278 MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT

quire that discount rates be established "every fourteen days, or oftener if deemed necessary by the Board".

As pointed out in the answer to Question A-1, one of the provisions of the Banking Act of 1935 required the Board to keep a complete record of all of its actions of policy and to include in its annual report to Congress a full account of all such policy actions. In view of this requirement, the Board requested the Federal Reserve Banks to include in their telegrams recommending changes in discount rates a definite statement in each case of the reasons underlying such action. It was made clear, however, that such a statement of reasons ordinarily would not be included in a telegram merely advising the Board of establishment without change of pre-existing rates.

During recent years no important changes have been made in the procedure for setting discount rates. However, as the result of the growing national character of the credit market, the recognized close interconnection between discount rates, open market operations, and changes in reserve requirements, the supplementary though subordinate role in national credit policy of selective credit regulation, and the significantly greater part which Government securities have come to have in the asset structure of banks and other lenders, it has become general practice for the Federal Reserve Banks to act uniformly in fixing discount rates and to give special consideration to their relation to other instruments of credit and monetary policy and to their effects upon the market for Government securities. For example, in October 1942, after considerable previous discussion with the Presidents of the Federal Reserve Banks, the Board approved the establishment at all Federal Reserve Banks of a uniform preferential discount rate of one-half of 1 percent for advances to member banks collateraled by Government securities having maturities of one year or less. This action was taken in support of the Treasury's war financing program and was designed to encourage banks to invest more of their excess reserves in short-term Government obligations. Subsequently, after the end of the war, the preferential rate on advances secured by such short-term Government securities was eliminated by all of the Federal Reserve Banks after considerable advance discussion within the Conference of Presidents of the Federal Reserve Banks, as well as by the Federal Open Market Committee, and with the Secretary of the Treasury. These actions were approved by the Board.

At the present time, the procedure for the setting of discount rates, as it has evolved over the years, is generally as follows:

Each Friday the Board considers all actions taken by the Federal Reserve Banks during the preceding week to establish discount rates, usually action to re-establish the existing rates. The possible desirability of any prospective change in discount rates is usually considered in advance by the Board with the Presidents of the Federal Reserve Banks and the Federal Open Market Committee in the light of changing credit conditions, including the Government's financing needs and current trends in the economy generally. Whenever it is determined that as a matter of policy there should be a change in rates, action to establish such a change usually is taken uniformly by the boards of directors (or executive committees) of the several Federal Reserve Banks at their next meetings following such determination. Thus, in August 1950, after consultation between the Board and the Federal Open Market Committee, as one measure for restrain

ing credit and monetary expansion, a discount rate of 134 percent-initially proposed by the Federal Reserve Bank of New York-was established at all of the Federal Reserve Banks and that rate prevailed at the end of 1951.

In accordance with the procedures established many years ago, as previously indicated, whenever discount rates are changed, the action is announced simultaneously by the Board and the Reserve Bank at the end of the day on which the Board acts and the new rates are made effective on the next business day following the day of the announcement.

Relative authority of the Board and the Federal Reserve Banks.— The law clearly contemplates that the establishment of discount rates shall involve joint action by the Federal Reserve Banks and the Board of Governors of the Federal Reserve System. It is also clear that rates established by the Reserve Banks shall not become effective until approved by the Board of Governors. Since prospective changes in rates are ordinarily discussed in advance between the Board and the Reserve Banks, it is only rarely that action taken by a Federal Reserve Bank for the setting of discount rates is not promptly approved by the Board. On occasion, however, the Board may fail to approve or defer its approval pending discussions of System credit and monetary policies and Treasury financing policies with the Presidents of all Federal Reserve Banks or with the Federal Open Market Committee. The matter is usually discussed also with the Secretary of the. Treasury.

Since the Board's authority is not limited to mere approval of rates established by the Reserve Banks, but includes power to review and determine such rates, the Board, as previously noted, has legal authority to initiate discount rates. However, methods evolved through experience for the taking of action on discount rates are calculated to avoid the development of procedural issues in this respect.

Discussion of the relationships of discount and other credit policy is given in the answer to Question C-18.

16. Trace the historical development of open market operations covering both their significance as instruments of monetary and credit policy and the nature and composition of the bodies which have successively had control over them.

Section 14 of the Federal Reserve Act authorizes the Federal Reserve Banks, under rules and regulations prescribed by the Board of Governors, to purchase and sell in the open market (1) bankers' acceptances; (2) obligations of the United States; and (3) certain types of obligations of Government agencies and of States and municipalities. Since establishment of the Federal Reserve System, there has been a considerable increase in the scope and importance of open market operations in the implementation of the credit and monetary policy of the Federal Reserve System. At first such operations were principally transactions in bankers' acceptances. Limited operations in United States Government securities and municipal warrants were carried on primarily as a supplementary means of investing funds of individual Federal Reserve Banks or for local purposes.

Open market operations in Government securities first assumed importance as an instrument of credit and monetary policy during 1922

23. Over subsequent years, such operations developed into a primary instrument of Federal Reserve policy. Their significance as a credit policy instrument has shifted from period to period and has been affected by their relationship to the discount and other instruments of Federal Reserve influence on the availability, supply, and cost of

money.

Closely related to the increase in the importance of open market operations has been an increase in the degree of centralization and formalization in the procedure by which decisions are made concerning such operations. Decisions originally were made by individual Federal Reserve Banks. They are now made by a statutory committee composed of all the members of the Board of Governors of the Federal Reserve System and five Federal Reserve Bank presidents. Further discussion of the allocation of authority over open market operations is included in the reply to the following Question (C-17).

Chart 1 shows the variations in the components of Federal Reserve credit from 1917 through 1933 and Chart 2 in Federal Reserve holdings of Government securities by types of issue from 1933 through 1951. Together, these two charts trace through the System's history the changing role of open market operations in Reserve Bank credit outstanding.

CHART 1

The period 1914-22.-Prior to 1922 open market operations were small in scale and in importance and were carried on largely by individual Federal Reserve Banks either to provide needed earnings or to meet local conditions. Under Section 14 of the Federal Reserve Act, the Federal Reserve Board had been empowered to prescribe the regulations under which Federal Reserve Banks might engage in open market operations. Late in 1914 the Board prescribed that the Reserve Banks might purchase Government securities as they saw fit. In 1915 it prescribed eligibility requirements for municipal warrants and bankers' acceptances. In addition, it required that small purchases be made of United States Government securities directly from member banks in order to aid in the retirement of national bank notes. Subject to these regulations, operations in Government securities and municipal warrants in this period were made by the Federal Reserve Banks on their own initiative and primarily with regard to the utilization of their own resources.

In this formative period of the System, the development of the use of bankers' acceptances to finance foreign and other trade was actively promoted by the Federal Reserve and various banking and trade groups. The principal reason for promotion of this type of financing was to provide in the money market a larger volume of prime shortterm, self-liquidating paper particularly suitable for purchase by the Federal Reserve to meet seasonal and other temporary credit needs. Federal Reserve Banks established rates at which they would buy bankers' acceptances, and these rates were generally below the established rates on advances to or discounts by member banks. The Federal Reserve acceptance portfolio reached its pre-1931 peak in the period of credit stringency early in 1920.

Federal Reserve purchases of United States Government securities played very little part in financing the First World War, although

some minor purchases were made both directly from the Treasury and in the open market. Prior to the last quarter of 1920, Federal Reserve holdings of Government securities were smaller than those of bankers' acceptances. Aside from the freeing of reserves by a statutory reduction in reserve requirements in 1917, rediscounting for member banks was the principal method by which banks were supplied with reserve funds for the currency and deposit expansion which attended the financing of the war. It had been expected that the rediscount process would be the means by which the Federal Reserve Banks would make credit available in peacetime to finance commerce and industry, and the same method was utilized to make credit available to the Treasury in wartime. The public was encouraged to borrow from commercial banks in order to purchase securities, and commercial banks were encouraged to borrow reserves from the Federal Reserve Banks.

The period 1922-33.-Beginning in 1922 the effects of open market operations upon the economy were an increasingly important consideration in decisions to operate in the open market, and open market operations soon became a major instrument for carrying out credit policy. As a corollary development, a more centralized organization for making and carrying out open market policy came into being.

In May 1922 a Committee on Centralized Execution of Purchases and Sales of Government Securities was organized at a conference of Governors of the Federal Reserve Banks. The position of Governor then corresponded to the present position of Reserve Bank President. This committee, consisting of the Governors of the Federal Reserve Banks of Boston, New York, Philadelphia, and Chicago (and, beginning in October, Cleveland), was originally organized merely to execute decisions made by individual banks on their own initiative and thus to avoid the disrupting effects of large competitive orders on the Government securities market. In October the committee's duties were extended to include the making of recommendations from time to time concerning the advisability of purchasing or selling securities. Such recommendations, however, were not binding on the Federal Reserve Banks.

On March 22, 1923, the Federal Reserve Board passed a resolution . creating the Federal Open Market Investment Committee. Although this committee had the same composition as the preceding committee, a more formal basis was now provided for its organization, and the resolution required that the committee give primary consideration to the accommodation of commerce and business and the effect of purchases or sales of securities on the general credit situation. The requirement for giving primary attention to general rather than local conditions was strengthened by the provision that recommendations be submitted to the Board for approval. Although the recommendations were generally followed, each Federal Reserve Bank, nevertheless, retained formally the authority to decide whether or not to follow committee recommendations. In 1923, operations were facilitated by the organization for the first time of a System open market account, participation in which was allocated among the Federal Reserve Banks, for carrying on transactions authorized by the Open Market Committee, although the individual Reserve Banks continued to maintain small separate accounts of their own as well.