Speech

STATEMENT ON BEHALF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT, FEBRUARY 14, 1949* Mr. Chairman and Members of the Joint Com- consisting of representative bankers from each Fed- mittee on the Economic Report: eral Reserve district, and through frequent System staff meetings. The System has constantly available I want to thank you for this opportunity to appear current information, factual and statistical, drawn here today to testify on behalf of the Board of from this great network. This is in addition to the Governors of the Federal Reserve System in regard masses of economic data regularly compiled and to the recommendations contained in the Economic analyzed by the Board's staff. I am sure that all Report of the President with respect to bank reserve members of the Board in Washington feel as I do, requirements and regulation of consumer instal- that the accumulation of facts, figures, as well as ment credit. The Board of Governors unani- opinions, which we are thus able to assemble is mously favors both recommendations. invaluable. It is supplemented from time to time Inasmuch as I have just returned from an 8000- by visits such as the one I have just made, which mile trip on which I visited the offices of the System gave me an opportunity for frank, face-to-face dis- in Seattle, Portland, San Francisco, Los Angeles, cussions with informed men in business, banking, El Paso, Dallas, and Houston, it may be of interest agriculture, and the many different interests linked to this Committee if I preface what I have to say together in this Reserve System. Since I took office on credit policy by summarizing the impressions I less than a year ago I have visited ten Federal brought back from this trip. Reserve Banks and seven of their branches, pri- You are aware, I think, of the unique nature of marily for this purpose. In addition I have talked this Reserve System, with its 12 Banks and their in different cities with scores of business and pro- 24 branches spread throughout this country, a fessional men not directly connected with the Fed- system tailor-made for the economic expansion eral Reserve. of our country. I have often referred to it as a great Partly because of the shift in emphasis brought pyramid with its base in the grass roots of our about by reappearance of conditions of a buyers' economy and its apex in the Board of Governors. market since my previous trips, I found business- The breadth and strength is in the base, with the men more alert and sensitive to the major external member banks and the Reserve Banks as elevations influences—international, legislative, and monetary in the slope toward the top. There are more than —which bear upon the activity, profitability and 250 directors, who serve without compensation and soundness of the enterprises with which they are represent not only banking but most of the widely connected. For instance, most all of them when diversified industrial, commercial, agricultural, edu- commenting on business prospects spoke about the cational, and other occupations of this country. dangers in the international situation, the implica- I submit here a list of the directors and their tions of a Federal surplus or deficit, their concern business or professional affiliations. about future Congressional legislation, and the The Board in Washington has the very great ad- importance of credit and monetary policies. vantage of close contact with the vast fabric of the I found a very general opinion of optimism that entire economy, by direct communication with we are in the midst of a healthy leveling off adjust- these men, with the presidents, other officers and ment and that the inflation may have run its course. staffs of the 36 System offices, through periodic Quite naturally those engaged in agriculture or meetings with the presidents, with the chairmen the manufacture of items which have suffered the of the Banks, with the Federal Advisory Council greatest price decline were not happy about their positions in relation to other producers whose prices * Presented by Chairman Thomas B. McCabe. 1 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT have not declined and in some instances have risen. This authority to the Board of Governors should It is the rapid change in price relationship in the not be confined to member banks of the Federal over-all picture that causes concern to so many Reserve System but should be applicable to all people. I found few who excluded the possibility banks insured by the Federal Deposit Insurance of a renewal of inflation. Among factors mentioned Corporation. that might bring this about were (1) deficit financ- "Authority for the regulation of consumer in- ing, (2) reappearance of critical shortages, (3) stallment credit, which likewise expires under further substantial wage increases, (4) excessive present law on June 30, 1949, should be con- spending by State and local governments, and (5) tinued in order to exert a stabilizing influence resumption of rapid credit expansion. on the economy." I have found an increasingly better understanding and appreciation of the actions of the Federal Re- The credit measures proposed at this time are a serve in the field of credit, of the importance of form of insurance against the possible renewal of arming it at all times with the authority to deal the upward spiral. Let me say a word, however, with changing economic conditions, and of its about the downside of the business cycle. It should record, particularly in maintaining an orderly mar- be very reassuring to member banks and to the ket for Government securities in which all classes entire banking community to recall that the Reserve of our people have such great interest. I have System is far better equipped now than ever before emphasized and re-emphasized to various groups to combat deflationary forces. Through open who have been subject to the System's regulations market operations, that is, by purchase of Govern- that our primary objective is to work for a ment securities, the System has virtually unlimited stabilized economy, and that in doing so we means of supplying the money market with addi- must serve the broader interests of industry, agri- tional reserves if the situation should call for culture, and commerce and not the limited interests such action. The Reserve Banks have about 23 of any particular groups. This purpose is fully billion dollars of gold certificate reserves, only half in accord with the objectives of the Employment of which are needed at this time to meet gold re- Act of 1946, namely, to promote maximum pro- serve requirements. Accordingly, the System could duction, employment and purchasing power. more than double its note and deposit liabilities. In his Economic Report, the President said: Furthermore, the Banking Act of 1935, by freeing Reserve Banks from some of the technical limita- "On previous occasions I have recommended tions on their lending functions, placed the Reserve that adequate means be provided in order that Banks in a position to lend to member banks on monetary authorities may at all times be in a any assets that the Reserve Banks are willing to position to carry out their traditional function of accept as security for advances. This is an im- exerting effective restraint upon excessive credit portant assurance of a liberal lending policy on the expansion in an inflationary period and conversely part of the Reserve Banks. of easing credit conditions in a time of defla- Also the Reserve Banks have authority to make tionary pressures. The temporary authority to so-called Section 13b loans for working capital pur- increase reserve requirements of member banks poses to business and industry when other credit of the Federal Reserve System, granted by the is unavailable to the borrowers. And, of course, Congress last August, will expire on June 30, in a downswing the Reserve Board would lower 1949. The expiration of this authority without reserve requirements and similarly adjust regula- further action of the Congress would auto- tions on instalment and stock market credit in ac- matically release a substantial volume of bank cordance with the needs of business and finance. reserves irrespective of credit needs at the time. The Congress should promptly provide con- I have referred to the System's ability to deal tinuing authority to the Board of Governors of effectively with credit problems on the downswing the Federal Reserve System to require banks to in order to emphasize and make clear why we say hold supplemental reserves up to the limit re- that if we are equipped with the proposed authority quested last August, 10 per cent against demand to deal with the problems of a further possible up- deposits and 4 per cent against time deposits. swing, we will be in a better position to perform at 2 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT all times the functions that are the primary respon- as shown on the chart, has increased from about sibility of monetary authorities. 100 billion dollars in 1940 to an annual rate of over Why is it necessary to ask Congress at this time 260 billion dollars in the last quarter of 1948, an for the monetary and credit measures to which the expansion of over two and a half times. The exist- President refers? I shall not take your time to go ing and potential money supply could still generate over familiar ground which has been well covered strong inflationary pressures. by other witnesses before this Committee, but I Some easing of inflationary pressures has been should like to summarize, as we see it, the situation indicated recently by marked declines in prices of which calls for these protective measures. various commodities, principally those that had War finance resulted in a huge and rapid ex- risen most sharply. This easing was brought about pansion in the amount of liquid assets—bank de- in part by the record volume of production of both posits, currency, and Government securities—held agriculture and industry in the past year. by the public. This expansion represented the Over-all consumers' incomes and holdings of accumulation of savings made possible and neces- liquid assets, nevertheless, have continued at high sary by the excess of wartime incomes over the levels and are fairly widely distributed. Expendi- supplies of goods and services available for pur- tures by businesses for capital investment, by State chase. The result, as shown in the chart, is that and local governments for public works, and by deposits and currency increased from about 60 bil- home owners and builders for*new housing have lion dollars in 1940 to 170 billion dollars at present. continued large. Resistance to high prices and some Nonbank holdings of Government securities, which abatement in the urgency of demands have been can be readily converted into money, increased from evident, however, in the case of housing and of about 20 billion dollars to 130 billion dollars. The many durable goods, now that the more pressing expansion in the combined total is more than three shortages have been overcome. and a half times. Today physical volume of produc- As for credit, the increase in bank loans, which had been very large in previous years, slackened GROSS NATIONAL PRODUCT considerably in the last quarter of 1948. Also there AND LIQUID ASSET HOLDINGS was an almost complete cessation late in the year of sales of Government bonds to the Federal Re- serve System by nonbank investors to obtain funds for other uses, a factor that had previously been an important inflationary influence. Taking the year as a whole there was a small decline, amounting to a billion dollars, in the total volume of bank de- posits last year, due to the Federal Government sur- plus early in the year and the use of part of that surplus to retire bank-held securities. It is possible but it is by no means certain that 194$ I960 postwar inflation has run its course and that addi- tional restraints for anti-inflation purposes will not tion of all goods and services, including output of have to be applied. However, no one can be sure farms, mines, and factories and various other ac- that inflationary dangers are over rather than merely tivities, so far as such a total can be measured, is interrupted. We have had a number of readjust- only about half again as large as in the maximum ments since the end of the war. Each was hailed prewar year. by some as the end of the postwar boom. Each was Partly as a consequence of an excessive money succeeded, in turn, by renewal of the inflationary supply relative to production, we have already ex- spiral. I recall so vividly the strong statements perienced a large degree of inflation. Consumers' made to me by financial and business leaders just prices for all items as measured by the indexes of before I took office last spring that they were the Bureau of Labor Statistics rose by 75 per cent confident that the break in the commodity markets above prewar and are still close to that peak. The in early 1948 was the beginning of the long antici- dollar value of the annual gross national product, 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT pated recession. You will recall that there was a times to cope with inflationary possibilities that may similar feeling in the spring of 1947. develop just as we must be prepared to move in In view of the uncertainties in the outlook at this the opposite direction by relaxing restraints when time, the temptation is strong to assume that infla- deflationary influences are dominant. tionary forces have been dissipated. This may We are also still confronted with the necessity of prove to be an unwarranted assumption. balancing our several objectives, one of the most The needs for enlarged defense expenditures, important of which is maintenance of stability in particularly if they involve the purchase of ma- the Government securities market. To accomplish terials in short supply and if they lead to a budgetary this, the Federal Open Market Committee stands deficit, are a continuing force making for inflation. ready to buy such securities when there are no Unless total production can be expanded—and the other buyers at established prices and also to sell ability to expand in any short period is limited by securities when demand is heavy. I think the available resources of materials, manpower and System's support of the Government securities equipment—additions to the goods and services market has been wise and necessary. It is one of devoted to defense must be diverted from those the outstanding accomplishments of the postwar going into private consumption and investment. period. As the President pointed out in his If private demands for goods and services are not Economic Report, such stability in the Government correspondingly adjusted, then higher prices will bond market "contributes to the underlying result. With such strains on the economy it is im- strength of the financial structure of the country." portant that governmental expenditures be fully At the same time we want to prevent any excess covered by revenues. reserves supplied to banks by our stabilizing opera- Not only is the surplus or deficit in financial tions in the securities markets from becoming the operations of the Government important, the basis for manifold expansion of credit and of de- economy is also affected by cash surplus or deficit posits. We also need to absorb reserves made avail- operations of the private sector. In a fully-employed able from other sources, notably gold inflow. It capitalistic economy, business and other investment would of course be possible to curb expansion of should be financed largely from current savings of reserves by failing to support Government securities the public. If, however, over-all expenditures for in the market. Although I fully realize that the consumption and investment exceed current receipts support program limits the System's ability to re- —which is possible if they are financed from ac- strain credit expansion, I am convinced that the cumulations of past savings or from bank credit consequences which might result from abandoning expansion—then the result is likely to be infla- the program could be disastrous. The measures we tionary. are recommending are designed to deal with this In view of the general liquidity of the economy, situation. one cannot be complacent about the possibility of The heart of the problem is bank reserves. If we renewed or continued deficit financing by businesses are to deal at all effectively with the problems of and individuals in the aggregate. We still have a inflation we must devote ourselves to the subject tremendous potential for a further increase in de- of bank reserves. There are other lenders in the posits and bank reserves as well as for a more rapid market who compete with banks for loans, but use of existing money. Commercial banks alone banking is unique because bank deposits are the hold over 60 billion dollars of marketable Govern- largest part of our money supply. ment securities, which they could convert at will Let me emphasize as I have before that I am into reserves capable of supporting an enormous not singling out bankers for criticism. In my deposit expansion. The turnover of bank deposits opinion this nation owes a debt of gratitude to com- is currently much less than it has been in many mercial bankers generally for their service in the previous periods of high economic activity, and task of financing the war, and reconversion from spending for all purposes could be considerably war. I also feel that the bankers are indebted to expanded without any further increase in the the Federal Reserve System for the part it has played amount of the outstanding money supply. Under in this period of strain. Never before in the history these circumstances, we must be prepared at all 4 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT of this nation has the banking system been in a 2 billion dollars, which is more than accounted for stronger position. by the excess of receipts in the first quarter, leaving Action by monetary authorities to prevent newly- a deficit for the rest of the year. Thus this element created reserves from becoming the basis for further of restraint is no longer available. deposit and bank credit expansion is in no sense a Another important means of absorbing reserves reflection on the banking community. If effective was the sale of short-term Government securities by restraint is to be exercised over the money supply the Reserve Banks. Since the middle of 1947 in- and the credit situation, the Federal Reserve System terest rates on such securities have been allowed to must be concerned with changes in the volume of rise somewhat from the very low levels that were bank reserves, which have a direct bearing on the reached in the depression and that had been main- volume of bank credit and bank deposits. Respon- tained during the war and early postwar period. sibility for the over-all volume of bank deposits and, Investors were encouraged by these higher rates to to some extent, for the general quality of bank purchase and hold short-term issues. Federal Re- credit rests primarily upon the monetary and bank- serve sales of short-term securities in the market, ing authorities rather than upon individual bankers. together with retirements by the Treasury, reduced The banking system today acquires reserves in the System's holdings of such securities by fully as three major ways: (1) imports of gold, (2) return much as System holdings of bonds were increased of currency from circulation, and (3) purchases of through the support program. It would be unwise, Government securities by the Federal Reserve however, to rely on this means of absorbing addi- Banks. If the volume of deposits is to be held in tional reserves that might be made available from check additional reserves arising principally from System purchases of bonds or from other sources, these sources have to be absorbed or immobilized. particularly if there should be a substantial demand Monetary policy has been directed to this end. for loans. During the year ending last October large Still another means of dealing with the problem amounts of reserves were supplied to banks as a of reserves was to increase reserve requirements. result of Federal Reserve purchases of bonds, largely Under authority of permanent law, the Board of from nonbank investors. These purchases amounted Governors increased reserve requirements at central to about 10 billion dollars. In addition, gold inflow reserve city banks in New York and Chicago in and return of currency from circulation supplied February and again in June. Then in the third banks with over 2 billion dollars of reserve funds. quarter, when nonbank investors were selling bonds These additional reserves were largely absorbed in large volume and the demand for bank credit or offset through fiscal and monetary measures. was active, the Board used part of its newly-ac- The most important of these was the large excess quired temporary authority to increase reserve re- of cash receipts over expenditures by the Federal quirements for all member banks. Let me em- Government during the early part of 1948. The phasize that we have not used the temporary transfer of these funds to Treasury account at the authority merely because we were given it. We Reserve Banks reduced privately-held deposits and have used only a part of it, cautiously and with also absorbed bank reserves. The Treasury used a discretion, to meet a specific development. large part of these funds to retire public debt held We should be prepared for whatever may de- by the Reserve Banks. Banks in turn maintained velop. No one can know how the volume of re- their reserve positions by selling Government securi- serves will change in the future. We should be ties to the Federal Reserve. The necessity to make prepared to deal with the problems that would these sales exerted a degree of restraint on the lend- arise if reserves increase significantly. That is why ing activities of banks. adequate continuing authority is needed to require The cash surplus of 6 billion dollars in 1947 and banks to hold supplemental reserves in the form of 8 billion dollars in 1948, used in the way I have balances at the Reserve Banks. described, was the largest single restraining force We are again asking, as we did last summer, for on the money supply. But at best the prospects for authorization to require supplemental reserves up this calendar year, in view of our enlarged defense to a maximum of 10 per cent against demand de- expenditures, are for a cash surplus of less than posits and 4 per cent against time deposits. Con- 5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT gress granted authority up to 4 per cent on demand absorb future additions to reserves. It would not deposits and ll/ per cent on time deposits, ap- be used to force banks to liquidate outstanding 2 plicable to member banks only, and expiring loans. At present most of the banks of the country June 30, 1949. The present request would replace hold short-term Government securities in amounts this temporary authority. more than adequate to meet their needs for liquidity, Since the temporary authority has been used in as well as to accommodate their customers or to set part to require member banks to hold additional aside additional reserves. Moreover, it should be reserves, expiration of the power on June 30 would borne in mind that monetary policy is not a one- immediately release about 2 billion dollars of re- way street. It has always been flexible, adapted to serves that could be used as a basis for a manifold changing requirements of the economy. Bank re- credit expansion. serves immobilized in a period of inflationary pres- sure would be released when business needs require. It is vitally important that the requirements be made applicable to all insured banks, and not In addition to the authority with respect to bank exclusively to member banks of the Federal Reserve reserves, we urge you to continue consumer instal- System. Banks now subject to Federal supervision ment credit regulation. and enjoying the protection of Federal insurance of Instalment credit is the volatile and dynamic their deposits comprise 95 per cent of all commercial element in consumer financing. It is subject to banks and hold 98 per cent of all deposits in com- wide fluctuations and exerts a pervasive effect on mercial banks, while member banks of the Federal consumer demand and prices. During the past Reserve System include slightly less than half of year, for example, nearly 80 per cent of the 2.5 bil- the total number and hold about 85 per cent of the lion dollar increase in total consumer credit was deposits. accounted for by instalment credit. The instalment It would be grossly inequitable to limit the re- credit portion has increased in the past two years quirements to member banks alone. Member banks from about one-third to one-half of the total of all already carry higher effective reserves than non- consumer credit. members, while nonmember banks benefit by the Consumer instalment credit, furthermore, is di- strength which the very existence of the Federal rectly associated with the distribution and financing Reserve System gives to the credit structure. It is of durable goods. In an advanced and rich economy unfair to have member banks bear the entire burden such as ours, the standard of living of the great mass of actions in the monetary field undertaken in the of the people takes more and more the form of public interest. I have found member banks, par- possession and enjoyment of a variety of durable ticularly small member banks, becoming restive goods. Thus instalment financing is subject to a because of the inequitable application of reserve requirements. Failure to include all insured banks growth force that is basic and persisting and is would seriously impair the effectiveness of national becoming a more important element in the economy. monetary policy. The unregulated use of instalment credit financ- It is not suggested that the proposed supplemental ing tends to accentuate instability of demand for reserve requirement is the perfect or final solution durable goods. Credit spending is stimulated dur- of the problem of arming the monetary authorities ing periods of business expansion when consumers with adequate means of performing their primary are more inclined to make commitments for the function. The pending proposal, however, is a future and lenders are more willing to extend necessary step in the right direction. Together with credits. New instalment credits exceed repayments other powers now available, it would equip our on old credits and outstanding credit volume grows. monetary mechanism with authority to cope with When economic recession sets in, accumulated overexpansion of the money supply in case that credit remains to be paid off in the period of con- danger again threatens us. As I have already indi- traction. The drain on consumer income for debt cated, we are amply forearmed to deal with the repayment curtails current purchasing of consumer credit needs of the opposite swing of the business goods and services generally. The over-all effect is cycle. to amplify fluctuations in consumer expenditures, The additional authority would only be used to directly for durable goods and indirectly for all 6 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT BEFORE THE JOINT COMMITTEE ON THE ECONOMIC REPORT types of goods. This makes for greater instability These economic units suffer most from the hard- of the entire economy. ships of instability. By helping to maintain sound We are interested in stability as well as growth credit conditions and also to moderate excessive in our economy. Regulation of instalment credit fluctuations in instalment financing Regulation W is designed to help maintain stability without pre- can serve well the public interest. Also, smaller venting sustainable long-term growth in such credit. business enterprises can compete more equitably Consumer instalment credit has risen since the and safely when terms conform to reasonable stand- end of the war from 2 billion dollars to 8 billion ards. dollars at present. This is an impressive increase The Board has consistently been mindful of the and has contributed to the heavy pressures of problems that confront those who have the job of demand against available supplies of goods for carrying on a business. We have tried to achieve purchase, which in turn have contributed to rising the purposes of Regulation W with the least pos- consumer prices. If these rates of increase in con- sible interference with usual business operations. sumer debt were to continue, we would eventually, I believe we have achieved reasonable success in and perhaps before long, exhaust the cushion of that endeavor. consumer borrowing power and thus endanger I want to say at this point that we have received economic stability. strong and friendly cooperatton from an over- Regulation W in its present form, which some whelming majority of those subject to the regula- have criticized as too stringent, has not prevented tion. We have a sympathetic interest in their expansion of instalment credit. But it has operated problems and we believe that in most cases they to restrain excessive instalment spending and lend- have made an honest effort to understand ours. ing especially for consumer durable goods. It has The Board is fully aware of the problems which tended to make quality and price more important consumer instalment credit regulation presents to factors than terms in the sale of such goods. The retailers, as well as to sales finance companies, restraint has served as a useful brake on further banks, and other credit-granting agencies. We are advances in retail prices in the consumer areas very conscious of the problems that increased re- affected by regulation, as well as on the excessive serve requirements raise for any bank that may expansion of instalment credit volume. have to obtain the additional reserves by liquidating The all-important thing is that the authority to other assets. We earnestly hope that the need will restrain be in hand when the need to restrain arises. not again arise for use of further restraints. We Appropriate instruments to meet possible infla- would only use them if it became necessary to tionary or deflationary developments should be con- do so in order to protect the economy. I can as- stantly available for use as circumstances warrant. sure you that these restraints will be modified as In adapting Regulation W to changing economic economic conditions warrant, and the Board will conditions, the Board of Governors by statutory not hesitate to relax them%when they have served direction would have in view the prevention of their purpose. In the world of today the United excessive expansion or contraction of consumer in- States, occupying as it does a place of world leader- stalment credit as well as the maintenance of sound ship, should be equipped at all times with flexible, credit conditions in this credit area and in the effective means of carrying out appropriate mone- economy generally. The regulation would thus tary and credit policies, adapted to changing help to carry out the objectives of the Employment economic circumstances. Act of 1946. Most of my business life has been spent in Consumer instalment financing has played an private industry. I would be the last to want important part in the development of the American Government to have power and authority merely system of mass distribution of consumer goods. for the sake of having power and authority. In the It should continue to play this important role by complex and fluid monetary field, however, the being used but not abused. Sound credit condi- timeliness of policy moves is of critical import. tions should be maintained at all times for the That is why the Board believes that in the interest protection of the entire economy. It should not be of a stabilized, progressive economy, it is essential overlooked that the users of instalment credit are that our monetary machinery be prepared in ad- primarily low and middle income households. vance to adapt itself to changing economic needs. 7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Thomas B. McCabe (1949, February 13). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19490214_mccabe

@misc{wtfs_speech_19490214_mccabe,
  author = {Thomas B. McCabe},
  title = {Speech},
  year = {1949},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19490214_mccabe},
  note = {Retrieved via When the Fed Speaks corpus}
}