requirements. The policy of the Reserve Board was to equalize the reserves of the several Federal reserve banks and to avoid "undue variations in their reserve position. This policy was adhered to in the post-war year 1919 when inter-Reserve bank rediscounting was almost continuous.

Congress was prompt to enact legislation necessary to make the Federal reserve system responsive to the abnormal conditions incident to the war. Section 13 was amended by the War Finance Corporation Act, approved April 5, 1918, to authorize the Federal reserve banks to discount direct obligations of member banks secured by bonds of the War Finance Corporation and to use notes so secured, if it should become necessary, as a basis for Federal reserve notes. An act was passed September 24, 1918, amending section 5200, Revised Statutes, by which loans of national banks secured by Liberty bonds were exempted under certain conditions from the loan limit of 10 per cent to any one borrower, thus greatly facilitating the sale of Liberty bonds.

The signing of the Armistice in November, 1918, did not terminate the period of war financing. The Victory Loan of April, 1919, and the issue of certificates of indebtedness for more than a year thereafter continued to engage the attention and the resources of the Federal reserve banks. As noted above, war paper holdings of these banks in May, 1919, when the Victory Loan was floated, constituted over 91 per cent of their total discounts. In their annual report for 1919 the Federal Reserve Board said (p. 2): “In order that the member banks might carry the burden of undigested Government securities they were obliged to rediscount with the Federal reserve banks, and in order that such rediscounting should not involve them in heavy loss it was essential that as long as the banks were lending to bond subscribers at coupon rates the rediscount rate should be related to the bond rate. The rediscount rates of Federal reserve banks, therefore, instead of being higher than the market rates, as in theory and in normal practice they should have been, were made

lower than the market rates. This circumstance is enough to prevent a normal functioning of a Federal reserve bank, whose rates should be so fixed that resort thereto is unprofitable to the borrowing institution and thus has a tendency to check expansion."

The Federal Reserve Board and the Reserve banks were reluctant to raise discount rates above the rates carried by Government obligations until the banks had been given a reasonable time in which to dispose of their Government holdings. Of the total amount of bills held by the Federal reserve banks under discount and rediscount for the reporting banks at the end of the year 1919, over $1,236,000,000, or about two-thirds, was secured by war paper, and $596,000,000, or about one-third, by commercial paper. It was recognized, therefore, that as Treasury needs became a less determining factor in the money market, and that as the demand for credit based upon rediscounts secured by bonds and certificates was increasing rather than diminishing, "raising prices to a point that takes no account of prudence," pressure would have to be applied through discount rates to bring about absorption by investors of the huge mass of "undigested securities." At the close of the year rates on paper secured by Government obligations of every kind had been advanced to the ruling rate, 434 per cent, for commercial paper.

In its annual report for 1919 (p. 67) the Federal Reserve Board, commenting upon its discount policy and credit control, said: "The experience of the past three years has demonstrated the expansive power of the Federal reserve system. It should be understood, however, that an elastic system of reserve credit and note issue implies capacity to control and the ability to curtail credit. The ability of the system to check expansion under present circumstances and to induce healthy liquidation is now to be tested; . . . the time has come for the system in the interests of commerce and business to exercise its power to regulate and control the credit situation. The Reserve Board recognized that in the abnormal and highly in

flated credit situation which prevailed during the post-war readjustment period, the normal and traditional method. of controlling credit through the discount rate was ineffective. The United States stood alone as an important free gold market. Vast credits had been extended to Europe, evidenced by the fact that our exports in 1919 exceeded imports by about four billion dollars, and we paid our adverse balances in gold. These credits created a demand for commodities that competed with the domestic demand and entered largely into the prevailing high level of prices. Furthermore, the world demand for goods so far exceeded the supply that the increased cost of credit through higher discount rates was absorbed in the price, while "speculation anticipating large profits is not checked by any reasonable advance in rates of interest. . . . Nevertheless, the discount rate is an indispensable factor in the regulation and control of credit. When there are legal limitations on the rates member banks may charge, a high reserve bank rate has a restraining influence upon them and upon their customers.

In furtherance of this policy of checking the expansion of credit set in motion by the war, the Reserve banks continued to advance their discount rates until they stood in June, 1920, at the levels shown in the table below.

Meantime member banks were urged to curtail unnecessary credits and to assist in the process of deflation by limiting loans to essential borrowing and business. In their efforts to control credit and excessive borrowing through the discount rate the Federal reserve banks were subject to serious administrative difficulties. That part

of Section 4 relating to the duties of the board of directors of a Federal reserve bank specifies: "Said Board shall administer the affairs of said bank fairly and impartially and without discrimination in favor of or against any member bank or banks and shall, subject to the provisions of law and the orders of the Federal Reserve Board, extend to each member bank such discounts, advancements

*534% on paper secured by 54 % certificates, and 5% on paper secured by 44% and 5% certificates.

and accommodations as may be safely and reasonably made with due regard for the claims of other member banks." This provision while prohibiting favoritism permitted the Reserve banks to limit the borrowings of any particular bank to a figure which would not prejudice the rediscount facilities available for other banks in the district. There was no authority in the Act, however, for establishing graduated rates based upon the total borrowings of a member bank; consequently when it became necessary to advance the discount rate to curb the demands of some banks rediscounting heavily at the Federal reserve bank, the same rate would necessarily apply to the moderate requirements of other banks whose demands were infrequent and reasonable. The application of rate advances as a corrective or deterrent to certain banks raised the rate to all.

In this situation the Federal Reserve Board recommended and Congress passed, April 13, 1920, the Phelan bill as an amendment to Section 14 authorizing each Federal reserve bank to establish a normal discount or credit line for each member bank and to impose graduated or progressive rates on discounts in excess of this normal line. By this device it was anticipated that excessive borrowings by member banks would be reduced and that their large borrowers would be held in check without raising the basic rate. Soon after the passage of the amendment several of the Federal reserve banks in the West established progressive discount rates on accommodations extended to member banks. The method of applying these rates may be illustrated by that adopted by the Federal Reserve Board of St. Louis. The "basic" line for a member bank was determined by multiplying 65 per cent of its required reserve plus the amount of its investment in the capital stock of the Reserve bank by two and one-half. Accommodations to member banks up to this basic amount took the normal discount rate current at the time. On borrowings above this basic amount, progressive rates applied as follows: for the first 25 per cent, 12 of 1 per