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form, which culminated in the federal reserve act, the advocates of a single central bank contended that a system of eight to twelve banks like that proposed in the federal reserve bill would perpetuate the old evil by leading to the same sort of scramble for reserves, in time of emergency, among the different federal reserve banks, that had formerly existed among the individual banks of the country. Specifically to meet this danger a provision was inserted in the act (Section II) empowering the federal reserve board “to permit, or, on the affirmative note of at least five members of the reserve board to require federal reserve banks to rediscount the discounted paper of other federal reserve banks at rates of interest to be fixed by the federal reserve board.” This means that in case there is an exceptionally heavy demand for reserve money in any section of the country—a demand heavier than the banks of that section can reasonably meet—the reserve banks in other sections where money is more plentiful will come to the rescue, either voluntarily or under compulsion of the federal reserve board, and will rediscount the paper of the reserve bank in the section under financial stress. This process, of course, will cause a flow of cash from the reserves of the former banks to the reserve of the latter, thereby easing the money market in the threatened section.

After the United States entered the war there developed a strong tendency for a compensatory movement of reserves among the federal reserve banks. Reserves of some of the banks frequently fall rapidly while those of others are rapidly rising, often with little or no change in the reserve position of the twelve federal reserve banks as a whole. This compensatory movement is due largely to operations of the government which often result in heavy withdrawals of funds from banks in one section of the country for the making of payments in another. This situation has made it desirable from time to time that one federal reserve bank should make advances to another. At times the federal reserve board has taken the initiative in this matter, but apparently the banks, in most cases, have willingly complied with the board's request. The twelve federal reserve banks have so far worked


harmoniously, thanks largely to the frequent conferences of the governors and the federal reserve agents both among themselves and with the federal reserve board, so that it seems improbable that compulsion by the board will often be necessary to require the more favorably situated banks to come to the rescue of those less favorably situated, in time of danger. The reserves of the twelve reserve banks are so closely piped together, particularly since the formation of the gold settle

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ment fund to be described later, pages 75-78), that they may reasonably be considered to be closely connected tanks of a single large reservoir.

Open-Market Operations While the federal reserve banks are essentially bankers' banks, since their stock is owned exclusively by member banks and since their only regular domestic customers are banks and the federal government, it is none the less true that Congress found it necessary to confer upon these banks certain limited rights of dealing with the outside public. The possession of such rights by the federal reserve banks appeared necessary, first, as part of the machinery for conserving the American money market and making their discount rates effective and second, as a method of profitably employing their funds in times of easy money, when member banks are making few calls

8 If, for example, a federal reserve bank raises its discount rate in order to prevent dangerous loan expansion on the part of member banks or to prevent an undue outflow of gold from the country, it may happen that the member banks may not be convinced of the need of such precautionary measures, and, not being in need of securing funds from the federal reserve bank by way of rediscount, may ignore the efforts of the federal reserve bank to conserve the money market. The banks may accordingly continue the policy of loan expansion at low discount rates. Under such circumstances the federal reserve rate would be said to be “ineffective.” To meet this situation and force the banks “into line” the federal reserve bank may go into the open market and sell bank acceptances, commercial bills, municipal warrants and government bonds, and, by withdrawing from the market the


upon them for rediscount.' The dealings with the outside public so authorized are known as "open-market operations,” and are provided for in section 14 of the Act. Into the details of this important section we need not go. For our purposes it is sufficient to note that federal reserve banks may buy and sell in the open market either at home or abroad commercial bills of exchange, bankers' acceptances, and certain specified kinds of government obligations. Under this authority a federal reserve bank in one section of the country may buy and sell eligible commercial paper and government securities in any other section of the country. Such dealings, of course, tend to cause a flow of reserve money from the district of the buyer to that of the seller. If the San Francisco federal reserve bank, for example, buys $1,000,000 worth of trade acceptances, bank acceptances and municipal warrants in the open market in New York, its settlement check to whomever paid is likely to be deposited in a New York bank, and for that bank to be collected by funds received in payment therefor, may tighten the market, and force up the discount rate thereby bringing the market rate into harmony with the federal reserve rate.

7 In the early days of the federal reserve system when the member banks were making very little call upon the federal reserve banks for rediscounts or other advances, the federal reserve banks invested substantial sums in municipal warrants and bank acceptances in the open market, and by that means covered a large part of their running expenses.

the New York federal reserve bank from the Francisco federal reserve bank. Unless offs payments in the other direction, the paymen San Francisco will necessitate a transfer o serve money, presumably through the "gold tlement fund," from San Francisco to York. If the New York bank, in which the lion dollar check was originally deposited, le the proceeds on deposit with the New York eral reserve bank, federal reserve "res money” will be transferred from the bank in Francisco to the bank in New York. In 'manner open market operations transfer res money from places of redundancy to place scarcity, and tend to maintain a national e librium in our money rates. Creation of a Broader Discount Market for C

mercial Paper The third method by which the federal rese system is rendering more mobile our rese money is through the creation of a broader count market for commercial paper. As we h already seen, under the old banking system great bulk of American commercial paper essentially local paper with little or no mar outside of the community in which it was creat The federal reserve system has provided 8 The gold settlement fund is described on pages 75-78.

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