tantly affecting the national economy. Consequently, they must all try to work together on problems which affect them all. In the final analysis, in the event of collision, all agencies of public power must recognize the ultimate and decisive authority of the Congress; and all must recognize that the Presidential office has always had the legitimate function of lending its influence toward harmonizing the executory or administrative aspects of national economic policy. But the genius of our system resides not so much in reliance upon command as in reliance upon voluntary accommodation through hard work, fair purposes, and mutual respect. Surely the Council of Economic Advisers, which finds its life in a statute the essence of which is cooperation, cannot bring itself to believe that cooperation is not the best method in dealings between any important organs of public power. From the peculiar vantage point of the Council of Economic Advisers, it has seemed to me that the Treasury and the Federal Reserve Board, as well as other agencies, have worked harder and with a finer spirit than the general public realizes to join hands in the national interest in these trying times. For example, those not involved in the process hardly realize how thoroughly the reports to the Congress under the Employment Act of 1946 are made the subject of full discussion, interchange of views, and a wise spirit of give and take among all of the agencies concerned with national economic policy. I have always found the Treasury and the Federal Reserve Board "independent" in the sense of being sturdy and vigorous in the assertion of their views; but I have never found any of them "independent" in the sense of being remote or unapproachable, provincial or narrow-minded, or overzealous in the control of its own domain. The result of this process of cooperation has not been perfect. But it has produced over the years, I believe, a more intelligent and harmonious approach to the problems of our national economy than would have been possible under any other approach. Based upon my observation of the relationships now in effect, I do not see the need for additional formal machinery, or for new legislative efforts to redefine relationships or relative responsibilities. I believe instead that we must continue to work together, seeking to improve our tools of economic analysis, to achieve even greater objectivity, and to enlarge the popular understanding of what we are trying to do. These things depend upon men, and not upon laws. I think the men with whom I have worked measure up to the task, and that is what is most important. At the same time, if it should be deemed desirable to follow the suggestion recently made by the Secretary of the Treasury, to the effect that the Treasury, the Federal Reserve Board, the Council of Economic Advisers, and certain other agencies recognize more explicitly through some new cooperative unit their mutual interests, and if the Federal Reserve Board should feel likewise, such a proposal would certainly meet with the hearty support of the Council of Economic Advisers. Representative PATMAN. Senator Douglas, would you like to ask some questions? Senator DOUGLAS. First, let me thank you, Mr. Keyserling, for your statement. May I ask if it is a function of the Council of Economic Advisers to offer current advice on economic developments to the President? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. Do you understand it to be a function of the Council of Economic Advisers also to offer current advice to the Congress? Mr. KEYSERLING. Yes, sir. I would like, if there is any question about that, to state briefly why I think so. Senator DOUGLAS. No; that is not necessary at all. Now did you watch the situation currently from the 1st of July 1950, until the 1st of March 1951? Mr. KEYSERLING. I have tried to. Senator DOUGLAS. You kept in touch with current figures? Senator DOUGLAS. Month by month, week by week, and in some cases day by day. And therefore you were continuously apprised of what was happening. Were you aware that the Federal Reserve Board through its open market committee was purchasing large quantities of Government securities during this period? Mr. KEYSERLING. I would be inclined to think that one would be aware of that, and I was aware of it. Senator DOUGLAS. Were you? Mr. KEYSERLING. Yes. Senator DOUGLAS. You were aware of it? Mr. KEYSERLING. Yes. Senator DOUGLAS. Were you aware of the fact that during these 8 months the Federal Reserve, depending on the precise termination date, purchased from $312 to $4 billion of Government securities? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. Were you aware of the fact that bank reserves in the Federal Reserve System were rising during this period? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. Rising by not quite as much as the purchases of bonds, but by substantially as much. Did you think there was a connection between the purchase of Government bonds by the Federal Reserve System and the rise in bank reserves? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. An immediate and direct connection? Mr. KEYSERLING. That is a question of degree, but I would be willing to answer it by saying there is a substantial and important connection. Senator DOUGLAS. And a direct connection? Mr. KEYSERLING. And direct connection. Senator DOUGLAS. The Federal Reserve Board testified yesterday that the purchase of Government bonds is paid for by checks which, moving through the banking system, are deposited in the Federal Reserve System and automatically become reserves of the member banks. Mr. KEYSERLING. I agree with that. Senator DOUGLAS. Did you notice that bank loans were increasing? Mr. KEYSERLING. Yes; bank loans were increasing. Senator DOUGLAS. Bank loans increased during the period of 8 months by ten billions of dollars, or an increase of approximately 18 percent. Did you notice that? Mr. KEYSERLING. Yes, sir. Senator DOUGLAS. Did you think there was a connection between the increase in bank loans and the increase in bank reserves? Mr. KEYSERLING. By no means the probable direct and substantial connection that there was with respect to the earlier parts of what you recited, Senator. Senator DoUGLAS. Is it not true that an increase in bank reserves makes possible an increase in bank loans due to the fractional reserve system? Mr. KEYSERLING. I think I would approach it from the other end and look at the volume of investment that took place. Senator DOUGLAS. I am not speaking of investment banking. I am not speaking of savings. I am speaking of bank loans, that is, of created credit. Of course, the fundamental distinction in banking is between the investment of savings through the investment machinery and the creation of bank credit in the commercial banking system. Mr. KEYSERLING. Senator, let me begin by saying as a coloration to my whole discussion, that at points where we differ, either of us may be right, and let's proceed from there. Now let me answer your last question, if I may. I have used the word "investment" in a somewhat different sense from what you have used it. I have used the word "investment" to express the use of funds to command materials, money, and human effort in the production of facilities, plant equipment, and housing, and other things of that kind, and I think that the point at which money exercises an inflationary impact upon the economy is when it begins to command. goods and services. In other words, you and I can exchange loans ad infinitum, and more and more loans, so long as we do not do anything with them. Senator DOUGLAS. What do you understand the difference between commercial banking and investment banking to be? Mr. KEYSERLING. May I answer the other question and then come back to that? I want to carry through with the idea. Senator DOUGLAS. There seems to me to be a connection between the increase in bank reserves in the Federal Reserve System and the increase in bank loans. I am referring to the Federal Reserve Bulletin for May 1951, on page 527. In the second column it is marked "Loans." whereas the third, fourth, and fifth columns are "Investments," so I am not speaking about loans and investments. I am speaking of loans. Mr. KEYSERLING. Senator, I am not at all sure there will be any disagreement if I can carry through on the one idea I am trying to express here. Senator DOUGLAS. Did you see any connection between the increase in bank reserves in the Federal Reserve System and the increase in short-term bank loans? Mr. KEYSERLING. I was trying to discuss, Senator, how much connection I saw. A question like that cannot be answered "yes" or "no." There is some connection between any two coincident events of a large character in the economy. What I am trying to say is that in looking at the question of investment Senator DOUGLAS. I am not speaking of investment. I am speaking of loans, commercial loans. Mr. KEYSERLING. But the loans have no effect upon the economy until they are translated into some kind of overt economic action. Senator DOUGLAS. Let me ask you this: Is it not true that in the case of commercial loans what happens is that the loan is made first. and it is made in the form of a credit which is set up to the account of the borrowers so that the loan creates the deposit, whereas in investment banking the savings are made out of the current incomes of individuals and corporations and are then deposited in financial institutions, which then act as middlemen to distribute these sums to the places where the investments are made? In the case of the investments, therefore, the saving creates the deposit, the deposit creates the loan or investment, whereas in the case. of commercial banking the credit is created by the bank when the amount of the loan is deposited to the account of the borrower and the borrower draws upon. In the case of commercial banking, therefore, the creation of this new credit constitutes an addition to the total money supply, whereas in the case of the investment banking what we have is a diversion of existing income for the purposes of investment and saving rather than for consumption. Now, isn't that distinction a valid distinction? Mr. KEYSERLING. Yes, sir, it is a valid distinction, but I think the distinction I am making is also a valid distinction, and let me carry it through to indicate its significance to this general point. The general point I am making is that you can start at either end of this road and the end I start at is this: That ultimately the impact on an economy occurs when manpower, materials, and economic activity are generated to command resources. In other words, if you and I lend loans Senator DOUGLAS. We did not have much unemployment in 1950. So that there was not much possibility of putting idle people to work on idle resources. Mr. KEYSERLING. I did not say that. Let me carry this forward. You and I, Senator, to simplify this thing, possibly oversimplify it, can lend money back and forth to each other, or a bank and individual or two kinds of banks can lend money back and forth to each other, and the volume of loans increases by that. It is only at the point where the loan is used for a dynamic economic function that it exercises a strain on the economy. Now, the point I am making is that, looking at the volume of investment, using investment in the broad sense of how our business system was commanding resources of manpower and materials and plant and equipment, which is what exerts the inflationary strain, during the period that you refer to and here I come to the part of it that is directly relevent to your question-I do not see as clearly as you do that the variation in bank reserves or the variations in the factors that you mentioned were the controlling or even the major factors in the actual level of capital formation which took place. I think that, under the conditions obtaining between the middle of 1950 and early 1951, the amplitude of business resources was such of all kinds, depreciation reserves, accrued profits, capacity to borrow that they would have maintained under any set of circumstances except changes so drastic in the economy that they would have knocked it for a loop, and I think the level of business outlays between 1950 and 1951 was conditioned primarily by availability of manpower, by the prospect of big markets, particularly in view of a new and growing defense program, by the general capital position of these businesses resulting from many accrued years of prosperity with unusually high profits even after taxes. In other words, the part at which I must respectfully depart from you, Senator, is the extent to which you ascribe functionings in the economy to a particular limited set of events. Now, I am perfectly willing to admit that that played some part, but I happen to think that that particular development played a relatively very small part in the level of business investment Senator DOUGLAS. Wait a minute; I am speaking of loans-let that be understood commercial loans. Do you think that the increase in the reserves played a very small part in the increase in loans, the increase in reserves being around $312 billion, the increase in loans during the same period was around $10 billion. Do you say that the increase in reserves played a very small part in the increase in loans? Mr. KEYSERLING. I think that is true within any variant that any responsible public official would have wanted to apply if he had had absolute power to contract that volume of loans. Now, I am perfectly willing to admit Senator DOUGLAS. Did not the increase in reserves make possible an increase in loans? Mr. KEYSERLING. It made possible an increase in loans, but Senator DOUGLAS. And is it not true that on the whole each added dollar of reserves makes possible increased loans of $6? Mr. KEYSERLING. I think you could get different computations as to whether it is $6 or $5, but broadly speaking there is a connection. Senator DOUGLAS. Required reserves of the class C banks were 14 percent, of the class B banks 20 percent, of the class A banks 24 percent. They were up virtually to their maximum. Class A could have gone up to 26, but it was 24. The general average is approximately 16 percent, a little over 16, so that you have a potential multiplier-and I want to put that word "potential" in a potential multiplier of 6; isn't that true? Mr. KEYSERLING. Yes, but I think Senator DOUGLAS. If that is true, an increase of $3 billion in reserve would have made possible an increase of about $18 billion in loans. Now, a $10 billion increase did occur. Is it your contention there was little connection between the increase in reserves and the increase in loans? Mr. KEYSERLING. It is my contention that if the Federal Reserve Board had been following at that time the policy which I think this is the easiest way I can describe it: If the Federal Reserve Board had been following at that time the policy which they are following now as described by them before this committee and reflecting the "accord," if that policy had then been in effect rather than the policy which was then in effect, it is my contention that the ultimate level of business investment, of capital formation, of economie activity in that sector of the economy, would during that period have been, under all the conditions playing upon it, approximately the same. Now, that is all I am trying to say, and I think that is important. Senator DOUGLAS. I appreciate your reply, which I think is somewhat elliptical to the question which I asked. My question is: Was there any connection or appreciable connection between the increase in reserves of banks in the Federal Reserve System and the expansion of commercial loans which they made to private business? Mr. KEYSERLING. Why, Senator, on the line of questioning which asks if there is any connection, I am perfectly willing to agree that there is a connection. Senator DOUGLAS. Do you think there is an appreciable connection? Mr. KEYSERLING. You move from "any" to "appreciable" to "great" to "prevalent.” Senator DOUGLAS. One step at a time. Mr. KEYSERLING. Yes, but that one step at a time involves some leaps. |