Evening star., 1933-09-29
Redisc0ur,t Method Offers
Elastic Credit Building q
actual Mechanism by Which Money Sup.
ply in U. S. Is Created and Controlled.
Important in Initiation Discussion.

Now we have seen that the dollar
in gold, which could do q dollars worth
Of work. and no more, when 1t circu-
lated from hand to hand, was enabled
to do the work of two and one-half
gold dollars when 1t was impounded In
the vaults of the reserve bank and
used as 40 per cent reserve against
Federal reserve notes. But q dollar
in gold, when used as a basis of bank
credit deposit money! will 60 much
further even than that. Let US see
why:
The reserve bank. in addition to
maintaining 40 per cent gold re-
serve against its notes, must maintain
IS per cent reserve against its de-
posits. In other words, 1t can create
1t holds in gold. But what are these
deposits? They are the reserves Of :ss
member banks. And we have already
seen that the member banks are per-
mitted to create deposits for their Gus
toners up to 10 times the amount Of
these reserves.
Under our central banking system
therefore, we have made it theoretically
possible for a dollar in gold-real
money-in our reserve system, to do
the work of 10 times $285. or $3.50
when transformed into bank credit. o.
deposit money!
Under the gold standard as it op-
crates within the framework of the
that the outside limits of currency and
credit expansion are set automatically
by the 40-35 per cent reserve provi-
sions against currency and credit. But
within the limits thus established the
reserve may exercise a considerable in
f1uence on the money supply by means
of two other control mechanisms
One Is its power to regulate the re-
discount rate; the other is its authority
to purchase and sell Government Sc
curities for its own account. Such
purchases and sales. when conducted
on a sizable scale, are referred to as
open market operations.
Power to Create Credit.
As the member banks employ the re-
discount method to build up their re-
serves, and hence their power to
create" credit, it is obvious that con-
troll of the rate may be an important
instrument in the hands of the Central
Bank A high rate tends to discourage
over-borrewing, and consequently too
great expansion of the volume of credit /;
a low rate is frequently effective in en-
couraging bank credit expansion, thus
stimulating business enterprise.
Open market operations have the
same general objectives. Suppose the
Central Bank buys a $1,000 bond in
the open market It will pay for this
bond with draft on itself, which, as
we have seen, is sufficient, in the hands
of member bank. to create $4,000
in bank credit. The theory Of such
purchases is that the draft ultimately
will be deposited with a member bank
and used by the latter to expand its
loans.
Open market purchases have the
same objectives, then, as low redis-
count rate. Indeed. they are frequently
resorted to in conjunction with a low
rediscount rate as a means of supple
menting the latter. BY the reverse
token, sales of securities by the Reserve
Bank, whose effect is precisely the op-
posite of purchases. are frequently used
to make a high rediscount rate ef-
| fective."
! (Copyright. 1893, by North American News.
paper Alliance, 1nc)