CHAPTER V

WHO DETERMINES THE MONEY SUPPLY?

93. Who appoints members of the Federal Open Market Committee?
Seven of the nineteen members of the “discussion” Committee are appointed by the President of the United States and confirmed by the Senate of the United States. Their term is 14 years. The other 12 participants at Open Market Committee meetings are elected through votes of private commercial bankers; specifically they are the presidents of the 12 Federal Reserve banks, elected to their posts indirectly by bankers from banks which are members of the Federal Reserve System.

94. What are the most important Open Market Committee powers?
The Open Market Committee has the power to determine the Nation’s Supply of money and credit, and therefore, the general level of interest rates, among other things.

96. Why is the Federal Open Market Committee one of the most powerful groups of men in our country?
Because in many ways their power is equal to that of the President in deciding how the world’s greatest economic mechanism will operate. By regulating the supply of money, the Committee can control the general level of interest rates. This in turn is one of the major determinants of the level of business activity in the country. The Committee, then, has the power to offset any action taken by anyone to stimulate or restrain the country. This indeed is power.

97. Are current open market operations what the founders of the Federal Reserve System intended?
No. It was expected that in monetizing “eligible” short term commercial paper, the Federal Reserve would provide sufficient liquidity to sound banks in periods of need (or restrain excessive credit expansion). While the Federal Reserve was expected to exert supervisory powers, it was expected that the money supply and interest rates, would be fully responsive to business conditions. Thus the discount rate, rather than open market operations was regarded as the Federal Reserve’s most important tool.

98. Why was the discount rate regarded as an important regulatory tool?
Because under the original Federal Reserve arrangement, no specific limits were placed on the amount of money the system could create. After all, if the banks had eligible paper to rediscount, then the regional bank would automatically create reserves. This raised the possibility of infinite money creation provided the banks’ lending rates and the system’s charges were in a fixed favorable relation. But if the system could control the discount rate, it could discourage rediscounting or borrowing from it simply by raising its discount rate high enough. At a high enough rate, the commercial banks would find no businessmen willing to borrow. Thus the supply of eligible paper available to the commercial banks would dry up and, in turn, the commercial banks would be unable to acquire more reserves by discounting. The automatic system than had a regulator; namely, the discount rate.

99. Is eligible paper discounted much today?
Very rarely.

100. Why have open market operations replaced discounting as the most important means of regulating the money supply?
Basically, because the Federal Reserve found open market operations a more sensitive tool to control the money supply. And through the years the Federal Reserve has decided that its responsibilities were not consistent with the authorization of an automatic money supply.

101. Precisely what does the Federal Open Market Committee do?
It determines the amount of government securities the Federal Reserve will buy and sell, in order to influence the level of bank reserves. In essence, the Committee determines U.S. monetary policy.

102. What functions have been left to the regional banks?
Now that discounting eligible paper is rarely used, the regional Federal Reserve banks clear checks and gather statistics and other economic data.

103. Have the intentions of the founders of the Federal Reserve System been altered by the turn to open market operations?
Yes, when the System was originally founded a struggle was waged over who would control the Federal Reserve—public or private interest. The solution was a compromise. But what (in 1913) was the master switch governing the money Supply—the discount rate—was left in the hands of a totally public body—the Federal Reserve Board in Washington. This was a deliberate act. President Wilson rejected the notion of diluting the public nature of the Board when he said, “Which one of you gentleman would have me select the presidents of railroads to be on the Interstate Commerce Commission to fix passenger rates and freight rates?” But when Congress in 1933 and 1935 authorized the Open Market Committee, which in effect succeeded to the policymaking role of the Board, it gave private interests a firm foothold in determining monetary policy—the money supply and the general level of interest rates. Five of the twelve voting members of the Open Market Committee are regional bank presidents. These men hold their offices through the votes of bank directors, two-thirds of whom are elected by private bankers. The other seven bank presidents, of course, participate in the discussions of the Open Market Committee. The upshot is that men whose views must meet the test of the private bank-selected directors help determine the Government’s monetary policy. A purely public group has given way to a mixed body with questionable qualifications to represent the public interest.

104. Who should be members of the Committee?
All members of the Committee should be public servants. There is absolutely no reason why they should not be. Private influences—especially private bank influences—have no place in setting the Nation’s monetary policies.

105. What is the Open Market Account?
It is the unit of the Federal Reserve Bank of New York that carries out sales of bonds and bills for the Treasury. The manager of this account acts as agent for the Treasury, the Federal Open Market Committee and seven foreign banks.

106. How does the open market work?
The actual operations are as follows: the Treasury determines each week how much money it will need during the week following and notifies the manager of the Open Market Account. All interested parties, including the 20 dealers are notified and bids are made on Monday. On the following Tuesday, the Treasury announces to whom the securities have been sold.

107. How much business does the Open Market do?
The annual volume of dealings in Government securities in New York amounts to over $400 billion. Of this the Open Market Committee of the Federal Reserve accounts for roughly $20 billion.