This system had for a long time been so unsatisfactory that when the Federal Reserve Act was framed effort was made to relieve the situation by the plan of constituting the reserve banks official depositories, requiring the Secretary of the Treasury to place his funds with them, and then constituting the reserve banks "fiscal agents" of the government. The effort of Treasury authorities resulted in making these provisions as carried in the final Act permissive instead of mandatory, and it was two years after the organization of the reserve banks before much progress had been made in giving them even full depository functions. Indeed, at the time of our entry into the European War in 1917, there was still a considerable sum of public funds on deposit in the so-called " pet banks" national banks scattered through the country - while no real effort had been made by the Treasury to adapt its method of management of public resources to the new system of banking. The opening of the war changed these conditions by compelling the Treasury to arrange for support and to make use of the reserve banks as agencies for the actual handling of the public finances. As great sums were offered in bonds and certificates of indebtedness the Treasury authorities soon found it a matter of convenience to use the reserve bank organization not only as a recipient, conservator and disburser of funds, but also as a mechanism for the issue of bonds and for their redemption and conversion. Around them gradually grew up the so-called "Liberty Loan Organization" whose duty it was to diffuse as widely as possible the current subscriptions for the successive loans, and to manage through their discount departments the whole machinery for the subscription to, and the "carrying" of, the bonds.

As the war advanced, public receipts and payments came to be made practically wholly in bank credit instead of, as formerly, in cash. Eventually Congress ordered the sub-treasuries closed (July 1, 1920) and with the suspension of these institutions a new era in the management of public funds set in.

The third period of Federal Reserve bank history has been far less uniform in its characteristics or transactions than either of its two predecessors, although in some aspects the work of the system since the close of the European War has been quite as unusual and abnormal as it had been before our entry into the struggle. After the armistice there ensued a continuous expansion or inflation of business in all countries, which in the United States worked up to a "peak" in May, 1920, and was followed by rapid decline both in prices, volume of business, production, and bank credit accommodation. The Federal Reserve System, which had been subjected to so terrible a strain during the war, had emerged from the war in a strong and reasonably liquid condition. At the close of the year 1918 it had on hand approximately $2,000,000,000 of gold, while its ratio of reserve to demand liabilities was in the neighborhood of 50 per cent. It was now to be subjected to a new strain which involved loss of gold due to changed conditions supervening after the close of the war, and tremendous expansion of demand for accommodation, partly due to the continuing rise of prices as well as to the sustained requirements of the government for heavy borrowing resulting from the fact that war necessities did not close with the end of the war but continued to make themselves felt for a good while thereafter. After the peak point of expansion had been reached in May, 1920, when the price level stood at about 270 compared with a level of 100 in 1913, a new type of service was called for. This was the service of controlling and regulating the process of credit withdrawal or reduction, and of ensuring that there should be no serious shock or disaster to business conditions, while it was in progress. Abstractly speaking, the duty of the Federal Reserve System, or of any central banking system, was that of retarding or slowing down as much as possible the progress of the business community toward the peak of activity and of prices in 1920, and in the same way, after the peak had been passed, of retarding the descent to a low point of prices and volume of business. Such a low point was reached about the middle of the year 1921 when the price level touched 140. In the effort to perform its service most satisfactorily during these years, the system naturally sought to make use of the instrument which had been found effective in foreign countries during past years of banking experience - periodic changes in the central bank discount rate. In order to understand the working of the Federal Reserve System during the post-war years and to appreciate in its true value much of the discussion and financial criticism which has centered around this phase of its activity, a brief reference to the theory of credit control through discount rates is necessary.

In classical banking practice during the latter part of the nineteenth century, it had become customary to view changes in the discount rate as an effective means of performing two services - the control of the supply of credit in the aggregate and the regulation of the amount of gold flowing into and out of the country. The use of the rate of discount in this way had been given a conspicuous and convincing demonstration in the experience of the Bank of England. That Bank habitually maintained a rate of discount slightly higher than the prevailing market rate so that those who needed accommodation were under no temptation to borrow in order to make a profit. When the Bank raised its rate it practically refused to the market further accommodation except at an increasing penalty or cost. Furthermore, as the Bank of England was the chief holder of specie in the country the exportation of such specie usually involved the necessity of borrowing at the bank in order to build up the reserves of the commercial banks which had been depleted through the withdrawal of such specie from the Bank of England, and the consequent lessening of their own balances on its books. The use of changes in the rate of discount was thus a very effective means of regulation in a country whose financial affairs and whose relations with others were as delicately balanced as those of Great Britain. Other countries sought to imitate the British method and had more or less success in so doing. One of the principal difficulties in the United States, before the organization of the Federal Reserve System, was the lack of any central bank which could be relied upon in this way to control credit and specie movements.