POSTWAR ECONOMIC STUDIES 

No. 8, November 1947 

FEDERAL RESERVE 

POLICY 

KARL R. BOPP 

ROBERT V. ROSA 

CARL E. PARRY 

WOODLIEF THOMAS AND RALPH A. YOUNG 

BOARD OF GOVERNORS 

OF THE FEDERAL RESERVE SYSTEM 

WASHINGTON 

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Federal Reserve Bank of St. Louis
Published November 1947 

COMPOSED AND PRINTED AT THE 

WAVERLY PRESS, INC. 

BALTIMORE, U. S. A. 

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Federal Reserve Bank of St. Louis
CONTENTS 

PAGE 

PREFACE Inside Front Cover 

THREE DECADES OF FEDERAL RESERVE POLICY 

KARL R. BOPP 1 

Evolution of Federal Reserve Policy 2 

Original Principles 2 

The First World War 3 

Postwar 4 

The Middle Twenties 6 

End of the "New Era" 8 

The Great Depression 10 

The Second World War 16 

The Experience of the 30 Years as a Whole 23 

Adequacy of Power to Discharge Responsibilities 24 

Reversing Direction 26 

Speed and Scale of Actions 27 

Resolution of Conflicting Objectives 28 

Experience and the Future 29 

IMPACT OF THE WAR ON THE MEMBER BANKS, 1939-1946 

ROBERT V. ROSA 30 

Differences among Banks in Deposit Growth 34 

Regional Growth in Deposits 35 

Deposit Growth among Banks of Different Sizes 37 

Shifts in Composition of Deposits, by Size of Bank and Region. . 38 

Changes in Composition of Government Securities Portfolio 41 

Over-all Changes in Member Bank Portfolios of Government 

Securities 41 

Differences among Banks in the Composition of Government 

Securities Portfolio 47 

The Loan Portfolio 51 

Wartime Differences in Loan Portfolios among Individual Banks. 53 

Changes in Loan Portfolios during 1946 55 

Profits and Capital Accounts 57 

Differences in Profits among Individual Banks 59 

Member Bank Capital Accounts 60 

Conclusions 62 

ill 

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iv CONTENTS 

PAGE 

SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 

CARL E. PARRY 65 

Examples of Selective Instruments 65 

Mechanism for Influencing Stock-Market Credit 65 

Mechanism for Influencing Consumer Credit 73 

Elements of Selective Mechanism 77 

Coordination of General and Selective Instruments 81 

Outlook for the Selective Concept 82 

Conclusion 87 

PROBLEMS OF POSTWAR MONETARY POLICY 

WOODLIEF THOMAS AND RALPH A. YOUNG 88 

Methods and Consequences of War Finance 90 

Maintenance of Interest Rates 91 

Effect of War Loan Drives 94 

Wartime Expansion of Bank Credit and Money 94 

Financing Policies in the Transition Period 97 

Nature of the Postwar Problem 101 

Interest-Rate Policy 102 

Flexible Interest-Rate Policy 103 

Limitations on Flexible Interest-Rate Policy 104 

Conclusions as to Interest Rates 107 

Debt-Management Policies 108 

Selective Credit Controls Ill 

Proposals for Additional Controls 112 

The Primary Reserve Plan 113 

The Secondary Reserve Plan 114 

The Bond Limitation Plan 115 

Application of the Proposals 117 

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Federal Reserve Bank of St. Louis
THRE E DECADES O F FEDERA L RESERV E POLICY 

by 

KARL R. BOP P 

Vice President, Federal Reserve Bank of Philadelphia 

If we can see farther than our forebears, surely it is not because our 

sight is keener but because we stand on their shoulders. By the same 

token we cannot see things exactly as they saw them, because our points 

of view are different. As one reads history, appropriate allowance must be 

made for the tendency of each generation to exaggerate the nature and 

magnitude of its own accomplishments. It is sobering to reflect that the 

complexity of the problems may have increased more rapidly than our 

ability to comprehend and solve them, though in this respect, too, 

contemporaries tend to exaggerate. 

The first thesis of this paper is that gradually over the past three 

decades greater emphasis has been placed on a broader, more human 

approach and less on a formal, mechanistic approach to central bank 

policy. Central banking, of course, was not a routine operation when the 

Federal Reserve System was established; but the emphasis that was 

placed on such factors as the definition of eligibility and the reserve 

ratio indicates that judgment and management were circumscribed by 

the tenets of the original conception. As one simple formula after another 

has proved inadequate or inappropriate, judgment has become increasingly important. 

The second thesis is that several issues on which judgment is needed 

have emerged as of permanent and crucial importance. These issues are 

(1) adequacy of powers to discharge responsibilities, (2) determination as 

to when a program should be reversed, (3) determination of the speed and 

scale of action, and (4) resolution of conflicting objectives. Although 

the powers of the System have been enlarged, some important monetary 

instruments have been placed in the hands of other agencies and the 

course of economic development seems, in certain directions at least, to 

be less and less subject to significant influence through strictly monetary 

devices. The importance of monetary policy arises from the fact that 

though an appropriate policy is not a sufficient condition for a healthy 

economy, it is a necessary condition and that an inappropriate policy can 

do much harm. 

1 

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2 FEDERAL RESERVE POLICY 

The third thesis is that these developments have increased greatly the 

difficulties confronting Federal Reserve authorities in discharging their 

responsibilities. They must resolve conflicts of objectives and be continuously prepared to take vigorous and timely action within the limits of 

their authority. Such action can be facilitated by utilizing the best tools of 

analysis in preparing plans to meet various possible developments. 

Adaptation of a plan to current conditions requires judgment, based on 

thorough information, as to the exact state of developments. Execution 

of the program thus requires comprehension and courage. Because it 

"is concerned, not merely with the relation of cause to effect, but with the 

relation of means to end/' Ralph Hawtrey, an eminent authority, has 

classed xentral banking properly as an art and not as a science, though 

"it is not for that reason any the less scientific."* 

EVOLUTION OF FEDERAL RESERVE POLICY 

Crowded into the first three decades of the Federal Reserve System 

have been two world wars, a turbulent boom, and the Great Depression. 

Yet periods of rapid change were punctuated by periods in which the 

economy seemed lodged at dead center. It is easier to write the history of 

such a period than to have been currently responsible for policy. Yet the 

very difficulties of these trying times point to conclusions relevant to the 

formulation of future Federal Reserve policy. 

Original Principles. The enumerated objectives of the Federal Reserve 

Act are: to establish Federal Reserve Banks, to furnish an elastic currency, 

to afford means of rediscounting commercial paper, and to establish a 

more effective supervision of banking. The Reserve authorities were not 

given exclusive jurisdiction over bank supervision because of our pluralistic system of banking. The remaining purposes clearly reveal the 

limited initial conception of the System. The predominant view that 

found expression in the Act was that these purposes could be served almost automatically by giving the Reserve Banks authority to create 

deposits or issue notes in exchange for gold and "self-liquidating'' commercial paper. Adjustment to regional needs was made possible by authorizing Reserve Banks to rediscount for one another, to receive checks 

and drafts on deposit at par, and through the establishment of a Gold 

Settlement Fund. 

It was thought that any change in the volume of "actual commercial 

1

 R. G. Hawtrey, The Art of Central Banking (London, 1932), p. vi. 

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THREE DECADES OF FEDERAL RESERVE POLICY 3 

transactions" would result in an appropriate change in the volume of 

eligible paper presented for discount to the Reserve Banks and would 

initiate automatically the required change in Reserve Bank credit. Some 

difficulties were anticipated in applying these principles to American conditions; but it was felt that they could be resolved by directing the 

Federal Reserve Board to "adjust the definition [of commercial paper] to 

the practices prevailing in different parts of the country."2 The Board 

"felt that the regulations relating to discount operations and commercial 

paper in general were fundamental" and made sincere efforts to devise 

appropriate definitions and to develop trade practices that would create 

eligible paper. Nevertheless "the great release of reserves under the 

Federal Reserve Act produced an unusual ease of money the country 

over" and in the early years few member banks rediscounted paper except 

as a token of cooperation with the new system. To provide a smoother 

discount procedure and to reduce clerical operations, the Act was amended 

in 1916 to permit Reserve Banks to make 15-day advances to members on 

their notes secured by eligible paper or United States Government 

securities. In its report for that year the Board called attention to the need 

for control over the inflowing gold and proposed that it be given power to 

raise reserve requirements in emergencies to enable it "in prolonged 

periods of extreme ease in the money market to check any tendency toward excessive loans or other forms of undue extension of credit." 

The First World War. With the entry of the United States into the war 

in April 1917, the objectives of the Federal Reserve System were enlarged 

to include aid in financing the Government. In recounting the efforts 

exerted by the System to maintain itself "in a strong and liquid condition," Governor Harding mentioned the creation of a general feeling of 

confidence, conservatism in acquiring earning assets and accumulation 

of as much gold as possible by the Reserve Banks, maintenance of adequate stocks of Federal Reserve notes, and aid in the distribution of 

Government securities. 

The compelling objective was to enable the Treasury to secure whatever 

funds it needed. The policy of the System was directed toward selling as 

many bonds as possible to nonbank investors and at the same time toward 

assuring the banking community that needed reserves would be forthcoming without penalty. The Reserve System played an important role in 

2

 Unless indicated otherwise, all quotations are from official sources or statements of System 

authorities. 

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4 FEDERAL RESERVE POLICY 

selling bonds to the nonbanking public. The governors of the Reserve 

Banks were appointed heads of the regional loan organizations which were 

created along Reserve district lines. They organized and directed the 

Liberty Loan campaigns which reached every hamlet and village in the 

country. 

The System recognized that "the commercial banks of the country .. . 

ought to act as distributors . . . rather than to absorb and hold the bonds." 

At the same time it established preferential rates of discount on notes 

secured by Government obligations to facilitate "the operations of the 

member banks in placing the bonds in the hands of actual investors who 

might not be in possession of the funds necessary to pay their subscriptions in full at the time of receiving the bonds." The preferential rate was 

established to make banks "feel free to assist would-be bond buyers, 

knowing that they could protect themselves if necessary by rediscounting 

the paper with the Reserve Bank." It has been estimated that on June 30, 

1919, commercial banks had extended 2.5 billion dollars indirectly to the 

Government on the basis of this "Borrow and Buy" program. They also 

had extended 4 billion dollars directly through purchases for their own 

portfolios of Government war securities. Finally, unlike in the recent war, 

banks greatly increased their loans to business, especially to enterprises 

engaged in war production. 

Postwar. The end of the war brought a sharp contraction, but after 

five or six months inflationary developments were resumed, bringing the 

Reserve officials difficult problems of choosing among conflicting objectives: consideration for the continuing needs of the Treasury would place 

emphasis upon holding discount rates at a level commensurate with the 

coupon rates on Government securities; consideration for the developing 

inflation would place emphasis upon raising discount rates to penalty 

levels. An attempt was made to resolve this dilemma through compromise. 

Rates were not advanced since "the Government had an unwieldy floating 

debt and Liberty bonds were largely unabsorbed" but banks and investment houses were urged to cooperate in "credit conservation" by restricting loans and investments to those needed by Government and 

industries engaged in essential work. This attempt at selective credit 

control did not accomplish its twofold objective. It satisfied the Treasury; 

but the Reserve System's warnings "were given only momentary attention by many banks," and inflationary pressures continued to accumulate. 

Not until December 1919 did the Board feel that "the program of the 

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THREE DECADES OF FEDERAL RESERVE POLICY 5 

Treasury for the adjustment of the floating debt had advanced to a stage 

where it could no longer be seriously affected by the adoption of a more 

normal banking policy." Virtually every analyst who has viewed this 

period in retrospect agrees that it was a serious error to wait so long to 

bring credit "under effective control." There was no longer any question 

of seriously conflicting developments. The year or more preceding the 

summer of 1920 "was characterized by an unprecedented orgy of extravagance, a mania for speculation, over-extended business in nearly all 

lines and in every section of the country, and general demoralization of 

the agencies of production and distribution." In addition the reserve ratio 

was approaching its legal minimum. Without a change in the law—which 

was not considered—the System had very little more to lend. 

At the close of 1919 it was the Board's conviction "that a substantial 

advance in all discount rates was necessary and that it should not be long 

delayed." It did not wish to accomplish "deflation . . . merely for the sake 

of deflation and a speedy return to 'normal' " and had no "intention to 

deny proper accommodation to agriculture, commerce, and industry, for 

any such limitation would defeat the very object of its policy." The intention in raising rates in May 1920 was "to discourage applications for 

rediscount for nonessential purposes," to accomplish "a sensible and 

gradual liquidation." Governor Harding expressed the opinion of the 

Reserve authorities when he said: "Here is an opportunity for wise discrimination, and this discrimination can be exercised more intelligently 

and effectively by the individual banker himself than by any governmental board." 

The hope of the Reserve authorities was that "credit should do its part 

in bringing about the readjustment, and should be made sufficiently expensive to exert pressure and discourage unproductive and unnecessary 

uses. But the movement should be gradual and orderly; sudden credit or 

price deflation might lead to disaster." 

Even after increases in Federal Reserve Bank rates they remained considerably below open market rates on commercial paper. Available 

business indicators were still rising, and the Reserve authorities could not 

have known in May 1920, when the decision was reached to raise rates 

again, that the postwar boom was at its peak. There ensued one of the 

most rapid and severe price declines in all history. The earlier stages of 

this reaction were viewed as an inevitable part of the process of "returning 

to normal" after the war. "The great economic reaction was not, however, 

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6 FEDERAL RESERVE POLICY 

reflected immediately in the operations of the Federal Reserve System. . . . The expansion of the loans of the Federal Reserve Banks continued until early in November and of Federal Reserve note issues until 

December 23, 1920." The reserve ratio varied within the narrow limits of 

a few points above the legal minimum through the year 1920. 

The authorities continued to exert pressure in the early part of 1921, 

although the reserve ratio improved rapidly and prices and production 

had fallen continuously and rapidly for considerable periods. They did not 

increase Reserve Bank rates; but existing rates, which were maintained, 

became more deterrent as market rates declined. In addition they maintained and even intensified their efforts to force member banks to repay 

their indebtedness and followed a rather rigid examination policy. One 

reason was the feeling among the authorities that the preceding inflation 

had not been completely "liquidated" and that premature lowering of 

rates would revive speculation. Another was the feeling that much of the 

incoming gold, which was primarily responsible for the increase in the 

reserve ratio, would remain only temporarily and that it would be a 

mistake to expand the credit superstructure on such a transitory base. 

Finally there was the desire to maintain discount rate above market 

rate. This rule of thumb was a widely accepted principle of central banking 

tradition. Violation of the principle was blamed for the war and postwar 

inflationary developments. Many persons felt that the principle was universally applicable even to periods of severe credit contraction. This was 

the all but unanimous opinion of the Reserve officials, although they were 

unable to provide a definition of market rate appropriate for the application of the principle. Since according to this principle discount rate must 

remain above the market, any downward movement of discount rate 

had to be delayed until market rates had declined sufficiently to keep discount rate higher even after the change. In other words, discount rate 

had to follow market rate. Some efforts were made to reduce market rates 

by establishing comparatively lower rates on bills and by maintaining 

Treasury certificates at a premium, but no determined efforts were 

made to facilitate revival through deliberate adoption of an easy money 

policy. 

The Middle Twenties. The volume of discounts had fallen from 2.75 

billion dollars in the fall of 1920 to 1 billion at the end of 1921, and a 

number of Reserve Banks became concerned about their earnings. They 

followed the policy that authors of the Reserve Act had indicated as 

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THREE DECADES OF FEDERAL RESERVE POLICY 7 

appropriate for such circumstances; they began to purchase securities to 

maintain earnings. Initial purchases were spasmodic, but it soon became 

apparent that they had important monetary effects. In May 1922 a 

Conference of Governors of the Reserve Banks adopted "a policy of 

buying and selling Government obligations in an orderly, systematic way, 

not solely with regard to earnings, but with regard to the whole credit 

situation and to the interest of the Treasury'' and appointed a Committee 

on Centralized Execution of Purchases and Sales of Government Securities by Federal Reserve Banks. This Committee was reorganized in the 

spring of 1923 and its policy was established "on the same basis as the 

discount policy." The Board established the following principle of operations: "That the time, manner, character, and volume of open market investments purchased by Federal Reserve Banks be governed with primary 

regard to the accommodation of commerce and business and to the effect 

of such purchases or sales on the general credit situation." 

Open market operations and rate policy were thus made coordinate instruments of Federal Reserve policy. In some respects open market 

operations were given first place. Changes in direction of policy first became apparent in the security portfolio. Open market operations, together 

with such external factors as gold and currency movements, initiated 

changes in market rates. The New York Bank rate, on the other hand, 

was changed usually merely to restore its position—between the commercial paper and bankers' acceptance rates—in the structure. When one 

considers the rate structure alone, it is clear that discount rate followed 

market rates. The structure would have been quite different had an active 

rate policy been followed. Since the purpose of increasing the rate would 

have been to discourage borrowing positively, increases would have been 

sufficient in amount to place discount rate significantly higher in the whole 

structure of market rates—specifically, somewhat above the commercial 

paper rate. Similarly, since the purpose of decreasing the rate would have 

been positively to encourage borrowing, the decreases would have placed 

discount rate lower in the market rate structure—specifically, below the 

bankers' acceptance rate. The passive rate policy was a consequence of 

faith in the so-called tradition against rediscounting, discussed on pages 

5 and 6. 

Broadly speaking, viewing instruments as a whole, the policy of the 

System was "to exercise its influence toward restraint at times when 

business and speculative activity appeared excessive, and to remove 

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8 FEDERAL RESERVE POLICY 

credit restraint at times of business depression in the hope that this policy 

might aid in avoiding the extremes of business expansion and contraction 

and encourage greater business stability." 

In addition to contributing to reasonable stability in the 1920,s the 

Reserve authorities perfected methods of virtually eliminating seasonal 

variations in interest rates, money market disturbances that originate in 

Treasury financial operations, and of providing a more elastic credit to 

meet sudden emergencies. It is difficult, perhaps, at this late date to 

appreciate adequately the importance that was once attached to these 

problems; yet not so long ago they were part of the very tissue of discussions of central banking policy. Stanley Jevons, Giffen, and Palgrave in 

England; Helfferich, Plenge, and Bendixen in Germany wrestled with the 

problems, and Kemmerer made an exhaustive study of them for the 

National Monetary Commission prior to the establishment of the Federal 

Reserve System. The remedy, developed in the 1920's, is to vary the 

amount of reserves provided to the market so as to maintain relatively 

stable rates over the seasons, at times of Treasury operations, and in 

emergencies. As C. O. Hardy concluded, "These cases are all excellent 

examples of the sort of service which a central banking system can render, 

for which it gets very little credit; for the potential disturbances which are 

prevented from occurring never come to the attention of the public."8 

End of the "New Era." Some businessmen and analysts, however, 

made much more extravagant claims. They spoke glibly of a new era of 

perpetual prosperity and felt that the business cycle was a matter of 

historical interest only. But toward the end of the twenties various economic forces began to move seriously in different directions. For example, 

a peak was reached in commodity prices in 1925 and in awards of construction contracts in 1928, but security prices and brokers' loans continued to 

rise at an accelerated rate. As was the case during the war and postwar 

boom and again during the depression, the Reserve authorities were 

confronted with conflicting objectives, which the Board expressed as 

follows: 

The problem was to find suitable means by which the growing volume of security 

credit could be brought under orderly restraint without occasioning avoidable pressure on commercial credit and business. With the system portfolio of Government 

* C. O. Hardy, Credit Policies of the Federal Reserve System (Washington, 1932), p. 71. See, 

however, p. 14 below for the policies in conflict with these principles followed in 1931 and 

1933. The principles were followed in 1939 and 1941; see p. 17 below. 

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THREE DECADES OF FEDERAL RESERVE POLICY 9 

securities practically exhausted by the sales made in the first half of the year 1928, the 

main reliance in a further firming of money conditions must have been further marking 

up of Federal Reserve discount rates, unless some other expedient could be brought to 

bear in the situation. 

The Board devised a method of "direct pressure" to meet the situation. 

In a public statement issued on February 7, 1929, it stated that "a member bank is not within its reasonable claims for rediscount facilities at its 

Federal Reserve Bank when it borrows either for the purpose of making 

speculative loans or for the purpose of maintaining speculative loans." 

In the Board's Annual Report for 1929 it was noted that "for eight weeks 

following the issuance of the Board statement.. . security loans fluctuated irregularly without definite trend, but in the first part of April they 

turned definitely downward and continued to decline until the end of May. 

During June, July, and August, however, speculation in securities once 

more became active and the demand for security loans increased rapidly 

as stock prices advanced by about 25 per cent." 

The policy of direct pressure was abandoned in the summer of 1929 

partly because most of the increase in brokers' loans was not for the account of banks but for the accounts "of others"—corporations, investment 

trusts, and so on—and was thus beyond direct control of the System. In 

August a new technique was devised with the hope of exerting pressure on 

the speculative situation without harm to business. On August 9 the 

discount rate of the New York Bank was raised from 5 to 6 per cent and 

at the same time the Bank's buying rate for bankers' acceptances was 

reduced from 5\ to 5 | per cent. 

A series of bearish events culminated in the last week of October 1929 

in a break in the stock market which by the middle of November carried 

average quotations down 40 per cent from the high point that had been 

reached early in September. Within a week lenders outside the New York 

banks withdrew over 2 billion dollars of loans to brokers and dealers. 

Since the restrictive policy of the Federal Reserve System was occasioned 

exclusively by credit developments in the securities market, the liquidation was accompanied by an immediate reversal in that policy, although 

apparently on the spur of the moment. During the first week the Reserve 

Banks bought 150 million dollars of Government securities to provide 

reserves for New York banks, which took over 1,400 million dollars of the 

loans withdrawn by outsiders. The New York Bank reduced its discount 

rate from 6 to 5 per cent on November 1 and to 4J per cent on November 15. 

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10 FEDERAL RESERVE POLICY 

The Great Depression. After the collapse voices were raised again to 

urge that steps be taken in the public interest to prevent a recurrence of 

speculative excesses. It had become increasingly apparent during the 

twenties that the self-liquidating commercial paper theory, on which the 

original Reserve Act had been based, was an inappropriate method of 

regulating credit. As the Board stated in its Annual Report for 1923: 

There are no automatic devices or detectors for determining, when credit is granted 

by a Federal Reserve Bank in response to a rediscount demand, whether the occasion 

of the rediscount was an extension of credit by the member bank for nonproductive 

use... . The technical administrative problem presented to each Reserve Bank is that 

of finding the ways and means best suited to the circumstances in which it operates of 

informing itself of when and to what extent the extension of credit for speculative uses 

is the real occasion of member bank rediscounting. 

These conclusions, on which the direct action policy of early 1929 was 

based, were reflected in the Banking Act of 1933. This Act envisioned exercise of powers through control over the uses to which Reserve Bank 

credit was put by member banks directly or indirectly and dealt exclusively with operations to which banks were a party. It established 

explicitly the right of a Reserve Bank to refuse for cause credit accommodation to a member that presented eligible and acceptable paper. 

The Reserve System was directed and empowered to prevent undue use 

"of bank credit for the speculative carrying of or trading in securities, real 

estate, or commodities, or for any other purpose inconsistent with the 

maintenance of sound credit conditions." The instruments of administration were authorization to the Reserve Banks to refuse credit 

accommodation to offending members and authorization to the Reserve 

Board "to fix . . . the percentage of individual bank capital and surplus 

which may be represented by loans secured by stock or bond collateral." 

The Act also prohibited member banks from acting as agents of nonbanking lenders in making security loans to brokers and dealers. 

The next step in the regulation of speculation was to deal directly with 

credit on securities rather than with the operations of banks alone or with 

all types of speculative credit. The Securities Exchange Act of 1934 supplemented the Banking Act of 1933 and empowered the Board to prescribe 

minimum margin requirements for purchasing or carrying securities or 

selling them short. 

This was a significant departure in method of control. It singled out a 

particular field of credit and directed the Reserve Board to regulate that 

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THREE DECADES OF FEDERAL RESERVE POLICY 11 

field directly rather than indirectly through denial of access to the Reserve 

Banks. It was an attempt to meet the difficult problem of adapting policies 

to conflicting developments in different fields. It was the first specific 

legal instrument of selective control of credit. 

Whereas the speculative excesses of the 1920's indicated that member 

banks might not be entitled to Reserve Bank credit merely because they 

were able to offer paper that met the formal standards of eligibility and 

acceptability, the depression demonstrated that the public interest might 

require that a bank be able to secure Reserve credit even though it had no 

such paper. Although faith in eligibility rules as a control device wavered 

from time to time, as in 1923, such rules were not abandoned immediately 

with the onset of the depression. The principle underlying the original 

Act was still evident in the proposal of the President on October 7, 1931, 

that a national institution be formed to rediscount "banking assets not 

now eligible for rediscount at the Federal Reserve Banks in order to assure 

our banks, being sound, that they may attain liquidity in case of necessity, 

and thereby enable them to continue their business without the restriction 

of credits or the sacrifice of their assets." A limited departure from the 

original principle was contained in the proposal of the President to the 

Congress "that the eligibility provisions of the Federal Reserve Act should 

be broadened in order to give greater liquidity to the assets of the banks, 

and thus a greater assurance to the bankers in the granting of credits by 

enabling them to obtain legitimate accommodation on sound security in 

times of stress." 

The Congress was not disposed to abandon the principle of control 

through eligibility requirements. The Glass-Steagall Act of February 27, 

1932, empowered the Reserve Banks to make advances to member banks 

that did not have adequate eligible and acceptable paper, but only 

"until March 3, 1933, and in exceptional and exigent circumstances" and 

subject to penalty rates and other restrictions. Subsequent legislation 

extended eligibility provisions to meet particular situations. Meanwhile 

the Board restated its position as follows: "Experience shows that the 

particular instrument on which Federal Reserve credit is obtained is not 

an adequate test of the use to be made by the member bank of the proceeds of the credit." 

Finally the original principle was abandoned in the Banking Act of 1935 

which provides that "any Federal Reserve Bank .. . may make advances 

to any member bank on its time or demand notes .. . which are secured to 

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12 FEDERAL RESERVE POLICY 

the satisfaction of such Federal Reserve Bank." The provision applied 

only to advances; yet the change is fundamental. The Board issued a new 

regulation in keeping with it. In effect this regulation made "all sound 

assets of member banks a potential basis of advances by the Federal 

Reserve Banks." The Board reiterated the view that "under the law a 

bank is not entitled to credit from a Federal Reserve Bank merely because 

it has eligible and acceptable paper." These new principles "mark a 

definite recognition of the fact that the lending function of the Federal 

Reserve Banks is not automatic but is an instrumentality of the System's 

general credit policy." 

The depression produced a similar change in law and practice as to 

collateral eligible for Federal Reserve notes. Originally Reserve Banks 

were permitted to issue Federal Reserve notes only against eligible discounts and acceptances and were required, in addition, to maintain a 

reserve of at least 40 per cent in gold against them. Acting upon a suggestion of the Board, the Congress modified this provision in 1917 to permit 

issuance of notes against either gold or discounted paper, provided the 

combined coverage was at least 100 per cent and the gold reserve at least 

40 per cent. Although discounts of member banks secured by United 

States Government obligations were eligible collateral for Federal Reserve 

notes, Government obligations themselves were not eligible. This limitation seriously restricted the power of the System to cope with the outflow 

of gold and the hoarding of currency that accompanied the departure of 

the United Kingdom from the gold standard in 1931. Money that the 

Reserve Banks might have put into the market through purchases of 

Government securities would have been used by member banks primarily 

to repay their borrowings from the Reserve Banks. The shift in earning 

assets from discounts, which were eligible collateral for notes, to Government securities, which were not, would have forced the Reserve Banks to 

use additional amounts of their declining gold reserves as collateral. The 

System was slow in proposing legislation to overcome this difficulty. Not 

until February 1932 was the law changed to permit Government securities 

to serve as collateral for notes. Initially the change was viewed as an 

emergency measure and a limit was placed on the period for which it was 

to be effective. The limit was extended a number of times before the 

original principles of note collateral were abandoned when the authority 

was made permanent in June 1945. 

After the passage of the Glass-Steagall Act the System began to purchase Government securities, slowly at first and then more vigorously 

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than ever before, and increased its holdings from 740 million dollars at the 

end of February 1932 to 1,800 million at the end of June. The portfolio 

remained at approximately this figure until May of 1933 when, two 

months after the banking holiday, further purchases were begun which 

carried the portfolio to 2,400 million dollars in October. 

The so-called easy money policy of the Reserve System early in the 

depression can be analyzed more fruitfully with reference to the background against which it developed rather than by comparison with more 

recent actions. Some considered the depression necessary and inevitable 

to purge the economy of the extravagances of the new-era prosperity. 

This feeling was accompanied by an unwillingness to do anything that 

might involve a return of what were considered the artificial conditions 

of that period. For a time there was both a return to traditional theories 

and principles and a hesitancy to devise or employ vigorously new 

techniques of monetary management. These developments are illustrated 

in the caution with which the Reserve officials pressed for extension of the 

discount facilities of the System and the collateral provisions for Federal 

Reserve notes. Furthermore, the magnitudes to which the Reserve officials 

were accustomed in 1930 were very small compared with those that have 

become current lately. To illustrate, for only two short periods prior to 

1930 had the System's portfolio of Government securities exceeded 500 

million dollars; recently it has acquired more than 1,000 million in a 

single month. In 1932, 120 million was a "considerable volume" of excess 

reserves; in 1940 excess reserves, largely as a result of gold imports, 

approached 7,000 million. As a consequence, even those actions which 

were considered bold at the time may now appear to have been timorous. 

The first limited goal of the System in its efforts to create easy money 

was to provide member banks with sufficient funds to repay their indebtedness to the Reserve Banks. This goal was indicated by the importance the Reserve officials attached to the volume of such indebtedness 

in influencing member banks. "Their lending and investing policy is very 

closely related indeed to the amount of such indebtedness. . . . The 

principle of open market operations may be summarized by saying that 

purchases of securities by Reserve Banks tend to relieve member banks 

from debt to the Reserve Banks, and lead them to adopt a more liberal 

lending and investing policy. Money rates become easier; bank deposits 

increase. Such purchases tend to create a borrower's market/' 4 

The assumption was that member banks would not hold reserves sub-

* W. R. Burgess, The Reserve Banks and the Money Market (New York, 1936), pp. 238-39. 

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stantially in excess of legal requirements but would utilize newly acquired 

reserves first to repay borrowings from the Reserve Banks and then to increase earning assets. This assumption seemed to be justified by experience 

during most of the period prior to 1932. The first objective of Reserve 

policy was to eliminate indebtedness of member banks so as to put them in 

position to expand freely. Reduction of indebtedness was interrupted by 

the international crisis in 1931 and the banking holiday of 1933, when the 

System followed the traditional policy, enunciated by Walter Bagehot 

over half a century before, of making funds available though expensive. 

The System did not obviate the need to borrow additional sums by 

placing funds in the market on its own initiative through purchases of 

Government securities in significant volume in either of these periods; 

but it did lend and buy roughly 1 billion to 1.5 billion dollars in each 

instance at the initiative of the market, though at higher rates than were 

charged before the crises. 

Purchases of Government securities in the summer of 1933 virtually 

eliminated member bank indebtedness. As member banks got out of 

debt, however, they did not utilize fully additional reserves to expand but 

allowed their actual reserves to increase beyond legal requirements. As a 

consequence, by the time indebtedness had been reduced to a small 

amount on the part of a few banks, members as a whole had acquired 

several hundred million dollars of excess reserves. 

A new principle, that of direct lending, was introduced in June 1934 to 

assure that recovery would not be impeded by inability of an established 

industrial or commercial business to obtain requisite financial assistance 

on a reasonable basis from the usual sources. The Reserve Banks were 

authorized to "make loans to, or purchase obligations of, such business, or 

make commitments with respect thereto." 

The problem of reserves, however, remained of crucial importance. It 

is a subject that receives continuous study and periodic reappraisal. For 

example, the Board had called attention to it in 1916 when it requested 

power to raise reserve requirements. Again, on December 12, 1929, the 

Conference of Governors adopted a resolution recommending "the most 

careful scientific study by experts devoting their entire time to the matter 

with a view... to establish bank reserves throughout the country on a 

more logical or effective basis." In its report made public in November 

1931 the Committee on Bank Reserves of the Federal Reserve System 

pointed out that "the most important function served by member bank 

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THREE DECADES OF FEDERAL RESERVE POLICY 15 

reserve requirements is the control of credit" and recommended that 

requirements be based on "the activity as well as the volume of 

deposits held by each individual member bank." Other reserve proposals 

were brought forward but none was enacted into law until the so-called 

Thomas Amendment of May 1933 empowered the Reserve Board 

"with the approval of the President" to change reserve requirements 

"during emergencies by reason of credit expansion." The Banking Act of 

1935 gave the Board exclusive power over reserve requirements of member 

banks but only between one and two times the ratios stated in the law. 

Thereafter the Reserve authorities could influence excess reserves 

either through changes in total reserve balances or through changes in 

required reserves. After the official revaluation of gold, which coincided 

with the virtual elimination of member bank indebtedness, the Reserve 

authorities took no actions designed to influence total reserve balances 

until after our entry into the war. Purchases of securities to relieve pressure on individual banks resulting from the increase in requirements in 

1937 and the decision not to acquire Treasury bills on a no-yield basis in 

1939, however, had incidental effects on total reserves. 

The chief influence on total reserve balances was the large and persistent increase in gold which greatly exceeded the flow of money into 

circulation. A related factor, important at times, was the policy of the 

Treasury with respect to the size of its deposits at the Reserve Banks and 

with respect to sterilization of gold imports. The importance of external 

forces in total reserve balances created a new dilemma for the Reserve 

authorities which they expressed in 1935 as follows: "The country is still 

short of a full recovery" but the "volume of member bank reserves. . . 

continues to be excessive, far beyond the present or prospective requirements of credit for sound business expansion." The problem of the System 

was "to lend its efforts to a furtherance of recovery" without initiating 

uncontrollable inflationary developments. 

As an aid to recovery the System reduced its rates on discounts and 

advances as well as maximum rates allowable by member banks on time 

deposits. As a preventive of inflationary developments the Board announced that it was giving "frequent consideration to probable future 

changes in the volume of excess reserves, to possibilities of excessive credit 

expansion on the basis of these reserves, to methods of reducing the 

reserves and controlling credit expansion, and to the proper timing of such 

action." 

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In 1936 and again in 1937 when the Board increased requirements it 

was careful to point out that "it was not the intention to reverse the policy 

of monetary ease which has been pursued by the System since the beginning of the depression. Rather it was an adjustment to a changed 

reserve situation brought about through the extraordinary inflow of gold 

from abroad. While there was no evidence of actual excessive expansion 

in bank loans, the excess reserves provided the basis for such an expansion, 

and it was considered far better to sterilize a part of the superfluous 

reserves while they were still unused than to permit a credit structure to 

be erected upon them and then to withdraw the foundation of the structure. At the time of taking action to increase reserve requirements the 

Board announced that the Federal Reserve System proposed to continue 

its policy of exerting its influence toward the maintenance of easy money 

conditions for the encouragement of full economic recovery. Analysis 

indicated that reserves were not only large but well distributed so that 

all but a relatively small number of member banks were in a position to 

meet the increased requirements either by utilizing their excess reserve 

balances with the Reserve Banks or by drawing upon their excess balances 

with correspondent banks." 

When some banks sold Government securities in March 1937 to meet 

the increases in requirements or for other reasons, the System bought 

bonds and reduced its holdings of notes and bills. On April 4 the Federal 

Open Market Committee issued the following statement: "With a view 

(1) to exerting its influence toward orderly conditions in the money market and (2) to facilitating the orderly adjustment of member banks to the 

increased reserve requirements effective May 1, 1937, the Open Market 

Committee of the Federal Reserve System is prepared to make open 

market purchases of United States Government securities for the account 

of the Federal Reserve Banks in such amounts and at such times as may 

be desirable." 

The "shift in emphasis in the use of open market operations from their 

influence on member bank reserves to their direct influence on conditions 

in the capital market" was reflected in the operations of 1939. Beginning 

in June the System decided that "no useful purpose would be served by 

continuing to replace maturing bills for which there was a strong demand 

in the market." The reduction in portfolio, which was incidental to this 

policy, did not reflect a change in the general policy of monetary ease. 

The Second World War. The System prepared well in advance to meet 

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THREE DECADES OF FEDERAL RESERVE POLICY 17 

the serious disturbances to the securities markets in this country that 

might be expected from an outbreak of armed conflict in Europe. On 

April 19, 1939, the Federal Open Market Committee unanimously 

authorized the executive committee to make large purchases of securities 

so that the System would "be prepared to exercise its influence toward 

preventing disorderly conditions in the market for Government securities" and "for the purpose of exercising an influence toward the maintenance of orderly market conditions." 

With the outbreak of war in Europe the System "deemed it to be in the 

public interest to exert its influence in a positive way toward maintaining 

orderly conditions in the market for United States Government securities." Instead of leaving it to banks to borrow and increasing rates, as 

central banks had formerly done in crises, the Reserve System purchased 

over 470 million dollars of securities from timid holders and announced 

that "all the Federal Reserve Banks stood ready to make advances on 

Government securities to member and nonmember banks at par and at 

the discount rate." This application to crises of the technique devised to 

deal with disturbances arising from seasonal needs and Treasury operations represents a forward step in central bank administration. The 

effectiveness of the new procedure was demonstrated when relatively 

modest purchases quickly steadied the market for Government bonds 

after the entry of the United States into the Second World War. 

Increased war production and employment expanded civilian purchasing power beyond the expansion in available civilian goods. The resulting inflationary pressures called for anticipatory restraint and on September 23, 1941, the Board increased reserve requirements to the maximum 

permitted by law. This act reversed the reduction that had been made 

in requirements in 1938 as part of the national program for arresting declines in business and employment and encouraging economic recovery. 

Meanwhile the President, under his emergency powers, authorized and 

directed the Board "to exercise a measure of control over consumer 

credit." This was the second selective instrument of credit control to be 

placed in the hands of the Reserve authorities. The technique devised was 

to prescribe minimum down payments and maximum maturities applicable to consumer credit extended through instalment sales of certain 

listed articles and instalment loans for the purchase of these articles. In 

addition limits were placed on the maximum maturity of miscellaneous 

cash loans of $1,000 or less repayable in instalments. 

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A frequently reiterated desire throughout the financing of the Second 

World War was that as large an amount of funds as possible be secured 

from nonbank sources and especially from current income. This general 

statement, of course, still leaves undetermined the amount of funds desired from banks. In reviewing Federal Reserve policy during the period 

of United States participation, it is helpful to recall that until about the 

time of the Second War Loan Drive in April 1943 it was necessary to encourage banks to take even the "residual" amount of securities not taken 

by others. It is easy to forget that banks were called upon at the last 

minute virtually to underwrite two new issues of securities in October 

1942. To those who recall those days, however, it will not be necessary 

to demonstrate that the initial problem was to encourage bank participation. Commitments made and programs adopted in this early period 

became increasingly serious obstacles when the problem, after the middle 

of 1943, became that of discouraging unnecessary bank acquisition of 

Government securities. 

The two primary objectives of the System were (1) to maintain relative 

stability in the Government security market, thereby assuring to the 

Treasury availability at low rates of whatever funds it needed, and (2) 

to restrict the creation of purchasing power to the minimum consistent 

with the achievement of the first objective. The initial objective was to 

assure adequate funds, and maintenance of stability was viewed as a 

means of accomplishing it. With the passage of time, however, stability 

became the actual objective with the result that more funds were created 

than it was necessary to create. 

As a contribution to achievement of the first objective the System issued 

the following statement when the United States entered the war in December 1941: 

The financial and banking mechanism of the country is today in a stronger position 

to meet any emergency than ever before. 

The existing supply of funds and of bank reserves is fully adequate to meet all 

present and prospective needs of the Government and of private activity. The Federal 

Reserve System has powers to add to these resources to whatever extent may be required in the future. 

The System is prepared to use its powers to assure that an ample supply of funds 

is available at all times for financing the war effort and to exert its influence toward 

maintaining conditions in the United States Government security market that are 

satisfactory from the standpoint of the Government's requirements. 

Continuing the policy which was announced following the outbreak of war in 

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THREE DECADES OF FEDERAL RESERVE POLICY 19 

Europe, Federal Reserve Banks stand ready to advance funds on United States Government securities at par to all banks. 

The most important single decision was, by agreement with the Treasury, to establish a structure or pattern of rates that the System would 

maintain. The decision to stabilize yields was based on the desire to 

keep down the cost of borrowing to the Treasury and to remove any 

incentive that might exist for delaying purchases in the expectation of 

higher yields. The structure agreed upon involved a slight modification 

of the pattern that had developed during the prewar years when excess 

reserves were abundant, demand for loans was slow, and the supply of 

desirable securities was small. It ranged from f per cent on 90-day bills, 

through | per cent on certificates of indebtedness and 2 per cent on eightto ten-year bonds, to 2 | per cent on the longest bonds. 

The f per cent rate was maintained by means of the policy adopted with 

respect to Treasury bills. On April 30,1942, the Reserve Banks announced 

their readiness to purchase unlimited amounts of bills at f per cent. In 

August 1942 they agreed also to grant the seller a repurchase option at the 

same rate. These commitments, in addition to pegging the bill rate at f 

per cent, were an inducement to banks to invest their excess reserves in 

bills. Bills became as liquid as cash and the policy in effect enabled banks 

to secure f per cent on their excess reserves. The System maintained ready 

availability of credit through this policy on bills rather than by maintaining a large volume of excess reserves as some proposed. The absorption of excess reserves was desired both because pools of excess reserves 

are available for credit expansion at any time at the initiative of the holder 

and are therefore beyond control, and because utilization of excess reserves 

would reduce the amount of additional Reserve Bank credit it would be 

necessary to create to finance the war. 

Rates for other Treasury securities were prevented from rising above 

the pattern by open market purchases of individual issues of certificates, 

notes, and bonds. 

The market was reinforced also by means of low discount rates. The 

standard rate was set at one per cent; and the short end was bolstered by 

the introduction in October 1942 of a preferential rate of one-half per 

cent on advances to member banks secured by United States Government obligations maturing or callable in one year or less, with a view to 

encouraging banks to invest in short-term securities. 

The relative importance of these methods of extending Reserve Bank 

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credit changed significantly as the war progressed, especially after the 

summer of 1942 when the volume of Reserve Bank credit began to increase. These changes reflected primarily the availability of various issues 

and market opinion. In the second half of 1942, and especially after the 

new issues in October, the entire market was weak and the System acquired a billion dollars each of bonds, certificates, and bills as well as half 

a billion of notes. 

Maintenance of the pattern of rates, however, provided a strong and 

continued inducement to investors to lengthen maturities. What was 

happening was not always understood. Many bankers observed that their 

deposits were rising, giving them more funds to invest. Tradition and 

conservatism led them to buy various maturities in order to maintain 

what they considered a proper balance in their portfolios. The higher rates 

and persistent opportunities for appreciation, however, tempted them to 

increase the proportion of longer issues. Whenever they needed reserves, 

they tended to sell the shorter issues, which they viewed as secondary 

reserves. 

Other investors, including some banks, consciously adopted a policy of 

increasing maturities. Their reasoning was that if a rate pattern is being 

maintained, all issues are equally liquid irrespective of maturities. Although the pattern was not maintained rigidly, only small variations in 

yields were permitted and the risk could be minimized by buying new 

offerings and careful selection of individual issues. In other words, even 

short-term funds could be invested in long-term issues, with little or no 

risk of loss, with the certainty of a higher nominal rate. In addition, 

longer issues were certain to go to a premium with the passage of time 

because they would be priced to yield lower rates as they moved into the 

shorter end of the pattern. The process of selling short issues and buying 

long became known as playing the pattern of rates. 

As long as the Reserve System maintained the pattern, the Reserve 

Banks of necessity became heavy purchasers of short maturities. The 

fact that the Treasury issued large volumes of short-term securities of 

itself gave the market great power over reserves. The holder of an issue 

can demand cash at maturity. As long as the market held large volumes 

of short issues, it was in position to force the monetary authorities either 

to meet its terms or to create new money. A consequence of maintaining 

the established terms was that the monetary authorities lost control over 

the volume of money. The power of the market, which would have been 

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THREE DECADES OF FEDERAL RESERVE POLICY 21 

great if issues had been necessary only for new money, was reinforced by 

the continuous need to meet maturities. At first the Reserve Banks 

bought mostly Treasury bills; but after they had acquired most of the 

outstanding bills it became necessary to purchase large amounts of certificates and short notes. The purchases were made not only from banks but 

also from nonbank investors. Some banks, after they had exhausted their 

bill holdings, also borrowed at the preferential rate on their short-term 

Governments. The System's holdings of bonds, on the other hand, declined from the beginning of 1943 despite frequent offerings of long-term 

issues during war loan drives. The average maturity of securities taken 

tended to increase in the later war loan drives. After the Treasury ceased 

to offer long-term issues, the process produced downward pressure on 

yields of long-term issues. The importance of this process in monetary 

policy arises from the fact that purchases of securities by the Federal 

Reserve System—to maintain the pattern of rates at the short end— 

create additional bank reserves. A large volume of additional reserves 

was needed to supply additional currency. Each dollar of reserves not 

needed for this purpose, however, enabled member banks to expand their 

loans and investments because it is capable of supporting about six dollars of deposits. 

The decision to stabilize rates was basic, but other elements of policy 

were important. One of these was policy with respect to the use of war 

loan accounts. A bank that qualified as a special depositary of public 

monies could pay for new issues of Government securities purchased for 

its own account or for the account of its customers by crediting the war 

loan account of the Treasury instead of transferring funds to the Federal 

Reserve Banks. The use of war loan accounts diminished the effects of 

Treasury borrowings on the money market. In the early days when it was 

desired to encourage bank participation in war loan drives banks were 

urged to use such accounts to the fullest possible extent. As an added 

inducement to their use they were made exempt from reserve requirements and assessment for deposit insurance. Prior to the change a bank 

had to secure additional reserves to meet the requirements against war 

loan deposits created by the purchase of securities for its own account— 

though not, of course, as a result of a shift from balances of customers to 

war loan account. The resulting pressure on reserves during war loan 

drives was an additional reason for recommending the change. After the 

change, a bank no longer needed additional reserves against deposits 

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resulting from its own purchases, while transfers from balances of customers to war loan accounts freed reserves. As a result war loan drives 

tended to produce a temporary excess of reserves. This factor became 

especially important after banks were virtually excluded from direct purchases in war loan drives. Banks used these excess reserves, created during 

the drives, to purchase additional securities in the market. As the Treasury spent funds, deposits were shifted from war loan accounts, which did 

not require reserves, to private demand deposits, which did. Banks met 

such increases in reserve requirements by selling securities, especially 

those of short term. The Reserve Banks bought the securities to maintain 

the pattern of rates and thus created new reserves to meet increasing 

requirements as well as the steady growth of currency in circulation. 

Another element of policy was to direct periodic war loan drives toward 

nonbank investors. Banks were officially excluded, except to a limited 

extent, from the last six drives and from acquisition of securities with 

maturities longer than ten years. On the other hand, local sales committees were zealous of reaching high totals and the results of their efforts 

tended to be measured both locally and nationally by the amounts sold 

and not by the sources of funds. "Roll-over" operations became common, 

especially during drives. Banks, excluded from direct participation in 

drives, were persistent buyers of securities that they were eligible to hold. 

The securities were sold at premiums by savings institutions and other 

corporations who used the proceeds to subscribe for new issues at par. 

In other words, the large totals reached in war loan drives were to a considerable extent a result of expansion in bank credit even though banks 

were excluded from direct purchases from the Treasury. 

Among the more important of the remaining policy acts were (1) reduction of reserve requirements in central reserve cities when local stringencies developed in New York and Chicago; (2) joining with other supervisory agencies in November 1942 in announcing that "banks will not be 

criticized for utilizing their idle funds as far as possible in making such 

investments and loans [in and on Government securities] and availing 

themselves of the privilege of temporary borrowing from or selling Treasury bills to the Federal Reserve Banks when necessary to restore their 

required reserve positions"; (3) advising banks against extending credit 

not related to the war effort and after the Third Drive discouraging banks 

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THREE DECADES OF FEDERAL RESERVE POLICY 23 

ties; and (5) tightening the terms of Regulation W with respect to consumer credit. 

In addition, the System aided in the smooth operation of the complex 

war economy. The largest job in terms of manpower employed was the 

work performed as fiscal agent for the Treasury in the issuance, exchange, 

and redemption of Government securities. Next in terms of volume of 

work was the maintenance of an efficient clearing system for checks. The 

System also was the clearing agent for the ration banking system of the 

Ofl&ce of Price Administration. It administered control of foreign funds 

for the Treasury. It represented the War Department, the Navy Department, and the Maritime Commission in the guarantee of certain loans for 

war production purposes. It participated in the formulation of borrowing 

policies and in the organization of war bond drives. 

In devising policies and programs for financing the war, attention was 

devoted primarily to the nominal interest charge on the public debt. The 

desire to keep creation of bank credit to a minimum was expressed frequently, but the maintenance of the pattern of rates made expansion of 

bank credit profitable. It is not surprising that many accepted the inherent invitation to profit rather than heed the warnings against inflation. 

At the conclusion of the Second World War the same basic forces were 

at work as those operating in 1918-19. The development of these forces 

in the postwar period is analyzed in other papers in this series. Many of 

the magnitudes involved, of course, are much larger. But the authorities 

have to combine or choose between the same conflicting objectives. 

THE EXPERIENCE OF THE 30 YEARS AS A WHOLE* 

The Federal Reserve System was born at the end of an era. As a result, 

the Reserve authorities have had to slough off many rationalizations and 

rules of thumb of central banking widely accepted during that era but not 

appropriate, at least, to the Reserve System. 

One of the most persistent rationalizations was that central bank credit 

can be regulated adequately through properly administered eligibility 

regulations and rules. Experience has demonstrated that such rules permit the extension of excessive credit in periods of prosperity; and that they 

may unduly restrict credit in periods of depression. Experience has demonstrated also that it is impossible to control through eligibility rules the 

uses to which Federal Reserve credit is put; and that if selective controls 

are to be exercised, they must be developed on another basis. 

* The remaining pages in this article were written in 1944. 

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The exceptional character and volume of international gold movements 

demonstrated that the reserve ratio is an unreliable guide to central 

banking policy. The undesirability of expanding even though or merely 

because the ratio was above the legal minimum became apparent during 

the First World War. The error of restricting credit merely because the 

ratio was declining or near the legal minimum was demonstrated in the 

early 1920,s. Thereafter the ratio ceased to be used as a guide to policy. 

The Great Depression demonstrated further that collateral requirements 

for central bank notes can become unduly restrictive. Once redemption in 

gold for internal use was suspended, the only function that gold reserves 

performed was to make international payments. To the extent that the 

Reserve Banks are required to maintain their gold certificate holdings as 

reserves the gold cannot be used for this purpose. Another lesson learned 

early is that earnings are an inappropriate guide or objective of Federal 

Reserve policy. This was demonstrated by the purchases of Government 

securities to increase earnings in 1921 when, fortunately, purchases should 

have been undertaken anyway because of existing general credit conditions. 

From this historical analysis four related problems emerge as of crucial 

and continuing importance in Federal Reserve policy. They are (1) adequacy of power to discharge responsibilities, (2) reversing direction, (3) 

speed and scale of action, and (4) reconciliation of conflicting objectives. 

Adequacy of Power to Discharge Responsibilities. The degree of faith 

in monetary powers varies not unlike the alternating movements of the 

business cycle itself. A high point of confidence was reached in the 

twenties; doubts arose in the early thirties; a new theory of fiscal policy, 

developed to buttress and renew the old faith, soon became a new religion, 

virtually replacing the old by the late thirties. As John Williams expressed 

it: "One of the most striking facts about the development of fiscal policy 

in the past decade is that, while it grew out of monetary policy and was 

designed to supplement and strengthen it, fiscal policy has ended up by 

threatening to supplant monetary policy altogether."5 

Failure to assess the role of monetary policy objectively has had serious 

consequences. It accounts both for the insistence in the middle twenties 

that the Reserve System should not be too much concerned with developments in the securities market and for the later use of general credit 

instruments to control speculative developments in the stock market. It 

6

 American Economic Review, Supplement, March 1942, p. 234. 

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THREE DECADES OF FEDERAL RESERVE POLICY 25 

also accounts in part for the indifference of the Reserve authorities in 

the early thirties to the diffusion of monetary powers among governmental 

agencies. The thirties demonstrated that Federal Reserve policy is not 

so powerful as some had supposed in the twenties; but the twenties 

demonstrated that it is not so impotent as some currently believe. One 

need only consider what would follow if the Reserve System disposed of a 

substantial portion of its Government securities to realize that recent 

skepticism has been carried too far. 

A proposition, confirmed by experience, is that the terms and conditions 

under which reserves and money are created and destroyed influence the 

willingness and ability of the public to acquire, hold, spend, borrow, and 

repay money. Yet if this is the case, monetary policy is a necessary and 

important ingredient in any effective over-all policy. 

The effectiveness of Federal Reserve policy appears to depend largely 

on the stage of the business cycle. This is true because there are two sides 

to the credit market. Broadly speaking, the Reserve authorities can control within limits the supply of credit, but they can influence the demand 

only indirectly. When the core of the problem is to restrict supply, System 

policy can be reasonably effective, because access to money is a necessary 

condition for a boom and the System can usually make money both scarce 

and expensive. Power over reserves and selective controls over security 

loans enable the System to play an important role in such periods, especially if the limitations on these powers, primarily over reserve requirements, are removed. Experience during the middle twenties indicates that 

Federal Reserve policy can be effective also in periods of relative stability 

at high levels of productive employment. Policy was directed toward 

stability and helped to moderate both booms and depressions during that 

period. 

When the problem is to stimulate demand, the effectiveness of Federal 

Reserve policy is much less certain. In depressions the System can make 

money both cheap and plentiful by purchasing securities, lowering reserve 

requirements, reducing rates, lowering margin requirements on security 

purchases, and easing examination policies. Such measures have proved 

powerful enough to stimulate demand and initiate revival. In severe 

depressions, however, they may be inadequate by themselves. In the 

middle thirties, for example, large excess reserves did not stimulate credit 

demands sufficiently to produce a high level of employment. Although 

the excess reserves were a result primarily of gold imports, they were no 

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26 FEDERAL RESERVE POLICY 

less effective than they would have been had they been created by action 

taken at the initiative of the Reserve authorities. Access to money is not a 

sufficient condition to create prosperity. Nevertheless it is a necessary 

condition, and the power of the System to create reserves and currency 

should not be permitted to become unduly restricted as it was in the 

Great Depression. 

Putting the matter crudely, monetary authorities can prevent credit 

expansion by making credit sufficiently expensive; they cannot force 

expansion if business will not borrow. The Federal Reserve System is not 

the only agency with monetary powers. Coordination of the monetary 

aspects of policies being followed by other agencies is necessary to secure 

a responsible, consistent national policy. 

Reversing Direction. Another difficult problem that confronts Reserve 

officials is to determine when to change the direction of its program. 

Both technical and human factors tend to produce delayed rather than 

premature action. On the purely technical side strictly current data are 

available to the authorities only in selected fields. At times major decisions 

must be based on estimates that apply to a recent rather than to the current situation, and even then the estimates may be preliminary. Yet 

future critics are apt to assume that all the information that is available 

to them was available when the authorities made their decision. The 

problem of imperfect knowledge can never be solved completely, but 

persistent and vigilant efforts can reduce errors to a practical minimum. 

A similar difficulty arises from the fact that monetary analysis cannot 

be either static or perfect. Great strides have been made since formal 

rules of eligibility were considered adequate and appropriate guides to 

policy; yet much remains to be learned, as the rise of analysis based on 

the relationship between "saving and investment" amply demonstrates. 

As more powerful tools of analysis are developed, certain past actions 

may appear to have been inappropriate. The central banker cannot permit 

this probability to disturb him unduly. On the other hand, he can discharge his responsibility fully only if he comprehends and evaluates new 

developments in principles. 

The human factor also tends to prevent timely, vigorous actions. 

A change in direction indicates a major change in program, and responsible officials naturally wish to be sure before they go ahead. Central 

bankers must expect popular and uninformed criticisms even when they 

pursue proper policies. Unlike their critics—most of whom, incidentally, 

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THREE DECADES OF FEDERAL RESERVE POLICY 27 

deal with past events—they are held publicly responsible. This is all to 

the good, but one cannot expect them to lay themselves open to attack 

unless they are fully convinced of the correctness of their position. Such 

conviction is not likely to appear in incipient phases of a new development when a change of direction is first indicated and when it would be 

most timely. 

A number of techniques can be employed as partial offsets to this 

factor. One is to prepare appropriate programs of action in advance of 

need. If it were possible to predict the precise course of events, a single 

program could be developed and followed. Since this is not possible, the 

best alternative is to devise a series of programs appropriate to various 

possible conditions. The purpose of preparing such plans is analogous to 

that of a general staff when in peace it prepares and revises strategy and 

tactics for use in possible areas of conflict. An excellent example of the 

wisdom of such foresight is the policy prepared in April 1939 to meet a 

possible outbreak of war in Europe. Preparation for the eventuality of 

war is quite different than predicting an outbreak of war. 

Another technique to facilitate timely action is to use the less spectacular instruments in the interval between first feeling that a change of 

direction may be called for and full determination that clear-cut action 

should be taken. The first upward or downward change in the rate or in 

reserve requirements is a dramatic act. It is not apt to be undertaken 

until there is strong evidence of its necessity, and conviction that it will 

not require early reversal. This may be some time after there is reasonable 

assurance that a change in policy is needed. One of the advantages of 

open market operations in such periods is that they are less dramatic than 

changes in the rate and can be reversed more readily. Even though these 

operations are now thoroughly understood, they remain less spectacular 

than changes in the rate, especially if the investment account has not remained stationary for a considerable period. 

Similarly, since weaker instruments are more apt to be used in such 

periods, emphasis could be shifted to them as a matter of policy. Selective 

instruments are more likely to be used precisely because they can do less 

harm if an error is made. Use of a combination of general instruments 

operating in opposite directions, such as an increase in reserve requirements coupled with open market purchases, is another device to induce 

prompt action. 

Speed and Scale of Actions. Once the direction of a program has been 

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Federal Reserve Bank of St. Louis
28 FEDERAL RESERVE POLICY 

reversed, the major question becomes that of the speed with which the 

authorities should move. Adequate timely action is peculiarly important 

because of the cumulative nature of the forces operating in the business 

cycle. The same factors that tend to delay a change in direction also tend 

to limit the aggressiveness with which the new program is pursued. A 

tendency to follow rather than to lead is illustrated clearly, for example, 

in the rate policy of the twenties. 

Events during the Great Depression have created an environment in 

which it will be peculiarly difficult to take adequate action to stop an 

inflationary development. The whole emphasis was to promote expansion; the only fear was that of contraction, both cyclical and secular. 

Recent experiences always tend to be accorded undue weight in arriving at decisions. It will be emotionally and intellectually difficult to 

apply restrictive measures until another experience demonstrates again 

the evils and injustices of inflation. Another recent development that may 

make adequate action humanly difficult in the future is the rapid increase 

in the sheer magnitudes involved. It is not easy to become fully adjusted 

to changes of the size we have experienced. 

Resolution of Conflicting Objectives. The original Act was based on the 

principle that the Reserve authorities should adapt their policies to the 

economic situation as a whole. The general powers of the System proved 

inadequate to meet special situations requiring a degree of restraint in 

some areas that was inappropriate for the business situation generally. 

The authorities experienced difficulties in determining how to employ 

general instruments to meet diverse developments. 

The new principle of selective credit control was developed to meet 

this situation. The Reserve authorities were directed to regulate a particular field of credit. Selective instruments can be used to reinforce the 

general instruments. More important, although experience with such 

tools is limited, there is reason to believe that some former conflicts of 

objectives can be reconciled by adapting selective instruments to diverse 

developments in different fields. Ideally, separate instruments should be 

available for each field of credit important in the business cycle. At present only credit on securities is covered. Regulation of consumer credit, 

which was established during the war on an emergency basis, was not 

made permanent by legislative action.6 

6

 The administration of selective controls is discussed by Mr. Parry in pp. 65-87 of this 

pamphlet. 

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THREE DECADES OF FEDERAL RESERVE POLICY 29 

Some have objected to selective instruments because they clearly require the authorities to form value judgments as to the desirability of 

developments in individual fields. Careful appraisal indicates that this 

always has been necessary. The difference is not in the need for judgment 

but in whether policy shall be restricted to influencing the entire situation which is appraised by combining judgments on many fields or 

whether policy shall be flexible enough to deal with individual situations. 

Selective instruments, however, are only a partial solution to the problem of conflicting objectives. Officials responsible for policy must still 

determine the relative order of importance in the general situation of such 

basic factors and indicators as employment, commodity prices, and yields 

on Government securities. 

EXPERIENCE AND THE FUTURE 

Most of the rationalizations that have proved erroneous have one thing 

in common. They are based on the supposition that wise credit administration can be secured by law or formula. Experience has demonstrated 

that—to use the words of the Baruch-Hancock report—"no formula or 

law can supplant—or supply—good judgment and ability.'' 

Even Hawtrey, who once wrote "the trade cycle is a purely monetary 

phenomenon,,, admitted that "regulating credit, in fact, is an exceedingly 

delicate operation."7 It is also a thankless task, calling for courage to remain calm and objective under constant attack. When a developing boom 

auto-intoxicates the economy, the central banker must discharge the 

thankless responsibility of a warning Cassandra and must apply restrictive measures that are unpopular. When a boom collapses he will be 

blamed both for having permitted it to develop and for causing its collapse. In depressions some will blame him for making the money market 

too easy and others for not making money easy and plentiful enough. 

Courage is not enough. Central bankers can keep errors of policy to a 

minimum only by keeping abreast of developments in the economy and 

in principles of dealing with economic forces. This does not mean the 

forthright acceptance of each "new" theory, for many new theories are 

but revitalized versions of exploded dogmas. It does require the central 

banker to subject his thinking to continuous reappraisal. The developmental nature of monetary analysis is disconcerting, but it provides the challenge that lifts central banking from a routine occupation to an art. 

7

 R. G. Hawtrey, Monetary Reconstruction (London, 1923), pp. 63 and 141. 

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IMPACT OF THE WAR ON THE MEMBER 

BANKS, 1939-1946 

by 

ROBERT V. ROS A 

Research Department, Federal Reserve Bank of New York 

Total deposits of all member banks were slightly less than 50 billion 

dollars at the end of 1939. By the end of 1945 they had risen to 130 

billion. This increase of 80 billion was more than eight times the reserve 

base available to member banks for credit creation during the six war 

years. Nearly all of this multiple expansion had been produced by bank 

purchases of Government securities. Government expenditures had been 

so enormous, and the share of national income passing through Government accounts had been so large, that the commercial banks served primarily as direct suppliers of Government funds rather than as suppliers of 

private credit. Member bank holdings of the public debt rose by 64 

billion dollars from 1939 to 1945. Loans increased 9 billion, but half of 

this increase was in loans for purchasing and carrying Government securities. 

During the fiscal years from July 1940 to June 1946, Government expenditures reached a cumulative total of about 385 billion dollars; including additions to cash balances, nearly 400 billion entered Government 

accounts in these six years. Despite impressive increases in taxes, the 

Government operating receipts yielded only about 175 billion dollars, or 

less than half the required amount. The remainder was borrowed from 

investors, from Government agencies and trust funds, and from the banks. 

The share of all commercial banks, including the member banks, was 68 

billion dollars; acquisitions of the Federal Reserve Banks provided 21 

billion more. In all, additional holdings of public debt by the commercial 

banking system furnished slightly more than one-fifth of the Government's cash income during the war period. 

With the end of the Government's war borrowing program in December 

1945, over-all member bank expansion reached a peak. Bank deposits 

were approximately 150 per cent larger than they had been in 1939. 

During 1946, as it appeared that the proceeds of the Victory Loan had 

far exceeded Treasury requirements, the wartime process was reversed 

and the Treasury war loan deposits with banks were drawn upon to retire 

debt. Retirements of bank-held debt, offset in part by further loan ex30 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 31 

pansion, resulted in a reduction of more than 11 billion dollars in total 

member bank deposits in 1946. But the deposits held by the public continued to grow. It was clearly impossible to expect that the great wartime 

growth in the public's deposits could be erased by a simple reversible 

process of rapid retirements. Commercial bank deposits, exclusive of the 

Treasury's war loan account, had attained a volume which was certain 

to be maintained for some time to come at more than double the prewar 

level. 

MAJOR ASSETS OF ALL MEMBER BANKS 

BILLIONS OF DOLLARS ENO Of YEAR FIOURSS BILLIONS OF DOLLARS 

1930 1932 1934 1936 1938 1940 1942 1944 1946 

The rise in the public's bank deposits to more than double prewar size 

was only one of several fundamental changes in commercial banking 

brought about by the war. A second was the one-sided growth in assets. 

Government securities had seemingly been grafted on to the prewar 

banking system, and it was the grafted additions which accounted for 

practically all of the 150 per cent expansion in assets. The accompanying 

chart shows that member bank loans, and holdings of other securities, had 

no more than returned to the level of 1929 by the end of 1946. Cash had 

increased considerably, but much of it was tied up in legal reserves against 

the deposits created in acquiring Government securities. 

New deposits, originally created through Government borrowing, had 

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JSrrata, Page 31 

The percentage distribution s of "United State s 

Government Securities" and "All Otirier Securities " shown 

on the grid in the upper left-hand corner of the chart 

on this page should be reversed. A revised copy of the 

chart will be supplied upon request to the Board of 

Governors. 

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Federal Reserve Bank of St. Louis
32 FEDERAL RESERVE POLICY 

found their way into private hands. The distribution of these deposits 

among classes of holders represented a third basic change for banking. 

The accompanying chart indicates that most of the increases had entered 

the demand deposit accounts of businesses and individuals. There was 

not the same concentration upon a single class of liabilities as had appeared among the assets, however. Time deposits had increased by 14 

billion dollars from 1940 to 1946, after remaining at a total lower than that 

amount for a decade. Private demand deposits, on the other hand, rose 

from 25 billion dollars at the end of 1939 to 69 billion at the end of 1946. 

DEPOSITS OF ALL MEMBER BANKS 

BILLIONS OF DOtLARS TMO OP YEAR FIGURES _ BILLIONS OF DOLLARS 

Changes apparent in the combined data for the entire system were 

experienced in different ways by individual banks. All banks experienced 

some expansion. But there were many, and these included most of the 

very large banks, which expanded proportionately less than aggregate 

data would suggest.1 At the other extreme, there were hundreds of banks 

which grew by 500 per cent or more. A large proportion of the latter were 

small banks in the South and West. 

Some redistribution of banking concentration accompanied the great 

growth of the system. In 1939 there were, for example, only 81 banks in 

1

 Measurement of the size and deposit growth of individual banks is described further in 

the section beginning on p. 34. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 33 

the country whose total deposits exceeded 100 million dollars; 25 of these 

were clustered together in the two central reserve cities. At the end of 

1946 there were 180 banks of this size, of which 34 were in New York or 

Chicago. The proportion of the extremely large banks located in these 

two centers had fallen from one-third to one-fifth. 

The pattern of asset and deposit change within individual banks also 

varied considerably from that suggested by system-wide aggregates. To 

take one example, the largest banks and some of the most rapidly expanded small banks materially increased their loans as well as their 

holdings of Government securities during the war years. As another 

example, the great growth of private demand deposits did not materially 

alter the deposit composition of the large banks; they had always dealt 

primarily with demand depositors. But deposit composition in the small 

banks was turned upside down, as their business and individual demand 

deposits became larger than their time deposits. 

These are a few leading instances of structural change that took place 

in the banking system during the war years. Structural change also affected the methods and principles of bank operation. While the system 

as a whole expanded one and one-half times, a number of banks passed 

from small to medium size, and from medium to large. They had to face 

much more than the traditional problems of stepping up to larger-scale 

operations; for the character of their operations had also changed with 

the peculiar wartime nature of the growth. Most of the deposit growth had 

occurred in deposits of less stability, or generally greater likelihood of 

withdrawal. Most of the asset growth had been in Government securities; 

but the typical bank of the prewar period had had very little experience 

in the Government securities markets. The new size and the new deposit 

composition were certain to evoke new problems of portfolio management. 

But the problems of the banking system at the end of the war were not 

merely those of getting accustomed to a new scale of operations, and a 

new kind of asset and deposit composition. There were also new dynamic 

factors, capable of producing still further complications. The machinery 

provided by the Federal Reserve System during the war years to reinforce 

the market for Government securities, thus incidentally protecting the 

banks against major portfolio risks during their rapid growth, left the 

way open to continued expansion after the war. Federal Reserve credit, 

the base for such expansion, was freely available to the banks through 

the direct exchange of Treasury bills for a deposit at the Reserve Banks, 

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34 FEDERAL RESERVE POLICY 

and through bank sale of Treasury certificates in a market supported by 

the Federal Reserve System.2 

Another paper in this volume reviews the development of Reserve 

System support for the Government securities market, and discusses the 

problems of monetary policy involved. This paper is intended as a summary of the accompanying changes in banking structure and operating 

performance. Some of these changes have already been suggested. They 

are examined further in the following sections: 

Differences among Banks in Deposit Growth; 

Changes in Composition of Government Securities Portfolio; 

The Loan Portfolio; and 

Profits and Capital Accounts. 

Most of the findings have been taken from two unpublished studies prepared at the Federal Reserve Bank of New York as part of the research 

program of the Federal Reserve System.3 

DIFFERENCE S AMONG BANKS I N DEPOSIT GROWTH 

Although deposit volume increased at all banks during the war, the 

incidence of the increase varied so widely among them that the problems 

created were by no means uniform. Data for 6,155 identical member 

banks from 1939 to the end of 1945, gathered by a Reserve System research committee,4

 describe some of these differences.5 This identical sample provides a useful summary of the differences in deposit growth by region, and by size of bank. To some extent the sample also reveals the 

2

 The Federal Open Market Committee announced the "unpegging" of the bill rate on July 

3, 1947, after this paper had been completed. The change has no material effect on the contents 

of this paper. 

3

 In 1944, Norris O. Johnson, at that time Manager of the Research Department at the 

Federal Reserve Bank of New York, prepared an unpublished manuscript entitled The Impact of the War on Banking. The methods and suggestions of that study were developed in 

cooperation with the Joint Subcommittee on Banking and Credit Policy of the System Research Advisory Committee and the Subcommittee of the Presidents* Conference on Research 

and Statistics. The analysis was carried forward in 1946 by the present writer, with the same 

committee cooperation, in a study entitled The Wartime Expansion in Commercial Banking. 

This second study concentrated on a cross-section analysis of differences among individual 

banks at the end of 1945. 

4

 The Joint Subcommittee on Banking and Credit Policy of the System Research Advisory 

Committee and the Subcommittee of the Presidents' Conference on Research and Statistics. 

8

 There were 6,362 member banks at the end of 1939. New memberships exceeded departures and consolidations during the war years so that the total at the end of 1945 was 6,884. 

The 6,155 members represent that group whose membership was constant, or for whom past 

records were available if they entered the System during this period. The total assets and 

deposits of this identical set of banks accounted for more than 95 per cent of those of the total 

membership at all times. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-194 6 3 5 

characteristic variations in the composition of deposits among banks of 

different size and rate of wartime growth. 

Regional Growth in Deposits. The distribution of wartime Government 

contracts, the placing of new plants, and the increases in farm income 

caused the center of gravity of the American economy to shift toward the 

West and South during the war years. This shift was mirrored in bank 

deposit expansion, even though a disproportionately large share of TreasGROWTH IN DEPOSITS OF 6,155 MEMBER BANKS, BY FEDERAL RESERVE DISTRICT, 1939-1945 

(Year-end data, dollar items in millions) 

District 

Boston 

New York... 

Philadelphia. 

Cleveland. . . 

Richmond... 

Atlanta 

Chicago 

St. Louis. .. . 

Minneapolis. . 

Kansas City.. 

Dallas 

San Francisco 

All districts 

Demand deposits of individuals, 

partnerships, and corporations 

1939 

$ 1,518 

10,609 

1,359 

1,810 

859 

728 

3,290 

755 

462 

829 

! 794 

1,845 

24,858 

| 1945 

$ 3,161 

18,756 

3,123 

4,618 

2,745 

2,787 

8,072 

2,184 

1,442 

2,942 

3,031 

7,887 

60,748 

Percentage 

increase, 

1939-45 

108 

77 

130 

155 

220 

283 

145 

189 

212 

255 

282 

328 

144 

1939 

$ 2,725 

18,178 

3,011 

3,956 

1,946 

1,726 

6,919 

1,703 

1,101 

1,845 

1,534 

4,861 

49,505 

Total deposits 

1945 

$ 6,288 

37,696 

6,236 

9,815 

5,478 

5,930 

17,916 

4,578 

3,305 

5,765 

5,321 

16,676 

125,004 

Percentage 

increase, 

1939-45 

131 

107 

107 

148 

182 

244 

159 

169 

200 

213 

247 

243 

153 

ury borrowing was carried out in the eastern financial districts until 1944. 

In 1942, for example, the New York Reserve District lost more than 2 

billion dollars of reserves to banks in the rest of the country as a result 

of Treasury disbursements outside the district. In 1943 the New York 

District losses were nearly 5 billion.6 

The accompanying table summarizes the growth of total deposits in 

each of the Federal Reserve districts from the end of 1939 to the end of 

1945. While the total deposits of the entire 6,155 member banks increased 

6

 The drain out of the New York District because of Treasury operations was less than 2 

billion dollars in 1944, and fell below 0.5 billion in 1945. During the four years 1942-45, a 

further 3.5 billion of reserves passed to other sections of the country as a result of withdrawals 

by correspondent banks and by corporate depositors. 

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Federal Reserve Bank of St. Louis
36 FEDERAL RESERVE POLICY 

153 per cent over the six years, the gain of those banks which were located 

in the Dallas District was 247 per cent. Atlanta and San Francisco banks 

showed aggregate increases of 244 and 243 per cent, respectively. At the 

other extreme, the New York and Philadelphia Districts each grew but 

107 per cent. 

The table also shows the growth in private demand deposits. Deposits 

of this type continued to grow another 6 billion during 1946, while total 

deposits fell off more than 11 billion. In the long run, changes in private 

demand deposits are more likely to represent basic developments than 

are total deposits, which were inflated by the Government deposits resulting from the Victory Loan of November-December 1945. While there 

were some sizable differences between the percentage increases shown by 

total and by private demand deposits, the general pattern was the same. 

Extreme growth occurred in the South and West; growth was much slower 

in the older industrialized sections of the country. 

Evidence of percentage growth is slightly misleading, however, without 

comparison of the initial magnitudes in each of the districts. In dollar 

volume, the Dallas growth, from 1.5 billion dollars of total deposits at 

the end of 1939 to 5.3 billion at the end of 1945, was still small alongside 

the New York increase from 18.2 billion to 37.7 billion. As a share in the 

national total, the deposits of banks in the Dallas District rose from about 

3 per cent to about 4 per cent, while those of banks in the New York District dropped from 37 per cent to 30. In private demand deposits, the 

Dallas banks rose from 3 per cent to 5 per cent of the aggregate, while 

New York dropped from 43 down to 31 per cent. 

Treasury use of accumulated war loan deposits (available largely as 

a result of the Victory Loan) to retire bank-held debt during 1946, and 

the widespread retirement of security loans, did not narrow the wartime 

disparity of deposit distribution among the districts. Data for a 1 member 

banks, used in the absence of 1946 data for the identical sample, indicate 

that the principal deposit contraction during the year occuned in the 

eastern Reserve districts. Partly because of a further substantial rise in 

farm prices, the assets and deposits of banks in the South and West continued on balance to increase relative to the rest of the country. There 

was a general feeling at the end of 1946, however, that this furthering of 

wartime regional differences was the result of temporary causes, following 

the end of the war, and that eventually there might still be a return flow 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 37 

of some deposits to the eastern districts, similar to that which occurred 

during the second and third years following World War I.7 

Whatever might develop, the regions which experienced the greatest 

growth were uncertain that their rapid deposit gains would remain stable. 

Their portfolio management could not immediately be adapted to the 

practices normally appropriate for banks of their size. The section beginning on page 41 describes the resulting policies which most of them have 

followed. 

Deposit Growth among Banks of Different Sizes. While regional differences dominated the wartime pattern of bank deposit growth, it was 

DISTRIBUTION OF 6,155 MEMBER BANKS, BY SIZE AND RATE OF GROWTH, 1939-1945 

Rate of Growth' (Per cent) 

0-150 150-300 300-500 Over 500 All rates of 

growth 

Percentage distribution of banks within each size group 

2.8 

2.6 

5.2 

14.6 

45.1 

7.5 

26.4 

34.0 

44.6 

55.8 

40.6 

40.4 

49.5 

45.6 

37.9 

23.9 

13.4 

38.3 

21.3 

17.8 

12.3 

5.7 

0.9 

13.8 

100.0 

100.0 

100.0 

100.0 

100.0 

100.0 

i As of Dec. 31, 1943. 

» Measured by increase of demand deposits of individuals, partnerships, and corporations from Dec. 31,1939 

to Dec. 31, 1945. 

generally true in all of the districts that small banks grew proportionately 

much more than large banks. The spread between the growth rates of 

large and small banks was considerably greater than the spread among 

districts. The table above summarizes the growth characteristics by size 

of bank. It shows that large numbers of the smaller banks grew by more 

than 500 per cent over the six war years. Fully one-half of the smaller 

banks grew by at least 300 per cent. The method of measuring size and 

growth represents a compromise among alternatives, and illustrates some 

limitations of the special tabulations.8 

The unequal rates of expansion of large and small banks reduced the 

relative deposit position of the largest banks. The 224 banks shown in the 

7

 During the first half of 1947 the adjusted demand deposits of central reserve city banks 

rose 0.4 billion, while those of country banks dropped 0.8 billion. 

8

 Spot testing suggests, however, that the principles of classification used yield results 

closely resembling those found by other methods. Bank size has consistently been measured by 

Size of bank1 

(Total deposits, in 

millions of dollars) 

Under 1.... 

1-2 

2 - 5 

5-50 

50 and over 

All sizes.. 

Number 

of banks 

1,250 

1,628 

1,708 

1 1,345 

224 

6,155 

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38 FEDERAL RESERVE POLICY 

largest size group in the table held total deposits of 36 billion dollars at 

the end of 1939, representing 73 per cent of the total deposits held by the 

6,155 member banks. At the end of 1945 these same banks held 84 billion 

in deposits, or 67 per cent of the combined deposits of the 6,155 banks. 

As a corollary, the banks in the four other size groups increased their relative shares in the nation-wide total. Banks in the group whose total deposits ranged from 5 to 50 million dollars rose from 18 to 22 per cent of 

the aggregate; and the combined deposits of the three smallest groups increased from 9 up to 11 per cent of the total. 

Apart from its evidence that the smaller banks have not been edged out 

by the larger during the war period, the table shows that the smaller banks 

generally had the greatest adjustments to make in the scale of their operations. These adjustments were further complicated by the fact that the 

smaller banks experienced proportionately greater shifts in the composition of their deposits. 

Shifts in Composition of Deposits by Size of Bank and Region. The 

chart on page 32 indicated that demand deposits had increased considerably more than time deposits during the war years, and in discussing the 

chart it was suggested that this rise in the proportion of deposits subject 

to immediate withdrawal had occurred at most banks. The largest item 

among these demand deposits, and the one least likely to decline appreciably in the aggregate after the war, was the demand deposits of 

individuals, partnerships, and corporations. Data have been compiled 

showing the volume of these deposits compared to all other types of deposits at the 6,155 banks at the end of 1939 and of 1945. Less extensive 

data suggest that the pattern of relationship between time and private 

demand deposits shown at the end of 1945 continued in 1946. 

All types of deposits held by the banks in each of the five size groups at 

the end of 1939 and of 1945 are shown in the next table. In each of the 

three lower size groups, time deposits exceeded demand deposits of businesses and individuals at the beginning of the war. Six years later at these 

the total deposits of the individual bank at the end of 1943, the midpoint of the war expansion. 

Use of total assets instead of total deposits as a measure of bank size would not have caused 

any noticeable change in the results. Deposit growth was not measured by the change in total 

deposits from 1939 to 1945, but by the change in the demand deposits of individuals, partnerships, and corporations. Thus, temporarily large Government balances were excluded from 

the measurement of growth, as well as highly fluctuating interbank deposits. The omission of 

time deposits is, perhaps, unfortunate, because of the rapid growth in such deposits during 

1944 and 1945. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-194 6 3 9 

same banks, demand deposits of this type were about twice the volume of 

time deposits. The proportionate change was not as great in the 5-50 

million dollar size group, where private demand deposits had exceeded 

time deposits even in 1939. At the largest banks the relation between private demand deposits and time deposits remained almost the same 

through the war period, with more than $3 of these demand deposits for 

DEPOSIT COMPOSITION OF 6,155 MEMBER BANKS, BY 

SIZE OF BANK, DECEMBER 31, 1939 AND 1945 

(Dollar items in millions) 

Size of bank1 

(Total deposits, in 

millions of dollars) 

Under 1 .... 

1-2 

2 - 5 

5-50 

50 and over , 

All sizes.. 

Under 1 ... . 

1-2 

2 - 5 

5-50 

50 and over . 

All sizes 125,004 

Total 

deposits 

Time 

deposits 

Private2 

Demand deposits 

U.S. 

Govt. 

Interbank Other 

Ratio of 

time deposits to 

private 

demand 

deposits 

(Per cent) 

425 

1,195 

2,713 

9,018 

36,154 

49,505 

$ 191 

573 

1,309 

3,623 

6,021 

11,717 

December 31, 1939 

$ 187 

494 

1,110 

3,951 

19,116 

24,858 

$ 2 

7 

21 

130 

578 

738 

$ 2 

8 

34 

600 

8,676 

9,320 

$ 43 

113 

239 

714 

1,763 

2,872 

102 

116 

118 

92 

31 

47 

December 31, 1945 

1,384 

3,826 

8,570 

26,908 

84,316 

$ 355 

1,101 

2,613 

7,308 

11,476 

22,853 

$ 874 

2,221 

4,538 

12,982 

40,133 

60,748 

$ 74 

266 

865 

3,858 

16,504 

21,567 

$ 4 

19 

94 

1,454 

11,764 

13,335 

$ 77 

219 

460 

1,306 

4,439 

6,501 

41 

50 

58 

56 

29 

38 

i As of Dec. 31,1943. 

* Individuals, partnerships, and corporations. 

each $1 of time deposits. Of course, during 1946 there was probably a 

greater shift of Government deposits into private accounts at large banks 

than at the smaller banks. But the basic difference between the wartime 

changes of small and of large banks could not have been altered by this 

readjustment. The disproportionate growth of individual and business 

demand deposits represented a fundamental change in the deposit composition of the smaller banks. 

The table presents deposit totals for all of the banks in each size group. 

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40 EEDERAL RESERVE POLICY 

Not all of the individual banks in each group could be expected to show 

the same proportions among their deposit items. But frequency distributions of the banks within each class confirm the broad conclusions 

suggested by the table. At the end of 1945 the typical small bank (under 5 

million dollars of total deposits as of 1943) had roughly $2 of private demand deposits for each $1 of time deposits. While 1939 data were not 

available bank by bank, there is little doubt that such a ratio for the 

typical small bank in that year would have been $1 or less of private 

demand deposits for each $1 of time deposits. 

The effect of regional differences on deposit composition is also shown 

by the individual bank data for 1945. In the Dallas District, for example, 

where over-all deposit growth was greater than in any other district, individual and business demand deposits had always greatly exceeded time 

deposits, at both large and small banks. But the ratio rose to $25 of private demand deposits for $1 of time deposits at the smaller banks by the 

end of 1945. Among the smaller banks in the New York and Philadelphia 

Districts, individual and business demand deposits had traditionally been 

well below half the amount of time deposits. At the end of 1945 the two 

types of deposits were usually about equal. These two were the only districts, however, where time deposits of smaller banks had not fallen far 

behind their private demand deposits. In addition to Dallas, there were 

six districts in which the ratio of private demand deposits to time deposits 

had more than doubled at the typical small bank. With the exception of 

Cleveland, these were the districts which had experienced the greatest 

expansion in total deposits—Atlanta, St. Louis, Minneapolis, Kansas 

City, and San Francisco. 

It is difficult to carry the inquiry further, relating this shift in deposit 

composition to the rate of growth at individual banks, because their 

growth was itself measured (in the available data) by the increase in their 

private demand deposits. The relation between regional deposit growth 

and high proportions of private demand deposits, however, supports the 

inference that individual banks of rapid growth generally experienced 

greater shifts in the composition of their deposits—characterized primarily by a rising fraction of demand obligations. There is no doubt that 

the most pronounced of these deposit shifts, those which fundamentally 

altered prewar relationships, occurred among the banks of the three smallest size groups. 

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IMPACT 01 WAR ON MEMBER BANKS, 1939-1946 41 

CHANGES IN COMPOSITION OF GOVERNMENT 

SECURITIES PORTFOLIO 

The wartime growth of 64 billion dollars in member bank holdings of 

public debt was followed by a decrease of 15 billion in those holdings during 1946, as has been shown in the chart on page 31. This section reviews 

some significant changes in the composition of the Government portfolios 

held by the banks during these years. The over-all pattern of member 

bank holdings was influenced primarily by considerations of eligibility 

and yield. Further variations among the individual banks were associated 

with differences in bank size and with changes in deposit composition. 

Over-all Changes in Member Bank Portfolios of Government Securities. 

At the end of 1939, before the impact of war had been felt by the banking 

system, the member banks held slightly less than 40 per cent of the 

Government securities outstanding. All types of marketable issues were 

equally eligible for bank purchase, and the distribution of total member 

bank holdings roughly reflected the relative amounts of each type outstanding. Bills, for instance, were less than 5 per cent of total member 

bank holdings of Government securities, and they were also less than 5 

per cent of outstanding marketable issues. Similarly, bonds were 75 per 

cent of total holdings as well as 75 per cent of all outstanding issues. The 

subsequent changes in total member bank holdings, and in the amount of 

outstanding issues eligible for bank purchase, are shown in the table on 

page 42. 

During 1940 and 1941 the banks increased their holdings slowly. The 

bank-held portion of each of the three types of debt form then existing— 

bills, notes, and bonds—rose to about one-half. In 1942, with the Treasury's shift to all-out war financing, the banks added 18 billion dollars of 

Government securities to their holdings, the largest annual increase of the 

war years. 

Certificates of indebtedness were reintroduced during 1942, for the first 

time since 1934. In the same year, the rate on Treasury bills was pegged, 

and a preferential discount rate was established on borrowing secured by 

Government obligations.1 The effectiveness of these measures in transforming bank reserve policy, by increasing bank reliance upon the reserve 

convertibility of short-term Governments, is clearly shown by the data 

in the following table. Prior to 1942, bills had never been more than one-

• For discussion, see pp. 17-23 of the paper by Karl R. Bopp, and pp. 90-101 of the paper 

by Woodlief Thomas and Ralph A. Young. 

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42 FEDERAL RESERVE POLICY 

PUBLIC DEBT HOLDINGS OF ALL MEMBER BANKS COMPARED WITH OUTSTANDING 

MARKETABLE PUBLIC DEBT ELIGIBLE FOR BANK PURCHASE, 1939-1946 

(Dollar items in billions) 

End of year 

Total* Bills Certificates Notes Bonds 

Eligible issues outstanding2 

$ 37.5 

35.4 

41.4 

75.5 

106.5 

138.2 

147.9 

125.5 

& 1.5 

1.3 

2.0 

6.6 

13.1 

16.4 

17.0 

17.0 

$ 

10.5 

22.8 

30.4 

38.2 

30.0 

$ 6.2 

6.2 

6.0 

9.9 

11.2 

23.0 

23.0 

10.1 

$29.9 

28.0 

33.4 

48.5 

59.4 

68.3 

69.8 

68.4 

Member bank holdings3 

14.3 

15.8 

19.5 

37.5 

52.9 

67.7 

78.3 

63.0 

0.6 

0.7 

1.0 

4.4 

4.4 

3.7 

2.3 

1.2 

$ -

6.3 

12.1 

14.0 

17.0 

10.0 

$ 2.2 

2.6 

3.0 

5.4 

6.9 

14.1 

14.3 

5.6 

$11.5 

12.6 

15.6 

21.5 

29.6 

35.8 

44.8 

46.2 

Member bank holdings as a percentage of eligible issues outstanding 

38 

45 j 

47 

50 

50 

49 

53 

50 

39 

50 

49 

66 

33 

23 

13 

7 

— 

— 

60 

53 

46 

45 

34 

36 

42 

50 

55 

62 

61 

62 

56 

39 

45 

47 

44 

50 

52 

64 

68 

i Owing to rounding, details may not add to totals. 

* Includes all guaranteed issues, and the amount of restricted issues reported held by commercial banks in 

the "Summary of Ownership of Government Securities," Treasury Bulletin. Savings bonds are not included. 

* Includes the fully guaranteed securities of Government agencies, and also a small amount of the restricted 

isgues that came out after 1943 (the result of subscriptions permitted as a limited fraction of time and savings 

deposits). A negligible amount of savings bonds is also included. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 43 

twentieth of the aggregate member bank portfolios of Government securities. Even taken together with notes, the combined amount of customarily shorter-term issues had never been much above one-fifth of total 

holdings. But during 1942, bills and certificates alone accounted for over 

one-half the member bank acquisitions; including notes, the fraction of 

shorter-term acquisitions was two-thirds. The average term of combined 

bank portfolios of Government securities, which had been approximately 

seven years at the end of 1941, fell to less than five years by the end of 

1942.10 

Large acquisitions of short-term issues were also fostered by uncertainty 

over the Treasury's interest-rate policy on longer-term issues. An October 

issue of nearly 2 billion dollars in eight- to ten-year bonds, at 2 per cent, 

almost ran into difficulty because the market was hoping for a rate of 2\ 

per cent. Subsequent announcements by Treasury spokesmen made it 

clear, however, that direct issues to banks would not henceforth exceed 2 

per cent, regardless of term, and the unsettling anticipations of higher 

rates were put to rest for the remainder of the war period. 

During 1943 the Treasury issued an additional 19 billion dollars of bills 

and certificates. The banks, however, permitted all of the new bills they 

acquired during the year to pass into the Federal Reserve Banks, as frequent short-run needs for reserves occurred, and by the end of the year 

their total bill holdings remained at the level of a year earlier. Bill holdings 

of the Federal Reserve Banks increased 6 billion dollars as a result of the 

support policy. Member bank holdings of the higher-yielding certificates 

increased another 6 billion. Bond acquisitions of 8 billion, however, 

exceeded the combined amount of additional certificates and notes held by 

the banks. 

The shift into certificates, as a basic instrument of reserve adjustments, 

continued in 1944, but the major change shown by the year-end data was 

a rise of more than 7 billion dollars in notes. No change in principle was 

involved, however, for during 1944 the Treasury had begun issuing 13-

month notes to fill gaps in the maturity schedules, and the notes were considered virtually equivalent to certificates as secondary reserves. 

Meanwhile, after the completion of the Third War Loan Drive in 

October 1943, the banks had been excluded from direct Treasury allotments, except for bills and a small fraction of longer-term issues deter10

 Data for the 5,751 commercial banks included in the "Summary of Ownership of Government Securities," reported in the Treasury Bulletin. 

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44 FEDERAL RESERVE POLICY 

mined by a fraction of their time and savings deposits. The Treasury 

banned further bank purchase of new issues carrying an initial term of 

more than ten years; such issues would not become eligible for bank purchase in the market until the passage of time had brought them to within 

five to twelve years of call date—the limit varied from issue to issue. 

Consequently, although there was an increase of over 40 billion dollars in 

marketable bonds outstanding during 1943 and 1944, there was an increase of less than 20 billion in those eligible for bank purchase. 

The pressure by the Treasury and Reserve authorities to hold bank 

purchases of longer-term items in check was followed, paradoxically, by 

a growing realization on the part of the banks that their holdings of 

shorter-term issues, which had reached a combined total of 23 billion 

dollars at the end of 1943, were probably becoming adequate for all probable reserve adjustments, and that future acquisitions could fruitfully be 

concentrated in bonds.11 The growth of note holdings was still substantial 

in 1944, exceeding bond acquisitions by 1 billion dollars. But in 1945, out 

of a total increase of 10.6 billion dollars in member bank holdings of all 

Government securities, 9 billion were bonds. In that same year, the total 

increase in eligible bonds outstanding was only 1.5 billion. 

Of course this very factor of a large demand, pressing on a smaller 

supply, removed the danger of capital loss through a sudden drop in bond 

prices. Consequently, the larger banks, followed later by many of the 

smaller institutions, became increasingly anxious to obtain bonds. The 

more anxious they became, the higher went the prices of eligible issues. 

The stability in bond yields, which had been maintained throughout 1943 

and 1944, collapsed. Bank-eligible issues in the seven- to nine-year class, 

which had been nearly constant at 1.9 per cent, dropped steadily throughout the year, reaching 1.3 per cent in the first quarter of 1946—the lowest 

level in history. 

In the end, the combined effect of further war loan drives, restricted 

eligibility, and the rising bond prices, prevented banks in the aggregate 

from making a decided shift in the term distribution of their Government 

securities portfolio. The passage of time brought the entire portfolio forward, and even the sizable new bank purchases of the longer-term bonds 

11

 This description of aggregate behavior conceals the time lag between large and small 

banks in acquiring short-term Government securities, and subsequently in reaching out for 

longer-term issues. The smaller banks continued to build their short-term holdings through 

1944 and most of 1945. The differences among banks by size, as well as by rate of growth and 

region, are discussed further below, pp. 47-51. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 45 

were not always sufficient to offset the decrease in average term resulting 

from this lapse of time. At the end of 1943 the average term of total bank 

holdings of Government securities had been 4.1 years; it continued at that 

level, and slightly lower, through 1944 and 1945. 

Eligibility was not the only limitation on the supply of bonds available 

for bank purchase. Another arose from the unwillingness of nonbank 

holders to dispose of longer-term issues. While nonbank investors were 

anxious to obtain bank funds to use in their war loan subscriptions, they 

generally chose to pass on to the banks only low-yielding "tax-exempts," 

or shorter-term bonds, in order to maximize their own return on the new 

subscriptions. The "bull market" further gave them a profitable opportunity to ride up with the rising prices on their holdings, and a motive for 

acquiring even more of the bank eligibles on which profits might later be 

taken. Consequently, the average rate of yield on bank portfolios of 

Government securities declined, even though the average term remained 

relatively constant. The bank which wanted to "go long" in June 1945 had 

to debate such choices, for example, as the purchase of an issue with five 

years to call date, yielding 1.35 per cent, or one running ten years, yielding 

1.77 per cent. The margin between these narrowed as the level of longerterm rates fell further throughout the year. 

In 1946, after borrowing for war purposes was completed, the Federal 

Reserve authorities discontinued the preferential discount rate as a means 

of supporting bank reserve positions. The Treasury's use of its swollen 

balances to retire debt dominated member bank policies during the year. 

There was a continual drain on bank reserves as holdings of the Federal 

Reserve Banks were retired; and retirement of nonbank holdings caused a 

rise in private demand deposits, against which reserves were required. 

Consequently member bank reserves were under moderate pressure most 

of the year. And because of the strong demand for loans, particularly during the last half of the year, member banks sold some Government securities in order to meet the demand. Thus there was not the same freedom 

as in 1945 to continue shifting into longer-term Government securities. 

And partly because of lessened bank participation in the Government 

securities market, interest rates recovered slightly in the last three quarters of the year, although with considerable irregularity owing to the 

thinness of the market. 

Because most of the Treasury retirement was in certificates and notes, 

and because such bank-held bonds as were retired were replaceable by 

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Federal Reserve Bank of St. Louis
46 FEDERAL RESERVE POLICY 

newly eligible issues, the term distribution of outstanding issues available 

for bank holding actually seemed to encourage a lengthening of bank 

portfolios during 1946. And on balance over the year, despite the reserve 

pressure, there was actually a small exchange between bank and nonbank 

investors in this direction, permitting banks to increase their longer holdings as nonbank investors accepted more of the short-term items.12

 However, there was no heavy exchange of certificates for new reserves to 

support a multiple expansion of deposits through bank acquisition of 

longer-term issues. The rise in the average term of bank-held Government 

securities to 4.5 years by the end of 1946 was, instead, largely caused by 

the retirement of bank-held debt, which by definition consisted of the 

shortest-term securities.13 

Looking ahead, at the beginning of 1947, the banks faced a steady decline until 1952 in the volume of eligible bonds outstanding. From 1950 

onward, the total amount of eligible outstanding bonds would be less than 

the total amount of bonds held by the banks at the end of 1946. For the 

three intervening years it seemed likely that the premiums on a shrinking 

volume of bonds outside the banks would discourage bank purchase. The 

maximum deposit expansion potential in further acquisitions of bonds 

12

 During 1946, the 7,341 commeicial banks included in the Treasury Survey of Ownership 

made net purchases of 2.3 billion dollars in bonds callable in more than five yeais. Their holdings of all other Government securities were reduced further by substantial sales (see footnote 13 following). Nonbank investors (with the exception of insurance companies) provided 

these bonds and purchased short-term issues in exchange—apparently anticipating a rise in 

longer-term interest rates. 

Analysis of the usual Call Repott classifications of member banks, at the end of 1946, suggested that more than half of the very long-term purchasing during the year had been done byNew York City banks. Increases in Government securities maturing in more than ten years 

were relatively small in most districts. They remained the same, or decreased, in the St. Louis, 

Minneapolis, Kansas City, Dallas, and San Francisco Districts. Holdings of bonds in the 

zero- to five-year class, however, increased in all districts, largely through the effect of the 

passage of time. No districts were able fully to replace the amount of five- to ten-year issues 

which had passed forward into this shorter-term class. 

13

 The net reduction of 15 billion dollars in member bank holdings of Government securities 

consisted of direct cash retirements plus bank sales for cash to the Federal Reserve Banks and 

other investors. The data do not permit a breakdown between direct retirements and sales 

for the member banks, but a general picture of what happened is available from the records 

of the 7,341 commercial banks which report to the Treasury Survey of Ownership. These banks 

showed a net decline in their total holdings of Government securities of 18.2 billion dollars 

from Mar. 1, 1946 through Dec. 31, 1946. Of this total, 11.3 billion represented actual cash 

retirements by the Treasury. The remaining decrease of 6.9 billion was accounted for by bank 

sales of securities. In all, these banks sold 9.0 billion dollars of bills, certificates, and notes; 

and purchased 2.1 billion of additional bonds. Thus, net sales of Government securities on 

balance were 6.9 billion dollars. Of the 9.0 billion of gross sales, approximately 5.0 billion were 

made directly or indirectly to the Federal Reserve Banks. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 47 

over these three years was still, however, about 20 billion dollars. From 

then on, even if the banks were to hold all outstanding eligible bonds, 

their total holdings would be steadily reduced as issues ran off. The initiative would then pass fully to the Treasury. Its decision on the type of 

refunding issues could determine the future direction of bank holdings. 

Differences among Banks in the Composition of the Government Securities Portfolio. It is the term rather than the type of Government securities which banks ordinarily consider in dividing their holdings among 

various alternatives. The foregoing review was limited to types of securities because comparable data were not available for the entire war period 

on a term basis. It has only been possible to prepare detailed estimates of 

the call-date distribution of holdings by the 6,155 member banks for 1943 

and 1945. These data form the basis for most of the comparisons among 

individual banks which follow. 

Up to the end of 1943, the banks were in the process of becoming adjusted to a "fully invested" position. The central reserve city banks in 

New York and Chicago had led the way, and were fully invested almost 

continuously after the early part of 1943. Other banks gradually followed, 

the larger banks generally preceding the smaller. By the end of 1943 the 

banks in the largest size group had acquired two-thirds of the Government 

securities which they were to obtain during the war period; those in the 

next largest group had acquired about half; and the smaller banks, considerably less than half. As a counterpart of their leading position, the 

largest banks at the end of 1943 held much larger proportions of their 

Government securities in the shorter-term issues suitable for reserve adjustments; nearly one-half of their holdings had terms of less than one 

year. The smaller banks generally held about half of their Governments 

in bonds running five years or more to call date. 

The great movement of reserves from the large eastern banks out into 

the West and South was largely completed by the end of 1943. The Treasury was able thereafter to distribute its new issues more closely in relation 

to its regional pattern of disbursements. The flow of bank funds to nonbank investors, in exchange for marketable issues, became common among 

the banks of all regions, and of practically all sizes. Consequently, from 

1943 on, the smaller banks built up their total holdings of Governments 

more rapidly, and acquired relatively more of the shorter-term issues, than 

they had up to that time. The large banks stabilized their short holdings 

and concentrated on market purchases in the one- to five-year class. The 

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48 FEDERAL RESERVE POLICY 

table below summarizes the holdings of the 6,155 banks by size groups in 

1943 and 1945. 

HOLDINGS OF ALL GOVERNMENT SECURITIES AT 6,155 MEMBER BANKS, 

BY SIZE OF BANK AND TERM TO CALL DATE, 1943 AND 1945 

[Year-end data] 

Size of bank1 

(Total deposits, in 

millions of dollars) 

Under 1 

1-2 

2 - 5 

5-50 

50 and over 

All sizes 

Under 1 

1 - 2 

2 - 5 

5-50 

50 and over 

All sizes 

Total 

1 

Years to call date as of 1943 

0-1* 1-5 5-10 

10 

and 

over 

Total 

Years to call date as of 1945 

0-1* 1-5 5-10 

10 

and 

over 

In billions of dollars 

0.4 

1.1 

2.7 

9.9 

37.6 

51.7 

0.1 

0.4 

1.0 

4.1 

! 18.3 

23.9 

0.1 

0.2 

0.4 

1.9 

7.7 

10.3 

0.2 

0.4 

1.1 

3.3 

10.5 

15.5 

0.0 

0.1 

0.2 

0.6 

1.1 

2.0 

0.8 

2.2 

5.2 

16.7 

50.6 

75.5 

0.3 

0.9 

1.8 

5.7 

! 19.2 

27.9 

0.2 

0.6 

1.6 

5.6 

16.4 

24.4 

0.2 

0.5 

1.2 

4.1 

12.4 

18.4 

0.1 

0.2 

0.6 

1.3 

2.6 

4.8 

Percentage distribution within each size group 

100 

100 

100 

100 

100 

100 

36 

37 

38 

42 

48 

46 

14 

17 

16 

19 

21 

20 

44 

40 

40 

33 

28 

30 

6 

6 

6 

6 

3 

4 

100 

100 

100 1 

100 

100 

100 

40 

39 

36 

34 

38 

37 

28 

29 

30 

33 

32 

32 

22 

22 

23 

25 

25 

25 

10 

10 

11 

8 

5 

6 

i As of Dec. 31,1943. 

* Includes bills, certificates, savings bonds (redeemable on demand), and an estimate of the notes and bonds 

becoming callable within one year. The estimated amounts were computed for each of the 6,155 member banks, 

after consultation with the 12 Federal Reserve Banks concerning the banks falling within the jurisdiction of each. 

But this later growth in the short-term holdings of the smaller banks 

reflected more than an adjustment to the reserve policy pioneered by the 

larger banks. The larger banks did not differ widely among themselves in 

the ratio of their short-term holdings to their total deposits.14 But among 

14

 Some large banks, along with a number of smaller banks whose growth had been relatively 

very slow, did have low ratios of cash and short Government securities to total deposits at 

the end of 1945. Of all ratios below 30 per cent, more than one-half were in the New York and 

Philadelphia Districts. Special study of the low-ratio banks in these two districts indicates 

that they had come to rely on Government securities in the one- to five-year class to serve the 

secondary reserve purposes for which the issues running less than one year were ordinarily 

uied. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 49 

the smaller banks there was a decided difference, a difference closelycorrelated with the rate of growth in private demand deposits. This was 

the outcome of the fundamental shift in deposit composition which 

affected many of the small, and only a few of the large, banks during the 

war. The smaller banks apparently found it increasingly expedient, during 

1944 and 1945, to adjust to the rapid rise in their private demand deposits 

by doubling or trebling their holdings of short-term issues, as a precaution 

against possible deposit withdrawals at some future time. As a corollary, 

the small banks which grew slowly accounted for a disproportionately 

small share of the short-term Governments held by the first three groups 

of banks indicated in the preceding table. 

Combined holdings of cash and all Government securities due or redeemable in one year as fractions of total deposits at the smaller banks at 

the end of 1945 are shown in the accompanying table. The ratios are presented in frequency distributions for smaller banks of various rates of 

growth. Among the smaller banks whose private demand deposits grew 

less than 150 per cent, the great majority held relatively low proportions of cash and short-term Government securities. The ratio of cash 

and short Governments to total deposits was below one-half at two out 

RELATION BETWEEN LIQUIDITY AND RATE OF GROWTH OF SMALL BANKS1 

Liquidity ratio' 

(Per cent) 

Under 20 

20-30 

30-40 

40-50 

50-60 

60-70 

70-80 

80 and over 

All ratios 

Rate of growth (Per cent)' 

0 to 150 150 to 30o|300 to 500 Over 500 

Number of small banks 

7 

27 

38 

42 

28 

11 

9 

4 

166 

12 

182 

418 

442 

312 

168 

69 

42 

1,645 

13 

135 

347 

431 

446 

345 

212 

79 

2,008 

1 

19 

62 

126 

185 

164 

140 

70 

767 

0 to 150 j 150 to 300 300 to 50o| Over 500 

Percentage distribution of small banks 

within each rate-of-growth group 

4.2 

16.3 

22.9 

25.3 

16.9 

6.6 

5.4 

2.4 

100.0 

0.7 

11.1 

25.4 

26.9 

19.0 

10.2 

4.2 

2.5 

100.0 

0.6 

6.7 

17.3 

21.5 

22.2 

17.2 

10.6 

3.9 

100.0 

0.1 

2.5 

8.1 

16.4 

24.1 

21.4 

18.3 

9.1 

100.0 

* These small banks are the 4,586 from the identical sample, whose total deposits were below 5 million dollars 

asof;Dec.31,1943. 

* Percentage ratio of cash and Government securities due in one year to total deposits as of Dec. 31,1945. In 

each ratio class the lower limit is inclusive. 

»Increase of demand deposits of individuals, partnerships, and corporations from Dec. 31, 1939 to Dec. 31, 

1945. 

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Federal Reserve Bank of St. Louis
50 FEDERAL RESERVE POLICY 

of every three such banks. At the other extreme, of the 767 smaller banks 

whose private demand deposits grew more than 500 per cent during the 

war years, nearly three-quarters had ratios above one-half. 

The tendency for rapidly expanded banks to hold higher proportions 

of cash and short-term Governments is also reflected in the regional data. 

The Dallas District, where the growth of total deposits was greatest, and 

where the proportion of private demand deposits in the total was highest, 

also was distinguished by a high proportion of cash plus short-term 

Government securities to total deposits. The proportion was 62 per cent 

at the median bank in the Dallas District at the end of 1945. It was 63 per 

cent in the Kansas City District, and over 50 per cent in all other districts 

of rapid growth—Richmond, Atlanta, St. Louis, Minneapolis, and San 

Francisco. The remaining five districts, those of proportionately less wartime growth, all fell below 50 per cent. The median bank in the New York 

District was lowest, with cash and short-term Government securities equal 

to 35 per cent of total deposits. 

It is, of course, possible that the relatively high holdings of short-term 

Government securities and cash by the banks of most rapid growth were a 

temporary phenomenon at the end of 1945. A sizable proportion of the 

shorter-term issues was retired during 1946, while private demand deposits continued to grow at most banks. Undoubtedly, if the holdings of 

all Government securities due within a year were known for individual 

banks for 1946, they would show that the average holdings of short-term 

Governments and cash among member banks had fallen below 40 per cent 

of total deposits by the end of the year, although they had been 50 per 

cent at the beginning. But there is good reason to infer from the 1945 data, 

without another nation-wide tabulation for individual member banks as 

of the end of 1946, that the smaller banks of rapid growth maintained 

their relative position in holdings of short-term securities. Comparison of 

such holdings with the amount of Government deposits at individual 

banks, at the end of 1945, showed that only the small banks of rapid 

growth consistently held short-term Governments well in excess of their 

Government deposits. Study of war loan accounts outstanding at the end 

of 1945 indicated a disproportionately high volume held in the largest 

banks. Since the major development of 1946 was a drawing down of 

Government deposits, the impact of that process apparently fell heaviest 

on the short-term holdings of the largest banks. In general, then, those 

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IMPACT OF WAR ON MEMBER BANKS, 1939-194 6 51 

banks in which private demand deposits had expanded most, in relation 

to time deposits, during the war period, apparently continued to hold 

comparatively high proportions of cash and short-term Government securities throughout 1946.15 

There was evidence, too, that the relative amplitude of week-to-week 

fluctuations in private demand deposits had increased since 1939. Actual 

study was limited to a very few banks in the New York District, whose 

records were readily available, but growing comment from other sections 

of the country indicated that what might be called the "volatility" of 

business and personal demand deposits had increased somewhat at individual banks since the prewar period.16

 If there had actually been an increase in the volatility of the deposits that had increased most in volume, 

the banks would have found it necessary to make greater provision for 

reserve shifts among themselves than they had made before the war. To 

the extent that increased volatility continues to characterize the behavior 

of demand deposits for individual banks, they will desire to retain sizable 

holdings of shorter-term Government securities. Because these securities 

have narrow price fluctuations, which minimize the danger of capital loss 

at the time of sale, they will likely remain the most attractive earning 

asset for use in reserve adjustments. 

THE LOAN PORTFOLIO 

The loan portfolio of the combined member banks passed through three 

distinct phases during the war years, and a fourth in 1946. From the end 

of 1939 to the end of 1941, while the Federal Reserve authorities followed 

first a policy of reserve ease and later one of tightening, there was a general advance in all types of business and consumer loans. Total loans of 

the 6,155 identical member banks increased from 13.8 billion dollars to 

15

 Even without a study of individual bank portfolios and deposit composition for the end 

of 1946, there is ample evidence in the Call Report totals by districts and by reserve classifications to confirm this hypothesis. 

16

 Volatility was defined, for purposes of an unpublished exploratory study of the weekly 

reporting banks in the New York District, as the frequency and the relative amplitude of 

weekly reductions in the volume of each major type of deposit held by an individual bank. 

Dr. Helen Mellon Cooke, who made the study, found that weekly reductions in private demand deposits at a single bank occurred with very nearly the same regularity in 1946 as in 

1939; but as a percentage of initial balance, the reductions occurring at individual banks were 

considerably higher in 1946. In 1939, one reduction out of twelve ordinarily exceeded 5 per 

cent of the initial amount of private demand deposits held by an individual bank. During the 

first six months of 1946, one out of every four instances of decline (in the sum of all private 

demand deposits held by a given bank) exceeded 5 per cent of the initial total at that bank. 

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52 FEDERAL RESERVE POLICY 

17.8 billion.17 The shift in policy back to monetary ease, after our entry 

into the war, however, was not accompanied by further increases in total 

loans. The period from the end of 1941 to the autumn of 1943 marked the 

second phase, one of general decline. Total loans at the 6,155 banks fell 

back to 15.9 billion dollars. 

About four-fifths of the increases of the first phase were canceled during 

the second. So-called nonwar loans to business declined under the pressure of production controls, which diverted more and more of the economy 

into war channels. Businesses engaged in producing for or servicing the 

Government met a major portion of their new working capital requirements through advance or progress payments on their Government contracts. Their borrowing requirements were also pared down through taking advantage of the accelerated depreciation rates permitted on plant and 

equipment acquired on private account. New plant requirements were 

frequently met by direct Government creation of production facilities. 

This pattern of Government participation increased the share of financing activities passing through Government accounts, and sharply altered 

the role of commercial banking from that of World War I. During the 

comparable period of expanding production in the other war, 70 per cent 

of the increase in commercial bank assets had arisen through nongovernmental loans and investments; and only about one-seventh of this amount 

had represented borrowing for the purpose of purchasing Government 

securities. The rapid expansion of industrial production in World War II, 

however, was accompanied by a reduction in total member bank loans. 

An effort was made, after our entry into World War II, to encourage 

direct bank financing of working capital requirements through war production loans guaranteed by the Government (V-loans), which were introduced early in 1942. These reached a peak of 2 billion dollars by the end 

of 1943, but were not sufficient to offset the decline in nonwar business 

loans. Total commercial and industrial loans of the 6,155 banks fell from 

8.6 billion dollars at the end of 1941 to 7.2 billion at the end of 1943. Consumer and real estate loans also declined; agricultural loans remained 

nearly constant. There was an increase, however, in loans for the purchasing or carrying of securities. Continuation of this increase was the dominant characteristic of the third phase in wartime bank lending. 

17

 Total holdings of Government securities by these banks rose from 14.6 billion to 19.6 

billion dollars during the same two years. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 53 

From the end of 1943 to the end of 1945 the volume of total loans moved 

upward, reaching 22.1 billion dollars in the 6,155 identical member banks 

at the end of the period. The reduction in commercial and industrial loans 

during the second period was replaced in the third; agricultural loans, 

however, declined, while real estate loans remained steady and consumer 

loans rose slightly. But the major impetus was provided by securities 

loans, particularly loans on Government securities, which grew rapidly 

after the banks were excluded from direct subscriptions to Treasury issues. 

Loans on securities increased sharply during the war loan drives and declined between drives. At the end of 1945, when the Victory Loan Drive 

had just been completed, loans on securities were 4 billion dollars larger 

than they had been at the end of 1943. 

During 1946 there were no further Treasury drives and securities loans 

fell more than one-half. Commercial and industrial loans at the same time 

increased by one-half, and real estate and consumer loans rose by twothirds or more. The total loans of all member banks reached 26.7 billion 

dollars at the end of 1946. After 17 years, the total volume of member 

bank loans had finally returned to the level of December 1929. 

Data have not been tabulated for individual banks at the end of 1946, 

but a number of the wartime differences in loan portfolios among the 

banks were shown in the 1945 tabulations. The greatest increases in loans 

over the war years as a whole occurred at the larger banks. Not all small 

banks were equally far behind, however. Those which had grown most 

rapidly during the war had also acquired proportionately more loans than 

did the small banks which grew slowly. The evidence suggests that the 

wartime gap between the lending of large and small banks was narrowed 

during 1946. 

Wartime Differences in Loan Portfolios among Individual Banks. Before the war the average small bank held one-third or more of its total 

assets in loans. Generally, the larger the bank the smaller was the proportion of loans to total assets. Banks in the largest size group of the 6,155 

identical banks held about one-fifth of their total assets in the form of 

loans in 1939. By the end of 1945 the largest banks held slightly less than 

one-fifth of their greatly enlarged volume of assets in loans, while the 

average proportions for banks of smaller and medium size had dropped to 

12 and 13 per cent. The dollar amount of outstanding loans in the three 

smaller size groups was about the same at the end of 1945 as it had been 

at the end of 1939. Banks in the 5-50 million dollar size group experienced 

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54 FEDERAL RESERVE POLICY 

a total loan growth of less than two-thirds of a billion dollars. The largest 

banks accounted for 7.5 billion dollars of the total increase in loans. The 

accompanying table summarizes these data. 

RELATION OF TOTAL LOANS TO TOTAL ASSETS OF 6,155 MEMBER BANKS, 

BY SIZE OF BANK, YEAR-END 1939, 1943, AND 1945 

Size of bank1

 # 

(Total deposits, in 

millions of dollars) 

Under 1 

1-2 

2 - 5 

5-50 

50 and over 

All sizes 

i As of Dec. 31,1943. 

The principal cause of this great rise in loans among the large banks 

from 1939 to 1945 was loans for the purchasing and carrying of securities 

(chiefly Government securities), which increased about 5 billion dollars. 

But their commercial and industrial loans also rose more than 2 billion 

dollars. Not all of this increase could be explained by the concentration of 

V-loans in the larger banks. Apparently the large businesses, characteristically served by the large banks, found it convenient from time to time 

to draw directly on their banks instead of obtaining funds through Government advances. The smaller businesses, comprising the clientele of the 

smaller banks, found Government advances much more attractive than 

the higher rates of 4, 5, and 6 per cent, or more, which banks customarily 

charge smaller borrowers. As a result of the greater advantages of Government progress payments for small borrowers, the small banks did not 

generally increase their commercial and industrial loan volume. 

Even among the small banks, however, there were a number of exceptions. Analysis of the proportion loans were of total assets at the end of 

1945, for each of the 6,155 banks, indicates a slight but regular relationship between the higher proportions of loans and the more rapid rates of 

bank growth (measured by the increase in private demand deposits). 

Rapidly increasing private demand deposits probably tended to appear at 

banks in localities where income payments also were rising considerably, 

with a resulting demand for loans by the ancillary concerns engaged in 

Total loans (In millions of dollars) 

1943 

186 

457 

929 

2,813 

11,486 

15,871 

1945 

193 

503 

1,082 

3,606 

16,694 

22,078 

Loans as a percentage of total 

assets 

1939 

38 

35 

33 

29 

23 

25 

1943 

20 

18 

16 

15 

17 

16 

1945 

13 

12 

12 

13 

19 

17 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 55 

serving consumers rather than the Government. Thus loan volumes could 

understandably have been higher among the rapidly growing small banks 

than among those of slower growth. 

The regional factor was also important, with Dallas again the leading 

example. The relationship of the loan-to-assets ratio to bank size, or to 

rate of bank growth, which prevailed in most other districts was not sufficient to explain the Dallas case. The total loans of the Dallas District 

banks more than doubled from the end of 1939 to the end of 1945. Even at 

the end of the war there were many individual banks in this district whose 

total loans exceeded their total holdings of Government securities. Onefifth of the Dallas District banks had loans equal to 30 per cent or more of 

total assets; one-tenth of them exceeded 40 per cent. In sharp contrast, 

less than one out of 40 banks in the rest of the country had a loan-to-assets 

ratio as high as 30 per cent at the end of 1945; and there were even fewer 

whose loan volume exceeded their holdings of Government securities. 

Changes in Loan Portfolios during 1946. Two of the causes of the wartime disparity between the loan portfolios of large and small banks were 

gone in 1946—the Government was no longer financing producers, and 

there were no more war loan drives (or large new Treasury issues) giving 

rise to securities loans. Business borrowers of all sizes turned to the banks 

for a much larger portion of their needs; loans of the industrial and commercial type increased at virtually every bank in the country. Securities 

loans, which had helped swell the portfolios of large banks much more 

than of small, were steadily retired. No tabulations have been made to 

measure the exact effect of these changes on individual banks, but a suggestion of what took place is apparent from the central reserve city, reserve city, and country bank tabulations. 

Total outstanding loans at all member banks rose 3.9 billion dollars in 

1946. The increase was made up as follows (in billions of dollars): 

Country +2.4 

Reserve city +2.3 

Central reserve city: 

Chicago +0.2 

New York -1. 0 

Total +3.9 

The total increase was 17 per cent over the amount of member bank loans 

outstanding at the end of 1945; but for the country banks, often considered representative of the smaller banks, the increase represented a rise 

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56 FEDERAL RESERVE POLICY 

of 43 per cent in the one year. The increase was 27 per cent for reserve 

city banks and 12 per cent in the Chicago central reserve city banks. 

Although New York City banks showed a decrease of loans in the aggregate, banks in the New York District outside New York City did not. 

Data were available for each of these individual banks. Although possibly 

not typical of the country as a whole, the data show that banks of medium 

size (5-50 million dollars of total deposits at the end of 1943) experienced 

the greatest gain in loans during 1946; that the margin between the loanto-assets ratios of the small and the largest banks had been narrowed; and 

that those small banks whose wartime growth had been greatest still led 

other small banks in their additions to total loans. 

There apparently was, then, so far as available data would suggest, a 

reversal of some of the characteristic wartime changes in the loan portfolios of member banks. As total loans generally increased, the segment 

taken up by securities loans diminished, and the proportion in business, 

real estate, and consumer loans increased. The shifting loan composition 

also resulted in relatively more lending by the medium-size and small 

banks, and relatively less by the largest banks. But there were two other 

significant aspects of the 1946 growth of loans at the smaller banks. 

Among country banks, and probably among small banks generally, the 

rise in real estate loans during 1946 was greater than the rise in commercial 

and industrial loans. While many of the loans reported by smaller banks 

as real estate loans were undoubtedly for commercial and industrial purposes, there was some concern over the possibility that small banks might 

be unduly affected if there should be a drop in inflated postwar real estate 

values. One cause of the small bank concentration on real estate loans as 

against commercial and industrial loans, as such, might have been a 

tendency for the large banks to serve the large business customers in the 

borrowing communities served by the smaller banks. 

A second important aspect of the growth in loans at small and mediumsize banks was the greater emphasis on consumer loans. A special study 

made at the Board of Governors as of mid-1946 suggested that many small 

banks were devoting relatively high proportions of their loan volume to 

this type of activity.18 Holdings of instalment paper plus single-payment 

18

 Frieda Baird, "Commercial Bank Activity in Consumer Instalment Financing," Federal 

Reserve Bulletin, March 1947, pp. 264-69. The banks in each size group under 100 million dollars in total deposits held an average of 7-8 per cent of their total loans in consumer instalment 

loans, while the consumer instalment loans of the largest banks were only 3 per cent of their 

total loans. 

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IMPACT OF WAR ON MEMBER BANKS, 1939-1946 57 

loans varied from 15 to 17 per cent of total loans in the three size classes 

of smaller banks used in the consumer loan study. But the very largest 

banks, those having deposits in excess of 100 million dollars at the end 

of June 1946, had an average of only 9 per cent of their loans devoted to 

consumer financing. While there is a general presumption "in the trade" 

that this type of lending requires mass production methods for successful 

handling, many small banks have apparently found it possible and profitable to handle consumer loans under present conditions. Extreme concentration on consumer lending by small banks might, however, be open to 

some question.19 

The over-all prospect for bank loans at the end of 1946 was uncertain. 

Total outstanding member bank loans then represented about 60 cents for 

each $5 of gross national product. At the end of 1939 the corresponding 

figure had been 75 cents and at the end of 1945 it had been 50 cents. The 

relative volume of loans outstanding at the end of 1946 was still less than 

half that of the twenties, when there were about $1.25 of member bank 

loans for each $5 of gross national product. While particular banks might 

again return to portfolios consisting largely of loans, it was obvious that 

an enormous further increase would be necessary if the banking system as 

a whole were ultimately to expand its outstanding loans in proportion to 

the doubling in gross national product that occurred between 1929 and 

1946. 

PROFITS AND CAPITAL ACCOUNTS 

The annual profits of all member banks, after income taxes, rose steadily 

from 347 million dollars in 1939 to 788 million in 1945. In 1946 they fell 

back to 758 million. There was relatively little increase during or after the 

war in the total amount of dividend payments, so that in the aggregate 

most of the wartime additions to profits found their way into the capital 

accounts rather than into stockholders' dividends. Because total capital 

accounts were continually increasing, the ratio of net profits after taxes 

to total capital accounts did not rise as much as the dollar volume of 

profits. That ratio was 7.0 per cent for the average of all individual member banks in 1939, and it was 11.0 per cent in 1945. It rose to 12.0 per cent 

19

 There were five relatively small commercial banks in New York State, for example, 

whose consumer instalment loans in June 1946 amounted to at least half a million dollars, 

and whose volume of these loans exceeded 45 per cent of their loan portfolios. The largest of 

these banks had total deposits of less than 20 million dollars. 

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58 FEDERAL RESERVE POLICY 

in 1946, however, because thousands of small banks increased their profits, 

while the large banks (whose profits fell off) were relatively few in number. 

A considerable portion, perhaps half, of the 441 million dollar increase 

in profits from 1939 to 1945 could be attributed to nonrecurring sources 

of income, chiefly recoveries and profits resulting from the sale of Government securities while interest rates were declining. The other half, roughly 

attributable to the excess of gross operating earnings over operating expenses, was in large measure the result of enlarged portfolios of Government securities. 

Gross operating earnings had not yet begun to decline in 1946, under 

the influence of the Treasury's retirement program, because the banks 

were largely able to offset the loss of income on retired Government securities through increased earnings on loans (and in some cases, through 

higher yields on newly acquired longer-term Government securities). 

Earnings on Government securities actually rose somewhat during the 

year. Operating expenses had, however, begun a more rapid rise—partly 

because of the inflationary pressure of the enormously enlarged volume of 

bank deposits. The principal factor in those rising expenses was higher 

wage and salary outlays. 

Added expenses were less than the aggregate addition to operating earnings. But despite the resulting rise of 100 million dollars in 1946 operating 

earnings, net profits before taxes remained about the same as in 1945. That 

was because the nonrecurring elements of profit, "net recoveries and 

profits/' fell to less than half the 1945 figure. At the same time, the amount 

of income taxes rose because the banks were beginning to run out of those 

"deductibles" which had reduced annual taxable incomes during the war 

years. The combined effect of a reduction in nonrecurring items of profit, 

and the diminishing amount of tax deductibles, was a drop in net profits 

after income taxes of 30 million dollars in 1946, a decline of 4 per cent from 

the peak profits reported in 1945. 

Member bank capital accounts continued to rise in 1946. In the aggregate, they had restored depression losses and returned to their 1929 volume by the end of 1944.20

 Capital account increases in 1945 matched proportionately the growth in so-called risk assets at the member banks, and 

the ratio of capital accounts to such assets remained about 25 per cent. 

The increase in capital accounts during 1946 w

T

as slightly less than 15 per 

20

 This generalization is roughly correct, despite changes in System membership over the 

15 years. 

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IMPACT OF WAR ON MEMBER BANKS 1939-1946 59 

cent of the rise in risk assets. Both in profits and in capital accounts, however, there were wide differences among the individual banks. 

Differences in Profits among Individual Banks. There was a marked 

change over the war years in the relative profitabilities of the large and 

small banks. In 1939, the average ratio of net profits to capital among all 

banks in the three smaller size groups was about 7 per cent. The average 

of such ratios among the banks in the two larger size groups was slightly 

less than 7 per cent. By 1945, the average ratio had risen to about 10 per 

cent for the small banks, and was more than 11.5 per cent among the 

larger banks. The larger banks had increased their profit ratios beyond 

those of the smaller banks primarily for four reasons. Perhaps the most 

important factor—one for which no correction could be made in the data 

—was the fact that capital accounts tended to be relatively larger in the 

smaller banks (particularly those of slow growth), thus causing the ratio 

of profits to capital to appear low. Second, the small banks which had 

experienced rapid growth held much higher proportions of very short-term 

Government securities in their portfolios; consequently their average yield 

on Governments was often lower than that of the large banks. Third, most 

small banks were slow to take their profits on the rising capital values 

which had resulted from the decline in interest rates; the "recoveries and 

profits" item in net profits was, therefore, higher at the large banks. 

Fourth, despite the shifting deposit composition at small banks, interest 

on time deposits constituted a larger increase in the expenses of small 

banks than in those ot large banks (this was particularly noticeable among 

small banks which grew relatively slowly). 

Despite the high average profit ratios at the end of 1945, one out of 

twelve member banks reported net profits after taxes equal to less than 5 

per cent of capital accounts. Further inquiry into the record of these least 

profitable banks showed that most of them were small (total deposits 

under 5 million dollars at the end of 1943). A high proportion of them had 

grown relatively slowly during the war. They differed from other banks 

of their own size and rate of growth in one of two ways. About three-fifths 

of them had gross earnings equal to those of similar banks, but exceptionally high expenses caused their net profits to fall below 5 per cent. The 

other two-fifths did not acquire gross earnings comparable to those of 

other banks of their own size and wartime rate of growth. Generally high 

wartime profit rates in banking had not automatically assured highly 

profitable operations for all banks. 

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Most of the fall in total profits during 1946 was accounted for by the 

central reserve city banks in New York. Most of the banks in the country 

reported increased profits. It did seem possible, however, that the New 

York banks, followed at some remove by other large banks, were mirroring in advance a major change in banking—just as they had done in so 

many other respects during the war years. But whether or not the declining profits of many large banks in 1946 were a portent of similar developments throughout the banking system, the immediate consequence was a 

closing of the 1945 gap between the profit rates of large and small banks. 

With the exception of very small banks whose total deposits were under 

1 million dollars (as of 1946), smaller banks had consistently higher average profit ratios than the large banks in 1946. 

Member Bank Capital Accounts. Because the adequacy of bank capital 

accounts is primarily determined by the type of assets held, the traditional 

ratio of capital accounts to total deposits was superseded, during the war, 

by a ratio of capital accounts to so-called "risk" assets. The supervisory 

authorities defined risk assets in their summary tabulations as total assets 

less cash and Government securities. Government securities were excluded 

because they are free of credit risk, although some of them of course are 

subject to a valuation risk due to fluctuations in their market prices. There 

is no doubt that the newer measure was superior to its predecessor. 

Special tabulations as of the end of 1945, prepared from records of 6,073 

of the 6,155 member banks analyzed in this study, show wide variation 

among so-called "risk ratios" of banks at the end of the war. 

These tabulations are presented in the accompanying table as percentage distributions for the banks in each of the five size groups. There were 

52 banks whose capital accounts were below 10 per cent of risk assets in 

1945. A high proportion of these extremely low ratios occurred among 

large banks, although large banks in the East had maintained higher 

ratios than were found among the large banks elsewhere. The tendency 

for the ratios to lower as size of bank increased can be observed throughout the table. The medians of each size group, for example, ran as follows 

from smallest to largest banks: 41, 35, 33, 32, and 26. 

While evaluation of the "correct" capital ratio must vary from bank to 

bank, according to the nature of the risk assets involved and the character 

of the deposits, the banks whose ratios of capital to risk assets fell below 

10 per cent in 1945 probably were in need of substantial additions to 

capital. On that premise, the earnings of those banks were studied to see 

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IMPACT OF WAR ON MEMBER. BANKS 1939-194 6 6 1 

what additions they might support. The analysis showed that the rate of 

capital accumulation permitted by retaining net earnings would be too 

slow, at nearly all of these banks, to provide for early increases in capital 

on a significant scale. Almost without exception, however, the 1945 rate of 

earnings seemed large enough to have supported sufficient issues of new 

capital stock to double the 1945 capital accounts. 

During 1946 there was a reduction in the ratio of capital to risk assets 

at most banks, although the ratio of capital to total assets increased. The 

major factors in these changes were the growth in total loans, which inPERCENTAGE DISTRIBUTION OF 6,073 MEMBER BANKS, BY RATIO OF CAPITAL ACCOUNTS 

TO RISK ASSETS AND BY SIZE OF BANK, 19451 

Ratio of capital accounts to risk assets 

(Per cent) 

Under 20 

20-30 

30-40 

40-50 

50-60 

60 and over 

All ratios 

Total 

14 

25 

22 

15 

10 

14 

100 

Size of bank (Total deposits, ic 

Under 1 

7 

20 

21 

20 

12 

20 

100 

1-2 

12 

26 

23 

15 

9 

15 

100 

2-5 

16 

27 

22 

13 

9 

13 

100 

millions of dollars) 

5-50 

19 

26 

22 

14 

8 

11 

100 

50 and 

over 

31 

32 

19 

9 

6 

3 

100 

1

 Capital accounts and risk assets for each individual bank were available only as averages of the amounts 

reported on three dates: Dec. 31, 1944, June 30, 1945, and Dec. 31, 1945. The banks were grouped into the same 

size classes used in all special tabulations made for this study, with size measured by total deposits as of Dec. 31, 

1943. 

creased risk assets, and the greater decline in holdings of Government 

securities, which reduced total assets, while capital accounts continued to 

grow.21 Because the smaller banks increased their loans proportionately 

more than did the large banks, and because the small banks generally increased their dividends in 1946, there was a greater reduction in the capital 

ratios of the small banks (as retained earnings failed to keep pace with new 

loans). The 1945 ratio-spread among size groups of banks, running from a 

capital ratio of 41 per cent for the smallest to 26 for the largest, was narrowed in 1946 to approximately 38 per cent at the smallest and 25 at the 

largest, with corresponding reductions in the three intervening size groups. 

11

 In the large central reserve city banks in New York, where total loans fell off during 1946, 

the ratio of capital accounts to risk assets rose. 

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In both capital ratios and profits, 1946 was a year of leveling. The 

capital ratios of the smaller banks fell more than those of the largest 

banks, bringing them nearer to equality. And, conversely, the higher wartime profits of large banks declined as the profits of the smaller banks remained steady or increased. The greatest over-all significance, however, 

lay in the probability (1) that a further decline in bank profits might occur 

in the years immediately following 1946, and (2) that ratios of capital to 

risk assets would continue to fall for a longer period as bank loans and 

holdings of non-Government securities increased. 

CONCLUSIONS 

The tremendous scope and inclusiveness of the American mobilization 

for World War II necessitated an extreme centralization of direction and 

of responsibility—which only the Government could assume. Consequently the burden of financial risk had also to be borne largely by the 

public, and most financing had to pass through Government accounts. 

Under these circumstances there was little room for private undertakings 

between the banks, as suppliers of funds, and the businesses producing 

war goods. The war was financed almost entirely through the proceeds of 

governmental taxation and governmental borrowing. The commercial 

banking system provided one-fifth of the Government's cash requirements 

through the creation of new money, while four-fifths was acquired by the 

Government from the current income stream either through taxes or nonbank borrowing. 

As a result primarily of their increased holdings of Government debt 

the member banks grew one and one-half times in aggregate size from 1939 

to 1945. All of the banks, whether they individually grew proportionately 

more or less than this average of 150 per cent, experienced both the problems of doing business on a larger scale and the necessity of adjusting their 

operations to a decided shift in the composition of their assets. Most of 

the smaller banks also experienced a change in the character of their deposits, as private demand accounts expanded proportionately much more 

than time deposits. 

Although most banks concentrated their early purchases of Government securities on issues of very short term, they became an increasingly 

important influence in the market for Government bonds as well. Treasury 

restrictions on the eligibility of new long-term issues for bank purchase, 

after 1943, funneled bank acquisitions into the older issues. But the effect 

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IMPACT OF WAR ON MEMBER BANKS 1939-1946 63 

of bank purchases spread as nonbank holders sold outstanding bonds to 

the banks at a premium in order to acquire funds for further subscriptions 

in the war loan drives. Bank-reinforced demand caused a considerable 

price rise in the Government securities markets during 1945, at the peak 

of the Treasury's borrowing effort. Continuation of bank purchases in the 

bond market during 1946 was limited considerably, however, as the Treasury reversed its influence by creating pressure on reserves through a debtretirement program. Barring future Government deficits, or a deliberate 

change in Treasury refinancing policy, bank portfolio managers will find 

less and less opportunity for additional bond purchases during the remainder of the decade. After 1950 the total volume of eligible bonds in 

existence would be less than the amount of bonds held by banks at the 

end of 1946. 

The wartime additions to bank-held Government debt might also be 

expected to alter the relation between banks and their business borrowers. 

Some few banks might choose temporarily to ride on their securities earnings, to the disadvantage of deserving applicants for loans. But the general 

effect should probably be very much to the borrowers' liking. Banks 

should have much less reason than ever before to press their business 

borrowers for repayment of loans at a time when the banks themselves 

were pressed for funds. As of 1947, in meeting any unusual reserve needs, 

the banks could sell shorter-term Government securities in a market 

supported by Federal Reserve credit. Or banks that were members of the 

Federal Reserve System could borrow at low discount rates by pledging 

Government securities of any term. 

Insertion of so large a volume of "bankable" Government securities 

into bank portfolios during the war substituted earning assets (several 

times greater in amount) for the excess reserves which had served banks, 

after 1933, as the cushion between reserve drains and the liquidation of 

bank loans. Conversely, the banks were left relatively unrestrained by 

central bank action in their extension of new loans.22 New loans to business, to real estate owners, and to consumers, many of them term loans, 

flourished during the reconversion effort of 1946. While the banks necessarily judged loans by their usual standards of credit risk, they had little 

motive to give primary consideration to conditions that would protect 

their own "liquidity." 

What limits remained on bank lending came from the state of business 

n

 Cf. pp. 98-101 of the paper by Woodlief Thomas and Ralph A. Young. 

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64 FEDERAL RESERVE POLICY 

demand itself, and from the size of bank capital accounts. Bank capital at 

the end of 1946 was generally over 20 per cent of risk assets, giving no 

cause for immediate concern. But even though losses caused by bank pressure for loan repayment might henceforth be slight, because of the new 

and larger cushion against "stringency," the normal course of business 

events would continue producing losses on loans and other investments. 

Bank capital would have to be adequate to absorb those losses. And the 

size of a bank's capital account would, therefore, be an important determinant of its maximum loan expansion. 

The post-reconversion outlook for commercial banks as business institutions seemed to be for some reversal from the high wartime levels of 

profitability. During 1946 the large banks, which had led the way to high 

profits during the war, experienced a considerable drop. Unless there 

should be a sustained rise in loan income to offset rising expenses and a 

reduction in nonrecurring items of profit, it seemed likely that the profit 

rates of most commercial banks would gradually decline to the levels prevailing prior to the war. 

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SELECTIVE INSTRUMENTS OF NATIONAL 

CREDIT POLICY 

by 

CARL E. PARRY* 

Director, Division of Security Loans, Board of Governors 

Selective instruments of national credit policy are distinguished from 

general instruments, such as discount rates and open market operations, 

by the fact that their primary and principal impact is not on the total 

amount of credit that is put to use in the economy as a whole but on the 

amount that is put to use in one or another particular sector of the 

economy. 

This paper undertakes to describe several of the existing selective instruments and the distinctive mechanism which they exemplify, to outline their relation to existing general instruments, and to inquire briefly 

into the outlook—especially the long-range outlook—for the selective concept. 

The whole discussion takes for granted that the objectives of national 

credit policy, however it may be implemented, are to help in stabilizing 

the national economy and in gradually expanding it. 

EXAMPLES OF SELECTIVE INSTRUMENTS 

The selective instruments to be here described are those which have 

been applied to the two fields of stock-market credit and consumer credit. 

They will be treated in this order for the reason that governmental concern with the course of stock-market credit and governmental interest in 

finding workable methods of influencing that course are of much the 

longer standing. 

Mechanism for Influencing Stock-Market Credit. Legislative concern 

respecting stock-market credit was registered in 1913 by the provisions 

of the original Federal Reserve Act which declared ineligible for discount 

notes drawn for the purpose of trading in stocks. The growth of stockmarket credit was the subject of official warnings by the Federal Reserve 

Board at intervals between 1915 and 1919, and was inquired into by a 

joint congressional commission in 1921. Later and greater growth 

prompted the Board's action early in 1926 in publishing currently figures 

* In charge of consumer credit regulation while this was in effect (1941-47). 

65 

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for loans to brokers, and inspired early in 1929 both the Board's emphatic 

warning against the expansion of stock-market credit and the Board's 

"direct action" campaign. The significance of the same sector was given 

further legislative recognition in the Banking Act of 1933, and more decisively in the Securities Exchange Act of 1934, which authorized and 

directed the Federal Reserve Board to regulate margin requirements on 

security loans. 

It was a long process of trial and error that eventuated in the devising 

of the margin-requirements technique. The instruments previously tried 

in this field included moral suasion, induced agreement, the publicizing 

of statistical facts, "direct action," and—first to be tried but last to be 

here discussed—the denial of eligibility for rediscount to stock-market 

paper. 

Moral suasion, as exemplified by admonitions issued by the Board in 

1919 and early in 1929, seems on both occasions to have had some effect 

in dampening speculative fervor, but only in slight degree and for very 

short periods. 

The only instance of induced agreement is the arrangement worked out 

during World War I, under the pressure of the needs of war financing, 

between the New York Stock Exchange and a group of banks in New York 

City, then called the "money pool" banks.1 From the autumn of 1917 to 

the autumn of 1918, the purpose of the arrangement was to insure that 

these banks would make enough street loans (on acceptable collateral) to 

serve the "essential needs" of the Exchange and to prevent stock-market 

money rates from going so high as to interfere with the marketing of 

Government securities to finance the war. In September 1918, however, 

there was increasing demand for such loans and the Exchange agreed on 

November 4—a week before the Armistice—to prevent any increase in the 

aggregate amount of the borrowings of their members above the level 

(about one billion dollars) at which they then stood. 

This arrangement, supplemented at first by a stiffening of the margin 

requirements imposed by the New York banks, remained in effect for only 

two months. It was successful during the short time that it was in force 

in stabilizing the volume of street loans. There is reason to doubt, however, that it had much to do with restricting speculation in stocks or re1

 This arrangement was worked out under the leadership of Benjamin Strong, then Governor of the Federal Reserve Bank of New York, and the Liberty Loan Committee of which he 

was chairman. 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 6 7 

straining advances in stock prices; both the volume of trading and the 

level of stock prices remained quite stable, but in the circumstances of 

the time this seems to have been only natural. Discontinuance of the arrangement on January 4, 1919, was soon followed by a sharp increase in 

the volume of trading, in the level of stock prices, and in the volume of 

brokers' borrowings—which increased during the next nine months by 

over 700 million dollars. The sharp upswing which culminated in November of that year was in turn succeeded by the larger downswing of 

1919-21. 

The publicizing of statistical facts is illustrated by the publication week 

by week, as initiated by the Board in February 1926, of figures showing 

the total volume of brokers' loans—then about 3.1 billion dollars. These 

figures had not before been available to the public, were much larger than 

the public had supposed, and their publication was considered by observers at the time to have had a temporary restraining effect. In any 

event, the volume of stock-market credit, the volume of trading, and the 

level of stock prices all fell off for a number of months. Late in 1926 and 

early in 1927, however, both the level of stock prices and the volume of 

stock-market credit resumed their upswing, and from that time forward 

did not seem to be appreciably affected, except occasionally and then only 

momentarily, by the weekly publication of the mounting figures for 

brokers' loans—which had doubled by the spring of 1929. 

The use of "direct action" for a few months early in 1929 consisted of a 

campaign, initiated by the Board, to have the Federal Reserve Banks 

insist that such individual member banks as were in debt to them should 

either liquidate their indebtedness or else reduce outstanding street loans. 

The stated purpose was to prevent the abuse of Reserve Bank credit— 

"the use of the resources of the Federal Reserve Banks for the creation or 

extension of speculative credit"—but it was upon the course of stockmarket credit that the campaign was expected to register. It was not 

pressed home at all points, but was reflected during the short period of its 

duration in some decrease in brokers' loans—about 300 million dollars— 

which was accompanied by a temporary decline in the volume of trading 

and a temporary halt in the upswing of stock prices. At the same time 

there was a sharp rise in short-term money rates, not only for street loans 

but also for commercial loans. The reduction in the street loans of banks, 

however, was offset to the extent of more than one-half by an increase in 

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68 FEDERAL RESERVE POLICY 

creased at banks which were not indebted to the Reserve Banks, and 

consequently were not subject to the "direct action'' pressure, has never 

been ascertained. It is obvious, nevertheless, that by reason of the limitations of the instrument this could have happened then and that it could 

always happen at any time when, as has in recent times been the case at 

intervals for several years in succession, member banks are not on]y out 

of debt to the Reserve Banks but are, on the contrary, holding large excess 

reserves. 

The denial of eligibility for discount to stock-market loans dates from 

the very beginning of the Federal Reserve System, in 1913. One of its 

purposes, though not the only one,2 was to exert influence on the amount 

of credit used for financing transactions in the stock market. It is accordingly to be considered as a selective instrument of credit policy; in fact, 

the oldest one of all, included as it was in the original Federal Reserve 

Act. According to that act, no Federal Reserve Bank was permitted to 

discount any paper "issued or drawn for the purpose of carrying or trading 

in stocks" or other securities except Government securities. For the purposes of the present discussion, this prohibition is chiefly significant for a 

misconception embodied in it which had to give way before selective 

instruments of the modern type could be developed. 

The original operational idea was that if member banks are prohibited 

from obtaining Reserve Bank credit through discounting stock-market 

loans their power to make such loans will be restricted, with the result 

that the total amount of credit used for stock-market purposes will in turn 

be controlled. As time went on, however, experience showed this idea to be 

illusory, because (1) a member bank can make stock-market loans on the 

basis of Reserve Bank credit obtained by it through discounting other 

loans; (2) a member or nonmember bank can make such loans on the basis 

of funds received by it indirectly through the permissible discounting 

operations of other banks or through such channels as the open market 

operations of the System and gold imports; and (3) loans can be made 

available to the stock market, as they were in fact made available in large 

volume (eventually about 6.5 billion dollars) in the late twenties, by nonbanking lenders. Under the fractional reserve arrangement, moreover, 

Reserve Bank credit, however obtained and even if used initially for a 

commercial loan, puts at the disposal of the banking system several times 

2

 Another purpose was to help insure that non-self-liquidating paper would be excluded 

from the earning assets of the central banking system. 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 6 9 

that amount of credit which would not be subject to any specific control. 

It follows, therefore, that whatever authorities are responsible for national 

credit policy, if called upon to apply effective control to stock-market 

credit—or for that matter any other selected category—cannot hope to do 

so by the selective granting or withholding of Reserve Bank credit. They 

must be able to exercise a more direct influence on the use of credit in 

the selected sector, from whatever source obtained. 

During the whole period prior to 1933, attempts by the Federal Reserve 

System to influence the course of stock-market credit were handicapped 

not only by the inadequacy of available instruments but also by the 

absence ol any explicit legislative mandate requiring the Federal Reserve 

authorities to take responsibility for the course of stock-market credit. 

Taking cognizance ol this fact, in the light of experience, Congress provided in the Banking Act of 1933 that each Federal Reserve Bank, in 

determining whether to grant or refuse credit accommodation, should give 

consideration to

 uwhether undue use is being made of bank credit for the 

speculative carrying of or trading in securities . . ."3 

This not only cleared up a question of governmental responsibility but 

also went far beyond the requirement of the original Federal Reserve Act 

that stock-market paper should be ineligible for rediscount. Not only the 

character of the paper, but also the behavior of the applying member bank 

and in addition that of other banks, became a prescribed criterion. Thus 

Congress in effect gave legislative recognition to the specific objective 

which animated the Board's selective approach in 1929 and undertook to 

implement that approach. At the same time, Congress authorized the 

Federal Reserve Board to suspend any individual member bank from the 

use of the credit facilities of the System for "making such undue use of 

bank credit," and to limit by rules of uniform district-wide application the 

volume of security loans that a member bank might carry, expressed as a 

percentage of the bank's capital and surplus. Significant as this legislation 

was in enunciating a principle, it added very little on the instrumental 

side; the technique contemplated for enforcing the principle was not 

greatly different from that used in 1929 and was subject to the same inherent limitations. 

Recognizing these limitations, Congress (in the Securities Exchange Act 

3

 The relevant provision has a broader, but still selective, coverage: ".. . whether undue 

use is being made of bank credit for the speculative carrying of or trading in securities, real 

estate, or commodities, or for any other purpose inconsistent with the maintenance of sound 

credit conditions; " (Italics supplied.) 

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70 FEDERAL RESERVE POLICY 

of 1934) gave the Board a mandate to issue margin-requirement regulations "for the purpose of preventing the excessive use of credit for the 

purchase or carrying of securities," and buttressed the mandate by making 

these regulations applicable not only to all banks, both member and nonmember, but also and primarily to extensions of credit by credit-grantors 

other than banks—i.e., by brokers and dealers in securities. The statute 

did not undertake to define, but left to be determined by the Board from 

time to time, what use of credit for the designated purpose shall be deemed 

"excessive," but did provide that in order to serve their preventive purpose the margin requirements should be "based upon" a stated standard 

under which the requirements, except as raised or lowered by Board 

action taken under prescribed statutory rules, could not be less than 25 

per cent or more than 45 per cent.4 

While this instrument, like all its specific predecessors, is selective in 

conception, it is altogether different in method. The control which it 

applies, though bearing directly on the conduct of lenders, puts restraint 

on the borrower. It limits the amount that he can borrow, or even bid for, 

by relating it to the type and value of the collateral that he must provide. 

It can be used, therefore, to keep down the amount of stock-market credit 

even though the lending power of lenders may be very large and the rate 

of interest they would be willing to take very low. By thus limiting the 

demand for credit for stock-market purposes, the control can reduce the 

amount of upward pressure on money rates that this demand for credit 

could otherwise exert. The selective methods previously employed, affecting as they did only the supply side of the money market, could not of 

course have this result. 

During the whole time that this new instrument has been available, the 

standard margin requirements have been higher, and for most of the time 

much higher, than they had been when they were fixed by the New York 

Stock Exchange, leading brokers, and the commercial banks. Information 

concerning the standard requirements during the boom of the twenties, 

though fragmentary, is sufficient to indicate that even when speculation 

4

 The rules seem to give the Board (though this is debatable) somewhat less power to lower 

margin requirements than to raise them: The guiding rule for lowering is "for the accommodation of commerce and industry, having due regard to the general credit situation," while that 

for raising is "to prevent the excessive use of credit to finance transations in securities." 

See also Section 2 of the Securities Exchange Act of 1934 which refers, among other things, 

to "national emergencies," to "sudden and unreasonable fluctuations of security prices," 

and to "excessive speculation." 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 71 

was most active they were seldom above 15 per cent (with exceptions as 

low as 10 per cent). Under the Board's regulations, effective October 1, 

1934, the margin requirements prescribed, which were about 28 per cent 

at the outset, have since early in 1936 never been less than 40 per cent5 

and were for a time as high as 100 per cent. 

During this 13-year period, partly in consequence of the higher margin 

requirements, the aggregate volume of stock-market credit has at no time 

been as much as one-fourth as large as it was during the stock-market 

boom of the late twenties. The amount of credit extended by brokers, 

which is measured by their customers' debit balances outstanding, has 

been as large as 1,560 million dollars—in the spring of 1937—but this was 

less than half as large as these balances had been early in 1927 when the 

boom of the twenties was entering its semi-final stage and in fact somewhat 

less than it had been in the autumn of 1924 when the boom was just starting. Judging by this general evidence, margin requirements can be used 

as an effective instrument for keeping the volume of stock-market credit 

at crucial times within officially determined bounds. 

The effectiveness of the instrument, in more respects than one, had a 

partial test in 1936-37. This is brought out by the chart on page 72. 

When requirements were raised by Board action early in 1936 from a 45 

to a 55 per cent level, the volume of stock-market credit, as measured by 

customers' debit balances, promptly declined somewhat along with a 

moderate decline in stock prices. It began to increase again in the summer, 

along with a renewed increase in stock prices, and continued to do so until 

the spring of 1937, but the total increase (about 15 per cent) was materially less than the accompanying increase (about 40 per cent) in the level 

of stock prices. In preregulation days, at any rate for the 1917-34 period 

for which figures are available, no such thing had ever happened; the 

typical relationship was one in which the growth of stock-market credit 

had been in much the same proportion as the advance in stock prices. 

The restrictive potency of the instrument was tested more decisively in 

1945 and 1946, when the Board raised the margin requirements from the 

40 per cent level at which they had stood since 1937 to a 50 per cent level 

(February 5, 1945), then to a 75 per cent level (July 5, 1945), and finally 

to a 100 per cent level that applied from January 21, 1946 to February 1, 

6

 Margin requirements on "the short side" were not fixed by the Board until Nov. 1, 1937. 

From that time until Feb. 5,1945, they were at the 50 per cent level (against 40 for "the long 

side"); since then they have been the same as those on "the long side." 

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1947. The first change did not halt the increase in stock-market credit, 

which continued to advance, along with a further increase in stock prices. 

But the second and third increases did, as is brought out by the chart, for 

although stock prices continued to advance until May 1946, the volume of 

stock-market credit actually began to decline after July 1945, and continued to do so, with a short interruption, throughout the period of price 

advance as well as afterwards. This reflected in part the effect of new rules 

which put restrictions on transactions in undermargined accounts. The 

STOCK MARKET 

END OF MONTH BASIS MILLIONS OF DOLLARS 

new rules (effective July 16, 1945) required that the proceeds of any sales 

of securities in such accounts should go first to reducing the debit balance 

of the account; they could no longer be freely used to buy securities, as 

margin traders operating in a rising market are always tempted to use 

them. Quite aside from the effect of this particular factor, however, the 75 

per cent requirement—and later the 100 per cent requirement—certainly 

applied substantial restraint to the use of credit for stock-market 

purposes. 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 73 

ing for the rise," or so it would certainly seem to anyone who observed the 

speculative mania of the twenties. A simple arithmetical example will 

bring out the point. At that time, a man having, say, $1,000 that he was 

willing to stake could buy (with one of the less prudent or 10-per-cent 

brokers) 100 shares of stock at $100, on which a rise of 5 points would 

bring him $500 profit; under the 75 per cent rule he could buy only about 

13 shares at $100, on which a rise of 5 points would bring him only about 

$65 profit. Under the 100 per cent rule established early in 1946, he could 

buy with $1,000 only 10 shares at $100, and his profit on a rise of 5 points 

would be only $50. The lure of a rising market as a place in which one 

may "get rich quick" was obviously far less potent in 1945,1946, and 1947 

than throughout the late twenties. 

The margin-requirements mechanism for influencing the course of 

stock-market credit has both its inherent possibilities and its inherent 

limitations. It can be used with effect to restrain speculative excesses in 

the stock market and to prevent those which may still occur from doing 

so much harm to the national economy as some of them did in preregulation days. Most of its inherent limitations, aside from those which it 

shares with general instruments of credit policy, arise from the circumstance that margin requirements can be prescribed only by reference to 

the amount of collateral by which a loan or account may be secured. In 

the United States, however, the practice of making loans to purchase and 

carry securities without collateral, or even on collateral other than securities, has never yet been at all common or widespread. 

Mechanism for Influencing Consumer Credit. Governmental concern 

with consumer instalment financing, another of the fields to which selective instruments of policy have been applied, does not have so long a 

history as governmental concern with stock-market credit, but its history 

does go back as far as 20 years. Special inquiry into member bank holdings 

of instalment paper was made through bank examiners in 1925-26; 

machinery was set up by Congress in 1934 for encouraging the use of 

instalment credit to finance home mortgages, repairs and improvements 

to residential property, and the purchase of electrical appliances; in 1937 

the Board put into its Regulation A, relating to discounts for and advances 

to member banks by Federal Reserve Banks, provisions designed to encourage, in accordance with specified standards of a general nature, both 

real estate loans and loans for financing the sale of goods on an instalment 

basis; and from 1941 to 1947, under an Executive Order valid during a 

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74 FEDERAL RESERVE POLICY 

period of national emergency, the Board exercised control over shortterm consumer credit by means of its Regulation W.6 

A noteworthy fact about national credit policy in the consumer-credit 

field is that, in different circumstances, it has employed selective instruments first to encourage expansion and then to exercise restraint. 

One of the principal stimulative devices has been that of Government 

guaranty (for private extensions of credit) used for example to encourage 

home building, improvement, and repair. Employing this mechanism, the 

Federal Housing Administration has undertaken to insure acceptable 

lending institutions against possible loss, or against at least a part of such 

loss, and thereby to stimulate loans for the designated purpose. It is 

notable that for home building the amount of a loan eligible for guaranty 

has been large relative to the valuation of the property (as determined by 

the insuring agency), that the length of the insurable loan contract has 

been relatively long, that the amortization provisions have been standardized, and that the rate of interest which might be charged on an insurable 

loan has been relatively low. In view of its purpose, the plan has naturally 

stressed low down-payments and long maturities. It has in particular 

influenced many banks and other financial institutions to go into a line of 

business that was new to them, and to develop it on an uninsured as well 

as an insured basis. The volume of loans under FHA insurance grew steadily until its growth was stopped by the war, and amounted at its peak to 

about 3.6 billion dollars. The efficacy of the instrument in stimulating private credit extension and private enterprise, though sometimes questioned, appears to those who have carefully studied the matter to have 

been amply demonstrated.7 

The techniques employed by the Board in the regulation of consumer 

credit, though analogous to those used in the regulation of stock-market 

credit, were different in several essential respects. The basic requirements 

(adjustable from time to time) were those which applied to "instalment6

 In exercising this control, the Board was required by the Executive Order to consult with 

a committee comprising the Secretary of the Treasury, the Federal Loan Administrator, and 

the Administrator of the Office of Price Administration, or such alternate as each might delegate. By subsequent Executive Orders, the over-all policy directives which two other agencies 

—the Office of Economic Stabilization and the Office of War Mobilization and Reconversion 

—were empowered to issue included directives relating to consumer-credit regulation. 

7

 See for example Leo Grebler, "Housing Policy and the Building Cycle," in The Review 

of Economic Statistics, May 1942, pp. 66-73. An easing of terms for low-priced houses early in 

1938, when down-payments were reduced and maturities were lengthened, is said to have influenced activity in this sector to turn up earlier than other sectors of the economy. 

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sale credit" and which prescribed a minimum down-payment, such as 

one-third, and a maximum length-of-contract, such as 12, 15, or 18 

months. They applied to vendors, such as automobile dealers, who create 

the instalment-sale paper but usually sell it to a financial institution, 

such as a bank or finance company. The basic requirements extended also 

to lenders; if the paper did not comply with the requirements of the 

regulation, lenders were forbidden to create it, to buy it, or to accept it 

as collateral for loans. Makers of instalment loans directly to the consumer, for the stated purpose of purchasing an automobile or other 

"listed article,"8 were subject to equivalent requirements. In addition, 

other instalment loans, though not limited as to amount, could not (unless the loan was an exempted loan) have a longer maturity than that 

specified in the regulation. 

Down-payment and maturity requirements, like margin requirements 

in the field of stock-market credit, apply a control which operates to 

influence the aggregate amount of credit that debtors or prospective 

debtors are in position to obtain rather than the amount that creditgrantors are in position to supply. Like the margin requirements, consequently, they can serve their primary purpose, such as limiting the use of 

short-term consumer credit, even though the total supply of available 

credit may be very large, and can do so without tending to raise money 

rates. 

The course of consumer credit for the past 18 years is shown on the 

chart on page 76, with separate curves for instalment credit (including 

instalment loans) and for that part thereof which represents instalmentsale credit. It shows that there have been wide fluctuations in the total, 

of the nature of cyclical swings, and that the dominant factor in these 

swings has been instalment-sale credit, well-known to be itself correlated 

as a rule with fluctuations in consumer purchases of consumers' durable 

goods. The large reduction in the total between 1941 and 1944, from about 

10 billion dollars to about 5 billion, reflects primarily a sharp wartime 

reduction in the available supplies of goods such as are commonly bought 

on the instalment plan, particularly automobiles and household appli8

 The list of articles (consumers' durable goods) included at all times those which were 

retained under the revision effective Dec. 1, 1946: Automobiles, refrigerators, cooking stoves 

and ranges, air conditioners, washing machines, ironers, dishwashers, sewing machines, suction cleaners, radios, phonographs, and furniture. Between May 6, 1942 and Dec. 1, 1946, it 

included also a wide range of other articles, among them many categories of "soft goods/' 

and made provision for regulating both charge accounts and single-payment loans. 

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76 FEDERAL RESERVE POLICY 

ances, and the wartime increase in consumer income which enabled many 

consumers to buy for cash instead of on credit and to pay promptly for 

credit purchases. But Regulation W, which went into effect September 1, 

1941, was also a factor in bringing about the initial decrease as well as 

in restraining the subsequent increase. On this point there seems to be 

very general agreement, notwithstanding considerable difference of opinion concerning the amount of influence that may fairly be attributed to 

the regulation. Without it, more credit would have been extended to 

consumers, the rate of repayment would have been less rapid, and the 

consuming public as a whole would have come out of the war and into the 

reconversion more heavily in debt. At any rate, as is shown on the chart, 

the total volume of consumer credit outstanding at the end of 1945 was 

no larger than it had been nine years before, when the country was only 

part way out of the great depression, and the volume of "instalmentsale credit'' was actually lower than it had been in 1933 in the trough 

of the depression. 

BILLIONS OP DOLLARS 

CONSUMER CREDIT 

END OF MONTH BILLIONS OF DOLLARS 

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INSTALMENT SALE CREDIT 

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Whatever efficacy consumer-credit regulation may have had in wartime was obviously dependent, to a degree that is hard to estimate, upon 

circumstances of the time which predisposed persons subject to the regulation to comply with it, such as the public spirit characteristic of wartime 

and the absence in an active "sellers' market'' of inducements to promote 

sales by offering very easy credit terms. This minimized immensely the 

problem of enforcement. Under peacetime conditions, after goods are in 

supply again, the disposition of the consumer-credit industry to comply 

with any regulation would depend very largely upon the scope and nature 

and stringency of the regulation; that is to say, upon the prescience and 

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judgment of the authorities responsible for shaping and administering the 

regulation. An important circumstance making for sustained cooperation 

from the consumer credit industry could be the disposition of a considerable part of the industry, in the light of its experience over the past 

30 years, to see in governmental regulation a safeguard against excessive 

relaxation of instalment terms such as competition has heretofore engendered, notwithstanding repeated cooperative efforts within the industry 

to halt the trend. 

After December 1, 1946, when Regulation W was revised and remodeled, discussion of whether or not consumer-credit regulation would 

be desirable and effective in peacetime—either for a transition period or 

indefinitely—was facilitated by the exhibit of a regulation better adapted 

to fit peacetime conditions. The remodeling took the direction of focusing 

the regulation on consumers' durable goods in the narrower sense, as 

distinguished from the numerous semidurables formerly included among 

the listed articles. The list was confined to those relatively few items of 

sizable unit-cost for which instalment methods of financing and refinancing typically predominate. This remodeling, by simplifying the 

regulation, minimized both compliance problems and enforcement problems and also served to make more clear-cut and manageable the central 

problem of the policy making authorities—that of determining as of any 

given time whether any change should be made (in either direction) in 

the basic requirements and if so to what extent. The revised regulation, 

with its narrowed scope, no longer covered the whole credit field of consumer credit, but it did cover that large part which is subject to the widest 

range of fluctuation and is most important in relation to stabilizing the 

national economy. 

ELEMENTS OF SELECTIVE MECHANISM 

A prerequisite to the development of selective mechanism, as the examples cited will have indicated, is that the field to which the given instrument is to apply shall be definable in precise terms. This is essential for 

policy making (as well as legal and legislative) reasons, in order that the 

policy makers may be in position to follow the course of the magnitude 

that they are interested in influencing. It is indispensable also for operating reasons, in order that credit-grantors who are to be subject to given 

requirements may know which of their manifold and diverse transactions 

must conform. How is it to be determined, for example, whether this or 

that transaction constitutes an extension of credit "for the purpose of 

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purchasing or carrying securities," or an extension of "consumer credit," 

or an extension of consumer credit "for financing or refinancing the purchase of consumers' durable goods"? 

For identifying precisely the included transactions, only three methods 

seem to be available, and all three have been used to some extent. They 

may be called the collateral test, the proceeds test, and the declaration 

test. If the credit-grantor is a broker or dealer in securities, his extensions 

of credit will almost always be supported by collateral consisting of securities and the proceeds can be presumed to have been used in almost 

all cases for purchasing securities. In such cases, the collateral test is 

generally adequate. 

If the credit-grantor is a banker, however, and the loan is not made to 

a broker or dealer in securities, there can be no such presumption even 

though the collateral consists of securities, and a bank loan for purchasing 

securities may of course be supported by other collateral or even by no 

collateral at all. For bank loans, therefore, up to the present time, a combination of the collateral and declaration tests has been employed. Unless the loan is secured by stocks the banker need not inquire into its 

purpose, but if it is so secured he may at his option either assume that its 

purpose is to purchase stocks or may, if acting in good faith, accept and 

rely upon a signed declaration of the borrower to the contrary. If, in the 

consumer-credit field, the credit-grantor is a dealer in some consumers' 

good, such as automobiles, and the extension of credit arises out of a sale 

of the good, the purpose is self-evident and neither a collateral test nor a 

declaration test is necessary—but if the credit-grantor is a banker or a 

small-loan company or a credit union the collateral test is not conclusive 

and, to some extent at least, the declaration test has to be employed. 

Wherever that test must be the main reliance, its use presents a number 

of special administrative problems. 

The proceeds test would require the lender to assure himself of the use 

to which the proceeds of a loan are put or are to be put. Superior though 

this test might seem to be in principle, extensive resort to it would present 

difficult administrative problems. Little specific use has consequently 

been made of it, and this has been mainly for helping to give definition 

to the declaration test. 

A given instrument clearly cannot be effective on the restrictive side 

if its application is so limited as to leave out any class of credit-grantors 

which could supply much credit for the selected purpose. For security 

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market credit, this problem has been handled by making the margin requirements applicable to any bank, to any member of a national securities exchange, and to any broker or dealer who (in the language of the 

statute) "transacts a business in securities through the medium of any 

such member;" this leaves unused, but in reserve, the Board's statutory 

authority to include other persons (except lending agencies owned by the 

United States) so far as loans made in "the ordinary course of their business" are concerned. The institutional scope of the Board's consumercredit regulations was considerably more inclusive. In their final (and 

limited) form they applied, in general, to any person who was "engaged 

in the business of making extensions of instalment credit in amounts of 

$2,000 or less, or discounting or purchasing obligations arising out of such 

extensions of credit." This included governmental lending institutions 

operating in this field, such as the Electric Home and Farm Authority 

(now in liquidation) and the Rural Electrification Administration.9 It 

stands to reason that any control of this type should apply in principle 

not only to private credit-granting institutions but to corresponding 

governmental institutions as well. 

Although the central part of the mechanism consists of such basic 

elements as minimum margin (or down-payment) requirements and maximum length-of-contract requirements, regulations in which such requirements are imbedded consist for the most part of provisions of the nature 

of supporting rules, designed both to prevent circumvention of the basic 

requirements and to facilitate permissible business transactions. These 

need to be so contrived that any of them can be changed, as occasion may 

require, without necessitating any change in the basic requirements. This 

contributes to giving the whole mechanism such inherent flexibility that 

necessary or desirable adjustments can be made from time to time both 

readily and promptly. 

For the margin requirements, and also for the consumer-credit regulations while they were in effect, the ultimate legal sanctions have been 

severe, consisting of fine, imprisonment, or both—the fine being limited 

to $10,000 in both cases and the term of imprisonment to 2 years in the 

one case and 10 years in the other. The development of less severe and 

consequently more workable sanctions has presented a problem in both of 

• Until Oct. 15, 1945, the Federal Housing Administration was affected indirectly in that 

certain home-improvement loans which that agency could insure if the loans were to be made 

could not lawfully come into existence under the consumer-credit regulations. 

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the designated fields, but some of these have in fact been developed. 

Under a novel provision of the Securities Exchange Act, for example, it 

is the obligation of the New York Stock Exchange or any other "national 

securities exchange" to enforce the law and regulations thereunder, including the Board's margin rules, against its own members, and the Exchange has on occasion censured an offender or fined him (e.g., by $100); 

it could go so far as to suspend him from membership or even to expel 

him. The Board's consumer-credit regulations were supported by a requirement that every credit-grantor subject to them should be licensed 

and might, after reasonable notice and opportunity for hearing, have his 

license suspended or revoked by the Board for any willful or negligent 

failure to comply with any provision of the regulations. As a practical 

matter, the compliance problem under these regulations was simplified 

and its solution promoted—to a degree that would be hard to overemphasize—by the fact that the enforcement program was carried out in the 

main on a decentralized basis, i.e., by the 12 Federal Reserve Banks and 

their 24 branches. 

The selectivity of the mechanism that has been described is not at all 

of the pin-point type. The use of credits in one or another sector of the 

economy, broadly defined, is governed by rules which apply throughout 

that sector. These rules are impersonal. They involve no official determination concerning who shall enter the business in question, or how much 

business he shall do, or with whom he shall deal. No official of Government is called upon to pass judgment on individual credit transactions. 

One need not labor the point that in a free society, such as we prize in 

this country, these negative characteristics are as important as the positive characteristics that are commonly most emphasized. 

In the course of time, experience and research will doubtless lead to 

improvements in selective mechanism. These may relate not only to 

matters of detail but to matters of principle as well. They would surely 

be necessary in case the principle of selectivity were ever to be applied 

to additional sectors of the economy, which might differ as much from 

the sectors now included as these differ from one another.10 

10

 The only additional sector to which it has been seriously suggested that the principle 

should be applied, at any rate by means of an instrument of the type described in this paper, 

is real estate credit. For comment see pp. 69-71 of Grebler citation given in footnote 7, p. 74 of 

this paper; E. C. Johnson, Federal Reserve Bulletin^ March 1944, p. 231; Consumer Credit Controls 

(80 Cong. 1 sess., Hearings before the House Committee on Banking and Currency, 1947), 

pp. 283-84; also references to Williams, Bopp, and Goldenweiser in footnote 11 on p. 82 of 

this paper. 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 81 

COORDINATION OF GENERAL AND SELECTIVE INSTRUMENTS 

General instruments of national credit policy—discount rates, open 

market operations, reserve requirements—have been in use for so long 

that the problem of coordinating these with one another has been measurably solved, both for easing the general money market and making 

credit more available and for tightening the market and making credit 

less available. Another problem, on which much less experience has been 

had, is that of coordinating the general and the selective instruments with 

each other. 

Such experience as has been had with this problem indicates that in 

relation to the general instruments the function of selective instruments 

is, according to circumstances, to reinforce, to compensate, or at certain 

times to serve as a partial substitute. The insuring of home-building and 

home-improvement loans inaugurated in 1934 served to reinforce the 

general credit-easing program that was then being pursued. The increase 

in the margin requirements that was made early in 1936 can be viewed as 

a compensatory measure, designed to prevent the over-expansion of 

speculation in the stock market at a time when general instruments were 

being used to supply the money market with ample funds and to keep 

down the general level of money rates. The tightening of terms on consumer credit early in 1942, although it had a specific wartime purpose, can 

be viewed also as somewhat of the nature of a general anti-inflationary 

measure, a partial substitute for tightening the general money market at a 

time when that was itself precluded by the necessities of war financing. 

An interesting instance of the coordinated use of selective instruments 

was the simultaneous employment early in 1936 of a stimulative and a 

restraining measure—the insurance of home-building and home-improvement loans at the same time that the growth of stock-market credit was 

being held back by an increase in the margin requirements. 

Not only the compensatory or balancing function of selective instruments when used in conjunction with general instruments, but also some 

of their independent functions, are indicated by a statement in the Annual Report of the Federal Reserve Board for 1928 (italics supplied): 

"Low money rates may have a favorable effect on domestic business, 

but at the same time may stimulate speculation in securities, commodities, 

or real estate. High money rates, on the other hand, may exert a moderating influence on speculation, but at the same time may result in a higher 

cost of credit to all lines of business, and thus be detrimental to commerce 

and industry; " 

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An impressive implication of the statement quoted is that precisely 

because the general or conventional instruments operate to influence the 

general level of money rates and the course of business as a whole, the 

question of just when to use them and to what extent is sometimes extremely difficult. If the authorities have at their disposal suitable selective 

instruments, a decision to use one or more of these may be considerably 

less complex and consequently more likely to be taken in good season. 

Need for the broader decision should accordingly arise less often, and be 

less difficult for the authorities to make when it does arise—both because 

the way for it will have been paved and because it can be taken with the 

assurance that the change in general pressure which it will occasion, if 

this turns out to have bad effects in a particular sector of the economy 

subject to selective credit control, can be dealt with in that sector. To 

ease the apprehension of causing a collapse of the whole economy by restrictive action, or causing runaway inflation by stimulative action, should 

tend to make national credit policy as a whole more vigorous, more flexible, and more effective. 

OUTLOOK FOR THE SELECTIVE CONCEPT 

In appraising the outlook for the selective concept—especially the longrange outlook—one may note at the outset that it has been, or is at least 

coming to be, well received by representative economists.11 They are 

giving it welcome as a promising contribution to the national combat 

against inflation and deflation and against extreme economic fluctuations 

in general, viewing it as all the more acceptable because it can be so employed as to strengthen rather than weaken such basic democratic institutions as private enterprise, a competitive economic order, and a 

freely functioning general price system. That is to say, the drift of thought 

among economists seems to be toward recognizing that selective instruments of national credit policy, though still viewed somewhat as innovations, may nevertheless possess to a significant extent the very attributes 

which have had so much to do with generating and sustaining the great 

11

 See for example Gottfried Haberler, Consumer Instalment Credit and Economic Fluctuations (1942), pp. 162-63,175; John Maurice Clark, Demobilization of Wartime Economic Controls 

(1944), pp. 13, 132, 135; Financing American Prosperity: A Symposium of Economists (1945), 

pp. 142-43, 146 (Ellis); p. 253 (Hansen); p. 290 (Slichter); pp. 383-84 (Williams). See also 

Karl R. Bopp, American Economic Review, March 1944, pp. 275—76; Charles R. Whittlesey, 

Quarterly Journal of Economics, May 1946, p. 345; E. A. Goldenweiser, American Economic 

Review, June 1947, pp. 327-35; The Council of Economic Advisers, Federal Reserve Bulletin, 

July 1947, pp. 828-29. 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 8 3 

tradition which has so long surrounded the more familiar general instruments. 

This receptive attitude among economists, so far at least as regulation 

of stock-market credit and consumer credit is concerned, seems to reflect in large part their appreciation of the strategic significance of the 

credit used in these sectors of the economy and also that of the sectors 

themselves. A boom in stock prices, whether viewed as supported by the 

growth of credit or as generating that growth, can beget a slump that has 

stunning effects on business enterprise and the level of employment; 

wide fluctuations in the demand for consumers' durable goods, dependent 

in large part on the use of consumer credit, help to engender wide fluctuations in the important industries which produce such goods and even 

wider ones in some of those which cater to these industries. The identification of strategic factors in economic fluctuations, as achieved by research into the history and theory of business cycles, is indeed fundamental to the philosophy of selectivity, whether in the field of national 

credit policy or the broader field of national economic policy in general. 

An objection sometimes advanced against selective instruments is 

that though some of them may be potent on the restrictive side most of 

them have little potency on the stimulating side. It is certainly true of 

margin requirements and of consumer-credit regulation, as it is of the 

general instruments, that their potency is greatest when they are used to 

restrain the growth of credit. A significant consideration here, however, is 

that their use in their respective sectors to prevent excessive expansion 

should reduce, if not eliminate, the likelihood of excessive contraction) 

such contraction is well recognized to be a serious factor in accentuating 

downswings in the business cycle. But it is not true that selective instruments can have in their respective sectors no influence at all in their less 

effective direction. Lowering the margin requirements in the autumn 

of 1937, though it failed to halt the decline in stock-market credit, can be 

fairly credited with having helped to slow down the decline for a number 

of months. It seems quite likely also that in some circumstances, though 

not in others, a relaxation of official requirements for instalment credits 

would tend to stimulate credit expansion in the consumer-credit field and 

consequently help the industries that make large use of consumer credit. 

It is a matter of common knowledge, certainly, that at times during 

recent decades the market for such consumers' durable goods as automobiles and refrigerators has been greatly expanded by the lowering of downpayments and the lengthening of instalment contracts. 

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84 FEDERAL RESERVE POLICY 

There is no logical reason, however, why every instrument of credit 

policy must itself be capable of two-way operation. Selective instruments 

which are valuable mainly for restraining purposes may be supplemented 

with others, such as the insurance of credits, which are valuable for 

stimulative purposes. In addition, and in the long run this may come to 

be the more important point, the availability of selective instruments of 

both types should enable the Congress and other policy-making authorities to make better use upon appropriate occasion, for both stimulative 

and restraining purposes, of the general or nonselective instruments of 

credit policy and other instruments of national economic policy. 

Even where the hold of the traditional and nonselective ideology of 

credit policy has been most firmly entrenched, the pressure of events as 

well as the progress of understanding has done a good deal to loosen up 

that ideology. Its hold on the minds of its adherents, already somewhat 

disturbed at intervals prior to 1929, was seriously shaken during the Great 

Depression when floooding the banking system with excess reserves did 

not of itself suffice to energize recovery. Misgiving was accentuated when 

successive increases in reserve requirements in 1936 and 1937, designed 

as a timely precautionary measure against possible inflation, were found 

to have in the securities markets some deflationary consequences which 

necessitated resort to countervailing open-market operations. The charge 

began to be pressed that exclusive reliance on general instruments tends 

to paralyze credit policy, in that for psychological and other reasons they 

may be so extremely powerful that to use them to moderate an unhealthy 

upswing in business activity may in fact precipitate a downswing. What 

necessity is there, it was asked, to tighten credit for all purposes at a time 

when excessive use of credit is being made only for some purposes? Is no 

differentiation possible, particularly when there are present in the economy simultaneously both inflationary tendencies and deflationary tendencies? Such considerations as these have had, and may continue to 

have, considerable influence on the dominant tradition. 

Whether national credit policy is destined, as time goes on, to make 

much use of selective instruments will depend in considerable part on the 

competence with which any selective instruments in current use are 

shaped and administered. It will depend also, however, upon the receptivity to the concept that may be expected from the public at large, from 

credit-grantors, and from the Congress. 

To the public at large, for fairly obvious reasons, the selective approach 

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actually seems to be more natural than the general approach. If the authorities undertake to stimulate business activity by the insurance of 

loans for home building or home improvement, for example, the relation 

between the means and the end is easy for the public to understand; 

much easier than when the authorities undertake to stimulate general 

business activity by flooding the general money market with funds. On 

the restrictive side also, measures directed against unhealthy developments in a single field, such as the stock market, seem to the public at 

large more sensible than measures which tend to tighten credit for everybody everywhere. But the selective incidence of the selective instruments 

may often be of less consequence, as a factor making for the acceptability 

of a restriction with the people, than the incidental circumstance that the 

particular device employed (though not designed for this purpose) serves 

in observable degree to protect the individual from incurring debt to his 

own detriment—as (1) by buying stocks on a margin so thin that a small 

but temporary price decline will wipe out his equity, or (2) by buying, 

perhaps by reason of his having low sales resistance and having that weakness played upon by the appeal of "easy terms/' more things at one time 

than he can ever hope to pay for and retain. At the level of the folkways, 

in short, there seems to be something obviously sensible and right in 

governmental measures that tend to limit the exploitation of improvidence. 

With credit-grantors, even including some bankers who instinctively 

dislike Government regulation in general, the tested selective instruments 

have met with some degree of favor—but, as with the general public, 

largely for reasons but incidentally related to their possible influence on 

the aggregate amount of credit put to the selected use or on the course of 

economic fluctuations. Some few stock brokers actually supported the 

margin-requirements legislation at the outset and few now complain 

against it in principle; many have appreciated the protection to their 

own financial condition that it affords, both directly and indirectly, and 

some approve the Government control on the ground that without it 

margin trading might sometime go again to such extremes as to threaten 

legislative prohibition; a proposal to that effect in 1934 came to vote in 

the Senate and failed by only a few votes. Many consumer-credit grantors 

(particularly small merchants) welcomed the advent of Federal regulation 

in 1941, or came to support it afterwards, for reasons growing out of their 

own previous experience—notably the financial hazard arising from the 

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inordinate competitive relaxation of instalment terms (especially for 

automobiles, etc.) over preceding years; the failure of repeated cooperative efforts made within the consumer-credit industry itself to halt the 

relaxation, with antitrust laws hindering some of these efforts; and even 

the feeling in some quarters that Federal regulation, implying some 

governmental recognition or sponsorship of the industry, would help to 

relieve it from a certain ancient odium that had not (and has not yet) 

disappeared. 

However meritorious the selective principle may seem to its proponents, and whatever support for it they may feel to exist already or to 

be in the making, when the matter of consumer-credit regulation came 

before the Congress in 1947 it was the opposition that was the better 

organized and the more vocal. Several trade associations, for example, 

notwithstanding sharp division of opinion within the ranks of some of 

them, pressed vigorously for the removal of consumer-credit regulation 

and against legislation to continue it—using in general laissez faire 

arguments of one sort or another. On that particular issue, notwithstanding efforts of the Federal Reserve Board and endorsement from the 

Council of Economic Advisers and the President, the immediate legislative outcome was adverse; although authorizing the continuance of 

consumer-credit regulation until November 1, 1947, the Congress directed 

that it be then discontinued. Sooner or later, however,—provided the 

concept of selectivity in national credit policy does in fact possess intrinsic merit and provided any selective instruments in actual use are 

competently administered—the concept may draw to itself the necessary 

political and legislative support. As bearing on this prospect, anyone who 

is familiar with the voluminous congressional hearings and debates on 

banking and credit matters over the past 30 years will have noted considerable disposition on the part of the Congress to appreciate their concrete 

and specialized aspects as well as their general aspects. It may well be 

that relating each of these to the other will be the crucial congressional 

problem. 

Whether or not a given selected field of credit should be brought under 

control, or remain under control if it is already there, is not a question to 

be settled all by itself. From the point of view of national credit policy, 

the value of selective instruments consists in considerable measure in the 

enfranchising effect that their ready availability can have on the effective use of general instruments. In that view, the retention of existing 

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SELECTIVE INSTRUMENTS OF NATIONAL CREDIT POLICY 87 

specialized controls and perhaps also the addition of others would have a 

presumption in their favor. The presumption will seem particularly strong 

to those who apprehend serious general price inflation (and subsequent 

deflation) and apprehend also that for use in combating such developments the conventional over-all instruments of credit policy may for 

many years, as a practical matter, be subject to severe limitations. 

CONCLUSION 

The concept of selectivity seems to be gradually making its way into 

the philosophy of national credit policy, for reasons that seem likely to 

stand the test of time. The obstacle to its progress that so long resided in 

the absence of appropriate selective mechanism has been overcome or is 

in process of being overcome. The older general instruments and the 

newer selective instruments complement each other, and taken together 

should make credit policy more resourceful. How to employ them in 

conjunction for constructive public purposes is a problem that calls for 

economic statesmanship, not only with respect to national credit policy 

in particular but also with respect to national economic policy in general. 

Over the long term, national credit policy will be able to make more of 

a contribution to the public welfare if it has at its disposal both general 

and selective instruments than if it should have to be formulated and 

carried out within the limitations imposed by its having to use general 

instruments alone. 

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PROBLEMS OF POSTWAR MONETARY POLICY 

by 

WOODLIEF THOMAS AND RALPH A. YOUNG1 

Director and Assistant Director, Division of Research and Statistics, 

Board of Governors 

Federal Reserve policies have evolved from experience in coping with 

the changing problems of the 30-odd years of the System's existence. This 

evolution has developed from the endeavors of the Federal Reserve authorities to perform the public duty for which the System was established.2

 Founders of the System could not have foreseen all the exigencies 

with which monetary policies would have to deal during the years to follow. They were impressed with the needs for an elastic currency, for the 

mobilization of the scattered reserves of the banking system, for reducing 

the reliance of that system upon stock-market credit as the central money 

market, and for avoiding money panics. To accomplish these purposes 

the Federal Reserve System was given power to create new money. This 

power is exercised through the lending and investing activities of the 

Federal Reserve Banks, which make available funds that can be used by 

member banks to obtain currency or to add to their reserve balances with 

the Reserve Banks. The Reserve Banks in turn can influence the lending 

and investing activities of commercial banks by regulating the supply and 

cost of funds which serve as the reserve base for commercial bank credit. 

Certain largely automatic limitations upon the System's operations 

were imposed by the Federal Reserve Act through requirements as to reserves, collateral for notes, and types of assets to be held. The System was 

also given certain discretionary powers, as in the fixing of discount rates. 

It appears from the discussion preceding and accompanying passage of 

the Act and from its grant of broad powers to the Federal Reserve Board, 

that some degree of judgment and discretion was expected to be exercised 

in the determination of the System's policies and that the general objec1

 This paper represents the results of study and work by many persons within the Federal 

Reserve System. In general it aims to present the thinking behind many of the policies followed 

by the System during recent years, although the explanations given are those of the authors 

and should not be considered as representing the official views of the System authorities 

collectively or individually. 

2

 For a description of this development, see the "Three Decades of Federal Reserve Policy," 

by Karl R. Bopp, the first paper in this pamphlet. 

88 

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PROBLEMS OF POSTWAR MONETARY POLICY 89 

tives of these policies were to be the maintenance of sound banking and 

monetary conditions in the interest of economic stability. It was widely 

recognized at the time that the previously existing banking and monetary 

system in this country had intensified the development of booms and depressions and had been responsible for the spectacular panic phase of 

those cyclical variations. 

Automatic and mechanical limitations in the Act apparently were designed with the thought that, by setting bounds to the exercise of discretionary power, excessive and unsound credit expansion would be prevented. History of the Federal Reserve System has shown, however, that 

these mechanical limitations have in practice not operated in that manner. They have often been most restrictive when restriction was undesirable and have contributed little or no restraint at times when restriction 

was needed. As a consequence, during the life of the System there have 

been many alterations in these statutory limitations to meet changing 

banking conditions.3 

Experience has demonstrated that effective limitation on excessive and 

unsound bank credit expansion under changing economic and banking 

conditions must be accomplished primarily by the exercise of discretionary authority rather than by automatic or mechanical means, for the 

reason that it is impossible to provide specifically in any credit and monetary statute for all future contingencies. Consequently, policies formulated and pursued by the Federal Reserve authorities for the purpose of 

influencing the total supply, availability, and cost of bank credit and 

money, as well as the specific availability of bank credit in particular 

strategic sectors, must be the main reliance of the System, rather than 

fixed rules and limitations. 

The use of discretionary powers by the Federal Reserve System in 

efforts to meet the ever-changing requirements of the credit system has 

brought about the development of Federal Reserve policy. Various limitations on the effectiveness of credit policy have been discovered in practice, and attempts to eliminate or moderate them have found expression 

in many amendments to the Federal Reserve Act. Taking the history of 

the Act as a whole, it can be said that its evolution has been in the direc8

 Critical defects in these mechanical limitations on Federal Reserve powers, as well as in 

the scope of the System's discretionary authority and in certain aspects of the banking structure not dealt with in previous legislation, were sharply demonstrated by the financial and 

banking crisis of 1929-33. Correction of these defects was a major objective of the Banking 

Acts of 1933 and 1935 and of the Securities Exchange Act of 1934. 

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90 FEDERAL RESERVE POLICY 

tion of making increasingly explicit the authority granted to the Federal 

Reserve System implicitly by the initial Federal Reserve legislation, 

namely, to use its discretionary powers in the public interest under 

changing economic conditions. 

METHODS AND CONSEQUENCES OF WAR FINANCE 

Hardly had the System been organized before it was faced with the 

serious problem of war finance. This task had not been foreseen by the 

founders, but the country would have been greatly handicapped in prosecuting World War I had not the Federal Reserve System been in existence. Also, the adjustments following the war, difficult as they were, 

would have been greatly aggravated and perhaps disastrous had there 

been no Federal Reserve System. In World War II the System was called 

upon again to aid war finance—even more exacting in its development 

than the former effort—and now again the country is facing the problem 

of adjusting monetary conditions distorted by war to the peacetime needs 

of the economy. 

One of the inevitable consequences of war is an abnormally rapid expansion in the supply of money and other liquid assets such as Government securities and savings accounts. Because of this financial heritage 

of war, the postwar economy is exposed to the risks of serious instability 

from monetary causes. The amounts of new money and other liquid 

assets generated during the Second World War surpassed all previous 

records. Unless absorbed or reduced in effectiveness by serious price inflation, redundant monetary liquidity seems certain to persist for many 

years to come. During the period ahead avoidance of disruptive fluctuations in credit, interest rates, and prices, at the least, or of recurrent inflation and collapse, at the worst, will require well-conceived and firmly 

pursued policies of monetary and debt-management operations. 

As a result of the heritage of war finance, the Federal Reserve System 

is greatly restricted in its capacity to perform the functions for which it 

was established, namely, to exercise an effective control over the volume 

of bank credit and the money supply. The re-establishment of the System's 

capacity to influence credit and monetary conditions in the interest of 

stable economic development is a primary postwar problem. 

Financing of war is inflationary because people receive incomes for producing and supplying goods that are not available for general consumption. War expenditures have to be paid for currently. No country has 

ever imposed upon its citizens a tax burden that would provide for war 

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PROBLEMS OF POSTWAR MONETARY POLICY 91 

expenditures as much as half of national income—the amount spent by 

this country during the war just ended—nor has any cotmtry in wartime 

been able to borrow out of the people's savings the entire balance between 

expenditures and taxes. Throughout the war, efforts were made in this 

country to raise as much as possible of its cost by taxation and by 

borrowing the peoples' savings. 

Fiscal and monetary authorities were agreed that financing through 

banks, which results in the creation of new money, should be used only as 

a last resort and only to the minimum extent necessary to provide the increased money supply needed by the expanding and abnormal war economy. Nevertheless, the banks had to be relied upon to a considerable extent. A high degree of liquidity was essential for securities sold to the 

public, and purchases by banks were needed to help maintain an active 

securities market and to facilitate the general sale of new issues. 

Although for these reasons a sizable expansion of the banks' holdings 

of Government securities and thereby in the money supply was necessary, 

the actual amount that occurred was excessive. "In retrospect," to quote 

from the 32d Annual Report of the Board of Governors of the Federal 

Reserve System, "it is evident that more vigorous policies should have 

been adopted in order to raise more of the cost of the war through taxation and to restrict bank purchases of Government securities." Many of 

the financing procedures adopted encouraged banks to purchase more 

securities than it was essential to have them buy and thus complicated 

the problem of postwar adjustments. 

Maintenance of Interest Rates. One pivotal Federal Reserve policy in 

facilitating war finance was the declared determination to provide banks 

with easy access to a volume of reserves sufficient to enable them to 

absorb all newly issued Government securities not taken by other investors. This decision involved the necessity of maintaining the interestrate structure at approximately the levels existing at the beginning of 

Jthe war. Besides facilitating bank purchases of securities this policy 

served a fourfold purpose: (1) to encourage prompt buying of securities 

by investors, who might otherwise have awaited higher rates; (2) to 

assure a strong and active market for outstanding securities; (3) to 

keep down the interest cost on the Government's war debt; and (4) to 

limit the growth in bank and other investors' earnings from their publicdebt holdings. 

The interest-rate structure generally maintained throughout the war, 

as is shown in the chart on page 93, was characterized by very low 

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92 FEDERAL RESERVE POLICY 

rates on short-term money, a wide spread between them and rates on 

long-term securities, and the lowest levels of long-term rates in the history of this country. This unusual interest-rate pattern came into being 

during the prewar period of recovery from severe deflation, when demands from borrowers were small, the flow of savings for investment was 

in large volume, and at the same time gold imports swelled bank reserves 

to far beyond current needs. Available funds were to a large extent invested in short-term paper, partly to retain liquidity and partly in anticipation of higher interest rates later. 

Maintenance during the war of the wide differential between shortterm and long-term interest rates established during depression stimulated expansion of bank credit, because it was possible for banks to sell 

short-term securities and buy longer-term issues bearing higher rates of 

interest. The short-term securities sold by banks were purchased by the 

Federal Reserve Banks in line with their policy of keeping short rates 

from rising. Since purchases by the Reserve System create additional 

bank reserves, the basis was thereby provided for a deposit expansion by 

the banking system as a whole of six to ten times the volume of such reserves.4

 Because this process of selling short-term securities to the Reserve Banks and purchasing longer-term issues was occasioned by the 

differential in yields between these maturity groups, it resulted in a kind 

of automatic "monetization of the public debt" without regard to the 

economy's needs for additional money. Such automatic monetization of 

the public debt has continued to some extent in the postwar period. 

Maintenance of short-term rates at a low level in relation to long-term 

rates also tended to induce a further decline in long-term interest rates. 

An implied assurance that prices of long-term securities would not be 

permitted to decline removed an important distinction between long4

 Actual reserves required of all member banks currently amount to about 15 per cent of 

total net demand and time deposits, or a ratio of expansion to reserves of nearly seven to one. 

When one bank obtains a deposit, which at the same time brings that bank additional reserves, 

it can lend or invest all of those reserves in excess of requirements; the funds thus pass to 

another bank which in turn can expand its assets. This multiple expansion might be less than 

the seven to one ratio mentioned above, if successive banks retained reserves in excess of the 

required amount. Moreover, since nonmember banks, which hold their required reserves 

largely with member banks, share in this process cf credit extension; and since time deposits, 

against which reserve requirements are lower, may increase more rapidly than demand 

deposits, the total multiple expansion in deposits may greatly exceed the ratio of seven 

to one. During the period from June 1940 to December 1945, the expansion in total 

deposits at all banks, other than interbank and United States Government deposits, was 

about nine times the increase in required reserves of member banks. For member 

banks alone, the multiple expansion in total deposits over this period was about eight times 

the increase in their required reserves. 

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THE STRUCTURE OF INTEREST RATES 

LONG- AND SHORT-TERM INTEREST RATES 

ANNUALLY, 1890 - I94S 

o I M i M 1 ) i i i 1 i i ; i 1 \ t t i 1 i i i i ! i i i, i 1 i i i i l i i i i i i i i i l J i ) i I I I i i i 11 o 

1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 

YIELDS ON U. S. GOVERNMENT SECURITIES 

1942 1944 

NOTE.—Securities are classified according to earliest call date or due date. References to data, and to their 

sources and composition, are given below. 

Commercial paper: for years 1890-1941, Banking and Monetary Statistics (Board of Governors), p. 448; for 1942-

44, Federal Reserve Bulletin, February 1945, p. 159; for 1945-46, Federal Reserve Bulletin, February 1947, p. 181. 

High-grade railroad bonds: Annual figures computed from monthly figures given in Frederick R. Macaulay, 

Movements of Interest Rates, Bond Yields, and Stock Prices in the United States since 1856 (National Bureau of Economic Research), Appendix A, Table 10, column 5, pp. A141-61. 

U. S. Government securities: for January 1942 through December 1944, Federal Reserve Bulletin, May 1945, pp. 

483-90; for January 1945 through September 1947, Federal Reserve Bulletin, October 1947, pp. 1251-53. 

Corporate high-grade bonds: data for years 1933-41, Banking and Monetary Statistics, p. 471, note 2; for 1942-43, 

Federal Reserve Bulletin, February 1945, p. 159; for 1944-46, Federal Reserve Bulletin, February 1947, p. 181, For 

composition of series, see Treasury Bulletin, January 1945, p. 56, and July 1947, p. 59. 

93 

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94 FEDERAL RESERVE POLICY 

and short-term securities. As a consequence, banks and other investors 

began to prefer long-term as against short-term securities, and the shifting from short to long issues by all groups of holders, especially by banks, 

tended to depress the yield on longer-term issues below prewar levels. 

The very low postwar levels of long-term yields have presented special 

problems of adjustment for life insurance companies and other savings 

and endowed institutions. 

Effect of War Loan Drives. Another wartime stimulus to bank credit 

expansion developed out of practices pursued during the war loan drives. 

Nonbank investors, in order to subscribe to new issues and thus help the 

attainment of local quotas, sold substantial amounts of previously acquired issues to banks. During the drives, banks had excess reserves because deposits against which reserves were required were drawn upon by 

depositors in the purchase of securities, while Treasury deposits, against 

which no reserves were required, increased.5 The resulting reduction in 

member bank required reserves and the investment of these freed reserves increased the earning assets of banks. 

As a consequence, banks increased their holdings of Government securities substantially during drives. Between drives, as deposits were reshifted from Government to private account, required reserves increased 

and banks sold sufficient securities to the Federal Reserve to meet the 

higher reserve requirements. The net effect was an impetus to expansion 

in bank holdings of Government securities throughout the war period. 

Wartime Expansion of Bank Credit and Money. Viewing the wartime 

period as a whole, banks were able to expand their holdings of Government securities by any amount they could obtain because the Federal 

Reserve System, in following its policy of supporting the market for 

short-term issues, keeping down short-term rates, and facilitating war 

loan drives, made additional reserves almost automatically available to 

banks. The volume of short-term securities outstanding was sufficient, 

if resold to the Federal Reserve, to permit a much further expansion of 

bank reserves. Thus under policies pursued in war financing, the banking 

system was not only permitted, but encouraged, to expand its holdings of 

United States Government securities on the basis of reserves freely supplied by the Reserve System in maintaining the structure of interest 

rates. 

6

 Special wartime legislation enacted in 1942 exempted war loan deposit accounts of the 

Treasury in member banks from reserve requirements. This exemption expired at the end of 

June 1947. 

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PROBLEMS OF POSTWAR MONETARY POLICY 9 5 

Total funds raised by the Treasury in the period from the middle of 

1940 to the end of 1945 amounted to 383 billion dollars. About 40 per cent 

or 153 billion dollars of this amount came from taxes. Nearly 230 billion 

was obtained by borrowing, of which about 104 billion came from the 

banking system, including mutual savings banks as well as commercial 

banks and Federal Reserve Banks. Some of this increase reflected large 

sales of securities during the Victory Loan Drive at the end of 1945. 

During 1946 and to some extent in 1947 the Treasury made use of the 

large balances built up from the Victory Loan to retire maturing debt. 

Most of the retirements were from commercial bank holdings. 

RESERVE BANK CREDIT, REQUIRED AND EXCESS RESERVES 

OF MEMBER BANKS, AND CURRENCY 

HU-tONS Of POU.AWS MONTHLY AVERAGES OF DAILY FIGURES BILLIONS OF DOLLARS 

1940 1941 1942 1943 1944 1945 1946 1947 

The wartime increase of 22 billion dollars in Federal Reserve holdings 

of Government securities, together with a decline of over 5 billion in 

excess reserves of member banks, as is shown in the accompanying chart, 

largely provided for increases of 21 billion dollars of currency in circulation and of nearly 8 billion dollars in the total amount of required reserves at member banks. This growth in required reserves reflected an 

expansion of 44 billion dollars in demand deposits, excluding interbank 

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96 FEDERAL RESERVE POLICY 

posits at all commercial and mutual savings banks. The growth in total 

deposits and currency is shown in the chart on page 98. 

From 1940 to 1945 commercial banks, as is shown in the accompanying 

chart, increased their holdings of United States Government securities by 

approximately 75 billion dollars, and after the substantial debt retirement in 1946 and early 1947 bank holdings still exceeded 70 billion dollars, compared with 16 billion in 1940. Bank loans also expanded, mostly 

since the end of 1944, to the highest level since 1929. During the war 

period loan expansion was to a large extent to finance purchases of GovLOANS AND INVESTMENTS OF ALL COMMERCIAL BANKS 

1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 

ernment securities. The rapid growth in the assets of banks increased their 

earnings substantially. While banks incurred additional expenses in 

servicing the greatly increased wartime monetary demands, total earnings increased more rapidly than expenses, with the effect that during 

1945 net profits in relation to capital funds reached the highest level on 

record. 

War financing was responsible for a very rapid and large expansion of 

liquid assets held by the public. The holdings of total deposits and currency by individuals and businesses increased from 1940 to mid-1947 by 

100 billion dollars to 2 | times the prewar level. The inflationary potential 

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PROBLEMS OF POSTWAR MONETARY POLICY 97 

in the expanded money supply is roughly indicated by the increase in its 

ratio to the annual value of the country's total production of all goods 

and services, shown in the accompanying chart. The ratio of total deposits and currency to gross national product attained a level of 80 per 

cent during 1946 compared with less than 70 per cent in the late 1930's, a 

period of considerable unemployment and unused resources, and with a 

little over 50 per cent in the 1920's, a period of active business and full 

employment. 

The chart shows that individuals and businesses, in addition to having 

greatly expanded holdings of deposits and currency, held over 80 billion 

dollars of Government securities in the middle of 1947, seven times as 

much as before the war. Savings bonds and notes, which are more than 

half of this total, are redeemable on demand and, as long as the Federal 

Reserve Banks stand ready to buy the marketable securities, these issues 

also are freely convertible into cash. This is a new and unprecedented 

situation which has great significance from the monetary point of view. 

FINANCING POLICIES IN THE TRANSITION PERIOD 

To a considerable extent inflationary developments after the end of war 

financing had their seeds in war finance. These inflationary effects, in the 

absence of adequate taxes, could only be counteracted by direct controls 

over demand, supplies, and prices of goods and services, since these market 

factors could not possibly be in equilibrium during war and its aftermath. 

In the war period serious inflation was avoided by the maintenance of 

controls, as well as through the public's exercise of voluntary restraint 

and investment of savings in Government securities, but after the war 

was over these restraints were greatly diminished and in many cases 

abandoned. 

With the end of war, financing of the Government's fiscal requirements 

quickly ceased to be the dominant factor generating inflationary pressures. Early in 1946 it was possible for the Treasury to initiate a largescale program to retire debt from its accumulated cash balances, and by 

the end of the year it was possible to project additional debt retirement 

from a budget surplus during the ensuing year. The Treasury's debt-retirement program, by redeeming securities held by Federal Reserve 

Banks, created a drain on bank reserves; this helped to check continued 

rapid expansion of bank credit and restrained further downward pressure 

on long-term interest rates. In addition, debt retirement directly reduced 

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98 FEDERAL RESERVE POLICY 

GROSS NATIONAL PRODUCT AND THE MONEY SUPPLY 

BILLIONS OF DOLLARS 

240 

BILLIONS Of DOLLARS 

240 

160 

DEPOSITS AND CURRENCY AS A PERCENTAGE OF THE GROSS NATIONAL PRODUCT 

1945 

' RE.VISED SERIES 

NOTE.—-Sources of data presented in chart are given below. 

Gross national product: For years 1916-18, U. S. Department of Commerce estimates based on National Bureau 

of Economic Research estimates of the production of finished goods; for 1919-28, Federal Reserve Bulletin, September 1945, p. 873; beginning 1929, U. S. Department of Commerce estimates in Survey of Current Business, National Income Supplement, July 1947. Figures are annual totals for years 1916-38 and seasonally adjusted quarterly 

totals at annual rates thereafter. 

Deposits and currency: Federal Reserve figures for all banks in the United States, partly estimated, and adjusted to exclude interbank deposits and items in process of collection. Figures through 1941 are from Banking 

and Monetary Statistics (Board of Governors), pp. 34-35; for later years from monthly issues of Federal Reserve 

Bulletin. Figures are for end of June, 1916-38; for end of June and December, 1939-42; for end of March, June, September, and December, 1943-46; for last Wednesday of March and June, 1947. Figures subsequent to December 1946 

are preliminary. 

U. S. Government securities held by individuals and businesses: Federal Reserve estimates based on banking 

and corporation data from various sources. For 1916 through June 1939 figures are from Banking and Monetary 

Statistics, p. 512; thereafter from Federal Reserve Bulletin, September 1947, p. 1104. Figures are for the end of June, 

1916-35; for end of June and December thereafter. Estimate for June 1947 is preliminary. 

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PROBLEMS OF POSTWAR MONETARY POLICY 99 

commercial bank holdings of Government securities. At the same time 

bank loans collateraled by such securities showed a sharp reduction from 

the high level reached in the Victory Loan Drive. 

Some discouragement to member bank borrowing at the Reserve Banks 

for the purpose of purchasing or holding Government securities was 

effected in April 1946 by elimination of the Federal Reserve Banks' 

preferential discount rate on advances collateraled by short-term Government securities. This preferential rate of | per cent was put into effect 

during the war to encourage banks to utilize their excess reserves in the 

purchase of short-term securities, rather than to keep them idle. It was no 

longer needed, and its elimination made the regular discount rate of 1 per 

cent applicable to such borrowing. 

Notwithstanding these developments, expansion in the public's deposits continued to occur, although at a slackened pace. This expansion 

resulted in part from a brisk postwar revival of bank lending to businesses, to property owners, and to consumers; and in part from the Treasury's retirement from accumulated cash balances of securities held outside of banks, which involved the transfer of Government deposits to 

private accounts. While bank loan expansion during the postwar transition, which carried loan volume close to record levels, reflected mainly 

the financing of expanding production and distribution of civilian goods 

at rising prices, it was also due, to an indeterminable extent, to speculative and excessive commitments induced by bottlenecks and shortages 

affecting many goods. 

The further expansion of bank credit to private borrowers added somewhat to the inflationary pressures that developed from many causes during the postwar transition. More important, however, than the current 

credit expansion was the already superabundant volume of money and 

other liquid assets available as the result of war finance and not subject 

to rapid reduction. The inflationary pressures generated by so large a 

volume of liquid assets were altogether too strong to be effectively 

checked by any quantitative restraints that could be imposed on further 

credit expansion. In addition, the use of available quantitative instruments of control would have resulted in declining prices of Government 

securities and, because of the huge public debt outstanding and its wide 

distribution, assurance of stable market values on this debt had become 

a major central banking responsibility. 

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100 FEDERAL RESERVE POLICY 

eral Reserve System to counteract inflationary developments, while at 

the same time fulfilling its responsibilities for maintaining an orderly and 

stable market for Government debt. Banks were under some pressure 

as a result of the reduction in reserves through the debt-retirement program and for this reason, as well as to meet the expanding loan demand 

from their customers, banks had to sell short-term securities to the Reserve Banks. Refusal of the Reserve Banks to purchase these securities 

or any attempt to sell additional amounts to absorb more bank reserves 

would have resulted in an increase in short-term money rates. 

Whenever it could, without abrupt stiffening of money rates, the 

System made vigorous use of available methods of influencing the amount 

of outstanding bank credit of selected types. It encouraged the liquidation of loans for carrying Government securities purchased in war loan 

drives. It made maximum use of its powers to determine margin requirements for purchasing listed corporate securities by fixing these requirements at 100 per cent of current market value of the collateral. It maintained, with some adjustments and revision, its special wartime control 

over consumer credit, particularly over instalment credit, until such 

regulation was ended by legislative action. Partly as a result of these 

selective measures, a significant contraction in bank credit for carrying 

securities took place and the expansion of consumer credit was restrained 

somewhat. On the whole, Federal Reserve policies left banks considerable 

flexibility in accommodating the transition credit needs of commerce and 

business, while bringing about contraction in over-all bank credit and 

some slackening in the rate of growth of money in private hands. 

By mid-1947 Treasury balances had been reduced to approximately 

normal working levels, making further debt retirement dependent upon 

current budget surpluses. Pressure on bank reserves resulting from the 

debt-retirement process was thus moderated and the latitude of banks in 

shifting from short-term Government securities into assets offering higher 

returns was substantially restored. By selling short-term securities to the 

Federal Reserve System, as stated earlier, banks obtain additional reserves on the basis of which bank credit may expand six to ten times the 

amount of such reserves. Some evidence of increased demand by banks 

for longer-term Government bonds appeared toward the close of the retirement program. In consequence of this development and also of conditions favorable to further bank shifting into other higher-yield assets, 

the Federal Open Market Committee early in July terminated its policy 

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PROBLEMS OF POSTWAR MONETARY POLICY 101 

of buying Treasury bills at f per cent. Subsequently issuing rates on 12-

month Treasury certificates were raised. These actions permitted shortterm rates to rise and contributed to a more flexible money market situation with regard to Treasury debt-management operations and to Federal 

Reserve credit policies. 

NATURE OF THE POSTWAR PROBLEM 

Superabundance of money, together with potential further expansion 

in the money supply—resulting from wartime growth in the public debt 

—presents a continuing problem for the postwar period. The magnitude 

of these forces and changes in their relation to the total national product 

have already been pointed out and are illustrated by the chart on page 

98. 

This volume of money can be reduced only through a contraction in 

public debt held by banks or by a shift in such debt from banks to more 

permanent investors; it can be further increased, on the other hand, by 

bank credit expansion. Since the principal basis of the expanded money 

supply is the Federal Government debt, a decrease to the economy's current level of need would be difficult to bring about; but in adjusting to a 

redundancy of money, the economy is likely to experience recurrent inflationary pressures interspersed with downward reactions. To prevent 

monetary redundancy from increasing and to re-establish conditions under 

which further credit expansion may be more closely related to the expanding needs of agriculture, business, and consumption are important tasks 

of fiscal, public-debt, and monetary management now and perhaps in the 

coming years. These tasks must be accomplished without permitting 

instability in the distribution and value of the public debt to disrupt the 

economy's financial operations. 

In view of this situation, the central problem that confronts the Federal Reserve System in the postwar period is to re-establish the System's 

primary function, which is regulation of bank credit expansion. At the 

same time the System must be able to fulfill its new responsibility, inherited from war finance, of maintaining a stable market for the public 

debt. With the postwar level of commercial bank holdings of marketable 

Government securities at 70 billion dollars and with 88 billion held by 

businesses and individuals, it is difficult for the System to exercise effective control over the total volume of bank credit as long as these holdings 

can be readily sold to the Reserve Banks. The additional bank reserves 

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102 FEDERAL RESERVE POLICY 

that can be thus generated at the initiative of banks and others could be 

the basis for an expansion in bank credit and deposits of from six to ten 

times the newly created reserves. 

A policy of maintaining short-term interest rates at wartime levels 

with a differential between short- and long-term rates would complicate 

the postwar problem of credit control. It would continue inducements 

that holders of short-term securities have had since early in the recent 

war to sell them and purchase longer-term, higher-rate issues. Furthermore, the Federal Reserve System would purchase the short-term securities sold by these holders and thereby create additional bank reserves. 

In this way, the policy would contribute to further credit expansion and 

to a further decline in long-term interest rates. A decline in long-term 

rates caused by the pressure of credit expansion rather than by a surplus 

of current savings over the capital demands of business would be an inflationary influence in the real estate and security markets and would 

otherwise prove disruptive to financial processes. Monetization of the 

public debt stimulated by this policy could result in a huge additional 

expansion of bank credit and a decline in long-term interest rates to new 

low levels. 

Various measures have been suggested for dealing with these problems 

of debt monetization and declining long-term interest rates. The more 

important are as follows: 

1. The Reserve System could permit short-term interest rates on Government 

securities to rise to a level at which banks would no longer be induced to sell short-term 

securities to the Reserve System in order to purchase longer-term securities in the 

market. 

2. Sufficient amounts of new long-term securities could be issued to check the 

decline in long-term rates. 

3. Monetization of the debt could be permitted to continue until long-term interest 

rates declined to a level at which banks would no longer be induced to sell short-term 

securities and buy longer issues. 

4. Adoption of one or more of the proposals made by the Federal Reserve Board in 

its 1945 Annual Report would provide a means of restricting the ability of banks to 

shift from short-term to long-term securities or to loan assets and could thus limit the 

extent to which banks could monetize the public debt. 

These various proposals are discussed in the subsequent sections of 

this paper. 

INTEREST-RATE POLICY 

Determination of the level of short-term interest rates has traditionally 

been considered an important instrument of central bank policy; at the 

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PROBLEMS OF POSTWAR MONETARY POLICY 103 

same time there has been considerable difference of opinion among monetary authorities and theorists as to the effectiveness of interest-rate variations in encouraging or discouraging borrowing and lending. Without 

attempting to settle this controversy, it may be said that monetary management cannot ignore the effect of interest-rate fluctuations, both shortand long-term; nor can it depend entirely upon interest-rate policy to 

accomplish its objectives. The postwar situation, moreover, presents 

many new aspects of the relation between interest rates and monetary 

policies. 

Flexible Interest-Rate Policy. The nature of the postwar monetary 

problem makes it necessary for central bank policy to place greater emphasis upon the availability of credit in influencing expansion and contraction of bank credit than upon the cost of credit. It is difficult, however, except through certain types of selective controls, to influence the 

availability of credit without having an effect upon interest rates. Thus 

adherence to stability of interest rates as the prime objective of monetary 

policy might prevent the adoption of policies to limit the availability of 

credit at times when such limitation was desirable. 

Although small changes in interest rates might in themselves have little 

influence on the volume of borrowing and lending, complete avoidance of 

variations would prevent the adoption of policies flexible enough to bring 

about gradual adjustment of the money market to changing conditions of 

credit supply and demand. If interest rates were held unchanged when 

quantitative restrictions began to be needed, it might eventually become 

necessary to resort to drastic action in order to meet a situation after it 

had fully developed, which more flexible policies might have forestalled. 

Inherent in the postwar situation, as already explained, is the tendency 

for long-term interest rates to decline even below existing unprecedentedly low levels. The large wartime accumulation by the public of funds 

held in currency, bank deposits, and short-term Government securities, 

as well as future current savings, will exert pressure toward lower interest 

rates unless there should be a correspondingly large demand for investment funds for capital expansion, or unless any gap in demand is offset 

by an increased willingness on the part of the public to hold liquid assets. 

Even in these circumstances the previously described process of debt 

monetization would make possible the satisfaction of part of the existing 

demand through bank credit expansion at low or perhaps even declining 

long-term interest rates. To supply capital demands through this process 

would contribute to inflation and economic instability. 

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The renewed decline in long-term interest rates from such causes would 

further reduce the return on family savings and decrease the incomes of 

endowed and savings institutions that depend on earnings from investments. Lower investment yields resulting from credit expansion would 

tend to discourage risk investment at times when increased risk-taking 

would be desirable to maintain economic stability. Individuals living on 

income from savings, life insurance companies, and educational and other 

endowed institutions have already been faced with difficult problems of 

readjustment because of declining interest rates. Further declines would 

seriously affect the livelihood of many of these individuals, impair the 

functions of such institutions, and alter established economic and social 

patterns. It would become essential for the Government to assume an increasing responsibility for such individuals and functions and to help bear 

their necessary costs. 

Limitations on Flexible Interest-Rate Policy. While the above-mentioned aspects of the problem of interest rates indicate the desirability of 

a flexible interest-rate policy in preference to rigid maintenance of shortterm rates at low levels in relation to long-term rates, other elements in 

the postwar situation make such a policy difficult to follow. 

Permitting short rates to rise in order to prevent further monetization 

of the public debt, for example, would increase the cost to the Treasury 

of carrying its short-term debt and would complicate the Treasury's refunding problem.6

 It would also increase bank earnings, which have attained high levels as compared with former periods. In view, however, 

of the postwar decline in bank earnings, the increase in their expenses, 

and the likelihood of a further decrease in earnings if holdings of highercoupon maturing issues are refunded into lower-rate issues, somewhat 

higher yields on short-term securities may be a desirable means of discouraging banks from selling more profitable assets and further monetizing short-term Government securities. In any case, a policy of raising 

short-term interest rates would cope with only one aspect of the postwar 

problem of further monetary expansion, namely, purchases by the Reserve 

System of short-term securities sold by banks and other investors in order 

to purchase higher-yielding longer-term securities. It would not prevent, 

8

 The aggregate current interest cost on the total public debt might not be increased above 

the present level, because refunding of maturing high-coupon issues with issues bearing lower 

rates would tend to reduce the total interest payable. Nevertheless, a rise in short-term rates 

would mean larger interest costs than would be incurred if rates did not rise. 

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PROBLEMS OF POSTWAR MONETARY POLICY 105 

although it might discourage somewhat, sale of short-term securities to 

expand other assets. 

The Federal Reserve System's general instruments for regulating the 

expansion of bank credit and the money supply developed over a period 

when private indebtedness was the predominant factor in the nation's 

debt structure. Even at the end of World War I, when the Federal Government debt in this country stood at a record level up to that time, it 

was still just over one-fifth as large as private and other debt. By mid1947, following retirement of part of the debt incurred in World War II, the 

Federal debt was 50 per cent larger than other debt. These changes are 

shown in the accompanying chart. 

TOTAL PUBLIC AND PRIVATE DEBT 

BtiuONS OF D0U.AH4 

500 

KLLtONS OP 0OU.AK9 

500 

400 

200 200 

NOTE.—Gross public and private debt as estimated by the U. S. Department of Commerce on the basis of data 

from various governmental and private agencies. 

With the economy's total postwar debt made up of three parts Federal 

debt to two parts private and other debt, discussion of customary Reserve System instruments of policy is put into a new frame of reference. 

Changes in the volume of public debt result primarily from war and other 

operations conducted in the public interest. These changes are not likely 

to be influenced materially by regulation of the supply, availability, and 

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106 FEDERAL RESERVE POLICY 

cost of credit. In fact, central banking policies need rather to be adjusted 

to public needs. In contrast, private debt is incurred on the basis of the 

expected productivity of investment in business and the satisfaction that 

consumers get from present as against future consumption. Demands for 

credit by businesses and individuals are responsive in some degree to 

monetary and credit regulation and may need to be restricted or stimulated in the interest of public welfare. There is little, if any, economic 

justification for considering public and private debt on the same basis 

with regard to the application of customary central banking policies. If 

traditional Reserve System methods of influencing changes in the amount 

of private debt through changes in interest rates are resumed, appropriate 

protections will need to be established against undue instability in the 

market value of the vast public debt. 

Meanwhile, should the Federal Reserve System refuse to purchase 

Government securities offered for sale and not taken by others, then 

interest rates on both public and private debt would be subject to wide 

fluctuations. With approximately 230 billion dollars of publicly-held 

marketable and redeemable Federal debt, broadly distributed among 

banks, businesses, investment institutions, and individuals at nearly all 

levels of income, the possible effect of w

T

idely fluctuating interest rates 

upon operations and actions of these holders, and upon debt-management 

expedients, is difficult to predict. The consequence of attempting to use 

such a remedy might be more harmful than the disease. 

To prevent wide fluctuations in short-term rates, the Federal Reserve 

System would have to be prepared to purchase Government securities at 

some level of rates. It is not possible to know how much of a rise in rates 

might be necessary to restrain sales to the System. With a substantial 

volume of Government obligations maturing virtually every month, Federal Reserve policies must also take into account Treasury refunding 

operations. 

Another risk in a situation in which the operations of financial organizations are dominated by public debt is the possibility that any substantial rise in short-term rates might be accompanied by a rise in longterm rates. While the prevention of further declines in long-term interest 

rates seems to be desirable, and toward this end some rise in short-term 

rates and some degree of uncertainty for long-term interest rates would be 

useful, particularly when bonds are selling at substantial premiums, there 

is a limit beyond which a rise in interest rates could not be carried withDigitized for FRASER 

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PROBLEMS OF POSTWAR MONETARY POLICY 107 

out seriously upsetting the market. The events of 1946, when long-term 

bond prices fluctuated within a range of four points, indicate that purchases of these bonds at premium prices are not without some risk. 

It is difficult to know how much of a rise in yields on Government securities would be needed to discourage banks from selling these securities in 

order to make private loans or to invest in corporate bonds, when there is 

an active demand for credit. Experience shows that increases in Federal 

Reserve discount or bill-buying rates have not always exerted effective 

restraint against credit expansion generated by speculative demands. 

Such increases would be even less effective in a situation where their 

primary effect would be upon prices of outstanding Government securities, rather than upon private borrowers. 

Experience with brokers' loans, which long served as liquid secondary reserves for this country's banking system, thus providing a 

type of central banking service, shows that banks will withdraw funds 

from the central money market in order to take care of the demands of 

their business and other customers and that they will not be discouraged 

from doing so by having to forego high money rates. In the case of 

brokers' loans other lenders had to be found to absorb called loans or securities forced to be liquidated, while in the case of Government securities 

the banks could readily obtain additional reserves to take care of the needs 

of their customers by selling some of their securities to the Federal Reserve 

System. 

Conclusions as to Interest Rates. This discussion of the relation of 

interest rates to postwar monetary policy leads to the following conclusions: Continuance of a pattern of interest rates in which short-term rates 

are stabilized at levels much below long-term rates is conducive to further declines in long-term interest rates based on expansion of bank 

credit. Flexible policies allowing some variation in the spread between, 

and levels of, short- and long-term interest rates would help to re-establish control over credit expansion as well as to prevent a continuing downward movement in long-term interest rates growing out of monetization 

of the public debt. Moreover, by permitting gradual adjustments to 

changed situations, moderate variations in the pattern and levels of 

interest rates might forestall or mitigate unstabilizing tendencies in the 

money market. 

Substantial variation in short-term interest rates, however, in view of 

the large volume of public debt outstanding and its broad distribution 

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108 FEDERAL RESERVE POLICY 

among owners, would have serious repercussions throughout the economy 

without exerting the same influence upon borrowing and lending as in the 

past when private debt was a more important part of the total debt structure. Maintenance of substantially higher interest rates, furthermore, 

would raise the cost of the public debt, and widely fluctuating rates would 

greatly complicate the Treasury's task of refunding its large maturities. 

Finally, it is important to recognize that higher levels of short-term interest rates would not prevent shifting by banks, corporations, and others 

from the vast holdings of Government securities in order to meet private 

demands for credit if these demands are particularly strong or banks are 

competing actively for such business. In other words, while sale of shortterm Government securities to purchase longer-term issues might be prevented by diminishing the existing spread between short- and long-term 

interest rates, the higher short-term rates would not prevent sales of 

Government securities to expand private debt. 

Under present and foreseeable conditions some flexibility in interest 

rates is desirable. In view of the limitation to which flexible interest-rate 

policy is subject as a heritage of war, however, other measures are needed 

to supplement the use of traditional Federal Reserve instruments of 

credit control. 

DEBT-MANAGEMENT POLICIES 

Since the problem of postwar monetary policy is so closely tied in with 

the value and distribution of the public debt, proper management of the 

debt could do a great deal to influence monetary developments. In view 

of the large portion of the public debt that is of short term—52 billion 

dollars of the marketable debt matures within one year and 95 billion 

within five years—flexible debt-management policies can be readily developed. Another element in the situation is that 33 billion dollars of Government securities are held by various Government agencies and are 

readily subject to change as to form and maturity. Amounts of marketable issues of various types and maturities held by the various major 

groups of investors during recent years are shown on the accompanying 

charts. 

Within the limits of market demands the Treasury can influence the 

distribution of the debt among various groups of holders by its choice of 

securities to be issued. For example, Treasury bills are almost wholly 

owned by Federal Reserve Banks and, as long as the System purchases 

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OWNERSHIP OF U S. GOVERNMENT MARKETABLE PUBLIC SECURITIES 

BILLIONS OF DOLLARS 

4 0 

20 

BILLS 

COMMERCIAL BANK 

HOLDINGS 

BY CLASS OF SECURITY 

END OF MONTH FIGURES 

rrrrrr 

NOflBANK 

HOLOIMftS 

d£ 

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CERTIFICATES 

-

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TTTTTl 

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^NOTE* 

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BY EARLIEST CALLABLE OR DUE DATE 

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YEARS 

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TTTTP 80 

60 

40 

20 

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1942 1944 1946 1942 1944 1946 

NOTE.—Basic data are from the U. S. Treasury's monthly Survey of Ownership of U. S. Government securities, published in Treasury Bulletin and summarized in Federal Reserve Bulletin for October 1947, pp. 1312-13. 

Postal savings and prewar bonds are included; guaranteed securities are excluded. Data understate commerical 

bank holdings somewhat and overstate nonbank holdings. 

109 

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110 FEDERAL RESERVE POLICY 

sufficient amounts of bills at rates below those that other holders will pay, 

changes in the volume of bills offered will be reflected directly in Federal 

Reserve holdings and hence affect the supply of bank reserves. Action 

taken by the Federal Reserve System in July 1947 to eliminate the fixed 

| par cent buying rate on Treasury bills permitted the rate on bills to rise 

to a level more nearly consistent with other market rates. This restored 

the bill as a market instrument and made it possible for the Treasury to 

vary the amounts of bill offerings and to use the bill as a more flexible 

instrument of debt management. 

At the other extreme, long-term bonds ineligible for purchase by banks 

could be offered to holders of savings. It has been suggested that issuance 

of enough additional long-term bonds to satisfy the demand for such securities would keep long-term interest rates from declining further and 

provide funds with which the Treasury could retire short-term debt. 

Even in such a case, however, if the issue were sufficiently attractive, 

some holders of outstanding bank-eligible issues would be likely to sell 

these securities to banks and then purchase the new issue. This in fact 

occurred during the war loan drives. Consequently, additional offerings 

of long-term issues, even though they be restricted as to purchase by 

banks, may nevertheless result in further debt monetization. 

Late in September 1947, the Treasury introduced a variation of this 

proposal through the issuance of Series A investment bonds. These bonds, 

which are nonmarketable and redeemable, have features similar to the 

Series G savings bonds, though with differences as to eligibility for purchase, purchase limits, and maturities. They were issued to absorb the 

savings of the public in the hands of institutional investors not being 

invested in private outlets. The use of this type of security permits the 

Treasury to pay an appropriate rate for genuine long-term savings and 

provides an instrument for protecting the income of bona fide investors 

while also protecting them against capital loss in case of liquidation before 

maturity. At the same time, this type of security safeguards the Treasury 

against paying a high coupon rate on liquid investments to temporary 

holders. 

The scope of this paper does not permit an exhaustive discussion of 

debt management or of its use to further monetary policies. Some aspects 

of this subject have been discussed in another paper in this series.7 It is 

7

 See Roland I. Robinson, "Monetary Aspects of National Debt Policy," in Public Finance 

and Full Employment (December 1945), the third pamphlet in this series. 

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PROBLEMS OF POSTWAR MONETARY POLICY 111 

clear that Treasury and Federal Reserve authorities, through joint planning of policies and operations, should carry forward a debt-management 

program that will preserve the taxpayers' interest in maintaining a low 

level of interest cost, provide the Treasury with the necessary funds, and 

meet the legitimate investment needs of various investor groups. In addition, this program should facilitate the adoption of credit policies designed 

to restrict excessive bank credit expansion and at the same time maintain 

an orderly market for Government securities. 

SELECTIVE CREDIT CONTROLS 

In view of the limitations upon the use of traditional methods of credit 

policy under the changed situation brought about by war, increased reliance may need to be placed on other methods of credit control. Banking 

history shows that bank credit may contribute to economic instability as 

a result of undue expansion or contraction in its total amount, as a result 

of undesirable conditions that are largely localized in particular credit 

sectors, or as the result of a failure of desirable credit developments to 

occur in individual sectors. It is difficult, if not impossible, to deal with 

such developments by using general credit instruments. Also, since these 

instruments operate by affecting the amount of bank reserves and thereby 

the availability, supply, and interest levels of all types of credit, their use 

and timing is necessarily influenced by the net balance of factors in the 

whole economic situation. Developments in localized credit areas may not 

be apparent in total bank credit soon enough for action to be taken in time 

to prevent a serious weakening of the credit structure. The use of general 

credit instruments to rectify a credit development that is narrow in scope 

might result in undesirable pressure in areas where the credit situation 

was essentially sound. 

For the correction of unsound conditions in special credit areas, the 

Reserve System's general instruments need to be supplemented by special 

selective instruments. These instruments are discussed more fully in 

another paper in this pamphlet.8 They include particularly controls over 

stock-market credit and over consumer credit, which have been effectively 

used. To these might also be added regulation of real estate credit, which, 

however, would entail difficult administrative and jurisdictional problems. 

Another type of selective device, of a stimulative rather than a restrictive nature, is the guarantee of certain types of bank loans against 

1

 Carl E. Parry, "Selective Instruments of National Credit Policy." 

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112 FEDERAL RESERVE POLICY 

loss by the lender. This instrument was used successfully and on a large 

scale in the case of war production loans, and has been employed to a 

limited extent by various peacetime agencies. 

Selective instruments of the type described are helpful adjuncts to the 

general instruments of Reserve System policy, since they permit application of policies of limited objective and also differentiation in credit policy 

when forces of inflation or deflation are present only in a particular sector 

of the economy. They are not substitutes for the traditional instruments, 

however, and should only be introduced where the costs and gains to the 

credit system and to the economy are fairly well determinable in advance. 

These characteristics apply to regulation of security loans and consumer 

credit, as well as to the guarantee of bank loans. Permanent authority to 

regulate consumer credit and adoption of guarantee loan provisions would 

therefore be constructive measures that would strengthen the System's 

ability to serve the purposes for which it was established. Permanent regulation of security loans is already authorized by law. 

PROPOSALS FOR ADDITIONAL CONTROLS 

In view of the banking and monetary heritage of war finance, the 

Federal Reserve System is faced with a twofold responsibility for the 

longer run: to prevent speculative or otherwise excessive expansion of 

bank credit and at the same time to assure reasonable stability in the 

prices of the large volume of Government securities outstanding. There 

should be limits to the ability of banks and others to convert Government 

securities into additional bank reserves and these limits should be imposed 

without bringing about widely fluctuating interest rates. 

It would not be possible to accomplish both of these objectives through 

exercise of existing powers of the Federal Reserve authorities. To assure 

effective discharge of the System's basic long-run responsibilities, additional instruments of general credit regulation such as those proposed in 

the 1945 Annual Report of the Federal Reserve Board are urgently 

needed. These instruments would serve to re-establish the System's functioning along traditional central banking lines. 

The three basic plans proposed by the Board for consideration by the 

Congress may be designated by the following terms: 

(1) A primary reserve plan 

(2) A secondary reserve plan 

(3) A bond limitation plan 

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PROBLEMS OF POSTWAR MONETARY POLICY 113 

These three proposals have many similarities and also important 

differences. In each case adoption would require legislation that should 

permit considerable administrative flexibility because of the wide differences between individual banks and groups of banks. It would also be 

necessary to apply the provisions to all commercial banks, not only to 

member banks of the Federal Reserve System. Each of these powers could 

be so applied as to leave banks adequate ability to accommodate commerce, industry, and agriculture; in fact, only if applied in this way would 

the System's credit operations under the proposals be consistent with the 

purposes of the Federal Reserve Act. At the same time, any one, or some 

combination of the powers would help to restore the System's capacity to 

exert an over-all restraint on undue expansion of bank credit by moderate 

but timely use of traditional instruments. 

The Primary Reserve Plan. This plan involves supplementary authority 

to increase commercial bank reserve requirements. The Board of Governors of the Federal Reserve System already possesses statutory power 

to vary reserve requirements within prescribed limits, but its authority to 

increase such requirements has been fully utilized since early in the war, 

except for a relatively small margin for further increases at central reserve 

city banks in New York and Chicago. In order to keep short-term interest 

rates on Government securities from rising above a specified level, any increase in reserve requirements might have to be accompanied by Federal 

Reserve purchases of short-term securities in an amount that might not 

fall far short of the increase in required reserves. 

The principal effects of the measure would be (1) to shift a certain 

amount of short-term Government securities from commercial banks to 

Federal Reserve Banks, and (2) to reduce the ratio of multiple credit 

expansion on the basis of a given amount of reserves. It would, therefore, 

diminish the amount of short Governments available for sale to the 

Reserve Banks and also reduce the degree of multiple credit expansion 

that would be possible on the basis of any reserves created by such sales. 

The plan could be applied to discourage further purchases of long-term 

issues or increased lending by banks, while Federal Reserve support could 

keep short-term interest rates on Government securities from rising above 

some pre-determined level. This measure would, in conformity with present banking practices, be relatively simple to operate, and permit adjustments to interbank flows of funds in the same manner as at present. 

The proposal would tend to reduce the earnings of commercial banks 

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114 FEDERAL RESERVE POLICY 

and increase those of the Reserve Banks. If the plan were adopted it might 

be desirable for the Reserve Banks to have power to pay some interest on 

reserve balances, in case bank earnings should be unduly reduced. Under 

a policy adopted in April 1947, the bulk of Federal Reserve Bank earnings 

over expenses and dividends at the statutory rate are paid over to the 

Treasury. This is accomplished by use of a provision of law authorizing 

the Board of Governors to impose an interest charge on the amount of 

outstanding Federal Reserve notes in excess of the collateral requirements 

and not backed by gold certificates. As a result of this policy, any increase 

in Federal Reserve Bank earnings would increase the receipts of the 

United States Treasury. Therefore, unless provision were made in applying the primary reserve plan for payment of interest on member bank 

reserve balances, amounts paid to the Treasury after its introduction 

would be increased. 

Legislation authorizing higher levels of reserve requirements might also 

include provision for amending various aspects of the present requirements. It should authorize the counting of vault cash as reserves and 

provide for greater administrative flexibility in imposing different requirements on different types of deposits and in classifying banks for 

reserve purposes. As stated, similar requirements would have to be imposed on nonmember banks in order to prevent a growing disparity 

between reserve requirements of member and nonmember banks. 

The Secondary Reserve Plan would establish a required reserve, in 

addition to balances with Reserve Banks, which might be held in Treasury 

bills and certificates equal to a specified percentage of net demand 

deposits.9 This percentage might be placed initially at a level that w

T

ould 

induce commercial banks as a group to retain the bulk of their present 

holdings of short-term Government securities—probably 10 to 20 per 

cent of net demand deposits would be sufficient. Subsequently the percentage could be established at a level which would assure a commercial 

bank demand for such securities sufficient to encourage or discourage 

credit expansion or to maintain a desired level of rates without Federal 

Reserve purchases. 

To facilitate transition to the new plan, as well as regular adjustments 

of bank positions required by interbank flows of funds, banks should be 

permitted to hold additional reserve balances with the Reserve Banks or 

9

 A reserve required to be held in some special issue of Government securities would serve 

the same purpose. 

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PROBLEMS OF POSTWAR MONETARY POLICY 115 

cash in lieu of bills and certificates. This provision, which is a major 

feature distinguishing this plan from those proposed by Lawrence Seltzer 

and by the economic staff of the Committee for Economic Development, 

would be necessary to make the plan effective as a limitation on bank 

credit expansion.10 Otherwise it would be necessary for the Treasury to 

supply bills or certificates to banks needing them to meet their secondary 

reserve requirements against expanding deposits. This would result in 

further pressure for bank credit expansion and deposit growth rather than 

in restraint, which it is the purpose of the plan to provide. 

The secondary reserve plan has the advantage of permitting banks to 

retain substantial holdings of short-term Government securities, while 

limiting their ability to sell these to the Reserve Banks in order to make 

other loans and investments. Its principal distinction from the primary 

reserve plan is that under its operation the commercial banks could continue to hold the short-term Government securities whereas in the primary 

plan the Reserve Banks would hold them. This plan would establish 

short-term Government securities in a preferred market position over 

other types of short-term paper and thus permit interest rates on Government securities to be stabilized, while allowing fluctuations in other rates. 

This proposal has been criticized because it would purportedly require 

the banking system to increase holdings of Government securities whenever there was an increase in deposits resulting from expanding loans.11 

This objection is not well taken. Bank loan expansion would increase the 

amount of reserves required to be held, just as it does now, and banks 

would have the same alternative as they have now of liquidating some 

other assets or of borrowing from the Reserve Banks. They would, however, not be able to reduce their holdings of Treasury bills and certificates, 

unless they had an excess, but would have to sell long-term issues out of 

their portfolios. They would use the proceeds of these sales to meet their 

increased reserve requirements, which could be held in part in the form of 

bills, certificates, or cash, or entirely in the form of balances with the 

Reserve Banks. 

The Bond Limitation Plan would limit the amount of long-term mar10

 Lawrence H. Seltzer, "The Problem of Our Excessive Banking Reserves," Journal of the 

American Statistical Association, March 1940, pp. 24-36; Research staff (Melvin G. DeChazeau, 

Albert G. Hart, Gardiner C. Means, Howard B. Myers, Herbert Stein, Theodore O. Yntema), 

Committee for Economic Development, Jobs and Markets (New York, 1946), pp. 90-95. 

11

 See, for example, J. H. Riddle, Interest Rates and Federal Reserve Policy (Bankers Trust 

Company, New York, 1946). 

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116 FEDERAL RESERVE POLICY 

ketable securities, both public and private, that any commercial bank 

could hold against its demand deposits.12 In a sense this plan would merely 

extend the principle, recognized in banking law and pursued during the 

war, of restricting investment of demand deposit funds in long-term 

assets. 

The limitation should apply to all bonds, or probably to all singlepayment marketable securities having a final maturity of more than one 

year at time of issue, but it might be more limited in scope. Bonds within 

a year or perhaps within five years of maturity might be exempt from the 

limitation, but such exemption would cause sudden adjustments in the 

market and in the banking position as large issues passed from under the 

limitation. It would have to cover obligations of State and local governments and of corporations; otherwise United States securities would have 

a disadvantageous market position. It might also cover real estate and real 

estate loans, in which many banks invest large portions of their time 

deposits and capital.13 

Adjustments of reserve positions between banks would not be particularly complicated by the bond limitation plan, although some reduction in bond portfolios might be necessary if banks lost deposits, 

particularly time deposits, and increases in portfolios would be permissible 

in case of additions to savings deposits. 

While none of the plans is designed to restrict specific bank lending 

activities, except as regards their effects on over-all credit expansion, this 

measure would probably have less direct restrictive effects than the 

others, except on real estate loans, and it might even encourage 

lending. It is primarily designed to restrict shifting from short-term 

securities into long-term securities, without restricting lending. With 

regard to bank investment, individual banks would be free to adopt 

whatever maturity composition of their investment portfolios, and whatever distribution among various types of bonds and real estate loans, 

u

 Various formulae are possible for this plan. The 32d Annual Report of the Board of 

Governors in describing this proposal in general terms suggested as a formula the relation of 

holdings of long-term securities to net demand deposits. A somewhat more complicated, but 

in practice more satisfactory, formula would relate such holdings to savings deposits plus 

capital accounts plus some percentage of demand deposits other than interbank balances without adjustment for collection items. This formula would avoid penalizing banks holding large 

amounts of cash items in process of collection and also avoid permitting banks to hold longterm assets against interbank balances. 

u

 In this way, account could be taken in the statutory formula of existing national banking 

law with regard to investment in banking premises and real estate loans. 

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PROBLEMS OF POSTWAR MONETARY POLICY 117 

would yield them the highest net return. The plan would not insulate the 

short-term Government securities market from the effects of tightening 

credit conditions and consequently would not provide as much latitude as 

the alternative plans for the use of the customary general instruments of 

central banking policy. 

APPLICATION OF THE PROPOSALS 

Any of these various plans would set off a large part of the public debt 

in such a way as to free Government securities from the effects of changes 

in the supply of bank reserves and in interest rates on private marketable 

paper. Once established any such plan could be fairly rigidly maintained, 

while traditional open market and discount rate instruments were largely 

relied upon for current policy in affecting availability, cost, and supply of 

bank credit for private purposes. Alternatively these new plans could 

be flexible in their application, with requirements and limitations being 

varied as bank credit and monetary developments and prospects might 

justify or require. 

These proposals are in no way revolutionary or drastic and their application need not interfere with the ability of banks to supply the credit 

needs of the economy. They are designed to adjust the banks' greatly 

expanded lending capacity to those needs. Combinations of the secondary 

reserve and bond limitation plans are, in effect, already being applied in 

Canada. Regulation of secondary reserves of banks is accomplished by 

distribution among the banks on an allotment basis of special short-term 

issues exclusively for bank holding. Limitation of bond holdings is 

achieved under a special agreement with the banks that confines their 

holdings of bonds to a percentage of savings deposits. However, there are 

but ten chartered banks in Canada and such plans can be effectuated by 

administrative arrangements more readily there than in this country with 

14,000 banks. Other countries have similar arrangements based on informal understandings or well-established banking traditions.14 

Another point of emphasis is that the primary purpose of the plans 

is not to save interest costs on the public debt or to keep down bank 

earnings from investment in that debt—although they would contribute 

to these results—but is to enable the Reserve System to deal with the 

monetary situation resulting from the huge public debt. The major task 

of postwar bank credit and monetary policies is to re-establish conditions 

14

 England and Belgium are examples. 

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118 FEDERAL RESERVE POLICY 

under which Federal Reserve control over general bank credit expansion 

can be effectively exercised through traditional central banking instruments. In accomplishing this task, it is important to recognize that the 

System is obliged to facilitate debt management by the Treasury at lowcost and with minimum unstabilizing effects. The central problem, therefore, is to free the market for private credit from excessive influence of 

public credit and to further reconversion of the current operations of 

banks and other financial organizations from a public to a private credit 

basis. Adoption of one, or some combination, of these proposals, appears 

an essential step toward reinstating the traditional instruments of monetary regulation—discount rates, open market operations, and changes in 

reserve requirements—as sensitive, flexible methods of Federal Reserve 

policy. 

Adoption of any one of the proposed measures would not necessarily 

mean relative rigidity in the level and structure of interest rates, except 

perhaps in certain categories of short-term Government securities. In fact, 

such rigidity would be inconsistent with a restored use of traditional 

Federal Reserve instruments of general credit policy. But some plan 

patterned along the lines of those proposed may be necessary before 

policies can be adopted which would accomplish an effective "defrosting" 

of interest rates on private debt and on that portion of the public debt 

held in the active money market. These measures are designed to set off a 

large part of the public debt and of bank investments in a way that would 

partly free them from the influence of changing interest rates. In all likelihood, variations in market interest rates would not seriously perturb 

institutional and other permanent investors holding savings bonds and 

marketable Government obligations. Marketable public-debt obligations 

held outside the banks, as well as private debt, could be traded freely in 

the active money market and permitted to fluctuate without the danger 

that these fluctuations would cause serious repercussions. 

If the economy should be in position where investment demands exceeded the available supply of savings, then it would be preferable for 

interest rates on marketable securities to rise somewhat than for bank 

credit to be forced into an inflationary expansion. It would, on the other 

hand, be possible to support the market for long-term Government bonds 

and at the same time offset the effect on the supply of bank reserves of 

any Federal Reserve purchases. It would likewise be possible to prevent 

a repetition of the undue decline in the level of interest rates caused 

by an expansion of credit in the early part of 1946. 

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PROBLEMS OF POSTWAR. MONETARY POLICY 119 

These instruments would not unduly restrict banks in making loans. It 

is the purpose of the proposals to restore to the System the power to limit 

excessive credit expansion—the function it was created to perform but is 

no longer able to fulfill. Any limitation either on the supply of bank reserves or on the ability of member banks to rediscount has its effects 

through exerting a restrictive influence on bank lending. The effects of the 

proposed instruments would not differ in this respect from those for which 

all credit regulative powers of the Federal Reserve System are designed. 

If banks want to take care of the needs of their customers at times when 

there is an active demand for loans but when over-all credit expansion is 

not desired, it would be better for the maintenance of a stable credit 

structure for them to sell securities of the kind that nonbank investors 

would absorb rather than of the kind that the Federal Reserve Banks 

would have to absorb. Through the one process there would be no net 

credit expansion, whereas through the other there would be a growth in 

bank reserves which would permit multiple credit expansion. 

Application by the Federal Reserve System of any one of the proposed 

powers could, and should, be so regulated as to provide banks with adequate funds for meeting the economically desirable needs of commerce, 

industry, and agriculture. It is the System's task to supply the banks with 

enough reserves to meet those needs, while preventing expansion in the 

available supply of reserves beyond the amount essential for sound credit 

demands. The System has adequate power to permit needed expansion 

but finds itself today in a position of having no corresponding power to 

arrest undue or harmful expansion. 

In summary, it may be said that because of a redundant money supply 

and the vastly increased capacity for further expansion, the credit 

situation in the postwar period is likely to be an unstabilizing influence 

upon the economy. The money supply, actual and potential, is disproportionate to current output and incomes, even at present inflated prices, 

and also to foreseeable prospective needs. In view of the situation resulting from war, one or more of the measures described is needed to restore 

more effective control over the supply and use of bank credit. Without 

such control, the national objective, as declared by Congress, of economic 

stability at the highest sustainable levels of production and employment 

may be seriously jeopardized. 

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