Inflation Has One Cure

January 15, 1951

On Dec. 28 the Federal Reserve Board announced increases in the legal reserve requirements for the 6,900 member banks of the Federal Reserve System as a measure to curb credit. The increases, to be spaced out over the period from Jan. 11 to Feb. 1, took the form of a rise of 2 percentage points in demand deposits and 1 percentage point in time deposits. The board explained that the effect of this measure would be to raise required reserves by member banks by about $2,000,000,000, and that this would make unavailable about $12,000,000,000 in potential bank credit.

It must be said in favor of this measure that it seeks to curb inflation in the only field in which it really can be curbed—that of monetary and credit policy. But it must be added in all candor that this step is wholly inadequate in itself, that it is little more than a token measure, and that even its small effects will be and are being offset by inflationary countermeasures on the part of the Federal Reserve authorities themselves.

As the National City Bank of New York points out in its January monthly bank letter: “As the reserve requirement increase was announced, there was evidence in the market that the Federal Reserve Banks had again put pegs under the government security market to maintain their price levels.... For most of the banks, doubtless, the adjustment will be accomplished with the greatest mechanical facility. Government securities will be sold with the Federal Reserve the buyer. In effect, banks will ship a part of their government securities to the Federal Reserve where they will get a credit of idle, unusable cash. By and large, the whole of the operation—increasing cash reserve requirements with one hand and supplying the cash with the other—is self-defeating. . . .

“Pegs, rigidly maintained, invite any and all holders of marketable government securities to turn their holdings into cash, for spending or lending, any time they please. Those holdings, outside the Federal Reserve Banks and Treasury investment accounts, run to $130,000,000,000.”

Monetary authorities have long recognized that changing cash reserve requirements is at best a supplementary—and an awkward—method of credit control. But if it is resorted to at all, it should certainly not be used in the disingenuous and self-defeating way in which the Federal Reserve authorities are now using it. What is sauce for the goose must be sauce for the gander. Whenever the reserve requirements of the member banks are raised, the reserve requirements of the Federal Reserve Banks ought also to be raised. The latter’s reserve requirements used to be 35 percent against deposits and 40 percent against notes. But under the Reserve authorities’ plea of emergency they were lowered by Congress in 1945 to a uniform reserve requirement of only 25 percent.

The most direct and immediate way in which Congress could put the country on notice that it is determined to prevent inflation, and knows the direction in which the danger really lies, would be to restore the former reserve requirements of the Federal Reserve Banks themselves. It should, in addition, give the Federal Reserve Board discretionary authority to raise even such requirements, just as it already has discretionary authority to raise requirements of member banks. And if Congress also allows the board discretionary authority to let a Federal Reserve Bank’s reserves fall below, say, 40 percent, it should only be with the proviso that such a bank cannot increase the net volume of its investments and advances as long as its reserves are below that ratio.

But even such legal requirements, though important, would be chiefly symbolic and supplementary. Nothing can take the place of proper credit policy on the part of the Federal Reserve authorities themselves. As Governor Eccles of the Federal Reserve Board said a year ago: “In making a cheap money market for the Treasury, we cannot avoid making it for everybody. All monetary and credit restraints are gone under such conditions; the Federal Reserve becomes simply an engine of inflation.”