VOLUME 75 • NUMBER 4 • APRIL 1989 FEDERAL RESERVE BULLETIN BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, WASHINGTON, D.C. PUBLICATIONS COMMITTEE Joseph R. Coyne, Chairman • S. David Frost D Griffith L. Garwood • Donald L. Kohn O J. Virgil Mattingly, Jr. • Michael J. Prell • Edwin M. Truman The FEDERAL RESERVE BULLETIN is issued monthly under the direction of the staff publications committee. This committee is responsible for opinions expressed except in official statements and signed articles. It is assisted by the Economic Editing Section headed by Mendelle T. Berenson, the Graphic Communications Section under the direction of Peter G. Thomas, and Publications Services supervised by Linda C. Kyles. Table of Contents 227 THE ESTABLISHMENT AND equilibrium price level provide a good fore- EVOLUTION OF THE cast of changes in the inflation rate over FEDERAL RESERVE BOARD: 1913-23 periods of one year or more. In the first decade after the passage of the Federal Reserve Act, the Board evolved 265 INDUSTRIAL PRODUCTION under the pressure of circumstances in Industrial production increased an esti- ways not foreseen by the framers of the act. mated 0.3 percent in January. 244 UNDERSTANDING THE BEHAVIOR 267 STATEMENTS TO CONGRESS OF M2 AND V2 Alan Greenspan, Chairman, Board of Gov- This article examines the properties of the ernors, discusses corporate restructuring M2 aggregate and of its velocity, V2, the and the need for reducing the federal budget ratio of gross national product to M2— deficit, and says that it would be unwise to particularly over the one- to two-year inter- restrict arbitrarily corporate restructuring vals that are associated with monetary tar- and that the budget deficit must be brought geting and over which V2 has fluctuated by down, before the House Committee on substantial amounts. Ways and Means, February 2, 1989. 272 Chairman Greenspan discusses recent mon- 255 TRANSFER RISK IN U.S. BANKS etary policy and plans for the future within The expansion of international lending has the framework of the Board's Monetary made an analysis of country risk an essen- Policy Report to the Congress, before the tial element in the overall evaluation of the Senate Committee on Banking, Housing, financial condition of the largest U.S. and Urban Affairs, February 21, 1989. banks. [Chairman Greenspan presented identical testimony before the House Committee on 259 TREASURY AND FEDERAL RESERVE Banking, Finance and Urban Affairs, Feb- FOREIGN EXCHANGE OPERATIONS ruary 22, 1989.] The dollar, which had moved lower in No- 278 Chairman Greenspan outlines the views of vember, found support at the end of No- the Board on the legislation for the reform vember and recovered through most of De- and recovery of the thrift industry and says cember and January to return to levels that that the Board supports this comprehensive had prevailed in the autumn. package of proposals to strengthen the thrift industry and depository institutions in gen- 263 STAFF STUDIES eral, before the Senate Committee on Bank- ing, Housing, and Urban Affairs, February In "M2 per Unit of Potential GNP as an 23, 1989. Anchor for the Price Level," the authors develop a measure for a long-run equilib- 282 Chairman Greenspan reviews briefly where rium price level that is proportional to the the economy has been over the past year stock of M2 per unit of potential GNP. and where it appears to be going to bring Deviations of the actual price level from the into focus the challenges that face monetary and fiscal policymakers, before the Senate monetary aggregates, and developments in Committee on the Budget, February 28, foreign exchange and domestic financial 1989. [Chairman Greenspan presented iden- markets. Depending on such developments, tical testimony before the House Commit- some added reserve restraint would be ac- tee on the Budget, March 2, 1989.] ceptable, or some slight lessening of reserve pressure might be acceptable. The reserve 287 ANNOUNCEMENTS conditions contemplated at this meeting were expected to be consistent with growth Change in the discount rate. of M2 and M3 at annual rates of around 3 Expression of support for the reform and percent and 6'/2 percent respectively over recovery program for the thrift industry the four-month period from November 1988 announced by President Bush. to March 1989. The intermeeting range for the federal funds rate was raised by 1 per- Amendment to Regulation H (Membership centage point to 7 to 11 percent. of State Banking Institutions in the Federal Reserve System). 297 LEGAL DEVELOPMENTS Interpretation to Regulation H. Various bank holding company, bank ser- Comment requested on a series of revised vice corporation, and bank merger orders; proposals regarding the finality accorded and pending cases. ACH credit and debit transactions pro- cessed by Federal Reserve Banks. Al FINANCIAL AND BUSINESS STATISTICS Changes in Board staff. These tables reflect data available as Availability of some Federal Reserve statis- of February 24, 1989. tical releases through the computerized bul- A3 Domestic Financial Statistics letin board of the Department of Commerce. A46 Domestic Nonfinancial Statistics Change in the database used in compiling A55 International Statistics the statistical appendix to the BULLETIN. A7i GUIDE TO TABULAR PRESENTATION, 290 RECORD OF POLICY ACTIONS OF THE STATISTICAL RELEASES, AND SPECIAL FEDERAL OPEN MARKET COMMITTEE TABLES At its meeting on December 13-14, 1988, A76 BOARD OF GOVERNORS AND STAFF the Committee approved a directive that called for some immediate firming of re- A78 FEDERAL OPEN MARKET COMMITTEE serve conditions, with some further tighten- AND STAFF; ADVISORY COUNCILS ing to be implemented at the start of 1989, assuming that economic and financial con- A80 FEDERAL RESERVE BOARD ditions remained reasonably consistent with PUBLICATIONS current expectations. In keeping with the Committee's usual approach to policy, the A83 INDEX TO STATISTICAL TABLES conduct of open market operations would be subject to further adjustment during the A85 FEDERAL RESERVE BANKS, intermeeting period based on indications of BRANCHES, AND OFFICES inflationary pressures, the strength of the business expansion, the behavior of the A86 MAP OF FEDERAL RESERVE SYSTEM The Establishment and Evolution of the Federal Reserve Board: 1913-23 Sayre Ellen Dykes, of the Division of Research plan forged by President Wilson, Congressman and Statistics at the Board of Governors, and Carter Glass, and Senator Robert Owen, which Michael A. Whitehouse, of the Board's Office of became the Federal Reserve Act—an act "to the Secretary, prepared this article. furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a When, on December 23, 1913, Woodrow Wilson more effective supervision of banking in the signed the act establishing the Federal Reserve United States, and for other purposes." System, he felt grateful, he said, for having had a While the process of investigation, discussion, part in "completing a work . of lasting benefit and compromise leading to the act had ended to the business of the country." The nation had with President Wilson's signature, another long been without an organization performing central process was beginning: that of organizing and banking functions since the charter of the Second establishing in practice the central banking sys- Bank of the United States had expired in 1836. tem of the United States and of developing new Financial stresses caused by the Civil War and a policies and tools to meet the changing needs and series of devastating liquidity crises and bank circumstances of the economy. At the time of the failures, especially the Panic of 1907, had fo- signing, Paul Warburg, one of the members of the cused public awareness on the need for banking first Board, said prophetically that "the Federal and monetary reform. The Congress passed the Reserve Act as passed should not be considered Aldrich-Vreeland Act of 1908, which provided as a finality, and . actual experience in its for the issuance of currency in an emergency. operation would prove the need of important The act also created the bipartisan National modifications or amplifications."1 Monetary Commission, headed by Senator Nel- The process of modifying and amplifying the son Aldrich, to study banking and currency re- act over the next 10 years was far from smooth. form and to develop some recommendations. H. Parker Willis, the first Secretary of the Board, After making a detailed study of banking in in a rhetorical flourish implied that it could even Europe and North America, the commission in be considered a war: "[The struggle that pro- 1912 published its findings in 38 massive vol- duced the Federal Reserve Act] is not merely a umes. Aldrich formalized the commission's rec- chapter in financial history; it is also an account ommendations in a bill, generally known as the of the first battle in a campaign for safe and Aldrich Plan, calling for one central bank and 15 scientific banking that has only just opened."2 branches. Willis's metaphor was apt. During its first dec- Although members of the Congress agreed on ade, the System struggled to gain acceptance the need for reform and on its general goals, they while facing the stresses caused by World War I differed strongly on its shape. The Aldrich Plan and its aftermath. stirred up a deep-seated distrust of the central- ization of power and of the banking establish- ment. Alternative plans, which attempted dif- ferent balances between public and