Credit Policies of the Federal Reserve System

CHAPTER V

MAINTENANCE OF SOUND CREDIT CONDITIONS

The basic principle which the Federal Reserve system has enunciated as a guide is that Federal Reserve policy must be shaped toward the promotion of a “sound” credit situation. The meaning of “soundness” and its adequacy as a guiding formula we have to analyze in the present chapter.

The most complete exposition of the concept of “a sound credit situation” is a ten-page analysis of “guides to credit policy” which was published in the report of the Federal Reserve Board for 1923. This statement has been elucidated and amplified in numerous writings and addresses by Reserve system officials. The subject was discussed very fully in testimony before the House Committee on Banking and Currency at the hearings on the Strong bill in 1926, 1927, and 1928.

The doctrine which we have to review has been summarized as follows by Mr. Walter W. Stewart, who was director of the Division of Analysis and Research of the Federal Reserve Board at the time the policy was first enunciated:

I would say that the responsibility that rests upon central banks abroad and the Federal Reserve system in this country is primarily one of maintenance of sound credit conditions. . . . What is meant by sound credit conditions depends on what one regards the sound functions of credit to be. The function of commercial uses of credit is simply to facilitate the production and the marketing of commodities with the maintenance of adequate stocks of commodities in order that the marketing may be orderly. . . .

To test whether or not the credit condition is sound, one has to begin by determining the volume of production, and whether or not that production is moving promptly through the channels of distribution and whether or not inventories are accumulating. I can see, as an example, a situation where prices may not be advancing, but, on the other hand, declining, yet inventories of commodities were accumulating, and where, if additional credit were granted, it would be used for the purpose of adding to the stock, and would mean simply encouraging the accumulation of additional stocks.1

The more complete discussion of guides to credit policy in the report referred to may be summarized as follows:2

First, though the ratio of notes and deposits to gold reserves is the banking index which enjoys the greatest prestige in the tradition of most countries, and especially in the tradition of the United States, it is not a serviceable working guide in the absence of an effective international gold standard. Since the international flow of gold does not exert a restrictive influence on credit in the countries from which the gold goes out, it would not be safe to allow it to work automatically in expanding credit in the countries into which the gold goes. The use of the reserve ratio as a test of credit policy rests on the automatic working of the gold standard, which cannot be effective for one country alone.3

Second, the Federal Reserve Act clearly contemplates the exclusion of all Federal Reserve Bank credit from speculative and investment uses and its limitation to productive uses; that is, agricultural, industrial, or commercial employment. The problem of credit control, therefore, involves both a qualitative and a quantitative determination. There will, however, be little danger that the credit created and contributed by the Federal Reserve Banks will be in excessive volume if it is restricted to productive uses.

Third, the volume of credit will seldom be at variance with the credit needs as reflected in the demands of productive industry so long as the volume of trade, production, and employment on the one hand, and the volume of consumption on the other hand, are in equilibrium. When credit is provided to finance the movement of goods through the productive process or to promote the flow of goods from producer to consumer, the use is productive. When the effect of credit is to impede or delay the forward movement of goods from producer to consumer, credit is not productively used. Administratively, therefore, the way to keep the volume of credit issuing from the Federal Reserve Banks from becoming very excessive or deficient is to keep it in proper relation to the credit needs which arise from the operating requirements of agriculture, industry, and trade, and to prevent the use of Federal Reserve credit for other purposes.

Fourth, an effective credit policy must be based on the wide variety of economic data which throw light on the changes taking place in the business situation and their relation to current banking and credit needs. The factual basis of banking administration consists of statistical information relative to the rate at which goods are being produced and marketed.

Fifth, the Board and the Federal Reserve Banks are collecting basic economic data bearing on the volume of production, trade, and employment, and the movement of prices, and a limited amount of information concerning stocks held by producers and distributors. These data are made available, not only to the Board and the Banks, but to the business community. The co-operation of the public, based upon an understanding of the broad outlines of Federal Reserve credit policy, and upon the use of current statistical data, is of the greatest advantage to a good functioning of the Federal Reserve system.

This report constitutes the most comprehensive statement of Federal Reserve credit policy, and embodies what may fairly be regarded as the leading contribution of the Federal Reserve system to the development of central banking theory and practice. In place of a simple test, such as a reserve ratio or an exchange rate or an index number of prices, there is set up as a standard the maximum facilitation of the production and distribution of tangible goods and the minimum facilitation of the accumulation of speculative inventories.

Under this system, commodity prices come into the picture, but only as a subsidiary element. They come in because it requires a different amount of credit to carry on the same volume of trade at different price levels, but the price level itself is not regarded as of primary significance. A rise in prices is not deprecated, so long as it is accompanied by an expansion of production and a corresponding expansion of consumption. By implication, it is the business of a Reserve system not to check price increases by manipulation of credit, but to supply a volume of credit appropriate to the higher prices, so long as the latter are not interpreted as the evidence of speculative accumulation of inventories. The time to check credit expansion comes, not when prices begin to rise, but when productive resources are so fully employed that additional credit and further price increases no longer stimulate increases in productive output and corresponding increases in consumption 5 when further credit expansion is absorbed in speculative withholding of goods from the market and the marking-up of the monetary value of existing inventories.

Though the theory of a sound credit condition is worked out in the annual report for 1923 with great care and skill, there is in it a certain ambiguity. On the one hand the report states that:

. . . Administratively, therefore, the solution of the economic problem of keeping the volume of credit issuing from the Federal Reserve Banks from becoming either excessive or deficient is found in maintaining it in due relation to the volume of credit needs as these needs are derived from the operating requirements of agriculture, industry, and trade, and the prevention of the uses of Federal Reserve credit for purposes not warranted by the terms or spirit of the Federal Reserve Act.4

The clear implication of this passage and of most of the report is that the Federal Reserve system should adapt its policy to the changing cyclical situation just as it does to the changing seasonal situation, curtailing credit when business declines and expanding it when business expands. By doing this, the System avoids the danger that the credit released in times of declining business activity will be drawn off into speculative channels, and the opposite risk that business will be hampered by lack of funds in times when trade is reviving. This line of analysis points to the conclusion that it is not the business of the Reserve system to stimulate business by making money artificially cheap in periods of depression or dear in periods of boom, but merely to adapt itself to conditions as it finds them.5

This is Professor Reed’s interpretation of the doctrine6 and is perhaps in harmony with an interpretation which was formulated by Governor R. A. Young of the Federal Reserve Board in 1928, as follows:

. . . A healthy banking situation must be forever the primary concern of the managers of the Federal Reserve Banks and of the Federal Reserve Board. These responsibilities are sufficient to require our best efforts in the determination of the wise course of action. This is one of the reasons why it would be unfortunate if the Federal Reserve system were to be charged with still further responsibilities which are not directly related to banking, such as responsibility for the stability of the general price level or for the moderation of ups and downs in business conditions.7

On the other hand, in a different connection the same annual report says:

. . . It seems clear that if business is undergoing a rapid expansion and is in danger of developing an unhealthy or speculative boom, it should not be assisted by too easy credit conditions. In such circumstances the creation of additional credit by rediscounting at Federal Reserve Banks should be discouraged by increasing the cost of that credit—that is, by raising the discount rate. It seems equally obvious that if industry and trade are in process of recovery after a period of reaction, they should be given the support and encouragement of cheaper credit by the prompt establishment at the Federal Reserve Banks of rates that will invite the use of Federal Reserve credit to facilitate business recovery.8

This view, that it is the business of the Reserve system to work against extremes either of deflation or inflation and not merely to adapt itself passively to the ups and downs of business, nor to confine itself to guarding against the inflow of credit into non-productive uses, is the view which in general has seemed to dominate Reserve system policy.

In tracing the way in which the actual record has conformed to the theory of the maintenance of a “sound business condition,” we shall assume, with some hesitation, that the doctrine does imply that the Reserve system is to exercise a positive influence on the cyclical movement of business. At the peak, less credit is to be offered by the Reserve system than business would gladly take; correspondingly at the bottom, more credit is to be thrust into the market than the immediate demands of business would justify. In both cases the objective aimed at is an adjustment of production to consumption, without a credit stimulus to either the piling up or the depletion of inventories.

Until 1928 Reserve practice was fairly consistent with the stated theory of a “sound credit situation” The indications are that there was no definite System policy till toward the end of 1922. At least it is difficult to frame a theory which rationalizes the 370 million dollar increase in government security holdings in the first five months of 1922, and the 300 million dollar reduction in the next six. The decrease cannot be accounted for as a measure of restraint, for there were no signs that business was being overdone until early in 1923, and by that time—say by February 1—the liquidation of securities was more than half completed.9

The mild policy of restraint in the spring of 1923 and the vigorous easy money policy of 1924 were clearly in accord with the doctrine under review. So also is the record of 1925-26, aside from the reduction of the rediscount rate at New York in April 1926 (referred to below). These two years furnish an exceptionally good illustration of the working of the “sound credit” standard of Federal Reserve policy, because in this period the procedure suggested by this theory differed more than is usually the case from that suggested by rival doctrines. Ordinarily, for instance, a policy of stabilizing business would be expected to coincide with a policy of stabilizing prices. But in 1925, while most business indexes pointed to a high level of prosperity, commodity prices moved downward and stock prices moved upward with much evidence of speculation. If price stabilization had been made the test, the System would have tried to force an expansion of credit; if the restraint of stock speculation had been the dominant motive it would have called for a contraction; the theory of stabilizing business called for no action one way or the other. The latter theory prevailed through most of the year. The slight increases in discount rates in the fall of 1925, however, are possible indications of a regard for the stock market situation which is not consistent with strict adherence to the stated set of tests.

There were some slight signs of business recession in the spring of 1926 but recovery was quick and the year as a whole was the most prosperous since 1916. In April the New York rediscount rate was reduced and about 65 million dollars worth of securities were bought, both actions being reversed in August. Officially these actions were coupled with the business situation, though as we point out elsewhere, the course of stock market activity furnishes a more plausible explanation.10 Commodity prices continued to trend downward through the year in spite of the high degree of business activity; this decline did not lead to any remedial action.

In 1927, as in 1924, price stabilization, foreign relations, and business stabilization, all pointed to a cheap money policy; only the fear of stimulating stock speculation pointed in the opposite direction, and the inflationary policy prevailed. In 1928-29 the System developed an entirely new set of standards, which will be considered in Chapters VII and VIII. The experience of 1930-31 is not of interest at this point, for here again, even more than in 1927, the cheap money policy was equally appropriate under any of the theories we have mentioned.

What are the merits of the formula of the Tenth Report as a guide to credit policy, first, as a means of dealing with the abnormal situation created after 1921 by an extraordinary inflow of gold which came for wholly temporary reasons; second, as a permanent working rule for normal times? We shall consider these questions separately, examining first the situation at the time when the policy was put into effect.

The “sound credit situation” test of policy, as appiled to conditions In 1922-23 gave good results. The fact that the gold standard was then not in operation in the rest of the world could not be ignored. To have treated the incoming gold as the equivalent of gold received through the operation of the balance of payments between countries on a full gold standard and to have built a credit structure on it—assuming that it was possible to do it—would have meant first an enormous inflation, and later, when other countries began to rebuild their gold reserves, either a world-wide deflation or the establishment of entirely new standards of the relationship between the world’s gold reserve and the outstanding volume of credit. The part of wisdom was to treat the inflowing gold as a trust fund and keep it outside the credit structure. This was done in part by carrying excess reserves, and in part by putting the gold into circulation in the form of gold certificates.11

The policy of 1922-23 was in line with pre-war central banking precedents. It is very easy to exaggerate the revolutionary character of what was done. There is no evidence of any such elaborate policy of sterilization as most European, and some American, writers assume. Unfriendly critics of the “sterilization” policy seem to believe that the inflationary effect of incoming gold is automatic, and that active, energetic, and skillful policy was exercised to prevent that effect. This assumption is quite untenable. On the contrary, there was such a general fear of inflation, based both on American and on European experience, that excess reserves would probably have accumulated somewhere in the System in spite of any measures the Reserve system might have taken. Certainly an active, energetic, and skillful policy would have been necessary to reverse the tide of sentiment and induce banks to offer, and business men to accept, such a volume of credit as would have utilized the incoming gold.

“Sterilization” has consisted in accepting gold deposits and suffering the loss involved in carrying reserves above the legal requirement, instead of trying to utilize them fully through vigorous open market operations, and through a very liberal rediscount policy. Had the Reserve Banks been guided solely by considerations of immediate profit they would presumably have pursued such an aggressive policy instead of making business stability the criterion of credit policy. But a refusal to be guided by considerations of profits, though an innovation in American practice, follows the line of well-established European precedent. Central banks of leading countries are not guided, and never have been guided, mainly by considerations of profit.

Aside from profit considerations, and assuming that the Reserve system could have forced into use a much greater volume of credit on the basis of the new reserves, it is very difficult to see what justification could have been found in 1922-23 for an active campaign to bring about a restoration of the expanded credit structure which had collapsed in 1920. True, such a structure could have been supported more safely than in 1919 because of the expansion of the gold reserves. But the debacle of 1921 was so fresh in men’s minds that public opinion would never have endorsed the reconstruction of the edifice of credit in the face of the risk that the abundance of gold would be only temporary. The world was sick of inflation and deflation and America counted herself fortunate to have had as light a dose of it as she had suffered.

It has been argued by foreign critics that a vigorous expansion policy would have helped European nations to stabilize their currency systems and would have lessened the burden of European debts to America. The latter reason could hardly have been offered to the American public as a criterion of American policy; the former had only a limited validity. A higher price level in America, if it had resulted from a different Reserve policy, would have been helpful to those nations which decided to struggle back to the old par values as the basis of stabilization; it would have been of but little aid to those more numerous countries which stabilized by devaluation.

We turn now to a consideration of the merits of the new formula as a working rule for normal times. Is it a permanent contribution to the theory of Reserve system management? And if so, is it equally applicable to the problem confronting central banking systems of other countries? Viewed from this standpoint, the case is much more complicated than it is with regard to 1922-23, and does not lend itself to a simple judgment of approval or disapproval.

Successful application of the policy discussed in this chapter requires large financial sacrifices. If the gold standard is to be maintained, a central bank which adopts as its policy that which is outlined in the Tenth Annual Report of the Federal Reserve Board must carry in normal times a large gold reserve in excess of legal requirements, and this gold it must stand ready either to carry idle or to let go as circumstances may dictate. So long as business conditions are deemed satisfactory, all major gold movements in either direction must be offset by credit movements. To offset a gold movement, as has been pointed out previously, tends to cause it to run further than it would have gone otherwise.

The size of the resources of the central bank sets definite limits to the possibility of its action in either direction. In the one direction, potential action is checked by the size of its idle reserves; in the other direction by the size of the portfolio. Only a bank whose assets are large in comparison not only with the total resources of its own market, but with those of the foreign markets with which its banks are in close touch, can hope for success. If in 1929 England and Germany had watched business indexes and disregarded gold reserve ratios they would have kept their discount rates stable or lowered them, with resultant losses of gold much greater than those which they actually suffered. The Reserve Banks could let 250 million dollars worth of gold go out in 1925, and 500 million in 1928, as the result of easy money policies which seemed to fit the domestic needs, but in recent years no other nation, except perhaps France, has been in a position to follow a similar policy under similar circumstances.

The effectiveness of this standard defends on the completeness and reliability of statistical information. Every standard is of course conditioned in its operations by the limitations of knowledge at the command of those responsible for its maintenance as the standard. But the “sound credit condition” standard makes enormously greater demands on the research departments of the Reserve system than would a simple adherence to reserve ratios, or a policy of keeping wholesale prices stable, or one of stabilizing money markets.12

No analysis of the business situation can be more adequate than is the theory of business fluctuations on which it is based. This fact points to a weakness more serious than the lack of statistical data. If credit is to be regulated in accordance with the requirements of business stability, the administering authorities must have a sound and adequate knowledge of the conditions which foreshadow a business boom or a business collapse. They must understand the theory of the business cycle and be masters of the art of business forecasting. And, without in the least reflecting on the competence of the able research staffs of the Federal Reserve Board and of several of the Reserve Banks, the fulfillment of this condition does not, in the present stage of economics, seem to be practicable. The experience of the last few years does not encourage confidence in any sort of cycle analysis as a basis of public policy.

The assumptions of the Tenth Annual Report are the assumptions of a certain type of cycle theory, which may be characterized briefly as the doctrine of over- and under-production. Business cycles are viewed as alternations of excess and deficiency of production above and below consumption. When production outruns consumption, goods are piled up in inventories and credit is called forth to carry them. When the load gets excessive, inventories are thrown on the market, prices fall, production declines. When stocks are exhausted, production picks up. The cause of the fluctuation is not necessarily to be found in the credit situation, but the credit system furnishes the key to its control. For, if the financing of a boom can be prevented, the conditions which engender the slump are avoided. As it was stated in 1923:

So long as this flow is not interrupted by speculative interference there is little likelihood of the abuse of credit supplied by the Federal Reserve Banks and consequently little danger of the undue creation of new credit. The volume of credit will seldom be at variance with the volume of credit needs as they are reflected in the demands of productive industry as long as (1) the volume of trade, production and employment, and (2) the volume of consumption are in equilibrium.13

This theory is in harmony with that to which I have in the past adhered and on the basis of which I have several times ventured to make specific forecasts. But I am not at all certain that it offers an analysis adequate to meet the requirements either of the theorist or of the administrator. The period 1929-31 has engendered much humility among cycle theorists and forecasters, and it is to be hoped among administrators of central banking institutions.14 Certainly since 1929 it can no longer be assumed that stable or falling prices, moderate reported inventories, and widespread complaints about hand-to-mouth buying necessarily mean that we need not worry about the risk of a business collapse.

The usefulness of central bank activity in checking depression or stimulating recovery in a period of depression is one on which I am not ready to express a positive judgment. A deliberate expansion of credit designed to offset a spontaneous contraction, if successful, would be a stabilizing factor, just as a deliberate curtailment of credit in a boom may be a stabilizing factor if it offsets an abnormal speeding up of expenditures. Certainly central bank action has been helpful in tiding over acute emergencies,15 and there seems to be no a priori reason why it should not be effective in checking a business fluctuation before an emergency appears. Given wisdom on the part of the credit administrator superior to that of the business community, it may be possible to improve on the working of the “invisible hand,” in a situation where the distribution of optimism and pessimism in the population is not a random one but is shaped by mass psychology.

In practice, however, the difficulties are great, and there is little in the experience of Federal Reserve control in the years from 1922 to 1931 to create optimism as to the probability of stabilizing business through credit control.16 Any argument from experience is always inconclusive, for no one can know what the results would have been if there had been less, or more, control. But, so far as the evidence goes, the record is not impressive. The business collapse of 1924 was extremely severe. For six months, in spite of a vigorous expansion policy on the part of the Federal Reserve system, credit contracted more rapidly than it did in 1920-21. Revival came quickly and the Reserve system claimed some share of the credit for it. But the initiation of the Dawes Plan, the conservative victory at the polls in the United States, and a favorable turn in the agricultural situation all have to be considered as alternative explanations. How much weight one gives to each factor depends on his preconceived theories; the facts do not give us a test of those theories. In 1927 business activity declined much less, and much more credit was poured into the banks—most of it after business had started to pick up, however. In 1930-31 there is no evidence that Reserve system efforts were successful in stimulating business activity, though there is little doubt that in the emergency of the autumn of 1929 and again in the autumn of 1931 the System’s capacity for quick expansion staved off a currency panic.

If we could assume that all depressions without credit control would be as severe as the worst that we had before 1913 we could congratulate ourselves on definite achievement in the field of stabilization. But if we compare the record of 1922-29 as a whole with 1909-16 or with 1898-1906, we find no evidence of progress.17 And the disheartening experience of 1930-32 needs no commentary. At the end of a decade of concentrated effort directed to the maintenance of business stability, we plunged into what is probably the worst depression in a hundred years.

The theory of central bank control of the business cycle is that commercial banks cannot afford to hold surplus reserves, and the public cannot afford to hold surplus cash and bank balances. Any purchases of securities by the central banks, and any importation of gold, force the banks to find a use for the new money. They must, so it is assumed, either pay off loans at the central bank, send money out of the country, or expand their own operations by buying bonds and by a more liberal loan policy. The first alternative disappears when the liberal policy has run to a point where rediscounts practically disappear—in the case of the United States fall below, say, 200 million dollars. The second alternative we have already discussed. The third means that the public is put in possession of more cash which burns the pockets of the people just as it first burned the tills of the banks. Thus liberal central bank policy translates itself into increased willingness and ability to buy on the part of the public, and so stimulates business revival.

The difficulty with this program is in the assumption that the response of the banks and that of the public to easy money in times of depression will be the same as it would be in times of prosperity. Depression psychology is ignored. But this is to ignore the central element in the problem. A depression exists precisely because there is a general preference for cash, and for safe short-time investments expressed in cash terms, over commodities and securities. To increase the supply does no good unless the preference decreases. In 1932, for instance, a policy of extraordinarily great open market purchases has been adopted by the Federal Reserve system when the banks are already holding unprecedentedly large quantities of cash and of government securities; to put them in possession of more cash does not change the conditions which have led them to pursue this policy. Likewise the public, which has absorbed and is holding without interest return a billion dollars of cash in excess of its holdings of a year ago, is not at all certain to change its attitude and become a buyer of goods merely because it has been deprived of a body of its safest investment holdings and given cash balances instead.

In short, there is a fourth alternative. The result of open market purchases in a depression may be simply to pile up idle reserves in banks, and idle balances in the hands of individuals, until the load gets so great that confidence in the currency suddenly disappears—with the usual accompaniments—an accentuated decline of business confidence, budget disorganization, gold hoarding, flight to foreign currencies, and finally complete collapse of the currency system.

With regard to conditions calling for a contraction the case is simpler and the prospects of successful central bank action are greater. If a central bank contracts its outstanding credit—and it can always do so if it is willing to lose revenue and to accept the criticisms which a harsh credit policy always calls forth—the only obstacle to its success in forcing similar contraction in the volume of bank reserves and of public holdings of bank deposits and cash, is the competition of the foreign money market. The experience of 1928-29 conformed closely to what ought theoretically to be expected. Money rates rose sharply. Gold flowed in, but not enough to replace fully the vanished Reserve credit. The public adjusted itself by a tremendous increase in the turnover of bank deposits to doing business on a smaller equipment of bank balances. But the limits to the possibility of doing this are narrower than the limits to the possibility of absorbing fresh money when it is poured out in a time of depression. The only important limitations on the possibilities of contraction are the size of the central bank’s resources and the inflow of funds from abroad. The significance of both these limitations is a function of the size of the country. The central bank of Denmark or of Egypt could hardly hope to check a boom while its nationals had access to the money markets of Paris and London, but the United States or France can more reasonably hope that the total volume of domestic credit and currency will respond appreciably to central bank pressure.

The final limitation, and perhaps the most serious, is the limitation of human foresight and wisdom. So far as the ultimate effects on commodity prices and the volume of business activity are concerned, credit control at best operates slowly and irregularly. To continue a liberal or a restrictive policy until its desired results are visible may be like pouring into a patient one dose of strong medicine after another until he begins to get well—a policy which fails to take account of the normal lag between action and reaction. Credit control of business cycles must be based on forecasts of business conditions and estimates of the lag of results behind measures. And, as was stated above, the present state of the art of business forecasting gives us small ground for optimism as to the feasibility of basing on it a sound effective technique of controlling the state of business.

It would be rash to claim that the policies indicated have no influence in the direction hoped for, though the experience of both England and the United States in the seventies and the nineties is not encouraging.18 The experiment which the Reserve Banks are making as this is written will throw fresh light on the problem, but whether it seems to succeed or to fail it will not definitely settle the issue. A dependable sequence of cause and effect in the economic realm can only be established by comparison of numerous similar cases.

In short, aside from the handling of the seasonal problem and of acute emergencies, the stabilization of business by credit control, though not discredited, has certainly not been validated by experience. Given the present large authority of central banks and the present urge that something be done to stabilize business, it is inevitable that further efforts will be made along the lines which have been indicated. The economist can only say that further experimentation is probably worth while but that the experience of the past does not create optimism as to the possibility of flattening out the course of the business cycle by credit control. One of the weightiest arguments in favor of the prescription is that no better one suggests itself.

One factor in the business situation which was conspicuously absent from the analysis described in the report for 1923, and succeeding reports, was the stock market situation.19 There was some criticism of the Reserve system during 1925-27 on the ground that it was permitting excessive stock exchange speculation,20 but Reserve authorities refused to be drawn into the discussion. They assumed tacitly that commercial and industrial data were a sufficient guide; that if the stock market—or any other fraction of the money market—exerted an over-stimulating effect on business, that fact would be evident from a direct study of the business situation itself. In this attitude many of the leading unfriendly critics of the System concurred.21 By 1928, however, the contrary view became dominant in the management of the Reserve system. The apparent stability of business was no longer allowed to dominate; the repression of excessive stock speculation became the leading immediate objective of policy. In Chapters VII and VIII we shall give attention to this phase of Reserve system history.

The other most important phase of the System’s credit policy which is omitted from the statements which were analyzed in the first part of this chapter, is the foreign situation. The “sound credit” policy is in general so described both by Reserve authorities and by their critics as to imply an exclusive interest in and attention to the outlook for domestic business. It is obvious, however, that even in a country as self-contained as the United States, the business situation cannot be viewed in entire detachment from the outside world. And in the decade which we are studying, the foreign situation has been peculiarly insistent in its claims on our attention. This phase of Reserve policy we consider in Chapter VI.

Mr. Stewart replied: “Nothing that I see that could prevent it. I see various devices to moderate it as far as the credit situation is concerned, to ease the abruptness of the decline and ease the readjustment that takes place during such period.” (Hearings on H.R. 7895, Part 2, p. 780.)

• 1The distinction between “banking policy” and “credit policy” is taken from Annual Report of the Federal Reserve Board, 1928, pp. 9-10.
• 2Compare pp. 132-40.
• 3This is, of course, in substance the position of the Banking School in the British banking controversy of the early nineteenth century.
• 4“. . . When increased credit demands can be met only by recourse to the Federal Reserve Banks, the volume of Reserve Bank lending is a sensitive indicator of credit conditions. . . .” (Federal Reserve Bulletin, 1923, Vol. 9, p. 411).
• 5Annual Report of the Federal Reserve Board, 1923, p. 10 (quoted below, pp. 79-80); Federal Reserve Bulletin, 1928, Vol. 14, p. 6.
• 6The omission of reference to price changes in the text is intentional and without prejudice. I believe that there is need of a thorough reexamination of the orthodox statement of the influence of gold movements on price changes and the extent to which in pre-war days changes in price levels were caused by gold movements and operated to check the gold movements.
• 7For fuller discussion of these points, see Chap. IX; compare also B. H. Beckhart, The Discount Policy of the Federal Reserve System, Chap. II.
• 8The cash balance carried in the United States Treasury was occasionally drawn upon to meet seasonal or crisis demands, either through the depositing of funds in banks or through the purchase of bonds by the Treasury, but the device was very crude and there was no continuity of policy in its management.
• 9Compare chart, p. 35.
• 10The possibility of temporary nullification of a central bank’s control through the mobilization of fresh resources is illustrated by an action of the Midland Bank, which in 1927 bought securities so heavily as to lower its own reserve ratio by several per cent. The amount involved was small enough so that the Bank of England was able to offset it. The net result was simply to increase the earning assets of the Midland Bank and decrease those of the Bank of England; not to ease the market.
• 11Compare p. 231.
• 12Annual Report of the Federal Reserve Board, 1927, pp. 10, 16.
• 13See pp. 104-05.
• 14Annual Report of the Federal Reserve Board, 1927, p. 11.
• 15The 4 1/2 per cent rate was charged on all maturities of less than 90 days, such paper making up the great bulk of the transactions.
• 16As reported by the New York Stock Exchange.
• 17At least such a policy was promulgated by the Board. It is difficult to say how far the Reserve Banks went in carrying it out. Apparently the New York Bank did not give much heed to it; alleging, truly, that New York banks were not loaning heavily in the stock market. Compare p. 133.
• 18Indexes of Standard Statistics Company.
• 19This increase is not altogether due to the rate change, as the supply of acceptances is always increased by autumn exports. The increase in 1929 was much more than seasonal, however.
• 20See 70 Cong. 1 sess., Brokers’ Loans, Hearings on S. res. 113 before Committee on Banking and Currency.
• 21See testimony of Cassel, Fisher, and Foster in Hearings on H.R. 78955 William T. Foster and Waddill Catchings, “Is the Reserve Board Keeping Faith?,” Atlantic Monthly, July 1929, Vol. 144, pp. 93-102.