A History of the Federal Reserve, Volume 2 (30 page)

Young then challenged the committee to choose between price stability and rapid response to cyclical and temporary fluctuations.
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A similar idea later became prominent as the Phillips curve tradeoff between inflation and output or employment. Erickson (Boston) complimented Young on his statement. Shephardson, Balderston, and Robertson wanted the committee to give more attention to long-term goals, but they did not suggest procedural changes. Most of the members confined their comments to conditions in their districts. Policy remained unchanged with an admonition to err on the side of restraint.

Pressure from the Eisenhower administration to ease policy increased. Raymond Saulnier, the new chairman of the Council of Economic Advisers, told Martin that policy was too tight (Bremner 2004, 107). Humphrey and Burgess expressed concern about problems the Treasury faced in marketing its debt. Martin called a telephone meeting of the FOMC to discuss a warning from Undersecretary Burgess that the Treasury’s current issue would fail. Dealers expected 25 percent attrition (FOMC Minutes, telephone meeting April 24, 1957, 1, 4). Rouse reported that many dealers shared Burgess’s view. They believed policy was too tight.

In the most recent week, member bank borrowing reached $1.2 billion and free reserves fell to –$700 million, about $100 million lower than planned. Interest rates on Treasury securities rose modestly during the month. An increase in float increased reserves, but usually the Federal Reserve offset the change.
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Remembering Morgenthau’s policies in the 1930s, the Treasury threatened to shift its balances from reserve banks to commercial banks to increase bank reserves.

Allen (Chicago) said the Treasury wanted a bailout by the Federal Reserve
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(FOMC Minutes, April 24, 1957, 7). Hayes wanted the instructions changed to give the manager discretion to make repurchase agreements. The committee voted to maintain restraint but assist the Treasury by giving the manager leeway to prevent further tightening.

172. In a clear warning of the risk that would become reality, Young said: “The Committee needs to consider carefully at this time whether it should not regard the objective of a stable value of the dollar as overriding the objective of adjusting flexibly and promptly to short-run cyclical changes in activity. It needs to weigh the risk that monetary policy may lose strategic opportunity to make its discipline effective” (FOMC Minutes, March 26, 1957, 15–16).

173. Some of the problems were transitory, for example a rise in float because of a Railway Express strike.

174. Carl E. Allen, Jr., was the fourth president of the Chicago bank. He served from October 1, 1956, to December 31, 1961. He was a strong proponent of price stability.

Hayes missed the committee’s next meeting. His alternate, William Trieber, discussed New York’s view of the relation of the Federal Reserve to the Treasury and the government. New York’s view was similar to Martin’s and, like Martin’s, restricted the meaning of independence. Congress set the budget and government spending. The Federal Reserve could discourage or postpone private spending, but “such a purpose is inapplicable to Government borrowing. The Government must be financed.” The Treasury determined how the Government was financed by setting the terms of its issues. The Federal Reserve had to coordinate its actions with the Treasury while maintaining responsibility for credit policy. If the Treasury priced its securities “in line with market rates . . . the System has responsibility to avoid action that may jeopardize the financing” (FOMC Minutes, May 7, 1957, 11–12).

Turning to recent problems, Trieber expressed most concern about the Treasury’s use of its cash balance to increase bank reserves.
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The Federal Reserve, for its part, must consider the Treasury’s problems. If it failed to do so, it could lose its independence.

Robertson argued that the Treasury’s use of its cash balances was “an obvious and unjustifiable attempt to interfere with Federal Reserve credit policy” (ibid., 22). The “Treasury should be obliged to compete with other borrowers for available funds and the System should avoid as much as possible making things easier for the Treasury with the result of creating a situation inconsistent with the System’s broad objectives” (ibid., 21–22).

Mills sided with Trieber. He believed that some members failed to distinguish “what was theoretically possible . . . with what was practically attainable” (ibid., 22). He thought the manager should have latitude to gauge the feel of the market and to balance the need to prevent over-expansion of credit against the Treasury’s requirements.

Chairman Martin tried to find middle ground between the conflicting views. “If the Committee ignored theory completely, it would be in trouble, and if it ignored practice, it also would be in trouble.” He agreed with Governor Vardaman on the value of studying communications problems with the Treasury, but the timing was not right. Once again the Federal Reserve looked directly at the conflict between implementing its policy and
maintaining an even keel to help the Treasury, then looked away. On this critical issue, Martin failed to exercise leadership or consider what might be done. Like others who argued for taking practical considerations into account, he had no suggestions about how or when to remove the reserves added during these periods of Treasury support.

175. “When, however, the Treasury manages its accounts for the specific purpose of increasing, or otherwise influencing, bank reserves, it is engaging directly in the act of credit management for which the Federal Reserve has primary responsibility. That we do not want” (FOMC Minutes, May 7, 1957, 12). This was reminiscent of several clashes between Chairman Eccles and Treasury Secretary Morgenthau in the 1930s. Then as in 1957, the Federal Reserve did not want the Treasury to take over its function. The Treasury wanted to reduce its borrowing cost. Trieber did not mention that open market sales could reverse the Treasury’s action.

Inflation continued to increase. The twelve-month average inflation rate reached 3.75 percent in April, the highest rate since the early months of the Korean War, before the Accord. Anticipations of continued inflation also increased and spread, as Young had warned. The Board was aware of the changed anticipations. The Federal Advisory Council told the Board that “the business community views with concern the rising price level and the increase in the cost of living. . . . [T]here is a tendency to consider only the immediate future and to grant wage increases, especially if they can be absorbed largely or entirely by higher prices” (Board Minutes, May 14, 1957, 10).

As anticipations of inflation became firm, wages, prices, and interest rates increased. The System now faced the problem that would remain. People complained about inflation, but they complained also about higher interest rates and tight money. William Mitchell, a member of the FAC, reported that businessmen would understand the reason for tight money, if it was explained. He urged the Board to undertake an educational campaign, but Martin demurred on the grounds that the System “might be accused of being in the political area” (ibid., 12).
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All but one member of the FAC believed business conditions would remain favorable or become stronger. The Board’s staff shared this view. Several FOMC members suggested increasing discount rates at the May 28 meeting, and Martin agreed that they should have increased the discount rate earlier. He was “alarmed about the picture; and ‘alarmed’ was the correct word to use” (FOMC Minutes, May 28, 1957, 33). He remained hesitant, however, because any actions would “compound the system’s and the Treasury’s difficulties” (ibid., 34). The System had to support a seasonal increase in demand for credit. The Treasury had to refund debt and maintain ownership of $55 billion in savings bonds. If rates rose, or were expected to increase, there might be a run from savings bonds.

176. Martin recognized that as anticipations of inflation firmed, it became more costly to reduce inflation. At a meeting with the FAC, “Chairman Martin inquired whether the public was growing increasingly cynical about the possibility of resisting inflation, and to this question Messrs. [William R.] Mitchell, [Robert V.] Fleming, [Homer J.] Livingston, and others indicated that such a tendency was developing. Chairman Martin went on to say that this compounded the difficulties confronting those who would resist inflation” (Board Minutes, May 14, 1957, 12). FAC President Fleming explained that with full employment and strong demand, businessmen became reluctant to resist demands for higher wages if it meant a strike.

He favored increasing the discount rate, but not right away. He thought the situation was “at a most critical juncture in the battle against inflation” (ibid., 36). On one side was a continued rise in velocity and a flight from the dollar, on the other a run on the Treasury. It was best, he concluded, to maintain current policy. Hayes responded to Martin’s statement by saying that he did not see the need for a higher discount rate. “He had not reached a conclusion that the inflationary forces were very definitely and strongly in the ascendancy” (ibid., 38). With its two leaders opposed and the others divided, the committee did not act.
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Discussion of the discount rate, inflation, and Treasury financing continued without resolution. Johns (St. Louis) believed “the System must assist the Treasury in its coming financing. I think this should be done without pique . . . not as a bailing out of the Treasury, but as a move in the public interest” (FOMC Minutes, June 18, 1957, 15). Raising the discount rate would flaunt their independence because the case was not strong. Mills, Vardaman, and Hayes agreed. The System must satisfy the government’s demand for funds in the public interest. Pressure to aid the Treasury came from Congress also. On May 31, Congressman Wright Patman sent a threatening telegram to Martin asking him to “carefully weigh the consequences—both for the Treasury and the Federal Reserve
of the continued refusal of the Open Market Committee to facilitate Treasury borrow
ings. . . . The time has come for the Open Market Committee to make a decision. Will the Federal Reserve be restored to its intended function of providing the economy with the money and credit necessary to carry on commerce and trade, and of aiding the Treasury in its borrowings . . . or shall the System insist on standing aloof ...” (telegram, Patman to Martin, Board files, May 31, 1957). Patman then urged the Federal Reserve to buy bonds until they reached par from the 12 percent discount at which some sold. This would mean a return to the pegging policy of 1942–51. The Federal Reserve’s position continued to be that independence did not remove its obligation to prevent failure of a properly priced Treasury offering. “While Federal Reserve policy may at times seek to discourage or postpone private borrowing . . . such purpose is inapplicable to government borrowing. The
government must be financed” (letter, Trieber to Vardaman, Board files, May 7, 1957). This repeated the System’s justification for even keel policy and for its occasional efforts to help the Treasury sell its bonds.

177. Although the circumstances were very different, the timing recalls the long delay in 1929 before deciding to increase the discount rate. In both periods, the System finally increased the discount rate in August, just as the economy reached a peak. This time, however, the two sides had reversed positions. New York was reluctant to move, while members of the Board—Robertson, Shephardson, and Balderston—were most eager. Growth was much stronger in 1929, and inflation was much higher in 1957. Stock prices began to increase, a move that the staff (Thomas) interpreted as evidence that the public expected inflation to continue (FOMC Minutes, June 18, 1957, 10). Thomas’s statement does not explain why he believed inflation should increase stock prices.

A few members remained opposed. Bryan argued that the System risked “frittering away . . . the integrity of the American dollar” (ibid., 17). Fulton (Cleveland), Robertson, and Shephardson agreed with Bryan. Allen (Chicago) wanted the banks to raise their prime rates before the System increased its rates. With no consensus on what to do, the FOMC did nothing.
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The discount rate remained below the bill rate, and inflation remained at 3 to 3.5 percent, but several FOMC members continued to oppose tighter policy, including a discount rate increase.
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A split developed in the FOMC. One group, led by Hayes, argued that raising the discount rate would raise market rates but leave the Treasury no better able to compete for funds (FOMC Minutes, July 9, 1957, 13). Those favoring a higher discount rate split also. Some wanted an immediate increase; others preferred to wait until after the Treasury completed its forthcoming financing.

Waiting for the Treasury meant a month’s delay.
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The July 30 meeting came just after the Treasury had completed its financing. The bill rate jumped to 3.36 from 3.17 percent a week earlier (FOMC Minutes, July 30, 1957, 3). Rouse reported that the market anticipated increases in the discount rate and the prime rate when the Treasury offering was in the market, but neither he nor others recognized that the anticipation weakened the case for an even keel policy.

Inflation continued. The staff reported wage increases of 1 percent a
month in May and June and a5.5 percent annual increase in GNP reflecting “rising prices and inventory accumulation in anticipation of further rises” (ibid., 6). Martin agreed with Mills that the System had to increase restraint before the next Treasury financing. Hayes disagreed. He thought the economy continued at a high level but growth showed evidence of slowing.

178. Woodlief Thomas reminded the FOMC that money growth remained low, about 1 percent for the past two years. Velocity continued to rise, a result, he said, of the liquidity built up in the war and early postwar. The increase in monetary velocity financed the rise in prices and wages. Velocity had increased 7 percent in 1956 and 5 percent in the most recent twelve months (FOMC Minutes, June 18, 1957, 9). For the entire expansion, 1954:2–1957:3, velocity increased 14.5 percent or an average of 4.5 percent a year. At the New York bank, Garvy (1959) studied the postwar rise in velocity and concluded, as Thomas had, that much of it was due to the excess money balances accumulated in the war and early postwar. Friedman and Schwartz (1963, chapter 12) accept this explanation also. On that interpretation, the adjustment was a change in level that would end without additional System action.

179. The 3 to 3.5 percent is the annual rate of CPI increase. The FOMC minutes report a much higher number, 8.5 percent (4.25 percent a year) for the period since mid-1955 for all commodities other than food (FOMC Minutes, July 9, 1957, 7).

180. Robert B. Anderson and Julian Baird replaced George Humphrey and W. Randolph Burgess as Treasury Secretary and Undersecretary. Baird was a Minneapolis banker. Anderson came from Texas, had served as Secretary of the Navy, then as Deputy Defense Secretary in the Eisenhower administration. Earlier he had been vice chairman of the Board of the Dallas Reserve bank. Martin announced that the Board had appointed the members of a committee to study the underwriting of Treasury issues.