Conducting monetary policy without government debt: the Fed's early years

The Federal Reserve implements its monetary policy by using open market operations in U.S. government securities to target the federal funds rate. A substantial decline in the stock of U.S. Treasury debt could interfere with the conduct of monetary policy, possibly forcing the Fed to rely more heavily on discount window lending or to conduct open market transactions in other types of securities. Either would cause the implementation of monetary policy to resemble the methods used by the Fed before World War II. This paper describes two things: (i) how the Fed implemented monetary policy before the war and (ii) the conflicts that arose within the Fed over the allocation of private-sector credit when discount window loans and Fed purchases of private securities were a substantial component of Federal Reserve credit. Those conflicts help explain the Fed’s failure to respond vigorously to the Great Depression. The experience suggests that a renewed reliance on the discount window or on open market operations in securities other than those issued by the U.S. Treasury could hamper the conduct of monetary policy if it leads to increased pressure on the Fed to affect the allocation of credit.