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The Discount Mechanism in Leading Industrial Countries Since World War Ii

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The Discount Mechanism in Leading Industrial Countries Since World War Ii FUNDAMENTAL REAPPRAISAL OF THE DISCOUNT MECHANISM THE DISCOUNT MECHANISM IN LEADING INDUSTRIAL COUNTRIES SINCE WORLD WAR II GEORGE GARVY Prepared for the Steering Committee for the Fundamental Reappraisal of the Discount Mechanism Appointed by the Board of Governors of the Federal Reserve System Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The following paper is one of a series prepared by the research staffs of the Board of Governors of the Federal Reserve System and of the Federal Reserve Banks and by academic economists in connection with the Fundamental Reappraisal of the Discount Mechanism. The analyses and conclusions set forth are those of the author and do not necessarily indicate concurrence by other members of the research staffs, by the Board of Governors, or by the Federal Reserve Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis THE DISCOUNT MECHANISM IN LEADING COUNTRIES SINCE WORLD WAR II George Garvy Federal Reserve Bank of New York Contents Pages Foreword 1 Part I The Discount mechanism as a tool of monetary control. Introduction 2 Provision of central bank credit at the initiative of the banks • . , 4 Discounts 9 Advances . , 12 Widening of the range of objectives and tools of monetary policy 15 General contrasts with the United States 21 Rate policy 33 Quantitative controls 39 Selective controls through the discount window 48 Indirect access to the discount window . 50 Uniformity of administration 53 Concluding remarks 54 Part II The discount mechanism in individual countries. Introduction 58 Austria . f 59 Belgium 71 Canada 85 France 98 Federal Republic of Germany 125 Italy 138 Japan 152 Netherlands l66 Sweden 180 Switzerland 190 United Kingdom 201 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis THE DISCOUNT MECHANISM IN LEADING COUNTRIES SINCE WORLD WAR H Foreword* The original objective of this study was to acquaint the Steering Committee with discount policies and techniques used by the central banks of the most important advanced industrial countries, in particular since World War II. Given this objective, there was a need for pulling together from the individual country studies which constitute Part II, and for organizing along comprehensive lines, endeavors to modify and refine the traditional discount mechanism. Since interest was focused on the role of discounting as a tool of monetary policy in relation to other tools, and on techniques rather than results, no attempt was made to appraise the efficiency of discount policy in each country. More- over, such an endeavor would have required review and evaluation of a wide range of factors which far exceed the resources and time available for this study. Given the considerable differences in the framework in which the discount mechanism operates here and in the countries covered, the first part of the study attempts to bring out at legist the main differences in institutional and policy environments that must be kept in mind when analyzing the potential of the discount mechanism in the U.S. against the background of foreign experience. In view of the general objective of this study, the review is not limited to policies and techniques in use * The author has benefited from comments and suggestions by Ralph A. Young ar}d Robert F. Gemmill, members of the Secretariat, who had special responsibilities for this Project. Robert C. Holland made substantial contributions to the analysis embodied in several chapters of Part II. The initial drafts of the country studies which constitute Part II were written by Ruth Lpgue of the Board's staff (France, Netherlands, and Switzerland), and Dorothy B. Christelow.(Belgium and Sweden), Rachel Floersheim (Austria and Federal Republic of Germany), Leon Korobow (United Kingdom), Isaac Menashe (Canada and Italy), and Joachim 0. Ronall (Japan), of the Federal Reserve Bank of New York. Mr. Stephen V.Q. Clarke of the New York Bank also participated in preparing Part II, I am also indebted to officials of the central banks of the individual countries whose discount mechanisms are described in Part II for their invaluable assistance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis now, since in some cases discarded or radically modified arrangements represent interesting variants, and the reasons for dropping or changing the original techniques cast light on the problems encountered, PART I. THE DISCOUNT MECHANISM AS A TOOL OF MONETARY POLICY INTRODUCTION Generalizations concerning the role played since World War II by the discount mechanism in the monetary policy of eleven leading indus- trial countries surveyed in this study-*- are difficult to make. In each case, discount policy has been shaped by the specific characteristics of the country, its financial structure, the evolution of its economic philosophy, and its actual postwar experience. Generalizations must be distilled largely by rationalizing the reasons for observed differences in policies and their evolution over time. The specific role played by the discount mechanism has depended in each given case on the policy objectives of the central bank;s, and in particular on the way in which these banks have supported government economic policies other than those designed to defend the internal and external value of the domestic cur- rency and to insulate it, to the extent possible, from disruptive in- fluences from abroad. Concern with the widening and proper functioning of capital markets, including assisting in the financing of the public sector, has grown in importance since the end of World War II, along with an older concern with stirjiulation of exports. 1. Austria, Belgium, Canada, France, the Federal Republic of Germany (West Germany), Italy, Japan, Netherlands, Sweden, Switzerland, and United 11 Kingdom. In this Reportt completed in 1967 "foreign central banks or "other banks" always refers to these eleven countries. Parenthetical references in Part I are not intended to be exhaustive, but merely to refer the reader to one or two specific examples that can be found in the country chapters in Part II. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 3 The way in which discounting is used in each country at a given time generally depends less on theoretical considerations and prefer- ences, than on policy objectives, institutional realities, possibilities, and constraints. In particular, it depends on the variability of foreign exchange surpluses or deficits, availability of alternative control mechanisms (such as cash reserve requirements, liquidity ratios, and open market operations); the ability of banks to make short-run adjust- ments through their investment portfolios, and the smoothness with which excess reserves are distributed through the interbank market• The choice of instruments to implement policy goals normally depends on the trade- offs in terms of positive and negative side effects, and most importantly, the degree of precision that may be expected from relying on any one of them, singly or in combination, to achieve the desired effect. Moreover, in each of the countries surveyed, the role currently played by the dis- count mechanism reflects not only the policies of t]ie central bank with regard to the means it chooses (or has at its disposal) to influence the cash position of banks, but also the willingness of banks to make full use of the discount facilities available. Against the background of foreign experience our discount mechanism, no less than our entire monetary and banking system, appears as a unique case rather than merely a variant among many quite similar systems. 1. The authority for monetary controls is in some countries quite diffused. Different agencies may have the authority to set the discount rate, liquid assets ratios or credit and reserve ceilings and to deter- mine eligibility requirements (or give final approval to such actions). Their actions are not always perfectly coordinated, even when elaborate coordinating agencies or arrangements exist. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 PROVISION OF CENTRAL BAM CREDIT AT THE INITIATIVE. OF THE BANKS Discounting is the oldest instrument of central bank policy. For a long period it was practically the only such instrument; together with advances, it is still the most important avenue for changing the reserve base at the initiative of commercial banks. The flexibility inherent in discounting has preserved its usefulness even where the range of tools available to the central bank has been expanded considerably. Our re- view of foreign experience encompasses both discounts and advances, even though in none of the countries surveyed are the two methods of obtaining reserves strictly equivalent in terms of cost, as in the United States. Basically, central bank policy becomes effective by affecting the liquidity of commercial banks, through it the liquidity of the entire economy and, in the last analysis, the level of real activity and the country1s international payments position. Changes in bank liquidity are normally reflected in market rates, which are usually closely related to the volume of borrowing from the central bank, and in the volume of money and credit. Central bank policy may aim primarily to influence either market rates or the volume of money and credit. The choice between basic approaches to monetary controls depends in each country on specific con- ditions, including institutional arrangements and linkage processes, as well as on prevailing monetary views. Foreign experience provides il- lustrations for both basic approaches and a number of variants. An example of the first basic approach is found in countries where the authorities aim at a level of short-term rates consistent with domestic and external objectives. The discount rate is then used as an anchor for the entire structure of interest rates. It is left to the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St.
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