows: To have an adequate amount of bills and certificates outstanding to meet the liquidity requirements of the economy; to have an adequate amount of Government obligations with a maturity of 1 to 10 years to meet the needs of investors who desire to space their maturities; and, finally, to have a considerable amount of long-term securities primarily in the hands of ultimate investors, such as individuals, corporations, pension funds, and insurance companies. Because the Federal debt was increased so rapidl> during the war, the existing maturity distribution leaves a great deal to be desired. Debt management is a very complicated affair, however, and has to be handled with extreme carj. The problem should not be approached with preconceived notions or the desire to establish ideal conditions within a short time. Debt management has an important effect on the flow of capital into corporate securities as well as into mortgages. The supply of capital is limited to the savings of the people, unless, of course, it is desired to monetize the debt, which is unsound and leads to inflation. Since the Federal debt is very large and the amount of marketable securities coming due within 1 year totals about $00 billion, it is evident that if the Treasury were willing to pay a high enough rate of interest it could preempt all the savings of the Nation. Obviously, such a policy would be undesirable and unsound. The debt-management policy must be tailored to prevailing economic condiditions. In periods when industry is not operating at capacity and there is more than normal unemployment, the Treasury in its refunding operations should not 86 UNITED STATES MONETARY POLICY compete with other borrowers for long-term funds. It should leave the capital market to private borrowers and political subdivisions. When private borrowers, such as industrial corporations, home builders, and the construction industry in general, borrow money, they use it for purposes which stimulate the economy, Tlie same is true of borrowing by States and local governments for public works. When the Treasury, on the other hand, refunds matured or called obligations into long-term bonds, it merely mops up thai- amount of capital without favorably influencing the economy. The short-term money market is usually the cheapest and most easily accessible source of funds. In principle, as far as the public debt is concerned, it would be desirable to keep it free for emergency needs, and for the execution of depression fighting financial strategy, as, for example, when the Federal budget is deliberately unbalanced in an effort to maintain or to stimulate economic activity. Under existing conditions it would seem advisable for the Treasury to offer some long-term bonds as previously indicated. That is, a moderate amount to meet the requirements of State pension funds, labor-union funds, and smaller institutional investors, whose investments consist largely of Government securities. At present, private investors, and especially institutional investors, are more interested in .obtaining a higher yield than prevails on Government securities, or. in buying'tax-exempt obligations. The debt-management policy of the Treasury, particularly as regards efforts to lengthen maturities and to reduce the volume of the floating debt, must therefore be handled with great care and must be based on existing conditions and not on preconceived theories. 8. Are the benefits and costs to commercial banks of handling Government transactions clear enough, or can they be made clearer, to determine whether or not the banking system is being excessively compensated or undercompensated? What about the Treasury cash balance—its size and management? Should the Government receive interest on its deposits with commercial banks? Answer: It is difficult for a noncommercial banker to make an authoritative statement as to whether the banking system is being excessively compensated or undercompensated. It seems clear, however, that the banks are rendering many services to the Treasury for which they are not being compensated. I might mention, for example, the handling of E, F, G, and H bonds, which involves a great deal of labor and which the banks are cheerfully doing as a patriotic duty. Also, the banks have been in the forefront in most bond drives and have otherwise rendered valuable services to the-Treasury. In view of the magnitude of the Federal budget, the Treasury should have a working balance of about $5 billion in order to be in a comfortable position. A large cash balance can be used to assist monetary policy. For example, it can ease the strain of heavy tax payments. Or, its manipulation can reenforce a contraction, for example, by shifting idle balances from commercial banks to the Federal Reserve. If there is a temporary monetary stringency, a large cash balance would enable the Treasury to postpone new financing until conditions impnn-ed. It would not be advisable for the commercial banks to pay interest to the Government on its deposits. I5y the Banking Act of 1033 the commercial banks were prohibited fn>m paying interest on demand deposits. This was done in order to avoid keen competition for deposits among the banks through the payment of higher and higher interest rates, which past experience indicated had had an adverse effect on banking policies and bank lending and investing activities. Tt would ?K> unfortunate, indeed, if legislation were to be passed to enable the Treasury to obtain Interest on demand deposits. This might lead to a renewal of the unsound practices which existed prior to 1933. In view of the large number of services rendered by the commercial banks to the Treasury, the insistence that the banks pay* interest on Government deposits would undoubtedly have an adverse effect on their relationship. There are other arguments opposing interest on deposits: One is that of favoritism, that the Government would be given better treatment than other demand depositors. Second, a cost-minded Treasury might be tempted to kee;> a maximum of funds with the bank to earn the interest, drawiner them out just after payment days, instead of gradually as required. This would make for wide swimrs in bank reserves, especially at interest-payment days. And, at the same time, fi>e banks' costs will have risen, since its interest payments to depositors (the Government) will be higher. In my opinion, therefore, it would be unsound for the Treasury to require that it be paid interest on its deposits with the commercial banks. UNITED STATES MONETARY POLICY 87 Senator FLANDEKS. Our next witness—I may say that all of you have cooperated in making your brief presentations. Our next witness is Mr. Wilde, Frazar B. Wilde, president of the Connecticut General Life Insurance Co. I am interested to note, Mr. Wilde, that you are in a present office or position which I once held myself, as Chairman of the Research and Policy Committee of the Committee for Economic Development. STATEMENT OF FRAZAR B. WILDE, PRESIDENT, CONNECTICUT GENERAL LIFE INSURANCE CO., AND CHAIRMAN, RESEARCH AND POLICY COMMITTEE, COMMITTEE FOR ECONOMIC DEVELOPMENT Mr. WILDE. Mr. Chairman, I feel honored to try to be in your position, .because I am not an economist, and I do not think that the work of our complicated civilization which we are now trying to run, is such that any one of us has enough knowledge to carry out on our own, so with the committee's permission I wish to make a brief statement with respect to this paper. I have tried to make the following points: First, that a flexible monetary policy is useful and constructive and is within the general interest if it is operated by a central bank, and that bank is free to use its individual judgment. I have said that I believe that a flexible monetary policy helps, and it has always helped in fighting inflation, and it'can function in restraining unhealtlvy moves. I t has an equally valuable positive function in that it enables ah increase of the money supply in proportion to legitimate growth demands of industry, trade, and commerce. I t is ni3r opinion that the Nation could use a flexible monetary policy as an important instrument in contributing to our objectives of growth and..high levels of employment without inflation, but this does not mean that we should place our sole reliance on monetary policy. A given situation will require several measures, but a flexible monetary policy is important for at least three reasons. First, its timing is more flexible. This would contrast particularly with budget policy. Now, I feel that budget policy is an important part of any program for the prevention of inflation as a deterrent to sound growth. But th#re are political and economic obstacles to excessive reliance on budget surpluses as a means of controlling inflation. Monetary policy is the most sensitive and flexible instrument, and I do not believe that an adequate anti-inflation program is possible without it. Second, as compared with direct controls or with selective measures, monetary policy has the merit of bein<* a general, overall, impersonal instrument and, as a matter of fact, direct controls are not likely to be available except and save in time of war, and I think are an inferior instrument, even if they were available, and I do not understand the confidence that some of our panel members have if our country would permit select measures or direct controls, if they were to have this good instrument. Thirdly, I believe that our recent experience with a flexible, twosided monetary policy has been most encouraging and justifies its continuation; and I think we have demonstrated that monetary policy 88 UNITED STATES MONETARY POLICY can be of assistance in the development of a healthy boom, and without developing serious consequences.. In my opinion, the most important consequences of a flexible monetary policy are its effects upon the stability and growth of the economy. Monetary policy should not only attempt to counter the short-term inflationary and deflationary movements, but should gear the money supply to our long-run growth potential; and, I believe, therefore, that the policy should be judged in terms of these important effects and not in terms of who gets or who pays higher or lower interest rates. As a matter of fact, it is exceedingly hard to trace the income distribution effects of a rise of interest rates and to make any judgment as to the desirability of these effects. There are a number of reasons for it. First, the initial payers or receivers of interest are, for the most part, not the.ultimate payers or receivers. The large financial institutions which receive interest as payments represent millions of depositors and policyholders; in other words, we' are dealing with literally millions of people who are both debtors and creditors at the same time, which is a relatively new economic development in this country. On the other hand, corporations and governments which pay interest represent millions of customers and taxpayers. You cannot trace and be dogmatic about who receives and \vho pays. Xow ; secondly, the alternative to higher interest rates is not simply lower interest rates, but lower interest rates on a larger volume of credit. Interest rates are kept from rising when demand is active by an expansion of the volume of credit. I t is not clear that financial institutions would earn more from higher rates than from lower rates on a larger volume. I make that point because there is an apparent belief on the part of some students that institutions are always narrowly and selfishly concerned with high rates as being more profitable. That is not necessarily true. Third, along^ with higher interest rates usually go losses on capital accounts, that is, the market prices of investments decline. The net effect of this would vary for different investors. In general, the net distributional effects of higher or lower interest rates are so diffuse and uncertain that they could not be a major factor in deciding upon monetary policy. In my paper I have belabored inflation, urged that we should concentrate at all times on stability and upward growth instead of taking undue risks with inflation. Now, that may be a personal bias, but I am always alarmed at the relaxation of my friends, many of whom, perhaps, may be skillful enough to take temporary advantage of inflationary conditions, but I read the history of the world, and I look at countries like France, which have capable people, who have great national resources, and the continual inflation of a country like that is one of the major deterrents to its growth. I t cannot get capital for capital expansion which they need, when people have no confidence in the future value of the money. I may be biased because of the fact that my business sells money for future delivery, and to me it is a pretty wicked thing to consider the possibility that people will make present sacrifices for future protection, and then get dollars of much lower value. UNITED .STATES MONETARY POLICY 89 I am not talking about this country going into an extreme inflation, but I am talking about the continuous erosion, deterioration that can happen if we adopt what to me might be reckless monetary and fiscal policies. I think it is quite unfair for large groups of the population, because it does lead to booms and busts of employment, with human suffering and money losses, which unemployment causes, and I am quite unable to be relaxed and optimistic about expansion with mild inflation as being a sound and safe thing to do. I have developed the theme that the difficulty with providing flexible monetary policy is because there is quite a lack of public understanding of how it is and how it can best function. The history of the last few years to me is evidence of the great use of monetary policy and accompanying extensive criticisms. I t requires a combination of at least three major elements: Favorable, friendly, optimistic environment; sound, constructive fiscal policy; flexible, healthy monetary credit and debt management policy. These are the ultimates which in combination can lead to a steady growth which the country desires, and which we believe it can have. I do say that this growth should be upward progressively; it cannot be in a straight line without any fluctuation. I t will go above a straight line of growth and progress, and we will dip below it if we are going to have a free society, and I do not want to have a society that is entirely regulated and planned, because I do not think it is either good judgment or in the American spirit. That is the end of my remarks. (The prepared statement of Frazar B. Wilde is as follows:) FLEXIBLE MONETARY POLICY AND INFLATION—STATEMENT SUBMITTED BY FRAZAR B. WILDE, PRESIDENT, CONNECTICUT GENERAL L I F E INSURANCE CO., HARTFORD, CONN., AND CHAIRMAN, RESEARCH AND POLICY COMMITTEE, COMMITTEE FOR ECONOMIC DEVELOPMENT My name is Frazar B. Wilde. I am president of Connecticut General Life Insurance Co., Hartford, Conn. The views expressed in this testimony are my own', and are based on some 20 years of experience in the management of an insurance company portfolio as well as a bank trustee. In addition to my business experience I have been for some years active in the work of the Committee for Economic Development, a nonprofit organization of businessmen conducting research on economic problems. Currently I am chairman of the research and policy committee of the CED. I have distributed to the members of your subcommittee copies of two policy statements that our committee has issued on the subjects of the present hearing. I do want to make it clear, however, that I am appearing today, in response to your invitation, as an individual and not attempting to register the considered current position of CED, which can only be done through its formal papers. A central bank which recognizes its responsibility to contribute to economic stability and growth, and carries out its duty by following a flexible monetary policy, is bound to be unpopular. Many of the reasons for this are unrelated to the merits of a flexible policy as such. This is the climate in which any inquiry into central banking operations is inevitably conducted. If any useful results are to come out of such an inquiry, we must at the outset take this climate into consideration. The principal reasons for this unpopularity are obvious, and yet are constantly forgotten by the critics. The most important of these arise out of the occasional need for restraining action on the part of a central bank. Even those who accept a flexible monetary policy in principle frequently object in practice, when restraint is the order of the day. Since people do not like to l»e restrained, and since they seldom agree on the correct timing and on the extent 90 UNITED STATES MONETARY POLICY of credit restriction, even though they accept the idea in theory, we find our monetary authorities generally in hot water. The sound direction of a flexible monetary policy is always handicapped and troubled by basic human emotional characteristics. The second reason arising out of the occasional need for restraint is that some do not believe in the use of a restraining monetary policy at any time. They question the effectiveness and the appropriateness of combating inflationary pressures by the use of general monetary and credit restraints and prefer other instruments. They feel that relatively low interest rates are appropriate under all conditions. A third reason for the underlying unpopularity of a central bank is that a large part of the public finds monetary matters difficult to understand and is either indifferent to or confused about them. At any rate, it is easily swayed by the propagandist, whether he is the businessman or the politician. A fourth reason is a historical tendency on the part of many groups in this country to distrust and to criticize banks and banking. By tradition, bankers are a convenient scapegoat. For all of these reasons it is difficult to make a rational evaluation of central banking operations. We should remember too that it is even more difficult, in such an atmosphere, for a central bank to carry out successfully a flexible monetary policy. Unfair and excessive criticism is never conducive to good administration. As a result, the central bank's imposition of restraint is in practice almost universally criticized and its expansion of the money supply, while more generally accepted, is often condemned as too little and too late. The unfortunate thing is that a good deal of such criticism comes from persons who believe implicitly in the theoretical virtues of a flexible monetary policy. Too often the practical result of these conflicts is an excessive reliance on easy money. I. THE UNPOPULARITY OF RESTRAINT *. 1 9 5 0 - 5 1 A striking illustration of this' principle—in terms of debt management as well as of central banking practices—appeared in the fall of 1050 and the early spring of 1951. By that time there was increasing criticism of the Treasury and Federal Reserve, who were collaborating at the insistence of the administration in maintaining pegged prices for Government bonds. While there was good reason to believe that the Federal Reserve, recognizing inflationary dangers, had wished to discontinue the practice at an earlier date, no important action had been taken up to the end of 1950. The majority of those who understood the crippling effect upon the Federal Reserve of maintaining a. pegged Government securities market were in agreement that this practice should be discontinued. The Federal Reserve has a major role in contributing to the maintenance of a sound and growing economy, and fixed prices for Government bonds, which might have been justified during wartime, were wholly unwarranted 5 years after the war. Those who believed that fixed prices should be maintained included several groups. There were those partisans who felt t h a t to change this policy was a direct criticism of the.administration. There were others who felt that low interest rates per se were desirable regardless of the actual and potential danger of inflation they created. Few, if any, who understood the true function of central banking and the need for freedom in operations, and certainly none who had respect for sound money, wanted the support program continued. At long last, in March of 1951, an accord was reached permitting flexibility in Government bond prices. This involved some retreat in prices. Immediately there was.a hue and cry, and it didn't all come from politicians. The purchaser of a marketable bond, whether an individual or an institution, must be willing to accept the fact that in a free, capitalistic economy, security prices are certain to fluctuate. When there has been a heavy demand for investment funds or bank loans relative to supply, interest rates are bound to increase and bond prices must reflect this situation, other things being equal, by going lower. * Many buyers of Government securities had forgotten that this fluctuation is normal. They had been spoiled by the abnormal wartime condition of pegged prices which had existed for a long time. They grew to think t h a t par and, in many cases, a premium over par was the natural price for their securities. This attitude is difficult to understand—in fact, quite incomprehensible—as to institutions whose buyers certainly know, or should know, the history of the market place. It is easier to understand in the case of individuals with little experience UNITED STATES MONETARY POLICY 91 in bond buying; but these, for the most part, were not the persons involved. The unsophisticated investor usually held E-bonds or some other nonmarketable security which did not fluctuate in price. Many seasoned investors were most vociferous, particularly after the end of the war, in contending that in a free economy fixed prices and price supports .should be abandoned everywhere. Then when the fixed price for bonds was withdrawn, some of these same people expressed dismay and unhappiness that it should happen to them and their institutions. The fact is that many people who should have supported a flexible monetary policy, even if it affected their own institutions, failed to do so. This episode is an excellent example of the way in which human nature tends to resist, even against the arguments of reason, any restraining pressure on the economy, I I . THE CASE FOR A FLEXIBLE MONETARY POLICY In my opinion the Nation should view a flexible monetary policy as a principal instrument for contributing to our objectives of economic growth and high levels of employment without inflation. This does not mean that we should place sole reliance upon monetary policy. Any given situation will require a complex of measures. But a flexible monetary policy is an important and especially valuable instrument in our-kit of tools for at least three reasons. First, its timing is more flexible. This is especially true as compared with budget policy. I would certainly agree that budget policy should be an important part of any program for the prevention of inflation. But there are political and economic obstacles to excessive reliance upon budget surpluses as a means of restraining inflation. Monetary policy is the most sensitive and flexible instrument and I do not believe that an adequate anti-inflation program is possible without it. Second, as compared with direct controls, or with selective measures, monetary policy has the.merit 6i being a general, overall, impersonal instrument. As a matter of fact, direct controls are not likely to be available except in wartime, and would be an inferior instrument even if available. Third, I believe that our recent experience with a flexible, two-sided monetary policy has been promising and warrants continuation. In my opinion the most important consequences of a flexible monetary policy are its effects upon the stability and growth of the economy. Monetary policy should not only attempt to counter the short-term inflationary and deflationary movements, but should gear the money supply to our long-run growth potential. I believe therefore that the policy should be judged in terms of these important effects and not in terms of who gets or who pays higher or lower interest rates. As a matter of fact, it is exceedingly hard to trace the income distribution effects of a rise of interest rates and to make any judgment as to the desirability of the effects. There are several reasons for this. First, the initial payers or receivers of interest are for the most part not the ultimate payers or receivers. The large financial institutions which receive interest represent millions of depositors and policyholders. On the other hand, the corporations and governments which pay interest represent millions of customers and taxpayers. We do not know who ultimately receives or who pays. Second, the alternative to higher interest rates is not simply lower interest rates, but lower interest rates on a larger'volume of credit. Interest rates are kept from rising when demand is active by an expansion of the volume of credit. It is not clear that financial institutions would earn more from higher rates than from lower rates on a larger volume. Third, along with higher interest rates usually go losses on capital accounts, that is, the market prices of investments decline. The net effect of this would vary for different investors. In general, the net distributional effects of higher or lower interest rates are so diffuse and uncertain that they could not be a major factor in deciding upon" monetary policy. I I I . A FLEXIBLE MONETARY POLICY I N PRACTICE How has a flexible monetary policy worked? Tne first 6 months of 1953 provide a spectacular illustration combining both the techniques of debt management and the operations of our central banking system. As many read the signs, the economy was giving definite evidence of boom in the closing months of 1952 and early spring of 1953. The demand for funds capital and for inventory accumulation was sharply accelerated. Digitizedfor forpermanent FRASER 92 UNITED STATES MONETARY POLICY Demand for residential and commercial mortgage funds, for municipal funds, and for consumer credit was pyramiding. The situation required the central banking authorities to refrain from adding to the credit supply. Their duty was clear. If boom and bust was to be avoided or mitigated through banking procedures, this was a time to let the borrowers compete for whatever credit was in existence, rather than to expand credit, no matter how vociferous the demand. Some would have said that sharp restrictions of credit were in order. The authorities lived up to their responsibilities. They restrained expansion of the credit base and, because the demand was far greater than current resources, money and credit became scarce, and interest rates increased as a matter of course. During this period, in furtherance of sound debt management policy—namely to lengthen the debt—the Treasury offered a long-term obligation. In order to assure the success of this issue, it was necessary because of market conditions to place a 3*4 percent coupon on the bond. In April and May, and running into June, the demands for capital and credit increased. Potential borrowers tended to stampede the capital market and interest rates increased sharply. Many borrowers who really didn't need funds a t the moment sought money or credit lines immediately, probably in expectation of higher interest, rates to come. A psychological situation developed which was perhaps the more acute because the issue of a long-term bond coupled with a restraining monetary policy had not been encountered in the market place for many years. The Federal Reserve quietly made bank reserves more readily available in May, and the clear-cut realization by the market in June t h a t monetary policy was not a one-way street—that it indeed was flexible—brought the stampede to a halt. The impact of this episode on production, trade, and commerce was slight. There was enough money available for current use in trade and commerce and for the payment of construction bills. Some demands for future funds, it is true, were not met a t the time. I t was not imperative that they should be, and no serious damage resulted to the country as a whole. The postponement of new building because a commitment could not be obtained was not serious. A new housing development or a new factory was merely postponed. This was entirely proper in view of the high rate of building and the full utilization of men and materials at the time, and probably contributed to the mildness of the subsequent recession. The same observation could be made in respect to other sectors. Further inventory accumulation would have been detrimental to the economy and would only have aggravated the later decline. Some strain developed in the mortgage market in the spring of 1053. The situation was a complicated one. When overall credit is restricted and money becomes scarce, those sectors of the investment area which are weakest will register the greatest difficulty. The mortgage area was weak for several reasons. A large volume of. mortgages had been issued for several years. Institutions tend to operate portfolios under the theory of diversification. Many banks and insurance companies had as many mortgages in their portfolios as they wanted. They were anxious to balance by buying more securities. The mortgages in many cases, because of small size and scattered locations with apparent greater credit risk and handling expense, were relatively unattractive as compared to bonds. The result,was a shrinkage of prices for mortgages oiTered for sale and a reduction in the commitments made for new mortgages. No great harm if any, resulted to the economy from deferring commitments. Any sound project, whether it was a new housing development or a new commercial enterprise, was simply deferred and this was highly desirable in view of the full employment conditions in the building trade. In the case of housing already constructed, where the builder wished to sell and found it difficult to arrange mortgage financing, there was a possible loss. . Either he didn't make the sale immediately or he accepted a lower price. This was not as serious a situation as it sounds. I t did not in most cases mean an actual loss, but merely a reduction in profit. So we're back again to a basic situation; namely, that in a profit and loss economy there will be times of loss or reduced profits which we must accept if they are a result of a sound overall national policy, namely, credit restriction to prevent an unhealthy boom. Viewed broadly, the operation of banking restraint in the early spring of 1953 is a good illustration of sound policy in the money and credit field and not, as the critics claim, a misuse of it. During such a period, when restraint had to be and was exercised, it is to be expected that some administrative mistakes would be made. With the bene- UNITED STATES MONETARY POLICY 93 tit; of hindsight some things would be done differently. Certain isolated instances might be discovered where there was actual economic damage, but the total of these individual cases of damage would bulk very small in the whole economy. Even overall, nonselective restraints are not perfectly uniform in their impact; it cannot be otherwise. But, overall restraints are much better than any attempt to use selective credit restrictions in time of peace. Under the latter practice very great mistakes are almost inevitable and large elements of inequity develop . . . This experience teaches something which has been known for some time, namely, the need of constant efforts to improve the market for Government bonds. The Government debt is very large and will continue to be of great magnitude. The capacity of the market mechanism to handle a large volume of longer term issues needs improvement so that more orderly markets may prevail in periods of strain. But this must not be done at the expense of eliminating price fluctuations which are vital to the success of any flexible monetary policy. People have said that the Federal Reserve should have publicized its intention to reverse a tight money policy if conditions indicated thte wisdom of reversal. It is a fact t h a t in May and June such a reversal was under way, but no categorical public statement to this effect was made. I think it is important that the basic objectives and instruments of Federal Reserve policy be generally understood. But, publicity for day-to-day changes of direction seems to me a rather debatable proposition. At any given time actions speak louder than words. For the Federal Reserve to discuss fully its actions and the reasons for them at the time they are taking place is certainly debatable, and it may be undesirable. This much is certain—the Federal Reserve is entitled to great commendation for what it did. It identified changes in the situation in May and had the moral courage to act in accordance with the changed evidence. IV. INFLATION AND FLEXIBLE MONET ART. POLICY Belief in the desirability of a flexible monetary policy is, to my mind, necessarily allied to the belief that inflation is one of the great menaces to any modern society. The wickedness of inflation is in its gross inequity. The great majority of people, and those least able to protect themselves, are the great sufferers in periods of inflation—people who have saved, people on salaries, working people in the majority of instances—despite the fact that certain union groups seem .strong enough at times to keep their wages in line with the depreciated buying power of the dollar. The impact of inflation in the period running from the end of the war until 1053 was not felt as acutely as the depreciation in the value of the dollar would indicate. This was.due to a high rate of employment and to multiple breadwinners in the family and other factors such as overtime; but, even with these advantages, there was great distress among millions of workers and people who were retired and on pensions. We expect in this country an increasing group of older citizens enjoying their retirement through income arising partly out of Government social insurance, partly out of private insurance, and partly out "of their own thrift. Their standard of living will be jeopardized if we accept either the idea that inflation is not a bad thing or that we cannot control it. The fact that monetary policy standing alone would be unable to cope with inflation is no reason for abandoning it. Courageous use of monetary measures is one of the most effective policies in the fight against inflation. Of course, fiscal policy, debt management, and growth of production are all factors which must be included in our attempts to conduct a successful, free society. Congress, reflecting the ambition of our country for constant progress, has expressed its viewpoint in the Employment Act of 1946. The Federal Reserve, along with other agencies of the Government, is expected to make its contribution to the objectives of this act. No central bank, no matter how long its experience nor how wisely executed its responsibilities, could carry out this directive in the sense in which some interpret it. The idea that at all times—every week, every month, andr every year—we could have full employment of all the citizens in this country w ho might under any conditions wish to be employed is a concept of Utopia. No free society could ever hope to attain it and the Congress itself, as the debate shows and as the act's statement of policy shows, did not expect it. This country can have, within the framework of a free, competitive, capitalistic society, a dynamic and evergrowing standard of living together with high employment—and certainly without serious unemployment. Most of us believe that we can do this and at the same time respect the individual and his freedom 55314—54 7 94 UNITED STATES MONETARY POLICY so that we can say that while we make material progress we are still a free society. Progress will not always be in a straight line. There must be periods when the growth will be above the line, and some when it will drop below. If we reduce the severity of thesefluctuationsand still march on the upward path, our country will make a major contribution to modern civilization. The program necessary to accomplish this goal will require continuous collaboration and the maximum of cooperation between all groups in our country. No one law or resolution passed by the Congress can hope to do it. Sound fiscal, monetary and debt management policies, as well as a stimulating environment, must be included. Senator FLANDERS. Thank you, sir. Now we have a little better than a half hour. I n order to give time for the other inembers of the subcommittee, I am at this time planning to raise onTy~~some general questions to some of which the members of the panel may, if they wish, engage in their discussion with other members of the panel this afternoon. One is this: I get the impression that some members of this panel feel that high levels of production, employment, consumption, can only be reached through means of inflation. If I have correctly understood some of the documents which have been presented, I would hope that that question would be discussed among you this afternoon. Another observation which I would like to make is that I get the impression at times in this discussion that there is some ultimate value assigned to stability or to inflation or to other elements of debt management and credit control, aside from its effects on men—aside from its human results. I would like to make the observation that personally I cannot assign any important objectives that are not human objectives. I am not going to catechize them at this time—I hope the rest of you will. In connection with the presentation of Professor Mitchell, I was a little bit puzzled by his, what seemed to me to be, indication of a need for great investment or at least considerable investment in agriculture, without taking into account what seems to be to the onlooker a situation of agricultural surplus and overproduction at current prices. That is all I wish to say at the present time, in general. As the man said, I am "instigating" you gentlemen to question each other this afternoon. Now, Mr. Patman, have you any questions you would like to ask at this time? Representative PATMAN. Possibly I should raise certain questions, Mr. Chairman, so that the panel will be in position to discuss them this afternoon. I think you have had some good statements filed today. Mr. Chairman. I have enjoyed every one of them, and I have certainly profited from the information that has been furnished. I would like to raise this question for discussion this afternoon: Are the members of the panel satisfied with the present Federal Reserve System as nowconstituted or should changes be made? The Open Market Committee is the most powerful Committee in the United States; it is more powerful even than the Congress in many fields. The Constitution gives the power to coin money and regulate its value to the Congress. The Congress has, in turn, delegated that ower and authority to the 12 members of the Open Market Committee, ometimes I think it is more important that the Open Market Committee meet in Washington and do something to help the country thaa g UNITED STATES MONETARY POLICY 95 it is for the Congress, because Congress has delegated to that Committee so much of its power and authority. Since that committee has so much power to determine whether or not we have sufficient money or lack of money, or whether or not we are going to have high interest rates or lovy interest rates, in fact whether or not we have a depression or prosperity, the question I would like to raise is whether we should have anyone on that board or committee except people who are charged directly and solely with protecting the public interest. That committee, as now constituted, has 7 members of the Board of Governors when membership of the Board is complete. Because of the vacancy on the Board there are only 6 on the Open Market Committee now. There are also five presidents from the Federal Reserve banks. The Federal Reserve bank presidents are elected by the bankers in their districts, either directly or indirectly. The question in my mind is whether or not a person who is in any way obligated to a business that is to bo regulated or controlled by it should luivo anything to do with the great power and policymaking provision that the Congress has delegated to the Open Market Committee. I remember when the Federal Reserve Act was passed, President Wilson referred to the fact that bankers should not run it any more" than railroad owners should run the Interstate Commerce Commission. Of course, if railroad owners were to run the Interstate Commerce Commission they would not only fix the rates of railroads but they would fix the rates of the buses and the trucks and the airlines and express companies. I just wonder if we have not gone quite far in terms of the role the bankers play in the Federal Reserve System. If so, is that in the public interest or should it be changed? May I say further that Mr. Eccles, Marriner Eccles, was on the Board of Governors, I guess, longer than any other one person, and I recall one time he made this statement: When a Reserve bank president sits as a member of the Federal Open Market Committee, he participates in vital policy decisions which affect all banking. So far as I know, there is no other major governmental power entrusted to a Federal agency comimsed in part of representatives of the organizations which are the subject of regulations by that agency. Another question that has been raised here by the pknel members is. about the ownership of Government bonds by the banks. I have no objection to the banks owning Government bonds when it is necessary to give them ample earnings. I believe in a privately owned commercial banking system. I believe in a profitable banking system, because if they are not allowed to make profits they cannot function satisfactorily for the people, so we want a profitable banking system. I do not object to their owning bonds, but should we allow them to fill their portfolios with bonds to the extent that they have no desire or not a sufficient desire to make local loans and serve the local communities they are obligated to serve when, in fact, that is the reason they were given charters. The question in my mind is, with banks filled with Government bonds like they are, and getting so much from their Government security holdings, and they are pretty well satisfied with their earnings as to whether or not they are performing their local functions in a satisfactory way. What raises my suspicions in that respect is that 96 UNITED STATES MONETARY POLICY small-loan companies are springing up all over the Xation, taking over functions that the banks, I think, should normally perform. Is that due to the fact that the banks in certain localities are not talcing care of their local needs? I would like the panel to discuss that question. I would like a discussion, in particular, about the present setup of the Open Market Committee and the. Federal Reserve System, and next as to whether or not the banks are doing their duty and whether or not they are persuaded or disuaded from supplying local needs because they get so much of their income from riskless securities of the Federal Government. Senator FLANDERS. Thank you, Mr. Patman. Much of this discussion which we have listened to so far seems to occur in a peculiar sort of vacuum. For instance, there is no reference made to the situations external to the monetary system, although connected with the debt system, which have tremendously influenced our whole economy. No mention, as I remember, was made of the inflation which followed on the beginning of the war in Korea. Again, no mention was made of the great drop in Government expenditures in the fiscal year 1954, and a presumably still greater drop in 1955, which resulted in a decrease of defense production. Those things are things pertinent to the whole problem, and it seems to me that monetary and fiscal policy should be considered with reference to that war inflation and with reference to that decrease in defense expenditures. Senator Goldwater. Senator GOLDWATER. I have two questions that have come to me that I think we should discuss briefly this afternoon. Throughout the presentation of most of these papers I have been impressed with the seeming thought of the authors that low interest will solve most of our problems—our economic problems. I would like the panel to give this consideration during the lunch hour. If that is true, why did not low interest rates help or why did they not add more between 1933 and 1939 than they did? The thesis that you now hold that we should keep interest rates low, that it is an obligation of the Government, does not quite seem to hold water in view of the fact that the market between 1933 and 1939 was a constantly downward one, and business—the business indexes—never recovered from the low of 1932, actually, until the start of the war. I have another question that comes to my mind, too, that I think is of importance: The desire to.get money into bur economy is the most important attitude that I think we should consider—investment capital, if you want to call it that. In view.of that, we should explore the fields from which that investment capital will come. I would like to know the attitude of the panel on tax reductions based on a sound fiscal policy as a means of getting more and more money into the economy to stimulate its growth. I am prompted to ask that question for discussion*in view of the rather healthy condition of the economy at the present time, particularly in the construction business, that I personally feel was brought about in a large measure by the relief in the recently enacted tax bill in the investor levels or investor ai-eas. UNITED STATES MONETARY POLICY 97 That is all I have, Mr. Chairman. I will pursue those further this afternoon. Senator FLANDERS. Senator Douglas ? Senator DOUGLAS. I am afraid we are raising more questions than the panel will have time to deal with this afternoon, but I would like to raise one general question, if I may. I t would seem to me we should have a dual set of goals. We should have, on the one hand, substantial growth and substantially full employment, and, on the other hand, substantial stability in the price level. Both of them are needed. Now, I had always hoped that those two aims might be consistent. I know that some say that they are inconsistent; that we have to have at least a moderate degree of inflation in order to get substantially full employment and growth. I hope that may not be true, but, at any rate, let us consider the question as to whether or not it is. Others are so afraid of imaginary dangers of inflation that they sometimes seek a fall in the price level at the expense of growth and full employment. I would, like to raise the theoretical question as to whether it is not possible to attain both of those goals, and, if so, how; and, secondly, I would like to point out that period from March 1951r the date of the so-called accord, to December of 1952 was one, on the whole, of substantially full employment and also of substantial stability in the price level. I have taken a monthly record of prices and I find that on the wholesale index, the index fell from 116.5 in March of 1951 to 109.G in December of 1952, or a fall of 7 points; that in the field of consumer prices there was a rise from 110.4 to 114.11 and if you take an average of the two, there was substantial stability or perhaps a 1-percent decline. Therefore, I would like to suggest that in those 21 months we had a successful economic policy in which those goals were combined. Was that accidental ? Was it just happenstance or were there factors behind it ? I would like to have some discussion both on that practical feature and on the theoretical issue this afternoon, if that meets with the approval of the group. Senator FLANDERS. Thank you, Senator Douglas. Mr. Talle, have you any thoughts for the consideration of this panel? Representative TALLE. Mr. Chairman, I have a couple of questions in my mind, but I would prefer to withhold thorn so that we may proceed immediately to sit at the feet of this impressive faculty of teachers. Senator FLANDERS. We have 20 minutes or so left of the time that I announced; we ought to do something with it. Representative PATMAN. May I ask Dr. Clark a question, Mr. Chairman ? Senator FLANDERS. YOU may do so. Representative PATMAN. If I properly interpret your statements, Dr. Clark, j*ou suggest that the Federal Reserve should use reserve requirements instead of the open market operations. Mr. CLARK. Yes, sir. 98 UNITED STATES MONETARY POLICY Representative PATMAN. Would you go so far as to iv a standard or a guide to govern them to the extent that open market operations would be unnecessary ? Mr. CLARK. Open-market operations to support important Treasury financing should always be undertaken by the Federal Reserve. In order to stabilize its own holding of Government bonds, it will then be necessary after the financing has been concluded, for the Federal Reserve to ease out its open-market purchases, doing it slowly; whereas their first move would have been an aggressive, rapid one. That, I think, is the extent of open-market operations that would benefit the present situation. I t would have too small an effect upon the total economy at this time to engage in open-market operations for the purpose of adding to the reserves of banks. On the Federal Reserve action with respect to reserves, the point I would make, first of all, is that there is not at this time any circumstance that justifies the imposition of reserve requirements higher than the limits fixed by the Federal law, and under those Senator DOUGLAS. When you say "normal" or "legal" limits, do you mean the minimum limits, Dr. Clark? I notice you used the phrase "normal," and I was not certain what you meant by that, whether it was the minimum that you meant. Mr. CLARK. Yes; they are the minimum. Representative PATMAN. None of them are normal now. Mr. CLARK. They are prescribed by the Congress, and they ought to be respected excepting when there are circumstances that make it necessary for the Federal Reserve to use its extraordinary discretionary power to increase those limits to twofold. Now, I do not know what would be the effect of this. I t would be a massive movement, and we apparently need some massive movement right now to start the economy under way, because we have had nearly a full year of nonexpanding economic activity. We have seen one thing which develops in a period in which the economy lags, and that is a slow lowering in the rate of private capital investment, a prime factor in maintaining the economy and in bringing it upward to the level established by the Employment Act. Representative PATMAN. I will have to admit, Dr. Clark, that I have not looked with favor on the use of reserve requirements, because of wrhat I consider to be an unfortunate experience we had in. 1936. You will recall on June 15,1936, the veterans of World War I were delivered about a billion and a half dollars in money in payment of what was called the bonus of the First World War. In order to offset that and acting on predictions that had been made, unwarranted predictions and unjustified predictions by the monetary authorities, who said it would be highly inflationary, the Federal Reserve Board, for the first time since it had the powersit was given the power by Congress shortly before—doubled the reserve requirements of banks and contributed to the downturn in the early part of 1937. Since then I have not looked with f avo'r on the use of the power to alter reserve requirements, but, at the same time, I recognize that it depends upon how it is used and the people who have the authority to use it. I t looks like a very effective weapon to me, a very effective weapon. I know it worked in 1936 because I witnessed the disastrous effect it Digitizedhad for FRASER upon the economy. UNITED STATES MONETARY POLICY 99 Mr. CLAKK. Mr, Patman, may I repeat what I said, that from the standpoint of the monetary authorities themselves, it should be highly desirable to gain leeway for action if they hereafter need to use reserve requirements boosts in order to meet some inflationary situations. As it is now, they have very little leeway. The reserve requirements have been reduced so slightly in the past year Representative PATMAN. That is only m certain banks, Dr. Clark. Do you think that the authorities should reduce them for certain banks, or certain categories or should they be reduced in proportion as Congress provided in the formula used for the reserve requirements of banks ? In other words, where it is 26 and 20 and 14, if there is going to be any reduction, should it be uniform across the board, or should they be allowed to reduce the 26 if they want to one-half, and not touch the others at all ? You know the last year or 2 or 3 years, rather, reductions have been made in the first 2 categories, I think, but not much in the lower ones; is that right ? Mr. CLARK. Well, there was not very much leeway in the lowest category on time deposits. Eepresentative PATMAN. On demand deposits. Mr. CLARK. They were only 3 percent above the normal limit. Representative PATMAN. I am talking about demand deposits. Mr. CLARK. On demand deposits, they did reduce the central reserve bank limits a little more than the others, but I was sympathetic to that because I agree with the idea that there are no longer any conditions in our banking system that make it necessary to have a higher reserve requirement for Chicago and New York than they have for the other so-called reserve cities. Eepresentative PATMAN. Well, that brings up a different theory entirely from the congressional act. Mr. CLARK. But the larger reduction for those two cities, I think, was just Senator FLANDERS. I wonder if any other members of the panel would like to comment on this question of using to a greater extent than, perhaps, as the primary tool, the reserve requirements rather than other tools at the disposal of the Treasury or the Federal Reserve ? Mr. SMUTNT. Mr. Chairman, may I say a word in reference to that? In the first place, I do not believe the reserve requirement is a.flexible enough instrument. In other words, you cannot bounce the reserve requirements around. In other words, you are trying to use that as a substitute for the Open Market Committee. Now, if you have excess reserves, and the Federal Reserve wishes to let some bills mature rather than doing it, would you go ahead and change the reserve requirements that week, would you follow it the following week by a change in reserve requirements? You would have to confuse the banks with that situation I t is not as mobile and flexible an instrument as the purchase and sale in the open market . would be. Point No. 2 is that the change in the central bank, the reserve requirements of the central bank is, of course, the recognition of the difference that exists now, which did not exist in prior years, that the deposit relationship with the interior has, has become much more im- 100 UNITED STATES MONETARY POLICY portant, the correspondent bank does not have.to. depend as much on the large New York and Chicago banks, so why should they be discriminated against, you might say, in having a higher reserve requirement as far as the central banks are concerned. 1 think that is something that has to be taken into consideration today. Representative PATMAN. Dr. Clark suggested that both be used. Mr. SMUTNY. Well, at times it. can be, but it is not an instrument that should be used as actively, let us say, in my opinion. Senator FLANDERS. D O any others of the panel wish to comment on the question ? Mr. HARRIS. May I make just one comment, and that is that there is some advantage in using the reserve requirements in that it more or less affects the prices of all assets; whereas open-market operations tend to disturb the Government bond market exclusively, at least at the beginning, and from that viewpoint, there sometimes may be some advantage in using changes in reserve requirements as against indulging in very large open-market operations. Mr. CHANDLER. May I make a couple of comments about that? Senator FLANDERS. Yes, sir. Mr. CHANDLER. The first is that I see no reason to presume that it is Letter to have reserve requirements down toward the lower part of the range than it is to have them up toward the top part of the range.' The purpose of reserve requirements is not to assure liquidity to the •individual bank; it is a device for limiting the money supply. I think that one of the reasons why changes in reserve requirements are so unfavorably looked upon instrument of policy is that so many people still persist in looking on them as a means of assuring liquidity, and that is hot the primary purpose. The other thing that should be pointed out is that the Federal Reserve will probably be reluctant to use this instrument repeatedly and frequently so long as the great bulk of American banks are free to leave the Federal Reserve System if they wish to do so. Every time the reserve requirements are raised, it creates new irritation on the part of the member banks who feel they are unfavorably discriminated against. Senator FLANDERS. Any other comments ? Mr. LAND. I would like to comment on the geographical nature of the present reserve requirements, in that they are based on the geographical location of the banks as related to demand deposits. I t would be well if somewhere along the line they could be recast so that they are based on the nature of the deposits and not on the location of the deposits. Mr. WILDE. I would like to make this observation about the tools of the Federal Reserve. It seems to me, as a practical matter, in a country that moves as fast as ours does, the open market is tlie most flexible and the most useful and, then, secondly, the rediscount rate and, third, the change in the reserve requirements. Representative PATMAN. Excuse me, the rediscount raters not being used; is it? Mr. WILDE. I t is occasionally used. Representative PATMAN. Seldom used. UNITED STATES MONETARY POLICY 101 Senator FLANDERS. YOU are so classifying them with relation to the ease and quickness of application or with regard to the desirability of the results ? Mr. WILDE. I think they are practically* the same, the ease and readiness and flexibility contribute to their being the most practical instruments, in that order. Senator FLANDERS. Why is not the rediscount rate on the whole, to the extent that it is used, more rapid and direct in its application than the reserve requirements? Mr. WILDE. Well, I do not believe, Senator, that I could answer that with conviction. As a bank director, sitting on this side, it seems to me that it would not make too much difference. But I guess just watching what the Federal Reserve was doing in the open market, as to the open-market policy, was an indication of how we should conduct ourselves more practically than with changes in the rediscount rate. Senator FLANDERS. Perhaps an interesting subject, although we can spend more time than we have this afternoon, would be, there is some indication of the reasons for the disuse of the rediscount-rate device, which was originally the primary device of the Federal Reserve System, and I have seen some indications that it is being revived to some extent, at least, now. I do not know whether that is right or not. If it is, the reasons for that would be of interest. Representative PATMAN. Mr. Chairman, may I suggest, of course, the banks would have to get in debt and expect to get into debt before that device would be worthwhile. If you will recall, at one time the rate was raised in the early part of 1953, and the interpretation placed on this action, and I think properly, was that it was purely a psychological move, that they were letting the bankers of the country know that money is not going to be as easy, it is going to be a little righter. I t was what you might term an unconversational understanding among the monetary authorities that they were going to make money just a little bit tighter, and if they were to lower it, it would imply that they were going to make money a little bit easier. In practice I do not think it has been worth anything except psychologically, Mr. SMUTXY. Mr. Chairman, may I add to what Mr. Patman said? Senator FLANDERS. Yes. Mr. SMUTXY. Actually, as Mr. Patman mentioned, after all, reserve requirements only come into use when some b ^ k is borrowing and at the Federal Reserve. The rediscount rates a., i all the banks. Now, therefore, would it not be a good idea to study the relationship between our reserve requirements in the United States versus those that pertain to banks in Canada and England? If you look at those rates they are very substantially below ours; of course, they have fewer banks, that is true, but, as you know, there are a very minor number of banks in comparison to the 11,000 banks we have, but nevertheless in Canada, if I recall their reserve requirement rates correctly, I think they are using something around 8 or 9 percent;, and in England G percent. 102 UNITED STATES MONETARY PO£JCY Now, after all, we are tying up substantial funds of the assets of a bank in the use of reserve requirements in this country in the rates we have. Senator FLANDEKS. We have arrived at the announced time for adjournment, Mr. Ensley? Mr. ENSLEY. Mr. Chairman, we have received a statement from Aubrey G. Lanston & Co. relative to the questions that the Treasury and the Federal Reserve answered and, with your permission, we would like to insert the statement in the record at this point. Senator FLANDERS. Without objection, that will be done. (The statement of the Aubrey G. Lanston & Co., is as follows:) STATEMENT BY AUBREY G. LANSTON, AUBREY G. YORK, N. Y. LANSTON & Co., INC., N E W The contribution to monetary policy made by earlier committee hearings The earlier hearings on monetary policy under the chairmanships of Senator Douglas and representative Patman produced many expert points of view, a record of events, and helpful data that otherwise would not have become available. These served to enlighten students and to broaden public knowledge. The complex nature of the things that must be considered in evolving monetary policy was fully demonstrated. The need for flexibility consistent with changing economic conditions was driven home to a mass of people, some of whom had rarely given this matter any thought. The conclusions reached by these earlier subcommittees lacked complete agreement on some important points, but the areas of agreement were sufficiently broad that this served as a mold by which future developments in monetary policy could be, and have been, shaped. The ensuing year* have been marked by more than ordinary progress. They have been years of change; of change in the direction of more widely accepted monetary policy objectives. The methods and techniques employed, and t h e workings of moneta*y~poliey have undergone change, also. The results have been multifold. People throughout the world have become more sure of the toughness, the resiliency, and the lasting qualities of American economic life. The public has demonstrated a renewed confidence in the stability of the currency. Generally, people have acquired more confidence in the longer run economic future. People have begun to believe, once more, that the horizons of our economic future are the widening, limitless ones of a society wherein individuals are permitted, and encouraged, to initiate new ideas and methods; to be free to apply these with their full energy and to be rewarded more commensurateiy—free of the hampering restrictions of a self-perpetuating bureaucracy. At the top of these rewards is the better safeguard privilege of freedom—freedom to run the details of one's own life. Both the Douglas and the Patman subcommittees have contributed substantially to these ends because they helped to release monetary policy so t h a t it could do the job of which it is capable, to free it so that it might better serve our kind of economy—the most dynamic the world has known. I believe that these hearings, under the chairmanship of Senator Flanders, will help to preserve the healthy changes t h a t have been made, and to promote further progress. Monetary policy is a three-wheeled vehicle As you know, monetary policy is not a one- or a two-wheeled vehicle. I t is three wheeled. Treasury debt management can't do the job by itself, neither can Federal Reserve credit policy. The two of them alone can't do it, either, at least very well. This is because the big wheel of the vehicle is the Treasury cash budget and the changes that occur in t h i s ; t h a t is, whether a cash surplus or a cash deficit comes at an appropriate time a s we roll along through different kinds of business conditions. UNITED STATES MONETARY POLICY 103 It therefore would be futile to attempt to analyze, or to weigh the objectives and the workings of debt management as though these could operate in a vacuum. The same is true of Reserve credit policy. The actual and prospective results in the Treasury cash budget cannot be ignored. A monetary policy, or the absence of one? In fact, the results in this budget—and I refer to both the actual and the prospective results in the cash budget—have a lot to do with the facility with which the debt can be managed. The way the debt is managed has a lot to do with the workings of credit policy. If the Treasury budget results are particularly bad, such as an actual or prospectively large cash deficit during a business boom, the impact on the Treasury's management of the debt is bound to produce a compounding, adverse impact on Reserve credit policy. The grinding and crashing repercussions that may be produced will be heard, felt, and seen throughout the Nation. But these are not the workings of a monetary policy—they are the consequences of not having one. Such a situation might better be described as one wherein Treasury and Reserve officials are forced to struggle to prevent the big wheel of the Treasury's deficit from running amuck in a way that might produce anything from mild economic instability to inflation or worse. Responsibility and improvisation Congress cannot be careless with respect to the results in the Treasury cash budget and still discharge its responsibility for the creation and proper functioning of monetary policy. If the Congress ignores whether the Treasury has a cash surplus or deficit, and whether these results are consistent with changes in the conditions of business, and the accompanying economic climate, the Nation is headed for trouble. In the absence of an appropriate cash budget result, any review of the objectives and workings of Treasury debt management and Reserve credit policy confines justifiable conclusions with regard to monetary policy pretty much to whether, in the resultant adverse monetary background, Treasury and Reserve officials have worked well together, and have done as much as might be expected of well-intentioned, well-informed human beings. It is not a question of how well, or how badly, monetary policy may have functioned; the omission of the required budget result means that monetary improvisation had to make up for an absence of policy. My review of the objectives and workings of monetary policy aims to illustrate the part that is played by the Treasury's cas budget results It seems to me that. I might best review the objectives and workings of Treasury debt management and credit policy over the last few years by pointing out (1) how, during the boom period of 1952-53, a Treasury cash surplus might have enabled monetary policy to contribute more to economic stability and (2) how the Treasury's cash deficits multiplied the problems the Treasury and the Federal Reserve had to resolve. It will be seen from this, I am sure, that the Treasury and the Reserve have done a good job. The relationship between the Treasury security market and monetary policy The committee asked several questions about the Treasury security market and its use in connection with the development of credit policy. These questions, and the answers, also develop the relationship between the Treasury market and monetary policy. In the Reserve's response to question 3 it describes the workings of the Treasury market; it tells how the normal functioning of the market was obstructed by past Reserve open-market operations; of how a return to these would cause the market to become less rather than more self-reliant. The Reserve's explanation is the most complete I have seen. But, because I live with the Treasury security market throughout most hours of the day, and sometimes the night, and because I have a sincere conviction about the importance of an adequate Treasury market to the future welfare of our economy, I want to add some comments of my own. I want to tell you why I believe the Treasury security market must be free—as it is now—to reflect in market prices and yields, the public's desire to buy and sell Treasury securities and their transactions. No other kind of market will adequately reflect the response of the public to business and credit conditions and to monetary policy. 104 UNITED STATES MONETARY POLICY I want to say something about the kinds of alternatives t h a t might be devised to replace the present publicly made market for Treasury securities. As I see it, the alternatives are an inflexible monetary policy and consequential inflation or an increasing number of selective controls, of diverse sort; ones that would serve, once more, to undermine our competitive form of enterprise and to infringe upon individual freedoms. Should the newborn free play in the Treasury security market be considered an experiment or a permanent characteristict In the Reserve's reply to question 3 it describes three decisions that have been made with respect to the conduct of its open-market operations. It says the purpose of these was to foster a stronger, more self-reliant market for Treasury securities in order to contribute as far as possible, to the development of a responsiveness, by that market, to monetary policy. It adds that the results, on th** whole, have fulfilled its expectations. Then it goes on to say that this approach, to open-market operations, is still experimental, that insufficient time has elapsed to draw firm conclusions. As you know, a minority of Reserve officials hold that these decisions went too far in imposing limits on the open-market operations. This minority urges a partial return to the very kinds of open : market practices that, as the Reserve's replies carefully point out, abort the normal functioning of the Treasury m a r k e t I hold the firm belief that any action taken by the Reserve which permits the Treasury security market to more fully reflect the response of the public to credit policy is not an experiment—unless flexible monetary policy, competitive enterprise, and individual freedoms also are to be viewed as an experiment Contrariwise, if the clock were to be turned back toward more open-market intervention in and manipulation of Treasury security prices and yields by the Reserve banks that would be an experiment to see if the Reserve could go back part way. The last such experiment turned out badly. I want to discuss what might happen if we tried to embark on another. IFe have a good market for Treasury securities'; it still has some problems—these can be resolved The functioning of the Treasury market has*constantly improved; it is considerably improved compared with that of 1% years ago. In fact, we have a pretty good m a r k e t I am concerned only that our aim continue to be to promote and to improve the functioning of this market. The Reserve has helped mightily to bring about improvement. The Treasury also has helped. Yes, we still have some major problems to resolve. The further help of the Reserve, of the Treasury, and of those who nave either a responsibility for or an interest in monetary policy is needed. I do not believe I overstress the importance of an adequate public Treasury security market when I say that failure to maintain it, and improve it, might make it more difficult to combine flexible monetary policy, competitive enterprise, individual freedoms, and a large national debt compatibly. Suppose the Treasury had had a cash surplus during 1952-53 When business activity is a t a high level, as it was from mid-1952 to mid-1953, it is not surprising to see a strong demand for capital and credit accompany the boom. Had the fiscal policy of the Government produced a cash surplus throughout this period this surplus could have been used to reduce the Treasury debt held by the general public. Had this been effected through the retirement of Treasury securities held by nonbank investors, more money would have become available with which to meet the private demand for capital and credit. Surplus tax receipts would have been channeled back into productive investment, interest rates would have been under less upward pressure, a lesser demand for bank credit would have been generated. The Treasury would- have been placed in a better position to lengthen its debt. Had the Treasury cash surplus been used to retire Treasury securities held by the commercial banks, the availability of private bank credit would have been increased without the necessity for quite as much restraint in credit,policy, and without a too large increase in the money supply. The impact on monetary policy, from mid-1952 to mid-1953, of the Treasury cash deficits But fiscal policy did not produce Treasury cash surpluses. For fiscal 1952 the Treasury managed to just about break even on a cash basis. For the second half of calendar 1952 the Treasury had to finance a substantial seasonal cash deflett* UNITED STATES MONETARY POLICY 105 This was only partly offset by a cash surplus during the first half of calendar 1953. Moreover, the cash deficit for the second half of t h a t calendar year, 1953, promised, early in the spring, to be quite large. When the market awakened to its true size (in May) the results were explosive. These Treasury cash deficit needs were important in the factors that precipitated the mild crisis in the money and bond markets in May and June (1953J.1 The reasons for this were quite plain. After all, the Treasury had to raise the money from either nonbanks or banks. Individuals could not be expected to supply much, if any, of the Treasury's cash needs. Nonfinancial corporations were seeking additional funds. Nonbank financial institutions were being asked to supply more private credit and capital than they could raise, even by selling Treasury securities on balance. And, so—the only remaining source of funds was the commercial banks. The supply of bank credit available to private borrowers had proven to be an exhaustible amount, borrowers had begun to anticipate further increases in borrowing costs, they began to hoard bank credit by taking more than they needed—if they could get it. With this sort of a hackground, in this sort of climate, how willingly and how readily would the Reserve make available the bank reserves necessary to support Treasury cash deficit financing through the banks? How high would interest rates go? Was this to be the death knell of a flexible monetary policy, or the return to a 4-pereent rate for Treasury bonds? Belief In the stalwart resolution of Treasury and Reserve officials to prosecute a policy of monetary restraint, to the extent necessary to cope with this new Inflationary threat, was mixed with a belief that the increasing tightness of credit conditions would soon bring about its own correction. The latter proved to he the case and when Itoserve officials acted to shift their aim with an insight .and intuition that has been rare in central bank history, the quick turnaround in the availability of reserve credit produced stabilizing forces—instead of an •expectancy that might have arisen, namely, of a new rapidly spiraling inflation. The actual and prospective results of fiscal policy in the period of mid-1952 through mid-1953 are outstanding examples of how an inappropriate fiscal result dominates Treasury debt management and creates, for the Federal Reserve, a series of difficult and hazardous decisions. The buildup in the amount of the near-dated debt and Hi Treasury debt-management problems The Treasury, as far back as December 1949, had recognized, apparently, the desirability of extending the near-dated debt. During the 12 months, to Novem-' ber 195D, the Treasury came to market 3 times with securities of from 4%- to 5-year term. Thereafter throughout a period of about 15 months—TreasuryReserve differences, the resulting accord, and the unexpected release of the Treasury market (from years of manipulation by the Reserve banks) made longer-than-1-year financing impractical. By February 1952 the Treasury found it possible to return to longer-term financing with modest success. In May, it offered 6-year bonds, but this was to meet a part of its cash deficit requirement's; it did not serve to reduce the near-dated debt. By the time the present Treasury administration took over, in January 1953, the amount of the near-dated debt 2 (in the form of marketable issues) had approached or exceeded the peak levels of January 1, 1946 (see charts 1A, I B , 2A, a n d 2 B ) . Adverse market conditions existed during the first half of 1953. These came about partly because of the heavy demands for capital and credit. They also were an Inevitable consequence of the only appropriate credit policy in such circumstances—namely one of restraint. This overall situation plus the Treasury's second half-year cash deficit requirements again prevented the Treasury 1 There Is some element of surprise in the picture. Treasury announcements, in connection with the offering of the 3 % -percent bonds did not adequately reflect the size of the Treasury's forthcoming cash needs.. Re the much-debated 3Vi -percent offering: A straight cash offering of these Iwnds intirht have been successful. This is clearly indicated by the initial reaction of bond firms throughout the country and of many professional investors. Actually, however, the 3 '/4 's wore offered for cash and for exchange. The terms of the exchange encouraged many to convert into 3%'s for the purpose of reselling these. This sort of secondary market supply figured importantly in the setting up of fresh forces for a decline in bond prices. a Measured either by the total due in 1 year or the total due within 2 years. 106 UNITED STATES MONETAKY POLICY from making any net reduction in its near-dated maturities in spite of the change in credit policy to an easy-money objective. As a matter of fact, by January 1,1954, the near-dated debt had increased by a substantial amount. Once again—the Treasury had to rely largely on the tanks The Treasury cash deficit and refunding needs of May 1953, and thereafter, must-have urged upon Reserve officials some greater degree of active ease than might have been necessary otherwise. Obviously, the Treasury had to seize upon the more favorable market conditions to reconstruct its maturity schedules. Among what classes of investors could this be accomplished? Not much help could be expected from individual investors, except through a more aggressive campaign to sell series E and H bonds. If nonfinancial corporations were to be persuaded to hold more Treasury securities substantial progress in this direction meant, conversely, that a like amount of the profits and cash resources of businesses would not be turned back into investment, production, and payrolls. Nonbank financial institutions continued to be sellers of Treasury securities on two counts: one, to take up forward commitments entered into earlier and, two, to meet the enlarged capital market demand emanating from toll road, other new money financing, mortgages and, later, to refund bank loans. Thus, once again the Treasury was forced to rely largely on the.banks. Treasury success, and a backwash During 1954, the Treasury has come to market seven times. On five of these occasions it has sold notes or bonds designed to lengthen the debt. On four such occasions the Treasury's financing has resulted in substantially reducing the amount of its 1-year debt. All such operations took place in a climate provided by a subnormal demand for bank credit and a credit objective of active ease. In these circumstances the existence or promise of a further cash deficit did not constitute an adverse market force. Early in 1954, the declining trend in bank loans, the easy money policy of the Reserve and Treasury debt-lengthening operations served to multiply the forces which were pushing the yields of short-term Treasury securities to lower and lower levels. There was first the normal, sharp decline that had come from the shift in credit policy in June 1953 plus the turn-of-the-year ease. The decline ip loans, the loan outlook, and Treasury refunding began to operate with force as we moved through the first quarter of 1954. As a consequence of the latter, a sharp reduction in the amount of short-term issues outstanding occurred. Indeed, by June 1954, the.erosion in the yields on short-term Treasury securities became so pronounced that the Reserve was forced, more or less, to employ methods which, while they would continue to effectuate "active ease," also would act to prevent the yields on short-term Treasury securities from disappearing altogether. Then, there was the other side of the coin, namely, a corresponding increase in the amounts of Treasury securities outstanding in other maturity areas, notably in issues of from about 4- to 9-year term. During the latter part of 1954, the increase in the supply of these issues had become large enough to cause their yields, and those on most issues of longer Treasury securities, to retrace most of the decrease that had taken place during the earlier portion of the year. The relative movements of such yields on Treasury securities is shown on chart 7. It may be noted that the differences between the yields offered on short-term Treasury securities (of up to 2-year term) and those of longer term (5 years or more) became, and remain, quite wide. In fact, these yield spreads are about the widest on record. This was a natural result of the Treasury's having to take the bull by its horns if it, finally, was to be able to effect any substantial reduction in its near-dated d e b t The income-consciousness of banks, during 1954, plus the success of the Treasury's debt-lengthening programs makes for a sharply triggered bond market—one that could lead to a rather sharp decline in bond prices The primary reason that the Treasury was able to effect a substantial reduction in this portion of its debt was that bank investors, on whom the Treasury had to rely, became increasingly income minded; that is, the desire to maintain future income, or to purchase insurance against too large a drop in earnings, caused them to be willing to decrease the amount of their short-term holdings below a level they might have wished had loans been increasing. UNITED STATES MONETARY POLICY 107 Consequently, the liquidity of banks has been sharply reduced. In terms of deposit liabilities, the ratios for member banks (expressed in terms of Treasury securities with a term of 2 years or less) are about as low as they were at the beginning of 1951 and 1952—the low points for the postwar era. In terms of risk assets the situation is about the same. (See chart GC.) At the present time business activity is increasing. I t is expected that this will continue—at least for some months. If it does, then the risk assets of banks, particularly loans, may turn upward sooner than many now hope. Bank deposits will follow suit. The Treasury cash budget result necessary to underpin an acceptable monetary policy in such circumstances, and the minimum result that might be necessary to maintain general confidence would be nothing short of a balance between the Treasury's cash receipts and disbursements. An appropriate monetary policy would call for a cash surplus. A balance (in the cash budget) would mean no increase in the Treasury debt held by the public, although an increase in the total debt would occur. A cash surplus should permit a reduction in publicly held debt. This would be expected to take place through the retirement of publicly held, maturing obligations. The commercial banks are the largest holders—would such retirement be made from bank portfolios? If so, what would be the attitude of the commercial banks toward their longer Treasury security holdings? In a period when both bank deposits and risk assets are rising, bankers may become more conscious of their liquidity needs. Will individual banks then seek to prevent another lowering of their liquidity ratios by attempting to sell Treasury bonds of longer term? Who will the buyers be? Attempts by individual hanks to sell means that banks as a group—the mainstay of the present level of Treasury security prices—will have reversed their position. In such event, Treasury bonds could fall in price rather sharply, before private bank credit expands very much. Therefore, the Treasury bond market has become very sharply triggered: its response to any relaxation in the present credit objective of active ease would be quick—possibly anticipatory. The short-term sector also is becoming more sharply triggered and any further upturn in short-term rates could touch off a slide in the prices of longer dated issues As I mentioned earlier, several forces have operated to reduce the yields on short-term Treasury securities—declines in loans, a credit policy of active ease and a large, steady drop in the amount of publicly held short-term Treasury securities. The problem of getting the near-dated debt under better control has been pretty much accomplished. The fact that the amount of short-term issues outstanding may not undergo further reduction, removes one factor that helped to bring about the present relatively low yields on these securities. A revival of the loan demand, or the prospect of a less than seasonal decline in loans during the early part of 1955 would remove a second such force. Consequently, and in spite of the reduction in the short-term debt outstanding, yields on these and on money market securities in general may prove to be surprisingly sensitive to any change away from the present degree of "active ease." But, an appropriate credit policy has to concern itself with other matters besides the condition of the market for Treasury securities; for example, the money supply and the rate of change in it, the overall economic climate and expectancies, and the like. So, even though an upturn in the yields on short-term Treasury and other money-market issues might touch off a slide in bond prices, the Reserve might nonetheless consider that economic conditions require a less heavy accent on active ease within the near future. Wide yield spreads between short-term and longer tctm issues are an invitation to many investors to lengthen maturity but iVs a danger signal, too, in the present situation There is a rather general belief among investors that extensions of maturity should be made largely when these can be effected at reasonably good increases in yields. In other words, the recent and prevailing wide yield spreads between short and longer term Treasury issues have been a factor in making possible the Treasury's sales of many longer dated securities, as well as being a consequence of these sales. At the same time, investors have been able to take the 108 UNITED STATES MONETARY POLICY view that the higher income to be obtained on these longer issues compensated them for the increased risk to principal that had to be assumed. Conversely, however, when interest rates are low (bond prices high) increases in the yields of successively longer maturities are wider than is the case when bond prices are low. Reference to chart 7 will illustrate this—note the difference between the yields prevailing on Treasury securities of varying terms during 1951-52 and during the second quarter of 1953. Consequently, when longer term bonds are purchased (at relatively high prices during periods of easy money) the possible loss through some subsequent downturn in prices is substantially larger dollarwise, than are the potential gains (through further price increases). The compensating factor of the increase in income that was obtained when the bonds were purchased becomes, at this time, a thing of the past. The prospect ive gain versus loss equation begins to dominate the attitude of the investor. This is particularly apt to be the case if a large number of investors (in this case bankers) believe their portfolios have become out of balance (too few short-term and too many longer-term holdings) for the current and prospective outlook. Such a set of circumstances would make it more necessary than heretofore that a further advance in the levels of business activity be paralleled by the expectancy of a Treasury cash surplus. This might be used to retire short-term issues and thereby (1) cause banks and others to become more reluctant to sell longer Treasury securities while (2) it also would provide banks with the reserves needed to extend private credit. A lot of charts In my remarks I have referred to certain of the charts that accompany this statement. A brief explanation of all the charts is appended to them. One particular chart that shows the Treasury security holdings of the Federal Reserve banks, ID, deserves comment before I leave this general area. Did the Reserve banks prefer certificates to bills? Throughout most of the 1940's, the Reserve's holding of Treasury bills "was quite large proportionately. Today, and for the past several years, they have been quite small although the Reserve's open-market practice has been to confine its purchases and sales largely to such securities. The reasons for this are excellently set forth in the Federal Reserve's replies to the committee's questions. In the refunding of 2 weeks ago the Treasury made 2 short-term offerings. a new 1 *4-percent certificate and an additional amount of the l W s of August 1955. The latter was said to be largely to permit the Reserve banks to achieve a more even distribution of their holdings. This Treasury move invites questions: Did the Reserve prefer to diversify its certificate holdings or to diversify by a reduction in certificates and an increase in bills? Why did the Treasury offer the Reserve additional certificates, instead of offering, additional amounts of the weekly series of Treasury bills? A nutshell picture of the progress made by the Treasury in debt reconstruction and some delayed-action problems that have been created The Treasury has been able to reduce its near-dated debt so substantially that the major portion of this task should be completed for now. Moreover, by withdrawing savings notes from sale, and by permitting series F and G bonds to mature without receiving any specific new refunding offerings, a net decrease may develop in the outstanding amount of the nonmarketable debt. This may give the Treasury more leeway with which to meet the steadily mounting requirements of the Government accounts. Also, while the short-term holdings of the commercial banks have been reduced at a rather rapid rate during 11)54, the speedup in the tax payments of corporations may provide some offsetting supply of short-term securities over the next few years. Altogether the Treasury has gained considerable elbow room for future debt management. The pressure of a too-large near-dated debt has been eliminated. Some delayed-action problems may have been created. These originated in the large cash deficits that had to be financed from mid-1952 to drfte. The best way of resolving these potential problems would be for Congress to make sure the Treasury has a substantial cash surplus should business activity continue upward. Such a fiscal policy goal could promote that sort of business trend if it is gone about in a manner that is not hostile to business. UNITED STATES MONETARY POLICY 109 If we get off to a bad start in the matter of the Treasury cash budget we are bound to head for problems. Congress needs to find a way to 7nake fiscal policy more consistent with appropriate, flexible monetary policy objectives W h a t I have been trying to say, and to illustrate by the events of the past few years, amounts to this: Monetary policy has to begin with fiscal policy, that is, with the Treasury budget result. As in everything else, if we get off to a bad start we are headed for problems from there out. The results in the Treasury budget over the past few years have compounded the difficulties of managing the debt. They were a major factor in building a near-dated debt that was out of all reasonable proportion. This has not been the fault of the Treasury—regardless of which administration—it was the consequence of Treasury cash deficits. The objectives that have guided debt management and credit policy during the past several years have been excellent. In working out monetary policy, a great many human judgments obviously were required of Treasury and Reserve officials. Human judgments are frail. But we should recognize that human judgments are not necessary only in connection with a flexible monetary policy. They are just as necessary, and more of them are required of a monetary policy that is inflexible—designed for inflation. They are even more necessary to and far more numerous in the conduct of most alternative forms of selective controls. We, therefore, should not confuse concepts and objectives with judgments. We can expect from judgments, not perfection, only good performance. We have met with extremely good performance by Treasury and Reserve officials during recent years. The presently most pressing problems of monetary policy are therefore the results that flow from fiscal policy, the Treasury cash budgets. Surely the Congress can find some way to provide for changes in the rates of taxation and to control Treasury expenditures so that the Treasury cash budget can be more consistent in the future with the appropriate objectives of a flexible monetary policy, one that must deal with changing economic conditions. Now I would like to turn to the matter of the Treasury security market and the manner iu which this market ties into monetary policy. Is the public market for Treasury securities a free onet Of course, the public market for Treasury securities is not "a free market," in the sense of the term. But the public market must be an adequate one. It, therefore, must enjoy freedom to reflect fully, into market prices and yields, the transactions of the general public. Such transactions can take place only in a market free of direct intervention from the Reserve, 3 because the public's transactions must reflect the competition of the market place and take place in the environment of the actual and prospective condition of the Treasury's budget, the objectives and the decisions of debt management and of credit policy and of business conditions. Only in such a market can the fluctuations in interest rates reflect accurately the supply and demand of Treasury securities that constitute the country's response to changes in business activity and in monetary policy. The resulting fluctuations in interest rates are the product of what has happened, what is happening, and of future expectancies. Monetary policy of any kind would become befogged if it were not guided by interest-rate fluctuations of this kind. Some refer to the fluctuations in interest rates as the best thermometer we have by which to judge the health of the economy. Of course, there are alternatives ta the kind of a public Treasury security market we now have Other alternatives to an adequate public Treasury security market can be devised. For example, the Treasury could engage in market transactions for its accounts, and/or for the sinking fund, and/or in the name of the stabilization fund, for the purpose of providing a market for its securities. This could take the place of the public market that is maintained through the private firms that are the intermediaries. No one can say whether the Treasury officials charged with handling the individual transactions in a market made by the Treasury could or would do so in a way that these fully reflected into prices and yields the transactions of the public. But I don't believe we could take a chance because 3 Or the Treasury. 55314—54 8 110 UNITED STATES MONETARY POLICY some Treasury administration in the future might try. Even Barnum couldn't fool the public forever, and the monetary pressures that could build up would assert themselves in other ways—in price increases, in inflation of the usual kinds, and in an increase in the overall costs of all of us and In the costs of government. The latter, alone, would be many, many times the reduction in Treasury borrowing costs that might come from the Treasury's manipulation of interest rates. Or, the Federal Reserve banks, with their gigantic portfolio, could engage in market purchases and sales of Treasury securities partly to provide a market, or for the purpose of facilitating the attainment of credit-policy objectives that some claim could be done in this fashion, or to further the success of Treasury financing. Each of these types of open-market operations would take on, in time, the characteristics of the past price-fixing operations—the experiment that was such a costly failure. The Reserve then would act as some kind of a benevolent dictatorship; so that interest rates would reflect only the assessment made by Reserve officials as to the prices and yields on specific issues and on maturity sectors that were "proper." Are we interested in thermometer readings or the health of the patientt If fluctuations in interest rates are the best thermometer we have with which to judge the response of the public to the administrations of credit policy, then any of these alternatives would be strange ones to adopt. Even the more moderate alternatives, such as advocated by those who would broaden the scope of the Reserve's open-market operations, would be dangerous, in my judgment It would be like applying heat and cold alternately to the bulb of the thermometer so t h a t we could obtain the temperature readings we wanted to see. Surely, we would learn little from this about the health of the patient. note can the Reserve intervene to directly affect the prices and yields of Treasury securities only a little and not too much? Some who nevertheless would have the Reserve discard its present narrow concept of open-market operations for an expanded one claim that it is not enough to produce and to absorb reserves; that the prices and yields on Treasury securities in the different maturity sectors are important, and may not correspond to their judgments of a proper response from the market; that credit policy cannot rely on what they claim to be the imperfect arbitrage within and between markets and, therefore, the Reserve should engage in open-market operations anywhere in the entire maturity range of the market. I cannot understand, and I have been unable to obtain a plausible explanation, in practical terms, of how the Reserve could intervene just a little and be sure such intervention would be within limits that would be consistent with creditpolicy objectives; that is, any credit-policy objective.except active ease. I have sought and I have been unable to obtain a plausible explanation, in practical terms, of how the Reserve might further the success of Treasury financing by the purchase of exchangeable and newly offered securities without running afoul of credit-policy objectives, except ones of wanton ease. Nor has anyone been able to tell me how decisions would be made that this or t h a t Treasury financing would justify Reserve support, whereas this or that one would not. I have asked what would happen (1) if the Reserve were to start to buy securities in the Treasury bond market because it felt prices were below some preconceived idea of an appropriate level, and (2) the amount of such purchases began to exceed that which could be made consistent with the prevailing creditpolicy objective. Should the Reserve banks in such a circumstance stop their buying? If they did, the subsequent price decline might reach a level substantially below that which Reserve oflicials disapproved initially. If the Reserve started off such a buying program and purchases definitely exceeded those that could be made consistent with the prevailing credit-policy objective, should the Reserve continue to buy on the grounds it might be impractical to stop such purchases? If so, which will have taken precedence—the management of the Government security market or the objectives of credit policy? Sometimes it is said that, in any such events, the Reserve could sell other securities. If that is true then, as always happens, intervention in the normal functioning of a market a t one point, requires supporting intervention a t a second, UNITED STATES MONETARY POLICY 111 and a t a third point until, finally, Intervention turns into the necessity of managing the entire market. That is what happened before. I could give you illustration upon illustration of how Reserve intervention that aimed at directly affecting the prices and yields of Treasury securities has interfered with the normal functioning of the market; of how it first drives the intermediaries to cover and then the investor and of how, in the end, the Reserve becomes;—it is inevitable—a not-so-benovolent dictator. Rut instead let me remind you of what happened when the Reserve attempted to further a Treasury financing of which Reserve oflicials fully approved. In November 1950 the Treasury offered a 5-year 1%-percent note—precisely the terms the Reserve thought the Treasury should offer. The Reserve undertook to further the success of the financing. Before the Reserve got through, it had acquired $2.7 billion, or 40 percent of the new issue. To this I would add that when the Reserve starts to intervene during Treasury financing periods, investors and the intermediaries, the Government security dealers, have no basis whatsoever for judging the market or the real reception that might have been accorded the new issue. Many thereupon follow the prudent course and sell. When the Reserve does not intervene, a new issue may touch par or break it and thereby actually uncover more buying power than the Reserve would have any desire to supply. This happened shortly after the offering of the 1%-percent notes of 1957 this fall; it happened the other day in the new 2^-percent bonds of 1963. As the Reserve moves in to intervene in the prices and yields of Treasury securities the public market begins to move out The basis upon which the public decides to buy or sell Treasury securities in a market that is conducted through dealers, who serve as intermediaries, is a composite of the needs and desires of individual investors plus their evaluation of current and future supply and demand, business conditions, and monetary policy. When the market is subject only to these forces and is free of attempts by the Reserve to directly affect prices and yields, we get a full response to monetary policy, and the Treasury has the benefit of this response when it has to engage in financing. When", however, the Reserve moves to directly affect prices and yields, for whatever purpose, the public and the dealer intermediaries have to reconsider their ability to weight supply-demand and the usual factors of response to monetary policy. They begin, instead, to spend an increasing proportion of their time worrying about the character, scope, and timing of the Reserve's intervention. In fact, they begin to ignore the significant purposes of credit objectives. The entire public market slows down. Its normal functioning becomes increasingly impaired. The so-called imperfect arbitrage becomes more imperfect. The market's responses to the objectives of credit policy become more slow, or too quick, and sometimes these have boomeranged in such degree as to emasculate the Reserve's objectives. Further, I believe it is correct to say that on about every occasion" since the creation of our tremendously large public debt, Reserve open market operations that aimed to affect directly the prices and yields of Treasury securities attained a size multifold that which was expected of these, and considerably more than could be made consistent with the credit or monetary policy objectives of the time. If the Reserve were to expand its open market operations and thereby move in, so to speak, then the public Treasury market has no other option but to begin to move out. Judgments as to what the reactions of others will be and one actual reaction I have heard it said that these are matters of individual judgments, that it is a matter of individual judgment as to whether the public and dealer intermediaries would react along the lines I have outlined and as stated in the Reserve's replies. This is another one of the things I cannot understand. The study made by an ad hoc committee of the Reserve Open Market Committee is replete, I am sure, with innumerable instances of how dealer intermediaries (and the public) have reacted to such intervention in the past. Why should they react differently in the future? Yet, even within recent weeks, I have heard it said that dealer firms, such as ours, would not discontinue their endeavors to enterprise in the Treasury market, 112 UNITED STATES MONETARY POLICY or to develop it, and t h a t we would not curtail the size of the commitments we normally accept. To such a judgment, I can offer a reply which has the greater merit of bring, a t least, the conviction of one dealer as to what he would have to do to conform with prudent standards of conduct. Were the Reserve to intervene again to directly affect the prices and yields of Treasury securities my firm would immediately seek to employ its capital in other fields; we could not afford to risk our capital in the same way and to the same extent that we do under the present, more normal functioning of the market. We would have to examine the desirability and the profitability of conducting a lower volume of transactions as an agent or broker. Tico troublesome problems which remain unresolved The techniques adopted by the Reserve to foster a stronger, more self-reliant Treasury security market have contributed mightily to that objective. It is gratifying to know that the Reserve finds its expectations to have been fulfilled, on the whole. I think we do have a pretty good market in Treasury securities today. Rut, as I said earlier, we must continue to aim to develop this market and to enlarge its scope. The biggest sector of the market, from the point of view of the size of transactions, and the manner in which it may be used to effectuate credit policy is the short-term end, and more particularly, the bill market. All these short-term Treasures compete with other money-market securities. Because, short-term Treasurys are the premier money-market investment, they usually sell to yield less than other such instruments, including Federal funds. To maintain a market of desirable breadth and resiliency throughout all market conditions dealers need to carry a rather substantial inventory. But, dealers cannot afford to do this, as a regular tiling, unless the interest rates they pay to carry their inventory are equal to or less than the rate of return on the securities in inventory. This is not usually the case where short-term issues are involved. When the Reserve, beginning with the end of World War I, decided to foster and promote a broad, active market for bankers', acceptances, it ran into exactly this problem with the same results; when the cost of money needed to carry inventory was higher than the rate of return received from the inventory, dealers proceeded to reduce their holdings. Then, as now, the result is that the market loses some of its breadth and activity, and the securities involved are not as suitable as they might be to many investors. The second problem stems from a change that had taken place in the methods employed by member banks to make day-to-day adjustments in their money positions. Before securities became the principal medium for such adjustments, the ability of one member bank to increase its reserves or to invest surplus funds brought about corresponding changes in the reserve position of the banking system. Today, Treasury securities are the principal medium for making such adjustments, and the results differ. Sales and purchases of Treasury bills, and other short-term Treasury securities, undertaken by individual banks, do not result in producing or absorbing reserves for the banking system as a whole; at least, not in ordinary circumstances. Fluctuations occur in the yields of Treasury bills and short-term Treasury securities, some redistribution of excess reserves or of borrowings at the Reserve banks takes place, but no increase or decrease occurs in the reserve position of the banking system as a whole. This means that money market conditions undergo relatively minor change, if any. The Treasury, too, has helped to promote a better functioning Treasury security market—it can help more In October 1033, Secretary Humphrey called for more enterprise in the money and bond markets with a view to developing a broad and vigorous market in Treasury securities. He pointed out that this was vitally important because the behavior of this market is watched and magnified throughout the country and the world. The Treasury has helped to promote such a market. I t has done so by gradually concentrating its short-dated maturities, other than Treasury bills, Into four maturities a year instead of the larger number that used to be outstanding. This served, as the Treasury reply points out, to leave the market more free to function normally and to reflect the public's response to credit policy. UNITED STATES MONETARY POLICY 113 Perhaps the Treasury could help more along the same lines. For example, it could increase the amount of its weekly bill offerings with a view to reducing the number of its other maturities to two a year. But there also are other ways in which the Treasury can help. Since these are technical I will not go into them except to say that their purpose would be to attract more bond firms, and more young people, into the business of regular daily dealings in Treasury securities. Although the size of the Treasury debt has been multiplied many times in the past 15 years there has not been much of an increase in the number of specialists, the intermediaries, who regularly deal in the Treasury security market. Most of us who head these firms have been in the business for 25 years or more. The number of young people coming up to take our pla *es, throughout the industry, is too few. The hard core of the public Treasury market is made by the specialists and their dealings with each other. Through these, the supply and demand flowing into one specialist may be matched off with that flowing into another. In such clearances, a constant testing process is also achieved wherein the specialists themselves derive what is called "the feel of the market." If there were more specialists, more intermediaries, this hard core would be, not only enlarged, but made harder, definitely more resilient and the market would become, automatically, more self-reliant. At the same time, an enlargement in the number of firms would mean a wider opportunity for young men. The Treasury security market needs them. Progress has been made, more progress can oe made, in the same way, with the help of the same people and with the help of others To sum up this portion of my remarks: The public market for Treasury securities is not "free" in the way some have misused the term. The public market is more free than it used to be, and it must remain so because the available alternatives would .make it difficult to keep competitive enterprise, monetary policy, individual freedoms and the large national debt a compatible combination. Attempts on the part of the Reserve to intervene directly, to affect the prices and yields of Treasury securities, would be an experiment that would amount to seeing whether the Reserve could go only part way back to the past price-fixing operations which proved to be a costly experiment. When the Reserve moves in to intervene in the market for Treasury securities, the public market has no option but to begin to move out. The normal functioning of the market becomes impaired, and the need for further intervention on the part of the Reserve is soon failed for. I t is not necessary to rely solely on human judgments for guidance in these matters. The working papers of the Reserve System are replete with innumerable instances of how the public and the dealer intermediaries have reacted. Furthermore, I have told you how my firm, one such intermediary, would react. There are some troublesome problems which still remain unresolved. The decisions made by the Reserve with respect to its open market operations, and the techniques with which these have been given substance, have contributed mightily to the resolution of some problems of the Treasury security market. The Treasury has contributed in other ways. Both the Reserve and the Treasury can contribute in additional ways, as can ail who have a responsibility for and an interest in monetary policy. APPENDIX THE CHARTS Charts 1A and IB show the maturity distribution of the marketable Treasury securities on two slightly different bases (1) essentially representative of the Treasury's potential liability to meet its maturities and (2) with certain taxable bonds shown to their first call date. Charts .lC and ID show the holdings of the Government accounts and the Federal Reserve Banks. When considering the problems of the reconstruction of the Treasury's maturities (which have to do largely with marketable issues) these holdings should be subtracted. Over the years the amounts involved (in each case) are apt to enlarge. This means that unless the total Treasury debt 114 UNITED STATES MONETARY POLICY increases, the amount of marketable debt that is publicly held (charts 2A and 2B) must decrease. Such decreases normally would be expected to come about by retirement of maturing obligations (a shrinking of near-dated debt). But, in any event, the size of the problems and of the progress made should not be measured in terms of either the total debt or the total marketable debt It is better viewed as two separate problems, (1) the nonmarketable debt, and (2) the marketable debt that is publicly held (charts 2A and 2B). On the matter of savings bonds and notes, for the past 4 years the amount outstanding has decreased. This is partly because savings notes are no longer issued. Maturities of the F and G bonds have not received, recently, any specific refunding offerings. Holders have had the choice of reinvesting in the series J and K bonds, or the series E and H bonds subject to the various limits on each. At the present time the prospects, under present Treasury policy, are that savings notes will decrease fairly steadily, as may the aggregate outstanding amounts of series F, G, J, and K bonds. Series E and H bonds should inereas, but not sufficiently to offset the decreases in other savings bonds and in savings notes. This means that decreases in the total amount of such nonmarketable obligations may make it possible for the necessary increases to occur in the holdings of Treasury accounts, without having to effect withdrawals of markets able debt held by the public. At the same time, the decrease in this nonmarketable debt may be larger than can be placed with the Treasury accounts, and this would require an increase in publicly held debt. If a Treasury cash surplus exists, it could be used to meet any such net redemptions. Chart 4 shows the lack of any visible relationships between the net current assets of nonfinancial corporations and their Treasury security holdings. It shows, however, a very marked correlation between such holdings and Federal income-tax liabilities. Since the current amount of the latter should decrease under the speedup plan for corporate tax payments, the Treasury security holdings of businesses may decline. This would provide some increasing amounts of short-term securities for commercial banks that might be needed in view of the prospective further reduction in their liquidity ratios. Charts 5A and 5B show the same two kinds of maturity distribution that appear earlier, in this instance, for the holdings of nonbank financial institutions. Chart 5C indicates that such investors have evidenced no concern about the decline that has taken place in their holdings of Treasury securities while their assets have been undergoing a substantial increase. We would expect these trends to continue as long as an adequate supply of non-Treasury investments is available. Charts 6A and 6B show the maturity distribution of the holdings of commercial banks. Charts CC shows the principal assets and liabilities of all member banks and illustrative changes in their liquidity ratios. Chart 7 is largely self-explanatory—it shows the relative fluctuations in the yields on Treasury securities of various term. UNITED STATES MONETARY POLICY 115 CHART IA OUTSTANDING MARKETABLE TREASURY SECURITIES INCLUOING INVESTMENT SERIES B BONDS IN 4 - 5 YEARS EXCLUDING TAX ANTICIPATION SECURITIES ANO POSTAL SAVINGS BONOS WRTIALLY TAX- EXEMPT BONOS TO FIRST CALL DATE TAXABLE BONOS TO MATURITY EXCEPT WHEN ACTUALLY CALLED Billions of Dollars 200 1940 1945 January t unless otherwise noted 1950 1955 I960 Aubrey G. Lantton a Co. Inc. UNITED STATES MONETARY POLICY 116 CHART IB OUTSTANDING MARKETABLE TREASURY SECURITIES MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE BONOS WITH COUPON RATES OF 2lfe% AND HIGHER TO FIRST CALL DATE Billions of Dollars 200 i 100 1940 1945 Jonuory | unlets otherwise noted 1950 1955 I960 Aubrey 6 . Lonsfon ft Co.Inc. 117 UNITED STATES MONETARY, POLICY CHART IC HOLDINGS BY U.S. GOVERNMENT ACCOUNTS Billions of Dollars 75 # 50 TOTALvV^ h- 25 ' SPECIAL ISSUES _ e - * " - " ' NON^%^MARKETABLE MARKETABLE i 1940 _]_ 1 1 1 I 1945 Jomiory I unless otherwise noted 1 _1 L_J 1950 7/1 i i ll/»? Lii—i 1955 I—I 1-.1 1 I960 Aubrey 6. Lanston & Co. Inc. 118 UNITED STATES MONETABT POLICY CHART ID HOLDINGS BY FEDERAL RESERVE BANKS PARTIALLY TAX-EXEMPT BONOS TO FIRST CALL DATE TAXABLE BONOS TO MATURITY EXCEPT WHEN ACTUALLY CALLED Billions of Dollars 40 I u H 30 h- 1 1 1 11 20 1 TOTAL J— u / H ^ f TOTAL WITHIN 1 YEAR j 10 H //BILLS r J CL-A 1940 1 1 1 I I 1_ J . J L . . I J i .1 1 .,JL_ 1 ,» 1 ., 1 1945 Jonoory f unless otherwise noted 1950 1955 I960 Aubrey 6. Lanston a Co. Ina 119 UNITED STATES MONETARY POLICY CHART 2A OUTSTANDING MARKETABLE TREASURY SECURITIES HELD BY THE GENERAL PUBLIC (EXCLUDING U.S. GOVT. ACCOUNTS AND F.R. BANKS) INCLUDING INVESTMENT SERIES B BONOS IN 4-5 YEARS EXCLUDING TAX ANTICIPATION SECURITIES AND POSTAL SAVINGS BONOS PARTIALLY TAX-EXEMPT BONOS TO FIRST CALL DATE TAXABLE BONOS TO MATURITY EXCEPT WHEN ACTUALLY CALLED BHIiont of Dollars 200 1940 1945 January I unl«« ofherwitt noted 1950 1955 I960 Aubrty G. Lantfon 8 Co. Inc 120 UNITED STATES MONETARY POLICY CHART 2 B OUTSTANDING MARKETABLE TREASURY SECURITIES HELD BY THE GENERAL PUBLIC (EXCLUDING US. GOVT ACCOUNTS AND F.R.BANKS) MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE BONDS WITH COUPON RATES OF 2 lfc % AND HIGHER TO FIRST CALL DATE. Billions of Dollars 200 1940 1945 Joouory I unless ofherwitt nottd 1950 1955 I960 Aubrty G. Lanston a Co.Inc 121 UNITED STATES MONETARY POLICY CHART 3 SAVINGS NOTES AND SAVINGS BONDS OUTSTANDING Billions of Dollars 70, SAVINGS NOTES r\ SERIES F,G, J AND K SERIES H -SERIES A TOE 1. I—I J_J 1940 1945 1. I l l L...1 1950 ( FISCAL YEARS ) 1 „,. I _ , _..l... 1955 1... .1 1. . 1 I960 Aubrty 6. Lontton 8 Co. Ine. 122 UNITED STATES MONETARY POLICY CHART 4 NON-FINANCIAL CORPORATIONS Billions of Oolksrs ' 125> l IOO 1 f75 NET CURRENT/^ ASSETS / H- 50 / 25 f/1 1 __JJ.S. TREAS. ^ ^ V SEC YTxx . 1940 FED. INCOME TAX 1 LIAB. 1 1 l_.l—J 1945 January I writs* othtrwitt nottd 1950 7/1 1 1 7/1 Mill 1955 111 I 1 I960 Aubrey 6, Lantton a Co. Inc. 123 UNITED STATES MONETARY POUCT CHART 5A HOLDINGS BY NON-BANK FINANCIAL INSTITUTIONS INCLUDING INVESTMENT SERIES B BONDS IN 4-5 YEARS EXCLUDtNO TAX ANTICIPATION SECURITIES AND POSTAL SAVINGS BONDS PARTIALLY TAX-EXEMPT BONDS TO FIRST CALL DATE TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED Billions of Dollar* 40 1940 1945 January I unless otherwise noted 1950 1955 (960* Aubrey G. Lonston & Co. Inc. 124 UNITED STATES MONETARY POLICY CHART 5B HOLDINGS BY NON-BANK FINANCIAL INSTITUTIONS MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE BONDS WITH COUPON RATES OF 2 1 / 2 % AND HIGHER TO FIRST CALL DATE Billions of Dollars 40 1940 1945 January I unlets otherwise noted 1950 1955 I960 Aubrey 0. Lonston & Co. Inc. UNITED STATES MONETARY POLICY 125 CHART 5C NON-BANK FINANCIAL INSTITUTIONS 8illion$ of Dollars 200 h 150 100 ASSETS U X 50 r x* \ 1940 "X 1—.1—„L _! 1 1945 Jonuory I unless otherwise noted 55314—-54 S) 1 ARKETABLE OIREC T GOVTS. 1 II 11 1950 T/l 11/17] 1 1 . 11 1 1 1 1955 L 1 1 J I960 Aubrey 0. lanston a Co. Inc. 126 UNITED STATES MONETARY POLICY CHART 6A HOLDINGS BY COMMERCIAL BANKS WCLUOING INVESTMENT SERIES B BONDS IN 4 - 5 YEARS, EXCLUDING TAX ANTICIPATION SECURITIES ANO POSTAL SAVINGS BONOS, PARTIALLY TAX-EXEMPT BONOS TO FIRST CALL OATE,TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED Billions of Dollars 100 r 1940 1945 January I unless othtrwist not*4 1950 1955 I960 Aubrty G. Lontton 8 Co. Inc. UNITED STATES MONETARY POLICY 127 CHART 6 6 HOLDINGS BY COMMERCIAL BANKS MATURITY 0ISTRI8UTION SAME AS CHART IA EXCEPT TAXABLE 80N0S WITH COUPON RATES OF 2 1 / 2 % AND HIGHER TO FIRST CALL DATE Billions of Doliors *IO0 1940 1945 Jonuory I unless otherwise noted 1950 1955 I960 Aubrey 6. LoosfM & Co. Inc. 128 UNITED STATES MONETARY POLICY CHART 6C CHANGES IN THE LIQUIDITY OF ALL MEMBER BANKS MEASURED IN TERMS OF HOLDINGS OF U.S. TREASURY SECURITIES TREASURY SECURITIES WITHIN 2 YEARS: MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE BONDS WITH COUPON RATES OF Z 1/2% AND HIGHER TO FIRST CALL DATE PRINCIPAL LIABILITIES AND ASSETS Billions of Dollors ILLUSTRATIVE CHANGES IN MEMBER BANK LIQUIDITY PERCENTAGES OF TREASURY SECURITIES WITHIN 2 YEARS TO ( A ) LOANS PLUS OTHER SECURITIES (B) DEPOSITS LESS RESERVE BALANCES Percent 150 100 1940 1945 January I unlets otherwise noted 1950 1955 I960 Aubrey 6. Lontton ft Co. Inc. CHART 7 FLUCTUATIONS IN MARKET YIELDS OF TREASURY SECURITIES OF VARIOUS MATURITIES AND IN THE AWARDS OF TREASURY BILLS 1951 THROUGH 1954 TO DATE TREASURY BILL AWARDS AS OF THE NEAREST ISSUE DATE TO THE 15 TH OF EACH MONTH. OTHER YIELDS FROM YIELD CURVES DRAWN AS OF THE 15 TH OF EACH MONTH. Q l i i i'I ii m l ii ii il H I i l l i ii i n i ii n i l n li ii 11 n l ii i n n i n i l m i M I ii n l i n I I n u n l i m In nil JMJSDMJSDMJSDHJSOMJSDMJSDMJSOMJSOMJSD 1951 1952 1953 1954 1955 1956 1957 1958 1959 Aubrey G. Lonston 8 Co. Inc. 55314—54 (Face p.128) UNITED STATES MONETARY POLICY 129 Senator FLANDERS. We will return at 2 o'clock. (Whereupon, at 12:30 p. m., a recess was taken until 2 p. m., the same day.) AFTERNOON SESSION (Senator Flanders presiding) (Present: Senators Flanders, Douglas, Sparkman, Goldwater, and Representative Patman.) (Also present:-George W. Ensley, staff director, and John W. Lehman, clerk. ) Senator FLANDERS. The hearing will please come to order. There is the problem of initiating a chain reaction, and the thought that I have had in mind was this. Since we worked out in the morning session alphabetically beginning at the beginning of the alphabet as represented here with Mr. Chandler, I think we will start the afternoon, the more free discussion of the afternoon, commencing at the other end of the alphabet. Mr. Wilde, I will ask you to make any observations which may seem pertinent to you about the discussion we had this morning, and initially we will proceed up the line in reverse order, but with a little more informality, a little more questioning back and forth, and it would not be completely undesirable if the discussion became so lively eventually that it had occasionally to be brought to order. The members of the subcommittee and the main committee are invited to contribute to the discussion as they see constructive opportunity while the panelists are talking with each other. So, Mr. Wilde, will you commence the discussion. Mr. WILDE. Senator it is very nice to be waiting in a food line to be first, but in an intellectual feast-it is better to be last and then you can make a much more cogent and forceful statement than if you are first. Without any particular speech to make, I would like to say that the impact of the discussion this morning on me makes me feel that we give too much emphasis to the probability that through very expansive monetary policy we can drive the economy forward and have full employment. I am not one who has that overall feeling. I believe that other elements must join to accomplish that result, and I have been trying in a small way in my formal paper to mention it. I am talking about such things as fiscal policy, with particular reference to the kind of a tax structure the country has, and I am talking about the intangibles which are covered in a term that I used, "environment." Those, to me, are awfully important if we are going to have the kind of a country that we all want, and I use the three of monetary, fiscal, and environment as the necessary trio that will produce a successful result, and I get, as I say, the impression that many members of the panel are more persuaded to the overriding importance of maximum use of monetary policy on the expansion side as the device that will accomplish more than I believe it will. Senator FLANDERS. Thank you, sir. Mr. Smutny, what struck you in the discussion this morning? 130 UNITED STATES MONETARY POLICY Mr. SMUTNY. Well, I felt this. I would like rather to follow a little bit on some of the questions that you would ask, if that is in order, some of the things that have occurred to you. You said development of a high level of our economy could only be reached through inflation. I think, whether we like it or not, as far as our setup is concerned, free endeavor, free enterprise, we are bound to have a natural tendency toward inflation. I t naturally feeds upon itself, the desirability of business to expand, new operations. Naturally, to get new jobs and the expansion of our general economy along the lines that we hadn't conceived of years ago Senator FLANDERS. Are you now thinking of inflation in the sense of a rising price level or in some other sense? Mr. SMUTNY. NO, I am not thinking of a rise. I am thinking of the expansion of the economy itself, not a- rise in the price level. I feel that it is the natural tendency in our country, after all, to expand the entire business sphere and sometimes in that expansion new industry, and so on and so forth, that we have industries we hadn't dreamed of would develop 4 or 5 years ago, there is a misnomer of tb« use of inflation, inflationary tendency in prices. I think we have stability, stability has been created as far as the price level is concerned through the operations, the monetary fiscal operations as we have seen them. I think we approve very heartily of what has been done. I think that the purchasing power of the dollar has been kept stable and the price level was kept stable in an expanding economy, but the natural tendency, however, is toward inflation basically. I t has to be as long as you are expanding. Senator FLANDERS. Is it toward inflation as represented in the price level; is that our natural tendency? Mr. SMUTNY. I think it is a question of demand that has built up, and demand begets production, and the answer to inflation is just a single word: production. Once you have production, you don't have inflation. Senator FLANDERS. SO now you are using inflation in the price-level sense. Mr. SMtJTNY. In the price-level sense. I don't think inflation in the price-level sense is necessary as long as our economy is free to expand, and I differ greatly with Mr. Mitchell, who felt that our economy had to be regulated. We have been through an era of regulation, that regulation breaks down no matter how good our intentions might be, through the administration thereof. Who can administer certain price levels ? How do you know one price level is correct? You can't substitute anything for the general give and take of purchasing and selling of the market place, and the minute that you get regulation, you have abnormalities created in the market place, you have black markets, and so on and so forth, things that we are familiar with. I would like to answer Mr. Patman with reference to the Federal Reserve System, the Open Market Committee's power, more power than the Congress. I think that, speaking as an individual, a tremendous confidence has been created throughout our country in the operation of the Federal Reserve System UNITED STATES MONETARY POLICY 131 Senator FLANDERS. I don't want to bring up anything extraneous, but since the comparison is between the Federal Reserve System and Congress, would you care to—well, I will end right there. Mr. SMUTNY. I would like to stick to Representative Patman's statement, the way he put it. He said are we satisfied with the Federal Reserve System, and I would say that the Federal Reserve System, the way it has conducted itself certainly over the years has begotten itself a tremendous amount of confidence outside of the general banking system. You referred to the fact that the composition of the Open Market Committee are primarily bankers. If you look back at the history of Chairman William McChesney Martin of the Federal Reserve Board as the president of the New York Stock Exchange, his experience with the market, and so on and so forth Representative PATMAN. May I interrupt you there. I wasn't talking about the Board of Governors. I was talking about private banks being represented on a committee that is supposed to perform public functions like the Open Market Committee, the five private bankers, are the ones I was referring to. Mr. SMUTNY. In compliance with the Federal Reserve Act, on the Federal. Reserve Board you have people other than bankers that we are familiar with, businessmen and so on and so forth, and their composite opinion is valuable. I don't think you could say John Jones, just because he is a banker, favors the banking industry. If anything, he has a high regard for what is good for the Nation as a whole. There is one other question you brought up about the ownership of Government bonds and that banks should stick to loans locally, in the local places where they were situated in favor of purchasing Government bonds. Actually I think you put the cart before the horse. They have purchased Government bonds due to the fact that the demand for loans has receded, and the purchase of Government bonds has a portfolio relationship of necessity as far as the bank policy is concerned. You have a certain percentage in governments, a certain percentage in cash, bills, and so forth, and you wouldn't want the banks to use their entire assets in loans. The fact that loans in banks have receded is the reason that their bond portfolios have risen over the past years. Also I think you brought out something in reference to the fact that finance companies have asserted the privileges of the banks to extend loans to individuals. I have had a great deal of experience in reference to that, probably having placed the largest amount of finance paper privately of any of the investment bankers. All my experience has been this. The banks have avoided going into the personal-loan business due to their experience in 1933, and so on and so forth. They chucked that out the window in 1936 and 1937, which you will find was primarily due to the fact they did not have the managerial experience to go into the finance market, not that there was something principally wrong with financing an individual in their time-payment plans. I t is only recently, of recent vintage, you might say, that some of our large banks have gone into that market, and the finance companies have been built up, it is true, due to their ability and experience in that type of credit, and the banks have avoided it. 132 UNITED STATES MONETARY POLICY I t seems to me that confidence in the finance companies has been justifiably established. You don't look down the nose at somebody who is going ahead and buying a car on time-payment plan. Nowadays it is the general experience that this is the way to finance automobile and other purchasers, and that actually what we are doing today is mass financing of mass production. If you haven't got mass financing you can't have mass production, and that is the basis of it, and we are coming into an atomic age when the whole volume of financing will be expanded terrifically, when we consider the amount of money that will be expended on atomic plants, hundreds of millions of dollars, we will say, in one plant, then we have some comprehension of additional mass financing and larger markets necessary to maintain it. I think Senator Goldwater said low interest rates didn't solve the problem in 1933-39. As a personal reflection on. that era, it seems to me that business wasn't encouraged. The difference between our present status and that status was the approach to the individual. You said, "Here, John Jones, you will rake the leaves from right to left and we will pay you so much, and rake them tomorrow from left to right and we will pay you twice as much." Well, that didn't support the economy because it didn't produce anything. Actually today we are trying to maintain general gross national product. We are encouraging business to expand along certain lines. The fact that money is cheap creates more employment because business can borrow that much more cheaply, and you can go ahead and expand your business generally, which creates employment from that angle. In my opinion this seems to be the proper approach, along with the general tax reduction. Senator DOUGLAS. Mr. Chairman, may I ask a question ? I think it was not merely during the period from 1933 to 1939 that low interest rates failed to provide the volume of private production, but from the outset the great depression in October 1929 to 1933 in which you had the familiar lowering of interest rates unaccompanied by expansion in private activity, and, on the contrary, accompanied by precipitous decline, so while I don't wish to score any party advantage over this point, since.you picked out the period 1933-39 as a whipping point, I would like to point out that this previous period was one in which low interest fates did not effect recovery, and, as a matter of fact, was at least accompanied by the sharpest decline in economic activity in the known record of the world. Mr. SM*JTNY. May I answer that, Mr..Chairman. Isn't that what this panel is here for and what we are trying to avoid today, that as a result of tremendous expansion in business you got what was commonly used in the terminology of the Federal Reserve, "that a bubble existed on top of an inflationary move,'? and that is what you are trying to avoid, or at least trying not to create the same situation as we once went through in 1929? , The sum of what was said this morning, at least from my reaction to the panel, and particularly was very emphatic in wanting to go on record against any encouragement of regulation in our markets. Our markets must be kept free. UNITED STATES MONETARY POLICY 133 Any regulatory agencies that are built up suffer through the fact of lack of administration, and I feel that the greatest benefit to the country at large is to keep our markets free from regulatory bodies. Senator FLANDERS. YOU will be willing to defend that thesis if it is challenged later, I take it? Mr. SMITTNY. Yes, sir. Senator FLANDERS. Mr. Shaw. Mr. SHAW. There are so many issues, Mr. Chairman, that it is hard to know just which ones to pick on first. Senator FLANDERS. Well, take the worst ones. Mr. SHAW. I have listed 2 or 3 specific ones and then 2 general ones that strike me as being of peculiar importance. First a technical matter brought up by Mr. Clark. He has urged that legal i*equirements be reduced to their legal minima of 13, 10, 7, 3, percent. There is no peculiar virtue in these percentages. They are a historical accident. The effect of lowering them would be immediately to create an enormous volume of surplus reserves in the hands of the commercial banks, and, in the present stage of events, I have little doubt that the immediate reaction of the banks would be heavy buying of Government securities, whereupon the Federal Reserve, despite present pronouncements, perhaps would sell Government securities of various maturities so that the effect would be simply transfer assets from the Federal Reserve to the commercial banks, conceivably so reducing the portfolio at the Federal Reserve banks that for any repressive purposes under subsequent inflationary developments the open-market operation would be immobilized and the rising reserve requirements would have to be used. This is difficult, as was pointed out this morning, because not all commercial banks are members of the Federal Reserve, I t seems to me that this is a step toward displacing one control instrument, open-market operations, with another control instrument, a rising legal reserve requirement for the purpose only of adding to the earnings of the commercial banks on their Government security portfolios. Senator FLANDERS. Is what you are saying in effect that the reserves should be set at such a point that you can easily move either way? Mr. SHAW. I t should be desirable to move them in both directions. The present legal limitation is still significantly above present effective reserve requirements. Senator FLANDERS. ^ Have you any notion just how far above it should be at this particular time? Mr. SHAW. I should think it would be quite adequate under present circumstances, but I admit being very sympathetic a number of years ago when the Federal Reserve requested the authority from the Congress to set higher maxima on legal reserve requirements than are now in effect. A second minor and technical point, Mr. Patman's relatively minor point, not absolutely so, Mr. Patman. The question was raised as to whether under some circumstances, at least, Government bonds would be so attractive that banks would not lend locally. They would choose to hold Government securities. Well, this is precisely what is desired under some circumstances. 134 UNITED STATES MONETARY POLICY Under some circumstances where local loans have been pressed so hard with the local resources already in heavy use that the effect does not give more employment, but it simply brings prices up, under such circumstances it is desirable that the central bank should raise prices of Government securities so that commercial banks will not lend more for employment purposes or for output purposes on local markets, and that in other circumstances when the generality of local areas is having unemployment difficulties, that the central bank should make buying and holding of bonds unattractive to banks so that they would be under pressure to lend locally. This is the technique of credit control, and it worries me just a little bit that the Federal Reserve, in foregoing the use of dealings in long securities, is giving up some of its grip on this particular pressure, causing local banks to be more interested at the right time in local loans and less interested at the right time in local loans. Another relatively minor matter, the composition of the Open Market Committee. I think it is known in the historical context originally the Federal Reserve was not known at all as we regard it now. In fact, a comparison of the present hearings with the hearings of 1912-14 would indicate very great advances in our understanding of how central banks operate. At that time the central bank was supposed to be essentially a passive instrument in the money market, giving accommodation to legitimate business, commerce, and agriculture when it should need it. I t was not supposed to be, it was not intended to be, an aggressive agent increasing or decreasing, the supply of money for some such goal as stabilizing price levels. Since it was felt the central bank was set up to insure there would be adequate credit accommodation for major economic interests in the country, those interests were represented, and since it was a mechanism for bringing the commercial banks together into a tightly knit organization no longer suicidally inclined, it was felt the commercial banks should be represented, all this quite validly, I think, under that original conception of central banking. This is no longer the conception of central banking that it should feed credit to certain specific interests, so I think the Congress might well consider some of the stipulations in the Federal Reserve Act regarding the representation of certain specific groups from which are omitted, let's say, labor unions and college professors. We should review those regulations to see whether something more relevant to the general interest might not be substituted. And one final minor matter: We have been debating a good deal the role of monetary policy in 1952-53. I don't think anyone of us is in a position yet to say how great the effect of the change in interest rates running from 194C, for that matter, will be when easy money was terminated. I don't see how anyone of us can say how powerful the punch was that this progressively tightening monetarj7 policy brought or how powerful the punch has been in terminating the recession. As one looks at the superficial data, he is<inelined to say that monetary policy probably was not very important. The decline in gross national product apparently was concentrated in two major fields: (1) The spending oi the Federal Government in relation to its receipts, and (2) in the accumulation of business inventory. UNITED STATES MONETARY POLICY 135 The demand for residential housing slumped vei7 little. The demand for consumer durables slumped very little. I t doesn't appear because of the specific place where recession occurred that monetary policy could have been primary phenomenon. To the professional economist this looks like an inventory cycle— a very minor inventory cycle of the type that we expect in a free-enterprise society. Now, as to two general issues, there has not been in this country for a very long time an intelligible debate on the ultimate goal in monetary policy. Some people have an absolute goal in mind—lengthening the public debt; other people have another goal in mind—stabilizing interest rates; other people have in mind stabilizing price supports; other people have a different goal—stabilizing employment. These are not mutually compatible goals. If one stabilizes employment, he cannot stabilize prices. Senator DOUGLAS. D O you feel that firmly? Mr. SHAW. I feel that quite firmly, that if one is going to stabilize employment in a technologically developing society where unit costs are falling, then he perhaps is going to have falling prices. On the other hand, money wage rates and farm prices are being pushed ahead of rising productivity in a growing economy, then full employment is going to need a rising cost hveh I t seems to me that full employment and price stability except under the very special circumstances where there is no net change in technological productivity and no net change in price Senator DOUGLAS. May I take up your first proposal, increasing efficiency. Isn't it possible to absorb the increased output per manhour through increased money wages and money distribution, which in turn would be financed through an expansion of bank credit commensurate with the increase in production so that the price level would be kept relatively constant. Mr. SHAW. If factor prices rise. Senator DOUGLAS. In money terms as well as in real terms.: Mr. SHAW. Yes, this isn't offset. I should put my answer in net terms. Senator DOUGLAS. Isn't that really the point. During a period in which output is expanded both in terms of total and hours, output per hour as well as total output, you should have commensurate expansion in total monetary purchasing power to help stabilize the price level. Mr. SHAW. I think this is probably the rather fortuitously successful result of policy. I don't think it can be counted upon that factor prices will rise perfectly in step with technological advance. Senator DOUGLAS. Oi course, this cannot be done in perfect step, but if there is validity, and there seems to be long-run validity in the approximately 3 or 4 percent increase in output per year, doesn't that point to approximately a 3 or 4 percent increase in the supply of money, assuming the velocity to be constant? Isn't that a fairly good rule, granted that the adjustment isn't perfect? Mr. SHAW. Well, my answer would still be, I think, Senator Douglas, that if our goal is full employment, then—and let me put it this way. Maintenance of stable prices is going to require that there be a closely comparable rate of increase in productivity technically to go 136 UNITED STATES MONETARY POLICY right along with the increase in factor prices which is determined really by factors other than an increase in productivity. Senator DOUGLAS. Excuse me, Mr. Chairman. Perhaps I am prolonging this discussion unnecessarily. Representative PATMAN. I t is a very important point. Senator DOTTGLAS. You speak of prices in terms of money. You have got to have an increase in the money supply and in factor prices. If you assume that the banking mechanism determines the total supply of money, then the increase in factor money prices is contingent upon a prior increase in the supply of money, and therefore it seems to me that it is perfectly consistent to have expanding output and stable prices. The other problem, however, is where you have ,to have some fever, where you have to have some inflation to get full utilization. I hope this will be very seldom. But it presents a different question. I still see no necessity for falling prices. Mr. SHAW. NO, I would rather expect rising prices, Senator. I would rather expect that if we were to succeed in maintaining consistent full employment, which would mean consistent pressure upon the total available supply of resources, that it would be highly improbable that the prices of those resources would stay stabilized within the limits of rising productivity. I would expect money factor prices to gain more rapidly than physical productivity. Senator DOUGLAS. Why is that inevitable? Mr. SHAW. Simply because of the bargaining position on the part of the supply factors as against the demand factors. Senator FLANDERS. We have here a most important question. Suppose we make mental or physical note of it and continue on, and then come back to it. Mr. MITCHELL. My first remark, Senator Flanders, would be on one of the two questions you raised, and of course it would be on the same thing that Mr. Shaw and Senator Douglas have been speaking of. I would like to see if I can't provide one of ,the little bricks that would fill the chinks in their argument. Senator Flanders mentioned before lunch those of us who suspect that some inflationary pressure, however mild, is necessary if we are really to maintain full employment. Senator Flanders asked if high levels could be reached and maintained only with inflation. Now, I wouldn't say it that strongly. I t is possible logically and it is historically a fact that for a time at least they perhaps can be maintained without inflation. But I believe that the chances for steady growth are better if a mild but certain upward pressure is kept on prices. I t makes several things possible, for example, that are not possible if we try rigorously to keep a very delicate balance, exactly on keel as far as prices are concerned. Agriculture, Senator Douglas, is one of the things that appears to me to be chronically depressed even when the general price level is stable. In that year you picked for illustration before lunch, 195152, when the general price level was pretty steady, agriculture lost seven points from parity. Senator DOUGLAS. I t shot up tremendously in the preceding year. UNITED STATES MONETARY POLICY 137 Mr. MITCHELL. Well, that is quite true, but the drop hurt worse than the rise had helped, because marketing margins had become rigid at the higher level. However, I think one of the points that would make me agree with Mr. Shaw is the fact that this Nation isn't a chart like the economists like to draw with such a thing as wages and factor prices falling neatly in place. I t is a combination of hundreds of different charts and some major industries behave in quite different wavs. 1 would say that I am about to be convinced by some figures that I have been studying for the past year and a half Senator FLANDERS. YOU feel it coming, do you? Mr. MITCHELL. That the general economy must rise about 3y2 to 4 percent in physical productivity, and about iy 2 to 2 percent on top of that in price inflation for a total of 5 to C percent gross national dollar product a year for agriculture to hold its own. Agriculture, it seems to me, is a chronically depressed industry for a number of factors which I have gone into in the papers I presented before this committee in February, if we try to maintain a very delicate stable price. Senator*DOUGLAS. You mean because of the inelastic demand? Mr. MITCHELL. That and several other factors, Senator Douglas; for example, the tendency of the marketing margin always to grow. Another point, we recognize that there will be fluctuations up and down because of the sheer administrative impossibility of keeping national indexes exactly level. Xow in that case there are bound to be some depressed and somewhat underemployed periods, if we try to hold exactly level and avoid inflation as the plague. If we plan a slightly rising trend for prices in this country, fluctuations would go for a period below the trend line, but can still nevertheless be kept above the line of acute trouble. What I am saying is that at times when we are above the trend line, we will be overemployed. I think you all recognize what a flexible thing this full-employment concept is. You can be overemployed by bringing women out of the homes and older people out of retirement, and so on. There will be periods of somewhat overemployment alternating with periods of less employment, but still well within the limits or reasonably full employment, and the result will average out pretty well, and I think we could still say it would fulfill the requirements of the Employment Act. Another point, imports are much easier in a long period of gradually rising price levels, and if we mean what we say, that we want to improve our international trade position, if we want to increase our international trade, we have got to find some way to keep business from yelling so hard whenever we make an attempt to open our borders to a few more foreign commodities. In time of a steadily rising price level, as other economists have pointed out, particularly Sumner Slichter in an August 1951,1 believe, Harper's article, "How Bad Is Inflation," Slichter points out, I think correctly, that we cannot really have an increasing international trade in this country unless we have a slightly rising price level. Our local manufacturers, farmers, laborers, and merchants simply won't allow it. 138 UNITED STATES MONETARY POLICY Senator FLANDERS. If I may say, the experience of New England with free trade as compared with the South has left us with the distinct impression that it is a very painful thing. Senator DOUGLAS. Well, since that issue has been injected, may I say that while I sympathize with the plight in which New England now finds itself, and while I would like to see a revival of New England industries and am against the special favors which the South gives, I would like to point out that New England for generations received special favors from the Government by means of the tariffs which the textile and other New England industries were able to impose, and that in a sense New England is now suffering or being punished for the sins of their fathers and grandfathers. They levied tribute upon the United States for decades. Senator FLANDERS. Those favors were accessible to anyone, and when the South finally began to take advantage of them, New England suffered very naturally, but I still say that it suffered from internal free trade. Senator DOUGLAS. May I say that from the time of Henry Clay and the foundation of the Whig "Party, which later became- the Republican Party, New England prospered at the expense of the rest of the United States, and I think in a sense the protection which New England received during that period atrophied their will, their courage, their resolution and desire for experimentation, and combined with the system of trusteeship which they built up in Boston, and which Mr/Marquand has characterized in his novels, this is partially to blame, although not wholly, for the plight that New England now finds itself in. Now I say that, and at the same time I do not approve of the unfair tax advantages and the excessive protection against wage scales which some of the southern communities hold forth to entice industry from New England. Senator SPARKMAN. Don't look so straight at me, Paul. We don't do these things in Alabama. Senator DOUGLAS. My good friend from Vermont, when he enters this piteous plea about the hardships of removing the tariffs, leaves me somewhat cold. Mr. SHAW. May I come back to the discussion for just a moment? Senator FLANDERS. Yes. Mr. SHAW. I t seems to me, Mr. Douglas, in illustrating full employment and continuous full employment, the odds^ favor inflation, and that if it is not New England or the South, then it will be agriculture or trade unions that will be insisting on a larger share than the one they have, a, more fair share of the national output. This means a rise in their money returns and inflationary pressures. Senator DOUGLAS. This is a fundamental point, and it goes back to the issue that Mr. Patman has raised. In a period of comparatively full employment where the danger is inflation, I would like to have the bankers run the banking system of the country, and I would trust them more than the politicians to determine the total amount of bank credit to be created. But in a period of recession or depression, if we are unfortunate enough to have a depression, I am afraid that the conservative policies of the bankers would probably not then be adequate to expand UNITED STATES MONETARY POLICY 139 active purchasing power, and if they did not then I would favor the politicians stepping in. I t is a somewhat humorous way of putting the matter, but I am suggesting a 2-platoon system to run the Federal Reserve System. Let the educated bankers run it during the period of prosperity and the educated politicians run it during the period of depression. Senator FLANDERS. Who makes the shift? Senator DOUGLAS. The people. Mr. MITCHELL. I must disagree with Senator Douglas. I am afraid if we did it that way, the bankers by their action would make certain that there would be a shift. Senator GOLDWATER. Mr. Chairman. Senator FLANDERS. Had you finished ? Senator GOLDWATER. I just wanted to ask Senator Douglas if he called that the two-platoon system. Senator DOUGLAS. That is the two-platoon system. Mr. SMUTNY. Actually, when you come right down to it, the basic ingredient of prosperity or continuity of prosperity is confidence. Confidence has been gained by our banking system through, I think, the leadership of the Federal Reserve. Although we have looked at this possibility in a slightly humorous light here, it is a very serious thing. Confidence in the banking system must depend upon the action of the Federal Reserve, in my opinion. Mr. CHANDLER. Mr. Chairman, may I make a comment on the implication that general monetary policy should be used to cure structural defects in the economy. I t seems to me that general monetary policy was never designed for that purpose and could never accomplish it. For example, if it be true today that the farmers are not getting their share of the real national income, I do not see how you can possibly cure their situation by having a continuous and perhaps a cumulative inflation, because this would be a situation in which everybody's money income would be going up, in which everybody's prices would be going up, and I can't see anything about the process that would raise the price of farm products relative to the price of other things. The farmers' trouble is not a low absolute price level; it is a low price level for their products relative to the prices of things they have to buy. And it seems to me it might get continuously worse rather than better. The other point relates to those American industries that suffer competition from imports. An inflationary situation would raise costs as well as prices, and the rising costs would be suffered by the American industries competing with imports just as well as by the other industries. So it seems to me we may get into very great difficulties here by expecting general monetary policy to cure structural defects that inquire a reallocation of resources. Some of these adjustments may be made easier if we maintain full employment, but not necessarily by a rise in the price level, and I am not yet pessimistic enough to think you must have continuously rising prices to have something like full employment. 140 UNITED STATES MONETARY POLICY Senator FLANDERS. May I make just two observations on my own. One is that if the.thesis is maintained that a continuously, even though slightly rising price level, is the simplest and best way to maintain a high degree of employment, I think it is also true that anything apfull employment by the interaction of the labor market (noaching: eads to higher prices. Xow, the Lord, I think, made the hen before He made the egg, but of that I am not quite sure. Maybe Hen made the egg first, but I think He made the hen first, and this is a hen and egg proposition. The other thing is just a matter of tactics. I t is inadvisable for those who feel that an increase in foreign trade is good in itself to attempt to make great gains except in times of high employment. I t just can't be done, so I think that that had better be put down as one of the facts of life. Mr. WILDE. Mr. Chairman, I wanted to ask, in view of Mr. Mitchell's emphasis on the chronic depression of the farmer, whether that is a correct premise. Xow, our company has been in a farm business, or was in a big way, owning over 1,500 farms, when I became president in 1936, so I have had personal experience. Commencing with the Second World War, in 1942, the farmer has had a high degree of overall prosperity, and it ran through the fifties, and it is still quite high, relative to any historical periods. In other words, it has been about 12 years where agriculture, instead of chronic distress, has been generally prosperous. Xow, individual farmers through the vicissitudes of weather have not done well, but on an overall basis agriculture has been good. If we have chronic distress, I don't understand the terni. We do have a problem with agriculture which is partly political and partly economic, looking into the future, because ot the relative inflexibility of demand,.and a great deal of this prosperity that I claim the farmers had arose out of an abnormal demand. So it was perfectly natural that in the last 2 or 3 years, with a reduced worldwide demand for agricultural products, there would be a reduction in profit, but to say depression and chronic depression, I do not understand. Senator FLANDERS. XOW, I would suggest, since there are 4 who have not been heard from formally and 3 who have not been heard fyom either formally or informally, that we ask Mr. Mitchell to conclude within the next few minutes, and we will move on. Mr. MITCHELL. I would like to suggest that I wait until the next time around, because the next question is the one you raised, Senator Flanders, on why I think a great agricultural investment revolution is needed in the face of the apparent surplus. Senator FLANDERS. YOU promise to keep that in mind. Mr. MITCHELL. Right. Senators FLANDERS. Thank you. Mr. Land? Mr. LAND. I would like to address myself first to Mr. Patnian's question as to the effect of banks' holding securities on banks' willingness to make loans. I think under normal conditions there is very little effect, that is, in the sense of restricting a bank's willingness to make loans. Banks, UNITED STATES MONETARY POLICY 141 if they are going to stay in business, have got to attract and hold depositors, and there is no better way to do that than by making loans. No bank that I know anything about under normal conditions decides that it will not make a good loan because it wants to retain a Government security. There is one condition, however, under which banks may tend to turn down loan requests, and that is when the Government securities market is down in price. If Government securities are selling materially below what banks paid for them, then banks may tend to turn down loan requests. But that is exactly the time when that is the right thing to do. In other words, that is the period of monetary restraint, and that is the right policy for banks to be following. That is the policy which the Federal Reserve intends that they shall follow at that time. As far as banks taking care of personal loans, that has been developed to a very large extent in this country. Our bank is thought of as being a bank for big business, and it is a bank for big business, but we have gone directly into the personal loan business in the last 8 or 10 years, and indirectly we have gone into it to a very large extent. By that I mean we make loans to finance companies all over the country. Most of the money which finance companies lend is bank money. In other words, the finance companies borrow from banks and relend it to customers, so that really a very large amount of bank money is being put out on small personal loans. My question about it is not whether it is enough but whether maybe we are not becoming too adept at it. Also, I would like to say that I agree very largely with what Mr. Patman had to say about the discount rate. I think within recent years its effect has been mainly psychological. I t has had very little practical bearing. Banks, as a matter of policy, borrow as little from the Federal Reserve and as infrequently as they can, so what the rate is is not too much a practical matter with the banks, but it has a general psychological effect, and that is all it has had in recent years. In addition to what Mr. Smutny had to say about why low interest rates did not work in the 1980's, I would like to make this observation. The 1930's followed a period in which many people got in trouble by borrowing money. Most people had a psychology of wanting to stay away from debt, having some very bitter experience in borrowing money. The will to borrow was lacking. Now, we have had a period of time when practically nobody has got in trouble by borrowing money, and a lot of people have made a lot of money by borrowing money. We have entirely a different psychology now, and easy money does stimulate business under these conditions, whereas in the 1930's it had substantially no effect. Senator FLANDERS.. May I ask you a question there? The question is: In the case of borrowing money, is there any difference either in the psychology of the borrower or the lender where the project from which the money borrowed is something whose results are easily calculable ? 55314—54 10 142 UNITED STATES MONETARY POLICY For instance, a bond issue for a utility plant or a soundly based real* estate operation, on the one hand, or, on the other hand, something in which there is an element of venture or risk. Doesn't the effect of a low interest rate apply almost wholly to those easily calculable undertakings? What difference does it make as between 2^/2 and 4 percent on something which, if it works out, will bring in a great deal more ? Take a manufacturing operation, not a wildcat operation. Mr. LAND. I was going to say, as far as business expenditures are concerned, I think the rate of interest has practically no effect. In other words, whether business pays 3 percent or 3*^> percent for money really hardly could be found in the final result, there are so many other factors of so much more importance. Easy money produces its greatest effect in two areas of the economy, residential construction and State and local public construction. There the interest element is a big part of the total cost, and I think we have seen that working in the last year. Senator FLANDERS. I t becomes more important as the length of the amortization is extended ? Mr. LAND. That's right, where the interest element is a large part of the total. In business the interest element is not a large part of the total. In residential carrying charges and in State and local carrying charges interest is a very important part. Mr. SsruTNY. Mr. Chairman, might I interpose there for a moment ? I beg to differ. I think that the interest element is very important, as far as business is concerned. I can bring out through experience that in 1953, when interest rates started to run up competition for loans on the part of the Treasury we immediately found that industry rushed into the market and did \ tremendous amount of financing. Subsequent to that, this year of 1954, we have seen some instances where industry has called the obligations that were issued in 1954 because they could be refunded at a lower rate, so therefore the interest rate does really become an important factor. Mr. LAND. Only as to timing. Sir. SKUTNY. I know there is a great deal of difference when you borrow on money and pay 3 % percent or 4*4 percent. Sir. LAND. I have never seen a corporate budget where the rate of interest made one bit of difference. In other words, you see all sorts of corporations laying out budgets for the next year or so. Senator DOUGLAS. Are you speaking of working capital now or fixed capital? I can see that in the case of working capital a change in the interest rate is not particularly important, but on a long-time investment would not a change Mr. LAND. I have never seen a corporation make up two sets of figures, one based on this assumed interest rate, and on the other Senator DOUGLAS. But f ov current operations; isn't it ? Mr. LAND. For working capital? Mr. SMUTNY. In 1953 we had two instances of the largest corporations of the United States deferring issuance of bonds because of the interest rate. Mr. LAND. I grant you that a period of disturbed interest rates, a period of disturbed market prices, can affect the timing of business UNITED STATES MONETARY POLICY 143 expenditures. I t can cause things to be put off, but on the question of whether expenditures are going to be made or not made, I think interest rate is almost immaterial. Mr. WILDE. Mr. Land, I see no evidence in our current experience that interest rates on housing are vital, within^ quite some range. A house today is bought as a package. The significant thing is the downpayment and the monthly payment, and the buyer doesn't inquire about the rate of interest. He will buy it at &y2 percent just as quickly as at 4 percent. More houses are being financed this year than when the rate was 4 percent. I t is in the cost, but it is so small spread over the years that the buyer doesn't know it or doesn't bother about it. "How much do I have to pay down, how much do I have to pay monthly ?" Senator FLANDERS. He doesn't inquire, then, as to the period required for amortization ? Mr. WILDE. Not particularly. He is principally interested from the straight merchandising angle, "How much do I have to pay down, how much do I have to pay a month?" He buys his automobile the same way. Senator FLANDERS. I S he thinking of his monthly payments, really, in terms of rent? Mr. WILDE. Yes, he does, and that is why he doesn't regard the components of it as important. I t is: Can he pay that monthly rent from his jpay check? Mr. LAND. I grant you he doesn't break up the monthly charge into its components, and yet interest is undoubtedly the largest component. Mr. WILDE. I t is a very large component, but if we hadn't had quite so much easy credit, I think the gross cost of a house wouldn't have been as high and he might have had a better buy. Senator FLANDERS. Thank you, Mr. .Land. Now, Mr. Harris. Mr. HARRIS. Senator Flanders, I want to make you a little happy and tell you that here is an economist who agrees with you on New England tariff. I might say you may be interested to Know that I am going to Washington next week to represent the six New England Governors on this issue, to point out to the Tariff Commission that the tariff is only one part of national policy, and that when you are doing a job on New England you ought to take into account not only the tariff but everything else the Federal Government has done to New England. This is the present, Senator Douglas. I am not talking about the past. Senator DOUGLAS. New England always wants to have the past forgotten. Mr. HARRIS. And I might say, Senator Douglas, and I think I told you this before, that if New England continues to lose its textile industry at the rate of the last 3 or 4 years, there will be no textile production left in New England in 10 years, and it would be a shame if through a tariff, a reduction of the tariff, the amount of competition the New England textile industry has to face would be increased. Although I still call myself a free trader, I think you can't be too doctrinaire about these issues. Senator FLANDERS. May I interpose a moment? 144 UNITED STATES MONETARY POLICY There was a certain watchdog of the Treasury in the House many years ago; I forgot his name and I forgot who made the remark, but he opposed every appropriation in the rivers and harbors bill until it came to an appropriation for the Illinois River, whereupon he favored it, and someone got up and said: T i s sweet to hear the watchdog's surly growl turn bark of welcome as we near our home. You and I are in the same box, but I think we have a modicum of reason on our side. Mr. HARRIS. I am sure we do—a great deal. I might say, Senator Flanders, if you will continue in this position you will be ruled out of the trade association of economists, as I am about to be. Xow, getting back to the issue we have been discussing, I think both Senator Douglas and Senator Flanders raise the issue, and several others, of whether we can have both stability and growth. I think Mr. Wilde expressed some doubts on this issue. Xow, I am inclined to think—of course, this is a matter of judgment—you weigh one against the other. For example, in the campaign—I am not saying this for political reasons, either—the statement was made often in 1952 that the dollar was only a 50-cent dollar. This, of course, was true and was a legitimate charge to make against the Democrats. On the other hand,, nobody did say there were four times-as many dollars around, which is also an important part of the whole* story. Of course, you don't expect the whole story in campaigns. At any rate, this is the problem, that inflation does to some extent contribute to growth, and it is very difficult, if you are interested in growth, to draw the line exactly, and assure no price increase. If you go back to 1913 you would find that we have had a price increase of about 125 percent over a period of about 40 years. In that same period we have increased our real income by 4 times, and had 2 major wars. Xow, is this really such a bad record? This amounts to a cumulative compound increase of prices of only a little bit more than 2 percent. Let me also point out to you that between 1948 and 1954, there has been an increase in prices of only 6 percent, which is quite a remark-able degree of stability, considering all the activity we have had. Let me also point out that from 1951 through 1953 we had an increase in gross national product of 10 percent, in addition to price stability, and this is also a rather remarkable thing. Senator DOUGLAS. Mr. Harris, that is just the point that I would, like to appeal to, that for 21 months we did have an approximate price stability at approximately full employment and growth, and the question I would like to raise is whether that was purely accidental or whether things weren't done pretty well during that period prior to the change of heart on the part of the Federal Reserve System and the development of a new regime at the Treasury. Senator FLANDERS. Senator Goldwater. Senator GOIWATER. I would like to ask your opinion of whether or not the majority of that gross national product—I won't say themajority, a large portion of it—went into nonconsunier goods, didn't. have some effect on that so-called period of stability? UNITED STATES MONETARY POLICY 145 We were producing, as I recall it, from 14 to 35 percent of our gross national product during that 10-year period for national defense or nonconsumer goods. Mr. HARRIS. That's correct, Senator Gold water, and I just jotted down some figures for 1951 to 1953. Here we had an increase of GNP of $37 billion, increase in consumption was $21 billion, a little more than half; investments were down by $3 billion; Government was up by $21 billion. There is no doubt about the high level of Government spending having a good deal to do with it, just as I would say the fall of $9 billion in Government spending last year has certainly helped to bring about recession, but this has been offset by a corresponding decline in taxes with a small lag, so you might say the net effect of these Government operations was zero. There was some small fall-off in investment, so I would say in a general way I don't khow, Senator Douglas, whether it was accidental or whether this was all planned. I think there was certainly some planning in it. YTe had our President's Council of Economic Advisers. The thing certainly worked beautifully, and it suggests that the thing is possible, and certainly we had all kinds of fiscal and monetary policies, although I myself feel monetary policies can be pretty powerful on the rise, but not too powerful on the decline. Our experiences seem to indicate this. Mr. Wilde said a great deal about the danger of inflation. France lias had a devaluation of 99 percent in 33 years. Latin America had an increase in prices of 500 percent, on the average^ since 1939. People don't save under these conditions, but when you look at our own price ]iistory, we have had too much inflation, we could have* had less? but, on the whole, considering what we have achieved, the inflation hasn't really been too bad. I can understand why an insurance man would be worried about inflation, but you have to look at the whole thing, not only the stability •of the dollar but the amount of growth and how much the small amount of inflation we have had has contributed toward that growth. I am sure we have had more growth because of the amount of inflation we have had. I am not trying to defend inflation. I think we have had too much of it, but I don't think we should leave out of account what has accompanied inflation. Senator DOUGLAS. Mr. Chairman, would I be impolite if I filed a •demurrer. Senator FLANDERS. YOU don't mean a demurrer—a brief. Senator DOUGLAS, T O the degree that you stimulate growth through inflation, you have done it by transferring purchasing power from those who have fixed incomes, notably the salaried groups, and also those whose incomes come from bonds, pensions, aaid so on. Senator FLANDERS. Don't forget the widows and orphans. Senator DOUGLAS. They are included in these other two categories. And you have transferred income from them to the adventurous classes of society, with the result that you have undoubtedly stimulated investment, but you have also increased nightclub spending, too,, in the same way, and I question whether this is a policy which should be consciously followed. 146 UNITED STATES MONETARY POLICY I t seems to me that it is something that should be avoided, if it is at all possible, and that we should try to hold to a doctrine of price stability, yet substantial, full employment, with investment financed out of savings rather than through transfer of income or the creation of additional short-time capital. Senator FLANDERS. Senator, not to interrupt, but would you say that again ? There were three points. One was maintenance of employment, maintenance of production, and expansion out of savings? Senator DOUGLAS. Well, price stability. Senator FLANDERS. Price stability; that's right. Senator DOUGLAS. Economic growth, and substantially full employment. Senator FLANDERS. Economic growth and substantially full employment. And the increase of employment and production that comes from the increase of population, do you expect that to come from savings or would you allow a corresponding growth in the credit money? Senator DOUGLAS. Oh, you have got to have a corresponding1 growth in credit money. Mr. MITCHELL. If it were financed all out of savings, the price would drop, so you have to have an equivalent inflation of credit. Senator DOUGLAS. That's right. I would not call it inflation, but rather an increase in money to stabilize prices. Senator FLANDERS. I just wanted to get that clear. Senator GOLDWATER. Mr. Chairman, isn't it true—and I direct this to you, Mr. Harris—we have only had in our economic history one very short period of so-called stability in prices? We have just gone through that, and that was brought about by very, very unusual circumstances, and I think you and I agree. I don't think it is an experiment that we want to continue. * I agree with these other gentlemen that price stability is something that is rather impossible, just as employment stability has proven to be impossible in the past, but maybe we can work out the secret. Mr. HARRIS. Senator Goldwater and also Senator Douglas, I would say this: I think we are all aiming at the same thing. X think, for example, the Federal Reserve is trying to give us growth, high employment, and price stability. I think they have tried to give us price stability but they also have given us some unemployment. This is the issue. I would be inclined to risk a certain amount of price instability, say, even an increase of 2 or 3 percent, and get rid of, say, one or two million unemployed. I would be ready to take that risk. The authorities don't seem to be ready to take that risk, or they would give us a much higher level of excess reserves, it seems jto me. Senator FLANDERS. Then, in brief, on this question, you feel that the opportunities for the maintenance of employment, and I presume of production and a stabilized standard of living, is improved if there is a slight expansion of inflation ? Mr. HARRIS. That's right; a slight inflation is what we want. Senator FLANDERS. That is what I wanted to get clearly in mind from you. Senator GOLDWATER. Mr. Chairman, would that be in excess of what we would consider normal inflation? UNITED STATES MONETARY POLICY 147 Mr. HARRIS, I wouldn't worry too much about 1 or 2 percent a year. I would certainly try to keep it down to that. I would say 125 percent over the last 40 years is a little too much, but we must not forget we had these two major wars, and I once made an estimate of how much inflation we had in World War I I compared to World War I, on the basis of the percentage of the economy going to war and compared with the Civil War, and our record in World War I I is 4 times as good as in World War I, and 12 times as good as in the Civil War. Senator GOLDWATER. Where did the dangers of inflation come in this last period; during the second war or the second war and Korea? Mr. HARRIS. It was sort of a postponed inflation which we should have had in World War I I , in the absence of controls, so I would count as part of the World War I I inflation some of the inflation we had after World War I I . I will try to answer 2 or 3 more questions rapidly because I don't want to take too much time. Congressman Patman raised an interesting question about whether it would be a good thing for the banks to have a large volume of public securities which kept them from lending money to the public. I was talking about public securities in terms of giving us an appropriate amount of money. In other words, the banks have to hold adequate earning assets to create adequate surplus of money. Now, I would agree with Congressman Patman that if they were to do the job by lending to the public, as originally suggested by the Federal Reserve Act, that is one thing, but since they don't seem to be able to do this, I would say it is important to hold a certain amount of public securities, or inadequacy of money will injure the economic system. On the issue Senator Goldwater raised, why didn't the low interest rates in 1933-39 do us any good, I would say it didn't do us much good, and the reason is there are sometimes factors that are much more important than interest rates. If businessmen lack confidence, if prices are falling steadily, if their anticipations are very pessimistic, then you can cut the interest rates down to zero and it wouldn't have much of an effect. But it would have a greater effect in the situation we are in now where there isn't this widespread pessimism. Now, the other point I wanted to make, a point I made this morning, I want to emphasize very much, and I think it is a very fortunate thing, it would be an awfully good thing, for example, one might argue it would be a very good thing if the net result of the Federal Reserve policy was that they control not only the commercial banks but all other lenders of funds, but the fact of the matter is that they don't do a very good job—I seem to have lost a sheet on which I had these notes, but I can give them to you—if you look, for example, at the 1952-53 fiscal year when they were trying to restrict credit, you will find there was an increase of $30 billion in loans and advances, and of these $30 billion the commercial banks provided only $3 billion. In other words, we had some expansion, fortunately, during this period, despite the attempts to restrict the total supply of financing, and this was because of the fact that the Federal Reserve bank did not control the noncommercial bank lenders, and exactly the same thing has happened in 1953-54. 148 UNITED STATES MONETARY POLICY In fact, virtually all loans in the fiscal year 1953-54 have been made by noncommercial bank lenders, and this is something we have to keep in mind. Senator FLANDERS. Are you saying, in effect, that you would like to see the Federal Reserve control expanded over nonmember banks, and perhaps over softie other lending institutions ? Mr. HARRIS. I will be a little more subtle than that, Senator. I was trying to say I would like to see them take over this control if they do a good job. If they don't, I think it is just as well that the control lies with the insurance companies and the savings and loan associations, and so forth, but this is an area, it seems to me, where the Federal Reserve System hasn't really got to first base. One final point and I will quit, and that is, I was talking to one of the gentlemen of the Federal Reserve right after lunch, and he said: "Don't you know that we know you have to control the rate of interest?" Well, all I can say is I wish anybody would read page 24 of the answer to the intermediaries in this. I won't bother to read it to you now, and see if you feel it is an adequate statement of what Federal Reserve policy should be on the rate of interest. I am glad to know that some of the high authorities believe that they should control the rate of interest, but I defy the Congress to read this reply and say that there is a clear statement the Federal Reserve is ready to go out and control the rate of interest, rather than wait until something disorderly happens. Mr. SMUTNY. Mr. Chairman, may I inject something here, please? Senator FLANDERS. Yes. Mr. SMUTNY. That is the following: I don't think any statement has been made here either on the panel or any recognition has been made of the fact that savings are institutionalized now. Years ago the individual saver was quite a factor in the bond market. Today actually a vast amount of funds available for investment is not through the individual in the bond market, but through institutions of deposit insurance companies, and so forth. We do not sell bonds,to the individual. We sell bonds to the institutions, the savings hanks and insurance companies, and a vast change has taken place in our entire investment market, and thereby the effect of the operations of the open-market operations of the Federal Reserve on bond prices is so important because the vast savings of the people have become institutionalized. I think that is a factor that should have due recognition. Senator FLANDERS. Thank you. Xow, Mr. Clark. Mr. CLARK. Mr. Chairman, I feel that the concentration of attention upon what monetary policy has done and can do in a period of inflationary danger gives a sense of unreality to this.meeting. No one is bothered about.inflation today. We are bothered about the fact that the economy under monetary and other policies has not been progressing since the first of the year, and unemployment has not been cured, and the number of employed has not been rising at all, let alone in step with the large increase in the labor force and the working force. UNITED STATES MONETARY POLICY 149 Now, the agenda for the meeting bars us from discussing and analyzing the condition today as it may lead to our proposing policies to bring about economic recovery other than monetary policies, but surely we do within the limits here imposed have occasion to consider whether monetary policy during the past year has advanced the cause of prosperity in this country, whether there is now some condition which may be improved by monetary policy, and if so, what monetary policy can do for us. I have suggested one monetary policy which now might be adopted, that would have terrific impact upon the economy and perhaps would give us the additional drive which we need to get out of the stalemate which has existed since January. We are going to have the industrial production figures for November in a few days. The circumstances which made it possible to bring out these figures before the> end of October hardly exist now, so we have to wait until well into December. And those are going to be tricky figures that you must look at with considerable sophistication. We know that there has been a very large increase in employment in the automobile industry, and we know that there has been an attending increase in steel production, an increase in employment in steel production. And if the economy otherwise has done nothing more than continue on the dead center which it has occupied since January, we are bound to have a noticeable increase in the industrial production index, and it will fool the casual observer into thinking that it means that longawaited recovery has finally come around the corner. Senator FLANDERS. Excuse me just a moment. Mr. CLARK. Yes, sir. Senator FLANDERS. But was not the recession in part due to the decrease in unemployment in just these same industries? Why shouldn't you take it on the upturn as well as on the decrease? Mr. SMUTNY. No, sir. Mr. CLARK. NOW, Mr. Chairman, to answer that, I have to again caution you against the acceptance of bare statistics. This apparent decreased unemployment, we find, occurs in a situation where the .labor force is not expanding. We know actually the working population is growing; we know that in the past 2 yearsit has increased by a net of more than a million and a half, but we do not find that in the official statistics, and the unemployment figure is merely a residual figure, the difference between the number who say they are hunting for jobs and thereby are qualifying for inclusion in the labor force, and the number of those who say they have jobs. Why is it that the labor forces does not show an expansion in the statistics ? I t is because in periods of slow business, many peoplewho otherwise would be looking for jobs, knowing that now there is no need to do it because they cannot get them*, do not classify themselves when interrogated, as being people who look for jobs, so that leaves them out of the labor force. Senator DOUGLAS. Would you amend that statement to say donot so classify themselves or are not so classified by the enumerators? Mr. CLARK. I do not know that that is just what happens, Senator. I think they are asked; I do not believe the interrogators undertake to classify them, excepting on a basis of their own responses. Maybe that is not what happens. 150 UNITED STATES MONETARY POLICY Senator FLANDERS. Are you taking into account the seasonal decrease in* the labor force on the part of those who seek employment during the vacation, and go back to school? Mr. CLARK. Well, of course, that is a real reduction in the labor force; we must take that into account. But having consideration for all of these factors, Mr. Chairman, I think that the figures on unemployment are understated. Senator DOUGLAS. That is correct. Mr. CLARK. And if we took those real figures, could get the real figures, we would find there has been no improvement in unemployment. How could there be when production has not been increased ? And, along with that, since you asked me to comment upon the subject, I take advantage of the opening, I read the other day a story about a Government release relating to the number of people who are no longer on the list of those continuing claims for unemployment insurance because they have exhausted their rights. I t was a very surprising figure of people who did have unemployment insurance no longer are receiving benefits and, therefore, are not listed in that statistical item, which has been dropping somewhat, and who are, perhaps, not unemployed at thi* *ime. I do not want to overdraw the pessimistic picture of the economy today. A year ago, I think I was, perhaps, the most outspoken of the optimists who saw a fine business year anead in 1954. If the agenda permitted us to discuss the situation that, I think, Mr. Chairman, if you will permit me, ought to be engaging the interest .of the committee today, I think I could point out the reason for the error in my optimistic.view that the slideoff would soon end, and that immediately thereafter, as happened in 1949, business recovery, business expansion, would begin. Xow, perhaps November is going to put us over the hump; perhaps the tremendous impulse to the economy which will come from the combination of increasing production and employment in the automobile industry, increasing production and employment in the steel industry, and the 3 weeks of frantic Christmas shopping which is ahead of us, will give, the economy the push it needs. The basic factors have all been there all the time,and I wish that we could see some way to add to these forces of the private-enterprise system, which are now giving us the third chance this year to come out of the doldrums, that we will be able to add to these forces some impulse from Government action. Senator FLANDERS. D O you see that impulse as coming in the monetary and debt-management field? Mr. CLARK. I see no sign of it, and that is what I mean. Senator FLANDERS* I mean, you do feel that it should come from that? Mr. CLARK. NO, indeed. I think the suggestion I made of one monetary policy which would be well worth trying was suggesting to you the poorest of the three major actions'which are possible and which, I think, ought to be taken; but it is the poorest. I do not know what would happen—I rather agree with Mr. Shaw, that the effect of increasing free reserves, freeing reserves, would be no increase in lending; there is no indication that bank lending is in any way restricted now by the reserve situation. The banks would simply put the money into Government bonds. UNITED STATES MONETARY POLICY 151 I do not agree with him that that would mean that the Federal Reserve would have to furnish the bonds. Why should it ? If the banks went into the market and bougnt the Government bonds, it would mean a substantial increase in the price of bonds, a reduction in the rate of return, and Mr. Humphrey would have that day he has been so eager. He would be able to refund succeeding maturities on a market that would not destroy the 2 ^ percent rate of the Victories. Mr. SMUTNEY. In my opinion, this is an endorsement on your part of the policies of the Federal Reserve and the Treasury, in direct contravention of your first statement. Senator FLANDERS. NOW, then, you do feel that so far as the existent or nonexistent recession is concerned, that in the field of our inquiry today, we might well consider the change in the excess reserves of the tanking system ? Mr. CLARK. Yes, sir; and that it could not do harm. I t would have to create prosperity, full employment, a larger purchasing power before it could reach the point where inflationary danger was appearing. You cannot have inflation Representative PATMAN. May I interrupt the gentleman ? Mr. CLARK. Yes. Representative PATMAN. I agree with Mr. Shaw's statement that reserves should not be reduced to the lowest point, but there should be a point in between so that in the event it was necessary they could be either lowered or raised in the future to take care of the situation. Mr. CLARK. N O ; I think if you are going to be daring enough to move, because you feel it is necessary to move, you had better use all your ammunition. I see no advantage whatever in retaining any margin above the legal minimum. Representative PATMAN. Would you reduce it right down to 7, 10, and 13? Mr. CLARK. I would, for this reason, Mr. Patman: We can see right now from our experience since last August—and we learned, as Senator Goldwater pointed out, in the thirties, that the action to reduce the rate of interest is of itself of very little significance in a period of depression or recession. So the only reason that we should preserve for the Federal Reserve some larger opportunity to act would be to enable it to act in the other direction, to impose restraints through the addition to reserve requirements which, I can tell you, is an action that does hurt banks. There is hot any difficulty coming to a bank when you reduce the reserve requirements; it is a harmless process, it enables the bank to buy some more Government bonds. But when you raise reserve requirements, since all banks try to keep fairly close to their reserve limit in their investments and their lending, it means that they have got to dispose of Government securities or they have got to withdraw from some profitable loans in order to meet the new reserve requirements, and there is not any doubt about that being a repressive action. Let us give the Federal Reserve enough leeway so that they can act that wray instead of having them caught, as we were in 1947 and 1948, when some of us were joining the Federal Reserve in approving the Eccles' plan, an action which he had to propose because they were up to their limit already on legal reserve requirements. Senator FLANDERS. Well, Mr. Clark, we thank you. 152 UNITED STATES MONETARY POLICY Representative PATMAX. May I ask him one question ? Senator FLANDERS. Yes; you may. Representative PATMAN. DO you mean to say that we are in for serious trouble if we do not take drastic action like that, Mr. Clark I Mr. CLARK. NO ; I said that it may be that this very important additional economic activity in the automobile and steel industries in November will be found sufficient to get us over the hump; but if it is not, there will not be a similar opportunity coming to us for several months, because 3 weeks from today we enter upon a period of seasonal business letdown. Senator GOLDWATER. Mr. Chairman, I wo.uld like to ask just one question. Senator FLANDERS. Senator Goldwater. Senator GOLDWATER. What are we talking about in terms of money, in numbers of billions of dollars, in this suggestion of yours? Mr. CLARK. The decrease to the legal minimum of 3, 7, 10, and 13 percent would mean freeing approximately 40 percent of the present reserves, and that would be $7 billion. Senator GOLDWATER. What was the amount of the last release, I think, in May or June of 1953 ? Mr. HARRIS. The total was 2% billion, I think, of all releases. Representative PATMAX. Senator Goldwater, would you yield for just a question there since it is an opportune time? Senator GOLDWATER. Yes. Representative PATJIAX. YOU state about $0 billion in reserves that would be released. Mr. CLARK. $7 billion. Representative PATMAX. That means a potential $42 billion in added credit then in the banking system. The banking system can expand to minimum of 6 to 1, and it might well be 10 to 1. That would mean a potential credit expansion of about $70 billion. Mr. CLARK. $70 billion of lending power Representative PAT3L4X. That is what I mean; it is not just $7 billion, it is 10 times that. Mr. CLARK. I t is $7 billion added reserves. You are assuming too much, Mr. Patman, if you convert that directly into increased lending. Representative PATMAX. What I mean it is possible. Mr. CLARK. They will not make the loans when they have excessive reserves there today. Why should the addition of excess reserves send them on a spending spree ? Representative PATMAX. They could buy more riskless securities. Mr. CLARK. They could buy (Government bonds, and wouldn't that be a good thing. Let us help the Secretary refund on a long-term basis a lot of these coming maturities. Mr. SMUTXY. Mr. Chairman, can I ask one question, please, of Professor Chandler because of the fact that he referred in the middle of the talk there about the fact that we were in a recession again, and quoted the figures that the unemployed jvere somewhere around 3 million people. After all, we recognize in 1953 that every time we got up to bat we knocked a home run, but you cannot expect to continue that, and in 1954, with 3 million unemployed, against a relationship, if you go UNITED STATES MONETARY POLICY 153 back to the records, where unemployed persons would run up as high as 9 million, and in 1933,13 million—3 million with GO million employables does not seem to me to be too far out of line. Senator FLANDERS. I t is not out of line statistically, but I think whenever we look at statistics of that sort we have to make them human and it is too much. Senator GOLDWATER. Mr. Chairman, one other question: I was prompted to ask this because of a story in this morning's paper indicating some concern about the situation in the stock market. Now, I neither subscribe to that nor do not subscribe to it. What d<*you think that the release of this money would do to the stock market? Mr. CLARK. The immediate effect would be on the bond market. Senator GOLDWATER. Yes. Mr. CLARK. And usually, I think, they believe that the shifting of interest from the one market to the other cools off the first market— the one they are moving out of. I am not able, though, to add any useful comment upon the relationship of the stock market and its boom to our economic problem. Within a few weeks, within less than a month, after the first Council of Economic Advisers was appointed, the business world greeted us with a market collapse. We wondered what that portended—that was in September 194(3—there was a very serious collapse. Well, it did not portend anything except great prosperity, and ever since then I have been willing to exclude the stock-market condition from my analyses of economic conditions. Senator GOLDWATER. D O you think that there should be any concern then today about the stock market's'being a little bit on the high side? Mr. CLARK. Well, I do not feel any myself, Senator. Senator GOLDWATER. I do not either; I just wondered how you felt about it. Mr. WILDE. Mr. Chairman, I would venture a guess that, based on historical precedents, if you had a radical change in reserve requirements, it would be interpreted as more inflation out of Washington that tends to drive the stock market higher. Mr. LAND. I would like to add my agreement to that. I feel that that would be the result. Senator FLANDERS. NOW, there is a patient man at the end of the line, Mr. Chandler. He did dip into the discussion once, but he is entitled to enter it on his own account. Mr. CHANDLER. Mr. Chairman, I hope I may be pardoned if I do not make any comments on American tariff policy or the policy of the Southern States in attracting industry. Senator FLANDERS. I also call your attention to the fact that we have not talked about the gold standard yet. Mr. CHANDLER. I should like to neglect that, too, if I may. First I should like to make a comment or two about tjie proposal to reduce reserve requirements to the minimum permitted bjr law. I t has already been brought out that this would add something in the neighborhood of 7 to 7y2 billion dollars to the volume of excess reserves which is already well over a half billion, making something in excess of $8 billion in excess reserves. One thing that shoud be a primary rule in central banking is that you must always leave yourself some way of reversing your policy if situation calls for it. To try to move from a situation of 8 or 8y2 Digitizedthe for FRASER 154 UNITED STATES MONETARY POLICY billion dollars of excess reserves to one of mild restraint, which would call for a degree of finesse that I doubt any central banker has. I am sure that he could not eliminate that volume of excess reserves by increasing reserve requirements, and do it with such finesse as to avoid adverse results. This would be using a most inflexible kind of expansionary instrument of a type that could not be used in the other direction without great potential danger. Senator FLANDERS. In other words, are you saying that you would tend to keep the bank reserves not too far—the bank reserve requirements not too far—away from the actual situation; is that what yo\i are saying? Mr. CHANDLER. A specific prescription is always dangerous, but I would suggest the thing: to do is to leave the reserve requirements where they are today, and if any further easing is necessary, to do that through open-market operations that have high flexibility attached to them. I would like to make a comment on one other topic which has turned out to be a key to our discussion this afternoon. That is whether full employment and relative price stability are consistent with each other. There are certain circumstances in which it, obviously—where they obviously contradictory. For example, the situation you had in 1930 •was one of widespread unemployment; it was perfectly obvious tlu.it one needed not only an increase in demand, but some rise of prices,, at least of some prices, to get anything like full employment. In that kind of situation we need some price rise in order to get, or even approach, full employment levels. But some of our economists, and the public at large, have learned the wrong lesson from that experience. They assume that when you already have full employment you cannot maintain full employment without having further price rises. Now, it is for that reason that I would dismiss, as largely without meaning, the statistics presented by Professor Harris, indicating the great rise in real income per person today as compared with that in 1939. I do not think there is a person at this table who would want to return to the 1939 level. Mr. HARRIS. I never gave 1939 figures in my statement, Mr. Chandler; I gave 1914 and 1951. Mr. CHANDLER. 1914? Mr. HARRIS. Yes. Mr. CHANDLER. Well, I would submit that a very considerable part of that increase was achieved during the twenties when you had relatively stable commodity prices. There were certain other periods of price stability in which the rate of growth was also quite satisfactory. We come to a much more ticklist question when we approach the one that was uppermost in Professor.Shaw's mind: When you already have full employment, can you maintain if without further priceinflation? UNITED STATES MONETARY POLICY 155 We do not have the ability to forecast, yet there is, I think, one real ray of hope in the point that Professor Shaw brought out, namely, the continuing technological improvement and the rising productivity which would give us room for wage increases offset by increases in output, so that Ave can perhaps have relatively stable prices and rising wage rates at the same time, while maintaining full employment. 1 have just one further point on that subject. I t is often stated that we would have a better chance of maintaining full employment if we had controlled inflation at the rate of 2 or 3 percent a year or some other relatively modest figure. I do not see any magic in those numbers. I t seems to me that an annual increase of zero percent is, perhaps, just as feasible as 2 or 3 percent. What reason do we have to believe that we can set up expectations of 2- or 3-percent rises in price levels a year and still maintain full employment ? Wouldn't you have exactly the same problem of costs tending to outrun prices, and so on, so that you would get unemployment unless you speeded up the rate of growth ? I do not know of any economist who has analyzed the problem of maintaining full employment while you have automatic escalator clauses in every contract; but I see no reason to believe it would be any easier than operating within the framework of a relatively stable price level. Senator FLANDERS. Well, we have been through the list. Representative PATMAN. Air. Chairman, may I ask if it it would be asking too much of the chairman to find out from the panel by a lifting of hands or some similar way as to how they stand on free convertibility of gold? Senator FLANDERS. I am sorry I mentioned it. Representative PATMAN. Well, the chairman mentioned it, and I kno.w from that it is a very important question which should be considered. Senator FLANDERS. Let me first have an introductory show of hands. How many of those across the table wish to raise their hands on that question? Will you.raise your hands to show your willingness to express yourself ? (There was a showing of hands.) Senator FLANDERS. A majority of them. Mr. HARRIS. Will you define the term. What does this mean? Do you mean United States present convertibility ? Representative PATMAN. Yes. Senator FLANDERS. The present convertibility of gold. Mr. SHAW. May I ask for a more explicit definition ? At what price is gold to be freely convertible, and to whom? Representative PATMAN. The same price as it is now. Mr. SHAW. And to whom and from whom? Representative PATMAN. Domestic, of course. Senator FLANDERS. That expresses itself to me, Mr. Patman, as being able to go to the bank and getting a $20 gold piece for a Christmas present. Representative PATMAN. That is right. 156 UNITED STATES MONETARY POLICY Senator FLANDERS. I do not know what the economic significance of that is, but that is what free convertibility means to me. Representative PATMAN. Just like it was before we did not have it. Senator FLANDERS. Yes. We are now taking a poll on that subject. All of those who believe that I ought to get a $20 gold piece to give away at Christmas when 1 go to the bank, please raise your right hands. Senator DOUGLAS. Just a minute, Mr. Chairman, you certainly would not limit the convertibility of gold to a desire lor Christmas presents, would you? If you convert money into gold, it could be for any purpose. This is a very apt illustration of it, but it is too restricted. Senator GOLDWATER. Mr. Chairman, I think Professor Shaw raised a very good point there as to the time element. I know in our discussions last year Senator FLANDERS. In my lifetime. Senator GOLDWATER (continuing). In the Committee on Banking and Currency—in your lifetime, well, that is a long time. Senator FLANDERS. Thank you. Senator GOLDAVATER. But that was one of the important things raised last year in our hearings, is when. There was not much question Mr. SHAW. The price, of course, is a highly critical factor, and also given the price, what collateral changes there may be in the reserve requirements of the Federal Reserve banks, because depending on the price and on these reserve requirements, this can be a highly deflationary operation. Senator DOUGLAS. I suggest we poll the experts on $35 an ounce. Senator FLANDERS. I would like to put this question properly. Representative PATMAN. Leave out the Christmas present. Senator FLANDERS. All right. Is this the question that you gentlemen would be willing to express yourselves on : Can you conceive of any proper action to be taken within the near future which would lead desirably to a free gold, interchangeability of gold with dollars ? Is that a good way to state that ? Now, all in favor say "aye," or raise your right hand. (No response.) Senator FLANDERS. All opposed, raise their right hands. (There was a showing of seven hands.) Senator FLANDERS. 1 noted there was one person not voting. I do not know what to do about him. Mr. LAND. I probably was the one not voting; I do not think it makes much difference whether gold-coin convertibility is restored or not. Mr. SMUTNY. Mr. Chairman, could I bring in something that has not been brought up today? Senator FLANDERS. Yes. Mr. SMUTNY. I do not think there has beeij really any recognition of the extension of maturity of obligation of the United States Government by the Treasury. In all Treasury ref undings in which we participate, there has been an attempt on the part of the. Treasury to extend the debt, and to reduce the amount and the number of refundings in each year, and UNITED STATES MONETARY POLICY 157 with the last refunding operation, December 2's, which, as you know, amounted to some $17 billion, you will find that the average maturity of United States Government marketable securities outstanding now has been increased to the longest maturity period of time that they have had, I think, in quite some years, if you go back to statistics. At present the average maturity is somewhat over 4 years, being 4 years and 3 months. Senator FLANDERS. How far does it go back before we again approach that average length of maturity, can you say offhand? Mr. SMUTNY. You mean how does this compare with what it was in 1933? Senator FLANDERS. Yes; if that average length of maturity is higher than it has been in the recent past Mr. SMUTNY. That is right. ^ Senator FLANDERS (continuing). How far back do you have to go to find a similar average length of maturity ? Mr. SMUTNY* In 1951 average debt of United States marketable bonds was 4 years and 4 months. Senator FLANDERS. Well, that is interesting. Mr. HARRIS. Mr. Chairman, may I make one comment, since Mr. Chandler commented on my views on full employment and the price level ? I t will take a half minute. I just want to say that on the basis of experience, where you have a rise of output, whether it is at a low employment level or a high, although greater at a high, there is a tendency for prices to rise. This is true of our own history, and I simply say let us try to get a stable price level and growing employment, but in practice wThat you are likely to find, especially as a Result of wages to inflation, and despite technological improvement; you are likely to find when output rises, on the average, you are likely to have some price rise. This is one of the costs of progress. Senator FLANDERS. NOW, there is a raised hand. Some of the members of this panel have engagements which they must meet. I t had been niy plan to adjourn at 4 o'clock; it is 4 now. I hate to discourage one upraised bond. Mr. MITCHELL. This is on that agricultural question; I can get it over with in 2 minutes, if you wish. Senator FLANDERS. TWO minutes? Mr. MITCHELL. I am recognized for 2 minutes? Senator FLANDERS. YOU are recognized for 2 minutes. Mr. MITCHELL. Senator Flanders asked why I was recommending a great agricultural investment surge in the face of our apparent surpluses. Well, as my paper, presented to this committee in February indicated, I do not think there is any such thing as a surplus in the human sense with regard to food and fiber, only in the economic sense, which means that we have got to find the answer not by cutting down production but by discovering better ways to distribute what American abundance can produce. America will need a half more dairy food; we will have to get out of butter, but we will have to produce more fluid milk, and get it into the mouths of great numbers of American children who do not have enough of it for good teeth, bones, an adequate diet. 55314—54 11 158 UNITED STATES MONETARY POLICY America will have to have one-third more meat, two-thirds more fruits and vegetables, if decent diets are to be attained, and I assume they will be under a fully employed economy. Even wheat and cotton, which are export products, will still be needed in the world,, and there again it is a problem of distribution, not one of curtailing production. But consider the credit needs of the agricultural producers, at least half of them, 2y2 million farmers. If we aim that way the next 10 years, they need to undergo a virtual revolution in their way of producing, and they are going to have to get out of the cash crops into dairy, fruits, vegetables, and livestock products. They are going to need $5,000 to $10,000 each over the next 10 years in new credit to achieve this kind of revolutionary production change. Now, banks are not making that type of loan, they do not, they cannot. Tliese are 7- to 10-year loans, and banks cannot, under banking laws and statutes and lending habits. I wish they could. A number of banks in the Midwest are finally hiring farm managers to help in the revolutionary type of farmmanagement change that will go with that kind of intermediate credit loan. In the past, whenever we have needed revolutions in credit for farmers, such as we needed to assist low-income farmers who were bad credit risks for the usual commercial banks, we found that credit, plus supervision, was necessary. I am suggesting that that will be necessary for the middle third of American agriculture, too, in the future. If private banks are not able to revolutionize their own way of doin<r business, and if they do not change their ideas of the proper length of time; in other words, if they do not change to a 7- to 10-year reorganization loan, there is going to be a demand for Government once again to get into the agricultural credit field. Senator FLANDERS. I was just going to say that I was about to thank you for your 2 minutes' worth, and you have explained yourself, I think, quite clearly. Now. I take it, you are not quite through with your explanation ? Mr. MITCHELL. Not quite. Senator FLANDERS. YOU can extend it in the record. Mr. MITCHELL. My article goes into that, so I think that is enough time for me. Thank you. Senator FLANDERS. We thank you all. Representative PATKAN. Mr. Chairman, all of them will be permitted to extend their remarks? Senator FLANDERS. Yes; all will be permitted to extend their remarks in the record, and I—in fact, it is allowable to extend the debate in the record, to one degree. That is, I do not think we would want to extend it by each one reading what the other had said about him, and coming back twice. Once will do. We have had a very—for the chairman at least—pleasant and an informative roundtable, and I hope that we may meet again. Everyone lias made a contribution. I am sure that the Representatives and Senators join me in that statement. The meeting is adjourned until 10 o'clock tomorrow morning. (Whereupon, at 4:05 p. m., the subcommittee recessed, to reconvene at 10 a. m., Tuesday, December 7,1954.) UNITED STATES MONETAEY POLICY: RECENT THINKING AND EXPERIENCE TUESDAY, DECEMBER 7, 1954 CONGRESS OF THE UNITED STATES, ^ JOINT COMMITTEE ON THE ECONOMIC REPORT, SUBCOMMITTEE ON ECONOMIC STABILIZATION, Washington, Z>. O. The subcommittee met, pursuant to recess, at 10:10 a. m., in room 318, Senate Office Building, Senator Ralph E. Flanders (chairman of the subcommittee) presiding. Present: Senators Flanders (chairman of the subcommittee), Watkins, Goldwater, Sparkman, Douglas; Representatives Talle, and Patman. Also present: Grover W. Ensley, staff director; and John W. Lehman, clerk. Senator FLANDERS. The hearing will please come to order. Yesterday we had a panel of economists and bankers who discussed their various points of view, and I think everyone who was here will agree these points of view were various, on the monetary and credit policies of the two branches of the Government which are most concerned with those questions, the Treasury and the Federal Reserve Board. Today Ave pursue the line of thought and the line of questioning introduced yesterday. Having been informed and stimulated by these widely varying points of view, we will have before us today the two branches of the Government cdncerned, who have very kindly offered to explain their positions, and defend them to the extent that they believe defense is necessary. "We also greatly appreciate the fine cooperation we have had from both the Treasury and the Federal Reserve Board in the preparation of their answers to the questions provided by this subcommittee prior to the hearings. These materials were inserted in the record at the opening of the hearings yesterday (pp. 3, 30). We are first privileged to have with us this morning, Mr. George Humphrey, Secretary of the Treasury, and with no further introduction, Secretary Humphrey, will you open this discussion. 159 160 UNITED STATES MONETARY POLICY STATEMENT OF HON. GEORGE M. HUMPHREY, SECRETARY OP THE TREASURY, ACCOMPANIED BY W, RANDOLPH BURGESS, UNDER SECRETARY FOR MONETARY AFFAIRS; DAVID M. KENNEDY, ASSISTANT TO THE SECRETARY; EDWARD F. BARTELT, FISCAL ASSISTANT SECRETARY; AND ROBERT P. MAYO, CHIEF, ANALYSIS STAFF, DEBT DIVISION Secretary HUMPHREY. Mr. Chairman, with your permission, I would suggest that we might make more progress if I made a relatively short statement, and then if Mr. Burgess would go through some charts with explanations which he has to offer and then, after having laid out that program, we would both be here and available for questions. I think that, perhaps, we would save time if questions could be postoned until we had finished that, and then the whole matter would be efore you, and it would be much easier to answer questions in that way rather than, perhaps, to anticipate some of the things that we may answer as we go along. Senator FLANDERS. We operated on that basis yesterday; I think we found it satisfactory, although we do hope that there will be a little time left after your uninterrupted flow of information. We will proceed on that on that basis. Secretary HUMPHREY. In that case, Mr. Chairman, I will be glad to start with this statement. We welcome this opportunity to appear before your subcommittee to review the fiscal and debt management policies of the Treasury from the point of view.of their economic influence. At the outset and before considering in detail the activities of the Treasury during the past 2 years, I want to make a few general comments on the direction of our entire fiscal program as well as the principles guiding us in the management of the public debt. The administration's budgetary and tax policies, along with its debt management policies, have all been designed to promote high employment, rising production, and a stable dollar. We have m fact been following the policies advocated by your predecessor subcommittees that—as stated in the. Douglas report of January 1950, in language reaffirmed in the Patman report of June 1952, as follows: "appropriate, vigorous, and coordinated monetary, credit, and fiscal policies" should "constitute the Government's primary and principal method" of promoting the purposes of the Employment Act, and further, their additional recommendation— E that Federal fiscal policies be such as not only to avoid aggravating economic instability but also to make a positive and important contribution to stabilization, at the same time promoting equity and incentives in taxation and economy in expenditures. Government spending programs have been cut by billions of dollars. Waste and extravagance have been eliminated in many areas. Economy in Government and efforts to get the Federal budget under even better control are continuing without'letup. These efforts are of great importance to the future of our country and are fundamental in the administration's honest money program. Major tax reductions and comprehensive tax revisions, along with the ending of price and wage controls, are removing barriers to economic growth and restoring individual initiative and enterprise. UNITED STATES MONETARY . POLICY 161 Savings in Government spending which have been returned to the people in the form of tax cuts are helping sustain the economy, increase employment and production. ( Progress is being made toward getting our huge public debt in better shape, so that its maturities can be handled more easily and debt operations will not stimulate either inflation or deflation. Treasury financings have been designed to tie in with action taken by the Federal Reserve System to keep the supply of money and credit in line with the needs of the country. The principles we have been following in the management of the large public debt are not new. They are, likewise, principles that have been laid down by your predecessor subcommittees after extensive study and careful consideration of the fundamental role they can play in effective monetary policy. The first principle is that monetary and debt management policies should be flexible. To be effective tney must lean against inflation as well as deflation. As put by the Douglas subcommittee and reaffirmed by the Patman subcommittee, and I quote once more: Timely flexibility toward easy credit at some times and credit restriction at other times is an essential characteristic of a monetary policy that will promote economic stability rather than instability. The second principle is that Treasury debt management operations should be consistent with current monetary and credit control policies of the Federal Reserve. This means close cooperation at all times between the Federal Reserve and the Treasury. The answers which we have already submitted to your subcommittee's questions detail the actions we have taken in cooperation with the Federal Reserve during the past 2 years in carrying out these principles. They show the manner in which our debt operations have been designed to complement monetary action taken by the Federal Reserve to promote economic stability, first by helping to restrain inflation and then later by helping to avoid deflation. The record has not always been as impressive. As you know, at the time of the earlier congressional hearings on monetary policy and debt management, the economy had been under strong inflationary pressures. Monetary policy had been largely ineffectual in helping to control inflation because of the previous administration's policy of selling mostly short-term securities and using the powers of the Federal Reserve System to hold down interest rates artificially. A fundamental conclusion of both of your predecessor subcommittees was that such action was not in the best interests of the Nation. This was their considered judgment in language used in their report. This administration has followed these principles because we believe them to be fundamental principles of good government. We believe the record of the past 2 years has indicated their effectiveness in giving us honest money and laying a firm foundation for the sound growth and prosperity of our country. That concludes my statement. I will ask Mr. Burgess if he will take up the matter of his charts with explanations that will illustrate this point. Mr. BURGESS. Mr. Chairman, I hope this does not look too much like a television,show, but it seems to tis, perhaps, the best way of presenting the facts of wThat we have been trying to do so that we can lay them bqfore you. 162 UNITED STATES MONETARY POLICY The first chart shows what we are dealing with, the public debt, running back to 1916. It went up in World War I as high as $26 billion, and then was reduced by 1930 to $16 billion; then during the depression it worked up to $48 billion, just before the outbreak of World War IL Char! I THE PUBLIC DEBT $BiL| 1 Dec. Dec. Dec. Dec. Dec. Apr. Dec. 'Excluding Victory Loan proceeds used to repay debt In I94S. In World War II the debt shot up to $280 billion. That top figure in a sense was a bookkeeping operation, because you will recall that in the Victory loan of 1945 we borrowed more than proved to. be necessary. We did not know that war expenditures were going to taper off so quickly, and so there was $20 billion left on deposit with the banks which was used in 1946 to scale down the debt, so that a figure of $260 billion would be a fairer figure of what it really cost us in terms of the national debt. The first debt reduction due to budgetary surpluses took place in 1947, 1948, and 1949, and they reduced the debt by $8 billion to $252 billion. Then came the Korean war, and the $27 billion increase since 1949 represents the Korean war and theT efforts to meet the cold war. ^ So we are left at the present time w ith a debt of close to $279 billion. Now, there is a way of putting the debt in its setting, and it is interesting to relate the Federal debt to our otller debts of the people. Back in 1939, we had a total debt structure of $208 billion, and the $48 billion of Federal debt was at that time 23 percent of the entire debt structure. The State and local debt was $20 billion, corporation debt $89 billion, and individual debt $51 billion, as shown in chart 2. 163 UNITED STATES MONETARY POLICY Chart 2 PUBLIC AND PRIVATE DEBT $Bil. ^Federal 500 State and "*Local 250 Corporation 208 23%$48 ^Individual 1946 December'Estimated •tVt if ff» UifMty •»•»» iTMMy By the end of the war the Federal debt had swelled up to $260 billion, using that adjusted figure, which was 58 percent of the total debt structure in December 1946. During the war the other segments of the debt were held back because of shortage of goods and inability to start building operations, and so on. Now, since that time, the Federal debt has risen, as indicated here, to $279 billion, which is now 40 percent of the total debt structure; that is, as the other sections have risen, the Federal debt becomes a smaller proportion of the whole debt structure. These others have gone up pretty smartly. The State and local debt is expanding. Of course, that includes these road programs which are in a sense selfliquidating; and then corporation debt has doubled since just after the war, and individual debt has risen much more than that; it includes consumer credit, of course, and the big item is mortgages. Now, once again in the way of showing the problem of the burden of the debt, the left-hand side of chart 3 shows the debt per capita of the population.. Before World War I that was only $12. At the end of that war it had risen to $245. I t went down to $130; it was $363 before we entered World War I I , and it went up to $1,832 by December 1946.' Then it shrank, partly due to payoffs and partly due to the growth of the population, to $1,690, and it is fair to say that since 1949, the increase in the population and the increase in the debt have more or less kept pace with each other, so that the per capita debt is about the same. 164 UNITED STATES MONETARY POLICY Chart 3 BURDEN OF T H E DEBT %f Debt as % of Per Capita Debt National Income 1832 1600 800 245 jLiim " 191619 "30 '39 46 49 '54 ' Dec ' Apr. Dec. ~ 1916 19 *30 "39 46 49 '54 < Dee. ' Apr. Dec Now, a rather more cheerful way of looking at it—we ought to seize on any aspect of the debt that we can that is cheerful—is to relate the debt to-the national income. After World War I the debt was 33 percent of the national income. Before we entered World War I I , it was 62 percent, and it rose so that it was larger than the national income, 136 percent; it was reduced by 1949 to 114 percent; because income was growing and there was some debt retirement. The debt has come down now to 94 percent of national income. That is due to 2 causes, 1 of which is not so good. That is inflation. Inflation has increased the national income in terms of dollars, so that a part of the adjustment of the debt to national income is due to inflation, so that it has caused in a sense the kind of evil you want to try to avoid. But part of it is due to good, solid causes, the growth of production and the expansion of the economy. There is one thought Senator DOUGLAS. Mr. Chairman, is Dr. Burgess including in his analysis—would it be appropriate if I asked a question at this time? Senator FLANDERS. Yes, you may do so. Senator DOUGLAS. The question I wanted to ask is this: If you take the carrying charges on the national debt as a percentage of national income, isn't the showing still more favorable because what we have had has been, until very recently, a very sharp fall in interest rates ? ^ I made some computations indicating that as a percentage of national income the interest on the national debt in 1933 was a larger percentage than it was in 1952. UNITED STATES MONETARY POLICY 165 Mr. BURGESS. Yes, we have those figures. The interest rates now, for example, are actually lower, the rate of interest is lower, than it was 2 years ago, so that Senator DOUGLAS. I think as a percentage of national income, the cost of the national debt to the community was lower in 1952 than it had been in 1933, because roughly you have had a fall from 4 percent to 2 percent. Mr. BURGESS. Yes, those figures are in the right area, Senator; I will have the figures inserted in the record. Computed annual interest charge on interest-bearing public debt as a percent of national income Computed annual interest charge (as of June 30) 1932 1933 1934 1952 1953 1954 Millions $672 742 842 5,981 6,431 6,298 National income (calendar year)» Millions $42,500 40,200 49,000 291,000 305,000 * 298,900 Interest charge as a percent of national income Percent 1.58 1.85 1.72 2.06 2.11 2.11 i Rounded to nearest hundred million. * Annual rate for first three-quarters. I t shows that—we have two ways of going at this problem of the debt. I t is an ugly thing to have such a big debt. One way is to try to keep it down and try to pay it off, ftnd the other is to grow up to it. This, of course, means that one of the important things we are dealing with in respect to the debt is to encourage a dynamic growing economy. Now, to come to the debt action in the past 2 years: As Secretary Humphrey has said in his presentation, one of our objectives was to gear our operations with the operations of the Federal Reserve System, and that is in accordance with the recommendation of your two subcommittees. Chart 4 is an attempt to single out from the great mass of economic facts one or. two that might shed some light on the situation that we have been facing. The first thing you will notice is the color on the left side of this chart. The pink color is the area during which the Reserve System was exercising credit restraint. Now, those are the years from 1951 through to May 1953. We put in that color in a gradually deeper shade because they were gradually increasing their credit pressure during that period. The evidence of their policy, of course, is contained in the reports of the Federal Reserve Board, which shows the policies they were following during those years. Now, what were the economic events against which they were •doing so? This solid black line represents industrial production, as shown by the index of the Federal Reserve Board. The dotted line represents business inventories, and this lower dashed line.represents the 166 UNITED STATES MONETARY POLICY Char! 4 ECONOMIC INDICATORS AND MONETARY ACTION 132 Credit Restraint—»H—Credit Ease DemandDeposits and Currency N June 1951 Dec. June Dec. June Dec. 1952 1953 Note; Seasonally adjusted data. June 1954 Dec. fm*mUmm*t*m»Hm*t volume of money, as shown by adjusted demand deposits and currency. Now, the interesting thin^ is that production was going through a great bulge from the middle of 1952 until about August of 1953, a bulge that carried it well above the levels that it had been and is now; in fact, it carried it above the highest level reached during the war. Now, that bulge represented m considerable measure the increase of inventories, as well as the normal flow of production into consumption ; inventories increased something like $7% billion over that period, and at the same time, you had a period of rapid credit growth. There was a budget deficit of $9.4 billion in the fiscal year 1953. At the same time in this period, the wage-price controls were removed so that you had again a question of restraining possible overexpansion. Now, this area over here on the right represents a period when the Reserve System was operating under a policy of credit ease, again as demonstrated by the reports'that they made I n the annual reports of the Federal Reserve Board, One of the things about it is that they turned their policy about very quickly when there was evidence of change in the business atmosphere; even before it showed up in inventory figures and in the production index. Now, our problem was to adjust our debt action to this sort of a situation. There were two major problems of debt management that we faced. One was to do exactly what the Secretary indicated, to adjust our debt management to the business situation, and to the monetary policy, and the other was gradually over a period to lengthen out the debt so it would not be so heavily concentrated in short-term maturities. 167 UNITED STATES MONETAEY POLICY Now, the first job with the volume of money rising, and with an inflationary situation in the early months of 1953, was to see than our debt operations.did not add to the volume of bank credit, that is, that our securities were sold as largely as possible outside the banks; and chart 5 shows that from January 1 to May 1,1953, bank holdings of governments showed a decline rather than an increase. The Federal Reserve holdings also were down a little. Then after the change in policy, commercial bank holdings of securities went u p ; the volume of money increased in accordance with what you would call a classical pattern. It no longer was so important for us to concentrate on selling outside the banks, but on the contrary, some increase in the volume of bank credit was a desirable thing for the economy. Chart 5 OWNERSHIP OF T H E DEBT *Bil. Commercial Banks and Federal Reserve Banks Nonbank Investors GOVT -^Invest Accts. 150 100 -*-Individuals Pension i^Funds *"Institutions —Coril 50 +JZorps. and Misc. Federal "Reserve Jan. I, May I. 1953 '53 Dec. I, '54 Jon. I, May I, Dec. I, 1953'53 '54 P** * M SMMwy t( to *H*rr Now, the right-hand side shows the absorption of Government securities by nonbank investors. The corporations and miscellaneous group increased their holdings slightly throughout the period; nonbank institutions, which means insurance companies and^ savings banks, and so on, decreased their Government holdings over this period, as compared with no change during early 1953. That was in a way a beneficial thing because they were putting the money in mortgages and in industrial securities and in other investments which created employment and offset the recessionary tendencies of the period. Pension funds held $6 billion of Government securities in that period, and they now hold $7 billion, when those figures are rounded off; that is a steadily growing market for Government securities., Individuals have increased meir holdings slightly, and that is where our savings-bond program comes in, which is a long-term program for getting individuals to buy Government securities, and getting a distribution of the debt. Digitizedwide for FRASER UNITED STATES MONETARY POLICY 168 Another steady absorption of the debt outside the banks is in the trust funds of the Federal Government—social security, unemployment funds, and so on—and that has increased over this period of 2 years by $3*£ billion. In a way, it is a kind of funding of the debt although it is, of course, on call if there is heavy unemployment or other economic situations that may lead to a more rapid withdrawal of social-security funds. Now, responding to these changes in policy and the change in the l^ressure on the situation, you have had this change in long-term bond yields (chart 6). They have been going up since early in 1951; in fact, if I projected the chart back further, they would show some rise before then. The rise was, of course, sharper in these last months of the boom period in 1953, when there was more pressure on the situation from the Federal Reserve, and when we were selling a billion dollars of long-term bonds outside of the banking system. Chart 6 LONG-TERM BOND YIELDS %! 1 1951 * Moody's Aaa. *«««r*iSM«*yrf*ifcN**y 1952 1953 1954 ^Standard andPoor's High-grade. ••If0» There is one rather interesting thing about this chart, which is that the rate on municipal bonds—and that is the broad figure of the municipal and State, of course, with the big element being State bonds. That has gone up faster than the yield in the other categories, due to the fact that the huge volume of State and mijnicipal issues was pressing on the market and congesting the market during that period. The amounts were so large that they overflowed the true tax-exempt market and had to go over into the life-insuranc6 companies and other investors, so that State and local governments really lost a great deal of the benefit of tax-exemption. All these yields have.come down sharply since that time, and are now lower than they were in the latter part of 1952. UNITED STATES MONETARY POLICY 169 The corporate yields are about even with what they were in late 1951 and 1952, and the Government yields are somewhat lower. Now, one thing that we have been watching very intently during all this period in our policy—and the Federal Reserve has been watching it as well—is the flow of money into new investment in the form of mortgages and corporate and municipal securities. The employment of money in those markets has been a great underlying strength in this transition period. Chert 7 NEW MORTGAGES AND SECURITY ISSUES Quarterly 1951-54 SBil. Mortgages 6h (Nosfarm recordings $20,000 «r less) Corporate and Municipal Securities Corporate Municw 1 Mmm^twMmfmA I 1951 52 "53 5 4 1951 52 53 54 Now? as to the restraining money policies in early 1953, the lefthand side of chart 7 shows the mortgage market, as represented by nonfarm recordings of $20,000 or less; and the right-hand column shows new corporate and municipal securities in separate areas. The credit restraint policy in 1953 came at a time when there were very heavy offerings ox mortgages in the market, and similarly when there were very heavy offerings of these securities. The higher interest rates and decreased credit availability led to the deferment of a certain amount of mortgage financing, and a certain amount of corporate and municipal financing. This meant that the work represented by that financing was available during the latter part of 1953 and 1954 to help hold things up. I noticed one of the speakers yesterday said that he believed that the policy took something off the peak, and helped to fill in the valley. That, of course, is exactly what we were trying to do. We were watching all during this period very carefully to see that money was freely available in these markets, and it is rather interesting that as you look at the charts, you will have difficulty in finding when this credit restraint policy was because the high volume of financing went on rather continuously. The presumption 170 UNITED STATES MONETARY POLICY is that without the policy of credit restraint and subsequent ease more financing would have been done in early 1953 and less later on. Now, a few words about the other phase of our financing. The first and most important phase is to adjust our debt management policy to the business situation and to the policies of the central bank in such a way as to encourage, and not discourage, a high level of employment and honest money. The other problem, the longer-term problem, is to distribute this debt more widely among the people, and to lengthen tha maturities, partly so we will not run into embarrassing jams in having so much financing to do in any one j^ear, and partly also to see to it. that the amount lield by the banks is gradually reduced because that has a lon^-term inflationary tendency. We do not want to reduce it any faster than the economic situation calls for, but some bank reduction is good over a period. Now, chart 8 is an attempt to show the structure of the debt today. The left-hand column is the total debt, and then a group of blocks are shown to represent the marketable debt of $158 billion. About $63 billion of that now matures within l.year, and of that close to $20 billion is in the form of Treasury bills. About $39 billion matures in 1 to 5 years, and $56 billion in over 5 years. All callable bonds are considered to their first call date. Chort8 STRUCTURE OF THE DEBT DECEMBER 1954 Total Marketable: $158 Billion Nonmarketabte: $121 Billion $Bil. SwM7M/esZJB% toTntstFantfs^lJM Time to Maturity- 200 279i 100 Oyer 5 Savings 58J& *^Bonds if ?•«• 1:56: \Coimrtibh Bond$,etc. WBHSU ******** imi Within ™$riYear "Callable bonds to earliest calldate. The other section of the debt is the nonmarketable debt and. that amounts to $121 billion. Of that, $20 billion is convertible bonds, savings notes, and miscellaneous issues. About $12 billion of that is the 2% percent bonds which were used in refunding a great big indigestible lump of 2*4 percent marketable bonds in the spring of 1951. 171 UNITED STATES MONETARY POLICY Savings bonds total $58.5 billion. We think that is a good way to get the debt better distributed. Then there are the special issues to the Government trust funds. Of the amount held by the Government trust funds, part is in special issues, which we issue directly from the Treasury, and part is in marketable bonds; the figures on the chart are the specials. Now, I want to show you what we have been trying to do on the shortdated debt. Chart 9 is an illustration. Chert 9 MARKETABLE DEBT DUE WITHIN ONE YEAR (Callable Bonds to Earliest Call Date) Mntftelmlvyif * t N M y t^lOi When we came in, the marketable debt due within 1 year was about $74 billion. Before we got through the calendar year of 1953, it had risen to $76 billion. We had not been able to do as much about it as we would have liked to because we faced, as you know, a deficit of $9.4 billion in 1953, and the credit situation was such that it was not desirable during the summer and early fall of 1953 to put any financing out other than short terms, so we wound up with $76 billion. Now, over the past year we have gradually reduced that $76 billion due within a year to $63 billion; $3% billion of debt was paid off; $24% billion was refunded into issues longer than 1 year; most of that went to the banks, but it stretched out their maturity to put their holdings in more manageable form. Then, as an illustration that you have to run pretty fast in this business to stand still, $15 billion of debt issued in earlier years came within the 1-year total. I t had been longer, and time had gone on, and it came within the 1-year period. That brings us out with $63 billion maturing within a year, which is a more manageable figure than at the end of 1953. 172 UNITED STATES MONETARY POLICY Now, another way of illustrating the change in the debt as to maturities is by figuring out the average length of the marketable debt. As I say, there has been a period during the last 2 years when we had to temporize with this problem—when we could not go out and try to spread the maturities very vigorously. We have been criticized for not putting out long bonds this year. I think we were absolutely right in not doing so, because it would have been clearly in competition with the enormous loan funds in the mortgage market and the new issue market. We have had to work within rather narrow limits, and those are the limits set largely by the maturities the banks are interested in. But we have tried to stretch out our maturities. Chart 10 AVERAGE LENGTH OF THE MARKETABLE DEBT (Callable Bonds to Earliest Call Date) YEARS Calendar 1951-52* Calendar 1953-54 4.9 4.3 3.B I 2.8 If all newissues hadbeen l-ymcerts. l i t itl i i 1951 i .iifiihiii-.il. 1952 1 1 1, t t I I i M 1953 I 1954 *Adju$tedto exclude 2'/?$ exchanged fornonmarketable 2%*$. Chart 10 shows the average length of the marketable debt, which was 4.9 years at the beginning of 1951. Then it went steadily down as the Treasury financed itself largely with short-term issues, so that at the beginning of 1953 it was 3.8 years. That is the average lengtli of the entire marketable debt. Now, as I have indicated before, in 1953 we did reasonably well just to hold even. We came out at the end of the year with about the same figures as at the beginning. This year we have been able to stretch out the debt somewhat in ref undings, particularly in February and i a our current December financing, so we will finish up the year with an average length of debt of about 4.3 years. J f we Had refunded all the securities that matured during 1953 and 1954 in 1-year certificates, the average length of the whole marketable? debt would have been only 2.8 years. UNITED STATES MONETARY POLICY 173 Now, chart 11 is a final chart. That does not draw any conclusions, but it keeps our sights upon the horizon, and relates to where we now are in the economic picture and to where we were in the past. I present this familiar chart of wholesale market prices running back to 1810, over 144 years, just to have that in mind. Chart ll WHOLESALE PRICES I n a way, it is not too good an index, as Senator Douglas knows. But it does give a .pretty good indication of the trend of prices, although we Tiave to rely on relatively thin data as you go further back. I t shows that each war, the War of 1812, the Civil War, the First World War, the Second World War, and the Korean war, and the cold war have tended to produce a rise in wholesale prices. Another interesting feature of it is that the general trend line, except for those war bulges, was moderately level over the first 125 years or so of that period. After each war we did tend to come back to the old price level, right or wrong, so that when people say, "Well, in my mother's day prices were just so much cheaper than they are now," that is really only true in the last 15 years or so. Certain prices did go down, and certain others went up. The price of manufactured goods came down over the long span. The prices of many other articles tended to go up. ^ But here we are with a new kind of thing. We have got one war piled on another, and it leaves us in what is in the history of the past, an inflated position. But we are trying something new this time. We are trying to hold the general level of prices stable rather than trying to go back to any previous level. Our firm belief is that we should benefit best from a stable-price level rather than trying to go backward and forward. I think it does 553M—54- -12 174 UNITED STATES MONETARY POLICY indicate that the inflationary forces are always there, waiting around the corner to leap on us. The fact is that the present high-price level does represent a tragedy for many people who have accumulated savings; but any attempt to readjust it would bring more of a tragedy than you would correct by doing it. We are trying to do something new; we are trying to use all our forces to give us stability instead of the pattern you see on that chart. I think, Mr. Chairman, that concludes it. Senator FLANDERS. Thank you, Mr. Burgess. I would like to pick up a question which arises from your last few words. Are we to conclude from what you have just said that your main interest in these matters is in price stability? There are other criteria, but price stability seems to be the one that you have emphasized. Mr. BURGESS. Well, I think if I emphasized that exclusively, it would be a mistake, because what we want is economic stability and growth, Mr. Chairman; the buying power of the dollar is a most im* portant element in that, but it is certainly less important than having a good, sound, solid economic growth. We believe that a stable dollar is one of the very important desiderata of growth as well, but, as in the old Federal Reserve days, there is not any single measure that you can follow and recognize exclusively as the guide. As the Congress, indeed, demonstrated when it was considering the Employment Act, they found they had to use a pretty broad brush to paint the objectives that they wanted. Senator FLANDERS. NOW, getting it into human terms, we think of high production and consumption. Do you feel that a stable price level leads to those ends? Mr. BURGESS. Yes, sir. Senator FLANDERS. One thought came to my mind in connection with your chart No. 4, which showed the rapid increase of industrial production up. until the middle of 1953, the rise in business inventories slightly beyond that, and then a gradual decrease. Would not a drop, not in wholesale prices necessarily, but a drop in the general price level have moved the inventories? I t seems as though that used to be considered the old free-market operation, but this time there was not any particular decrease in prices to the consumer, so the inventories dropped off slowly. As they were worked off, production went down. Mr. BURGESS. That is one of the very extraordinary features of this business movement. As you indicate, in previous ones, there has tended to be an adjustment in prices which has helped to move the goods. I think that, perhaps, there has been a little more price adjustment than shows in the indices, the sale of cars at discount or white goods, and so on. One can debate that question that you raise at great leijgth. The difficulty is that if you do have a sharp drop in prices it tends to accentuate the whole movement, and may lead you into a spiral downturn. I think also that the fact that there was no great drop in prices was an indication of confidence in the future that business had, so they thought they would wait it out, and so far it looks as though they may have been right in so doing. UNITED STATES MONETARY POLICY 175 Senator FLANDERS. Then in business practice and j n certain governmental operations we must qualify some of our ideas about the automatic effects of free market supply and demand on production, and employment. We think of that as sort of a norm which we look at occasionally; is that about the size of it ? Secretary HUMPHREY. Well, I think, Mr. Chairman, in connection with this, just from a practical viewpoint, that we had large consumer buying during all this period, and I think that with that large consumer buying, that was the thing that tended to help stabilize the situation, and the goods kept moving, and there was not the pressure, the price pressure, that you otherwise would have. Further than that, you have not had the great rise in prices immediately preceding it, either, that usually occurs just before this sort of thing. Senator FLANDERS. Yes. Secretary HUMPHREY. SO that with the combination of rather stable prices "on the way up, and with a continuing distribution going on, you did nothave the wide price swings that you might otherwise have had during the last 2 or 3 years. I would not say that that phase of our economy was gone for all future time. Senator FLANDERS. Well, that is a good subject for contemplation; I will not press it further. Now, there is one element in our debt structure which ought to be perfectly simple to me, but somehow or other I get tangled up every time I look at it. That is the special issues to trust funds; who owes what to whom. These funds flow in from the States and from the beneficiaries into the Treasury; with this money the Treasury buys for its own account some special issues, which are put into trust funds as reserves against future payments. How do these issues get into circulation as Government funds? Are they paid out? Secretary HUMPHREY. I can illustrate this in a kind of common garden way. Senator FLANDERS. That is the only way I shall understand it. . Secretary HUMPHREY. And by a little story that I have told before, 1 had a businessman one day speak to me about these funds, and ho said, "Isn't that just crooked? Aren't you just deceiving people by that!" And I said, "Well, I really don't think so." I said, "You have"— this was a businessman running a large business—I said, "You have a substantial pension fund for your company, don't you?" And he said, "Yes," that they had a big pension fund; that every year they contributed to that pension fund so as to not have a big burden all come at one time, and that they, perhaps, were not actuarilly sound, but they reached toward actuarial soundness in their fund, and they kept putting annual deposits each year in this fund so the fund would be available for use when the occasion required it. I said, "Now, what have you done with that fund ? How have you got it invested?" He said, "Why, we have our fund invested in Government bonds. That is what we put our fund's investment in." 176 UNITED STATES MONETARY POLICY I said, "That is exactly what we do. The United States has its funds invested in exactly the same way. We charge to income annually an amount to bring these funds into the realm of actuarial soundness." You can get into all kinds of arguments about actuarial soundness, but it is in that realm. Then I said, "We invest our money in Government bonds just as you do." Senator FLANDERS. And the money received for those bonds is available for expenditures ? Secretary HUMPHREY. That is right. Senator FLANDERS. I have another question. Secretary HUMPHREY. I will just say one more thing, that I think we should never fail to keep in our minds: That practice—while I do not know what else you can do with your money, or how else you would handle it—does hold this fear that we might just as well recognize. This applies particularly to unemployment funds or other funds that are subject to emergency withdrawal. In the event of an emergency withdrawal, an emergencv need for funds, not only the private funds will be wanting to sell their bonds in order to turn them into cash to use the cash currently, but the Government funds—for the same emergency purpose—would do the same thing. So that we might run into a period where you would have the private funds and the Government funds and a number of other people all trying to realize on funds which they have laid aside in bonds for their protection. Then you might have an emergency in which you would have an excess of Government bonds offered on the market which might present a serious problem for the time being. Senator FLANDERS. One further question on that line: How much interest does the Government pay itself, and does it make any difference ? Secretary HUMPHREY. Well, I think it does make a difference. I think you have to treat these funds just as you would treat the private funds. Senator FLANDERS. Except that you do not have to market them. Secretary HUMPHREY. YOU may have to market them sometime. Senator FLANDERS. I t would then be these very instruments which you put into the trust funds that you would market in an emergency ? Secretary HUMPHREY. NO. They would be changed into the kind of thing that would sell to meet the market condition at the time. Senator FLANDERS. Then the marketability is not a determinant of the interest which you pay yourself ? Secretary HUMPHREY. Not necessarily. Senator FLANDERS.. Well, I have always wondered how you determined the interest you should pay yourself and whether, as debtor, you ever had any arguments with yourself as creditor on that particular subject. , As I say, I personally do not see that it makes any difference. Secretary HUMPHREY. Many of the interest rates are fixed by law. So that part is settled. Senator FLANDERS. Yes; I see. In order to give time for others, I will be as brief as possible in questioning. . We had some discussion here yesterday to indicate that there was something in the nature of a near panic in the money market around UNITED STATES MONETARY POLICY 177 June 1 last year. Would you say that that was a correct description of what happened ? Mr. BURGESS. Well, Mr. Chairman, I think that is a little exaggerated. There was no doubt about it; the market was disturbed and disorderly for some days. The new $1/4 percent bonds went to a discount of just over 1 percent; it was not very bad. I t restored itself reasonably well. The Federal Reserve put money into the market through the purchase of Treasury bills, and that was taken as an indication of a change in policy. The market cleared itself up over a period of weeks. I t undoubtedly was a crisis of sorts. Of course, most changes from a boom to a leveling off in economic conditions do have some sort of crisis, and in the light of other crises, this was a relatively mild one. Senator FLANDERS. D O you feel that it would be helpful if the Reserve System went back to the policy of offering some support while securities were being marketed, or are you content to go along with the plan of their holding off during that period ? Mr. BURGESS. Well, I want to say, first, that during these nearly 2 years that we have been working with the debt, we have had very fine cooperation from the Federal Reserve System. We have not been conscious of any deficiency in their cooperative efforts. Now, I think in the discussion yesterday, and in other discussions, there was a tendency—you may want to ask Mr. Martin about this— to overstate the decision of the Reserve System to stay out of the market. I think they have always qualified that by saying that if the market became thoroughly disorderly they would be prepared to go in and do whatever was necessary to straighten the market out. Senator DOUGLAS. Mr. Chairman, before you proceed, might I refer to the previous question asked of Mr. Burgess? Senator FLANDERS. Yes. Senator DOUGLAS. Mr. Burgess, you spoke of the fact that in June of 1953 the new bonds'fell by only 1 percent, but is it not true that the bonds of older issues had fallen by approximately 10 percent? Mr. BURGESS. Well, they fell by 10 percent from 1951 to June of 1953. Senator DOUGLAS. Yes; but I mean was not the sudden decline from March to June of 1953? Mr. BURGESS. That was not 10 percent, Mr. Senator. As I remember it, it was about 4 points—from 94 to 90. Those bonds had already been declining for 2 years. The decline was sharper, admittedly, in that; last period. Senator DOUGLAS. Excuse me. Senator FLANDERS. NOW, one other question: Is there such a thing as a free market for paper representing debt when, in your chart No. 2, you show that at the present time 40 percent of the total public and private debt is Federal, and back in 1946, 58 percent was Federal? How can a market be free when so much of it is on the terms of a single issuer? Mr. BURGESS. Well, Mr. Chairman, of course, it is not entirely free. We are in and out of the market constantly, and the Federal Reserve, with almost $25 billion of governments, is a constant factor in the market. I t is a relative term, but the market is certainly freer than 178 UNITED STATES MONETARY POLICY it was, a great deal freer* and the question is how much leeway thsre is for the natural forces of supply and demand for money to operate. Now, we believe that things will be healthier if the natural forces of supply and demand have a good deal of leeway to operate, and that they tend to be self-corrective of difficulties in the market—I say tend to be. When we are such large factors, the Federal Reserve and ourselves, we always have to be alert to the market, and ready at some point to see that at least we do not upset it, and at times to act as a stabilizing factor, but whatever freedom you can give it we believe is very useful. Senator FLANDERS. Mr. Patman? Representative PATMAN. Mr. Secretary, you mentioned the possibility of an emergency arising through the sale of Government securities by these trust funds to take care of their obligations. Don't you consider that a pretty good reason to consider support for Government bonds under certain conditions, at least? Secretary HUMPHREY. Well, I think that I would answer that just exactly as Mr. Burgess answered the previous question. I think that there are times when there ought to be some attempt to stabilize market conditions; but that, by and large, the best thing we can do is to keep our activities in such shape that we are not influencing the market either way, but to let the market use it$ natural correctives to the greatest possible extent. Representative PATMAN. Will you put that first chart back up, about the public debt; that is $279 billion? You do not list Federal Reserve notes in that, do you? Secretary HUMPHREY. NO. Representative PAT3rAN. Federal Reserve notes, after all, are obligations of the United States Government, carrying the same obligation as a bond, is that right, Mr. Secretary? Mr. BURGESS. They are secured obligations; they have gold and the assets of the Federal Reserve System behind them. Representative PATMAN. But they are obligations. They state on their face, just like a Government bond; they are obligations of the United States Government. Now, when the Federal Reserve bank, for instance, buys $1 million in Government bonds, and it gives $1 million in Government Federal Reserve notes, that is paying out one form of Government obligation for another. You are just listing one of them up there now in the public debt. Why should not the Federal Reserve notes be listed because there are $30 billion worth of them outstanding today, £nd the Government has got to pay every one of them ? Secretary HUMPHREY. Well, you understand this does not attempt to reflect all of the obligations of the Government in any way. Representative PATMAN. I know, but this is a debt obligation. Secretary HUMPHREY. There are a whole lot of obligations much larger than that. If we put in all of the contingent liabilities and all the other things, you would have a far different picture than this. Representative PATMAN. We have an enormous debt, the total debt being $697 billion, public and private. Now, 1 percent interest on that would be $6,970 million. UNITED STATES MONETARY POLICY 179 In view of the fact that the public debt—I mean the national debt— represents such a large part of that, don't you think the cost of money should be considered in all the policies that you are adopting, Mr, Secretary ? Should it be a major factor ? Secretary HUMPHREY. The cost is an important factor. Representative PATMAN. I t is an important factor, of course. Now, Mr. Burgess said a while ago that he placed the level of prices, the buying power of the dollar, 1 believe, No. 1 on your list m importance. Secretary HUMPHREY. I think that is very important. Representative PATMAN. What would you list second ? Secretary HUMPHREY. For what purpose ? I do not know what Representative PATMAN. For the purpose of looking after the public interest and economic interest of the Nation. Secretary HUMPHREY. Well, I think what we are trying to do is this*: Wfc are trying to create stable conditions and conditions that are favorable for the making of jobs. I think this whole thing gets back to the people and the making of jobs. Representative PATMAN. That is the point I am coming to, Mr. Secretary. Don't you think that full employment is more important than the level of prices? Secretary HUMPHREY. I think the making of jobs is probably the most important thing that this country has to do. We have a growing population, and I think the basis of our prosperity, of the living of the people in this country, gets back to the making of jobs. Representative PATMAN. Well, I am glad to hear you say that because that puts the Employment Act No. 1, does it not? Secretary HUMPHREY. Well, I do not know that I would say the Employment Act, is it? Representative PATMAN. Well, I mean the policies set forth. Secretary HUMPHREY. I think I would put it just as I set forth, the making of jobs. Representative PATMAN. And the policies set forth Secretary HUMPHREY. There are certain things that help to make jobs, and certain things that help to discourage that. Representative PATMAN. I think that is the Employment Act. Secretary HUMPHREY. And I think we ought to help to make jobs. Representative PATMAN. Isn't that one of the things in the Employment Act, the making of jobs ? Secretary HUMPHREY. I will not quarrel with you on words; in my point of view it is making jobs. Representative PATMAN. I think you have dovetailed it in, and I think it parallels the Employment Act. I am glad to hear you say that is more important than the level of prices. I want to ask you about this S^-percent bond issue of last year. When was that issued, April 1 or April 30 ? Secretary HUMPHREY. I do not remember the exact day, but it was in April. Representative PATMAN. I believe it was dated May 1. Mr. BURGESS. Yes; for payment on May 1. Representative PATMAN. I t was announced in the early part, of April. Secretary HUMPHREY. Some part of April. 180 UNITED STATES MONETARY POLICY Representative PATMAN. I cannot understand, Mr. Secretary, why you put out that issue at all. You did not have to have the money ? Secretary HUMPHREY. We needed to borrow about a billion dollars, and we wanted to do it that way for a number of reasons. One reason that does not show in the charts I would like to just call to your attention: We had had since early in the Korean war extensive controls in our economy. Those controls covered many prices, wrages, and so forth. We had great bureaus down here exercising those controls. During the latter part of the preceding year there had been some discussion as to whether or not those controls could be taken off. When we first came into this Government, there was a great division of opinion as to whether or not the controls could be removed. I t was thought that it was beneficial by some to get controls off just as rapidly as possible, and let the economy begin again to function freely. I t was said by others that if that were done we would have a runaway inflation, prices would go right through the ceiling, and we would have a lot of difficulties. That was the atmosphere in which we were operating in the early part of the spring of 1953. We decided that it would be best for the economy if those controls were removed, and removed just as rapidly as possible, to return the economy to a free operating basis. In order to attempt to keep prices from running away, with the removal of those controls, there were several things that could be taken into account. One of them was the productive power of industry coming u p ; another was prospective demand; another was some restraint on credit which would help dissuade speculative buying for inventory purposes, and all those things were taken into account, and this issue was part of the program that was used in taking off those controls. We did take off the controls, and all of the calamity howls that we might set off an impossible price rise proved to be false, and our prices did not rise. We went along without the controls, and I am sure the country was much better off because we did so. Representative PATMAN. I have great respect for your judgment, Mr. Secretary, but I don't think that was related to issuing $1 billion in 3 % percent bonds. Secretary HUMPHREY. That was part of the program. Representative PATMAN. NO. 1, it was not necessary to issue them. You had the money. Xo. 2, the rate was excessive, as is evidenced by the fact that a purchaser of the 3*4 percent bond at the low point, selling them at the high point within 1 year, would have made more than 15 percent. Secretary HUMPHREY. Everybody had the same chance. The bonds have always been freely traded in the market. Representative PATMAN. A windfall. Secretary HUMPHREY. Everybody had a chance. They were available in the market at par or below all during May and June. Representative PATMAN. Somebody got an awful windfall in that. That is about the biggest windfall I know of in the history of Government bonds. Secretary HUMPHREY. The bonds went below par after they were put out and they didn't get above par again until July. Representative PATMAN. I know, but some people bid on those bonds, their subscriptions were cut in half and the commercial banks UNITED STATES MONETARY POLICY 181 got them. Mr. Burgess said you were trying to take them out of the commercial banks. Secretary HUMPHREY. There were plenty in the market for many weeks. Nobody was denied an opportunity. Representative PATMAN. And another question, Mr. Humphrey: Why did you permit the F- and G-bond holders to exchange their bonds at 3*4 percent, and not permit the E-bond holders to do the same thing? Secretary HUMPHREY. I will ask Mr. Burgess to answer that. Mr. BUKGESS. Well, the E-bonds are an entirely different kind of bond. The E-bond holder was already getting 3 percent for a bond that is completely protected from all fluctuations in the market. Representative PATMAN. I know, but this is 314. You let the F and G's, getting 2.9 percent, the same that the E's were getting, exchange theirs that were maturing for the Z1/^ percent, although you didn't permit the little fellow, the E-bond holder, to do. Mr. BURGESS. We did peymit him, Mr. Congressman. Any E-bond holder that wanted t o cash in his bonds and buy the others had the full privilege of doing it. They were available in the market. Representative PATMAN. If he could get them through a bank or a broker who would be paid a commission. Secretary HUMPHREY. Of course, he could get them. But the E-bond buyer is a completely different kind of buyer. He is a small buyer who doesn't want to take the risk of the market. He, typically, hasn't any reason to buy 3*4's or 2%'s, or any other marketables. Now, for example, suppose you sold 2 ^ ' s to the E-bond buyer, he would have suffered, as you indicated awhile ago, 10 percent Representative PATMAN. I am not talking about 2 ^ percent. I am talking about 3*4 percent. You gave the F and Gr holders, who are in a higher income class than the E bondholders, an opportunity to exchange their maturing bonds that were drawing 2.9 percent interest for the Z1/^ percent without going through any market or anything else, just exchange them, but you did not permit the little fellow with the E bonds, to do the same thing, and that is the point I can't understand. Secretary HUMPHREY. Well, I just want to insist that the E-bond man could get his money at any time from the banks and invest it in that market if he wanted to. Representative PATMAN. Why didn't you give him the same privilege you gave the F and G holders ? Secretary HUMPHREY. He had it automatically. Representative PATMAN. Well, he didn't. Secretary HUMPHREY. He could cash his bonds and take the money and put it in the other bonds. Representative PATMAN. E's are held by the little fellows. Secretary HUMPHREY. Sure. Representative PATMAN. The F and G's by the big fellows. You specifically stated in your notice that the F and G bondholders could make an exchange directly with the Treasury. They didn't have to go through a broker or a bank. They just made a direct exchange of their 2.9 percent bonds for the 3*4 percent bonds. You made it very easy for them which was fine, but why didn't you let the E bondholder do the same thing? He had the same type bond, 182 UNITED STATES M0NETA11Y POLICY 2.9 percent. Why didn't you let him exchange them for the 3*4 percent bonds ? Secretary HUMPHREY. He could automatically have done exactly the same thing bv redeeming his E bonds. As a matter oi fact, we have given holders of maturing E bonds an even better proposition. They can automatically extend their bonds and get 3 percent interest on an obligation that can be turned into cash on demand without any market risk. The fact that the great majority of holders of matured E bonds did not turn them in to buy the 3*4 percent marketable bond is fairly good proof that they preferred to keep the E bonds. Representative PATMAN. I know you went to a lot of trouble to do it. You made it easy for one and hard for the other. That is what I can't understand. Secretary HUMPHREY. NO ; there wasn't any trouble for anybody. Representative PATMAN. And brokers' commissions, possibly, and expenses of different kinds. Secretary HUMPHREY. NO. There are no brokers' commissions or anything like that. All those bonds are redeemed without charge. Representative PATMAN. The reason I say you shouldn't have put this issue out, Mr. Humphrey, is because you had nearly $6 billion iii the banks that could have* been used and should have been used. There was never a time during that year that you didn't have 2 or 3 times the amount of that issue in the banks, subject to your use, if you wanted to use it, and that is the reason I can't understand it. Secretary HUMPHREY. TWO or three times the amount of issue hasn't got a thing.to do with it. What we need to have is cash funds to operate on, and I don't think you can find a business in the country that operates any closer than we do on cash on hand. Representative PATMAN. I know, but Congress—— Secretary HUMPHREY. We have been operating with less than 30 days' cash must of the time we have been here. Representative PATMAN. YOU are overlooking something. Secretary HUMPHREY. Wait a minute. We've been keeping less cash than was on hand relative to expendi? tures at any time for a long time prior to that. We have operated this Government with relatively less money than has been used for years. Representative PATMAN. YOU are overlooking something. Congress has very wisely provided for a $5 billion overdraft between you and the Federal Reserve banks. In other words, if you exhaust these funds, you can get $5 billion directly from the Federal Reserve banks at any time. You have a $10 billion leaway there. Why should you want over 5 billion? And if you don't want over five, why don't you use this money that is in the banks? Secretary HUMPHREY. DO you want an answer to that? Representative PATMAN. I do. Secretary HUMPHREY. The day you are talking about we had in the tax and loan accounts in commercial banks four billion, nine eightythree—«— Representative PATMAN. What day was that? Secretary HUMPHREY. That was the last day of March. The end of April, we had $1,589 million in these accounts. UNITED STATES MONETARY POLICY 183 Representative PATMAN. Well, that is three times as much. Secretary HUMPHREY. The end of May, we had $2,109 million and so the end of June we had $3,071 million. , Representative PATMAN. I have here on March 31, you had $0,108 million; on April 28, you had $3,627 million. Secretary HUMPHREY. I think your trouble is you are counting; in there a billion dollars of gold that was on hand, and about $500 million in Federal Reserve accounts. Representative PATMAN. I think that's right. You had $500 million in the till. Secretary HUMPHREY. I am talking about usable cash in our working accounts in the commercial banks. The figures I just gave you are the correct figures. Representative PATMAN. I reiterate according to your own figures, not counting this $1 billion of which you have used about half since you had about $1 billion gold and $500 million usable cash. Not counting that you still had 2 and 3 times as much money all during that period as the amount of this bond issue, and what I can't understand is why you would issue a bond and at three and a quarter Secretary HUMPHREY. I t was an amount of Representative PATMAN. Wait just a minute. Let me finish. Why you would issue bonds and of the highest rate clear out of reach, as evidenced by the fact that they had gone so high since that time, when you didn't need the money. You could have gotten every bit of that money from the banks and had twice as much left there. In addition to that, if you needed more money, you could have gotten $5 billion from the Federal Reserve banks as you are permitted to do by congressional law. Secretary IIUMPHREY. Well, now you are saying two things at once. You are saying first we didn't need the money and, second, you are saying we could have gotten the money elsewhere. Repersentative PATMAN.' No. No. 1,1 will close right there. You didn't need it. Secretary HUMPHREY. Whether we got it one place or another is not what you are now talking about. You are now saying we didn't need the money. Representative PATMAN. That's right. Secretary HUMPHREY. I am saying we did need the money, as shown by our balances where, at the end of April, we had $1.8 billion in the tax and loan accounts. Do you know how long that lasts ? We were spending $6 billion a month at that time. Representative PATMAN. That doesn't make any difference, Mr. Secretary. Why keep on saying that? Secretary HUMPHREY. We had on hand about 10 days of cash. You pretty nearly have to write checks Representative PATMAN. That is not alarming at all, when Congress has very wisely provided that you can get $5 billion instantly from the Federal Reserve banks. It is in the law. You asked for the law to be renewed here a while back. Secretary HUMPHREY. YOU have got to have it right now if you are going to write checks against it. Representative PATMAN. YOU can get it right now, draw it on the Federal Reserve. That is the only bank you draw on, anyway. 184 UNITED STATES MONETARY POLICY Secretary HUMPHREY. Wait a minute. Now you have switched again. Now you are talking about where you get the money, not whether we need it or not. Xet's talk about one thing at a time. Representative PATMAN. That came up. Secretary HUMPHREY. A S to whether we needed it? Representative PATMAN. That came up, assuming you did need it. I don't say you needed it, you didn't need it. In other words, you put out an issue to give somebody—you didn't do it deliberately, I am not charging you with that. There is nothing personal in this, Mr. Secretary—you gave these fellows a big windfall. I t gave these people a big windfall equal to about 15 percent in one year on the finest and best securities on earth. I t has never happened before, I don't think in any country on earth,, and when you didn't need the money and you had twice that much in the banks that you could use, as to why you would do it, I still can't understand, to save my life. Secretary HUMPHREY. I think if you will look at the figures, you will understand it much better. Representative PATMANT Furthermore, why should you keep those deposits in these banks at all, anyway ? You don't have to. Secretary HUMPHREY. There is another subject, and we will be very glad to talk about that. Representative PATMAN. All right, now, I have your very fine comprehensive report on that, for which I now want to express my thanks. The report is very full and very complete. I ask that it be inserted in the record at this point. (The report referred to is as follows:) THE SECRETARY OF THE TREASURY, Washington, October 29,195 f^ Hon. WRIGHT PATMAN, House of Representativest Washington 25, D. C. DEAR MR. PATMAN : In response to your letter of September^, which I acknowledged on September 13, I am enclosing herewith a memorandum giving you the history of the depositary practice of the Treasury Department, legislative authority therefor, and other information concerning the maintenance of deposit accounts by the Government in commercial banks. I trust that this memorandum will furnish .the information you desire. Very truly yours, G, M. HUMPHREY, Secretary of the Treasury:. W H Y THE FEDERAL GOVERNMENT KEEPS FUNDS IN COMMERCIAL BANKS This memorandum has been prepared in response to Congressman Patman's letter to the Secretary of the Treasury, dated September 3, 1954, regarding the practice of the Federal Government in keeping funds in the commercial banks of the Nation. The memorandum presents the following information requested' by Congressman Patman: 1. History of depositary practice of the Treasury Department. 2. Legislative authority. 3. Complete and definitive statement explaining the operations of, and reasons for, this practice. 4. Specific terms on which banks accept these deposits. 5. Precisely how decisions are arrived at as to leaving funds on deposit and to transferring them. 6. why these funds are not transferred to the Federal Reserve banks immediately upon receipt. 7. What the high, low and the average balance carried in commercial depositaries has been during the fiscal year ending June 30,1954. 8. Same information for each of the 12 Federal Reserve districts. UNITED STATES MONETARY POLICY 185 1. History of depositary practice of the Treasury Department Except for brief intervals the United States Government has throughout its history followed a practice of depositing its public funds in the banks of the Nation. Among the first acts of Alexander Hamilton as Secretary of the Treasury was the designation of the Bank of North America and the banks of New York, Massachusetts, and Maryland as depositaries of Government funds. The First Bank of the United States, chartered in 1791, served as a Government depositary and fiscal agent. When the bank was not reehartered, the Government funds were transferred to State banks. The act authorizing the chartering of the Second Bank of the United States in 1816 specifically authorized the Secretary of the Treasury to deposit Government funds "in places in which the said bank and branches thereof may be established." When the Second Bank ceased functioning as a national institution in 1830, the Government again relied upon State banks to act as depositaries. In 1840 a system was set up to separate, as completely as possible, the Government's financing operations from the money market. Congress passed a law establishing the Independent Treasury System, and the Government became its own banker. This act created four subtreasuries, located in New York, Boston, Charleston and St. Louis. Their duties were to receive deposits of public moneys, to make disbursements, and to transfer money from one point to another, functions theretofore performed by commercial banks. The financial history pf the ensuing years proved the inadequacy of the Independent Treasury System to meet the needs of a growing country. This System received a serious setback at the beginning of the Civil War when the attempt to collect in specie the money which the Treasury needed to finance the war forced the suspension of specie payments. The result was the establishment in 1863 of the National Banking System, which provided for the designation of these banks as depositaries of public funds. One of the disadvantages of the Independent Treasury System, not fully met by the National Banking System, was its inability to supply business with sufficient note circulation whene needed and to avoid overexpansion when speculation reached the danger point. It was not capable of keeping pace with the growth of business in the United States and had become obsolete by the time the Federal Reserve System was established in 1014. The Federal Reserve Act contained authority for the Federal Reserve banks to act as fiscal agents for the United States Government and to hold deposits of Federal funds. In order to give the Federal Reserve banks time to become organized, the Treasury did not appoint them as fiscal agents until January 1, 1016. The Independent Treasury System was abolished by act of Congress, approved in May of 1020, when the remaining duties of the subtreasuries were taken over by the Federal Reserve banks. However, it was necessary for the Treasury to continue to utilize commercial banks as depositaries in those principal cities which did not include Federal Reserve banks or branches. In the Second Liberty Bond Act of 1917, the Congress provided for t h e establishment of Treasury war loan accounts to take care of the financing of the Liberty loans. These accounts were originally established to enable the banks to retain, until withdrawn by the Treasury, the proceeds arising from sale of Liberty bonds to such banks or their customers. Later authority ITor use of these accounts was extended to the sale of other Government securities, including United States savings bonds and Treasury sayings notes. Under the Current Tax Payment Act of 1943, and later legislation, withhold income taxes, certain quarterly income and profit-tax payments, social-security taxes and excise taxes are deposited in these accounts which have become known as tax and loan accounts. 2. Legislative authority The legislative authority for deposit of Government funds in commercial banks is provided under several basic acts of Congress. Citations of these acts and the pertinent provisions are as follows: (1) Revised Statutes, section 5153, derived from the act of June 3, 1864 (13 Stat. 113, as amended), relating to the designation of national bank associations as depositaries of public moneys: "All national banking associations designated for that purpose by the Secretary of the Treasury, shall be depositaries of public money, under such regulations as may be prescribed by the Secretary; and they may also be employed as financial agents of the Government; and they shall perform such reasonable duties, as depositaries of public money and financial agents of the Govern 186 UNITED STATES MONETARY POLICY ment, as may be required of them. The Secretary of the Treasury shall require the associations thus designated to give satisfactory security, by the deposit of United States bonds and otherwise, of the safekeeping and prompt payment of the public money deposited with them, and for the faithful performance of their duties as financial agents of the Government: * * * " (12 U. S. C, 90). (2) The Federal Reserve Act of December 23, 1913 (38 Stat. 259) as amended on May 7, 1928 (45 Stat. 492), relating to the designation of member banks as depositaries: "All banks or trust companies incorporated by special law or organized under the general laws of any State, which are members of the Federal Reserve System, when designated for that purpose by the Secretary of the Treasury, shall be depositaries of public money, under such regulations as may be prescribed by the Secretary • • • " (12 U. S. C. 332). (3) The act of September 24, 1917, with regard to authority to deposit the proceeds of sales of bonds, certificates of indebtedness, and war savings certificates (40 Stat. 291, as amended) : "The Secretary of the Treasury, in his discretion, is authorized to deposit, in such incorporated banks and trust companies as he may designate, the proceeds, or any part thereof, arising from the sale of the bonds and certificates of indebtedness, Treasury bills, and war-savings certificates * * * and arising from the payment of internal-revenue taxes, * * *" .(31 U. S. C. 771). (4) Act of June 19, 1922 (42 Stat. 602), relating to depositaries in foreign countries, territories, and insular possessions: "The Secretary of the Treasury may designate such depositaries of public moneys in foreign countries and in the territories and insular possessions; of the United States as may be necessary for the transaction of the Government's business, under such terms and conditions as to security and otherwise, as he may from time to time prescribe: Provided, That in designating such depositaries American financial institutions shall be given preference wherever, in the judgment of the Secretary of the Treasury, such institution is safe and able to render the service required" (31 U. S. C. 473). (.V) Act of June 11, 1942 (50 Stat. 350), relating to insured banks: "AH insured banks designated for that purpose by the Secretary of the Treasury shall be depositaries of public moneys of the United States * * * and the Secretary is hereby authorized to deposit public money in such depositaries, under such regulations as may be prescribed by the Secretary; and they may also be employed as financial agents of the Government; and they shall perform all such reasonable duties, as depositaries of public money and financial agents of the Government as may be required of them. The Secretary of the Treasury shall require of the insured banks thus designated satisfactory security by the deposit of United States bonds or otherwise, for the safekeeping and prompt payment of public money deposited with them and for the faithful performance of their duties as financial agents of the Government * * *" (12 U. S. C. 2G5). (0) The Current Tax Payment Act of 1943 (57 Stat. 12G) with respect to the designation of depositaries for withheld taxes: "The Secretary may authorize incorporated banks or trust companies which are depositaries or financial agents of the United States to receive any taxes under this chapter in such manner, at such times, and under such conditions as he may prescribe; and he shall prescribe the manner, times, and conditions under which the receipt of such taxes by such depositaries and financial agents is to be treated as payment of such taxes to the collectors" (20 U. S. C. 1G31). (7) Section 0302 (e) of the Internal Revenue Code of 1954 (derived from t h e act of August 27,1949, 03 Stat. 008), with respect to depositaries for collections; "Use of Government Depositaries.—The Secretary or his delegate may authorize Federal Reserve banks, and incorporated banks or trust companies which are depositaries or .financial agents of the United States, to receive any tax imposed under the internal revenue laws, in such manner, at such times, and under such conditions as he may prescribe * * *." 3. Complete and definitive statement explaining the operations'of, and reasons for, this practice The Congres has vested in the Secretary of the Treasury authority to utilize the services of the Federal Reserve banks and the commercial banks of the country as depositaries and fiscal agents of the Government. Not only has the Congress granted authority to/the Secretary to utilize the services of banks but it has also established, by law, the basic procedures for handling the receipts and expenditures of the Government. UNITED STATES MONETARY POLICY 187 The 12 Federal Reserve banks are now the principal fiscal agents of the United States Government. Each Reserve bank maintains an account in the name of the Treasurer of the United States. Into these accounts virtually ail Government receipts eventually are credited, and from them nearly ail payments are made. Implementing the Treasurer's accounts a t the Federal Reserve banks is a nationwide network of deposit accounts in commercial banks. Most of the money collected by the Government feeds into the United States Treasurer's accounts at the Reserve banks through the banking system of the country. Any incorporated bank is eligible to qualify as a Government depositary. All Government deposits in banks must be secured by a pledge of collateral security, this collateral, usually being in the form of United States Government securities. {a) Operation of Special Depositaries (Tax and Loan Accounts).—The system of "special depositaries" originated during World War I. The lirst Liberty Loan Act of 1917 provided that banks purchasing securities issued under terms of the act, for their own accounts or for the accounts of their customers, could deposit the proceeds from such purchases into special accounts known as war loan accounts. Until 1035, dei>osits in these accounts wefe not subject to reserve requirements. Originally the banks were required to pay 2 percent interest on such deposits. However, this was considerably below prevailing interest rates at that time. In the early 1030's, this interest rate was lowered and then eliminated entirely along with interest payments on other demand deposits in keeping with the provisions of the Banking Act of 1033. During the 1930's, receipts from the sale of Government securities were relatively small and comparatively little use was made of the war loan accounts. The heavy borrowing requirements of the Federal Government accompanying World War II provided a need for the Treasury to utilize more fully the war loan accounts. The act of April 13,1943 (57 Stat. 05), suspended, for the duration of hostilities plus 6 months, against balances in these accounts, all reserve requirements and Federal deposit insurance assessments. The reserve and insurance requirements were reimposed after June 30, 1017. Following World War II, the Congress provided for whler use of these accounts by authorizing the Treasury to use them for processing certain tax receipts. Beginning with March 1018, the banks were permitted to credit to these accounts their receipts of withheld income taxes, which previously had been turned over to the Federal Reserve banks monthly or more frequently. On January 1, 1050, the Treasury revised the system for deposit of withheld income taxes and extended the provisions for deposit to war loan accounts to include deposits of payroll taxes from the old-age insurance program. The war-loan accounts were renamed tax.and loan accounts on January 1, 1050. Other appropriate taxes have since been made eligible for deposit in these accounts. Under a special arrangement, large quarterly payments (checks of $10,000 or more) of income and proiits taxes, may be deposited in tax and loan accounts when, and to the extent, that the funds are not immediately needed by the Treasury. This arrangement was first provided for quarterly tax payments of March 1051. Beginning in July 1051, railroad retirement taxes became eligible for deposit to these accounts. In July 1053, certain excise-tax payments became eligible. It must be borne in mind that deposits are not made by the Treasury into these accounts. Deposits to the tax and loan accounts occur in the normal course of business under a uniform procedure applicable to all banks whereby customers of banks deposit tax payments and funds for purchase of Government securities. In most cases the transaction involves merely the transfer of money from a customer's account to the Government's account in the same bank. On occasions* to the extent authorized by the Treasury, banks are permitted to deposit in these accounts proceeds from subscriptions entered for their own account as well as for the account of their customers. The working cash of the Treasury, is held mainly in the Federal Reserve banks and branches. The Treasury draws upon these balances for its daily disbursements. As these balances become depleted they are restored in part through various receipts deposited to the Treasurer's account at the Federal Reserve banks. However, the larger part of receipts to these accounts is derived by calling in funds from the tax and loan accounts. Well over half of the Government receipts now flow through tax and loan accounts. In order to reduce the administrative cost to the Treasury by avoiding making frequent withdrawals from small accounts, Treasury has classified special depositaries into group A and group B. The present classification places in group A those banks whose Treasury tax and loan account balance as of Febru 188 UNITED STATES MONETARY POLICY. ary 16, 1954, was less than $150,000. Banks with balances in excess of this amount on that date are classified in group B. Banks are regrouped at least once a year. Still another classification in use is what is known as X balances. These are the balances derived from deposit of large quarterly payments of income and profits taxes. These balances are usually depleted more rapidly than those of the A and B accounts. These X balances may be held by banks of both group A and group B. Calls for withdrawals from group B depositaries and on X balances are usually announced on Monday or Thursday and payments scheduled for several working days subsequent thereto. Withdrawals from group A depositaries are made less frequently, usually only once a month. The tax and loan accounts are very active, and the flow of deposits and withdrawals is rapid and continuous. As a result of the uneven flow of the Government's receipts and expenditures the balances fluctuate considerably. (See attachments 1 and 2.) Using end-of-the-inonth.figures, the balances in these accounts fluctuated during the fiscal year 1954 from $6,G90,000,000 on July 31, 3953, to $2,400,000,000 on January 31, 1954. The volatility of these accounts is indicated by the frequency and size of withdrawals made against uncalled balances in the group B accounts. (See attachment 3.) Withdrawals from these larger accounts are usually made twice weekly and frequently reach 25 to 50 percent of the balance in the account as of a particular date. The single monthly withdrawals on the smaller accounts usually equal or exceed 50 percent of the balances. The volume of receipts and disbursements flowing through the tax and loan accounts has increased almost steadily during the past 7 years as follows: [In millions of dollars] Receipts Fiscal year 1048 1949 1950 1951 _. - $8,575 15,231 10,876 24,128 Withdrawals $7,765 15,233 15,380 21,716 Fiscal year j 1952 1953 1954 Receipts $36,492 41,267 41,645 Withdrawals $37,066 43.302 39,880 Out of approximately 14,500 eligible banks in the United States, nearly 11,000 have qualified as tax and load depositaries. (&) Operation of other depositaries.—While the principal balances are held in the tax and loan accounts of special depositaries, relatively small amounts (aggregating about $500 million) are held in other types of depositaries which are designated by the Treasury to hold balances of Government funds and to perform certain services for the Government. It is the policy of the Treasury to utilize the facilities of the Federal Reserve banks and branches to the fullest extent possible for these services. However, as these facilities are available at only StJ points in the United States, it has been necessary to supplement them by designating banking institutions as depositaries at other points when justified by the volume and character of essential Government business. These depositaries, which extend to all areas of the United States, our Territories and insular possessions, and foreign countries, are briefly described as follows: General depositaries: There are approximately 1,420 general depositaries which hold about $400 million of Government deposits exclusive of balances they may have in tax and loan accounts. This type of depositary is authorized to maintain on its books an account in the name of the Treasurer of the United States. It is maintained only at points where there is a necessity to meet cash requirements of Government officers for payrolls or other expenditures, or to receive deposits of cash from depositors of public moneys. General depositaries are given a stated balance which is fixed in relation to the volume of business in the Treasurer's account and which may be retained until the need therefor no longer exists. All moneys received in excess of the authorized amount must immediately be remitted to the Federal Reserve bank of the district. Limited^depositaries: Limited depositaries are designated at such points as are required to receive up to specified maximum amounts deposits made by postmasters, officers of United States courts, and other officers in special cases for credit in their. official checking accounts with the depositary. As a general rule, no Treasurer's balances are maintained in limited depositaries for this purpose. UNITED STATES MONETARY POLICY 189 Bank draft depositaries: These depositaries are designated by the Treasury to issue bank drafts to Government officers in exchange for funds received by the officer for the account of the United States. These designations are made when the volume of business does not justify a general depositary. Small Treasurer's balances are maintained in these depositaries. The balances are .fixed in relation to volume of business handled. Depositaries for State unemployment compensation accounts (social security) and veterans' unemployment compensation benefit payment accounts: Depositaries for State unemployment compensation accounts are designated for the purpose of handling receipts and payments for social security unemployment compensation under arrangements with the Social Security Board. Likewise, depositaries for veterans' unemployment compensation are those designated to handle the receipt of Government funds and the payment of unemployment compensation1 to veterans under arrangements with the Veterans' Administration. In both instances payments are made by checks signed by State officials. Treasurer's balances are maintained in these depositaries. Banking Facilities: Banking facilities are those offices provided by commercial banks, primarily at military posts, to render certain necessary banking services to the post and its personnel. These services include cashing Government checks, furnishing cash for payrolls, receiving deposits of Government funds, and similar services. The facilities are located at Army posts, Air Corps installations, naval stations, military and veterans' hospitals, Atomic Energy Commission plants, and other Government establishments where regular banking services are not readily available. Treasurer's balances are maintained with the banks designated to operate banking facilities. Check-Cashing Facilities: Because of the large concentration of Government employees in the District of Columbia and adjoining area, certain banks have been designated for cashing of Government payroll checks for noncustomers. Treasurer's balances are maintained with these banks. Territorial and Insular Depositaries: These may be either general or limited depositaries located in the Territories or insular possessions of the United States. Foreign Depositaries: Banks in foreign countries may be designated as general depositaries, limited depositaries, or depositaries of foreign currency. Substantial amounts of foreign currency are acquired from foreign governments without payment of dollars in connection with various economic, technical and military foreign-aid programs, as well as in settlement for lend-lease, surplus property, etc. Foreign branches of American banks are given preference when available and able to render the service required. As a basis of offsetting expenses incurred by the banks in handling Government business of this nature the Government has long followed a practice of maintaining Treasurer's balances with the depositaries, or, as with limited depositaries, authorizing Government officers to maintain minimum operating balances in their official checking accounts. Briefly, the procedure followed in establishing these depositaries and in determining the balances to be authorized for handling Government business is as follows: The request to establish a particular depositary is generally initiated by a Government officer in the field, who presents to his administrative officer in Washington the reasons for needing a Government depositary in the particular area. An estimate is made of the amount of business the depositary would be called upon to perform. If the Washington headquarters of the agency agrees with its field officer that a depositary is necessary, the agency requests the Treasury to designate such depositary. In addition to considering the volume of business to be transacted and the possibility of utilizing other depositary facilities already established, the Treasury will usually estimate, or call upon the banks under consideration for designation to estimate, the cost of performing such service. Any possible earnings accruing to the bank as a result of serving as a Government depositary must be shown as an offset against cost. If, in view of all factors concerned, it is believed to be in the best interests of the Government to establish a depositary, the Treasury will issue the necessary designation. A Government deposit will be made to the depositary in an amount sufficient to offset the e x c u s e s incurred by the bank for servicing the Government. The initial allotment of a Treasury balance to a depositary must be based upon an estimate. Each depositary is advised that the initial allotment will be subject to adjustment upon the basis of the volume and character of the Government business actually handled./ Depositaries 55314—54 13 190 UNITED STATES MONETARY POLICY submit monthly analyses of business handled and their costs. Due to differences in the size and location of banks, nature and volume of business handled, etc., it is not practicable to adopt uniform standards which may be applied to all banks. However, based ui>on experience gained in reviewing analyses submitted by banks throughout the Nation, and even in foreign countries, and a day-to-day review of cost studies made by banking associations and individual banks, certain guides have been established for use in determining reasonableness of bank costs. Treasury balances maintained with these depositaries are generally time deposits. They are subject to both reserve requirements and Federal deposit insurance assessments. • Depositaries at present are required to compute the earning value of the average daily loanable balance in the Treasurer's account at the rate of 2 percent per annum for analysis purposes. Depositaries may, if they so desire, purchase 2 percent depositary bonds, in amounts equal to their authorized Treasury balances. The depositary bonds are held as collateral security for the Treasury balance. If the depositaries do not purchase depositary bonds, they must pledge other acceptable collateral. (c) Rraxonsjor this practice.—The Treasury uses commercial banks as depositaries of Government funds for two reasons: (a) The system provides the most efficient and most economical way of transacting the Government's business and (b) it reduces to a minimum the effect of Treasury financial operations on the economic stability of the country. These advantages will be discussed in turn. There have already been described those services which are performed for the Government by the commercial banks and for which the Treasury authorizes maintenance of Government balances as an offset to bank costs. In addition, the banks incur expenses in rendering a number of other important services for, which no reimbursement is made. One of the most important public services the banks render is the sale and issuance of United States savings bonds, either by direct cash sales or through the servicing of payroll-savings plans. They do this work without charge to the Treasury, notwithstanding the fact that in many cases it is necessary to employ full-time employees on the work. The banks distribute announcements and receive subscriptions for the purchase of marketable securities, and they handle matured marketable securities for redemption or for exchange into new issues, all without reimbursement by the Government. Commercial banks render considerable assistance to the Treasury in the weekly sale and distribution of Treasury bills. Treasury bills are usually issued with maturities of 01 days, with an issue maturing each week for 13 consecutive weeks. The proceeds of these bills are not deposited in tax and loan accounts. In bidding for Treasury bills, many subscribers submit their .tenders through commercial banks. The banks check with dealers on possible bid ranges and enter their customer's bid for the amount requested. This work is done without compensation to the banks. In World War I and again in World War II the banks played a major role in the success of the war-loan drives. Three-quarters of the dollar volume of war-loan campaign sales were made through commercial banks. Banks handle without charge to the Government remittances from employers in connection with the deposit of withheld income and social-security taxes. As a nteans of assisting the Treasury in preventing or reducing tax evasion, banks furnish the Internal Kevenue Service, without charge, information regarding large currency transactions. They report to the Internal Revenue Service interest paid on savings accounts and the payment of dividends where banks act as financial agents for corporations. They cooperate with the Government's foreign funds control activity in order to prevent leakage of American assets into certain foreign hands, requiring the keeping of supplemental records and the filing of many reports with the Treasury. There are only a comparatively few areas where banks receive fees for services such as the redemption of savings bonds and the servicing of Commodity Credit Corporation crop loans. These services entail risks of loss as well as expense which the Government could hardly expect the banks to assume without reimbursement. For instance, when a bank redeems a United States savings bond, if is liable for any loss resulting from an error in identification. Thus the banks perform for the Government, and particularly for the Treasury, a number of indispensable services. Most of these services are performed free of charge, either as a public service or in the interest of fostering good customer relations. Without such services a large increase in the number of Federal employees would be necessary and a large expense to the Government would be UNITED STATES MONETARY POLICY 191 entailed. Even though the Government did perform these services itself, and at a great cost, it could not provide many of these services as expeditiously and as conveniently for the public as can the banking system. By having the commercial banks perform certain fiscal agency functions of the Federal Government in conjunction with serving the regular business needs of their customers these functions can be handled most efficiently and most economically for the Government. This arrangement works to the mutual advantage of the Government, the public, and the banking system. The second reason for depositing Government funds in the commercial banks of the Nation is that this practice provides the most effective method yet devised for maintaining a smooth flow of funds from the banking system into the Treasury and back again into the channels of trade through Government disbursements. Nearly all Government disbursements are made from funds held on deposit in the Federal Reserve banks. This means that virtually all funds, both receipts and expenditures, sooner or later, How through the Treasurer's accounts with the 12 Federal Reserve banks. When checks drawn on the commercial banking system for payment of taxes or purchase of Government securities are deposited in the Treasurer's accounts at the Federal Reserve banks, there is an equivalent drain on member bank reserves, since the member banks pay the checks by drawing the amounts from their reserve balances held in the Federal Reserve hanks. Each payment from the public into a Federal Reserve account involves a corresponding reduction in bank reserves. Each disbursement by the Treasury from a Federal Reserve account causes an equal increase in member bank reserves. The impact of these money Hows could be held to a minimum if each day's inflow of funds into the Federal Reserve accounts were approximately offset by a corresponding amount of disbursements. Obviously it is not possible for the Government to time its borrowing operations and to make its tax collections in such a maimer that daily receipts will equal the Government's daily disbursements. The uneven ilow of Government receipts and expenditures and the need for spacing cash borrowing operations make such perfect balancing impossible. However, the likelihood of abrupt changes resulting in intense stringency in the money market can be lessened immeasurably by Treasury's practice of initially funneling a considerable part of its receipts from borrowing and taxation into its deposit accounts at the commercial banks. In this manner, reserves are not withdrawn from the banking system until such time as they can he returned by Treasury disbursements. Through the utilization of its tax and loan accounts the Treasury can largely neutralize the money market impact of the ilow of funds,through its accounts and can so regulate the impact of Treasury financing operations on the money'market as to avoid disruption to the market. If the special depositary system did not exist there would be heavy drains on bank reserves during periods of heavy taxpayments or of large-scale borrowing operations. 1'he banks would have to draw down their reserves to transfer funds to the Treasurer's accounts at the Federal Reserve banks. In order to meet this drain-on their reserves the banks would have to liquidate Government securities previously purchased, restrict normal extension of credit to their customers, or obtain credit from the .Federal Reserve System. As the balances built up in the Federal Reserve banks w-ere disbursed by the Government they would be deposited by the customers of the commercial banks and bank reserves would be built up again. The Federal Reserve System would then have to absorb the resulting excess reserves. These fluctuations in bank reserves would have an extremely disrupting effect on the money market and the Nation's business. Not only does the system of tax and loan accounts make it possible to leave funds in the banking system until such time as they are required for Government disbursement, but it also permits such funds to be retained in the communities from which they come. For example, assume that a commercial bank in Panhandle, Tex., sells $100,000 of savings bonds to its customers. This money is left on deposit in Panhandle until such time as it is needed to pay the Government's bills. If this money should be immediately deposited in the Federal Reserve bank before it can be returned to channels of trade through Government disbursement* the money in the community of Panhandle would be transferred to Dallas. Without the tax and loan accounts there would be during periods of heavy taxpayments or during borrowing operations tremendous shifting of fund» between banks,and communities. On occasion, the Treasury, in anticipation of heavy tax receipts during heavy tax months, will, under statutory authority, replenish balances at Federal Re 192 UNITED STATES MONETARY POLICY serve banks by. borrowing directly from such banks through the issuance of special certificates of indebtedness, rather than withdrawing funds from Treasury tax and loan accounts. These funds are borrowed for only a few days and enable the Treasury temporarily to make disbursements in excess of its current receipts thus providing the banks with additional reserves in advance of a later unavoidable drain. Such an operation is, of course, consistent with the overall policy of smoothing out the effects on bank reserves of the Government's financing operations. The tremendous growth of the Federal Government budget and of the public debt in recent years has made Treasury operations the largest and most important single influence on the flow of funds through the money market. Federal fiscal operations growing out of an annual budget of more than $G0 billion and a public debt of more than $275 billion also underscores the importance of the Treasury maintaining a suflBciently large cash operating balance to be able to meet any unusually heavy drains upon the Treasury. The Federal Government, like any private corporation or business, cannot be prudently managed if its cash operating margin is so close that every time unexpected bills come in, it has to rush out and borrow the money to cover them. In the case of the Federal Government it seems reasonable to carry an operating reserve at least equal to a month's expenditures. Not only are there great fluctuations in the Government's receipts and expenditures within the year, but in addition, there is a huge volume of demand debt outstanding—such as sav ings bonds—which adds to both real and potential demands on the Treasury. Many of these fluctuations are predictable and cash can be built up ahead of time. But the timing of many of the demands cannot be anticipated exactly and the Treasury has to be prepared to meet them. By providing an effective mechanism for smoothing out the impact of the Government's financial operations on the banking system and the economy, the Treasury tax and loan accounts render a service of inestimable value. 4. Specific terms on which banks accept deposits Specific terms on which banks accept deposits are spelled out in Treasury circulars, the more important of which are Circulars 92 and 176. However, for the major types of depositaries the most important terms are: (1) The banks must be designated by the Treasury subject to qualifications set by the Treasury, (2) the banks must pledge collateral at least equal to deposits, (3) deposits may not exceed limitations set by the Treasury, (4) deposits are subject to reserve requirements and Federal deposit insurance assessments, (5) the banks must perform the services stipulated in the designation and submit such reports ns prescribed oy the Treasury. All deposits to tax and loan depositaries are of z demand nature~an& can be called by the Treasury at any moment. 5. Precisely how decisions are arrived at as to leaving funds on deposit and to transferring them Treasury's calls for withdrawals of funds are based upon its cash requirements. Balances with the Federal Reserve banks are maintained at a fairly constant level adequate to cover expected daily cash needs and to provide for a proper regional distribution of funds. A day-to-day analysis is made of these balances, of anticipated direct deposits to the Federal Reserve accounts, and of estimated disbursements. Calls for withdrawals are issued on tax and loan accounts to the extent that additional funds will be required to meet Treasury's daily cash requirements. As pointed out earlier the calls generally provide that payments be made several days subsequent to date of call. The calls provide for withdrawal of a specified percentage of the balance within the account. All accounts are treated uniformly except that withdrawals from banks holding balances in excess of $150,000 are made more frequently than from banks holding balances in smaller amounts. The Treasury does not take money from one bank to put into another. It draws out money as needed for Government expenditures. 6*. Why these funds are not transferred to Federal Reserve danks immediately upon receipt There are two principal reasons why funds are not transferred to Federal Reserve banks immediately upon receipt. The most important one is that such a procedure would have damaging effects on the economy of the country. The second reason is that it would result in no .financial gain to the Treasury— .on the contrary, it could easily result in increased overall costs of Government financing. UNITED STATES MONETARY POLICY 193 As discussed at considerable length earlier in this memorandum, the immediate transfer of Government funds from commercial bank accounts to Federal Reserve accounts would disrupt the even flow of money and the Nation's system of bank reserves. Serious dislocations would occur if the Government receipts should be transferred immediately from local communities to the Federal Reserve banks, perhaps long before the money is returned to channels of trade by Government disbursements. This action would, in fact, remove the economic stability advantages now derived from the use of tax and loan accounts. There would be no financial gain to be derived from such action inasmuch as it does not cost the Treasury any more to keep the money on deposit in commercial banks than in the Federal Reserve banks. While no interest is received from the commercial banks on their Government deposits, neither would interest be received if the money were immediately deposited in the Federal Reserve banks. Moreover, all Government deposits in Treasury tax and loan accounts are fully protected by collateral pledged by the commercial banks. On the other hand, such action would likely result in substantially increasing, the Government's general financing costs. The transfer of the funds immediately to Federal Reserve banks might affect commercial banks' decisions to buy Government securities and banks might feel that they should be reimbursed for the numerous services the Treasury now receives free of charge, such as issuance of savings bonds and assistance in the sale of marketable issues. 7. What the high, low, and the average balanee carried in commercial depositaries has been during the fiscal year ending June 80,1954 The high, low, and average balances in the tax and loan accounts by months for fiscal year 1954 are shown in the following table: Tax and loan balances fiscal year 1954 [In millions] High $7,493 July 1953...... August . - . . . . . . . . . . . . 6,448 S e p t e m b e r . . . . . . . . . . . . . 5,642 O c t o b e r . . . . . . . . . . . . . . . . 5,164 N o v e m b e r . . . . . . . . . . . . . 5,177 D e c e m b e r . . . . . . . . . . . . . 4,194 Low $1,649 5,758 3,984 2,812 2,573 2,302 Average $4,944 6,095 4,957 3, 098 4,268 3,223 January 1954 March April ..... ... High Low $3,114 3,659 4,540 4,727 4,574 4,836 $2,081 2,507 2,4502,698 1,902 1,722 Average $2,536 3,129 3; 450 3,541 3,303 3,297 The tremendous fluctuations occurring in. these balances is well illustrated for the month of July 1953, when the balance ranged from a high of $7,193 million down to $1,649 million. The above figures do not include balances in general and limited depositaries. These balances are fairly consistent running usually slightly below $500 million (see attachment 4). If balances in these depositaries exceed certain stated maxima the excess is immediately sent to the Federal Reserve banks. An important yardstick in assessing whether Treasury tax and loan balances appear to be unduly high or dangerously low is to measure the Government's cash operating balance (which is made up primarily of tax and loan balances but also includes our deposits in Federal Reserve banks and gold in the general fund) in terms of average monthly budget expenditures. As pointed out previously, to be on the safe side this operating reserve ought to be at least equal to 1 month's operating expenditures. For the 1954 fiscal year as a whole, for example, budget expenditures averaged $5.6 billion a month and the end of month cash operating balances averaged about $5.4 billion—less than a month's expenditures. Furthermore, the fiscal year average hides the fact that there were many times during the year when the balance was under $3% billion, or less than two-thirds of a month's outgo. Viewed historically, the Treasury's cash balance margin in relation to budget expenditures has been much smaller recently than earlier years. Obviously, it was necessary to carry unusually high balances during World War II, but even in the 1930's the average balance was well over double the average monthly expenditures. (See attachment 5 for table and chart showing Federal expenditures and the operating cash balance for fiscal years 1932-54.) 194 UNITED STATES MONETARY POLICY 8. Same information for each of the 12 Federal Reserve districts Tax and loan balancesfiscalyear M5b by Federal Reserve districts [In thousands of dollars] High balance Low balance Federal Reserve district Date Boston . * Philadelphia Cleveland . . . ... .. Richmond .......... Atlanta.-.. .... ,... Chicago . St. Louis Minneapolis Kansas C i t y . . . . ... T>allas San Francisco... ....... July 16,1953 Aug. 24,1953 July 17-19,1953 July 16,1953 July 17,1953 July 21-23,1953 July 17-19, 1953 July 16, 1953 July 17-19, 1953 July 16, 1953 July 18,19,1953 Amount Date Amount $286,805 2,905.084 322,799 543.362 282,285 310,802 1,231,064 228,094 197,628 232,659 179,397 840.138 June 15,1954 do July 14,1954 May 12,1954 July 14,1953 do June 15,1954 July 14,1953 Jan. 11,1954 July 14,1953 do July 10,1953 $91,024 407,287 88.265 135.992 77,253 59,499 344,189 64,721 57,467 68,502 56,593 106,437 Average balance $182,931 1,219,953 204,344 325,170 160,855 156,795 744,767 137,914 102. 020 152.002 114.557 370,189 LIST OF ATTACHMENTS 1. Treasury tax and loan accounts—deposits and withdrawals and balances by A, B and X accounts (table)< 2. Treasury tax and loan accounts—analysis of deposits, withdrawals and balances (table). 3. Calls on Treasury tax and loan accounts (table). 4. Deposits in banks (table). & Federal expenditures and operating cash balance (table and chart). 195 UNITED STATES MONETARY POLICY ATTACHMENT NO. 1.—Treasury tav and loan accounts—Deposits, withdrawals and balances in A, B, and X accounts ]Tn millions] Balance * (at end of period) With- 2 Deposits i drawals Qrouo A Oroun B Period banks Fiscal vear: $767 6.902 33,231 54.018 50, 10? 27,007 1941 1942 1943 1944 1945.. 1946 19-17 19-18 1949 1950. 1951 1952 1953 1954 Flseal vear 1954: 1953: Julv August September October November December 1954: January February March April May June _ 1 „ r ,. "!• ... . . . .... --— . ... ... banks 7, 430 8. 575 15.231 16.876 24.128 36,492 41,267 41,645 $911 5.884 27, 213 43,678 45.487 36,609 19,488 7,765 15,233 15.380 21. 716 37.066 43.302 39,880 7.336 2.545 3,-110 1,969 4.404 2,339 3,718 3,410 3,681 4,331 2, 752 3, 526 422 324 476 368 461 428 6,208 5,501 4,779 2,521 4,084 2,930 1,349 2, 369 4. 607 2.404 4, 486 4,030 2,301 1,316 3. 685 3,601 3, 656 3,903 382 391 264 333 652 553 2,024 3,067 2,321 2.936 3,451 1,944 5661 1,679 « 7,667 « 18,007 * 22. 622 $12,447 $575 731 231 1,501 272 1,611 160 2,921 347 2,404 285 1,915 327 1,527 217 1,944 553 " X " ! Total accounts < $661 1.679 7,667 18,007 ! 22,622 » 13,020 962 $2,991 2,865 1,328 2,339 1, 772 1,774 3,270 5.680 5,106 3.071 4,836 6.690 5.825 5.255 2.893 4,545 3,358 1,794 2,339 2,406 3,4.58 4.379 3,273 4,103 4,836 1 Deposits consist of proceeds from sales of securities, deposits on account of withheld taxes, beginning March 22, 1948, deposits on account of taxes withhel I unaer the Federal Insurance Contributions Act, beginning Jan. 1,1950, deposits on account of Hailroal Retirement taxes, beginning July 1,1951, and deposits on2 account of excise taxes, beginning July 1, 1953. Includes calls by Treasury and voluntary prepayments accepted by Treasury. * Elective May 11, 1943, Federal Reserve banks were instructed to establish subsidiary controls so as to classify war loan depositaries in their districts into two groups, group A including all depositaries having balances of $.300,000 or less and grouo B those having balances of more than $300,000. Various amendments have since been made to the original disposition, the current dividing line being $150,000. * Represents income taxes deposited under a special procedure, first adopted in March 1951, for crediting in tax and loan accounts the proceedsof checks of $10,000 or more. This procedure is usually followed in quarterly tax payment periods. * Breakdown into A and B banks not available. e Does not agree with daily. Treasury statement. Breakdown based on telegraphic reports for last day offiscalyear which was a Saturday. 196 UNITED STATES MONETARY POLICY ATTACHMENT NO. 2.- -Treasury tax and loan accounts- -Analysis of depositst withdrawals and oalances [In millions] Credits to tax and loan accounts Proceeds from sales of securities Period Savings Savings Other bonds notes Fiscal year: 1941 ........... 1 P> 1942 1943 * i (•) ! (») 1944 .... (3) h 1945— . b) 1946 .... <*) 1947 . •$4,493 •$2,937 1948 •3,931 •2,024 1949 4,879 3,878 1950 3,755 5,834 1951 3,390 3,347 1952 2,227 4,678 1953 . 2,667 2,231 1954 3,457 2,333 July 1953 240 378 August .............. 211 363 September .......... 211 911 October..., ......... 222 681 208 263 389 January 1 9 5 4 . . . . . . . . . . . . February . ._ 339 March...... . ..... 396 April . . . 349 May ...... . 300 June .... ..... 330 to Taxes Income i Total taxes credits not Other * withheldi (•) to (») (*) (») $804 2,738 10,285 11.164 5,874 $6,971 13,270 10,227 4,791 136 2,150 996 2,144 2,134 180 2,341 $1,820 6,473 7,287 10.331 13,581 15,858 19.899 708 1,971 1,988 1,066 2,046 2,077 961 2,029 2,076 969 2,043 1,966 $767 ! 6,902 33,231 54,018 60,102 27,007 7,430 8,575 15,231 16,876 24,128 36,492 41,267 41,645 7,336 2,545 3,110 1,970 4,404 2,339 1,349 2,369 4,606 2,494 4,486 4,636 OutstandWith- Balance at end ing drawof calls at als period end of period $911 5,884 27,243 43,678 45,487 36,609 19,488 7,765 15,233 15,380 21,716 37,066 43,302 39,880 3,718 3,410 3,681 4,331 2,752 3,526 2,301 1,317 3,685 3,601 3,656 3,903 ! $681 1,679 7,667 18,007 22,622 13,020 962 1,772 1,774 3,270 5,680 5,106 3,071 4,836 6,690 5,825 5,255 2,893 4,545 1 3,358 1 2,406 1 3,458 4,379 3,273 4,103 4,836 I (*) $2 10& 291 796 804 310 1,400 1,475 934 1,233 938 1,825 1,728 888 1,782 1,261 345 1,501 1,101 1,487 1,688 1,233 i Represents income taxes deposited under a special procedure,firstadopted in March 1951, for crediting In tax and loan accounts the proceeds of checks of $10,000 or more. This procedure is usually followed in quarterly tax payment periods. * Represents withheld income taxes, beginning Mar. 22, 1948; taxes withheld under the Federal Insurance Contributions Act, beginning Jan. 1, 1950; Railroad Retirement taxes, beginning July 1, 1951; and excise taxes, beginning July 1,1953. »Breakdown not available. < Not available. • Partly estimated. 197 UNITED STATES MONETARY POLICY ATTACHMENT NO. 3.—Calls on Treasury tax and loan accounts, fiscal year 1954 [In millions] A accounts * Date Calls Percent Amount 1953 July 2 July© July 9 July 13 July 16 July 20 July 23 July 27 July 30 Aug. 3 Aug. 6 Aug. 10 Aug. 13 Aug. 17 Aug. 20Aug. 24 Aug. 27 Aug. 31 Sept. 3 Sept. 10 Sept. 14 Sept. 21 Sept. 24 Sept. 28 Oct. 1 Oct. 5 Oct. 8 Oct. 1 3 . . . . Oct. 15 Oct.19 Oct. 22 Oct. 26 Oct. 2 9 . . . ' Nov. 2 Nov. 5 . . . . Nov. 9 Nov. 12 Nov. 16 Nov. 19 Nov 23 Nov. 25 Nov. 30 .. Dec. 3 Dec. 7 . . Dec. 10 Dec. 22 Dec. 28 Dec. 30 Jan. Jan. Jan. Jan. 1954 4 21 25 28 B accounts * Uncalled balance 50 $133 $133 50 245 245 50 230 230 50 177 177 50 219 219 50 202 202 . . See footnote at end of table. Calls 1 Percent Amount X accounts * Uncalled balance 10 22 22 $161 387 413 $1,450 1,211 916 8 4 5 5 10 5 6 9 4 541 278 336 325 613 313 350 501 216 6,214 6,136 5,967 5,698 5,181 5,016 4,981 4,554 4,518 9 6 16 16 7 16 6 6 6 13 18 6 24 13 8 8 8 14 12 6 9 8 10 5 8 9 18 18 19 10 15 10 12 24 496 352 928 897 365 694 254 251 280 648 I 860 283 I 993 ! 480 268 | 251 220 ! 370 298 151 211 197 441 217 364 427 812 760 723 350 398 274 358 702 5,019 5,369 4,355 4,498 3,580 3,258 3,102 3,924 4,135 ] 3,927 3,271 3,241 2, 574 2,221 2,106 2,133 2,149! 1,925 1,819 1,811 1,886 1,902 3,559 3,483 3,821 3,731 3,093 2,437 2,019 1,923 1,662 2,465 2,348 1, 730 20 15 6 5 587 321 133 101 1,288 1,821 1,769 1,786 Calls Percent Amount (4) $424 (») ioe -« Uncalled 1 balance 198 UNITED STATES MONETARY POLICY ATTACHMENT NO. 3.—Calls on Treasury tax and loan accounts,fiscalyear 1954— Continued (In millions] B accounts * A accounts * Calls Calls Bate Uncalled balance Percent Amount 50 $206 $206 75 363 121 Calls Uncalled balance Percent Amount mi Feb. 1 Feb. 4 Feb. 11 Feb. 15 Feb. 18 Feb. 23 Feb. 25 Mai". 1 Mar. 4 Mar. 11 Mar. 15 Mar. 18 Mar. 25 Mar. 29 Apr. 1 Apr. 5 Apr. 8 Apr. 12 Apr. 15 Apr. 19 Apr. 22 Apr. 26 Apr. 29 May 3 May 6 .„ May 10 Mavl3. M a y 17 M a y 20 Mav24 M a y 27 June 1 June 3 X accounts» 12 4 4 6 15 6 27 14 15 $243 99 93 144 429 199 871 429 400 55 1,081 Uncalled balance Percent Amount $1,679 2,033 2,224 2,168 2,287 2,545 1,870 1,566 1,550 88425 14 10 45 30 - June 10 June i 4 . _ . .. . 50 188 188 50 313 313 1. 21 580 2,183 M0 5 10 30 33 7 32 24 10 18 15 4 24 11 12 15 40 10 15 '259 122 246 722 1,001 203 274 487 150 281 503 158 845 3«0 386 430 979 221 196 2,090 2.055 1,962 1,310 1,311 1,250 1,274 864 861 700 2,834 2,946 2.331 2,0°>8 1,891 1,673 844 725 890 (8) (») $115 226 294 807 509 $3i3 1,391 1,318 692220 237 56 71 i Accounts with balances of $150,000 and under (approximately 8.000 banks). * Accounts with balances over $150,000 (approximately 2,500 banks). * These accounts are used during heavy tax*paymcnt periods to avoid excessive strain on bank reserves.. Incomcta* checks of $10,000 and over are deposited in them. * 100 percent of uncalled balances. * 100 percent of remaining balances. * 80 percent of uncalled, balances. »Includes $8.7 million special call of 28 percent on New Orleans district only to adjust for error made by that bank on previous B call. NOTE.—Banks are segregated into groups A and B in the interest of economy. Calls are made usually twice a week upon the group B banks (the larger banks but smaller in number) and about once or twicea month on the group A banks. Source: Office of the Fiscal Assistant Secretary. 199 TJGNITED STATES MONETARY POLICT A T T A C H M E N T N O . 4.—Deposits in banks (End of monthfigures)on basis of daily treasury statement * [In millions] Commercial banks E n d of month or fiscal year June: 1941 1942 1943 1944. 1915 1946 1947 W4H 1919 19.50 1951 1952....* 1953 Fiscal year 1954: July 1933 August September October.November December January 1954 February March April May June Fiscal year 1955: July 1954 August September.. October Federal Reserve banks (available) $1,024 603 1,038 1,442 1,500 1,006 1,202 1,928 438 950 338 333 132 „ 548 496 642 662 451 346 404 548 722 579 422 875 * Special depositaries (tax and loan accounts) * General depositaries ! $63 69 228 235 225 227 215 213 238 270 319 397 413 $661 1,679 7.667 18,007 22,622 12,993 962 1,773 1,771 3,268 5,680 5,106 3.071 423 420 466 440. 420 409 4S4 422 459 427 420 433 6,690 5,825 5,'255 2,892 4, 545 3,358 2,406 3,458 4,379 3,273 4,095 4,836 480 399 416 2,538 4,078 3,469 727 511 704 Foreign depositaries Total Total $724 1,801 ! 7,946 18,254 22,863 13,225 1,191 2,006 2,036 3,571' 6,036 5, 555 3, 533 $1,748 2,404 8.984, 19,696 24,363 14,231 2,393 3,934 2,474 4,521 6,374 5,888 3,065 102 102 119 121 122 89 86 89 87 91 88 88 7,215 6,347 5,840 3,453 5,087 3,856 2,976 3,909 4,925 3,791 4,009 5,357 7,763 6,843 6.482 4,115 5,538 4,202 3,380 4,517 5,647 4,370 5,031 6,232 88 86 89 3,106 •4,563 3,974 3,833 5,074 4,67a $53 I 51 12 16 5 14 20 27 33 37 52 49 1 December 1 1"" i Thesefiguresdo not include Saturday transactions when Saturday falls on last day of reporting period. * Prior to Jan. 1,1950, these accounts were designated as war loan accounts. NOTE.—There are approximately 14,ff0rarkF ellgirle to held Gcvnrirert cVrcsits. As of Aug. 31,1954, there were 1,422 general depositaries; 11,113 special depositaries; and 34 foreign depositaries. ATTACHMENT NO. 5.—Treasury operating cash balance and average Federal budget expenditures fiscal years 1932-5'f [In billions of dollars] Fiscal year Average Average monthly operating budget cash balance* expenditures 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 0.4 .6 2.1 2.4 1.8 1.6 2.3 2.3 1.7 1.5 2.3 5.8 * 13-month average of end of month figures, 0.4 •4 .6 .5 •7 .6 .6 •7 .8 1.1 2.8 6.6 j Fiscal year 1944 1945 1946 1917 1948 1919 1950 1951 1952 1953 1954 J .w Average Average monthly operating budget cash balance' expenditures 12.9 16.0 20.1 7.2 3.9 4.4 4.5 5.3 5.2 5.7 5.4 7.9 8.2 5.1 3.3 2.S 3.3 3.3 3.7 5.5 6.2 5.6 200 UNITED STATES MONETARY POLICY FEDERAL EXPENDITURES AND OPERATING CASH BALANCE. $Bil. 15 Average x Cash Bo Ionce (End of Month) 10 Average Monthly / Expenditures ^Sy 1932 A innnnnnnfl •35 "40 '45 Fiscol Yeors — •50 '54, #MM«rMS«inuryKtM«MM)r Representative PATMAN. But you say essentially in your memorandum that it is necessary to do this—I am not trying to use your language, or put words in your mouth, but the impression I received is—it is necessary to do that because the banks went to a lot of trouble in selling bonds. Secretary HUMPHREY. NO. That is not right. Representative PATMAN. And rendering other services, and that you wanted to compensate the banks by leaving these deposits there a certain time. Secretary HUMPHREY. No. Representative PATMAN. Was my conclusion correct or was it incorrect? Secretary HUMPHREY. I t is incorrect. Representative PATMAN. All right, why did you want to leave all this five or six billion dollars there all the time ? Secretary HUMPHREY. We have to have it for working funds that move in and out. When you are spending as we are anywhere from four and a half to six billion dollars a month, you have to have cash on hand to pay your bills with, to meet your checks as your checks are presented. Representative PATMAN. Let's analyze t h a t . Secretary HUMPHREY. SO we have to keep a working balance on hand to meet our bills. Now, the reason we do it through the banks is because with the money coming in and the money going out,, if we keep this money spread throughout the country and run tax and loan accounts in the commercial banks we have less dislocation of funds througout the country and we don't pull one area way down and build another area way up. UNITED STATES MONETARY POLICY 201 Private deposits in a bank are just shifted to Government deposits in the same bank until we have to pay our bills. We don't put most of that money there ourselves, you know. I t gets there as people pay their taxes or buy bonds. That's all explained in the material I sent you in October, and again in the answer to question 8 of the subcommittee's questionnaire. Representative PATMAN. That is the object of the Federal Reserve. Let the banks go to the Federal Reserve and borrow temporarily. Secretary HUMPHREY. By doing it this way we avoid that difficulty. Representative PATMAN. But you are going around the Federal Reserve. Secretary HUMPHREY. We keep an even flow of money throughout the country and we do not dislocate bank reserves or bank balances by doing it in this way. I t is the way you get the most even flow you can possibly work out, and that is very desirable. Representative PATMAN. I don't want to take up too much time, Mr, Chairman. There is nothing personal in this, but there is just 2 or 3 New York banks that had a quarter of a billion dollars all the time that you were putting out this issue, and I venture to say that there wasn't a time that the banks, just a few banks in New York City, didn't have as much as $1 billion on deposit, andT can't understand why you would keep that money on deposit when it is unnecessary. Secretary HUMPHREY. We don't discriminate among banks. Why don't you come up, Mr. Patman, and sit Representative PATMAN. Wait just a minute, please. If the banks render service, pay them for it. I want them adequately compensated. I am not trying to take anything away from them, but I don't believe in just having those accounts there, keeping that money there idle and unused. You don't even check on it. Secretary HUMPHREY. D O you keep a personal checking account? Representative PATMAN. YOU don't even check on these banks. Secretary HUMPHREY. Do you keep a personal checking account? Representative PATMAN. I try to. Secretary HUMPHREY, YOU try to keep a balance in it, don't you, so your checks are good? Representative PATMAN. That's right. Secretary HUMPHREY. And that balance has something to do with the amount of checks you are going to write. Representative PATMAN. But you don't check on these banks, you check on the Federal Reserve. Secretary HUMPHREY. The effect is the same as checking on the banks. Representative PATMAN. Don't you call on them for a certain percentage? Secretary HUMPHREY. That's right. Representative PATMAN. In other words, you check on the Federal Reserve. Secretary HUMPHREY. I t is the sam6 thing as checking on the banks, because we are constantly transferring funds, day by day from those accounts to our accounts at the Federal Reserve were the checks are paid. Representative PATMAN. And I just wonder if some person were charged for failing to pay his taxes and the defense lawyer should 202 UNITED STATES MONETARY POLICY contend before the jury that the charge really is that this taxpayer didn't turn it over to the corner national bank so that the corner national bank could use it, it might have some weight on the jury in the collection of taxes, and this nioney is powerful money, every dollar of it; they expand six times. In other words, if they have $1 billion on deposit, they can make loans aggregating $6 billion, and if they charge them 6 percent like the Small Business Administration charges, that you happen to be connected with, 6 percent, that would be 3G percent interest there. Secretary HUMPHREY. The fact that we have a billion dollars on deposit in the banks certainly does not mean that they can turn around and expand their lending power by $6 billion. These are deposit liabilities; they aren't reserves, which are assets. It's the reserves that enter into the expansion of lending power—not the deposits. I think it might be very helpful to you if you would come up and sit with Ed Bartelt for a while and see this actual operation and see how fast you have to move when you are trying to pay $6 billion worth of bills with only $4 billion worth of money. Representative PATMAN. Well, that is the reason Congress very wisely provided that you had that $5 billion cushion there, $5 billion, and that is a fine cushion, and that could take care of any of these temporary upsets, or upsets that are not temporary. Secretary HUMPHREY. The authority given the Treasury to borrow up to $5 billion directly from the Federal Reserve was never intended to cover anything but situations where temporary borrowing is helpful, as around tax dates. Its purpose is to smooth out the effect on the economy of short-run peaks m the Government's cash receipts and disbursements. Now the Treasury and the Federal Reserve have never used this borrowing authority on other than a temporary basis and have no intention of. doing so. If we did, I think the Congress would properly object. Representative PATMAN. NOW, another thing, and I shall be through, Mr. Chairman, about the interest rates on the housing, and particularly the veterans' loans, the Veterans' Administration, and the F H A . There was pressure brought to bear to raise those interest rates. Do you have coordination between the Treasury and the Federal Reserve ? You know what they are doing, don't you ? They have been telling you all the time. Secretary HUMPHREY. We have very cordial relations with them, and we try to keep informed as well as we c£n. Representative PATMAN. YOU knew that the Federal Reserve was going to take an about-face on May the 6th last year and reverse their policy and take the easy-money road instead of the hard-money road, didn't you? Secretary HUMPHREY. I knew that they were buying some bills in the open market at some point, but I can't tell you exactly when. Representative PATMAN. That was May the 6th. ^ On Saturday, May 2,4 days before that, the Veterans' Administration raised the interest rates on veterans loans. The F H A raised interest rates on F H A mortgages. Now, if you have liaison between the Treasury and the Veterans' Administration and the FHA, why didn't you warn them not to raise UNITED STATES MONETARY POLICY 203 those interest rates, that the Federal Reserve was going to change its policy in a few days, and there would be no need to raise them ? The excuse was—and it was a good excuse—that the mortgage lender is entitled to a 1%-pereent spread, and, as long as the long-term Government rate was 2y2 percent, he was satisfied with 4 percent. That was a 1 ^-percent spread. But, when the long-term Government bond rates went up under this hard-money policy and they kept going up and got to 3, with a great deal of logic and reason, and it is very persuasive, the mortgage lenders 1said, "We are entitled to a 4i/£-percent rate to make that spread l ^ percent." I t is irresistible logic and reason, so the VA and F H A were persuaded to raise that rate on the theory that the long-term rate was going to remain 3 percent. I am not trying to say that it was bad faith or you did anything that was wrong. However, you, or someone in your organization, failed to exercise due diligence in stopping that tremendous raise which went into effect. Four days later the necessity for it was changed but the increase has never been rescinded. They are continuing to pay that high rate. Secretary HUMPHREY. As soon as you get through, I will tell you why. Representative PATMAN. I am through now. Secretary HUMPHREY. What happened was this, that with these interest rates as they were, veterans were not able to get their loans because the loans didn't pay enough interest. Representative PATMAN. I explained that. I t was partly because the long-term, interest rate was increasing and partly because ai> increase was exnected after you issued the 3*4 percent 30-year bond. Secretary HUMPHREY. That's right, and that is what the interest rates were then, and that is what the interest rates were for months later. Investors wouldn't lend them enough money at 4 percent. We wanted the veterans to have the benefit of getting that money to use, and so they changed the interest rate, so that veterans could have the benefit of the law and actually build some houses, rather than having something on the books that wouldn't work. Representative PATMAN. I am in sympathy with the objective of building homes for veterans. Secretary HUMPHREY. That is why it was done. Representative PATMAN. But why do that just before you knew that the policy Secretary HUMPHREY. Because we wanted them to b& able to build some houses. Representative PATMAN. That the policy that caused the 3 percent long-term rate, which would justify \y2 percent for mortgages, that policy was going to be changed in a few days? Secretary HUMPHREY. And it didn't change in 3 days, and you knew it wouldn't work in 3 days. Representative PATMAN. I t didn't even go into effect in 3 days. Secretary HUMPHREY. That's right, and the veterans have had the benefit all the rest of the time of having something that would work. Representative PATMAN. Why haven't you reduced it since? Why don't you reduce it now ? Why* don't you reduce it today ? 204 UNITED STATES MONETARY POLICY Secretary HUMPHREY. Because it is still working in the right way. Representative PATMAN. But you are getting a 2-point spread when they never did want but 1%-point spread. Secretary HUMPHREY. Tne veterans are getting the benefit of it right now. Representative PATMAN. They are getting a 2 : point spread. Secretary HUMPHREY. And one of the great ihiags that has happened has been this great building going on, and that is one of the reasons for it. Representative PATMAN. I t looked like just increased interest, Mr. Secretary, and you know 1 percent interest is a.lot of money. You take 1 percent on $697 billion, it is $6.7 billion a year. That is about $50 per person. That's about $200 per family of 4 a year. That means that they have got to divert that much purchasing power, at least that much purchasing power is diverted from comforts and conveniences of life to the family to paying interest. Secretary HUMPHREY. Mr. Patman, you know perfectly well Representative PATMAN. That is a lot of money. Secretary HUMPHREY. That the real interest cost depends not only on the dollar amount of interest but also on the amount of principal. If you have to cut your principal to make the rate fit, you might better adjust the rate and keep the principal. Now, that is the way it was done. The home builders began to get the money they needed, they began to go forward, they began to build things, and we have had the benefit of that, and they have hail the benefit of it ever since. Representative PATMAN. They would have still gotten it if you hadn t raised it, because the monetary policy was changed. Secretary HUMPHREY. NO. Representative PATMAN. And the direction was 2% percent longterm, and they were perfectly satisfied with the 1% percent spread. Under your policy they are not only getting 1-^, they are getting a 2 spread which they never asked for. Secretary HUMPHREY. One is theory and the other is practice. One won't work and the other did. Representative PATMAN. I would like to yield my time for the present, and when the others get through I have another question or two I would like to ask. Senator FLANDERS. Before calling on the next member of ti ;> subcommittee, I am reverting to a suggestion made by Mr* Pptman a few minutes ago to the effect that there might be some correspondence between a Federal Reserve note and a Government bond,.each of them representing an obligation. Now, I have on my bedside table a book called the Treasury of American Humor. I read it when I get distraught. I have here in my hands another document which I would call Humor of the American Treasury, and I think it is decidedly humorous, Mr. Secretary. I t says: "Federal Reserve note, the United States of America will pay to the bearer"—I am the bearer—"on demand $20." I turn it in, they hand it back. Now, I think that is Humor of the American Treasury. UNITED STATES MONETARY POLICY 205 Representative PATMAN. But don't overlook the fact that you can pay debts, including taxes, with that, and they don't hand it back. Senator FLANDERS. But it says that in the fine print, print so fine that I have difficulty in reading it. The humorous part is the way in which it is redeemed. Representative PATMAN. Well, you are making it humorous, Mr. Chairman, when the fact is you turn it in on taxes and they keep it. They don't give it back to you. Senator FLANDERS. Senator Goldwater. Senator GOLDWATER. I don't have a question at this time, except one that might clear the record a little bit. Mr. Secretary, during the last colloquy with Representative Patman, I am sure he didn't want to indicate this but, nevertheless, he did, that your actions in the spring of 1953 added 1 percent to the total debt of the country. Now, what portion of the total debt did that 1 percent actually apply to ? Secretary HUMPHREY. Oh, it was a very, very small percent. Senator GOLDWATER. I t wouldn't add $50 to $200 per family, as might be indicated by the question? Secretary HUMPHREY. Oh, no, no. Representative PATMAN. I said it was creeping in that direction* I t would have finally gone clear across the board. Secretary HUMPHREY. I t is almost infinitesimal when you take it as you have indicated. Senator GOLDWATER. Thank you. Senator FLANDERS. Senator Sparkman. Senator SPARKMAN. Thank you, Mr. Chairman. I am not a mem* ber of the subcommittee. I pass. Senator FLANDERS. Senator Douglas. Senator DOUGLAS. Mr. Secretary, there is a^ question which Congressman Patman raised as to whether the May issue should have been issued at all. The question I should like to raise is whether however it was wise to raise the interest rate as rapidly and as quickly as you did, namely, from 2% to 3 % percent. I would like to ask whether it was the fact that you wanted to check past inflation of prices, which caused you to raise the interest rate by this amount, which was half a percent in absolute terms, and relatively almost onfe-fifth. Secretary HUMPHREY. NO, Senator. The reasons we put out a longterm, issue at that time were that we were trying to stretch the debt out and trying to help Federal Reserve in its monetary restraint policy. Senator DOUGLAS. Mr. Humphrey, that goes back to the question Mr. Patman raised. I t does not deal with rav question. Secretary HUMPHREY. NOW, that is as to the reasons for putting out the issue. Now, as to the interest rate which you are now speaking about Senator DOUGLAS. That's right. Secretary HUMPHREY. A S to the interest rate itself, the thing that determines the interest rate itself is this, ^nd it determines the interest rate almost always: We have quite wide markets in bonds, in theseGovernment bonds. Every day somebody is buying and selling Government bonds. Every day the public is fixing the interest rate that will be paid on Government bonds, and as you go through the list, you will find what 55314—54 14 206 UNITED STATES MONETARY POLICY the public is willing to pay for certain maturities of these bonds daily, so that the Treasury doesn't fix the interest rate. The public fixes the interest rate, and we have to adopt a rate, when we have an issue to sell, which is what the public is demonstrating daily that they are willing to buy bonds at. Senator DOUGLAS. In other words, you need to give 3*4 percent in order to issue the bonds at par ? Secretary HUMPHREY. That is right. Senator DOUGLAS. What are they selling for now ? Secretary HUMPHREY. They are selling considerably above that figure. Senator DOUGLAS. Aren't they selling for 110? Secretary HUMPHREY. Yes. Senator DOUGLAS. May I say this. To err is human. We all make mistakes. Secretary HUMPHREY. Sure. Senator DOUGLAS. Senators make mistakes, Secretaries of the Treasury make mistakes, and so on. Secretary HUMPHREY. Sure, lots of them. Senator DOUGLAS. But in view of the fact that a year and a half after issuing this 3V± percent interest rate has produced price of bonds at 10 percent higher than par, if you could have foreseen what was going to happen, would you have put it up at 31,4 percent? Secretary HUMPHREY. Yes; let me put it this way: Let's go back to when we took off the controls. I think to leave the controls on would have been a very bad thing. If when we took the controls off we had had runaway prices, that would have been bad, too. I think either one of those would have hurt the public so much more than any possible change in this relatively small amount of interest rate that there is no comparison. Senator DOUGLAS. NOW you are going back to the price question. Secretary HUMPHREY. That was the price at the time. Senator DOUGLAS. YOU mean, the price of bonds or the price of commodities? Secretary HUMPHREY. The price of interest. The price of borrowed money, as fixed hy the market at that time, was that price. That is where it came from. We didn't pick it out of thin air. Senator DOUGLAS. Just a minute, Mr. Humphrey. In view of the tremendous importance of Government issues, you certainly cannot say that the Government merely accepts the interest rate fixed by the market. You helped fix that interest rate. The raising of the interest rate from 2% to 3*4 percent caused all interest rates to move up. Secretary HUMPHREY. NO. The interest rates Senator DOUGLAS. When the public debt was only a small fraction of the total debt, then perhaps you could argue that the Government merely has to accept the interest rate dictated by the market, but when, according to jour own figures, it forms such a large percentage of the fluid capital, certainly the terms upon which you issue Government bonds affect other interest rates. You do not merely accept the market. You help to determine the market, and that was evidenced in what happened to the price of previous issues at lower rates of interest, which went down because you tvere raising the interest rate. I t is what happened in interest rates UNITED STATES MONETARY POLICY 207 where other flotations had to be issued immediately afterwards. I don't think you can say you merely accept conditions. You help frame conditions. Secretary HUMPHREY. Let me see if I can explain that to you as we see it, and let's get it into very simple terms. We are selling eggs, and the current price that eggs are selling for is 50 cents a dozen. Now then, we come along and we have some eggs to sell. If we go out and offer those eggs at 55 cents, nobody is going to buy them, so if we have a dozen eggs to sell, we have to offer them at a price that the market wTill take. If we come out and offer them at above the market, nobody is going to buy them. If we come out and offer them approximately at the market, we have a chance to sell them. Now then, we do affect the market somewhat by the amount of eggs that we do offer. If we came out with thousands of cases, we would present an oversupply of eggs and it would tend to push the market down. If we came out with a very little bit and there was a strong demand, we would have to come at approximately the market. Now, the same thing is true of bonds. These bonds, the rate that people were buying bonds for at the very day we put these bonds out was, as nearly as we could figure it, about S1/^ percent. Now, by coming out and adding some more bonds to the supply we, of course, did to some extent affect the rate. That is why we put out as small an issue as we did, because we didn't want to affect the rate any more than we could help, so we met the market with as small an amount as we could that we thought would not affect the rate, and in that way did not increase interest rates by these bonds over what they then were. Senator DOUGLAS. Well, Mr. Humphrey, the analogy which you draw between the housewife who sells eggs, a few dozen eggs, on the market of millions of dozens of eggs, and therefore sells only an infinitesimal proportion to the total eggs sold, and hence has to accept the price, is not applicable to the Government, which sells a large proportion of the securities which are issued. Secretary HUMPHREY. Now, wait just a minute. Senator DOUGLAS. There is a difference. You are assuming perfect competition in the egg market and carrying it over into the bond market, which doesn't apply. Secretary HUMPHREY. NO, I don't think that is correct, Senator, We sold just a little over $1 billion, and compared.with the Government debt outstanding at that time in the hands of the public—leaving out the Government accounts—it looks very small. We put out $1 billion or a little better, and there was outstanding in the hands of the public at that time about $220 billion. Now, when you put 1 out in 220, it isn't such a large proportion, after all. Senator DOUGLAS. Then you were treating this as purely an extraordinary occurrence raising the interest rate on this one issue? Secretary HUMPHREY. We didn't raise it. Senator DOUGLAS. But it didn't indicate any permanent policy ? Is that what you are now saying? Secretary HUMPHREY. We didn't raise the interest rate. We accepted the interest rate as the market had it determined that day, and wre took that interest rate and offered to sell our goods at the price the market was paying at that time. 208 UNITED STATES MONETARY POLICY Senator DOUGLAS. The previous issues of comparable bonds, as I remember it, drew some 2% Secretary HUMPHREY* I don't know, what their market yield was. Senator DOUGLAS. Is that not true, that they drew 2% percent? Secretary HUSIPHREY. NO, it is not true, and the reason is this: Interest is a function of both principal and rate, and unless you take into account both principal and rate you can't figure interest. Interest of $2 on $100 of principal is 2 percent. That same $2 on a principal of $50 is 4 percent. Senator DOUGLAS. Then let me ask you this Secretary HUMPHREY. SO you always have to take two things into account to figure what interest is. Senator DOUGLAS. What was the yield on comparable Government securities at the time ? Secretary HUMPHREY. It was approximately this same rate. Senator DOUGLAS. 3*4 percent? Secretary HUMPHREY. That's right. Mr. BURGESS. There is a difference in maturity. Secretary HUMPHREY. For that maturity. Mr. BURGESS. There weren't any Government bonds that long outstanding at that time. The longest bonds were 2%'s which had become medium-term maturities. They were selling around a 3 percent yield basis. Senator DOUGLAS. Three? Mr. BURGESS. That's right. t Senator DOUGLAS. That is what I understood. Secretary HUMPHREY. But that was for a shorter maturity. Senator DOUGLAS. May I just finish? Secretary HUMPHREY. YOU have got to take,maturity principal, and interest into account in figuring what a new interest rate should be. Senator DOUGLAS. NOW you have introduced a third dimension. Secretary HUMPHREY. That is always true. Senator DOUGLAS. May I say I can understand your raising the rate to 3 percent, but I have thought that that extra quarter of a percent was a mistake; that the yields were 3 percent on comparable securities. Secretary HUMPHREY. NO, they weren't comparable. Those were medium-term maturities, and were much shorter. Now, we thought, based on all those rates Senator DOUGLAS. HOW long is this issue ? Mr. BURGESS. The longest marketable bonds outstanding then were December 1967-72's, so you were stretching this new issue very substantially into an area where there was no marketable debt outstanding. The new issue was more than 10 years longer. Senator DOUGLAS. That raises the question immediately as to whether you should have issued i t for so long a period. Secretary HUMPHREY. All right. We thought that it was the right thing to do, and I still say that I believe it was the thing to do if it was helpful in deterring runaway markets in commodities, and I think it was. Senator DOUGLAS. NOW, when you speak of deterring runaway markets in commodities, I think there has been a lot of—I won't say issued by you, Mr. Humphiey, but a lot of—misapprehension on this point. UNITED STATES MONETARY POLICY 209 Sometimes this rise in the interest rate has been spoken of as a move to check price inflation. I am happy to see that this morning neither you nor Mr. Burgess have advanced that argument. I have here a sheet of wholesale prices and consumer prices, and they indicate that wholesale prices fell from 116.5 in March 1951 when the accord between the Treasury and the Reserve was negotiated, to 109.6 in December of 1952, and approximately to 110 in March of 1953, so that there has been a fall in wholesale prices. ^ There had been a slight increase in consumer prices from 110.4, 110.3 in March 1951, to 113.6 in March of 1953, but if you take the two together, there was roughly price stability. In fact, there was a slight price decline, so that I do not think it can be maintained as some have maintained in their speeches that this was necessary to check price inflation, and I hope the record is clear that whatever the justification may have been lor it, that this was not a justification. Would you agree with that? Secretary HUMPHREY. Let me put it this way, Senator, I have to get these things into very simple form or I don't understand them myself. Senator DOUGLAS. YOU are a very clever man, Mr. Humphrey, to be able to put them in a simple form. Secretary HUMPHREY. T O just be simple about it, when you take controls off there are several tilings that have to be taken into account in judging where prices will go. I n the first place you have to judge as best you can looking ahead, and it is always easier to be a Monday morning quarterback than it is to do the job Saturday afternoon. Looking ahead you have to judge how the relative increase in productivity was coming up in production of goods. That was increasing. There was a lot of plant capacity that was coming in, and it was increasing. You also had to look at what the demand probably was going to be. Now in addition to all of that, there was the question of how'purchasing agents throughout the country thought things were going. They donx study economics particularly; they just go the way you and I go along in judging how things are going to go. If they think prices are going to go up, they want to raise their inventories to protect themselves. If they think prices are going down, they cut down on their inventories somewhat. If it costs them a little more money to carry an inventory, they are not quite so apt to speculate with it. So that with all of these things, with the production, gaging the production that would probably be available, gaging the demand that would probably be made, and with it costing a little more to carry a speculative inventory, all those things converged to a point where you didn't have an increase in speculative inventory. And it was the most fortunate thing in the world that we didn't get it because we were accumulating inventory at that time, anyhow, and if we had added substantially to our inventory accumulation at that time we would have had a much farther down curve in business, which was what you were predicting yourself only a few months ago. Senator DOUGLAS. Mr. Humphrey, for the record I have never made any predictions. I have never made any predictions about the future. The record is perfectly clear on that point. I merely stated what was occurring, namely a decline in industrial activity or a recession. 210 UNITED STATES MONETARY POLICY Secretary HUMPHREY. In any event, we didn't have that severe down curve partly because we had not had that speculative inventory buying. Senator DOUGLAS. Now, Mr. Humphrey Secretary HUMPHREY. All these things contributed to stop that, and I think that by and large the whole thing did stop the inventory accumulations that would have driven us further down had it occurred! Senator DOUGLAS. Then what you were afraid of was not past increases in prices, but anticipated increases in prices. Secretary HUMPHREY. That is right. Senator DOUGLAS. Resulting from the removal of controls. Secretary HUMPHREY. That is what many people said. That is what the big argument was, and there are many people who argued very sensibly that if those controls were removed, there would be an immediate rise in prices that would be uncontrolled. Representative PATMAN. Would you permit an interruption there? Senator DOUGLAS. Certainly. Representative PATMAN. He said if those controls were removed. Secretary HUMPHREY. That is right. Representative PATMAN. Indicating that you were going to take* them off. Secretary HUMPHREY. That is right. Representative PATMAN. The 83d Congress in 1953—isn't it a fact,. Mr. Secretary, that the Defense Production Act of 1952 passed in the82d Congress provided for the automatic decontrols that went into effect, and practically all of them had been removed before April 1953 ? Secretary HUMPHREY. Onlv because we took them off. Representative PATMAN. They were automatic. Secretary HUMPHREY. And if they had been taken off earlier, we would have been better off. If that had been done in the fall before,. we would all have been better off. Senator DOUGLAS. A S a matter of fact, Mr. Humphrey, even under the imposition of controls, what we had was a fall in wholesale prices. The controls pegged prices at their peak, of January-May 1951 but did not appreciably impede the rise in prices. The trouble had occurred by the time controls were imposed, and a business fall of 7 points. Secretary HUMPHREY. Of course, you don't know what the peak would have been if you hadn't had them. When a control is put on, it will always peg it at the peak because that is where you stop the rise. Senator DOUGLAS. What I am trying to say, is I see no evidence that there was any pent-up inflationary movement at the time the interest rate was raised so sharply, and that this was taken as an indication of Government policy. The rise was not merely an isolated occurrence. I t was said to be the shape of things to come, and the result was that it was not merely a coincidence that the yield on municipals went up, that other yields went up as well due to the falling of prices of securities already issued. I t had a profound effect, and the very fact that it was not needed was shown in that within a month you reversed j^ourself. I wish that as public men we didn't always have to take the position that we are infallible. I t is possible that we make mistakes, honest mistakes. UNITED STATES MONETARY POLICY 211 Secretary HUMPHREY. I am not taking that position at all, but if we had to do it again tomorrow, I would do exactly the same thing, and let me tell you why. I think that one of the greatest things that has happened has been the stabilization that has resulted during this period, the maintenance of that stability, the stopping of inflation. We had been for 15 years in a period of self-imposed inflation that was fostered and carried on, and it was depreciating the value of the dollar very rapidly. Now the value of the dollar stopped depreciating. I t all has to do with the reduction of Government expenditures, with the handling of the taxation, with all of these things that all contributed, and it is not a bookkeeping fetish or anything of the kind. The stopping of this inflation saved the people of America, the savers of America, the people of America a great deal of money, and it has stabilized the economy. It has helped to make jobs for them to work at, and I think it is the foundation of the conditions that we have today. Senator DOUGLAS. I t is always impertinent to play the role of amateur psychiatrist, Mr. Humphrey, but I would say that your subconscious has oozed out in your reply, because now you are making emphasis upon the checking of inflation, which a few7 minutes ago you disavowed. Secretary HUMPHREY. No; I didn't disavow it. I never disavowed it. I have said right straight along that our objective has been to stop these inflationary pressures. Our objective has been to stop this depreciation of the dollar, and so far we have done it. Senator DOUGLAS. This is my point: That had already been done by the Federal Treasury Reserve Board in March 1951, as indicated by what happened after that. Secretary HUMPHREY. NO ; that is not the whole story. Senator DOUGLAS. What I think happened is you carried over your impression of what existed prior to that accord into a period in which it no longer applied. Secretary HUMPHREY. NO ; I don't think so. In any event, it has worked. Senator FLANDERS. Will the Senator yield? Senator DOUGLAS. I have taken up too much time. Senator FLANDERS. I would just like to express this situation as I see it. I may not be seeing it rightly. In the first place, inflation wTas checked before you, sir, came to the Treasury. In the second place, a new factor entered after you came to the Treasury in that controls were removed. The assumption you are making, which seems to me a valid assumption, is that positive action on your part wras required to maintain an already existing situation in the face of the removal of controls. That, at least, is the way I see the picture. And just one other point, and that is this: that you have disavowed the direct fixing of interest rates by saying that you put that issue out at the market. There had to be an element of judgment in your case because there were no Government issues of that length of maturity in the market. You had to make a judgment as to what the market was for maturities for that length. I t would seem to me then that your policy is either approved or disapproved on the basis of your decision to issue securities of greater length than any that were present in the market. 212 UNITED STATES MONETARY POLICY Secretary HUMPHREY. That is right, Mr. Chairman. You might want to add that there were, of course, other influences that also bore on this. We inherited a $9% billion deficit that year, which was an inflationary pressure in itself, so that to say that inflationary pressures were all removed is not correct. We were under many inflationary pressures at that time. Consumer credit was rising rapidly. New issues of corporate and municipal securities were running very high and credit demands were threatening to spill over at a time when our productive capacity was already fully utilized. We felt it necessary to resist those pressures so that we would not have a runaway rise in prices, and we could stabilize the dollar. Now, the proof of the pudding is in the eating. What was done did stabilize prices. I t did arrest the threatened rise and it continued stabilization and the value of the dollar didn't depreciate further. That is very beneficial for the American people hi the form of jobs, in the form of savings, in the form of insurance, in the form of pensions, in all the things that the American people want to haVe. Senator FI^ANDERS. Senator Douglas, you still have the floor. Senator DOUGLAS. I don't want to monopolize the questioning, but I would say this. I think this argument that it was necessary for stabilization is very dubious. I t is true that the money supply was increasing, but it is also true that production was increasing, and it is important to view those two together in relationship to each other. If you have the normal increase in production of 3 percent a year, and as a matter of fact, it was going up close to 5 percent a year during the preceding year, you can have some increase, a corresponding increase in the money supply without any inflationary effect on prices, and that is precisely what had been happening. The Federal Reserve had allowed the monejr supply to. increase in absolute terms, but not in relative terms. This is something that I think monetary managers should consider, not merely the question of absolute increases, but relative increases, and it is only when the relative supply of money is increasing more rapidly than the index of production or physical production that you get into danger. Our good friends at the Treasury, I think erred in just being frightened at the absolute increase, and disregarded that increase in production which counterbalanced the increase of money, and had enabled stable prices to be maintained, which would have continued. And the very fact that it wasn't necessary is shown in that within a month the Treasury had to beat a retreat, that interest rates were lowered, that this issue now stands out as a sore thumb at a price of 110, that the verdict of the market to which the Secretary has appealed has been that that was not necessary. Now, I say it was a bad mistake, but I believe it was an honest mistake. But I know how hard it is for public figures to admit mistakes. I sometimes find it difficult myself, Mr. Secretary. But I think nothing is gained by trying stubbornly to maintain a position thftil you are correct, when history indicates you were wrong. UNITED STATES MONETARY POLICY 213 Secretary HUMPHREY. Senator, I have made a great many mistakes in my life, and I expect to make a lot more, and I have never been a bit backward in admitting them. On the other hand, when you are looking forward and making judgments and those judgments work in practice, that is the test after all, I am not much of a theoretical economist. I don't care too much about the theory of it as long as it works. This one worked, and it worked well, and therefore I think it was all right. Senator DOUGLAS. NOW, Mr. Secretary, I have kept off of this question of whether it worked, but since you have raised it, I want to address myself to that very point. You say it has worked because prices have been stable, but there is no doubt that that rise in interest rates checked production, checked volume of output during the second half of 1953 and contributed to the recession and contributed to the employment of human beings. Now, I do not say that it was the sole factor in the recession. I have never argued that. But I do say the rise of one-half percent in interest rates helped it along. Secretary HUMPHREY. I t is a mighty good thing it did check inflation. Senator DOUGLAS. Did you consider the increase in unemployment, Which has been very severe in many regions of this country ? If you took that into consideration, then I think you would not be quite as self-satisfied with this decision that you say "worked." Senator FLANDERS. May I interrupt a moment, Senator ? Senator DOUGLAS. Certainly. Senator FLANDERS. I t seems to me that one part of the production that it checked was the flow of production into inventories. Secretary HUMPHREY. That is right; that is exactly right. Senator DOUGLAS. Well, did it? Senator FLANDERS. Yes. Secretary HUMPHREY. Yes; it did, and if it hadn't we would have been in a lot worse trouble. Senator DOUGLAS. But for about 5 months inventories continued to increase despite the rise in interest rates Secretary HUMPHREY. And think how bad it would have been if it hadn't helped to check it. Senator DOUGLAS. Your own chart shows that the inventories did not begin to decline until October, and you had placed your increase in interest rates into effect in May. Secretary HUMPHREY. That is simply illustrating your point that we did need a check. Senator FLANDERS. NOW, I am anxious that Mr. Talle, if you will excuse me, shall have an opportunity, and so it is his turn now. ^Representative TALLE, Thank you very much, Mr. Chairman. I will not take any time. Senator FLANDERS. Well, now it lies between those who have already spoken. Let's see if Senator Sparkman would like to ask any questions. Senator SPARKMAN. NO, Mr. Chairman, don't save any time for me. I am a visitor, not a member of this subcommittee. 214 UNITED STATES MONETARY POLICY Senator FI*ANI>RRS. You are welcome as a member of the full committee. Mr. Goldwater? Senator GOLDWATER. Mr, Chairman, I have one question to ask, brought about by the chairman's first suggestion that possibly the law of supply and demand hasn't been working during this period of inventory adjustment. Isn't it true that temporary price reductions are not noted in price indexes ? Secretary HUMPHREY. That is right. Senator GOLDWATER. Isn't it true that there has been in this country a great deal of price reductions, particularly in the automobile field and appliance field in the past 9 to 10 months? Secretary HUMPHREY. In almost every field, Senator, there have been sales involving price reductions moving substantial quantities of goods that have tended to reduce inventory, and those price decreases are not noted in the figures. Senator GOLDWATER. SO wouldn't you say it would be safe for me to assume that the fact that the law of supply and demand has been allowed to operate with a minimum of Government interference has been the dominant factor in the present economic condition of the country ? Secretary HUMPHREY. That is exactly right, and price concessions have been effective in that operation. Senator GOLDWATER. Thank you. Senator DOUGLAS. Mr. Chairman, before we break up could I give a Biblical quotation which I think is applicable. Senator FLANDERS. Well, now just before we have the Bible, I want to say that I, not quite tacitly, have offered Mr. Patman a chance to say something more. Representative PATMAN. I will certainly yield to a Biblical quotation. Senator FLANDERS. I don't believe you can quote the Bible indefinitely, so let's^ Senator DOUGLAS. I was going to only use the Bible as a jumping-off point. Senator FLANDERS. Just give us the jumping-off point, anyway. Senator DOUGLAS. Mr. Secretary, it finally comes down to this. You believe this increase in interest rates, or at least the extra quarter of a percent, was necessary to check increases in prices which had not yet occurred but which might do so, or increases in inventories which had not yet occurred but which might. In other words, it was a faith that there would have been inflation in the future if this had not occurred. That reminds me of St. Paul's definition of faith. I t is the substance of things hoped for, the evidence of things not seen. But in this connection I would like to point out that despite the rise in the interest rate, inventories continued to accumulate until October, and on a seasonal basis even until November, and that within a month almost the Treasury and the Reserve, finding that they had made a mistake, though they did not wish to admit it publicly, had reversed their policies, and it was after the fall in the interest rates that the inventory ceased being accumulated. UNITED STATES MONETARY POLICY 215 Secretary HUMPHREY. These curves, Mr. Senator, as you know begin to show up long afterwards. If you don't live way ahead of the curves, you are going to be in a lot of trouble. Senator GOLDWATEU. Mr. Chairman, a question on that point. Isn't it true that new orders in both retailing and manufacturing at that particular period were at quite a high point, and they had to be filled. Secretary HUMPHREY. That is right. Senator GQLDWATER. A businessman just can't cancel orders because he thinks something is going to happen. Secretary HUMPHREY. If you wait until you see it on the chart, you will go broke. Senator GOLDWATER. That is right. Representative PATMAN. I raised the question of permitting the banks to have so much of the Government's money on hand all the time, an amount which in the recent past has been around 6 or 7 billion dollars. Secretary HUMPHREY. I think our average is about 4 billion, but I won't quarrel with you over a billion or 2. Representative PATMAN. I want the banks to be profitable. I am not going to do anything that will keep them from making money because they are so important in our entire economy. But it occurs to me in permitting them to hold so much of the Government's money, every dollar of which has a potential credit of $6—in other woirds, if they have $0 billion, they can extend loans of $:)G billion, that we are doing a lot for them that could possibly make them become a little indifferent toward talking to small-business people, who want local loans. The point is this, Mr. Secretary. I just feel like it is just doing too much toward making these banks a little bit indifferent and careless toward local loans, and I just wanted to invite that to your attention. The value of the dollar today is about the same as it was in early 1953? Secretary HUMPHREY. Yes. Representative PATMAN. XOWT, during that time the gross national product has gone down; hasn't it? Secretary HUMPHREY. I t has gone down a little, a very small percentage. Representative PATMAN. Dr. Burgess said you have to run awfully fast in this game to stand still. Now, I think that is a good statement, but in our economy if we just stand still, if that line is just even, it doesn't go up, it goes just exactly like it has been, we are going backward; aren't we? Secretary HUMPHREY. Mr. Patman, we have a growing economy. This country is growing right now. We have got to make more jobs for more people all the time. Representative PATMAN. That is right, that is what I am talking about. Secretary HUMPHREY. And this country is going to have a continual growth. 1 am a great believer in America. We are not going to stand still. 216 UNITED STATES MONETARY POLICY Representative PATMAN. NOW, gross national product is the index; isn't it? Secretary HUMPHREY. YOU aren't going to keep making new records every day. You are going to catch your breath now and then, and then run again. Representative PATMAN. When are we going to start running ? Secretary HUMPHREY. We are on the way up right now. Representative PATMAN. Right now? I t must have been the last month. Secretary HUMPHREY. I t started last month and the month before. Representative PATMAN. Mr. Clark yesterday made a very interesting statement. He seems to be concerned that if the economy does not respond adequately to the current automobile and steel expansion, this, coupled with the usual post-Christmas letdown, may not leave our economy in good condition. He suggested then that we should take a drastic step. We should reduce reserve requirements of banks down to the bare minimum. Of course, that would release a lot of reserves and that would increase the potential lending power of the banks by possibly $75 billion. I would be afraid of it. I think it is too much. But if the country doesn't respond to this stimulation via expanded automobile the steel production and doesn't come back after the seasonal letdown anyhow, do you not think we should do something drastic ? Secretary HUMPHREY* There is nothing in the present situation that would lead me to believe we should do anything drastic now. I have no idea of it, and I don't think it is worthwhile to speculate on a lot of thoughts that nobody knows whether they are going to come true or how they will work out. Senator FLANDERS. Are there any other questions that any of the members of the panel or any members of the committee here wish toask? If there are no other questions, we will call this hearing adjourned,, and we are particularly grateful to the Secretary and the Under Secretary. We meet again at 2 o'clock when we have a most remarkable aggregation of talent. Never before has the entire Federal Reserve System faced a group of Senators and Representatives. (Whereupon, at 12:20 p. m., a recess was taken until 2 p. m., the same day.) AFTERNOON SESSION Present: Senators Flanders (presiding), Goldwater, Sparkman, Douglas; and Watkins; Representatives Patman and Talle. Also present: Grover W. Ensley, staff director, and John W. Lehman, clerk. Senator FLANDERS.. The hearing will come to order. Congressman Patman? Representative PATMAN. Mr. Chairman, the Federal Reserve System, made up of the regional banks and the central governing board in Washington, has been established for 41 years. The Open Market Committee, with its broad powers over the economy, nas been in existence for 20 years. I n all that long history, this is the first time that any congressional committee has had the opportunity of meeting face to face with the men who, through their UNITED STATES MONETARY POLICY 217 position in the Reserve System and their control over the availability of credit and purchasing power, have more power than almost any group, in shaping the destinies of the economy of the Nation. While the Chairman of. your Board and some of the presidents of individual banks have appeared before Congress from time to time, never before has the top management of the Reserve System appeared as a group before representatives of the Congress, as you are appearing today. In many ways, this is strange and, I believe, an unfortunate fact. I t is strange and unfortunate because however one may choose to describe the relationship between Congress and the System, the fact is that under the Constitution, the powers to coin money and regulate the value thereof are expressly placed in the Congress. The fact that Congress has seen fit, as a practical matter, to entrust or delegate the day-to-day exercise of this power to the Reserve System, does not lessen the ultimate power or responsibility of the Congress in this respect, nor does it make the functions which you and the Reserve System perform any less public governmental functions. Congress, recognizing that restrictive monetary policies must sometimes be strongly stated to control inflation, has chosen to endow the System with a considerable degree of independence. But under the Constitution this independence can never rise above the relationship of a faithful and trustworthy servant and a responsible, watchful master, in this case the Congress. Since the country cannot prosper without a sound basic economy and sound credit conditions, since the economy cannot exist without an adequate medium of exchange by which goods and services change hands, the powers which the Congress has delegated to the System are in many ways closer to the destiny of the country than many of the other congressional powers. In many respects, the actions which you take at your regular meetings of the Open Market Committee are thus more important to the well-being of the plain citizen and to business, labor, and agriculture than most of the actions taken by a long session of the Congress itself. I am sure that as individuals you fully appreciate this responsibility, but there can be no harm in.its reiteration and emphasis. In a dynamic and delicately balanced economy, such as we have, actions taken by monetary authorities must be constantly sensitive to economic changes and threatened instability. Yours is thus a day-to-day task as well as a sensitive vital one. Since it is such a sensitive.and serious responsibility, it is appropriate that those entrusted with it should report frequently to, the Congress, whose constitutional powers they exercise* through delegation. I t is true that the Board of Governors does file an annual report with the Congress. Ideally this report should be even more complete than it is. For example, it should contain details on the volume of open-market purchases and sales which have to be made in pursuance of the policies determined upon. I t should report the success of the operation undertaken and explain fully the thinking behind the decisions and policies. Faithful and full reporting to the principal is expected of every agent. I t might indeed well be that reports should be made more frequently than once a year. 218 UNITED STATES MONETARY POLICY I hope that this hearing today will establish a precedent which will lead to similar meetings and your appearance before congressional committees regularly. I certainly hope and feel sure that none of us want another 41 years to go by before repeating a meeting similar to this. Thank you, Mr. Chairman. Senator FLANDEKS. Congressman Patman referred to the fact that this is an unusual occasion. I t is a fact that a group of Congressmen and Senators wTho have the kind of responsibility that is laid upon the Joint Economic Committee have never before asked this group as a whole to appear before us. I might remark, parenthetically, that in the 41 years of the Board, and in the 20 years of the Open Market Committee, it took a Kepublican Congress and the-Republican chairman to get this result achieved, and Senator SPAKKMAN. YOU just did get under the wire, Mr. Chairman. Senator FLANDERS. There is an old hymn about the prize: The prize secure, the wrestler nearty fell, bore all he could endure, and bore not always well. But the idea is that he won nevertheless. Xow, this is an unusual occasion. I think it is very much to the advantage of the Open Market Committee, the Board and the other members and the group of presidents and this committee to be personally acquainted with each other. J assume there are opening statements to be made by Mr. Martin, the chairman, and by Mr. Sproul the Chairman of the Open Market Committee. That being the case in order not to take any further time from the statements we will want to begin with Mr. Martin immediately. Let me first say that we greatly appreciate the care and thought which have gone into the preparation of the answers to the series of questions propounded by this subcommittee to the Federal Reserve Board prior to the hearings. These materials were inserted in the record at the opening of the hearings yesterday (p. 3). Mr. Martin? STATEMENT OF WILLIAM McCHESNEY MARTIN, JR., CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM, ACCOMPANIED BY MEMBERS OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM AND RESERVE BANK PRESIDENTS . Mr. MARTIX. Mr. Chairman, this is the first time that I have ever really felt comfortable in appearing before a committee of Congress, because I have a lot of artillery with me today. Usually, I am up here all alone, although I am flanked by my very able staff assistants; but it seems to me very helpful for us to have a meeting of this sort,Mnd I would like to reiterate what Congressman. Patman has said. UNITED STATES MONETARY POLICY 219 I have no prepared statement today, but I would like to make a few comments on the Federal Reserve System, along the lines that are contained in the opening statement that Mr. Fatman has given us. The Federal Reserve System, I have tried to emphasize, has the word "System" in its title, and I believe that to be the most important word in its title. In the history of credit and money policy in this country, it is obvious that the Congress has struggled to know how best to administer this great power that it has. The Congress has evolved, in accordance with the American way of life, an institutional concept, recognizing that decisions on money and credit policies are like the decisions of the judiciary, in that they depend for their effective exercise upon freedom to analyze the problems and act on the problems that, as Mr. Patman rightly says,, occur from day to day and week to week and month to month and year to year, free of political pressures on the one hand, and of private pressures on the other hand. Therefore, in establishing the Federal Reserve System, after long and careful discussion, the Congress determined that they would not have a single bank with many branches, but that they would have a regional system, and that that regional system would be knit together by a governing board in "Washington, You have today at this table the operating heads of the 12 Federal Reserve banks and the 2-i branches under those 12 banks, as well as the members of the Board of Governors that knit the System together in Washington. We might also have had here today the Federal Advisory Council, a statutory body which the Congress provided for in the Federal Reserve Act, and we might have had the chairmen of the 12 Federal Reserve banks and the some two-hundred-and-fifty-odd directors of the Federal Reserve banks, who are also an integral part of the System. Now, this System represents a trusteeship over money which the Congress has granted to the Federal Reserve System under a trust indenture, which is the Federal Reserve Act. That trust indenture can be changed at any time by the Congress, but it is under that trust indenture that we are acting, and what I am outlining as the regional system of the Federal Reserve is in accord with the trust indenture which you have given us to operate under. Now, it is my firm conviction that credit and monetary policy has to be conducted not on a one-man basis, but by bringing together from all over the country, a country as large as this, a composite of views in such a way that they will be brought to bear on policy so that Ave will have some understanding of what we are trying to do, as well as some recognition of the nature of the problem. And so, today it gives me a great deal of pleasure to be here and to be surrounded by my artillery, and to be in a position so that I do not have to answer all of the questions. Now, I would just like to make one further comment, and that has to do with the questions which have been asked us by Mr. Ensley and the very able staff of your committee. They are very good questions; they are very searching questions, and they are questions that we welcome having the opportunity to answer at this time and put in the. record. 220 UNITED STATES MONETARY POLICY We think they are deserving of study and careful consideration, and we welcome your comments and your judgment on them because only in that way can we be helpful. I want you to know that the Board and the staff and many of the people in the System have worked as diligently and as faithfully as they can to give you the best answers that we can to these questions. Thank you. Senator FLANDERS. Thank you, Mr. Martin. With regard to the artillery which you have massed here, I may say that they are not arranged in any respect with regard to their bore or the weight of the projectiles; they go alphabetically from Mr. Balderston, Mr. Bryan, Mr. Earhart, and then, take a great leap, and end tip with Mr. Williams and Mr. Young. I thought it would be interesting to know that we use the alphabet instead of protocol. Without objection, we will insert in the record at this point brief notes on the members of the Board and the presidents, and a listing of the present members of the Federal Open Market Committee. I n response to a request from Congressman Patman there is also included the membership of the Federal Open Market Committee and of the executive committee of the Federal Open Market Committee, Marc^ 1951 through February 1954, and a list of the present members of the Federal Advisory Council. (The documents referred to follow:) MEMBERS OF BOARD William McChesney Martin, Jr., Chairman: Effective date of appointment April 2, 1951; term expires January 31, 1956; formerly president of New York Stock Exchange, chairman and president of Export-Import Bank; and at the time of his appointment was Assistant Secretary of the Treasury. M. S. Szymczak: Effective date of appointment June 14, 1933; reappointed effective February 3,1936, and February 1,1948; term expires January 31, 1962; formerly engaged in banking; professor, DePaul University, Chicago, 111*; and at the time of his appointment was comptroller of the city of Chicago. James K. Vardaman, Jr.: Effective date of appointment April 4, 1946; term expires January 31,1960; formerly engaged in business and banking in St. Louis, Mo., and at the time of his appointment was naval aide to the President of the United States. James Louis Robertson: Effective date of appointment February 18, 1952; term expires January 31, 1964; formerly special agent of FBI, Counsel to the Comptroller of the Currency, and at the time of his appointment was First.Deputy Comptroller of the Currency. Abbot L. Mills, Jr.: Effective date of appointment February 18, 1952; term expires January 31, 1958; formerly engaged in banking since 1920, and at the time of his appointment was first vice president of the United States National Bank, Portland, Oreg. C. Cahby Balderston: Effective date of appointment August 12, 1954; term expires Januarj' 31, 1966; formerly director and deputy chairman of Federal Keserve bank of Philadelphia, and at the time of his appointment was dean, Wharton School of Finance and Commerce, University of Pennsylvania. RESERVE BANK PRESIDENTS J. A. Erickson, president, Federal Reserve Bank of Boston, since December 15, 1948. At the time of his appointment as president he was executive vice president of the National Shawmut Bank of Boston, having been associated with that institution since 1920. Allan Sproul, president, Federal Reserve Bank of New York, since January 1, 1941. He has been associated with the Federal Reserve System since 1920, first serving as head of the division of analysis and research and assistant Federal Reserve agent at the Federal Reserve Bank of San Francisco until 1930 when he UNITED STATES MONETARY POLICY 221 came to the Federal Reserve Bank of New York as assistant deputy governor and secretary. Alfred H. Williams, president, Federal Reserve Bank of Philadelphia, since July 1, 1941. At the time of his appointment as president he was dean of the Wharton School of Finance and Commerce of the University of Pennsylvania, having been a member of the faculty of the Wharton School since 1915. Wilbur D. Fulton, president, Federal Reserve Bank of Cleveland, since May 14, 1953. He began his service with the System as an examiner at the Federal Reserve Bank of Cleveland in 1933, advancing through the positions of chief examiner, vice president in charge of the Cincinnati branch, and first vice president. Hugh Leach, president, Federal Reserve Bank of Richmond, since March 12, 1936. He began his service with the Federal Reserve System in 1920 as a clerk in the auditing department of the Federal Reserve Bank of Richmond and advanced to positions of auditor, managing director of the Charlotte and Baltimore branches, and first vice president. Malcolm Bryan, president, Federal Reserve Bank of Atlanta, since April 1, 1951. He taught economics at the University of Georgia, 1925-36; economist with Board of Governors of the Federal Reserve System, 1936-38; vice president of the Federal Reserve Bank of Atlanta, 1938-41, and first vice president, 1941-46; vice chairman of Trust Company of Georgia, 1946-51. Clifford S. Young, president, Federal Reserve Bank of Chicago, since March 1, 1941. He began his service with the Federal Reserve System in 1921 as an assistant examiner at the Federal Reserve Bank of Chicago, advancing through the positions of examiner, assistant Federal Reserve agent, and vice president and secretary. Delos C. Johns, president, Federal Reserve Bank of St. Louis, since February 1, 1951. He was in general law practice in Kansas City until 1945 when he was appointed general counsel and secretary of the Federal Reserve Bank of Kansas City. Oliver S. Powell, president, Federal Reserve Bank of Minneapolis, since July 1, 1952. He has been associated with the Federal Reserve Bank of Minneapolis in various official capacities since 1920, except for his service as a member of the Board of Governors from September 1,1950, to July 1, 1952. H. Gavin Leedy, president, Federal Reserve Bank of Kansas City, since August 28, 1941. Engaged in the general practice of law prior to 1924, at which time he became counsel for the Federal Reserve Bank of Kansas City. Prior to his appointment as president, he served as general counsel, vice president, and first vice president. Watrous H. Irons, president, Federal Reserve Bank of Dallas, since February 15, 1954. Professor of banking and finance at the University of Texas prior to coming to the Federal Reserve Bank of Dallas in 1945 as director of research. He was a vice president of the Dallas Reserve Bank at the time of his appointment as president. Cecil K. Earhart, president, Federal Reserve Bank of .San Francisco, since October 17, 1946. He began his service with the Federal Reserve System in 1917 a s an auditing clerk at the Federal Reserve Bank of San Francisco, advancing through the positions of cashier, vice president, and first vice president of that institution. PRESENT MEMBERS OF THE FEDERAL OPEN MARKET COMMITTEE William McC. Martin, Jr., chairman (Chairman, Board of Governors of the Federal Reserve System) Allan Sproul, vice chairman (president, Federal Reserve Bank of New York) C. Canby Balderston (member, Board of Governors) Malcolm Bryan (president, Federal Reserve Bank of Atlanta) H. G. Leedy (president, Federal Reserve Bank of Kansas City) A. L. Mills, Jr. (member, Board of Governors) J. L. Robertson (member, Board of Governors) M. S. Szymczak (member, Board of Governors) James K. Vardaman, Jr. (member, Board of Governors) Alfred H. Williams (president, Federal Reserve Bank of Philadelphia) C. S. Young (president, Federal Reserve Bank of Chicago) 55314—54 15 222 UNITED STATES MONETARY POLICY PRESENT MEMBERSHIP OF EXECUTIVE COMMITTEE OF FEDERAL OPEN MARKET COMMITTEE William MeC. Martin, Jr., Chairman Allan Sproul, Vice Chairman J. L. Robertson M. S. Czymczak Alfred H. Williams FEDERAL ADVISORY COUNCIL William D. Ireland, Boston district Henry C. Alexander, New York district Geoffrey S. Smith, Philadelphia district George Gund, Cleveland district Robert V. Fleming, Vice President, Richmond district Wallace M. Davis, Atlanta district Edward E. Brown, President, Chicago district W. W. Campbell, St. Louis district Joseph F. Ringland, Minneapolis district Charles J. Chandler, Kansas City district Geo. G. Matkin, Dallas district John M. Wallace, San Francisco distrjct Herbert V. Prochnow, Secretary MEMBERSHIP OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1 0 5 3 THROUGH FEBRUARY 1954 (NOTE.—March 1 is the beginning of the committee's organization year.) William MeC. Martin, Jr., Chairman (Chairman, Board of Governors of the Federal Reserve System) Allan Sproul, Vice Chairman (president, Federal Reserve Bank of New York) J. A. Erickson (president, Federal Reserve Bank of Boston) R. M. Evans (member, Board of Governors) Ray M. Gidney (president, Federal Reserve Bank of Cleveland) * Delos C. Johns (president, Federal Reserve Bank of St. Louis) A. L. Mills, Jr. (member, Board of Governors) Oliver S. Powell (president, Federal Reserve Bank of Minneapolis) J. L. Robertson (member, Board of Governors) M. S. Szymczak (member, Board of Governors) James K. Vardaman, Jr. (member, Board of Governors) MEMBERS OF EXECUTIVE COMMITTEE OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1953 THROUGH FEBRUARY 1 9 5 4 William MeC. Martin, Jr., Chairman Allan Sproul, Vice Chairman J. A. Erickson R. M. Evans A. L. Mills, Jr. MEMBERSHIP OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1 9 5 2 THROUGH FEBRUARY 1 9 5 3 William MeC. Martin, Jr., Chairman (Chairman, Board of Governors of the Federal Reserve System) Allan Sproul, Vice Chairman (president, Ffederal Reserve Bank of New York) Malcolm Bryan (president, Federal Reserve Bank of Atlanta) C. E. Earhart (president, Federal Reserve Bank of San Francisco) R. M. Evans (member, Board of Governors) 1 On June 11, 1953, W. D. Fulton (president, Federal Reserve Bank of Cleveland) assumed his duties as a member of the Federal Open Market Committee, succeeding Ray M. Gidney, whose resignation was effective Apr. 16,1953. UNITED STATES MONETARY POLICY 223 Hugh Leach (president, Federal Reserve Bank of Richmond) A. L. Mills, J r . (member, Board of Governors) Oliver S. Powell (member, Board of Governors) * J. L. Robertson (member, Board of Governors) M. S.~ Szymczak (member, Board of Governors) James K. Vardaman, Jr. (member, Board of Governors) C. S. Young (president, Federal Reserve Bank of Chicago) MEMBERS OF EXECUTIVE COMMITTEE OP FEDERAL OPEN MARKET COMMITTEE, MARCH 1952 THROUGH FEBRUARY 1953 William McO. Martin, Jr., Chairman Allan Sproul, Vice Chairman Ilugh Leach Oliver S. Powell • James K. Vardaman, J r . MEMBERSHIP OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1 9 5 1 THROUGH FEBRUARY 1 9 5 2 Thomas B. McCabe, Chairman * (Chairman, Board of Governors of the Federal Reserve System) Allan Sproul, vice chairman (president, Federal Reserve Bank of New York) Marriner S. Eccles (member, Board of Governors) R. M. Evans (member, Board of Governors) Ray M. Gidney (president, Federal Reserve Bank of Cleveland) R. R'. Gilbert (president, Federal Reserve Bank of Dallas) H. G. Leedy (president, Federal Reserve Bank of Kansas City) Edward L. Norton (member, Board of Governors) * Oliver S. Powell (member, Board of Governors) M. S. Szymczak (member, Board of Governors) James K. Vardaman, Jr. (member, Board of Governors) Alfred H. Williams (president, Federal Reserve Bank of Philadelphia) MEMBERS OF EXECUTIVE COMMITTEE OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1 9 5 1 THROUGH FEBRUARY 1 9 5 2 Thomas B. McCabe, Chairman 8 Allan Sproul, Vice Chairman Marriner S. Eccles * M. S. Szymczak Alfred H. Williams Mr. Sproul, we would now like to have a few remarks from you. Mr. SPROUL. Mr. Chairman, if I heard you correctly, you spoke of me as the Chairman of the Federal Open Market Committee. I am only the Vice Chairman. The Chairman of the Board of Governors is also Chairman of the Federal Open Market Committee. I share^vith Chairman Martin the pleasure in having my associates here, having undergone, as he has, at times, the dubious privilege of being here alone without the support of these associates. • Resignation of Oliver S. Powell as a member of the Board of Governors was effective June 30, 1952, at which time he ceased to be a member of the Federal Open Market Committee. 8 As of July 1, 1052, A. L. Mills, Jr., as first alternate, succeeded Oliver S. Powell. * In April 1051, William McC. Martin, Jr., succeeded Thomas I*. McCabe as Chairman of Bthe Board of Governors and as Chairman of the Federal Open Market Committee. Edward L. Norton resigned as a member of the Board of Governors effective Feb, 1, 1052, and as of that date censed to be a member of the Federal Open Market Committee. 6 In April 1951, William McC. Martin, Jr., succeeded Thomas B. McCabe as chairman of 7the executive committee. In July 1951, Oliver S. Powell, as first alternate, succeeded Marriner S. Eccles. 224 UNITED STATES MONETARY POLICY I am going to speaJt of something which I am sure is not the major concern of your hearing, just as it is not the major concern of the Federal Open Market Committee, but nevertheless it is something which I do not think was covered, from my point of view, in the answers submitted to you by the Chairman of the Board of Governors and, therefore, if 1 may take your time, I would like to refer to it. I t is, perhaps, what might be called the negative, in answer to your question No. 3. Your subcommittee addressed five questions to the Chairman of the Board of Governors, and his answers have been made available to other participants in these hearings, as well as to the public. With respect to the answers to questions 1, 2, 4, and 5,1 am in general and substantial agreement, even though there might be some shades of difference of opinion or degrees of emphasis in answers to the same questions which I might prepare. This suggests the first point I would like to make: So far as general credit policy is concerned, there has been a high degree of unanimity within the Federal Reserve System throughout the period covered by your inquiry, that is, since March 1951. Our differences, or my differences with other members of the Federal Open Market Committee, have related to the techniques of open market operations, not to general credit policies. I t is to these questions of techniques that your question No. 3 is directed. Here again I can express a good deal of agreement with much that is included in the answer of the chairman. I t is a persuasive and stimulating discussion of the issues involved. Yet there is also a good deal with which I disagree, and my conclusions as to the most effective use of open market operations, to implement credit policy and to promote economic growth aiid stability, diverge quite sharply from those set forth in the answer of the Chairman. His answer is, of course, responsive to the question of the subcommittee, which asked for affirmative support of the actions of the Federal Open Market Committee to which it refers, not for the arguments for and against such actions. Obviously, there is not time here for a full-dress presentation of the negative side of the question. I should like to make certain points which, I think, are significant to an understanding of the problem, however, and I should be glad to submit to the committee later, if it so desires, a written statement of views which might match the answer of the chairman in completeness and I would hope, in persuasiveness. First, as a matter of background, I think I should say that I am not for pegging Government security prices nor for trying continuously to determine the structure of interest rates by means of open market operations. As one of the principals in the fight to free the Federal Reserve System from the pegging of prices of Government securities, throughout a difficult period of controversy on this point, beginning in 1946,1 think I have the right to make tfiis clear. And, as one who has a great deal of respect for the operations of the market place, I would not want to be classed tvith those who believe that a continuously better result can be obtained, so far as the structure of interest rates is concerned, by completely substituting the judgment of the Federal Open Market Committee for the market place. If We want to find out how the patient is doing, there must be some place where we can take the patient's pulse. UNITED STATES MONETARY POLICY 225 Now, taking up the real issues in this minor problem. The least controversial issue \vas dropping from the directive of the Federal Open Market Committee the clause authorizing open market operations to maintain orderly conditions in the market for Government securities, and substituting for it a clause authorizing operations to correct disorderly situations in the market. I voted in favor of this change, and thought it desirable, not just as a question of semantics. But 1 would stress the avoidance of disorderly situations rather than their correction after they have happened. One of the virtues of credit control is supposed to be its ability to take prompt acti9n to head off financial disturbances which might otherwise have harmful repercussions throughout the economy. If open-market operations in longer term Government securities can be used to this end, I would use them rather than wait until a disorderly situation or a crisis has developed, and only then depart from operations solely in Treasury bills. The most controversial issue was the instruction by the Federal Open Market Committee that open-market operations must be confined to the short end of the Government securities market, except in correcting disorderly situations which, in practice, has come to mean confining operations to Treasury bills. I did not get the impression that the action was merely an assertion of the power of the Federal Open Market Committee to determine whether and when the System Open Market Account should engage in transactions outside of the short end of the market. There need not be any question of the power of the full committee to determine the conditions and the general timing of operations in the longer term areas of the market. I was concerned with the strong emphasis which I thought was given to permanence of the "bills only" doctrine. Suggestions for publishing a set of rules of the game, references to a. constitution for openmarket operations, and the repeated argument that Government security dealers could not create a broad, continuous market if we did not forego operations in long-term securities—except to correct disorderly conditions—gave me the disturbing impression that we were in danger of placing ourselves in a strait]acket which would not permit us to accomplish what the Congress and the public might expect us to accomplish in terms of monetary management. I, therefore, welcomed the statement in the answer of the chairman to your question No. 3 that the door is being kept open to a change in the present basic technique of open-market operations, and the recognition in his answer that the present approach to open-market operations is still experimental and that insufficient time has elapsed to draw firm conclusions as to its performance. The publication of these views should help to dispel the idea that present techniques have been adopted for all time, and should help to avoid further hardening of the dangerous opinion that any future operations by the System in the long-term market will be the signal of a critical situation. I also welcome the repeated references, in the answer of the chairftian, to the concern of credit policy with developments in the longterm sector of the market and the assertion of the particular concern of the Federal Open Market Committee that its policies be reflected in the cost and availability of credit in the long-term markets. I t has been, and still is, my contention that this concern can find its best 226 UNITED STATES MONETARY POLICY expression, at times, in open-market operations specifically directed at these longer-term markets. This is, perhaps, the variant approach to open-market operations briefly commented upon, and summarily dismissed, beginning on page 20 of the answers of the chairman to your question No. 3. As set forth there, it is described as a method of operation in which— the Federal Open Market Committee would normally permit the interplay of market forces to register on prices and rates in all of the various security sectors of the market, but would stand ready to intervene with direct purchases, sates, or swaps in any sectbTwhere market developments took a trend that the committee considered was adverse to high-level economic stability. That seems to me to be an eminently reasonable approach to our problem, but it has never really been tried—not even in the period 1951-53 to which the chairman refers. And now it has been dismissed on what I believe is the shaky assumption that it "did not appear to Qffer real promise of removing obstacles to improvement in the technical behavior of the market." This probably brings us down to the nub of the differences. The Chairman's answer to your question No. 3 embraces the view, with which I agree, that the "depth, breadth, and resiliency" of the Government securities market, or its "continuity and responsiveness," should be furthered by all means that are consistent with a credit policy of maximum effectiveness, and that, in general, the greater the "depth, breadth, and resiliency" of the market, the greater will be the scope and opportunity for effective credit control through open-market operations. But the proof of that pudding must be found in the actual market, not in a theoretical discussion of a supposedly ideal market. The answer of the Chairman asserts that the market has become increasingly stronger, broader, and more resilient since the Committee adopted the "bills only" technique. I t suggests most persuasively why, theoretically, this should be so. But it does not prove that it has actually happened. In fact, I wonder whether we are talking about the same market, and what are the definitions of "strength" and "breadth" that are being used. I t is my information and observation that the market for longer term securities has remained at least as "thin," under existing open-market procedures, as it was before these procedures were adopted. I think it has lost depth, breadth, and resiliency, whether you view it in terms of dealer willingness to take position risks, volume of trading, or erratic price movements. We must not be misled by the claims of one or two dealers who urge the present techniques and now proclaim that they are helping to create a broader market for Government securities. I do not think we have helped to create such a market. And, therefore, I do not see how the responsiveness of cost and availability of credit in all sectors of the market since June 1953 can have been the result of a progressive strengthening of the Goverment security market growing out of the actions of the Open Market Committee with respect to the open-market techniques. Much of the success of the System's actions during this period has derived from the promptness of adaptation of overall credit policy to changes in the economic situation,, and to a high degree of coordination of Federal fiscal policy and debt management with credit policy. For the rest, it has sometimes UNITED STATES MONETARY POLICY 227 taken massive releases of reserves, under the techniques adopted or in support of those techniques, to accomplish what might have been accomplished mor& economically with the help of limited direct entry into the long-term market. I am hopeful, therefore, that the present period of experimentation will not be too long extended, and that we shall soon have an opportunity to experiment with the middle way—the variant approach— which I mentioned earlier. One final comment should be made, perhaps, in connection with your question 3 on the discontinuance by the Federal Open Market Committee of direct supporting operations in the Government's security market during periods of Treasury financing. I would agree that the system open market account should not, as a matter of routine, provide such direct^ support, but I would also say that we cannot, as a matter of routine, turn our back on such support. The emphasis in the present approach to Treasury financing is good. The Treasury should meet the test of the market, in relation to other credit needs of the economy, to the fullest possible extent. But too rigid application of this doctrine is questionable as a matter of market procedure and Treasury-Federal Eeserve relationships. I n periods of credit ease, when policy considerations point to the need of keeping Treasury demands from draining credit away from desirable private use, reliance on bill purchases alone may lead to unwanted consequences. The flooding of funds into the bill market, in order to assure adequate credit in the area? tapped by the Treasury, may produce s*n undue enlargement of bank reserves, or an extreme distortion in Treasury bill prices and yields, or both. There will also be times,' particularly in periods of credit restraint, as distinguished from the recent period of overall credit ease, when rigid application of the present rule may result in serious collisions of debt management and credit policy, which might have been avoided without jeopardizing the overall public interest. Now, let me repeat, what I have been discussing are disagreements over techniques of open-market operations, not over general credit policy. I t is good to have these differences^ opened up, and I hope that this hearing will result in more discussions of the problems involved by an informed public. We in the Federal Reserve System cannot consider ourselves to be the sole repositories of knowledge in these matters. What I have been most afraid of is that we might come to think that we can indulge in the luxury of a fixed idea. There is no such easy escape from specific and empirical decisions in central banking. We cannot have a general formula, a kind of economic law, which will serve the ends of credit policy under all sorts of economic conditions. I apologize if I have taken too much of your time. Senator FLANDERS. Mr. Sproul, the responsibility of the congressional committee across the table from you lies ultimately in recommendations for legislation. As preparatory to that, it lies in comprehension of the problem concerning which we are to recommend. You have contributed to that comprehension. I t is not quite clear in my mind whether you have the feeling—but I judge you do not have the feeling—that the structure which has been set up by legislation needs changing. At least if you do have the idea that it needs 228 UNITED STATES MONETARY POLICY changing, I did not note that you brought it out in your discussion. Mn SPROUL. I have no such idea. Senator FLANDERS. SO that you were engaged in the necessary and often difficult task of increasing our comprehension. Mr. SPROTTL. I hope so. Senator FLANDERS. Yes; thank you. Did I note that the points to which you addressed yourself related largely to the technique of operation ? Mr. SrROuL. Yes, you did, and they related to your question No. 3 which you addressed to the Chairman of the Board of Governors. Senator FLANDERS. Yes. Mr. SPROUL. I t was an attempt to supplement his answer.Senator FLANDERS. And the general impression I got from >;our statement was that you were not personally favorable to too rigid rules, but felt that there should be a good deal of flexibility. You mentioned that in connection with, the question of whether the Board and the Open Market Committee should concern itself solely with the short end of the market. I think you raised the same question of rigidity with regard to another point, as to whether the open market system should intervene in the markets at the time when the Treasury was floating a new issue. In both of those cases, I take it, you feel that it is not wise to have too rigid rules to go by! Mr. SPROUL. I think that is right. But I think' my fellow members were not abandoning concern with other parts of the market than this, short market. They were really confining their operations to that part of the market, but are still concerned, as I am, with the other areas of the market. Senator FLANDERS. Yes. Mr. SPROUL. But, in general, I was objecting to too rigid rules of conduct. Senator FLANDERS. I think we have our minds clearer on that, I think, at the moment. I would like to ask Chairman Martin to give us his understanding of the way in which the controls applied to the short end of the market affected (1) the whole range of Government securities and (2) affected the longer range purposes of the Federal Reserve Board's sphere of influence. Mr. MARTIN. I would like to say, Mr. Chairman, that I am glad this statement is available. I hope that the membersof the committee will read Mr. Sproul's statement along with the statement that I have made here, because this is a fairly complex subject. Now, as Mr. Sproul has stated, this discussion is over techniques and procedures, not over policy itself. Having come out of the Treasury and into the Federal Reserve, and having seen the open-market operation from both sides of the fence, my own view is directly contrary to Mr. SprouPs. I believe that the depth, breadth, and resiliency of the market is being improved: That is, that we are developing a broader, stronger, more vigorous market when the trade, so to speak, knows in a general \vajr that we will deal, for the most part, though not as a fixed rule, nor for all time—as I have been very careful to spell out in my answer—in the closest equivalent to money that there is. UNITED STATES MONETARY POLICY 229 Now, that does not mean that we are not interested in interest rates or that we are not influencing interest rates. It does mean that we confine ourselves to supplying and absorbing reserves in the shortest area of the market and let the processes of the market channel those reserves throughout all the other areas and maturity sectors of the market. As Mr. Sproul states, and as I state, this is still an experimental technique, but it is my view that we will do better by not applying the slide rule to the market, thus permitting the market to make its own adjustments around the supply of reserves that we put in. Now, Mr. Sproul would disagree with me as to how effective this technique has been during the period it has been in use. My own judgment is that it has been very effective and very useful, and has contributed to a better Government securities market; but that is a matter that I think the Open Market Committee will continue to wrestle with for some time to come. Our sole objective is to operate in the most effective way in the public interest. Senator FLANDERS. Perhaps I wished to ask an earlier question than the one which I just asked you, which related to the way in which, in your judgment, operations on short-term obligations affect interest rates, as a whole and, presumably, affect the market for the long-term operations. There is, perhaps, a question which should be asked before that one. The primary question might be: What is the Federal Reserve System for? What are your ultimate objectives? I may interpose there a remark of my own which is to the effect that in my conception, all governmental objectives are ultimately human objectives, they are for the sake of people. Is there too long a connection, in your mind, from the open-market operation on short-tenn paper down here to where Mr. X lives so that it is difficult for you to tell us what this has to do with Mr. X? Mr. MARTIN. L<et me say, first, that I think that funds spread faster through the market with minimum intervention than with maximum intervention. Now, when we talk about a free market, we are not talking about absolving the Federal Reserve of its responsibility to regulate the money supply. That is the problem that you gentlemen have charged us with resolving. We do that by supplying reserves and absorbing reserves. I t is my conviction that we clo the most service, for the individual that you are talking about, consonant with the concept of private competitive enterprise, by giving the play of the market the maximum influence that it can have without disruptive effects. Senator FLANDERS. But now without going through all the multiple steps down to Mr. X , you are saying this: that the policies you have in mind lead toward a high degree of freedom in the market for Government securities and other evidences of debt; that, in your judgment, it supports the free competitive system and that, in your judgment, a reasonably free competitive system, as free as is practicable, in consideration of other interests, does lead toward a better living for Mr. X ? Is that the chain that you are going to follow ? Mr. MARTIN. That is my contention. Senator FLANDERS. I just wanted to establish that chain, because otherwise I have comparatively little interest in this hearing, just between you and me. 230 UNITED STATES MONETARY POLICY Now, that having been established, I shall shortly stop my questions, except for one horse which I want to trot out of the stable in a minute. I would like first to have your idea as to how your operations largely confined to short-term paper affect interest rates all through the structure and affect the long-term paper, as well. Mr. JIARTIN. Well, I think the process of arbitrage, which is the adjustment which Mr. Sproul thinks has more of a lag than I think it has, takes place very quickly in the market for Government securities. I believe that when we inject funds via the closest equivalent to money that there is—and do not forget that does not always have to be 90-day bills, they might not be available, I am talking about the short end of the market—thatthe injection of those funds will quite rapidly permeate to the other areas of the market and will be reflected by the forces of the market in changes in interest rates throughout the market. Now, if we should operate directly in all maturities, we could, perhaps, be wise enough to know just what the relationships between the Erices of different securities ought to be at all times. But we would ave to use a slide rule to determine these relationships. While I respect Mr. Sproul's judgment, I think that that is a step toward pegging which he deprecates just as much as 1 do. Senator FLANDERS. The question then arises as to the timelag; the question is how quickly the one operates or how slowly, and whether it operates too slowly or not. One other question on this point. When you speak of the nearest tiling to money, you are speaking of short-term securities which are taken up by the banks ? Air. MARTIN. That ght. Senator FLANDERS. And it is the fact that they are taken up by the commercial banking system which makes them the nearest tiling to money; am I right in that ? And that long-term instruments which may be bought for semipermanent investment do not have the same effect of injecting money into the market as the short-term ones. Mr. Sproul points out they can be taken up by others than banks also. Any purchase by the Open Market Committee injects money into the market. Senator FLANDERS. Yes, that is right. Mr. MARTIN. Yes. Senator FLANDERS. Without any excuse whatsoever except that the horse is an old friend of mine, I would like to lead my steed out of the stable. I t came to my mind a number of times in the discussion yesterday and this morning. For the life of me, when we speak about the quantity of money, I cannot understand why there is so little interest in the Board or anywhere else that I can find, in the velocity of money. Do you consider that is a constant ? Mr. MARTIN. Oh, I do not think that is correct, Senator. There is a very real interest in the Board in the velocity o r money, and also in the individual Reserve banks. Senator FLANDERS. D O you have information on that in your bulletin and on your charts ? I t seems to me one knows little about money if one does not join velocity and volume. Representative PATMAN. Mr. Chairman, is it not in the Federal Reserve Bulletin each month ? UNITED STATES MONETARY POLICY 231 Mr. MARTIN. Yes. We do have information in the monthly Federal Reserve Bulletin on the rate of turnover of demand deposits in New York City and other reporting centers. The data are also shown in our chart book. Senator FLANDERS. I t is a very important factor. At this point, I will turn over the questioning .to other members of the committee, and I would also like to say that I think it will not be out of order from your standpoint, Mr. Chairman and Mr. Vice Chairman, if other members of the Board and other members of the group of presidents, join in the discussion from time to time as you come across something in which they have particular interest or knowledge. That is agreeable to all, I take it. Mr. Patman ? Representative PATMAN. Thank you, Mr. Chairman. In order to bring out the importance of this great committee, the Open Market Committee, composed of the members of the Board of Governors of the Federal Reserve System and the five presidents who are on the Board at this time, of the Federal Reserve banks, I desire to quote Mr. Eccles, who testified before the Banking and Currency Committee, in which he stated: Now, the fact that the interest is where it is, of course, is not just an accident. The rates during the twenties and during the last war, had there been an Open Market Committee, which there was not, in the Federal Reserve System, they could have financed the last war and financed the Government during the twenties, at prevailing rates. Mr. Monroney, who was then a member of the House and sitting on the Banking and Currency Committee of the House, asked this question: Do you mean to say that with your present Open Market Committee and the operation of the Federal Reserve as it now stands, that regardless of what the national income is or other economic factors, that you can guarantee to us that our interest rate will remain around 2.06 percent? Mr. ECCLES. We certainly can. We can guarantee that the interest rate, so far as the public debt is concerned, is where the Open Market Committee of the Federal Reserve desires to put it. I bring that out to show the tremendous power of this great committee that has been properly delegated, this power, by the United States Congress. Certainly, the Congress itself cannot carry out the constitutional requirement relating to the money and credit supply; it must delegate that power. We have done the right thing by delegating the power. But the point is, this committee has the power to determine whether we have high interest rates or low interest rates, or whether we have good times or bad times. This committee also has the power to send over to the Bureau of Engraving and Printing and get the printed money of our country, the Federal Reserve notes, and properly distribute those Federal Reserve notes; and I assume in the course of a year that runs into billions of dollars. The power that is lodged in this committee is tremendous. During the last 40 years, the Federal Reserve System has taken $135 billion worth of Federal Reserve notes from the Bureau of Engraving and Printing. I bring that out to show the importance of this committee. 232 UNITED STATES MONETARY POLICY Now, Chairman Martin, all these people are not members of th& Open Market Coirimittee. Of course, the Board is now composed, I assume, of six members, since you recently had a vacancy. The other five members of the Open Market Committee representing the presidents of Federal Reserve banks, who are they ? Mr. MARTIN. I might ask them to raise their hands, that will be the simplest way. (Members of the Federal Open Market Committee are listed on pp. 220,223 of-the hearings.) Representative PATMAN. Mr. Sproul is always a member, is he not? Mr. SPROUL. That is by statute. Representative PATMAN. The statute made you a permanent member, that is the New York member. Now, the other change from time to time, and these other gentlemen who are here, representing Federal Reserve banks, they either have been—they are now or will be members of the Open * Market Committee; is that right? Mr. MARTIN. That is correct. Representative PATMAN. And that is the reason you brought them along? Mr. MARTIN. Well, I was requested to bring them. Representative PATMAN. YOU work together, do you not, when you have a meeting of the Open Market Committee ? Mr. MARTIN, We usually do. Representative PATMAN. Don't you have a meeting of all the presidents at the same time? Mr. MARTIN. We usually do. Representative PATMAN. And they, in effect, represent the Open Market Committee, whether they are officially on it that year or not? Mr. MARTIN. Yes. Representative PATMAN. In other words, the ordinary Federal Reserve bank, like Dallas, would have one-third of a vote at each meeting ? Mr. MARTIN. Oh, no; oh, no. Representative PATMAN. I mean for all practical purposes. Of course^ there is somebody officially on there. Mr. MARTIN. No, you underestimate the stamina of the members of the. Committee. Representative PATMAN. I should not have named Dallas; I should have named some other city. But now, then, these 11 members represent the Open Market Committee. The executive committee that carries out the orders and instructions of this committee, how many are they? Mr. MARTIN. There are five. Representative PATMAN. They are five. Now, you are always on that Committee, Mr. Sproul is always on that committee; who is on that committee now representing the banks ? Mr. MARTIN. Will the three members that are on the executive committee, please raise their hands. Senator FLANDERS. Mr. Sproul is a,member, I mean at the present time. Mr. MARTIN. Mr. WilliamsRepresentative PATMAN. And Mr. Sproul for the banks, and Mr. Martin, and who else for the Board? Mr. MARTIN. Mr. Robertson and Mr. Szymczak. UNITED STATES MONETARY POLICY 233 Representative PATMAN. They are the ones on now. Who will be on next yea: in Mr. Robertson's and Mr. Szymczak's places? Mr. MARTIN. Well, it will go by rotation. Representative PATMAN. I am bringing it up to indicate whether or not you have a certain policy or formula to go on, that certain people will come in automatically; is that right? Mr. MARTIN. Well, we have a system of rotation; yes. Representative PATMAN. All right. Now, then, there is a vacancy on this Board. Who is the Vice Chairman of the Board of Governors ? Mr. MARTIN. There is no Vice Chairman at the present time. Representative PATMAN. Does not the law say there shall be a Vice Chairman? Mr. MARTIN. The President has the power to appoint a Vice Chairman. Representative PATMAN. Well, does not the same law that says "shall appoint," does it not say that the President shall designate a Vice Chairman? Mr. MARTIN. The law says that; you will have to take that up with the President, Mr. Patman. Representative PATMAN. Well, I have taken it up with him. How long has it been since you had a Vice Chairman ? Mr. MARTIN. I think it has been a number of years. I would have to look up the exact date. Representative PATMAN. I S there any particular reason why you do not have a Vice Chairman, except that the President has just failed to designate one? Mr. MARTIN. Well, we have had your committee and Senator Douglas' committee investigating us, and that has been one of the reasons why we have been stuoying the problem Representative PATMAN. What does that have to do with the Vice Chairman's selection? Mr. MARTIN. Well, it only has to do with the fact that there might have been some changes in the composition of the Board. Representative PATXAN. I do not see where that had anything to do with the failure of the President to—I am honestly seeking the correct information about that, Mr. Chairman. Mr. MARTIN. Well, I am merely Representative PATMAN. HOW does that have anything to do with the failure to designate a Vice Chairman of the Board, when the law says that the Vice Chairman shall be designated? Mr. MARTIN. I think it depends on whom you are going to designate, and I think that is a matter for the President to decide. Representative PATMAN. That is what I say. But don't you think that the President should be importuned by the Board or call it to his attention? I will not place that burden on you and require an answer. How did it happen that the hard-money policy was pursued in the spring of 1953 right up to a few days after rates on veterans' guaranteed-mortgage loans were raised ? I will finish this and then ask you to comment. Does this not indicate either a failure of liaison among Government agencies or that the change in monetary policy was deliberately delayed until this action, 234 UNITED STATES MONETARY POLICY unfavorable to veterans and other mortgage borrowers, was put into effect? What is your answer to that, Mr. Martin? I n other words, the interest rates on F H A insured and VA guaranty of veterans' loans were raised about 3 days before the Board met and decided to reverse its policy. If I understand correctly, you testified before anoflier committee that the Board met on May 6,1953, and.decided to reverse policy; am I correct in that or not ? Mr. MARTIN. I think May 6 is the date. Representative PATMAN. When you decided to reverse your policy that meant that interest rates would decline, did it not? Mr. MARTIN. NO. I t takes some time for policy to work, and it might have been changed again. As you pointed out very ably in your statement, this is a fluid operation. We decided to reverse tne policy on May 6. We could not be sure then how long the reversal would l>e or what the degree of the reversal would be. That was something that had to unfold with time. Now, the rates to which you refer had no connection with our action whatever. They had been out of line with the market for some time past. So far as I was concerned, and so far as I know, nobody from those agencies consulted with me with respect to this change in direction of monetary policy. There was no way of telling on May 6 or even on June 1 whether our change in policy wrould continue or how far it would go. Representative PATMAN. Let us see if we agree on that rate being too low for some time. Is it not a fact, Mr. Martin Mr. MARTIN. I did not say too low; I said out of line with the market. Representative PATMAN. Language like that is very appropriate and discreet; I am not trying to criticize it. The truth is that the mortgage lenders were satisfied with 4 percent as long as the longterm Government bond rate was 2% percent; is that not right? I n other words, they were satisfied with a li^-percent spread. Mr. MARTIN. The volume of mortgages tliat was being placed with investors at that time was not really high. The change in mortgage interest rates was made to bring them in line with the market, so that mortgage credit would be more readily available to veterans and others. Representative PATMAN. Well, am I correct in stating that the lenders, mortgage lenders, were satisfied writh a li^-percent spread which was considered the traditional spread over a long period of time, and they were satisfied with it; am I right about that or hot? ]\Ir. MARTIN. I really do not know. Representative PATMAN. AH right; that is my contention anyway, whether it is right or wrong. I t was the spread they accepted for a long time. Then, when your hard money policy went into effect, commencing in January 1953, Government oonds commenced to slide, and 1 issue went down to 89. That made interest rates go up in proportion and, as Government bonds declined to where the 2 ^ ' s sold at a price that yielded 3 percent, the mortgage lenders came in and said: "Now, we are entitled to an increase in the Veterans' rate from 4 to 4% percent; we are entitled to an increase in the F H A rate from 4*4 to 4y 2 "UNITED STATES MONETARY POLICY 235 percent. The traditional spread is 1% percent, and since the longterm rate is now 3 percent, we are entitled to 4%." Was it not on that basis that the interest rate on VA- and FHA-baeked home mortgages was finally increased ? Mr. MARTIN. I have to go back a little bit, Mr. Patman. The socalled hard money policy that you are talking about wag realty initiated at the time of the Treasury-Federal Reserve accord, and it was not a case of Representative PATMAN. Well, you will cause me to take up these whole 40 minutes, and I did not want to dothat, Mr. Chairman. Mr- MARTIN. Well, in this kind of operation I cannot take a single specific point out of the picture as a whole. We are dealing with a process that goes on, with many ramifications. You cannot at any precise point say, "this is the end result." The forces of the market had been playing in the direction of higher interest rates, in my judgment, for some time. Representative PATMAN. Well, it commenced in 1946 for the shortterm rate? Mr. MARTIN. I do not remember the precise date. Representative PATMAN. But here is what I am talking about: The aay before the inauguration,, the rediscount rate was raised by important banks, most of the others had already raised it, Federal Reserve banks, one-half of 1 percent, was it not, January 1953? Now, the rediscount Mr. SrROUL. One-fourth of 1 percent. Mr. MARTIN. One-fourth of 1 percent. Representative PATMAN. One-fourth of 1 percent, excuse me. You know the rediscount rate is believed to have little practical significance outside of its purely psychological value, am I right on that or not? Mr. MARTIN. The rediscount rate is a very important rate. Representative PATMAN. Nobody was borrowing Mr. MARTIN. Don't you think $2 billion is a lot of borrowing? Representative PATMAN. I S it not a fact that you have said it was strictly psychological ? Mr. MARTIN. Oh, no. The borrowings through the discount windows rose to $2 billion. Representative PATMAN. Well, at any rate, that was my understanding. I t was strictly psychological to let the Federal Reserve banks know that we are going to have tighter credit conditions, and "you fellows might just as well get ready for it." This is just kind, of an unconversational understanding. Mr. MARTIN. The adjustment of the discount rate at that time was to bring it closer in line with the market then existing. Representative PATMAN. But that is when I thought that notice was given to the world that you were starting on a real hard money policy, and I think the bankers of the country recognized that as a signal, that is what I thought. But, anyway, when the bonds began to decline afterwards more than they had in the past, and much more rapidly, and as the interest rates went up, that is when lenders began to ask ior a higher interest rate on housing loans, and the rate was increased just 4 days before you took an about-face on your policy, Mr. Martin. 236 UNITED STATES MONETARY POLICY I t occurs to me that there should be—if there was no liaison between your department and these other lending agencies, there should be. What liaison do you have? Mr. MARTIN. I think we have pretty good liaison. I want to point out that when the policy was changed on May 6, there was no certainty at that time that we would continue the new policy. I t gradually unfolded in response to developments. Representative PAT-MAN. A S to how long you would do i t Mr. MARTIN. YOU have to move very delicately in this operation, and that is the way we started to move. Representative PATMAN. I see. This morning I interrogated the Secretary of the Treasury about the debt of the Government, and the question came up about the ability of the Treasury to borrow money from the Federal Reserve banks to take care of their unpaid bills. I think it has been referred to in the past as the Treasury overdraft. You know the bill I am talking about ? Mr. MARTIN. That is right. Representative PATMAN. For years, commencing about 10 or 12 years ago Congress has passed a laiw which has been extended each year, sometimes 2 years at a time, that gave the Treasury the privilege, if it wanted to, to call on the Federal Reserve banks to finance any short-term obligations or debts up to $5 billion. Now, that is still the law, is it not? Mr. MARTIN. That law was passed by the Congress. Representative PATMAN. And it is up to the Secretary of the Treasury as to whether or not it is used, is it not? I t requires no action on the part of the Federal Reserve banks. Mr. MARTIN. Oh, yes, it requires action. The law gives the Reserve banks the power but does not make it mandatory on them. We discuss every instance with the Secretary of the'Treasury. Representative PATMAN. I know, but you cannot refuse to give the credit, can you ? ^ ^ Mr. MARTIN. We could. Also, if we thought it was being abused we could bring it to your attention. .Representative PATMAN. I know, you would bring it to the attention of Congress, but, as long as there is the law, you feel that you are compelled to finance any expenses of the Government up to $5 billion directly between Federal Reserve banks and the Treasury without going through the open market or the banks or any brokerage ofiice. You are obligated to do that, are you not? Air. ALVRTIN. Not obligated—the Reserve banks have the authority. In practice, it is. a very short-term operation. Representative PATSIAN. Well, that is right. Mr. MARTIN. And I know of no instance when it has been abused. Representative PATMAN. I am not talking about the abuse of it; I am talking about the use of it; use, not abuse. Xow, the point I am making is why should you have any deposits in banks at all ? I will not ask you to answer that, because it is really the Treasury's business when they can call on you any time, and you will finance any of their obligations up to $5 billion; that is the reason I say that they should not keep six or seven billion dollars in the banks all the time; it is unnecessary. UNITED STATES MONETARY POLICY 237 Now, if the banks need that to compensate them for other things, why, pay them for it. I do not want to deprive the banks of anything, but I do not want to keep idle and unused balances there. I am just trying to show that the Federal Reserve banks may advance to $5 billion to the Treasury at any time, as long as this law is upon the statute books; that is right, is it not ? Mr. MARTIN. Only if they felt it proper. The authority is one that is used in connection with short-term advances. Representative PATMAN. That is right; yes, sir; that is all. I will not press you on it, Mr. Martin. Mr. SPROUL. I would question that, Mr. Congressman. Representative PATMAN. All right, Mr. Sproul, what is your question about it? Mr. SrRouL. I think the Congress has shown great reluctance to grant that power to the Secretary of the Treasury to borrow directly from the Federal Reserve banks, because it was unwilling to have such a grant of power except for very short-term use under very special conditions, and that the whole legislative history of the power would be one which would justify us in coming immediately to the Congress if the Secretary of the Treasury tried to abuse the power in the way you suggest. If Congress wants to indicate that is the way it should be used, that would be a different matter, but it has not so far, and there is nothing in the legislative history to suggest it. Representative PATMAN. I do not agree with you, Mr. Sproul. I have been on the committee that has handled it ever since it first passed. Senator FLANDERS. Will you yield for a moment? Representative PATMAN. Yes, Mr. Chairman. Senator FLANDERS. I t is my recollection that in the Finance Committee we have considered that authority primarily as a means for getting past the hump of the income-tax payments. From the standpoint of the Senate, at least, I think we had that purpose primarily in mind. Representative PATMAN. That is right; that was given as an illustration. I n other words, there is a certain time that the Treasury needs money. That was an illustration that has been given. I t is given in the House all the time. But the point is, and the fact remains, that the Treasury has the power to draw upon the 12 Federal Reserve banks up to $5 billion to finance its bills; that is the law of the United States Congress, and signed by the President of the United States; and, for that reason, there is no reason why you should have these idle deposits in the banks. Now, I will go right ahead. Since the Secretary of the Treasury is legally enjoined from holding Government bonds, and properly so, for the reasons that we know, since their value may be influenced by' his official decisions, should the chairman and members of the Federal Reserve Board, and the Open Market Committee, of course, be restricted in a similar manner as to trading in bonds and stocks whose levels can be influenced by monetary decisions? If the public buys stocks because of the easy money decision of the Board, isn't someone, the Board, in a good position to profit by advanced knowledge of these decisions ? 55314-754 1C 238 UNITED STATES MONETARY POLICY What kind of rales or regulations do you have, Mr. Chairman, about members of the Board dealing in Government bonds or stocks on the market ? Do you have any ? Mr. MARTIN. I am glad to tell you that I do not own a single stock, and I do not trade in stocks or bonds. Representative PATMAN. I.am not questioning you personally, Mr. Chairman, but I am just asking, as a matter of policy, for the Government oi the United States. Mr. MARTIN. I understand that, but I would like to put that in the record in connection with this case. I do not have a single stock nor own a bond, outside of series E bonds, personally, because I take my job that seriously. So far as rules and regulations are concerned, we do not have any statutory rule on the part of the Board of Governors. However, the Board has a rule which is annually called to the attention of every employee that if he uses confidential information for any improper purpose he will be subject to appropriate disciplinary action. I know that the individual Reserve banks have watched this matter very closely and that their staffs are subject to a similar rule. We take this matter extremely seriously. I do not believe there is any rule which would precisely bind people that would be effective. You are depending upon the integrity of this group. Nobody realizes more clearly than I do from my long association in markets how easy it would be to abuse the position that we have; that is why I am very careful not to make comments on margin requirements or comments on Federal Reserve policy in open meetings or around the country because it could be construed by speculators for their own use. I cannot prevent that sort of discussion from going on, but I have been extremely careful about making any comments of that sort. Representative PATMAN. I do not bring this up to impugn tho motives of yourself, Mr. Chairman, or any other member, Mr. MARTIN. I understand that, Mr. Patman. Representative PATMAN. I am just asking that as a matter of information, knowing that the Government has always been very careful about things like that, and I did not know of any rules. Now, you do not have any rules yourself except just each member is supposed to do what is ethically right and not do anything wrong; but what about the people who conduct the Open Market Committee? I read in a financial paper not so long ago that about a hundred people had something to do with the operation of the Open Market Committee; is that right or not? Mr. MARTIN. I do not know the exact number. Representative PATMAN. Mr. Sproul might tell us about that since he has charge of the Open Market Committee, I mean the executive part of i t Mr. SPROUL. There are not a hundred people who know what' the policy of the committee is and how it is going to be executed. Representative PATMAN. HOW many know that, Mr. Sproul? Mr. SPROUI* Really only the memoers of the committee and the manager of the system of the open-market account can know that in its entirety, although the staff ot the committee itself will know pretty largely what the Open Market Committee has in mind, but the rest of Ihe 100 people that you read about must have been people who are UNITED STATES MONETARY POLICY 239 Representative PATMAN. Clerks and stenographers, Mr. SPROITL (continuing) . Clerks and stenographers and secretaries who do not know what the policy is and could not make any. use of the information they have if they had any designs or desire to. Representative PATMAN. DO you have any rules or regulations about the ownership of stocks and bonds, whether it is Government bonds or otherwise? Mr. SPROUL. We have the rule that no one in our bank is allowed to purchase securities on margin. There is no prohibition against their purchasing securities of any kind outright. We also have a general rule that no one is to engage in any transactions of any sort, particularly financial transactions, which would in any way brin^ the bank or the system into disrepute, and that is the kind, the only kind, of rule I think you can make to cover this situation which must place great reliance on the honor and integrity of the individuals you are working with. Representative PATMAN. DO you not agree, Mr. Sproul, that since the Congress has had a standing rule that the Secretary of the Treasury, for instance, could not even own a Government bond, that that is notice to all other agencies, such as your own, that similar rules should probably be adopted ? Mr. SPROUL. That is a matter for the Congress to decide. Whether you get better results from a hard and fast rule of that sort, as to which there may be legal or technical evasions, or whether you get better results by having the general rule and trying in every way you can by adequate supervision to see that it is enforced, I could not say. Representative PATMAN. All right. Now, I will make it short, Mr. Chairman. To prevent the accumulation of unemployment, and restore employment and production to normal capacity, it is estimated that we should increase the gross national produt rate by about $30 billion above the current rate in the next year. A normal capacity gross national product rate in 1955 should reach $386 billion. Can we do this, Mr. Martin, and still have a sound money policy ? Mr. MARTIN. I cannot comment on whether it takes $30 billion of increase in the gross national product to provide that number of jobs. Representative PATMAN. Well, we will change that. I t is down $14 billion from last year, isn't it? Mr. MARTIN. I want to say that it is my absolute conviction that inflation will not create jobs and sustain them. If we maintain a stable price level and a sound dollar, I believe we will create jobs that will be sustained and that will really add something to our economy. I think that it would be a delusion to believe that we can disregard stability, the stability of the dollar, and create jobs by froth ol the sort that occurs often from waste and extravagance and incompetence and imprudence, and all the bad habits that go alonjr as byproducts of inflation. If we were to believe that, we would be doing a disservice to our goal of having as high levels of employment as we can possibly have in this country. Representative PATMAN. Which do you consider comes first, full employment or a stable price level ? Mr. MARTIN. I do not believe you can separate them. I t depends on your 240 UNITED STATES MONETARY POLICY Representative PATMAN. Suppose there is an alternative, I mean, you cannot have both right at the present time. Which would you select? Mr. MARTIN. The definition of the term "full employment" is a difficult one. But if you are talking about full employment in terms of having it for just a couple of months and then having the jobs disappear, that is one thing. If you are talking about employment that is Representative PATMAN. Lasting. Mr. MARTIN (continuing). Permanent, lasting employment, I believe you can Representative PATMAN. ,YOU think the price level should come first? Mr. MARTIN. I think it is an important ingredient. I do not know on which you put the most emphasis at a given time because the level of employment has an effect on the price level. Representative PATMAN. I want to ask Mr. Sproul a question. Mr. SPROUL. May I make a comment on that question ? Representative PATMAN. Certainly, sir. Mr. SPROUU I agree with the findings of the Patman subcommittee of the Joint Committee on the Economic Report that high-level employment and price stability are not necessarily incompatible, and I would like to see that spelled out in the declaration of policy in the Employment Act of 1946. I think those who would seek to obtain high-level employment by a form of creeping inflation, induced by credit policy, are trying to correct structural maladjustments, inevitable in a highly dynamic economy, by debasing the savings of the people. They should tell the holders of savings bonds, savings deposits, building and loan shares, life-insurance policies and pension rights, and other small savers, that a rise in prices of say 3 percent a year is a small price to pay for removing the swings of unemployment. If our dynamic, growing economy throws too many people out of work from time to time, we will have to devise further means, resting on the whole economy, to take care of the situation. We cannot debauch credit policy, trying to make it do the job, and we should not steal the savings of the people with one hand, while we promise them a steady job with the other. Representative PATMAN. I want to ask you a question^ Mr. Sproul: What was the nature of the Government bond transactions carried out by the Xew York Federal Reserve Bank from May 27 to June 10, 1053 ? What significance, if any, did the $20 million reduction in the Xew York bank's bond portfolio have for the investors in the Government^bond market? Did the inter-bank bond transactions carried out in this period have any connection with the break in bond prices on June 1 ? Mr. SrRouL. I cannot speak for every transaction during that period or on that date, but I would say that the actions of the New York banks were only one small part of a whole market situation which developed at that period. Our transactions, as you know, were wholly in Treasury bills during the period you mentioned. Representative PATMAN. A S I understand it, the Open Market Committee has been in operation for 20 years and the Federal Reserve for 41 years. Before the Open Market Committee was officially set up UNITED STATES MONETARY POLICY 241 by law, each bank carried on its own open market operations; did it not? Mr. SPROUL. Yes, it did. Representative PATMAN. One of the first reasons for having any open market operation was to get more earnings; was it not? Mr. SraouL. That was the original reason, but that quickly lost its meaning. The ultimate reason, and the continuing reason, for. the Open Market Committee is to get coordination of open market operations throughout the system. Representative PATMAN. Well, naturally, it was easy for a bank to <jet Federal Reserve notes and trade them for Government bonds and keep the bonds and collect the interest. They had earnings that way, and that is what started the open-market operations, as I understand it from your testimony and Mr. Martin's testimony in the past. But now I thought all the banks had to go along together in their bond selling and buying. I though that your bank, Mr. Sproul, was just a part of the Federal Reserve System—of course, it is a huge part, a major part—but it is a part, and that of the bonds that were bought by the Open Market Committee, you got your share and no more; is that right* Mr. SPROUL. We get our proportionate share. Representative PATMAN. That is what I mean. Mr. SFKOUL. I t is based on the total assets of the Reserve banks with a formula related to it. Representative PATMAN. That is what I am trying to say, your proportionate share. Why was it along during that period that your bank lost about $20 million in Government bonds and the banks, say, at Boston and at Atlanta, I believe they were, gained about $20 million? How did that happen? Mr. SPROUL. Because in the formula which we then used there were allowances for the differences in the expenses and the reserve needs of the individual reserve banks. There is an adjustment made at the end of every quarter, and there may have been an adjustment at that time which transferred some securities from the New York bank to some of the other Federal Reserve banks, but it had nothing to do with the open-market transactions; it was a wholly internal transfer of a small amount of securities between the reserve banks. Representative PATMAN. NOW, the banks engage in no open-market operations themselves, I mean individually as a bank? Mr. SPROUL. Under the law, the Federal Open Market Committee directs the Federal Reserve Representative PATMAN. That is right. They are compelled t a carry out whatever the Open Market Committee says in the way of banks? Mr. SPROUI.. That is right. Representative PATMAN. Suppose wage rates, Mr. Martin, through the process of collective bargaining, are adjusted upward, and threaten a sound money policy. Will monetary policy be permitted to adjust itself to wage developments?, Mr. MARTIN. Money policy will have to take each individual situation as it comes along. Now you are talking about wage rates which, in a country as large as this, cannot be adjusted at least at this time, across the board. You would have to be talking about it in a particular segment of industry. 242 UNITED STATES MONETARY POLICY Representative PATMAN. Well, suppose we put it another way. Suppose, in Order to rid our country of unemployment, it becomes a real problem, that we have a certain degree of inflation or anything else you want to call it, expansion, and the cost of production goes up. Now, what will you do, will you try to have policies, restrictive policies, that will cause production to go down, or will you increase the flow or volume of money So that the purchasing power will be increased to take care of the added production ? ^ Mr. MARTIN. Monetary and credit policy is just one factor in the economy. I t cannot make people borrow money if they do not think they can make a profit on it. Credit by itself is not a source of jobs. I t is just, as I have said a number of times, a stream or a.river that courses through business and commerce and from which business and commerce can derive assistance, but it is not in itself a force which will give us the millennium. I t never will be. Representative PATMAN. Thank you, Mr. Chairman. I will stop. I have taken up too much time. Senator FLANDERS. YOU have not taken up your full allotment. The thought came to me as I listened to the discussion that there was one question that came up upon which we might hear from the presidents from the different Federal Reserve banks. The question was raised as to the very short timelag which I would think myself was a little bit unfortunate, between that historic bond issue and the raising of the mortgage rate from 4 percent to 4% percent. The question is raised whether that increase was justified by a forthcoming increase in rate or whether it stood on its own? I would like to know if there are any of the presidents here who would like to comment on the question as to whether there was, previous to this issue, a satisfactory amount of mortgage money available for financing home building, and whether they would have felt it necessary to raise the rate in any event in order to get sufficient funds flowing for home building. Do any of you wish to comment on that? What was the condition in your area, Mr. Leach? Mr. ERICKSON. Mr^Chairman, I might comment that as far as a satisfactory amount~5T concerned, that is a very difficult thing to answer. There were bankers who would not buy mortgages at 4 percent at the time. They had to have a higher rate if they were going to do that. Both the F H A and VA were pinched in getting their mortgages, out. Senator FLANDERS. And the lending institutions were not interested at that time in a 4-percent rate ? Air. ERICKSON. That is right. Senator FLANDERS. Had that existed for some time? Mr. ERICKSON. I t was growing in intensity; yes. Senator FLANDERS. When the rate was raised to 4%, money flowed more freely into that market, and building increased; was that your experience, Mr. Irons? Mr. IRONS. Speaking for Dallas, I would say that our experience was the same in that during the latter part of 1952 and the early part of 1953 it was very difficult to get mortgage money at 4 percent Subsequently, when the rate was raised, there was an increased flow of money into mortgage lending—very definitely. UNITED STATES MONETARY POLICY 243 Senator FLANDERS. And that resulted in a definite increase in new housing? Mr. IRONS. Well, there have been very substantial increases, yes; but the big increase has come in more recent times since the relaxation of the credit terms. However, that increase in the rate did serve to bring about a better flow of money into the mortgage market and create a better mortgage market situation. Senator FLANDERS. I S there any variation of the experience of the presidents on that matter ? Senator SPARKMAN. Mr. Chairman, may I intervene there ? My recollection is not in accord with the statements made. I know that that pressure was before us on the Banking and Currency Committee for a long time with reference to raising the interest rates. The interest rates were raised on June 6 or June 3, was it—it was somewhere about that time. I believe, if you will check, you will find that it was several months after that before there was any appreciable easing up of the housing mortgage; the home-mortgage market. I remember we remarked on it frequently during that time, and it is my opinion that the thing that started moving money into the home-mortgage market was not the increase in the interest rate. As a matter of fact, it seemed for 2 or 3 months to have the adverse effect, to dry it up still further. I believe that the record will show that there was no appreciable effect until sometime probably several months after the reversal of the policy that the chairman referred to was anounced and put into effect. Now, I think that is something that could.very easily be explored, but in my own opinion, that is what we would find to be true. Senator FLANDERS. From .your point of view and from the experience you have just given, that would seem to raise significant questions as to the fundamental importance of the interest rate in expanding business. Now, is that not a rather serious blow at all the theory of monetary controls and their effects, at least from your story, which I think you, knowing you, I am sure you are prepared to document with suitable statistics—does not your story indicate that the interest rate is not the all-powerful thing we are accustomed to think it ? Senator SPARKMAN. I do not know that you could draw a conclusion such as that. I think there are many factors that must be considered in connection with this. I think the putting out of the bond issue that was discussed here this morning, proauced a shock that resulted in many things that probably were not regular taking place, and I think that probably was true in connection with the home-mortgage market. I am not saying that under normal conditions the increase in the interest rate would not have poured more money into the home-mortgage market, but I think, first of all, at that particular time, the psychology of the situation was that many people who ordinarily would have made money available, waited expecting a still higher rate, and I think others who might have poured it in were afraid of what was going to happen, they were waiting to see. Senator FLANDERS. Mr. Fulton? Mr. FULTON. I n the investment of funds by banks, there is one factor that all banks look to, which is liquidity. 244 UNITED STATES MONETARY POLICY At that time, when the mortgage market became very tight, banks, by and large, had rather full portfolios of mortgage loans. The banks had rather large demand deposits which could not be invested in mortgage loans. Such deposits go largely into short-term securities and business loons. Mortgages had bfeen in supply and had been absorbed in large quantities. Regardless of interest rates, mortgages will not be absorbed by the banking system when it feels that it is impairing its liquidity by taking on more. That, I think, was part of the situation at that time. I t was not wholly an interest-rate problem but also a matter of liquidity, so far as the banks were concerned. Subsequently, funds became available as time deposits grew and business loans fell off. Also banks improved their liquidity by achieving a better distribution of long-term and short-term obligations. But primarily it was the availability of funds from the standpoint of maintenance of liquidity and the ability of banks to meet their obligations that influenced that market at that time. Senator FLANDERS. Any other comments on this? Senator GOLDWATER. Mr. Chairman, I would like to comment on this because I recall, with Senator Sparkman, having sat through these hearings. There seems to be, from the figures in the Economic Indicators of November of this year, on page 17, very little change in construction during the particular period we have been talking about. If we look at the 1953 monthly average we find 2.9, 2.8 billions of dollars; that is 2.9 billions monthly average, and if you go through the year of 1953 by months from September, you find tliat that change is very, very little, and if you bring it up at the present time, the change is very little; I think that substantiates the remarks of these gentlemen that the law of supply and demand probably influences the building a lot more than interest rates. Senator FLANDERS. Have you any other questions you would like to ask? Senator GOLDWATER. I have none; they may come. Senator FLANDERS. All right. Senator SPARKMAN. Mr. Chairman, it has just been pointed out to me that in the Economic Indicators on page 18, showing the housing starts, it shows that they continued to go down, and were going down rather steeply right up until December of 1953, so there was no early response to the increase in interest rates. Senator FLANDERS. Yes. Representative PA'OIAN. I t w*»-s May 3 when it was anuounced. (Senator SPARKMAN. Yes; I believe that is true. Well, back in May or June 1, and you can see that the curve is going down rather sharply right on through the end of the year. Senator GOLDWATER. I am talking about dollars, you are talking about building Senator SPARKMAN.. I am talking about housing starts which represented, of course, mortgages that went* into effect. Senator GOLDWATER. I disagree. Mortgages are reflected by money, I do not think by starts, but there again I feel that the facts that were brought out during our hearings were that the market had become rathei saturated, had a greater effect on starts than, the fact that UNITED STATES MONETARY POLICY 245 the interest was 4 or 4% or any rate we might have put it at or agreed to put it at. Senator SrARmiAN. Well, I don't agree that the market—that we had enough houses, if that is what you mean by the market having become saturated. They very fact that during the present year we are building 1,300,000 houses, that many, indicates there was no saturation, and still is none. Senator GOLDWATER. There was a saturation at that point or they would have been soldj*. There has been an adjustment period as there has been in automobiles, as there has been in everything. The point I wanted to bring out was in dollars to our economy there hasn't been any appreciable fall-off or increase anytime during the period we are talking about. Senator SrARiotAN. I don't follow you, in view of the number of starts. That is what counts in the housing market. Senator GOLDWATER, We are talking about mortgages, and that relates to the dollar market. Senator SPARKMAN. The two certainly go together. Senator FLANDERS. Senator Douglas, have you any questions? Senator DOUGLAS. Yes, sir; I would like to have the gentlemen discuss what seems to have been a change in Federal Reserve policy beginning in December of 1952 and January 1953 from that which had prevailed during the period of the so-culled accord. I not only approved of that accord, but possibly had something to do with its conclusion, and I think it was a very great step forward. I would like now to point out what I have been trying to point out at previous meetings, that in the ensuing 21 months, namely, March 1951-Deeember 1952, we did not have what Mr. Martin has referred to as a "hard money" policy. We moved instead from an easy money policy into, say* that we had a flexible money policy, because during that period of 21 months the index of fiscal production rose by 6 percent on an unadjusted basis to 9 percent on a seasonal or adjusted basis, somewhere between 6 and 9 percent. During that period, too, member bank reserves in the system rose by 5 percent, approximately, that is. The Reserve was buying Government securities at approximately the same rate as the index of fiscal production advanced. I t is true that loanable funds by banks were increased somewhat more than that, but the net result was a stable price level and maintenance of full employment. I congratulate the Federal Reserve System and the Open Market Committee for the work which they did during these 21 months. The question I raise is whether it was wise to change this policy, as I think it was changed in December of 1952 or January 1953, Now I would like to point out that during the ensuing months according to the Reserve's own statement in its tabular form here, that the Open Market Committee sold or redeemed $800 million net of United States Government securities or certain other adjustments so that member bank reserves at least did not increase. Loans by banks and demand deposits declined. I think that the open market operations had some effect on this. Loans by member banks decreased by about 6 percent, but the index of fiscal production during this time, from December to April, actually 246 UNITED STATES MONETARY POLICY rose, rose oil an unadjusted basis by 4 percent, on a seasonal basis by approximately 3 percent. This is the question I would like to raise: Whether the Reserve did not take fright at something which was nonexistent, namely, inflation, in fact there was no inflation, that the price level had been stabilized. But the Reserve adopted a restrictive policy at a time when a restrictive policy was not needed, and failed, at the very least to increase the money supply at a time when it should have been increased, and possibly actually diminished the money supply, with the result that it had some adverse effect upon the level of business activity, and contributed to the decline of business which set in during the summer of 1953. Now this is a question I should like to have answered. Mr. MARTIN. I will accept your amendment of the word "hard" to "flexible," if you would like, Senator, to start off the discussion. I will accept your amendment of the word "flexible" for "hard." Senator DOUGLAS. I did not think you adopted a hard money policy in March 1951, and I may say I am oposed to both a hard and an easy money policy as evils in themselves. What I want is a supply of money which., taking into account velocity, moves with the volume of trade and production, to maintain two purposes: namely, substantially full employment and substantial stability in the price level, and I want to suggest that for 21 months both of those conditions were satisfied. Mr. MARTIN. I wouldn't agree that they were completely satisfied. I hope that all the members here will discuss this. In the early months of 1953 there was forming what my colleague, Mr. Sproul, has called a bubble on top of a boom. We were endeavoring to stem it, and perhaps were slow. There was in the economy at that time, as I see it, a great deal of what I have described before as waste, extravagance, incompetence, inefficiency, and imprudence. All that was a part of the hysteria that went on in the post-Korea days. We finally reached a point where we permitted the credit mechanism to function once again as one of the governors in the economy. Senator DOUGLAS. What were you afraid of ? Production increasing, prices were stabilized, and there was substantially full employment? Mr. MARTIN. Look at what was happening to inventories, for example. Do you think ycu can just build up inventories more and more and let production go up higher and higher, and that there will never be any adjustment, particularly when shortly thereafter there wap going to be an end to the constant increase in defense expenditures ? Now, all of those were factors that had to be taken into account in our policies. As we approached the spring of 1953 we had the expectations of the market revolving around all of these developments. Some of them were misconstrued by the market. I t seems to me that you can't eliminate the fact that inventories were rising rapidly at the same time that production was continuing very high. Senator DOUGLAS. Well, high production is not evil. Mr. MARTIN. I didn't say it was fevil. I am just talking about it in relationship to inventories and the fact that we were heading towards a precipice. Perhaps we jammed on the brakes at one point a little bit too tight. I have admitted this. We are certainly not infallible in our judg UNITED STATES MONETARY POLICY 247 ments. Within a few areas we are bound to make some misjudgments. But by and large it seems to me that the situation was kept well in hand. I believe we would have had much more unemployment and further distress if we had not pursued those policies. Senator DOUGLAS. I think you make a mistake, myself. There is a further inconsistency which I find. You say that you wanted to reduce latent inflationary tendencies back doors which did not manifest themselves in the price index, but at approximately the same time, namely February of 1953, you diminished the margin requirements for the purchase of securities from 75 percent to 50 percent. Now, that is, of course, a directly inflationary move so far as the prices of stocks are concerned, namely, that it permits a much greater purchase of stock with a small amount of individual cash, and I fail to see why you should be wanting to deflate one section of the market and inflate another at the same time. I think this shows gross inconsistency. I would be interested in your answer to that. Mr. MARTIN. I can take a long time, not on that question, but on the inconsistencies that were bound to develop after the Korean hysteria. Before the "accord," we invoked almost every possible control short of the one control which would have been effective, that is, general control, to try to restrain the inflation that followed the Korean outburst. Now, in the early stages of that Senator DOUGI^AS. "Well, my objection is that when Korea started you did not do that; that instead, you became the handmaiden—I don't think you were on the Board then, but that the Reserve became the handmaiden—of the Treasury and permitted a greater increase in prices than was needed. My criticism of the Reserve was that during that period they contributed to inflationary forces, so I think the record of the Reserve up to 1951, March 1951, was a bad record, largely because the Treasury turned on the heat and the Reserve didn't have the courage to restrain itself. But I think from March 1951, to December of 1952 it was a good record. Now you moved in the other direction. Having given in one period excessive doses of castor oil and then getting the organism on a healthy basis for 21 month, you proceeded to dose the organism up with excessive does of bismuth. Isn't there a happy medium which can be maintained? Having reached virtue for 21 months, isn't it possible for the Federal Reserve to maintain it for a further period ? Mr. MARTIN. Senator, we are struggling for the happy medium all the time. Senator DOUGLAS. I don't think you have succeeded. Mr. SZYMCZAK. Mr. Chairman, I think the Senator recalls certain facts, because the Senator was very closely identified with some of them at the time. If we made a mistake in pegging the Government security market, it was made at a time when the war began with Pearl Harbor. We pegged the Government security market at that time to help the Treasury through the financing of the war, and that was all to the good. Nobody could complain about winning the war. We needed money to win the war. That pegging was done on our own initiative. 248 UNITED STATES MONETARY POLICY Now, the difficulties that arose were subsequent to the end of the war. We did try to unpeg, and we did unpeg the short-term Government security market. The short-term rates were up as a result. We continued to move.in that direction together with the Treasury, and, of course, it was very difficult to unpeg once we had pegged and continued the pegs too long after the war, as you know. Many people wTho had securities and valued them at the pegged price, banks, individuals, insurance companies, and many others, in addition to the Treasury, did not want to see a drop in the price of the securities they held. That would make the refunding by the Treasury more difficult. And, therefore, when we finally did get to Korea, we announced in August—Korea was in June 1950—we announced a higher discount rate, and also not only announced the higher discount rate but announced a tight money policy throughout. I t was from that point on until March that we had the discussions witli the Treasury, and while we kept on pegging the long-term securities, you will recall, we kept dropping that long-term support price to par. Our attempt was to unpeg the long-term market. We finally did unpeg in March 1951, and by the end of that year we completely unpegged the Government security market. You, Senator, will recall that because you were very helpful, particularly at that time. Xow, as we got into the latter part of 1952 and early 1953 we did have a capital situation, we did have abnormal inventory increases, and the demand for credit kept increasing—it was partly psychological—for in a cyclical, dynamic, competitive economy such as ours the greater the rise in demand for credit to build up inventories the greater the, urge for more credit. True, the price level was not rising and production and employment were at high levels. But what we were trying to do was not to take away credit for growth, but not to supply the amount of credit that was being asked for by the market to build up inventories to unsound and unstable heights. We stood on the side line, not giving the reserves that building up of inventories required in order to expand credit further and thus expand the inventory and allied elements further. Subsequent events proved that course to be right, because it was the inventory condition of industry and others throughout the country, plus the reduction in defense expenditures that came in the second half of 1953, that brought on the downturn. I t would have been much worse had we allowed the inventories to increase to even greater heights through an additional supply of credit. Senator DOUGLAS. But m your tabular statement, exhibit A, you say from January to April you sold or redeemed $800 million net Mr. SZYMCZAK. We were buying as well as selling, but that was net; yes. Senator DOUGLAS. YOU thus diminished member bank reserves, and therefore diminished their lending capacity. Mr. SZYMCZAK. The essence of that situation was that business was seeking much more credit because of the great demand to build up inventories—which demand was feeding on itself in a competitive economy. They were just building up inventories hand over fist, and the demand was so great that to the extent we didn't satisfy the demand by adding the reserves required, of course the rate went up because UNITED STATES MONETARY POLICY 249 of the demand and supply relations—and not because we pushed up the rate. Senator DOUGLAS. Well, are you happy—may I ask you this—at having made such a large increase in funds available for the purchase of stocks? Mr. SZYMCZAK. Well, that is a different question because the total amount of credit involved there was not large. I t was about 1 to 2 billion, so we wished to make an equitable adjustment in February 1953, and therefore we placed margin requirements on a basis where we could increase or decrease margin requirements as required rather than move by 25 percent once in a while and thus dramatize our action beyond its actual worth. I t was merely an adjustment that gave us a better base from which to operate. I t wasn't at all related to the credit or economic situation because the amount of credit in that sector of our econQmy was relatively small. And, of course, it doesn't necessarily relate itself to price. I t does relate itself to volume. Senator DOUGLAS. The more you stimulate purchases, the greater is the effect on the general level of stock prices. The low margin requirements in the twenties certainly contributed in part to the stock market boom in the late twenties. Mr. SZYMCZAK. Of course, as you know, when the SEC and margin requirements were considered by Congress there was a question whether margin requirements shouldn't because of other considerations be placed in the SEC, and somebody suggested that since it was credit no matter what.the other considerations that it should be placed in the Federal Reserve, and that is how Congress placed it in the Federal Reserve. But, so far as the actual amount of credit is concerned, it is and was relatively small—especially as related to other credit sectors of the economy. Senator FLANDERS. Mr. Talle, have you any questions you would like to ask? Representative TALLE. NO, thank you, Mr. Chairman. Senator FLANDERS. I might say that at times we get confused with some of these complicated subjects. I have a very simple one which I would like to present. I would like to have a poll of the members of the Federal Reserve Board and then have the presidents of the Federal Reserve banks polled on a simple question, but I will first ask you if you are willing to be polled. We tried it on the economists yesterday, and they were all willing.^ This is the question taken from tbe report, the Patman report, of the 2d session of the 82d Congress: We believe that to restore the free domestic convertibility of money into gold coin or gold bullion would militate against rather than promote the purposes of the Employment Act, and we recommend against such restoration. First, I would like to ask the members of the Board whether they are willing to be polled on that subject, convertibility of gold. All appear to be willing to be polled, so will those who favor the free domestic convertibility of money into gold coin or gold bullion raise their hands ? Mr. VARDAMAN., Mr. Chairman, may I ask if you refer only to the immediate foreseeable future? 250 UNITED STATES MONETARY POLICY Senator FLANDERS. Yes; foreseeable future; let's call it that. All in favor of convertibility in the light of the foreseeable future, raise your hand. (There was no showing of hands.) Senator FLANDERS. All against. (There was a showing of hands by a majority of the group.) Mr. SZYMCZAK. I doivt think you can answer it "yes" or "no." I think the question is whether we wish to return to the institutional method once adopted, or whether we think we can use the powers we have without going back to gold convertibility. Senator FLANDERS. YOU think we can do what we want to, without going back to convertibility ? Mr. SZYMCZAK. I don't think we need it. We can get along without it, but I have no very strong objection to it. Senator FLINDERS. We have, I think, a clouded but not too direct a poll on that. Perhaps I will put it for the presidents in this form: I will again read the paragraph and ask if you agree with it. Are you willing to be polled ? Mr. SPROUL. I would prefer not to be polled on such a question, under such conditions, although my views are very well known. Senator FLANDERS. YOU are excused. Mr. SPROUL. Thank you. Senator DOUGLAS. I think the record should be very clear on this point, that Mr. Sproul is not pleading the fifth amendment. Mr. ERICKSON. Mr. Chairman, is there a time limit there? Senator FLANDERS. NO, there is no time limit in this statement. Are you ready, however, to express approval or disapproval with the statement? All who approve, raise the right hand. Representative PATMAN. Why don't you read it off, Mr. Chairman. We have had so much discussion, I think it has been lost sight of. Senator FLANDERS. This is the proposition: We beliere that to restore the free domestic convertibility of money into gold coin or bullion would militate against rather than promote the purposes of the Employment Act, and we recommend against such restoration. All who feel they can accept that statement raise their hand. (There was a showing of 10 hands.) Senator FLANDERS. All opposed ? All who wish to amend the statement by inserting the words "in the foreseeable future," raise their hands. (There was a showing of hands.) Mr. BRYAN. Mr. Chairman, I would have liked to have voted for it because it would have made central banking so easy. Senator FLANDERS. You might just explain yourself on that. Mr. BRYAN. Well, last year it would have oeen very simple when the Atlanta district was losing reserves, I would have raised the rediscount rate to attract them back, and so forth and so on. I would have had no qualms, no problems of intellect or conscience. Senator FLANDERS. D O you want it that way? Mr. BRYAN. NO. Senator FLANDERsTTthink we got a vote on that. 1 hope there will be no recount. I just received word that I must leave a little bit earlier than I had intended to. UNITED STATES MONETARY POLICY 251 Is there anyone who wishes to proceed with further questioning? We have quite a record already. Senator DOUGLAS. Mr. Chairman, I don't wish to proceed with any further questioning, but I am told that there is a report of an ad hoc subcommittee of the Open Market Committee dealing with some of the questions discussed this afternoon, and I request that it be made part of the hearings. Senator FLANDERS. I am not quite sure what documents wou are referring to, Senator Douglas. Senator DOUGLAS. I believe it refers to a point which you raised earlier, at the very beginning of your questioning this afternoon. The documents, since they are documents either of the Open Market Committee or of the Executive Committee, are naturally not known to Members of Congress. I naturally am not certain of the exact content, but I think they will be known to the Open Market Committee and to the subcommittee itself. Senator FLANDERS. YOU are not suggesting the minutes? Senator DOUGLAS. NO, no; the report. Senator FLANDERS. The report of the Open Market Committee? Senator DOUGLAS. The report of an ad hoc subcommittee. Representative PATMAN. YOU mean, it made a report today ? Senator DOUGLAS. No; it was niade earlier. Senator FLANDERS. Mr. Martin, I would like to have you comment on that. I am not just clear what the document is. Mr. MARTIN. I think the reference is to an ad hoc subcommittee report which was made on the subject, referred to at the start of this hearing, on which Mr. Sproul and I are in disagreement. Senator FLANDERS. I t would seem to me that the disagreement was quite clearly expressed. I wonder what more there is m the ad hoc report ? Does it censure either of you ? Mr. MARTIN. I t doesn't censure either of us. I t contains analytical and descriptive material, as well as recommendations. Representative PATMAN. Does it condemn you? Senator FLANDERS. Yes, or commend you? You feel that it was descriptive material; did you say ? Mr. MARTIN. Well, as far as I am concerned, I am perfectly willing to make it available to the committee for publication, if they wish it. Senator FLANDERS. I t would seem to me offhand, Senator Douglas, that we had a fairly clear expression of the difference of opinion between the two men. Senator DOUGLAS. Mr. Chairman, I wias the one who 2 years ago moved that the very spicy exchange of correspondence between the Treasury and the Federal Reserve Board in 1950 and 1951 be made part of the official records. Mr. Martin at that time was very reluctant to have those documents brought forward, but they were published, and I think they contributed greatly to an understanding of the monetary history during the period 195G-51. Now, since those documents were published, I think they did, in general, help everybody. I think the publication of this document would be of some assistance. In short, I believe that the Federal Reserve, the Open Market Committee, should not conduct their operations with the secrecy which has previously attended them, that the more we have an airing of differences on these matters, the better educated Congress and the 252 UNITED STATES MONETARY POLICY public will be, that sunlight is not to be feared, that honest differences are not to be feared, and that there is nothing quite like facts and knowledge. Senator FLANDERS. We will ask the Opfen Market Committee, then, to make that available for inclusion in the record. Mr. SPROUL. I would like to say something on that, Mr. Chairman. I have been, and continue to be, of the view that this was a working paper, prepared by an ad hoc committee of three members of the Federal Open Market Committee for the consideration of the full committee, not as a public document. I believe it would be a bad precedent if we began publishing working papers of the committee, inhibiting and corroding free discussion within the committee. In this case, to complete the record would require the publication of all letters and documents commenting on the ad hoc report prepared by the majority and minority members of the Open Market Committee. The ad hoc committee report did not have unanimous acceptance. There would inevitably be a lot of deadwood in this material. There were 14 items of action culled out of the ad hoc committee report, but only 3 of these were of significance so far as present policy is concerned, and only 2 of these 3 recommendations—confining open market operations to short-term securities and support of Treasury financing operations—have been the subject of continuing debate. If there is a real public interest in these two matters, the way to feed that interest is by public discussion of these issues, such as we have today, uncluttered with a lot of extraneous material such as is included in the ad hoc committee report. The answer of the Chairman of the Board of Governors to question No. 3 of this subcommittee's questionnaire is an example of the kind of discussion of these issues which I would say is constructive. I have tried to present my opposing views. I regret to say that the public interest in these matters does not seem to be great nor intense. The minor clamor for publication of the ad hoc committee report, with few exceptions—and this does not include Senator Douglas—has come mostly from the curious, or those who think they see a chance of stirring up trouble within the System, or between the System and the Congress. I would not pander to that curiosity, or to the decisive urge. This does not mean that there is anything that needs.to be hidden or covered up in the ad hoc committee report or that we want to shut out the sunlight. There isn't anything to be hidden in the report. I t merely means that publication of this internal working document is not necessary if we want to discuss soberly and constructively the issues of current policy, which, I believe, would benefit by more informed discussion, both within and outside the System. Mr. VARDAMAN. Mr. Chairman, may I, as one member of the Board, gladly follow the lead in this instance of Chairman Martin, who states that he sees no objection to the publication of the ad hoc report. I regard the ad hoc report as far more than a working paper. If, when publication of the ad hoc report takes place, it becomes advisable to reveal documentary evidence filed with the Board in the form of letters and other forms connected with it, then we should give those papers, if you please, to this committee for editing before publication, UNITED STATES MONETARY POLICY 253 but I would like very much to see the ad hoc report published for the information of this committee. Mr. BRYAN. Mr. Chairman, I would like to say that I also support the publication of that report. I had the honor to be a member, and I think the committee would be in error if it believes that it was a mere working paper. We have had here a most fundamental attack upon the policy of the System. I believe that this committee deserves the whole history out of which that policy was evolved. Senator FLANDERS. I would suggest to the committee that this material be placed in its hands, and that then the committee itself, the subcommittee itself, determine on the use of the material, if that is satisfactory. (See statement by Chairman Flanders on action taken on ad hoc subcommittee report, p. 257 and following.) Mr. WILLIAMS. Mr. Chairman, may I suggest also that the subcommittee may wish to call someone into consultation to get the implications of f uli disclosure here. Senator FLANDERS. I will be glad to have comments from all those concerned as to significances which don't appear in the material. Representative JPATMAN. Mr. Chairman, I ask unanimous consent that when it is received that it be left up to the chairman and Senator Douglas as to whether or not it goes in. Senator DOUGLAS. Oh, no; I am not a member of the subcommittee, so I should not serve on it. I think you should serve, Congressman Patman. Senator FLANDERS. I regret that I must go. Representative PATMAN. I want to bring up one question. These people are so cooperative, I want to ask them what is going to happen m the next few months. Senator FLANDERS. We will have a lot of hearings in January and February when the full committee will consider these matters. Representative PATMAN. I bow to your judgment, Mr. Chairman. Senator FLANDERS. Additional statements to clarify the presentation can be offered for insertion in the record. (By direction of the chairman, the following is made a part of the record :)• (The following comments on the Treasury and Federal Reserve statements of December 6, 1054, to the Joint Committee on the Economic Report have been submitted by Edward C. Simmons, professor of economics, Duke University, Durham, N. C , in response to an invitation by the subcommittee to present material for inclusion in the record:) The statements of the Treasury and the Federal Reserve reveal that monetary and debt-management policy is formulated on only vague and indefinite criteria. Such things as stability and growth of the economy are frequently mentioned as having a bearing on policy matters, but these concepts are not reduced to objective criteria. One cannot tell whether or not the desired goals have been reached. Both agencies Express satisfaction with their achievements, yet both seem to reveal uncertainty as to events preceding and following the downturn in the spring of 1953. In view of the admitted inability to forecast the faith expressed in ability to apply discretionary judgment is quite remarkable. The Treasury's expressed view is that floating debt can be excessive and also that long-term financing may not be undertaken when long-term funds are needed to finance private investment outlays. This may explain why the Treasury does not bother to argue the case for funding. Much is made in the Treasury statement of the quite modest achievements in the direction of lengthening maturities. The Federal Reserve statement is very long and very technical. It provides an abundance of information on recent central bank operations, particularly as to sales and purchases of Government securities, although the attempt to expound 55314—54 17 254 UNITED STATES MONETARY POLICY what is meant by "preventing disorderly conditions" is hardly successful. On monetary policy proper, the outcome is only slightly better. Year-to-year changes in bank reserves are commented upon, but one cannot be.sure that what happened was the result of design or of conjecture; Similar changes in the economy's stock of demand deposits are discussed, but one never learns what should happen to this most important economic quantum, nor can one tell whether the Federal Reserve has been successful in bringing about the result it desired. The discussion of monetary policy is conducted along with the discussion of a great many other matters, and one cannot always tell whether these matters are means or are ends of the same order.of importance as monetary policy. At various places in the Federal Reserve statement, one encounters language such as policy is "* * * to influence the level of bank reserves and the money supply in accordance with seasonal requirements, the capacity of the economy to produce goods and services, and suitable growth in the economy." Obviously, a target so poorly defined can never be said to have been missed. Question No. 4 is allocated only 1% pages of text, although other answers extend over much more space. Reference is made to a Federal Reserve statement to the Patman subcommittee and to an appended 10-page reprint from the Federal Reserve Bulletin. Both of these, as the reply indicates, are concerned with describing the complexities of the monetary mechanism and only incidentally if at all with answering the question, "How much money does an economy need?" Some may doubt if question No. 4 is answered by saying that monetary policy is a complex matter upon which the Federal Reserve brings to bear its best judgment Specifically the lengthy statement cast little light on the causes of the marked seasonal and other short-run fluctuations in member bank reserves and the stock of money, although these would seem to be subjects for comment in a discussion of monetary policy. Neither the Federal Reserve nor the Treasury may be said to have failed to answer the questions. Much of the difficulty lies in the questions themselves. They do not call for incisive replies. (The following memorandum was submitted December 8, 1954, in response to the invitation by the subcommittee to present material for inclusion in the record: ) MEMOBANDUM TO SENATOR FLANDERS, CHAIRMAN, SUBCOMMITTEE ON ECONOMIC STABILIZATION, JOINT COMMITTEE ON THE ECONOMIC REPORT (By Arthur R. Upgren, Dean, the Amos Tuck School of Business Administration, Dartmouth College, Hanover, N. H.) i—LIQUIDITY The two ideas I would like to forward as being the major responsibilities of our banking system are assistance in avoiding deep economic declines and acceptance of the responsibility to maintain liquidity. I think the void in liquidity all through the latter 1920's and up to 1933 is simply the negative of too much credit inflation which we so commonly think of as coming with wars. When we have such credit inflation we have rising prices. Similarly wthen the banking system in short of liquidity, we have our busts and sharp falling prices. Each is rather inexcusable but of the two, the existence of illiquidity is by far the most needless and most damaging. This can be illustrated by the record of the banking system. Up to the end of the 1920's our banks in the Midwest were very illiquid. Country banks probably had about 10 or 12 cents on each dollar of deposit in liquid assets. Out in that section of the country when the break came, something of the order of 15 to 22 percent of all deposits were withdrawn. The net result was that in the United States 15,000 banks failed from 1921 forward. Some readjustment immediately following the First World War was inescapable but the loss of the banks, the absence of liquidity, and # the colossal damage inflicted on the American people following the year 1930 was mostly needless and could probably have been avoided if we had discovered some way to create the needed liquidity. Today all the banks are extraordinarily liquid and the western banks are more liquid than the banks of Wall Street. In Denver this summer bank statements released at that time revealed a liquidity ratio ranging from 60 to 75 percent. Comptroller of the Currency, Ray Gidney, recently reported that all the member banks were 62 percent liquid. UNITED STATES MONETARY POLICY 255 Thus we have solved the problem of liquidity and in fact, we probably have an oversurplus of liquidity in the banks at this time. But this liquidity is surely "going to run out" sooner or later. One recent estimate suggested that total commercial bank credit outstanding in 2000 will be at least $2,000 billion. If it is, that will be about the slowest rate of increase we have ever known for such a period. If we should have bank obligations of that size, we would need a banking system whicli would be at least 20 percent liquid, or better, 25 percent. This will call for a liquidity in absolute amount of about 400 to 500 billion dollars. You will readily appreciate that is far short of the liquidity which is likely to be had by the banking system on a basis of scanning of all the liquid assets which might come to the banks. I think our national debt is not going to be appreciably increased; I think Europe is going to retain most of the world's newly mined gold; and I am not inclined to think that short-dated liquid paper of the business system will be developed in any large amount. Thus we could say that we might, by 1073, be lulled into such a state of complacency by the liquidity we then shall have enjoyed for 28 years, that we could have a repetition of 1873. The banking system already is using a fair share of its liquid assets and certainly will be expanding its deposits as soon as we have further economic growth and expansion which is probably proceeding at the very present time. This is indeed a long-run problem. It will be a problem for the next 15 to 25 years. But its delineation and the experience we have had with it in the past, reveals how completely we have ignored it. If memory is correct in this matter, in 1S57 and in 1S93 the British Parliament indemnified the Bank of England for any damage or loss that might be caused by its overissue of bank notes. That overissue of bank notes broke the extreme tightness in the money markets on both of those occasions. Yet in 1933, 40 years after one experience and 85 years after the other, we got into the same kind of a jam and it was the central bank which did not perform the function. It accepted failure. Banks were needlessly sacrificed because the central bank and the Treasury did not provide liquidity. If a crop is to be grown in the arid West, water must be sprinkled upon the fields. Out in Minnesota and Wisconsin farmers are now instructed by the State universities in the techniques to be followed to grow more than 100 bushels of corn per acre. To do so fertilizer must be spread upon the fields in very large amount. This analogy may be used for an economy. If it is to survive the shocks and moderate recessions, then that economy must be sprinkled generously with liquidity. I think the struggles of the American people for 12 years reveal this very fact. In 1S37 we so lacked liquidity that the State of Wisconsin passed a law making banking illegal for approximately the same length of time that prohibition made liquor illegal about 80 years later. The people were disgusted with a banking system that could break so completely. We only need remind ourselves of later dates of other illiquidity. These were, as I remember, the outstanding ones w^hen financial crashes made the most noise, 1857, 1873, 1SS4, 1803, 1007, 1021, and 1033. Today we have the Employment Act of 1946 which has been' considered the economic capstone of all economic and financial policies of the Federal Government. I am sure that to promote that high level productive employment for the people, we shall find ways and means to increase debts, "the promises men live by" as Harry Scherman once defined debt. II—FUTURE DESIRABLE FISCAL AND MONETARY POLICY I now turn very briefly to the side of monetary policy for the future. I t seems to me that this can be simply stated. The American people are very literate, fiscally speaking, as has been evidenced by their willingness to bear taxes. In the First World War we produced about one-third of Government expenditures by taxation and prices fell only a little short of reciprocally short of tripling. The wholesale price index went to 247. In World War I I we taxed for 4(y percent of total expenditures—and there was no improvement in this ratio when there could have been the most improvement in this ratio, namely in 1044. In consequence, prices almost doubled, the index rising to 100. After Korea, at least except for one larger deficit in fiscal June 30, 1053, we taxed for 95 percent of total Federal expenditures. The net result has been that the inflation in wholesale prices has been only 10 percent and in consumer prices only about 15 percent. In addition, we have had remarkable stability of the price level for 8y2 years. The rise in that period, which has been slight in the con 256 UNITED STATES MONETARY POLICY sumer price index, has been wholly an adjustment to the needs of the earlier, 1950-51, sharp rise in wages. It has not been the result of any recent inflationary pressure. Moreover, as a result of this high rate of taxation we have the happy consequence of now being able to reduce taxes as rapidly as defense expenditures are being reduced. That has been very stimulating to the economy in the past year. In 1940, and the years following, defense expenditures had to come down by §54 billion, or from $100 billion of spending to $46 billion of spending before we could have any tax reduction on the basis of the $46 billion tax revenues we then had. Happily defense expenditures declined by almost $68 billion so that we did have tax reductions which I have estimated were worth the difference of about $14 billion. But those tax reductions were only $1 for each $5 of expenditure reduction. In the last year we have been able to have almost $1 of tax reduction for $1 of defense expenditure reduction and still retain a balanced budget. This tax reduction has been sufficient to sustain personal disposable income without any diminution at all despite a decline in personal incomes (before taxes) which decline has been caused by somewhat shorter hours and somewhat increased unemployment, slightly offset by some increases in hourly wage rates. In addition, this tax reduction has been able to convert the declining earnings of corporations due to an approximate 7 percent decline in sales, into an absolute increase in profits for most companies. The importance of this increase in profits is that a good record of profits is the most important single requirement for a good record of continued high capital investment by industry. That continued high investment is expected now for 1955, now seems likely, according to recent reports. What is needed is education to the fact that monetary policy should be flexible and liberal at any time when there is unemployment above, say a 3-percent figure, or about 2 million unemployed. Moreover, that liberality and easiness in monetary policy should continue until the reduction in unemployment comes at a very much slower rate and there is a tendency toward wage rates and toward price levels to rise. That rs the only guide I would give for monetary policy. It is the guide that when we have unemployment, policy should be liberal and generous and there should be tax reductions. As unemployment subsides and does not s<*em to be able to drop any more, nor employment rise, and as prices tend to.rise somewhat and especially wage rates rise, then monetary policy should be restrictive. This leads to the fact that the simulation of an economy must, however, come primarily out of fiscal policy. Then when restraint is needed, since taxes are said not to be something the American people will vote quickly, monetary policy can be used to restrain, that growth of credit at "too fast" a rate. "Too fast" means, of course, that the rise of prices is beginning and the rise in wage rates at an increasing rate becomes apparent and total employment is not appreciably lifting—barring, of course, a rise in the labor force. Such a policy even if somewhat slowly applied at times, here I refer to the restraining- monetary policy, will provide the liquidity which the country needs. I would like to think that we would be imaginative enough, and abstract enough in our thinking as was Gustave Cassell, to create liquidity in a very abstract way. But we know we do not wish to create liquidity by emissions of excessive amounts of currency. Thus we must fall back on the orthodox and accepted form of creating liquidity which is an enlargement of the Federal debt. If there are other ways and they can be widely accepted, they certainly should be offered and adopted. In summary, I see our economic history as showing that our society has for about 200 years in this country struggled to provide needed liquidity. The struggle became so tense and arduous at times that we placed great premium upon gold and silver mining and we could not meet demand so that we had complete collapses. The struggle was also attended with extremely high interest rates such as the 9 percent call money rate of 1929 and tlie 8 percent borrowing rate of some good industrial companies in 1921. We have eased on that but that only means there will be debt expansion of the banking system, the central banks, and therefore we need to facje up to the creation of liquidity so that we may retain for ourselves the fruits of these new modern, more orderly scheduling of debt repayment which contributes so very greatly to the high prosperity of the American people and which provide places in which they can so satisfactorily lodge their savings. This is the time for a discussion of these issues because the issues are not "hot" a t the present time. Thus, we should be able to place it in perspective UNITED STATES MONETARY POLICY 257 SO that we would be certain to take action to provide needed liquidity when that time comes. In my own view that time will not come immediately ahead but could come by perhaps the year 19G5 or the fateful 100th anniversary of 1873, in 1973. I t seems to me, therefore, that the maintenance and creation of liquidity is one function of the banking system. The second function is the sharp restraint by monetary policy in the event of any inflation and excessive boom. The monetary authorities can act. June 1953 showed us that their action need not endanger the banking system as so many had falsely predicted in connection with their arguments for 100 percent support prices for all Government securities. Fiscal policy then can be via tax reduction, the powerful lever to move an economy upward in the event an adequate full level of employment is not maintained and in the event output of the economy is not expanding as we know it can at rates of a t least 3 percent per year. STATEMENT BY CHAIRMAN FLANDERS ON ACTION ON AD HOG SUBCOMMITTEE REPORT, DECEMBER 9, 1954 The subcommittee has decided to release and make part of this record the report of the ad hoc Subcommittee on the Government Security Market of the Open Market Committee dated November 12, 1952. At the hearing on December 7 the Subcommittee received arguments both pro and con, with respect to publication of the document, from officials of the Federal Reserve System. Our decision to publish the document is based upon the following statement by Chairman William McChesney Martin, contained in the record above: "Well, as far as I am concerned, I am perfectly willing to make it available to the committee for publication, if they wish it." The subcommittee believes that proper procedure has been followed in this matter since the head of the agency involved has assented to its publication. This view is concurred in by Senator Barry Goldwater and Congressman Wright Patman, members of the subcommittee. Senator J. W. Fulbright and Congressman Richard Simpson were unavailable for the hearings and did not participate in this decision. We have advised both Mr. Martin and President Allan Sproul that the document will be published, and have invited them to append any additional papers that they believe should be published simultaneously with the ad hoc report. They are appended. FEDERAL OPEN MARKET COMMITTEE REPORT OF AD HOC SUBCOMMITTEE ON THE GOVERNMENT SECURITIES MARKET, NOVEMBER 12,1952 PREFACE Securities of the Federal Government have come to play a unique role in the flexibility and sensitiveness of the American money market. Our financial institutions now hold the bulk of their secondary or operating reserves invested in these issues, particularly in the shorter term securities. This is true especially of commercial banks but also of insurance companies and savings banks, as well as savings and loan associations. I t . i s also increasingly true of many of our larger industrial corporations. As a result, any change in the demand for funds or their supply is felt promptly in the open market for Government securities. When our financial institutions gain funds, they usually invest immediately in Government securities, and, conversely, when they have net payments to make, they liquidate Government securities. When their customers borrow or opportunities for profitable investment arise, financial institutions switch out of Government securities, and when loans are paid or investments are sold the proceeds are usually invested, at least temporarily, in Government securities. The resulting daily turnover of securities in the market is enormous. It reflects the transactions by which 'thousands of individual financial institutions and business organizations keep their funds fully employed at interest, without sacrifice of their ability to meet the changing financial requirements of their more basic business operations. Arbitrage transactions add to this daily turnover in the market. There is no credit risk in a portfolio of Government securities, i. e., no possibility that the holder will not be able to obtain cash at par at maturity. The relative 258 UNITED STATES MONETARY POLICY prices at which different issues trade, therefore, reflect predominantly changes in the demand for and the supply of loanable funds in the money market as a whole and also as between the various short-term, intermediate, and long-term sectors of the market. Since trading is done at commissions or spreads as small as one sixty-fourth ($150.25 per million) and even smaller in very short issues, there are constant opportunities for arbitrage of small differentials in prices when the impact of buying or selling is especially heavy in some particular sector of the market. The secondary reserve portfolios of practically all the large financial institutions are managed by skilled professionals to take advantage of such opportunities. The Federal Open Market Committee is a major factor in this market. At present its portfolio consists wholly of United States Government securities. It is the largest existing portfolio under one control. When the Federal Open Market Committee adopts a policy directive, it is executed in the market for Government securities. I t takes the form of a series of specific transactions in Government securities. Total transactions for the account—purchases and sales—mount up to billions of dollars in the course of a year. The impact of these operations is not measured by the volume of transactions alone. It is much greater, for example, than the impact of a similar volume of purchases and sales by a private investor. The Federal Open Market Committee releases or absorbs reserve funds when it operates in the Government securities market. When the Committee buys, it augments not only its own holdings of Government securities but also the ability of other investors to enter the market on the bid side Conversely, when the Committee sells Government securities, it does much more than add to the market supply of such securities. The reserves that it absorbs subtract also from the capacity of the banking system to carry Government securities. I t is necessary to keep these basic features of the money market in mind, in considering the subcommittee's report. They help to explain why relatively small operations, sometimes even rumors of operations, by the Federal Open Market Committee.may give rise to such quick and pervasive response not only throughout the money market and the investment markets generally but also in business psychology. Any purchase or sale of Government securities by the Committee adds to or subtracts from the reserves of the member banks and is promptly reflected in the tone of the money market. A relatively small injection of funds through the purchase of bills will ordinarily find a response in the market for long-term securities. Large purchases of bills could scarcely fail to elicit such a response. These transactions condition the tone of the money market and the general availability, of credit because chey immediately affect the value of securities in the operating portfolios of leading financial and business institutions. They cause changes in the prices of the specific issues bought or sold, and affect opportunities for arbitrage as between various issues and sectors of the market. As a result, a new pattern of yields emerges as between all different issues and sectors of the market. When the readjustments have worked themselves out, both the prices of Government securities and the pattern of their yields will have been affected. Both the absolute and the relative market values* of the securities that constitute the liquid operating reserves of all our major financial institutions will have changed. In other words, there will have occurred a shift in the financial liquidity of the money market and of the economy. Experience has demonstrated that the climate or tone of the money markets tends to respond directly to the volume of member bank borrowing at the Federal Reserve banks. Changes in the volume of borrowing represent the first response of member banks to losses or accessions of reserve funds from any source, including open-market operations of the Federal Open Market Committee. It constitutes, in fact, an essential link in the mechanism by which these operations exert a magnified effect on the money markets. When such borrowing is low, the tone of the money market is easy, that is, funds tend to be easily available at going interest rates for all borrowers who are acceptable as credit risks. When member banks themselves are heavily in debt to the Federal Reserve banks, the tone of the money market is tight, t h a t is, marginal loans are deferred and even better credit risks may have to shop around for accommodation. These responses seem to be independent, to some extent, of the level of interest rates, or of the discount rate. For example, the tone of the money market might be easy even though the discount rate were 4 percent. This would happen mainly in a situation where the volume of member-bank borrowing was low. Conversely, the tone of the money market might be on the tight side when the UNITED STATES MONETARY POLICY 259 discount rate was 1% percent. This would occur when member banks were heavily in debt. The fact that the tone of the money market is responsive to the level of member bank borrowing at the Reserve banks gives a unique character to the role of open-market operations in the effectuation of credit and monetary policy. They can be used flexibly to offset the net impact on bank reserves of other sources of demand and supply of reserve funds in such a way as to result in an increase or decrease of member-bank borrowing, or, if desired, to maintain a level of sucli borrowing that is fairly constant from week to week, or month to month. This means that when the Federal Open Market Committee decides that a tone of tightness, or ease, or moderation, in the money markets would promote financial equilibrium and economic stability, it has the means at hand to make the decision effective. Changes in the discount rate cannot be used in this way. They can exert powerful effects upon the general level of interest rates, but cannot be counted on to insure that the relative availability or unavailability of credit at those rates will be appropriate to the requirements of financial equilibrium and economic stability. Neither can changes in reserve requirements be used with this precision. There are many administrative and technical problems which militate against the continuous or frequent use of this instrument of policy. Even if these did not exist, however, the instrument is much too blunt to be used to maintain member-bank borrowing from week to week or month to month at an appropriate level. In short, open-market operations are not simply another instrument of Federal Reserve policy, equivalent or alternative to changes in discount rates or in reserve requirements. They provide a continuously available and flexible instrument of monetary policy for which there is no substitute, an instrument which affects the liquidity of the whole economy. They permit the Federal Reserve System to maintain continuously a tone of restraint in the market when financial and economic conditions call for restraint, or a tone of ease when that is appropriate. They constitute the only effective means by which the elasticity that was built into our monetary and credit structure by the Federal Reserve Act can be made to serve constructively the needs of the economy. Without them, that elasticity would often operate capriciously and even perversely to the detriment of the economy. They require an efficiently functioning Government securities market characterized by depth, breadth, and resiliency. It is with these characteristics of the market that this report is mainly concerned. The subcommittee was authorized shortly after the Federal Open Market Committee decided that the continued maintenance of a relatively fixed pattern of prices and yields in the market for Government securities was inconsistent with its primary monetary and credit responsibilities. The Federal Open Market Committee felt that a freer market for Government securities would lessen inflationary pressures and better promote the proper accommodation of commerce, industry, and agriculture. It came to the conclusion, in fact, that a securities market, in which market forces of supply and demand and of savings and investment were permitted to express themselves in market prices and market yields, was indispensable to the effective execution of monetary policies directed toward financial equilibrium and economic stability at a high level of activity without detriment to the long-run purchasing power of the dollar. Accordingly, the subcommittee was authorized to examine and report on the relevance and adequacy of the Federal Open Market Committee's own procedures and operations in the new context. Transactions for the Committee's account exert a powerful impact on that market. It is important that they be so executed as to avoid disruptive technical repercussions. In particular, it is important that technical operating procedures and practices, conceived in the atmosphere of war finance and developed to maintain a fixed pattern of prices and yields in the Government securities market, be reviewed to ascertain whether or not they tend to inhibit or paralyze the development of real depth, breadth, and resiliency in today's market that operates without continuous support. This is the problem with which the subcommittee has been most concerned. The absorption and release of reserve funds which results from Federal Open Market Committee transactions should constitute a constructive factor in the Government securities market, as well as in the economy generally. Without open market operations, appropriately conceived and executed when there is need to absorb or release reserve funds, it would sometimes be impossible for the market to evaluate correctly fundamental trends in the economy as they affect the supply of money relative to its demand. 260 UNITED STATES MONETARY POLICY It is evident, therefore, for the well-being of the Government securities market itself, that the possibility be minimized of disruptive technical market repercussions from Committee transactions. It is also evident that the Federal Open Market Committee should be in a position to operate promptly and in appropriate volume a t all times, without fear of such adverse technical market repercussions, when the need for operations exists. This requires a Government securities market characterized by great depth, breadth-, and resiliency. Without a market possessing these characteristics, the Committee might, on occasion, And itself unable to discharge its responsibilities. INTRODUCTION (1) The Federal Open Market Committee, at its meeting on May 17, 1951, authorized an ad hoc subcommittee to study and report on the operations and functioning of the Open Market Committee in relation to the Government securities market. The subcommittee was organized in April and May 1952, as follows: Win. McC. Martin, Jr., chairman; Abbot L. Mills, Jr., Malcolm Bryan. Robert H. Craft, vice president and treasurer of the Guaranty Trust Co., of New York, was appointed technical consultant to the subcommittee, and was given, leave of absence by the Guaranty Trust Co. to devote his full time to its work. (2) Efforts have been made to keep the executive committee of the Federal Open Market Committee, all the Governors of the Board, and all* of the presidents of the Federal Reserve banks informed of the activities of the subcommittee. The interval, amounting to nearly a year, between the authorization of the subcommittee and its actual establishment reflected the desirability of deferring the study until the conclusion of the hearings of the Patman subcommittee of the Joint Committee on the Economic Report, as well as the desirability of permitting some experience to accumulate on operations of the Committee under the more flexible conditions that followed the TreasuryFederal Reserve accord of March 5, 1951. Procedures of the subcommittee (3) As its first step, the subcommittee, with the help of suggestions from the executive committee, prepared an outline of study which was sent to a list of the individuals and institutions active in the market for Government securities, either for information or response. So that there would be no misconceptions, the outline and letters were made available to the press. (4) Beginning June 9, 1952, the subcommittee held 10 sessions with recognized dealers, 11 meetings with unrecognized dealers, and S meetings with nondealers intimately familiar with the operations of the Government securities market, discussing the material covered in the outline of study. The subcommittee also received letters from other individuals to whom the outline was sent. Stenographic notes of the discussions were taken for the convenience of the subcommittee but are not part of the record, since they were not subsequently cleared with the discussants. (5) The outline of study, together with the list of individuals and institutions to which it was sent, and the covering letters by Chairman Martin, are attached to this report as appendix A. Mr. Craft has prepared a technical analysis of the correspondence and discussions focused on the outline of study which is attached as appendix B. Mr. Craft has also prepared a memorandum, entitled "Ground Rules," with respect to certain problems before the subcommittee which is attached as appendix C. Amemorandum from the staff, discussing the possibilities of reopening an open market call money post to finance dealers' portfolios, is attached as appendix D. THE GOVERNMENT SECURITIES MARKET Size, participation, and composition (G) Of the total gross Federal debt of $265 billion, about $145 billion are outstanding in marketable form. Ownership of the marketable debt is about as follows: Commercial banks have about $G0 billion; corporations about $15 billion; mutual savings banks, life insurance*companies, and State and local governments about $7 billion each; casualty insurance companies about $5 billion; Federal agencies and trust funds about $3 billion; and savings and loan associations and foreign governments about $2 billion each. All other investors, including individuals, trust funds, private pension funds, endowments, etc., own around $13 billion in the aggregate. The Federal Reserve banks, which have nearly $24 billion, or about one-sixth of the marketable securities, have by far UNITED STATES MONETARY POUCT 261 the largest single holding in the market, about 10 times larger than the next largest portfolio under one control. (7) The marketable debt is comprised of $20 billion of Treasury bills, $17 billion of certificates, $30 billion of notes, $36 billion of bonds due or callable in 5 years, $17 billion of longer term bonds not restricted as to bank ownership, and $27 billion of restricted bonds. Commercial banks hold about one-third of the bills and certificates, half of the notes, and two-thirds of the bank-eligible bonds. I t is roughly estimated that business corporations hold about half of the bills, one-fourth of the certificates, and much lesser proportions of the notes and bonds. Savings institutions, including life insurance companies, pension funds, etc., own the bulk of the long-term bonds. Federal Reserve holdings are heavily concentrated at the present time in certificates, notes, and short-term bonds. Ularket structure and actviity (8> The Government securities market provides the mechanism through which marketable Government securities have their secondary distribution. I t is an over-the-counter market; it is really a group of markets made by the various dealers and knit together into a unit by an extensive communications system. About 20 dealers, including some banks with trading departments, comprise the basic structure of this market. The focus of the market is in New York, and most dealers have a network involving branch offices, representatives, correspondents, local investment houses, or the like through which they maintain contact with major Government security holders throughout the country. There are a. number of secondary dealers who also trade in Government securities, frequently as a part of the broader over-the-counter business. (9) The volume of transactions in marketable Government securities runs to a very large figure—on an average several hundred million dollars a day. These transactions are typically made by dealers without commission on a very narrow spread between the price at which they will buy and the price at which they will sell. So-called inside markets are typically made on spreads ranging from %o ($312.50 per million dollars) for long-term bonds down to an 0.01 in yield ($25 per million dollars) on 90-day bills. As a usual thing, transactions of good size—as much as $1 million or more for long-term bonds and up to $5 million or more for short-term issues—are executed on-the-w|re with customers. Trading is thus on a split-second basis, in large amounts in relation to dealer capital, and on close margins. Alert arbitraging is also constantly going on among the various issues of securities, both by dealers and by other active elements in the market. Success or failure in professional trading in such a market turns importantly on ability to appraise changing market factors quickly and accurately. (10) The Federal Reserve stands in a key position with respect to the entire money and capital market in this country and particularly with respect to the Government securities market. System contacts with the market for United States Government securities take four main forms—transactions in Government securities made for the account of the system, extension of credit by a Federal Reserve bank to the nonbank recognized dealers through purchases of shortterm securities under repurchase agreement, transactions made as agent for Treasury and foreign accounts or for member banks, and the gathering and dissemination of information on developments in the Government securities market. Aside from some transactions executed by the other Reserve banks for the account of member banks, these points of system contact with the market are focused at the trading desk at the Federal Reserve Bank of New York. Trading desk facilities and activities (11) The trading room at the Federal Reserve Bank of New York is equipped with some 10 or 12 key-type telephone stations with direct lines to each of 8 dealers in New York City, plus several trunklines for outside calls. These phones are manned continuously by 4 or 5 people regularly assigned to direct contact work with the dealers. Instantaneous contact can be made either by the personnel at the trading desk or by any 1 of the 8 dealers simply by pushing the proper key. At least one officer of the Bank is always on call at the desk during trading hours. (12) Other personnel assigned to the trading desk handle special tasks of various kinds such as transactions for Treasury agencies, foreign accounts, or for member banks in the New York district. Clerks maintain current price quotations on all Government securities on a large quote board, which can easily be seen by any of the personnel on the trading desk. The quotation board itself lists quotations on all Government securities as received hourly from 262 UNITED STATES MONETARY POLICY several dealers. From these quotations a composite or average quotation for each issue is computed. Routine reports on developments in the stock market and corporate and municipal bond markets are received and transmitted to the operating personnel on the trading desk. Transactions (13) Purchases and sales of securities for the System open market account are supervised by the manager of the account and are made in accordance with instructions issued by the Federal Open Market Qomjnittee. Such transactions, both on a repurchase and on an outright basis, (as well as all transactions in Government securities made by the New York bank for foreign accounts, member banks, or the Treasury) are now confined to 10 recognized dealers. This strict limitation of the dealer group with which the account now trades was formalized by the committee in 1944. Previously, the Federal Reserve Bank of New York had followed a less formal arrangement with a larger group of dealers. (14) The policy of confining open market account business to a small group was adopted by the Federal Open Market Committee in 1944 in an attempt to deal only with that portion of the market where the final effort at matching private purchases and sales takes place. This approach was based on the hope that by operating closely with a small group of key dealers responsive to its discipline, the Federal Open Market Committee could peg a pattern of low interest yields in a period of heavy war financing with minimum monetization of the debt. (15) In accordance with the instructions of the Federal Open Market Committee, open market transactions are practically always made on an agency basis, that is, not with dealers as principals but with other, holders, using dealers as brokers. This has meant that dealers could not ordinarily sell to the account from position. The Commitee has specified that the commission allowed shall not exceed $15G.25 per million dollars on notes and bonds, and $100 per million dollars on certificates and bills. In practice it generally has been smaller on maturities of less than one year. Repurchase agreements are by their nature made with the nonbank recognized dealers as principals. (10). Transactions executed by the trading desk are never made for cash, i. e., for delivery the same day, but rather for regular delivery the following day (occasionally for delayed delivery). For short-term issues, however, a large part of transactions made by others in the market is on a cash basis. The account will not knowingly buy securities handled by dealers, on a cash basis. (17) In addition to transactions for the System's open market account, a large volume of purchases and sales is made by the New York bank for domestic and foreign accounts. Acting as fiscal agent for the Treasury, the New York bank transacts business for various Government agencies and trust funds. These transactions may be of a routine nature or may involve special operations designed to support the market. Foreign central banks and other foreign agencies also employ the.New York Federal Reserve Bank as agent and channel purchase or sale orders on Treasury issues through it. Member banks in the New York Federal Reserve District—usually smaller banks in outlying areas—also use the New York bank for what are typically odd-lot transactions. All' of these transactions by the bank a* agent are handled through the trading desk. (18) Transactions for the open market account are normally handled by any 1 of 4 or 5 persons who maintain constant direct contact between de.alers and the account. Transactions for the Treasury, foreign.agencies, or member banks are usually handled by an individual on the trading desk who is not one of the persons regularly contacting dealers for information or normally trading for open market account. Thus, the dealers can generally distinguish between agency transactions and those for the open market account on the basis of the origin of the call from the trading desk. There are also other clues in the trading operation which dealers can use in appraising the source of a transaction. At times, however, the regular procedures of the desk may be changed in order to conceal the operations of the open market account. Orders for the account may be channeled through the individual who ordinarily handles foreign agency and member bank business, or those who usually trade for the open market account may take over business to be done for agency or foreign accounts. Pending the weekly report of condition of the Federal Reserve banks, the actual operations of the account may thus be screened from the market or the market may be led to believe that the Federal Open Market Committee was active at a time when it was not. (19) The volume of transactions in Government securities carried out by the New York bank's trading desk for foreign, Treasury, and member bank accounts UNITED STATES MONETARY POLICY 263 is very substantial. In the 12 months ending June 30, 1952, such business amounted to about $2.4 billion, of which $1.5 billion was in bills, $G00 million in certificates and notes, and $300 million in bonds. These transactions amounted to about one-third the volume of total trades for open market account; they were almost as large as open market transactions other than in periods of Treasury refunding. (20) Federal Reserve banks outside New York also transact business in Government securities as a service for some of their member banks. In the 12 months ending June 30, 1952, $1.0 billion of such business was handled. While some Keserve banks confine such dealings to those dealers qualified to transact business with the open market account, others do business with a wide group of investment houses. Information arrangements (21) The%4 or 5 individuals assigned to contacting dealers at the New York trading desk are constantly receiving oral reports from dealers, maintaining current records of reported transactions in the market, and checking and relating the information thus received with various written reports also submitted by the dealers. In addition, 1 or 2 of these contact men report to various interested officials in and out of the System on current trends in the market. (22) Before the market opens each day, several meetings are held with representatives of recognized dealers. These meetings, which are limited to approximately 10 minutes each, are scheduled on a rotating basis, with 2 or 3 dealer organizations participating each day. At the meetings, the dealer representatives report on the major transactions handled in the market during the previous trading session. They also pass on other information about the Government securities market or other aspects of the money and capital m a r k e t The meetings are largely devoted to reporting by dealers rather than to an exchange of information, as the comments of the Committee's representatives in attendance a r e very guarded. (23) During trading hours in the market, contact is maintained regularly between the trading desk and each recognized dealer in New York City. Any transactions involving a million dollars or more are currently reported to the trading desk. A worksheet is maintained on the transactions for the day, divided into various categories of securities, with a general description of the type of customer involved in each trade. This transaction sheet provides a quick general picture of the demand or supply of various types of securities in the market. Important discrepancies between the information on this transaction sheet and the written reports submitted by dealers on their volume and positions or the oral reports made during the morning session are usually clarified by checking further with the dealer. (24) On days when auctions for Treasury bill issues are being held, one of the contact persons on the trading desk makes several special calls to all dealers to.get their appraisals of developments in the auction. At about 11:30 a. m., each one of the dealers gives his estimate of the level at which customer bids (i. e., bids of nonbank investors who usually submit them as customers of banks) will be submitted and also as to the lowest price level at which awards will be made. Again, at about 1 p. m., dealers will be contacted to see if there has been any change in sentiment. Based on the information received, bids are submitted for the amount of maturing bills held in the portfolio. The manager of the foreign department is also informed as to the market estimate of the bill auction and he then determines at what price bids for foreign agencies will be submitted. (25) Supplementing the information received verbally by the trading desk, various written reports of a statistical nature are also made by dealers. Daily reports are received from each of the recognized dealers, as well as many of the nonrecognized dealers, on their current positions broken down into various categories. Reports are also made on the total transactions handled each day in each of those categories. Thus, shortly after the opening of the market on any day, the trading desk personnel has available to it data on the current long and short positions of each dealer, the aggregate positions of nearly all dealers in the market, and the volume of transactions in various classes of securities made by each dealer and the aggregate of such transactions. (2G) The trading desk also received from other departments of the New York bank a daily report on the reserve position of each of the central reserve city banks in New York City and reports on the money market factors affecting the 264 UNITED STATES MONETARY POLICY New York market, including a prediction of the effect of these factors for the ensuing day. The most recent figures on factors affecting reserves of all member banks are also supplied to the desk, as well as frequent projections of major factors affecting bank reserve positions over the next 2 weeks. Estimates supplied on Treasury receipts and expenditures are compared each Monday and Thursday with the operating personnel at the Treasury in a discussion of the amount of calls on tax and loan accounts to be made and the timing of such calls; this contact is handled at the trading desk by an officer of the securities department. (27) At regular intervals during the day, information on market prices is given by the trading desk personnel to representatives of the Treasury and of the Federal Reserve Board. In addition to the routine price reports, a summary of market developments during the day is given shortly after the market closes to the Treasury and the Board. Flash reports are sent to each Federal Reserve bank president twice daily—at about 11 a. m. and after the close. (28) Two regular reports on developments in all securities markets are issued by the New York bank, and trading desk personnel contribute a summary of developments in the Government securities market to each of these reports. One of these is a daily report to the Board of Governors which is distributed to various System representatives and to the Treasury. A somewhat more complete report is made weekly to the Federal Open Market Committee, and circus lation of this report is limited to a list approved by that Committee. FINDINGS AND RECOMMENDATIONS Structure of the muxrket (29) It is the conviction of the subcommittee, based on its intimate discussions with a very large segment of key participants in the United States Government securities market, that that market at the present time possesses, with one exception noted below, the organizational elements essential to successful performance of its functions. It is competently staffed, and its operations cover the relevant sections of the community. (30) The only serious qualification that the subcommittee makes to these generalizations relates to certain deficiencies in the credit facilities available to dealers. During recent months, the rates paid by dealers to carry their portfolios of United States Government securities have averaged above the yield on these portfolios. This amounts to a negative "carry" and obviously affects seriously the ability of the dealer organization'to maintain broad markets. This problem has become more serious since the discussions with the dealers. At the time of those discussions, the dealers dealt at length with the problem of negative carry but they were referring, for the most part, to periods of stringency of very limited duration, not to the kind of continuing stringency that prevailed in most of the third quarter of 1052. The subcommittee advances suggestions to correct this deficiency later in the report. (31) It is likewise the conviction of .the subcommittee that the market for United States Government securities is already sufficiently broad, experienced, competitive, and arbitrage minded as to minimize the success of attempts of private operators to "rig" the market. (32) The market has developed a considerable degree of resiliency and ability to handle itself fnnce the accord. After years of pegging, it took a few months for the establishment of market equilibrium, but this was achieved without the development of disorderly conditions and with none of the drastic changes in prices and yields that had been feared by so many. In the long-term area, this equilibrium has now been maintained for more than 1 year without material Federal Reserve intervention. Subsequent to mid-year 1951, total dealings of the open-market account in securities of longer than 14 months* maturity have amounted to $32 million, excluding securities acquired in exchange for maturing issues. Most of these transactions occurred in late November and late December of la<?t year. (33) The actual record of transactions by the Federal Open Market Committee since mid-1951 is shown in the following table: 265 UNITED STATES MONETARY POLICY ; Open market account transactions in U. 8. Government securities —July lt 1951Sept. 80,1952 [In millions of dollars] During periods of refunding' Total Class of security Purchases Maturing Issues (rights) Other securities maturing: Within 91 days 91 days to 14 months 14 months to 5 vears 5 years to 10 years Over 10 years .... Total „ Sales 3,059 i. ._. Purchases Other than periods of refunding Sales Purchases Sales 372 1,154 1,834 1,123 2,959 3,059 1,568 594 1 3 23 2,20G 2,277 5 6 3 1,027 253 1 3 17 5,248 4,4S8 3,947 1,529 1,301 541 341 2 i Excludes repurchase agreements with dealers and brokers and purchases and sales of special certificates from and to Treasury. »Commitments from date of announcement to closing of books, plus all transactions in new securities on a when-issued basis. (34) The table indicates t h a t the Federal Open Market Committee has concentrated its transactions very heavily in short maturities since mid-1951. Purchases of issues of over 14 months were negligible, despite the fact that this record covers a period during which the price of Victory's moved between $95*^ and $99%, and that both the market and the Committee were feeling their way out from the conditions that prevailed under the pegs. The $32 ruillioa of transactions in the intermediate and long-term sector are the only ones that could properly be described as undertaken by the Committee to "maintain an orderly market." (35) It would be inaccurate, however, to describe the present market for United States Government securities as possessing depth, breadth, and resiliency to the full degree that would be desirable for the efficient conduct of effective and responsive open-market operations. It is important that there be no misunderstanding of the intent of the subcommittee in making this qualification. The subcommittee is not referring to the degree of fluctuation that has characterized prices in the market for Government securities since the accord. Considering the pressure, on the economy and on the supply of savings, the range of price fluctuation in the market for Government securities has been moderate. The subcommittee refers rather to the psychology that still pervades the market, to the confusion among professional operators in the market with respect to the elements they should take into consideration in the evaluation of future market trends, and to their apprehension over the attitude toward prices in the market on the part of the Federal Open Market Committee and of its representatives on the trading desk. This psychology would not characterize a market that possessed real depth, breadth, and resiliency. (36) In strictly market terms, the inside market, i. e., the market that is reflected on the order books of specialists and dealers, possesses depth when there are orders, either actual orders or orders that can be readily uncovered, both above and below the market. The market has breadth when these orders are in volume and come from widely divergent investor groups. It is resilient when new orders pour promptly into the market to take advantage of sharp and unexpected fluctuations in prices. (37) These conditions do not now prevail completely in any sector of the market. They are most nearly characteristic of the market for Treasury bills, but even in that market reactions have been sluggish on more than one occasion since the accord. They are least characteristic of the market for restricted 266 UNITED STATES MONETARY POLICY bonds. In these issues, there has prevailed persistently since the accord a wide gap between the prices a t which the least firm holders are willing to sell and potential buyers are willing to purchase. Within this gap, quotations have fluctuated widely, either in response to relatively small buy or sell orders, or, more frequently, as a result of professional efforts to stimulate interest by marking quotations up or down. (38) In the view of the subcommittee, the persistence of this condition operates to weaken the effectiveness of open-market operations and emphasizes the importance of steps to improve the depth, breadth, and resiliency of the m a r k e t Since the Committee's transactions are among the most important factors that condition the market, the Federal Open Market Committee has an obligation to scrutinize its own organization and its own operations to see in what respects, if any, they can safely be modified, if the effect of such modification would contribute to the depth, breadth, and resiliency of the market. Hole of the System in the market (39) I t is the unanimous view of the subcommittee that the Federal Open Market Committee should keep its intervention in the market to such an absolute minimum as may be consistent with its credit policy. This position rests not only on the fact that the System's primary role has to do with credit policy in .the broad sense, but also because of important technical considerations related to the highly desirable development of strength in the private market for United States Government obligations. The normal functioning of the market is inevitably weakened by the constant threat of intervention by the Committee. In any market, the development of special institutions and arrangements that serve to provide the market with natural strength and resilience and to give it breadth and depth tend to be greatly inhibited by official "mothering." Private market institutions of tliis kind are repressed particularly by the constant possibility of official actions which, by the market's standards, will frequently seem— and be—capricious. Such actions constitute a risk that cannot reasonably be evaluated in advance and anticipated in the formulation of individual, private judgments of market prospects. (40) The subcommittee has come to the conclusion—fully supported by the testimony before it—that the Federal Open Market Committee bears a real measure of responsibility for part of the lack of depth, breadth, and resiliency in the Government securities market. There is not only the history of many years of closely controlled markets, but also the fact that the Committee has not yet been specific with respect to what it means by a free market for United States Government securities. In replies to the Patman questionnaire, in official publications, and in public speeches by its personnel, the Committee has indicated t h a t it contemplates operating in a free market from here on out, but at the same time the policy record of the Federal Open Market Committee, published in t h e . 1951 annual report, shows that it is still committed to the "maintenance of orderly markets," which clearly implies intervention. (41) This inconsistency has not added to dealer or customer confidence. To take positions in volume and make markets, dealers must be confident that a really free market exists in fact, i. e., that the Federal Open Market Committee wil permit prices to equal demand and supply without direct intervention other than such as would normally be made to release or absorb reserve funds. They have no such assurance. To the dealers, and to professional buyers and sellers of Government securities, the pronouncements of the Federal Open Market Committee mean (1) that it has dropped the pegs, (2) that it is willing to see fluctuations in the market, but (3) that it is watching .these fluctuations closely and is prepared to intervene on occasion whenever it considers intervention necessary. From the dealer's point of view, this means that the Federal Open Market Committee desires a fluctuating market but will not necessarily permit one to develop that is free. Their conclusion is that they are operating in a fluctuating market subject to unpredictable, however reluctant, intervention by the Federal Open Market Committee. (42) The distinction has a vital bearing on the ability of the market mechanism to function with depth, breadth, and resiliency. I t is in the nature of a dealer's business that he is constantly exposed to market risk from both sides of the market. One test of his professional skill and, indeed, of his fitness to be in the market a t all is the ability to judge the factors in a free market with sufficient foresight and prudence to preserve or even augment his relatively thin margin of capital, whichever way the market turns. He does this by reversing or covering his positions at times or by alert arbitrage of markets for particular issues that are out of line. Thus he is able to function continu TJNITED STATES MONETARY POLICY 267 ously and to make markets. He cannot do this, however, with anything like the same degree of skill in a market that is subject to unpredictable and overpowering intervention by the Federal Open Market Committee. The Committee, with practically unlimited resources to back up its intervention, is not guided in its operations by considerations of profit, and unlike other investors, is not forced to cover its operations to minimize loss. Such intervention can impose drastic risks on a dealer or other holders, particularly if the intervention is in intermediate or long securities where the dollar impact on the capital position of modest changes in yields is large. (43) It is easy to understand why dealers, with their lack of confidence in the Committee's intentions to restore a free market, would be reluctant to go very far in taking positions. To do so would not only involve the risk of being wrong in their evaluation of economic and market trends, but also of being wrong in guessing at what point the Federal Open Market Committee might feel it necessary to intervene. A difference of a few thirty-seconds in the level of prices of such intervention would not necessarily be of great moment to the Federal Open Market Committee, but it might be of real importance to a dealer's operations. (44) It is the judgment of the subcommittee that the lack of professional dealer confidence in the intentions of the Federal Open Market Committee is justified, and that it is not enough for the development of an adequate market that the Committee's intervention be held to a strict minimum. It is important that the dealers be assured, if it is at all possible to give such assurance, that the Committee is prepared to permit a really free market in United States Government securities to develop without direct intervention for the purpose of establishing particular prices, yields, or patterns of yields. (45) When intervention by the Federal Open Market Committee is necessary to carry out the System's monetary policies, the market is least likely to be seriously disturbed if the intervention takes the form of purchases or sales of very short-term Government securities. The dealers now have no confidence that transactions will, in fact, be so limited. In the judgment of the subcommittee, an assurance to that effect, if it could be made, would be reflected in greater depth, breadth, and resiliency in all sectors of the market (4G) Such assurance would not impede open market operations by the Committee designed either to put reserve funds into the market or to withdraw them to promote economic stability. It 'would simply guarantee that the first impact of such purchases and sales would fall on the prices of very short-term issues, where dollar prices react least in response to a change in yield, and where the asset value of a portfolio is least affected. A dealer organization, even though it operates on thin margins of capital, can live with impacts such as these and consider them a part of its normal market risks. (47) Nor would such an assurance prevent the effects of open market operations, initiated in the short-term sector, from spreading to other sectors of the market in the form of changes in prices, yields, and the pattern of yields. These changes would come about as a result of market arbitrage, i. e., of the exercise of market skill by the professionals who make up the market, the dealers who specialize in matching bids and offers and the professional managers of portfolios who are constantly balancing their investments to take advantage of shifts in prices and yields between the different sectors of the. market. A dealer can survive, even if the capital value of long-term issues reacts sharply, when these reactions are brought about as a result of market trading and arbitrage. His risk exposure, on positions in intermediate and long-term issues, is much greater when these changes are induced by direct intervention at arbitrary prices by the*Federal Open Market Committee. (48) The subcommittee realizes the difficulties involved for an operating body, such as the Federal Open Market Committee, in giving any assurance that would limit its own future freedom of action. An assurance, of course, that the Committee would limit its intervention to the very short-term market would fall within, not without, the boundaries of the best central banking traditions. It was long held axiomatic that central bank portfolios should properly be confined to very short-term bills of the highest liquidity and quality. In fact, most effective central banks have operated within this restriction, imposed either by tradition or by law. Traditional principles of central banking made no provision for operations in the intermediate or long maturities of any borrower. (49) There are only two types of situation where the freedom of action of the Federal Open Market Committee would be seriously limited by such an assurance. In the one case, potential System intervention revolves in general around its commitments with respect to "orderly markets/' In the other, it is 268 TOOTED STATES MONETARY POLICY associated mainly with the purchases and exchanges in periods of Treasury financing. (50) So far as the first type of intervention is concerned, the form and wording of the directive issued by the Federal Open Market Committee with respect to "orderly markets" assumes a particularly crucial importance. The subcommittee was much impressed with the wide differences in opinion among dealers and nondealers as to what constitutes an "orderly market." From the discussion, it is thoroughly apparent that the term "orderly markets*' does not have a clearly delined meaning which is generally understood and accepted. (51) In view of these differences in concept, and particularly in view of the narrow definition of this term held by some market elements, it seems to the subcommittee that the apprehensions of the dealers have substance. The present wording of the directive of the Federal Open Market Committee on "maintenance of orderly conditions" carries with it an unduly, and even dangerously strong, implication of continuing intervention in all sectors of the market. This prospect of intervention seriously impairs the ability of the market to stand on its own feet or to evaluate correctly the real forces of demand and supply in the economy. It is clearly evident that a directive to "maintain orderly markets" can mean all things to all men, and in effect constitutes a blanket delegation of discretionary authority which can be interpreted to cover almost any action by the Committee in the market. (52) In the subcommittee's view, a directive which is subject to such an interpretation by either the market, the executive committee, or the management of the account is entirely inconsistent with the minimum role in the market which the Federal Open Market Committee must assume if the Committee and the market are each to perform their respective functions most effectively. (53) The subcommittee recommends, consequently, that the wording of the directive of the Federal Open Market Committee to the Executive Committee be changed to provide for the "correction of disorderly conditions" rather than the "maintenance of orderly conditions" in the market for Government securities. The directive by the Executive Committee to the management of the account in this regard should involve an instruction to notify the Executive Committee whenever conditions become sufficiently disorderly to warrant the consideration of corrective action by the Federal Open Market Committee. (54) In making this recommendation, the subcommittee takes the position that fluctuations resulting from temporary or technical developments are selfcorrecting in a really free money market without the necessity for intervention of any kind. This is particularly true of a functioning market characterized by depth, breadth, and resiliency. Of the movements that are not self-correcting, most reflect basic changes in the credit outlook and should not be the occasion for intervention. Of the remainder that do not fall in either of these two categories, the ^rreat preponderance, throughout all sectors of the market, will respond readily to arbitrage induced by positive intervention on the part of the Committee in the very short sector of the market. In other words, it is only rarely that selling creates a sufficiently disorderly situation to require intervention in other than the very, short market. A disorderly condition created by buying is very unlikely to occur if the Committee is in a position to absorb reserves by selling in the short-term market. (55) The subcommittee considers a declining market really disorderly in the sense that it requires intervention to meet it when selling feeds on itself so rapidly and so menacingly that it discourages both short covering and the placement of offsetting new orders by investors who ordinarily would seek to profit from purchases made in weak markets. There are occasions when such really disorderly reactions occur in the market. They may lead, if left unchecked, to the development of panic conditions. These must be corrected. In the judgment of the subcommittee, it is in these circumstances, and these circumstances only, that the Federal Open Market Committee would be impelled, by its basic responsibilities for the maintenance of sound monetary conditions, to intervene, and intervene decisively, in other than the very short-term sector of the Government security as market. (5(5) The reserve funds put into the market 4n such operations would complicate the smooth execution of monetary policy, but the occasions for intervention would be infrequent. Once properly explained, consequently, this specific exception to a general public assurance that the Committee henceforth would confine its operations to the very short maturities, preferably bills, should not impede the development of a market with greater depth, breadth, and resiliency. UNITED STATES MONETARY POLICY 269 The problem of Treasury financing (57) The Federal Open Market Committee now follows the practice of intervening in the market to support rights values on maturing Treasury securities. So long as this practice continues, it will be impossible to give the type of assurance discussed above. These interventions are recurrent. When sales to the Federal Reserve are appreciable, they result in the injection of reserve funds into the market in amounts that are embarrassingly large. They impose a pattern of yields on the market, and, consequently, are disturbing to its depth,, breadth, and resiliency. (58) The practice of supporting Treasury financings developed during the period of war finance, when the Treasury and the Federal Open Market Committee undertook jointly to see that lack of funds would not impede e l e c t i v e prosecution of the war. In the judgment of the subcommittee, it would be appropriate to sit down with the Treasury and review the practice in the light of current experience. If any change is to be made, there would be need for extensive consultation with the Treasury, since the Treasury's present debt'management policies and its current practices in managing its cash balance would be directly affected. (50) The subcommittee's views on this point have been considerably influenced by the judgment of its technical consultant, Mr. Craft, and it urges that the Federal Open Market Committee give most serious consideration to the views expressed in the memorandum, entitled "Ground Rules," attached as appendix C. The conclusion presented in this document is that for the open market operation to be successful there must be new. ground rules, i. e., new methods of operation by the Committee, known in advance, that will permit the Committee to pursue vigorous credit and monetary policies without incurring the danger of disruption in the market for Government securities. The principal recommendations with respect to the most appropriate ground rules are three: (1) that the Committee (except in the case when it is dealing with a disorderly market) confine its operations to bills, (2) that, in the rare case of the emergence of a disorderly market, corrective actions be deferred until the need for them is clearly indicated and then be taken only after a poll of the executive committee rather than a t the discretion of the management of the account, and (3) that the practice of supporting directly either new or refunding issues of Treasury securities be abandoned. The memorandum outlines in detail the considerations that have led to these conclusions, and the specific technical operations that would best carry them into effect. (CO) The memorandum outlines the serious operating problems that the Federal Open Market Committee will face, necessarily, if it continues to acquire Treasury issues of new or refunding securities. The subcommittee is particularly impressed by the conclusion that the .portfolio of the open market account may become, in fact if not in theoretical composition, frozen or semifrozen. Asis pointed out, the securities which the open market account has acquired as rights in underwriting a refunding have subsequently been exchanged for the new issue and the Federal Open Market Committee haa been hesitant to dispose of these new issues under normal conditions in the market—a justifiable hesitation because sale of the securities in the market before they have been held quite near to their maturity might be disruptive. (CI) It is also pointed out that when these securities or, in fact any securities other than bills, however acquired, were sold into the market as they approached maturity, they have been purchased largely by corporations or other investors who had a specific need for cash at the maturity date. They have tended, consequently, to increase the natural and inevitable attrition connected with any maturing Treasury issue. Consequently, the securities have tended to be reacquired by the Committee in supporting the refunding. (C2) The persistent growth in the open market account of securities acquired directly or indirectly in support of Treasury refundings is disquieting. (G3) The present semifrozen position of the portfolio brings out in new form the desirability of a larger proportion of bills in the System's portfolio, and underscores the cogency of the recommendation that henceforth the Committee operate exclusively in bills except when it is intervening in the market to correct conditions of very serious disorder. Bills, in addition to their ready market ability and other qualities that make them preferred components of the portfolio, have the unique advantage, from the point of view of the Committee's operations, that they are marketed at auction for cash and are redeemed in cash at maturity. Neither at issue, nor at redemption, do they raise problems of support for the Committee, nor of attrition for the Treasury. 55314—54 18 270 UNITED STATES MONETARY POLICY (64) It is eleaf that the Federal Open Market Committee cannot consider the type of assurance that would contribute most to the development of depth, breadth, and resiliency in the market until it has come to a decision on the question of whether or not the Committee should continue to buy rights or any other securities other than bills during periods of Treasury financing. There are two opposing viewpoints on this basic and difficult problem. (65) If it is believed that the System's responsibilities are strictly limited to the formulation and execution of credit and monetary policy, logic would preclude the Federal Open Market Committee from purchasing rights or other issues to support Treasury financing. Under this view, the Treasury, being responsible for debt management, would be responsible also for naming such terms and coupons on new securities that a natural-rights value in the market would be established automatically. There would be no occasion, therefore, for intervention or support by the Federal Open Market Committee. The Committee might, of course, engage simultaneously in open-market operations to relieve an unexpected stringency in the money market, but it would not be expected to do so, and if it did it would operate only because of its responsibility for the general credit situation. (66) This view rests on the doctrine that the governmental structure must provide that responsibility for public decision be clearly fixed and that public officials be held strictly accountable for their decisions. ' It, therefore, leaves little scope for purchases to support a new issue by the Federal Open Market Committee during the period of subscription. In this view, the Federal Open Market Committee would buy no rights on a maturing issuet with the result that all attrition would fall on the Treasury if the issue were not attractively priced. (67) This would be expected under the logic of the doctrine of responsibility. Since decisions with regard to debt management are unquestionably a prerogative of the Treasury, the Treasury, under that doctrine, would'expect to accept the consequences of an erroneous decision. If attrition were large, the Treasury would be expected to replenish its cash balance with a second offering on terms more in tune with the market. (6S) In contrast to this view is the position which holds that debt-management and reserve-banking decisions cannot be separated. While the Treasury is primarily responsible for debt-management decisions, that responsibility under this second view is shared in part by the Federal Reserve System, and while the Federal Reserve is primarily responsible for credit and monetary policy, that responsibility must also be shared by the Treasury. According to this position, the problems of debt management and monetary management are inextricably intermingled, partly in concept but inescapably so in execution. The two responsible agencies are thus considered to be like Siamese twins, each com-pletely independent in arriving at its decisions, and*each independent to a considerable degree in its actions, yet each at some point subject to a. veto by the other if its actions depart too far from a goal that must be sought as a team. This view was perhaps unconsciously expressed by the two agencies in their announcement of the accord in March 1951. In that announcement they agreed mutually to try to cooperate in seeing that Treasury requirements were met and that monetization of debt was held to a minimum. (60) In the view of the subcommittee, it would be wise to.avoid pushing either of these positions to the full logical extreme. Neither position exactly fits the immediate situation facing the money market, the Treasury, or the Federal Open Market Committee. (70) The Federal Open Market Committee has only recently abandoned its previous policy of continuous control of prices and yields throughout the list of Government securities. During periods of refunding, it is still purchasing rights, and on occasion interfering with market arbitrage by supporting issues whose maturity approximates the maturity of new Treasury issues. The object of these transactions is to shield the cash balance of the Treasury from the attrition that might otherwise occur when maturing issues are not presented for exchange. (71) The Treasury, faced with enormous financing problems both for new money and refundings, has modified to a considerable degree the debt-management techniques developed during the war. Maturing certificates, however,* are usually rolled over into a similar issue and when projections are made of needs for new money it is assumed that only moderate attrition will fall on the Treasury in connection with these refunding operations. (72) The market, too, is in a period of transition. It is confused with respect to the occasions when it should expect intervention from the Federal Open "Market Committee, and it is uncertain with respect to the sectors in which this intervention might occur. It is hesitant, therefore, and lacks the depth, breadth, UNITED STATES MONETARY POLICY 271 and resiliency t h a t would be desirable. It is in the interest of the Treasury as well as of the Federal Open Market Committee that every effort be made to improve these characteristics of the market. (73) It is in the context of this situation that the subcommittee is formulating its recommendations. It has found (1) that the Federal Open Market Committee can promote the well-being of the market for Government securities by an assurance that henceforth it will avoid unnecessary intervention in the market, and will confine that intervention as much as possible to the very short maturities, preferably bills, (2) that the ability of the Federal Open Market Committee to give such an assurance is blocked by the present practice of purchasing rights and certain issues during periods of Treasury financing, and (3) that, in addition the portfolio of the open market account is becoming unduly weighted with the securities that have been acquired in these support operations. (74) The subcommittee recommends, therefore (1) that the Federal Open Market Committee ask the Treasury to work out promptly new procedures for financing, and (2) that, as soon as practicable, the Federal Open Market Committee abstain, during periods of Treasury financing-, from purchasing (a) any maturing issues for which an exchange is being offered, (&) any when-issued securities, and (c) any outstanding issues of comparable maturity being offered for exchange. (75) Should the Federal Open Market Committee adopt the recommendations of the subcommittee with respect (a) to the type of situation justifying intervention to correct disorderly market conditions, and (&) to the kinds of transactions appropriate during a period of Treasury financing, it would be in a position" to give a public assurance to the market that henceforth, with two exceptions, the Committee will intervene in the market only to absorb or release reserve funds to effectuate its monetary policies, and that it will confine its intervention to the shortest sectors of the market, preferably bills. (70) The two exceptions should be carefully explained to the market. They would occur (1) in a situation where genuine disorderly conditions had developed to a point where the executive committee felt selling was feeding on itself and might produce panic, and (2) during periods of Treasury financing. In the first case, the Federal Open Market Committee would be expected to enter more decisively in the long-term or intermediate sectors of the market. In the second case, intervention, if any, would be confined to the very short maturities, principally bills. The subcommittee recommends most strongly that the Federal Open Market Committee adopt the necessary measures and give this assurance. Judgments of System market techniques (77) The whole Federal Reserve System can take pride in the prestige enjoyed by the Federal Reserve Bank of New York, and by the management of the open market account in their relations with the Government-securities market. The subcommittee in its discussion made every effort to provide an atmosphere where the market participants would feel encouraged to talk freely with the understanding that their comments would be considered impersonally and objectively. In most cases, the participants in the discussions responded to this atmosphere and discussed their problems objectively, including problems that have arisen in dealing with the Federal Open Market Committee. Without, in any sense, diminishing the importance of these problems and the urgent necessity of taking actions recommended below to eliminate their recurrence, the subcommittee found that by and large the market personnel which participated in the discussions had confidence in the integrity of .the personnel of the Federal Reserve Bank of New York, and respect for the competence of its management. (7S) At the same time, the subcommittee was surprised to find extensive criticism of many of the technical operations of the Committee, especially in its relations with the dealer organization. As was anticipated, it found that the drawing of a rigid line between "recognized" and "nonrecognized" dealers was resented by the latter. In addition to this, however, there were evidences, even among the recognized dealers, of irritation with the dealer-Federal Open Market Committee relationship, and some doubt and .confusion as to exactly what function the relationship now serves under conditions of unpegged markets. (79) It is the view of the subcommittee that these two sources of dissatisfaction and irritation cannot be brushed off lightly or viewed complacently as inevitable accompaniments of the difficult and broad operations that are performed by the Committee in the market for the huge outstanding Government debt. The complaints are specific and relate to specific techniques of operation. Unless corrected, they will continue to fester and rankle. 272 UNITED STATES MONETARY POLICY (80) In all too many cases, the criticisms are interrelated; that is, the technical operations of the Federal Open Market Committee most broadly criticized in the market are the very types of operations which require for their effectuation a sharp differentiation between dealers who are recognized and others who are not. If these technical operations of the Committee were abandoned in accordance with the suggestions of the bulk of the participants in the discussions, there would seem to be less need or justification for the present rigid system of dealer recognition. The subcommittee proposes, therefore, (1) to examine the technical operations to which objection has been raised in its discussions, (2) to come to a judgment as to whether or not the objections are valid, (3) to recommend alternative procedures if they are considered valid, and (4) to consider what form of relationship between the Federal Open Market Committee and the dealers would be most appropriate to a situation of unpegged markets. (81) "Reluctant buying,"—The "reluctant buying" technique employed on frequent occasions by the Federal Open Market Committee during the period of pegging, and apparently still used in more limited extent and in modified form during certain refunding operations since March 1951, furnished the most prevalent and active target for criticism on the part of dealers, both recognized and unrecognized, as well as of nondealers. This criticism was practically unanimous on the part of all who referred to the subject in their discussion. (82) Reluctant buying is the term used to refer to the practice followed by the Committee of limiting its purchases of securities to only a portion of the amounts offered while a t the same time requiring that dealers not lower their quotations. This practice involves the exercise of judgment as to whose securities will be taken. The technique is premised on the theory that failure to secure prompt execution will discourage offerings and give time to the dealers to shop around and find market lodgment for securities pressed for sale. It requires a tight Committee control over the major trading elements in the market—maintained through the recognized dealer mechanism—in order to enable the Committee to prevent changes from being made in quoted dealer prices without having to use reserve funds to clear the market of securities being offered for sale at those prices. (s:*) Criticisms of the technique (and these were more or less tied together with all the arrangements under which the System took control of the market under the pegs) relate in part to the effects it has on market institutions. I t precludes proper functioning of the dealer mechanism, both recognized and unrecognized. I t makes brokers of recognized dealers and prevents their taking positions and making markets. Unwillingness to deal with unrecognized dealers, or even to permit recognized dealers to split commissions, makes unrecognized dealers refuse business and turn their customers away since they cannot cover costs. When first applied, it automatically eliminated the auction market for Government securities on the stock exchange, since the specialist, unlike the recognized dealers, could not cover his bids through the Federal Open Market Committee. (84) However, the most striking criticism, in the opinion of the subcommittee, was that the technique failed in its basic purpose of pegging prices with a minimum of Federal Open Market Committee purchases. I t was the general conclusion of most discussants that the theory underlying the entire "reluctant buying" technique rests on an incorrect judgment of market reactions. I t was the consensus that the response of investors to this technique is perverse in that holders are induced to attempt to force a greater volume of securities on the market than they otherwise would. Failure to secure prompt execution of sales at quoted markets, instead of reducing sales, heightens uncertainty, encourages further offerings, and in the case of the restricted bonds seems to have stimulated attempts to dispose of bonds to the Federal Open Market Committee through resorting to various types of "blinds." For example, the Committee was believed to have been less reluctant to buy restricted bonds from recognized dealer banks (because of the $500^000 limit on their portfolios) than from nonbank dealers. (85) I t was the almost universal recommendation that, should tfn occasion ever arise again that justified support operations,* a policy of aggressive rather than reluctant buying on the part of the Committee would reduce uncertainty among investors as to their ability to sell and to that extent diminish the volume of offerings. The subcommittee finds this technical judgment persuasive. Certainly the technique of "reluctant buying" should be avoided. In the execution of an aggressive technique, moreover, purchases should not be confined to recognized dealers. If the objective is to engender confidence and remove uncertainty from the market by a show of bids, the desired effect will be achieved UNITED STATES MONETARY POLICY 273 more readily and with less monetization of debt by spreading the bids among all dealers with whom the public is accustomed to trade rather than by raising questions in the minds of investors as to whether or not they can secure execution through accustomed channels. (86) The "reluctant buying" technique is perhaps merely the ultimate development in a series of arrangements for controlling the market that had their genesis during the war period. These were further strengthened in the postwar period. The principles and theory underlying these arrangements were that control over the market could be achieved with a minimum outlay in reserve funds if the iinal effort at matching off private transactions were narrowed to a small group of dealers, provided that the Committee could control these dealers by various devices and could confine its buying to the residual transactions. It is the view of the subcommittee that with the passing of the pegging operation the need for such arrangements, if it ever existed, has also passed. Fortunately the circumstances which give rise to most of the serious criticisms directed against the operations of the Committee revolve about the arrangements made to control the market under pegs. By dispensing with these arrangements, no longer needed, these sources of criticism can be corrected. (87) Trading on an agency basis.—Dissatisfaction was general throughout the group of recognized dealers with respect to agency transactions on behalf of the Federal Open Market Committee. This dissatisfaction was expressed most openly and acutely with respect to the commissions allowed by the Committee. These were claimed to be too small in many cases to cover costs. I t was also alleged by some, but not all, that the commissions allowed by the Committee have been a factor in the narrowing of spreads in the market to the point where it has weakened the dealer organization. (88) Dissatisfaction was expressed with the rule that prohibits a recognized dealer from selling from his position when engaged in an agency transaction for the Federal Open Market Committee. Whenever the Committee is the major buyer1 of a particular issue, the rule has the effect of freezing the recognized dealer's position in that issue, precluding him from making a market in that issue, and turning him, in effect, into a broker for the Federal Open Market Committee. It constitutes a strong inducement not to make markets and thus acquire positions if the dealer thinks the account may enter the market; it raises the specter of losses on positions previously acquired; and in some circumstances it creates a situation where the Committee is subsequently under moral compulsion to absorb dealer positions to protect them against loss. (89) Nonrecognized dealers resent the fact that they have to absorb all handling costs themselves or refuse customer business when the Committee is the sole buyer in the market, since recognized dealers are not allowed to split commissions on agency transactions. The unrecognized dealers also suspect or are aware that recognized dealers have been "bailed out" on occasion. (00) These are problems that arose most acutely during the pegging operations, but they did not end with the accord. They still arise during periods of Treasury refundings and, in fact, whenever the Federal Open Market Committee operates, as it customarily does, on an agency basis. One recognized dealer was troubled by the fact that in many instances he is put in a morally indefensible position of acting as agent for both buyer and seller, i. e., for the Committee as well as for his customer. (91) In the judgment of the subcommittee, this bundle of problems and irritations all stem from a common source, i. e., the emphasis on agency transactiona in operations of the Federal Open Market Committee, and would be corrected by willingness to transact business at the market with dealers as principals. This would eliminate the problem of inadequacy of commissions and allow competition in the market to establish spreads adequate to support an efficient and functioning dealer organization. It would remove the problem of frozen positions and permit dealers to make markets by building up and reducing positions in accordance with market considerations. I t would end the problem of "bail outs." (92) From the point of view of operations to effectuate Federal Reserve credit policy, reserve funds are put into or absorbed from the market just as effectively when securities are bought from dealers as principals as when dealers are used as agents. From the point of view of promoting a strong self-reliant Government securities market characterized by intelligent pricing, alert arbitrage, depth, breadth, and resiliency, the Committee's purposes are better served by techniques of operation which avoid the freezing of positions, always at the hazard of loss, on the part of those whose professional attitudes toward the mar 274 UNITED STATES MONETARY POLICY ket are probably most influential in hour-to-hour and day-to-day shifts in market situations. (93) I t is the subcommittee's conclusion, therefore, that agency transactions should be abandoned and that the Federal Open Market Committee should enter into transactions with dealers as principals on a net basis. Such transactions should, of course, be made at the best market available. It is very doubtful whether they should be confined as a matter of procedure to the presently recognized dealers. A case may perhaps be constructed for rigid rules of dealer qualification where agency relationships with the Federal Open Market Committee are involved, but there is little basis in public policy for such discrimination among dealers in transactions where dealers are principals. (04) Use of the repurchase facility.—The role occupied by repurchase agreements and the terms of settlement in the technical operations of the Federal Open Market Committee is a subject of considerable controversy within the dealer organization, and many conflicting points of view are present. Recognized nonbank dealers are quick to point out that their bank-dealer competitors have direct access to the Federal Reserve banks and therefore are in a position to borrow a t the Reserve banks at the discount rate in order to carry portfolios when money is tight. Nonbank dealers, on the other hand, borrow a t the money market banks at rates that frequently rise above the bill rate. A negative "carry" thus develops which makes it expensive and at times prohibitively costly to maintain adequate portfolios. This problem is particularly acute when money is tight over a period of weeks or months, and also when a holiday falls on Friday or Monday, necessitating a 4-day carry. In these circumstances the nonbank dealers are a t a serious competitive disadvantage in their ability to make markets. In the endeavor to mitigate this situation, they try to borrow from out-of-town banks and also use credit accommodation from corporations on repurchase agreements. (95) Bank dealers, in part because of their access to Federal Reserve credit, are readily able to service customers on a cash, rather than the usual regular delivery basis. There has been an increasing use of cash transactions which has constituted an increasingly serious competitive disadvantage to nonbank dealers. Except when the repurchase facility at the Federal Reserve bank is available, the only way they can meet the competition is by buying Federal funds, which is costly when money is tight. (96) All of the recognized nonbank dealers felt strongly that the Federal Op<*n Market Committee should alleviate these difficulties by a more liberal policy with respect to the extension of Federal Reserve credit on repurchase agreements. Their proposals ranged from the suggestion that each nonbank dealer be given what would be in effect a line of credit for repurchase contracts by the Federal Open Market Committee to be used at his own discretion, to the more modest suggestion that repurchase facilities be extended freely over weekends, particularly over weekends lengthened by a holiday. They complained that frequently they are not informed until the last moment whether or not repurchase facilities would be available. They also desired a change in the policy of the Committee under which it now refuses to buy bills, either outright or on a repurchase basis, which dealers have bought for cash delivery. Some even suggested a change in policy by which the Committee would be willing to buy bills outright with payment in immediate funds. (97) Most bank representatives, but not ail, opposed the availability of repurchase agreements to nonbank recognized dealers. They maintained that the advantage enjoyed by a member bank of direct access to Federal funds at the rediscount rate was an inherent advantage of membership. The equivalent extension of facilities to dealers on repurchase contracts would constitute, in effect, the opening up of membership privileges to nonmembers. They also maintained that the competitive advantage they enjoyed over the nonbank dealer in their access to Federal funds merely offset the competitive advantages enjoyed by the nonbank dealer in being able (1) to. take positions in excess of $500,000 in restricted bonds, and (2) in being permitted to enter large subscriptions for attractive Treasury issues, such as# the 2%s of 1958. They further claimed that free extension of repurchase facilities to nonbank dealers would have the effect of pegging the bill rate. (98) Nonbank unrecognized dealers complained that they worked under a double competitive disadvantage. They enjoyed neither the full access to Federal funds of the bank dealers nor the occasioned access to repurchase facilities of *he recognized nonbank dealers. Nonbank dealers-, both recognized and unrecognized, stated that they were forced to bid to miss in the weekly bill auction when the impact of these competitive cost disadvantages was too severe. UNITED STATES MONETARY POLICY 275 (99) The subcommittee feels that this.testimony reveals unsatisfactory aspects of the bill market. In some degree these basic frictions are inevitable in a market structure that is shared by bank and nonbank dealers. No problem would exist, for example, if all dealers were also member banks. Then the dealer organization would price securities and develop competitive patterns in an environment in which access to immediate funds to carry portfolios and to buy for immediate cash were available at the discount rate to ail dealers alike. There would be no call for repurchase contracts since the member bank discount window would meet the need. (100) Similarly, there would be a less difficult problem if there were no bank dealers. Then all dealers alike would have to pay the market money rate to carry portfolios and likewise would have to buy Federal funds in the Federal funds market if they bought securities for cash delivery. In that case, the Federal Open Market Committee could confine its consideration of whether or not to make repurchase facilities available to the effect of such facilities on the rate structure and to the desirability of mitigating the sudden development of very tight conditions in the money market over periods of temporary strain. (101) The problems created by the presence of both bank and nonbank dealers as indispensable components of the market structure must be recognized by the Federal Open Market Committee. Little comfort can be derived from the fact that the competitive disadvantage of nonbank dealers with respect to direct access to Federal funds is alleged to be compensated by a competitive disadvantage that prevents bank dealers from freely competing in the market for restricted securities. Both disadvantages react adversely on the structure of the Government securities market. Both impair the market's ability to perform efficiently under all conditions. Certainly a serious situation is revealed when the nonbank dealer component in the weekly auction for bills bids to miss at times of stringency, not because the bills acquired could not be marketed but because the necessary risks and costs of carrying the bills prior to resale is higher for* nonbank dealers than for their bank competitors. (102) The subcommittee feels that these fissures in the structure of the market can be alleviated somewhat by changes in the technical operations of the Federal Open Market Committee. They should not be accentuated by the Committee's operations. The subcommittee sees no purpose served by a procedure under which the Committee first divides the bills bought by a dealer into two categories, according to whether or not they were acquired for immediate cash, and then confines its purchases to those which have been acquired on a regular delivery basis. It may be that the original consideration back of this discrimination was to discourage deals for immediate cash and encourage market transactions on the basis of regular delivery in order to achieve a more effective control over the New York money market. If so, the maneuver has lost utility anc should be dropped. Sales for cash are increasing and will probably continue tj do so as long as banks use this medium for adjusting reserve positions and dealer banks with ready access to immediate cash are in a position to service them. (103) The subcommittee likewise sees no consideration sufficiently relevant to Justify overlong delay in letting dealers know whether or not repurchase agreement facilities will be extended. If the facilities are to be made available, the-dealers should be informed in sufficient time to perform their market functions efficiently. (104) The subcommittee doubts whether our experience with operations in a free market has yet developed to the point where it is possible to lay down definitively all the situations in which the availability of repurchase facilities would or would not be advisable. The testimony, however, has presented a clear case for the more ready availability of repurchase facilities to nonbank dealers over weekends as well as in periods of acute credit stringency. It recommends that they be made available regularly to nonbank dealers over weekends. Any tendency to abuse the privilege should be subject to control by variations in the rates on these facilities. (105) These moves should go some distance toward alleviating structural impediments which have acted to prevent the nonbank dealers from carrying their full load in the bill market. They should make it more possible for all nonbank dealer participants in the weekly bill auction to gage their bids at each auction on their evaluation of the demand for bills rather than on their lack of access to credit facilities enjoyed by competitors. (106) In addition, the subcommittee feels it would be worth while to see whether or not a call-money post could be reactivated where nonbank dealers could borrow for portfolio purposes. It is anomalous to find money-market banks 276 tfNITED STATES MONETARY POLICY maintaining over a considerable period of time a portfolio of bills that yields them a lower return than the rates a t which they are willing to lend on call an equivalent collateral. Normally one would expect the opposite relationship to prevail; provided the market were truly impersonal the loan with less risk exposure should carry the lower rate. It is disturbing to find a money market so unorganized t h a t dealers, to counteract this situation, cultivate both out-of-town banks and corporations individually on a customer basis as sources from which to borrow money. Revival of an effective call-money post for dealer loans such as existed in the l&20's would go far to correct this condition. A more detailed discussion of this problem is given in appendix D of this report. (107) The restrictions against bank ownership on most of the remaining restricted issues will expire^by-1954 and this will go far to restore equal competitive relationships between bank and nonbank dealers in that sector of the market. These restrictions may be removed a t any time by the Treasury. (10$) The subcommittee sees no public purpose served by limiting repurchase facilities to the present restricted list of recognized nonbank dealers. The market structure would be better served by equal extension of the privilege to all nonbank dealers of integrity who participate effectively in the bill market. It recommends that in the future when repurchase contracts are made available by the Federal Open Market Committee, they be offered fairly and impartially to all nonbank dealers who participate regularly in the weekly bill auction, and in amounts related to that participation, say, in some relationship to the average of the dealer's bill awards over the preceding 3 months. (100) Operations during Treasury financing.—The techniques applied by the Federal Open Market Committee during Treasury refunding operations were subject to some criticism, but the more important conclusion that emerged from the discussion of this phase of the Committee's operations was the fact that neither the committee nor the dealer organization has yet come to well-defined, and consistent positions on this difficult technical problem. Because the subject dealt with the placement of new Treasury issues, the discussion inevitably touched on problems that fall also in the area of debt management. For example, the view was unanimous that the dealers cannot function effectively as secondary underwriters unless the coupon and terms placed on new issues are sufficiently attractive to establish a natural rights value in the market. There were other suggestions t h a t may minimize the problem of attrition, as, for example, that refundings be conducted.through new issues for both cash and exchange rather than solely on the basis of exchange. The subcommittee h a s not considered problems of debt management and the following comments and recommendations deal solely with technical, procedures which the Federal Open Market Committee has followed during periods of Treasury financing. (110) All of the criticisms of the dealers that relate to the technical practices of the Federal Open Market Committee during periods of refunding stemmed basically from the agency relationship of the Committee with the recognized dealers. Nonrecognized dealers complained that they were forced out of the market during periods of refunding. They had no outlet that would cover costs for issues they might take from their customers since the Federal Reserve refused either to deal with them directly or to permit recognized dealers to split commissions with them. (111) Recognized dealers for their part complained that the commissions allowed by the Federal Open Market Committee on agency transactions barely covered clearing, telephone, and other current costs and made little or no contribution to carrying overhead costs. They also complained that because of the agency relationship their.own holdings of. the maturing issues were frozen so long as the books were open or the Committee was operating since under this relationship dealers are not allowed to sell to the Federal Reserve from their own position. The practical result is that in the case of any offering that requires Committee support dealers are frozen into any maturing securities they had in position at the time the Committee started supporting operations. In their capacity as dealers they feel obligated to tender such securities in exchange. Under these circumstances they avoid making markets in order not to add to their positions. They become, temporarily, merely brokers for the Federal Open Market Committee, "they resent losses they sustain when the rights value established by the Committee is high in relationship to the market, and they feel that the Committee should feel morally obligated to bail them out. (112) Recognized dealers also complained (1) that the Committee has been slow on occasions in deciding what rights value to pay when the books are opened on refinancings, and (2) that at times it has operated for short periods UNITED STATES MONETARY POLICY 277 with different rights values to different dealers, thus giving the dealers' customer the idea that some dealers can secure better execution than others. (113) Most of these problems will disappear if the Federal Open Market Committee decides to abandon agency transactions as recommended by the subcommittee. All, of course, would disappear if the Committee should decide to refrain from purchases of rights. Presumably the emphasis on the agency relationship stems from the period of general pegs when it was feared that dealers, if permitted to operate as principals, would canvass investors 10 stimulate market activity and persuade them to sell rather than exchange maturing issues. This apprehension may have been justified when the Committee was operating with more or less continuous pegs, but has no substance in a free competitive market. In a free market, any dealer who solicited customer business merely to create activity would soon find himself with fewer customers. (114) It is the subcommittee's recommendation, therefore, that if the Federal Open Market Committee decides to purchase rights during a period of Treasury refinancing, it purchase them from dealers as principals without regard to whether or not the securities come from a dealer's own position. This will eliminate the problems of frozen positions, of the bailing-out of losses on those positions, and too narrow commissions. It will also free the dealers to perform their function of making markets at* all times. (115) The subcommittee also recommends that these transactions be conducted without regard to whether or not a dealer is on the recognized list. It is hard to see how a refunding operation, accompanied as it must be by a very general turnover of securities in the market, is aided by a technique that either eliminates some dealers from the market or forces them to trade exclusively off other dealers' markets. The problem of dealer recognition (116) There is no room for complacency on the part of the Federal Open Market Committee over the problem of dealer recognition. That fact emerged more and more vividly as each of the unrecognized dealers discussed his prob-. lems before the subcommittee. The unrecognized dealers showed up well as individuals both in terms of personality and integrity, and in terms of professional grasp of the business and ability to evaluate the impact of credit and monetary problems on the money markets. I t would be hard for anyone sitting through all the hearings to reach the conclusion that this group of unrecognized dealers differed significantly, on the average, from those who represented the recognized dealers with respect to training, integrity, professional capacity, or ability to analyze problems. The fact is that they made a very good impression as a group. (117) These were the dealers who fell outside the line when the Federal Open Market Committee, at the same time that it was pegging the prices of Treasury securities and wras frequently the only source of demand, established formal criteria to distinguish the dealers with whom it would deal from those with whom it would not. That line seriously impaired the ability of unrecognized dealers to function and survive in the Government securities business. Of that fact there can be little question. The impairment came, not only through loss of prestige, which was bitterly resented, but also through loss of customer contacts because of inability to function in rough markets, i. e., when the Committee was operating in the market. This impairment is not so serious now that the Committee has stopped pegging but it still persists to some degree. Curiously, it has not seemed to impair the credit standing of the unrecognized dealers at the banks. All stated they had no difficulty in securing the financing necessary for their business. (118) There was practically unanimous agreement on the part of dealers, recognized and unrecognized alike, that character, integrity, and professional grasp of the business are the essential prerequisites to effective operation as a Government securities dealer. All seemed to feel that capital, though important, is secondary. Even some of the recognized dealers who defended the practice of formally designating the dealers with whom the Federal Open Market Committee would do business, indicated that capital is not the first essential for successful dealer operation. Since additional capital can apparently be attracted when justified by the scope and profitability of the business, a determining factor in success and growth of a securities dealer is the ability to gain customers, to hold them, and to sev /ice them at a profit. (119) The lines drawn by the Federal Open Market Committee, therefore, struck the unrecognized dealers in a most vulnerable spot, namely, in their ability to service their customers. It cut down the range of their customer potentialities 278 UNITED STATES MONETARY POLICY and thus reduced their ability to attract or earn capital to meet the minimum capital requirements. of the Federal Open Market Committee. I t acted in the same way to impair the ability of a nonrecognized dealer to earn recognition by developing customer relations that were nationwide in scope and that extended to all sectors of the list. In short, once the lines were drawn and recognition was accorded to some dealers and not others, a hurdle of some magnitude was imposed on the unrecognized dealers which impaired their ability to develop their business to the point where it would be able to meet the standards imposed by the committee. (120) The subcommittee probed both recognized and nonrecognized dealers alike to ascertain whether there were not also special responsibilities imposed upon the recognized dealers that might be considered to offset in some degree the privilege of direct contact with the Federal Open Market Committee, but this line of inquiry enlisted only feeble response. The unrecognized dealers professed a willingness to submit reports to the Federal Open Market Committee. In fact, many do report now even though they are unrecognized. In general, the dealers, both recognized and unrecognized, did not seem to feel that the responsibilities to the Federal Open Market Committee imposed on the recognized group operated seriously to their disadvantage in competition with the nonrecognized group. It is clear that the unrecognized dealers would be only too willing to accept such burdens in return for recognition. (121) The Federal Open Market Committee cannot afford to be complacent about this situation. I t has explosive potentialities. Privilege as such is repugnant to the spirit of American institutions. The privilege of dealer recognition, if it is to be continued, must be justified on grounds of high public policy as essential and necessary to the effective conduct of open market operations. It is not sufficient to aver that dealer recognition was once useful or that it should be maintained because it is already in existence, in the absence of a positive reason for change. The fact that privilege exists by virtue of actions of the Federal Open Market Committee is in itself a positive reason for its eradication unless there are necessary and compelling considerations to require its perpetuation. (122) The present system of official dealer .recognition instituted by the Federal Open Market Committee in 1944 was an element in a technique of open market operations designed to peg the yield curve on Government securities and at the same time minimize the monetization of public debt. This technique was based on the hope that the yields on Government securities could be pegged with only a few securities monetized by the Federal Open Market Committee if all offers to the committee had to pass first through a very limited number of dealers with whom the committee would maintain intimate and confidential relations, and who would be required by the committee to make strenuous efforts to find other buyers for securities in the market place before they looked to the committee for residual relief. (123) The inexorable march of events on which that hope foundered is now a matter of history. The facts are that debt was monetized in volume and that the country suffered a serious inflation until the Federal Open Market Committee abandoned the pegs. The basic reason, therefore, that seemed to justify a small privileged dealer group no longer exists. The technique of which it was an integral part did not work out according to expectations and failed of its purpose. (124) The subcommittee has already recommended that the Federal Open Market Committee discontinue the technique of reluctant buying and abandon agency relations in its transactions with dealers. I t has recommended that the Committee enter into transactions with dealers outside the recognized list if it is operating to support markets, e. g., to peg rights during periods of Treasury refunding. I t has also recommended that in its dealings in the bill market both on an outright and on a repurchase basis, it enter into transactions with all dealers who perform a responsible and continuous role in the weekly bill auction. If these recommendations are adopted by the Federal Open Market Committee the competitive importance of recognition in the market place would diminish greatly. I t would become a matter of less im\x)rtance, therefore, whether the fiction of a recognized list of dealers was maintained or dropped. For its own part, the subcommittee feels it advisable to drop the relationship completely and so recommends. (125) If the Federal Open Market Committee decides to maintain the recognized dealer relationship, on the other hand, the subcommittee recommends most earnestly that it proceed promptly to revise the present list of dealers who enjoy UNITED STATES MONETARY POLICY 279 the privilege of recognition. It is difficult to justify exclusions that have been made from .the select group when comparison is made with some that are within. There are bank dealers within the recognized group that do not take positions or make markets, that do not attempt a nationwide coverage, that -do not operate in volume in all segments of the list, and that are clearly motivated in their conduct of operations by a desire to attract and hold correspondent banks for their institutions rather than by a desire to earn a competitive return on the capital at their disposal as dealers. If the relationship is continued, it is urgent that the Federal Open Market Committee draw the lines for recognition on bases that can be justified as impartial and objective. Reports and information (120) The Federal Open Market Committee faces no problem of lack of access to market information available to dealers. The Committee has been too powerful a market factor for its requests for information to be easily challenged. It lias frequently been the determining factor in hour-to-hour and day-to-day trading in the market for Government securities, i. e., the market in which dealers risk their capital on a relatively thin margin of equity in continuous, almost split-second, trading operations. Despite the dropping of the pegs and smaller intervention in the current market, the potential power of the Federal Open Market Committee, backed by the power to create bank reserves, remains. Under those circumstances, dealers will continue to cultivate contacts with the Committee since no single quality is more important to their ability to survive than their ability to forecast correctly (1) the probabilities of intervention in the market by the Federal Open Market Committee, (2) the direction of that intervention, either on the bid or the offered side, if it occurs, and (3) the sectors in the market to which it may be directed. (127) Under these circumstances, also, dealers tend to seek orders from the Committee, not because of the profit potentialities of business involved but because they may indicate the direction of the Federal Open Market Committee's thinking. Receipt of an order from the trading desk, in fact, acquires a significance out of all proportion to the actual commission involved. In addition, the dealer endeavors to cultivate access to the Committee and to its staff representatives. He readily accepts the obligation to give information on his activities and to make reports. He welcomes hour-to-hour contact with the trading desk, both to submit quotations and to tender market reports. The responses, however guarded, may provide clues to the state of the market. Even when the Committee is pursuing a neutral policy and is out of the market, the trading desk has business to do, orders to execute for agency and foreign accounts. As noted earlier, this amounted to $2.4 billion in the year ending June 1952. The dealer does not necessarily know whether or not these represent market intervention on the part of the Federal Open Market Committee, but he is likely to feel that continuous and close contact with the trading desk helps him to come to a judgment .on whether they do or not. Under the present arrangements the trading desk has probably more knowledge of the sources of demand and supply in the market as well as the money position than any other element. (128) This situation places a heavy responsibility upon the Federal Open Market Committee. It cannot, in this instance, rely on the customary reluctance of respondents to furnish information to act as a check on its own curiosity. It must decide for itself not only what- information should properly be supplied to the market so that it can function effectively but also the limits of what the Committee can, with propriety, ask from the dealers in the way of informaion. (129) The fundamental rule is that no general information should be furnished a dealer that is not equally available to others. It is unavoidable that dealers executing orders for the Federal Open Market Committee gain special knowledge with respect to that particular transaction, but every effort should be made, as in fact the subcommittee believes it is, to be close-mouthed with respect to these transactions. It goes without saying, of course, that no member or representative of the Federal Open Market Committee should indicate an attitude toward the prices which dealers quote and at which they do business in the m a r k e t <1S0) So far as additional information to be supplied to the market in the weekly condition statement is concerned, the subcommittee recommends (1) that securities held under repurchase agreement by the Federal Open Market Committee be segregated from the balance of the System portfolios; (2) that the amount of special certificates of indebtedness outstanding be regularly indicated, either in the text or on the stub of the statement; (3) t h a t weekly averages of member bank borrowing be shown in addition to the actual .volume of member 280 UNITED STATES MONETARY POLICY bank borrowing at the close of business on statement days, as is now done for excess reserves. (131) The extent of the limitations which the Committee should impose on itself and its representatives in seeking information from the dealers poses a more serious problem. In the discussions with the dealers, expressions of irritation, dissatisfaction, and resentment were confined to three quite specific points: One, they did not like the tone or content of the morning meeting when different dealers report individually to the manager of the open market account before market opening. They stated they got little out of the contact and some suggested that it would be better to drop the meeting and substitute a more general type of meeting from time to time between the manager of the account and all the principal dealers together as a group. They felt that they might be given a chance to ask questions at such a meeting and to receive helpful enlightenment on the attitude of the Federal Open Market Committee toward tbe market. Two, the dealers did not like it when-they were questioned so closely by the trading desk on the geographical source of current customer orders as to reveal indirectly the identity of their customer. While the great bulk of the dealers did not object to disclosing the general source of their customer orders, they did feel that it was morally wrong to be asked a series of indirect questions so pointed as to permit identification of the source of their business. Some felt that incorrect use of this information may have been made by the Committee, either by direct approach to sellers, thus revealing that the dealer had not maintained secrecy on a confidential relationship, or by discrimination between offerings, buying some securities pressed for sale by a particular customer but not all. Three, they were apprehensive lest the disclosure of their individual positions to the personnel of the trading desk might tend to affect the decisions of that personnel in subsequent dealings with them. (132) With respect to these three specific points, the subcommittee recommends: (1) That the individual morning dealer conference be abandoned. It recognizes that there may be merit in the more general type of conference suggested by some of the dealers as a substitute for these meetings but feels that any information furnished by the Federal Open Market Committee at such a meeting should be such as might properly be given to any other segment of the public, (2) that disclosure of the source of customer orders be so limited that there will be no possibility of identification, direct or by inference, of the individual source of customers to the trading desk, and (3) that the Federal Open Market Committee discontinue its present practice of collecting statistics on dealer positions and activity, and substitute for this practice the regular collection of dealer position and activity reports by an officer of the System not connected with the Federal Open Market Committee. This officer would furnish aggregate summaries to the trading desk that did not reveal the position or activity of any individual dealer. (133) The subcommittee feels that the furthest its representatives can go with propriety in soliciting or accepting information from individual dealers with respect to the source of their orders, Is to receive only information as to the general type of customer, the volume of the business, and the sector of the market involved. I t questions seriously the propriety of the present practice in which its representatives on the trading desk are free to press dealers for quite specific information on customer transactions and on the basis of this information proceed to compute transaction sheets currently during the trading day, such sheets being subject to later verification against the dealers' statistical reports. I t recommends that this practice be dropped. Housekeeping (134) In many respects, the Federal Open Market Committee is unique both in the form and the substance of its organization. In form, it is a completely independent organization, specifically set up by statute, with exclusive power of decision with respect to the matters delegated to it. Its composition is designed to insure, to the full extent that legislation can insure, that its members will not only be fully competent, but will also be immune to outside pressure. I t is neither an appendage of the Federal Reserve Board nor a creature of the Federal Reserve banks, but a completely independent body, each member of which, as an individual, whether he be a Governor from the Board or a president from a Federal Reserve bank, reports to no one. His actions are a matter of public record but each member sits as an individual, bound only by his oath to execute the law. The responsibilities delegated to the Committee are of almost incomparable import. UNITED STATES MONETARY POLICY 281 (135)* The statutory individuality of the Federal Open Market Committee and its separation both from the Federal Reserve Board and the Federal Reserve banks is expressed in its chart of organization. It has its own staff, and when it gathers it meets as a separately organized and stalled body. Its sessions are not joint sessions of the Federal Reserve Board and the Federal Reserve banks, but statutory meetings of the Federal Open Market Committee. (130) In a very general sense, the Federal Open Market Committee stands in the relation of a fiduciary to the Federal Reserve banks. It, and it alone, has the decision with respect to the amount, as well as the issues, of their open market portfolios. They hold, at the moment, nearly $24 billion of securities, the greatest investment portfolio by far in the history of the world. I t is wholly in the discretion of the Federal Open Market Committee to direct the investment of large additional amounts. (137) In an even more general sense, the Federal Open Market Committee stands in a fiduciary relationship to the whole American economy. It could be •called special trustee for the integrity of the dollar, for the preservation of. its purchasing power, so far as that integrity can be preserved by its operations. I t is especially charged, also, to use its powers to provide an elastic currency for the accommodation of agriculture, commerce, and business, i. e., to promote financial equilibrium and economic stability at high levels of activity. (138) This unique structure of the Federal Open Market Committee was hammered out after long experience and intense political debate. Like other components of the Federal Reserve System, it exemplifies the unceasing search of the American democracy for forms of organization that combine centralized direction with decentralized control, that provide ample opportunity for hearing to the private interest but that function in the public interest, that are government and yet are screened from certain governmental and political pressures since even these may be against the long-run public interest (139) When the substance, rather than the form, of the Federal Open Market Committee is analyzed against this background, certain possible anomalies arise. I t lies no individual budget, nor does the act provide for one. There is no single person on its operating staff who is responsible to the Committee •alone. Each of its ollicials is paid either by the Federal Reserve Board or by a Federal Reserve bank. Each would automatically cease to have any relationship with the Federal Open Market Committee the moment that connection was severed. No member of the Committee, nor of its staff, is charged to give exclusive attention to its concerns. Everyone connected with it wears also another hat. Even the manager of the open market account, who comes nearest to devoting his full time to its functions, has heavy independent responsibilities in connection with the fiscal agency and other operations of the Federal Reserve Bank of New York. (140) The Federal open market account is not managed by the Federal Open Market Committee. This function has been delegated to the Federal Reserve Bank of Ne*w York, subject to policy directives that jjrovide discretionary leeway within which the management operates. The manager of the account is selected by the directors of the Federal Reserve Bank of New York and approved by the full Federal Open Market Committee each year. In his day-to-day operations, he is subject to the authority of the Federal Reserve Bank of New York, and not to that of the Federal Open Market Committee. (141) The subcommittee urges that the Committee take the initiative in reexamining and reviewing this structure of organization. There has been much experience since the arrangements were first established. In the light of that experience, is the structure well designed to carry out the Committee's important functions? For example, should, the Federal Open Market Committee operate under a budget of its own? This might require legislation, but if a separate budget would improve its operations, the Committee is- morally obligated to suggest such legislation to the Congress. (142) Should all or part of the staff of the Federal Open Market Committee be separate and distinct from the staffs of the Federal Reserve Board and the Federal Reserve banks? However paid, should they wear one hat, and one hat only, devoting all their time exclusively to the operations of the Federal Open Market Committee? There are both advantages and dangers in this suggestion which must be weighed. The Federal Reserve System is a family, and the Federal Open Market Committee urgently needs the knowledge, the judgment, and the skill of all the members of that family. I t would be extremely difficult to build up a new and independent staff as qualified as the personnel which it now enlists to work on its problems. I t would be equally unfortunate to 282 UNITED STATES MONETARY POLICY lose the contributions of that staff to System problems that fall outside the limited area of responsibility of the Federal Open Market Committee. Yet there are equal dangers in a situation where the time of no one person on the whole staff of the Committee is wholly devoted to its responsibilities, where everyone wears two hats, and where each must fulfill duties separate and distinct from those imposed by the Federal Open Market Committee. (143) Should the present situation, which delegates the management of the open-market account to the Federal Reserve Bank of New York, be retained, or should the manager of the open-market account be made directly responsible to the Federal Oi>en Market Committee? The present arrangement has the advantage that the mechanical operations of the account, the keeping of its books and records and the handling of its funds, are under the immediate supervision of the Federal Reserve Rank of New York with its superb facilities. More important, it has the advantage that the president of the Federal Reserve Rank of New York, situated as he is in the center of the Nation's money market, with his personal insight into problems of monetary policy and his immediate access to financial information not so readily available to anyone else, can supervise on the spot the execution of the general policy directives of the Federal Open Market Committee and the executive committee and thus determine that that policy is made effective in operations. (144) I t has the disadvantage that the president of the Federal Reserve Bank of New York sits at meetings of the Federal Open Market Committee and of the executive committee necessarily in a somewhat different role from that of his colleagues. He comes not only as a contributor to the discussion on policy formation, but, also necessarily, as a protagonist for the actual day-to-day operations of the account. These operations are his responsibility. He cannot criticize them without criticizing his own staff. The committee, therefore, in some part loses contact with the critical insight of its best informed member. I t has the disadvantage also that other members of the Federal Open Market Committee, reluctant to seem critical of a colleague, may hesitate to scrutinize adequately the technical operations of the account. This is a serious deficiency because the other bank president members of the Committee are usually scattered and out of intimate touch with one another as well as with the market. They must depend on give and take discussion a t Committee meetings and at the meetings of the executive committee to sharpen their appreciation of the Committee's operating problems. (145) The present arrangement makes one major contribution of paramount concern to effective operations. There must be confidence throughout the market and throughout the financial community generally that open-market operations are immune from political pressures. This confidence is undeniably strengthened by the fact that the Federal Reserve Bank of New York actually conducts open market operations for the Committee. Under the present management arrangement, the actual contacts of the market are contacts with personnel of the Federal Reserve Bank of New York, subject to the discipline of its directors. (140) There is, of course, the equal necessity of maintaining the confidence of the public generally that the Committee's operations are immune from banker domination. This consideration is reflected in the general structure of the Federal Reserve System with the Board of Governors and the regionally decentralized Federal Reserve banks. It is also reflected in the actual statutory composition of the Federal Open Market Committee. From this point of view, the present arrangement by which the management of the open-market account is delegated to the Federal Reserve Bank of New York requires that the individual members of the Federal Open Market Committee maintain close contact with all important aspects of its operations. (147) Throughout its consideration of the recommendations it is making in this report, the subcommittee has had this problem in mind. These recommendations do not stop with the evaluation of technical practices of the Committee, originated during the period of the pegs, that now handicap the development of a free market. The subcommittee has been aware also of the urgent necessity of simplifying as much as possible, the operating procedures of the committee and the points of impact which its operations have on the market mechanism. The problem has. been to work out procedures (1) that will provide more effectively for the execution of the Committee's monetary policies in the open market, (2) t h a t will do this in a way that will minimize confusion in the market with respect to the committee's purposes, and (3) that will enable individual members of the Federal Open Market Committee to maintain more intimate contact with its technical operations. The subcommittee feels that Digitizedoperations for FRASERunder its recommendations will not only make for greater depth, UNITED STATES MONETARY POLICY 283 breadth, and resiliency in the market, with less misunderstanding, but will also enable eaeh member of the Federal Open Market Committee to carry out more effectively his individual statutory responsibility as a committee member. (148) The subcommittee desires to raise one aspect of the problem for special consideration. I t urges that the full Federal Open Market Committee take a definite position with respect to the suggestion advanced above that the manager of the open-market account be employed by the Federal Open Market Committee as a whole, rather than by the Federal Reserve Bank of New York. (140) The subcommittee is not proposing this shift. It is recommending, however, that the change be most seriously considered. The operations of the account would continue to be located in the Federal Reserve Bank of New York, as at present, and the Federal Open Market Committee would,continue to avail itself of the personnel, wisdo.m, and experience of the whole Federal Reserve System, as at present. The only change would be that the manager of the openmarket account would be employed by the Federal Open Market Committee as a whole, that he would be solely responsible to the Federal Open Market Committee, and that he would have no responsibilities other than those imposed on him by the Federal Open Market Committee. (150) Should the Committee decide to make such a move, certain details of organization would have to be solved. They are not of concern at this point. The immediate concern is whether such a move would be in the public interest, whether it would improve the functioning of the Federal Open Market Committee. Certain features of the proposed arrangement stand out as crucial. Since the manager of the open-market account would be directly responsible to the whole Federal Open Market Committee, the individual members of the Committee might feel less reluctant to make direct contact with him and thereby familiarize themselves with details of the Committee's operations. The manager of the account also would no longer occupy the dual role of manager of the account and also of vice president of the Federal Reserve Bank of New York. He would, be relieved of responsibility to its directors with respect to any of his activities. Finally, he would no longer participate in transactions originating in the fiscal agency or foreign correspondent relationships of the Federal Reserve Bank of New York. (151) Some duplication of facilities would result from this change but there would be offsetting advantages. For example, the money market might be less confused with respect to the significance of orders transmitted through the trading desk. The execution of an order for the Treasury, or for a foreign correspondent, could not then give rise to rumors that the Federal Open Market Committee had entered the market. (152) The chief change, of course, and the one which requires the most serious consideration would be the change in the relationship of the president of the Federal Reserve Bank of New York to the account. As Vice Chairman of the Federal Open Market Committee, he would have, as he now has, full access to all the operations of the account and continuing responsibility for maintaining a vigilant scrutiny over them. He would continue to be in the same building with the manager of the open-market account, and would be as continuously available for consultation as at present. The line of. responsibility between the whole Committee and the manager of its account, however, would be direct and undivided. It would not impose upon the president of the Federal Reserve Bank of New York the added individual responsibility which he now bears for operational and discretionary decisions within the directives laid down by the whole Committee or its executive committee. Relations with the Treasury (153) There is one final recommendation the subcommittee would like to make. It falls in the difficult and delicate area that deals with problems of debt management and Treasnry relationships. Specifically, the subcommittee recommends that the Federal Open Market Committee inform the Treasury that in the future it will keep the Secretary continuously informed as to its credit and monetary policies but that it will refrain as an official body from regularly initiating specific proposals with respect to details of individual Treasury offerings. That is, it will no longer on its own initiative regularly write formal letters or seek official interviews to lay before the Secretary of the Treasury its suggestions as to issues, coupons, etc., that in its judgment would be appropriate for particular debt management operations. The Federal Open Market Committee would, on the other hand, be prepared to respond to a request of the Secretary for the committee's judgment as to whether the terms he had in mind for a new issue were appropriate in the light of market conditions, i. e., whether the 284 UNITED STATES MONETARY POLICY committee would expect them to develop a sufficient rights value, and also whether they would create complications for monetary management or would conflict with or run into difficulties because of credit operations in contemplation by the Federal Open Market Committee. (154) The subcommittee urges this change in procedure in order to establish formal official communications with the Treasury on a more correct basis than prevails a t present. The Secretary of the Treasury is primarily responsible for decisions in the area of debt management. In coming to those decisions, he should feel free to consult and talk over his problems with anyone he wishes, commercial bankers, investment bankers, security dealers, etc., and also with anyone he chooses within the Federal Reserve System, either in or out of the Federal Open Market Committee. So far as system personnel is concerned, however, it should be wholly understood that he consulted them as individuals. The decision he arrives at should be a decision for which he, as the responsible official, takes full responsibility. Neither the Federal Open Market Committee nor the executive committee should take responsibility, as it now does, for initiating a recommendation as to coupon and terms in the area of debt management. (155) In the judgment of the subcommittee, the present practice under which the Federal Open Market Committee convenes itself and, after consideration and vote, writes a letter outlining its official recommendation with respect to debt management policies is improper and unwise, in view of the clear location of responsibility for debt-management decisions in the Treasury. I t is just as unwise and improper as the converse would be, namely, that the Secretary of the Treasury should regularly and officially, as a member of the President's Cabinet, write the Board of Governors and the Federal Open Market Committee his considered views with respect to future credit policies and open-market operations. (156) Such formalized action by either, however well intended, trespasses upon the statutory responsibility of the other. It tends to complicate rather than to facilitate that adjustment of views and of official decisions which is essential to the achievement of their common objectives in the public interest. SUMMARY OP CONCLUSIONS AND RECOMMENDATIONS S A. Relations with the market The subcommittee finds that a disconcerting degree of uncertainty exists among professional dealers and investors in Government securities with, respect both to the occasions which the Federal Open Market Committee might consider appropriate for intervention and to the sector of the market in which such intervention might occur, an uncertainty that is detrimental to the development of depth, breadth, and resiliency of the market. (35-43) In the judgment of the subcommittee, this uncertainty can be eliminated by an assurance from the Federal Open Market Committee that henceforth it will intervene in the market, not to impose on the market any particular pattern of prices and yields but solely to effectuate the objectives of monetary and credit policy, and that it will confine such intervention to transactions in very short-term securities, preferably bills. (44-48) The subcommittee feels most strongly that it would be wise to give such an assurance. The subcommittee finds two outstanding commitments that may require intervention by the Federal Open Market Committee in other than the very shortterm sectors of the market, and that may add to or subtract from reserve funds available to the market for purposes other than the pursuit of monetary policies directed toward financial equilibrium and economic stability. (40) These commitments are, first, the directive to the management of the open-market account to "maintain orderly conditions" in the market for United States Government securities, and, second, those arising from the practice of purchasing rights on maturing issues.during periods of Treasury financing, and also on some of these occasions of purchasing when-issued securities and outstanding securities of comparable maturity to those being offered for cash or refunding. With respect to the first of these commitments, the subcommittee recommends that the Federal Open Market Committee amend its present directive to the executive committee by eliminating the phrase "to maintain orderly conditions 1 For the convenience of readers, the numbers of the paragraphs to the. report specifically dealing with each recommendation have been inserted opposite to the same recommendation as It appears in this summary* UNITED STATES MONETARY POLICY 285 in the Government securities market" and by substituting therefor an authorization to intervene when necessary "to correct a disorderly situation in the Government securities market.'' I t has indicated in its report the conditions it would consider sufficiently disorderly to require correction. (50-56) The subcommittee recommends also that such intervention be initiated by the executive committee only on an affirmative vote after notification by the manager of account of the existence of a situation requiring correction. With respect to the second, 'the subcommittee recommends that the Federal Open Market Committee ask the Treasury to work out new procedures for financing, and that as soon as practicable the Committee refrain, during a period of Treasury financing, from purchasing (1) any maturing issues for which an exchange is being offered, (2) when-issued securities, and (3) any outstanding issues of comparable maturity to those being offered for exchange. (57-74) The subcommittee feels that such qualifications as are implicit in these two recommendations would not seriously impair the constructive effect of a general assurance from the Committee that its intervention henceforth will be limited to the effectuation of monetary policies and will be executed in the very* short sector of the market. I t recommends most strongly that such assurance be given as soon as its existing commitments have been appropriately modified. (75-76) 2?. Relations with dealers The subcommittee finds no present or prospective justification for continuing the present system of rigid qualiftcation for dealers with whom the account will transact business, and recommends that the system be dropped. (116-124) Jn the event the Federal Open Market Committee, contrary to the subcommittee's basic recommendation, decides to maintain the system of recognized dealers the subcommittee recommends: (a) that the present list of recognized dealers be revised, both by eliminations from and additions to the list. (125) (h) that repurchase agreements be extended impartially to all dealers who participate regularly in the weekly bill auction, irrespective of whether or not they are on the recognized list,' (108) (c) that if rights are acquired in support of Treasury refundings they be purchased as freely from nonrecognized as from recognized dealers. (115) (d) that transactions to correct disorderly conditions in the Government securities market be made with unrecognized as well as recognized dealers. 0S5) C. Operating techniques The subcommittee finds that many of the present operating techniques of the account are upsetting to the smooth functioning of the market. In general, these techniques were prescribed by the Federal Open Market Committee at a time when it was attempting to peg market prices and yields of United States Government securities. With respect to market techniques, the subcommittee recommends specifically: (a) that "reluctant buying" be completely abandoned, and that supporting operations in the market, if undertaken at all, be executed through a technique of aggressive rather than reluctant purchasing. (81-86) (6) that agency transactions be abandoned and that the account conduct its transactions with dealers as principals on a net basis. (S7-93, 110-113) (r) that if rights are acquired during refundings they be purchased from dealers without regard to whether or not they come from the dealers' positions. (114) (d) that refusal to buy bills acquired by dealers on a cash basis be discontinued. (102) (c) that nonbank dealers be informed adequately in advance when repurchase facilities will be made available. (103) (/) that repurchase facilities at an appropriate rate and with appropriate limitation as to volume be made regularly available to nonbank dealers over weekends. (04-104) The subcommittee finds that relations between the open market account and the dealers are not as impersonal as is desirable now that the Committee Is no longer trying to peg prices and yields on Government securities by maintaining a tight rein on the activities of dealers. It recommends: (a) that the Open Market Committee make known-to the dealers the "ground rules" which henceforth will govern the occasions for its transactions with dealers. (59, 75-76) 55314—54 19 286 UNITED STATES MONETARY POLICY (ft) that the individual morning dealer conference be abandoned. (131-132) (c) that the information obtained by the trading desk from dealers be so restricted as to eliminate the possibility of identification, directly or by inference, of individual customers, (.131-132) ((f) that reports on individual dealer positions and activity be collected by an officer of the System other than the manager of the account, that the individual reports be kept confidential, and that only aggregates compiled from the individual dealer reports be disclosed to the manager of the account. (131-132) (e) that the present practice of asking dealers to report transactions currently during the trading day in sufficient detail to permit the computation . of current individual dealer transactions sheets be discontinued. (131,133) The subcommittee finds that there is a serious gap in the structure of the money market as it affects the functioning of the market for Government securities. Continuously in recent months, funds available to dealers to carry portfolios have been inadequate in volume and available only at rates higher than the yield of their portfolios. This deficiency could not exist so continuously in a central money market equipped (1) to attract temporarily idle funds from over the country to New York, and (2) to make these funds available on call to dealers in the money market* The subcommittee recommends that the feasibility of reestablishing a central call-money post for dealers be explored. (IOC) D. Federal Reserve reports The subcommittee finds that the Federal Reserve System can inprove the data which it makes available to inform the market on its operations. It recommends that the following information be shown henceforth on the weekly condition statement of the Federal Reserve banks: (a) securities held on repurchase agreement; (b) special certificates of indebtedness held by the system; (c) weekly averages of member bank borrowing. (130) E. Organization of the Open Market Committee The subcommittee finds many anomalies in the structure and organization of the Federal Open Market Committee, particularly (a) the absence of a separate budget covering its operations, (6) the absence of a separate staff responsible only to the Committee, and (c) the delegation of the management function to an individual Federal Reserve bank. It recommends that the Committee reexamine and review its present organization, and in particular that it consider the advantages and disadvantages that would ensue, were the manager of the open market account made directly responsible to the Federal Open Market Committee as a whole, and not, as at present, responsible through the Federal Reserve Bank of New York. (130-152)' F. Relations with the Treasury The subcommittee finds that the Federal Open Market Committee is frequently placed in an inconsistent position by its present practice of Initiating advice to the Secretary of the Treasury with respect to decisions in the area of debt management. It recommends that the Committee inform the Secretary of the Treasury that henceforth it will refrain, as an official body, from initiating regularly proposals with respect to details of specific Treasury offerings, and will confine itself officially to providing information currently on its monetary policies and to counseling on the credit and.monetary implications of debtmanagement suggestions advanced for its consideration by the Treasury. (15315G) OUTLINE OP STUDT (1) Outline of Study prepared by ad hoc subcommittee on the Government securities market (2) Letter dated May 28,1952, from Chairman Martin to individuals and organizations receiving the Outline of Study for informational purposes (3) List of recipients of Outline of Study for informational purposes (4) Letter dated May 28, 1952, from Chairman Martin to individuals who received, as addressees, the explanatory letter and Outline of Study (5) List of recipients of Outline of Study as addressees UNITED STATES MONETARY POLICY 287 I. FUNCTION OF DEALERS III TREASURY OBLIGATIONS A. What are the essential functions performed by dealers in Treasury obligations?" Discuss their functions in relation to the operations of banks and financial institutions, of the Treasury, and of the Federal Reserve banks, particularly the open-market account. How were these functions affected by the maintenance of pegs by the Federal Open Market Committee? B. What are the essential attributes which a dealer must possess to perform these functions efliciently (capital, borrowing facilities, moral and technical qualifications, etc.) ? Were these affected by the maintenance of pegs? How are these attributes affected by specialization: (a) geographical (with respect to location of customers; (?;) structural (with respect to types of securities); (e) types of customers (e. g., banks as against insurance companies, etc.)? II. EFFECT ON DEALERS OF OPERATIONS OF FEDERAL OPEN-MARKET ACCOUNT A. IIow have the operations of the open-market account affected the ability of dealers to perform their essential functions? Discuss with relation to amount of capital required, credit availability, adequacy of commissions, effect on spreads, willingness and ability of dealers to take positions, etc. Distinguish between open-market-account operations during maintenance of pegs and the effects since the discontinuance of pegging operations. B. From the point of view of successful dealer functioning, what are the advantages and disadvantages of qualification? Distinguish between conditions prior-to and following the discontinuance of pegs. C. Either as a qualified or nonqualified dealer, have you any suggestions or criticisms of the effect of the operations of the open-market account on your own operations? Do you feel that the standards for qualification are appropriate and are applied objectively? D. Is disclosure to the Federal Reserve by qualified dealers of the general sources of customer orders a justifiable aid to the orderly functioning of the market? E. Do you feel that the operations of the account are, or have been, discriminatory and, if so, that the discrimination was not justified by overriding considerations? Distinguish between operations of the account when it was working under the overriding directive to maintain a relatively fixed pattern of yields and operations since the discontinuance of the pegs. F. To what extent have you been directly or indirectly influenced in the quotation and positioning of selected issues of Government securities by the openmarket management? in What should be the general relation of the open-market account to the dealers and the market in view of the discontinuance of pegging operations? Are any broad changes in the organization of the open-market account indicated? How frequently and under what conditions should the account intervene in the market, either through outright purchases and sales of securities or through resort to repurchase or resale contracts? Is it desirable to effect a closer liaison between the open-market management and dealers? If so, what suggestions do you have for achieving a closer liaison? Discuss separately under each of the following headings: A. Operations to temper seasonal, emergency, and week-to-week or day-to-day fluctuations in the money market resulting from changes in currency demand, float, Treasury calls and payments, etc. 1. Should the account operate from day to day to offset such fluctuations in the availability of funds or can the necessary adjustments be-left to the market mechanism with necessary access to and absorption of Reserve bank funds provided by member bank borrowing? Under which circumstance would the market develop greater breadth, resilience, and strength? 2. If you feel that direct operations of the account are needed in addition to member bank borrowing, should these be provided mainly through outright purchases and sales of securities or should more use be made of repurchase and resale agreements? 288 UNITED STATES MONETARY POLICY 3. If outright purchases and sales are used, should they be made in .that sector of the market best able at the moment to absorb such operations in the judgment of the management of the account, or should they be concentrated, as a matter of routine, in the very short maturities? 4. Are the present repurchase facilities adequate to enable dealers to take positions and make markets? Do you have any suggestions for the improvement of the present type of repurchase contract? 5. Would it be worth while to explore the use of 1-day resale agreements to absorb reserves when they are temporarily redundant? For example, the open market account might make bills or certificates available to the market on a 1-day resale agreement for sale to banks with redundant excess reserves. 0. To what extent does the increasing use of Federal funds transactions between banks in different Federal Reserve districts affect the short:term market for Government securities? B. Operations affecting dealers as underwriters of the weekly bill offering. In view of the importance of bills as a medium for Treasury financing, it is desirable that dealers be in a position to enter bids sufficient to assure adequate coverage of each auction. 1. Are the dealers now in a position to perform this function effectively or is greater assurance needed that, in the event of an unexpected stringency, Federal funds will be available on repurchase agreement? 2. Assuming repurchase facilities are provided, what limitation should be placed on their use! 3. When the Open Market Committee purchases bills to relieve congestion in the money market, should such purchases be made 'at a penalty rate, as in London, and should these operations be confined to short-dated bills? C. Operations during periods of Treasury refundings. 1. Should the open market account maintain a rights value on maturing issues during refunding? 2. Have you any criticism of the technical operations of the account during refundings; or any suggestions for improvement in the technique? D. Operations to maintain orderly markets in Treasury securities. 1. What, in your judgment, constitutes an "orderly" market? 2. What criteria should the open market account apply to determine whether intervention is necessary for the maintenance of order in the market? 3. Except for extreme emergencies, do you foresee the frequent occasion for System intervention to maintain "orderly" conditions? K. Operations to carry out basic changes in credit policies of the Reserve authorities for the mitigation of economic instability, i. e., major changes in the open-market portfolios of considerable duration designed to reduce the availability of credit during periods of boom or to make credit much more freely available (luring periods of recession. 1. Have you any recommendation as to the types of securities to be sold or purchased in operations of this type? 2. Should the operation normally be in the long-term or the short-term sector of the market? Why? 3. What would be the effect of large-scale operations in the long-term sector on the market mechanism and on the ability and willingness of dealers to hold adequate portfolios? IV. ADEQUACY OP DEALER ORGANIZATION A. What has been the effect of greater market flexibility since the accord on willingness of dealers to take positions, participate in the bill auction and make markets, both in long-term and short-term Treasury issues? B. Are more dealers needed and is more dealer capital desirable? If so, how could it best be attracted? C. Has the lack of personnel trained to operate under flexible market conditions hampered operations and smooth market functioning since the discontinuance of the pegs? B. Have you any suggestions or comments concerning the basic organization of the market for Treasury obligations? Does the present over-the-counter market adequately fill the need or would a continuous auction market enlarge participation and give greater depth and breadth to the market? If so, should an existing securities exchange be used? How would this be effected? 289 UNITED STATES MONETARY POLICY V. APPROPRIATENESS OP PRESENT ORGANIZATION OF OPEN MARKET ACCOUNT A. Would the employment of a special broker to execute Federal Reserve System transactions (in substitution for the operations of the present trading desk) be adequate for the performance of System operations? Would it be preferable? Have you any other suggestions as to an appropriate organization for System operations in Treasury obligations? Please discuss this problem with specific reference to System operations under each of the five major headings in question I I I above. B. Assuming the continuance of operations as presently organized, i. e., overthe-counter markets with a trading desk in the Federal Reserve Bank of New York, have you any suggestions as to the basis of distinction for the qualification of dealers? Please discuss this problem as it would be affected under each of the five major headings in question I I I above. 1. Are formally qualified dealers needed? 2. If so, what should be the essential requirements for qualification? 3. Should qualified dealers be required to report positions to the open market manager? If so, in what form do you suggest that reports be made? 4. Can distinctions be drawn between the role of bank and nonbank qualified dealers? In what respects should they be differentiated? C. Would it be desirable to make additional data regarding System operations available through the regularly published weekly figures of the Federal Reserve banks? For example, should repurchase figures be segregated from total System holdings of United States Government securities? Should daily average member bank borrowings be included in the published figures? Do you have any other suggestions? VI. MARKET COVERAGE Have you any suggestions for broadening and deepening the customer market for Treasury obligations? A. Institutional. Is there adequate coverage of institutional investors, such as small insurance companies, commercial and savings banks, etc.? B. Noninsti.tutional. What suggestions have you to ericourage greater participation by corporations, particularly smaller corporations and businessmen, and by individual investors? C. Is there any manner in which Federal Reserve banks and branches outside New York City could be more helpful in aiding smaller investors in the purchase and sale of Government securities? Is it an economical operation for the dealer organization to attempt this type of coverage? VII. TECHNIQUES OF OPEN-MARKET OPERATION A. Assuming for policy reasons the Open Market Committee desires to effect changes in total holdings or in the composition of the portfolio, what methods aside from letting maturing securities run off should be employed to effectuate these changes with a minimum of disturbance to prices? Would it be desirable to employ the mechanism of secondary offerings by inviting bids or offerings up to a certain time limit on specific blocks of Government securities? B. Should the open-market management buy and sell on dealers' quotations and should dealers be required to make firm markets up to some minimum amount? If so, what minimum would you suggest? BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, Washington, May 28, Wo2. Enclosed is an outline of a technical study, together with explanatory letter, which is being sent to dealers and other specialists in the United States Government securities market. We are sending you copies herewith for your information. Sincerely yours, W M . M C C . MARTIN, Chairman, Federal Open Market Jr., Committee. 290 UNITED STATES MONETARY POLICY INDIVIDUALS AND ORGANIZATIONS WHICH RECEIVED A NOTE ENCLOSING COPIES OF THE LETTER AND OUTLINE OF STUDY FOB THEIR INFORMATION S. Sloan Colt, president, Bankers Trust Co., 16 Wall Street, New York 15, N. Y. J. Luther Cleveland, chairman of the board, Guaranty Trust Co. of New York, 140 Broadway, New York 15, N. Y. Harold II. Helm, president, Chemical Bank & Trust Co., 165 Broadway, New York, N. Y. IJomer J. Livingston, president, First National Bank of Chicago, Dearborn, Monroe, and Clark Streets, Chicago 90, 111. Walter J. Cummings, chairman of the board, Continental Illinois National Bank & Trust Co., 231 South La Salle Street, Chicago 90, 111. Winthrop P. Aldrich, chairman of the board, the Chase1 National Bank, 18 Pine Street, New York, N. Y. George Whitney, J. P. Morgan & Co., Inc., 23 Wall Street; New York, N. Y. August Ihlefeld, president, Savings Banks Trust Co., 14 Wall Street, New York, N. Y. Dr. G. Keith Funston, president, New York Stock Exchange, 11 Wall Street, New