Speech

! J:(J<;\_, 1J .U'i J:'"J.L!.!J') ;:}l'Jl..1.UVJ:'i , i ~ JUN 1 1948 \ t :i I . i · / )<WHAT ABOUT MONEY AND CREDIT?·i-~~·-~~_;,,.:.=. .= ~~~-=-~-="·~·'""..t by x M. S'. Szymczak The economic situation in which we find our first, the lowering of support levels for Government selves today is indeed difficult. Instead of the security prices at the end of December; second, the happy security we hoped to enjoy after the war, rise in discqunt rates early in January; and third, we are beset with fears, confusions, and discourage the moderate increase in reserve requirements for rCarderl ment. We are dangerously close to a process of banks in N~w York and Chicago in February. turning around and heading back in the direction Despite aj large inflow of gold, a heavy seasonal from which we just came. return of currency from circulation, and large sales During the past winter we were making notice of Government securities by nonbank investors to able headway in the fight against inflation. Al: the Federal Reserve during winter months, fiscal though the underlying economic situation con and monetary operations kept bank reserves under tinued to be basically inflationary, there were signs unslackened restraint. Federal Reserve holdings of that the pressures of an undersupply of goods and Government securities fell by about one and a half an oversupply of mon~ were undergoing gradual, billion dollars. The combined effect of fiscal and cumulative abatement. monetary operations, too, was to reduce the total On the side of production, the output of goods money supply by nearly 4 billions. Considering all was not only holding up at maximum .levels, but of the circumstances, this was a notable anti-infla in some areas was catching up with demand. Crop tionary accomplishment. prospects in the world at large were encouraging, and the fall in the prices of foods and other agri GOVERNMENT BUDGET OUTLOOK cultural products was a desirable, corrective read In view of these salutary developments, it came justment. The program of world aid recovery, to be widely hoped that inflationary pressures were then under consideration, seemed to hold promise finally under control and that taxes could be safely of providing an effe~tive basis on which to re reduced. The response of Congress to this belief establish lasting peace. was a general reduction, taking away about 5 bil lion dollars per annum from the revenue of the RECENT Mo'NETARY DEVELOPMENTS Government and adding this sum to the annual On the monetary side, fiscal and monetary poli purchasing power of the public. The effect of this cies were having significant restrictive effects. The action was to eliminate any further budgetary sur money supply, though still excessive, was being plus and any anti-inflationary restraint the surplus sharply reduced by the Treasury's seasonal surplus might have had on bank credit expansion, while at of tax receipts over expenditures and by accelerated the same time unleashing new inflationary pres retirement of public debt held by the Federal Re sures through larger purchasing power. serve Banks and commercial banks. There had While Congress was acting upon a tax program been some rise in interest rates during the fall and and a program of world aid, the international situ early winter in response to tightening credit condi ation commenced to display alarming portents tions. At that juncture, the Government bank especially in Czechoslovakia and in Berlin. These supervisory authorities launched efforts to discour portents put an entirely new face on our interna age further expansion of bank credit, and these tional position. They produced a program of re efforts were strongly reinforced by a nationwide newed military preparation that promises before it program of voluntary restraint by the banking fra is completed to add billions to the Federal budget. ternity. Finally, the credit situation was affected In undertaking such a preparedness program, we restrictively by successive Federal Reserve actions: must remember that our recently enacted program i Address delivered by Governor Szymczak on May 7, 1948 of world aid for the coming year is only a part of at the morning session of the SSth Annual Convention of the Alabama Bankers Association in Birmingham, Alabama. a larger program covering several years. It is, so 1 ,.··: ! WHAT ABOUT MONEY AND CREDIT? to speak, a first instalment. I wish to underscore taining an orderly market. Finally, commercial this. fact. It means that we are adding expanded banks, though obliged to sell some Go~"t:rnment military preparedness on top of an already heavy securities in recent months, still hold about 66 bil budgetary load. We may shortly be confronted by lions of such investments, which are readily con budgetary deficits; in fact, we may have some vertible at the discretion of banks into reserves. budget deficit as early as this coming fiscal year. And as reserves from these various sources expand, And this is only the beginning of developments for they make possible, for the banking system as a which no terminal point, as a matter of stark real whole, a six-to-one inflationary expansion of bank ism, cah now be set. credit and deposits. The elimination of the Government's budgetary Faced with these prospects, further bank credit surplus and the prospect of imminent budgetary expansion, which will add to our existing super deficits strike the economy before the fight against fluity of money and liquid assets, will be very diffi postwar inflation has been decisively won. Prices cult to keep in check. We must probably resign of many products are still very high in comparison ourselves to some credit expansion; we should cer with prewar and wartime levels, and many com tainly take every precaution, however, to keep it modity and service prices, including wages, are still within the bounds of the essential. I suggest as a advancing. The total money supply, while reduced criterion of what is essential the expansion of bank from last fall, continues redundant in relation to credit required by our current program of national the output of goods, and the public's 250 billion preparedness and world aid. This means, of course, dollar stock of available purchasing power--cur priority for the bank financing of production related rency, bank deposits, and Government securities to these programs and also for the financing of any remains excessively large. Sustained high levels of Government deficits that may result. It means, production and employment, which are likely, will too, a rigorous avoidance of bank credit expansion generate high levels of consumer income, but sup for nonessential production, for speculation, and for lies of goods for final consumption must be dimin consumption purposes. ished by amounts required for foreign aid, for military preparedness, and for domestic capital MEASURES FOR MONETARY RESTRAINT maintenance and expansion. There is no simple or single way of accomplish PROSPECTIVE BANK CREDIT EXPANSION ing this task. It will have to be accomplished in a combination of ways-by general credit controls These conditions present a picture of continuing and in particular areas by selective controls. More inflationary pressures. They also add up to a strong over, credit controls alone cannot do the entire job. possibility that the financing needs of the Federal Banking and monetary policies will need to supple Government, together with those of business, State ment fiscal and other national policies-including, and local governments, home owners, and con if necessary, direct economic controls. I speak, sumers, will exceed the supply of available savings. however, only of the factors lying in the field of This possibility implies a large demand for financ money and credit; they are not the most potent but ing through the banks, repeating the type of bank they are essential. credit development which occurred last year. Re The responsibility of the Federal Reserve System newed expansion of bank credit and money could in this situation is to conserve the nation's credit only result in accentuating our inflationary pres resources in the interest of the longer-run stability sures. of our democratic capitalism. In view of this re The commercial banks could readily accommo sponsibility, the System will be obliged to use its date any amount of demand for further bank credit influence to restrain unnecessary credit expansion. expansion. In all likelihood, bank reserves will be Its capacity to fulfill this responsibility is neces increased somewhat by an inflow of gold from foreign sources, and also by such purchases of Gov sarily circumscribed, in part as a result of statutory ernment securities from nonbank investors as the authority, and in part as a result of the nature of Federal Reserve may make for the purpose of main- our banking system. 2 WHAT ABOUT MONEY AND CREDIT? APPLICABILITY OF INTEREST RATE POLICY amounts to 162 billion, or approximately 75 per cent more than the value of all listed stocks and Taking these limitations into account, there are non-Government bonds. two lines of general credit policy open to the The additional cost to the Government of a System. The first of these alternatives, which is higher interest rate program is another matter re entirely within the System's existing statutory au quiring thoughtful consideration, since a maturing thority, is to permit a general rise in the level of debt of 50 billion dollars this year and 100 billion interest rates. Such a program would have a three in five years would have to be refunded at higher fold purpose: first, to strengthen the incentive for rates. This aspect of the interest rate problem has savings; second, to meet increased financing needs; a further implication. The Treasury might become and, third, to discourage nonessential borrowing. a borrowen at the higher interest levels. This It is a program that would conform in major re would raise the knotty question of equity with spects to the traditional precepts of "orthodox" regard to present holders of Government securities. finance. The program of financing participation in World Yet it is a program that should not be accepted War II, in contrast to that of World War I, was without careful consideration; for the effect of geared to avoidance of this problem by adherence rising interest rates varies and may be the opposite to a stable pattern and level of interest rates. at one time of what it is at another. Thus the These considerations with respect to the general initial effect of rising rates may be to encourage level of interest rates do not mean that the existing economic activity anl they may not become re structure of interest rates should remain rigid. strictive till an alarmingly high level has been Long-term interest rates reflect conditions in the reached. They are first taken as harbingers of capital market-the supply of savings relative to rising prices and active business. Under inflation the demand for investment. Short-term interest ary conditions, especially, rising rates would put rates are more largely determined by liquidity pref businesses under a strong inducement to undertake erences and other more transient money market expansion programs before rates and costs went factors. To the extent possible without raising still higher; and they would hardly become deter long-term rates, short-term rates may be permitted rent until they had become extremely high. They more flexibility than they have had in recent years. would impel consum<:rs to avoid higher prices in In particular, short-term and discount rates some the future by making. credit purchases in the pres what higher than those now prevailing may help ent. They would draw out savings now held in to encourage investment in short-term Government bank deposits or in· savings bonds and add them securities by banks and other holders of liquid to the volume of credit. But they would not dis funds and reduce the amounts that need to be courage Government borrowing, for the Govern bought by the Federal Reserve. Such a policy may ment borrows not because rates are low but because be helpful in avoiding creation of additional bank appropriations and tax legislation make borrowing reserves. necessary. Still further aspects of a policy of higher interest PROPOSALS FOR HIGHER REQUIRED RESERVES rate levels are the primary effects of such a policy In the light of these considerations, I think you upon the market prices of Government bonds and will agree that there are fairly clear practical limi the secondary effects of lowered price levels for tations on the use of interest rate policy to restrain Government bonds upon the soundness and the further growth in bank reserves and accompanying functioning of financial institutions. It is one thing bank credit expansion. This leads me to the second to contemplate higher interest rates on a public debt alternative, namely, an increase in the reserve re of 25 billion dollars, such as we had at the end of quirements of all commercial banks. This alterna World War I; it is another thing to contemplate tive would require legislation granting additional higher interest rates when public debt amounts to authority to the Reserve System. The System still 253 billion and exceeds the total of all private and has unused power to increase the reserve require other debt by nearly 50 per cent. We have also to ments of member banks in New York and Chicago, keep in mind that marketable public debt alone but the leverage to be exerted through this authority 3 WHAT ABOUT MONEY AND CREDIT? would be relatively minor in relation to the prob was adverse. It was objected that the situation lem that the banking system confronts. What is was not yet serious enough to warrant sueih a meas needed is a more ~eneral authority which would ure, and that the Board already had enough power apply, as a matter of equity as well as economics, anyway. As to the timing, the Board proposal was to all commercial banks. To this end, the Federal not that the power be granted for instant applica Reserve Board has recently recommended to the tion but that its use be authorized when necessary. Congress that authority of a two-fold character be The mere existence of such an authority would provided. have some effect, of course, for most bankers had In the first place, the authority should make it rather act on their own initiative than wait for a possible for the System to impose on all commer regulation ·to tell them what to do. Moreover to cial banks a primary reserve requirement up to 10 wait till a situation is desperate before recommend per cent of aggregate demand deposits and 4 per ing appropriate legislation is scarcely what one cent of aggregate time deposits, in addition to would call statesmanship. As for the adequacy of present requirements. If desired, the authority Board powers, I think the point is whether the could be graduated by class of bank. This measure present powers are applicable. The power to raise would give the Reserve System authority to increase reserve requirements in New York and Chicago, total reserve requirements by a maximum of about for example-which the Board could do-is not 12 billion dollars. It would enable the System, over very helpful when the problem largely lies else the next few years, to absorb and sterilize the where. Moreover, it is impracticable to exhaust credit expansion pote'i-itial occasioned by gold in powers before the moment of their greatest effec flows and by Federal Reserve purchases of Govern tiveness and unfortunate to have to exhaust them ment securities from nonbank investors. without some power in reserve. Finally, the Board In the second place, the recommended legislation was not seeking power but was re~ponding to a re would enable the System to impose on all comi'ner quest for suggestions at a time which was not of its cial banks, under proper safeguards, a special re own making or choice. serve requirement up to 25 per cent of aggregate Some bankers have liked the special reserve plan demand deposits and 10 per cent of time deposits. and some have not. I have had doubts about it This may be preferably described as an optional myself, and can sympathize with the doubts of reserve requirement, because' the special reserve others. Yet I know of nothing better, and the plan could be held, at the ~ption of the individual bank, has advantages, I think, which have not been in specified cash assets or in certain marketable understood or appreciated. short-term Government securities. Generally speaking, the optional or special re It seems to me at this time that perhaps the most serve requirement would be capable of accomplish desirable arrangement would be to package to ing the same restraints on bank credit expansion gether the optional reserve plan and the proposal as a straight increase in primary reserve require for authority to increase primary reserves made by ments, but it would be considerably less onerous the Board to Congress in April. Provision might to the banks. As I have just said, I sympathize be made both for the optional reserve and for an with bankers who have questioned the desirability increase in primary reserves as proposed, with the of the special reserve plan and I think I understand general limitation that the total increase in required their misgivings. Bankers naturally resent being reserves that might be applied by the two types of blamed for everything. They did not bring on the authority taken together could not exceed 25 per inflation and they do not like to feel that all the cent of aggregate demand deposits and 10 per cent pressure to stop it is being put on them. In reality, of aggregate time deposits. of course, restraint on the extension of credit hap- At the special session of Congress last fall when . pens to be one of the effective ways of resisting the Board was asked to say what might be done inflation, and we must not forget that we are speak in the monetary and credit field to deal with infla ing about it because banking is the field of our tionary forces, its response was to recommend con responsibility and not because we expect everything sideration of the special reserve plan. The proposal that is done to be done in that field and nowhere attracted considerable attention, much of which else. I certainly do not wish to give the impression 4 WHAT ABOUT MONEY AND CREDIT? that I have any patience with the tendency to take reserves, i.e., as assets equivalent to cash and avail everything out on the bankers. I have a public able for conversion into actual reserves at rhe bank's duty to perform, but that duty is certainly not discretion through sale to the Federal Reserve. against the long-run interests of bankers. One of The optional or special reserve, which would its aims is the protection of banking through bank strengthen the demand by banks for short-term ing itself. It is in this spirit that I should like to Government securities and thus aid in the main clarify the optional reserve plan, for perhaps our tenance of relatively stable interest rates on Gov explanations have not sufficiently described the ernment sc:;curities, would, on the other hand, make relative merits of the proposed measures. possible so,me increase in interest rates on private borrowing/·particularly on short-term and medium OPTIONAL RESERVE PLAN term borrowing. Any such rise would have the By way of preface it should be emphasized, as I same restr;iining effects on inflationary borr9wing noted earlier, that banks now hold 66 billion dollars as higher i interest rates in general might have. of Government securities. From the standpoint of More importantly, the plan would put pressure on an individual bank and from the standpoint of the the lender. to ration scarce bank credit among banking system as a whole, these securities are customers . and to reduce voluntarily the bank virtually excess reserves. That is, banks may sell credit available for business expansion and con Government securities in the market to obtain re sumer financing. serves and unless oth~r buyers appear, the Federal Furthermore, if Government deficit financing Reserve System must buy them in support of orderly again becomes necessary at some not too distant and stable market conditions. In the process new stage, the optional requirement would make it bank reserves are created. As a matter of fact, possible to tie the deposits created in deficit financ nearly all large banks and many medium-sized and ing to the securities sold to the commercial banks small banks recognize this characteristic of Govern and held as assets against the deposits. Conse ment securities by adjusting their reserve positions quently, it would be much more adaptable in continually through purchases and sales. coping with the problems of credit control incident Any plan to place restraint on the total volume to Government deficit financing than ai:i increase of bank credit and the money supply must recog in primary reserve requirements would be. nize the potential re~erve feature of the Govern Lastly, the optional or special reserve authority ment securities held by banks, or for that matter, would restore flexibility and effectiveness to the of those held by other investors. As a measure to customary instruments of Federal Reserve policy, reduce the volume·· of potentia.l reserves, it is as i.e., open market operations and discount rate~. effective to immobilize a part of these securities in In the traditional sense of their use for credit con the portfolios of banks as it is to require banks to trol purposes, these instruments have become largely sell them to the Reserve Banks in order to meet an unusable because of the dominance of public debt increase in primary reserves. In fact, as a device in the credit situation. for meeting the very special kind of situation that Criticism has been made of the special reserve now confronts us, the special or optional reserve plan that it would be too restrictive and again that plan has certain important advantages both to it would not be restrictive enough. Yet as a device banks and to the public generally. for meeting the serious problems of excessive credit In the first place the optional or special reserve expansion the special reserve could be used with requirement, if imposed, would leave the banks greater precision and with less danger of adverse with their holdings of Government securities intact. reaction than could an increase in primary require It would make possible an increase in bank re ments, since the special reserve, as I said before, quired reserves and at the same time avoid a con would involve fewer banking adjustments. More siderable amount of banking readjustment, as well over, safeguards against too rapid application of as any serious adverse effect upon bank earnings. the requirements are.. an integral part of the plan. It would simply immobilize a portion of commer It has been said that the special reserve would not cial bank portfolios of Government securities and be restrictive enough because immobilization of discontinue the treatment of these holdings as excess short-term Government securities would still per- 5 WHAT ABOUT MONEY AND CREDIT? mit banks to sell longer-term securities to obtain Regulation of down payments and matunues in reserves. It is of course true that the plan would the field of consumer instalment credit 'is also leave banks largely free to do this. Banks would needed, in my opinion. Re-establishment of this be deterred from doing this, however, because they control would help to dampen consumer demand, would be sacrificing a higher-yielding security, pos especially for durable goods, financed on time-pay sibly at a book loss. Further, since their short-term ment plans. This would help to curb further infla securities would be immobilized as special reserves, tionary growth in consumer expenditures and to banks in practice would need to hold at least a reduce the wmpetition for available supplies of portion of their long-term Government securities basic materials and manpower, on which the na as secondary operating reserves. Should banks sell tional defense and world aid programs must draw long-term securities, moreover, buyers other than heavily. An auxiliary effect of this restraint would the Reserve Banks might be attracted by these be some increase of savings, encouragement of higher-yielding issues, thus avoiding the creation of which may be put down as an essential element of new bank reserves through Reserve Bank purchases. any program to fight inflation in the period ahead. Some have criticized the special reserve plan The third area that I mentioned where selective because banks might need to sell higher-yielding credit control might be used to advantage is mort bonds to obtain sufficient short-term securities to gage credit for housing, which for some time ~ow meet requirements. The resulting loss in earnings, has been one of the most inflationary factors in the it has been said, might cause banks to reach out current situation. Since early last winter, there for more risky, high-interest loans and investments, have been mounting complaints-mainly from the with consequent expansion in private bank credit building industry and veterans organizations-that and impairment of the condition of our banks. I residential mortgage credit is becoming tighter. believe this criticism does less than justice to the Partly in response to these complaints, consideration good common sense of the average banker as well is being given by· Congress to legislation designed as to the effectiveness of our bank supervisory to reverse this situation. You are perhaps familiar agencies. It also does not take into account possible with the proposals under consideration. They are, higher interest rates on sound private credit, and first, to continue on an unsound basis the IJIOrtgage the increase in bank earnings from this source. insurance program under Title VI of the National It is worth mention that a special reserve re Housing Act; second, to create a Government quirement, like an increase in primary require financed secondary market for mortgages already ments, would reduce the ratio of multiple deposit underwritten by the Government; and third, to re expansion that could be built on new reserves that lax lending conditions under Titles I and II of the banks might acquire from whatever source. National Housing Act. However, I am glad to say that, in this proposed legislation, some relevant SUPPLEMENTARY MEASURES OF CREDIT RESTRAINT economic facts have been faced; permissive interest My remarks thus far have been concerned with rates on guaranteed and insured mortgages have the major means of restraining redundant credit been placed one-half per cent higher, and the per expansion. But there are also other measures sup nicious "necessary current cost" cost formula for plementary to general credit policy which should be appraisal has been replaced by a "value" formula. restrictive in particular credit areas and therefore We are not at all sure that mortgage credit is helpful in controlling the aggregate volume of bank getting tighter in any real sense. Financial insti credit. I refer to the areas of stock market credit, tutions, including commercial banks, are still mak consumer credit, and housing mortgage credit. ing mortgage loans at a substantial rate. Mortgage Credit to finance the purchase or carrying of listed premiums, bonuses, and fees offered by lenders are stocks has been restrained up to the present by the lower or have disappeared, but loans are being Federal Reserve Board's regulation of margin re placed. Borrowers are having a harder time getting quirements; and in view of the dangerous infla 100 per cent or 90 per cent loans, but there is no tionary possibilities of the immediate future, it sound economic reason why they should ever have would be a grave mistake, in my judgment, to ease had such loans. If recent anti-inflationary mone those requirements at this time. tary and fiscal policies have been tightening resi- 6 WHAT ABOUT MONEY AND CREDIT? dential mortgage credit somewhat, that seems to munities, and at the same time refrain from me all to the good, and, considering the inflationary redundant credit expansion on a national basis- conditions that prevail in the housing market, en especially with the basic factors present that are tirely consistent with the objectives of those policies. now stimulating credit expansion. There is no such thing as an effective program of over-all credit restraint that avoids restrictive effects FINANCIAL STRENGTH EssENTIAL in particular areas which have large financial im Before closing, I should like to stress the fact portance, such as residential mortgage credit. that there is such a thing as a prudent, sound Even without a strongly inflationary outlook for financial course for an entire economy. We are domestic economic developments, there would be compelled by circumstances beyond our control to very good reason for reconsidering and moderating undertake commitments for world recovery and any new program for the encouragement of mort peace that no one till very recently would have gage lending. With such an outlook, the need for anticipated. These commitments come at a time reconsideration is urgent. It would be better if we of full utilization of our manpower and resources, abandoned the' program altogether, but at the least of heavy current and deferred peacetill'\e demand any further special encouragement of mortgage by our own people, and of recent action to reduce credit should be limited to rental housing. We shall our heavy burden of Federal taxes. There is no not succeed in overcoming the housing shortage by financial sleight-of-hand by which we can carry increasing the competitive pressures on scarce sup the unavoidable burden of our national program plies of materials and construction labor. What is and still avoid further serious inflation. We must needed is a continuing effort to keep the volume raise from the public the money that has to be of mortgage credit from pressing too powerfully spent and there must be some restriction on do against these important supplies. mestic demand for goods firianced through bank The sale of savings bonds offers a positive check credit. on inflation that approaches the problem from a These matters I have put before you are matters different· angle. It withdraws money from the that it is the duty of the Board to bring not only spending stream, thus reducing the pressure of to the attention of Congress but also to the attention buyers on a scanty supply of goods, and it substi· of bankers and the public at large. Furthermore, tutes private investment in Government securities it is our duty to do so in sufficient time to allow for bank investment, thus reducing the volume of Congressional and public discussion and debate. bank credit and of bank deposits. And furthermore the powers the Board requires in Lastly, an over-all restrictive credit policy will the discharge of its responsibilities must first be need to be supplemented by vigilant watchfulness granted by Congress in sujJicient time for their on the part of the supervisory authorities and by exercise to be effective. Powers granted too late voluntary self-restraint on the part of individual serve no particular good. bankers. We believe that supervisory policy should I hope the suggestions we are offering will not vigorously maintain the soundness of credit. exten be greeted with the hackneyed comment that the sion by individual banks, and we have actively Federal Reserve merely wants more power. To cooperated with the American Bankers Association make that comment is to beg the question. The in its nationwide program of fostering banker Federal Reserve System was set up nearly thirty self-restraint. But the banks may expect continuing fi ve years ago to exercise certain authorized func strong credit demands from businesses' and indi tions in the public good. The world has not stood viduals, and they are not in a position to refuse still since then, and presumably it will not stand the sound credit demands of individual customers still in the near future. We have had two great in good credit standing. I think that banks can wars in that time, the magnitude of business opera fairly be asked to adhere strictly to conservative tions has grown, and new forces have arisen. These lending standards, and I believe that banks uni developments make it necessary to adapt and en versally will respond to such requests. But I do large the powers that changed conditions have not believe that they can extend credit competitively, rendered inadequate. I leave to your consideration as they must, in the interests of their local com- the question what should be done about it. ,., 7

M.S. Szymczak (1948, May 6). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19480507_szymczak

@misc{wtfs_speech_19480507_szymczak,
  author = {M.S. Szymczak},
  title = {Speech},
  year = {1948},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19480507_szymczak},
  note = {Retrieved via When the Fed Speaks corpus}
}