A History of the Federal Reserve, Volume 2 (37 page)

In the winter of 1974, President Nixon reappointed Burns as chairman. That provided continuity during the uncertainty arising from the Watergate scandal. But in May, George Shultz left the government because he opposed President Nixon’s second effort to freeze prices (Shultz, 2003, 15). Shultz had served as coordinator of economic policy for the administration. His departure set off a struggle to assume his role between William Simon, the new Treasury secretary, and Roy Ash, the budget director. Neither received Shultz’s authority or his central position, and neither could acquire his leadership role.

Early in 1975, dissatisfaction with economic outcomes raised new challenges. Many real estate investment trusts, financed by leading banks, borrowed short-term and lent long-term to finance real estate. As real estate prices fell, the real estate trusts faced insolvency. Feedlot operators who fed cattle suffered losses as meat prices fell. The operators had borrowed heavily. The high nominal interest rates added to their burden. Other distressed borrowers included airlines hurt by fuel prices and electric utilities caught between higher fuel prices and many state regulators reluctant to raise prices (Wells, 1994, 141–42).

At the June FOMC meeting, the committee voted eleven to one (President Clay dissenting) to hold the funds rate between 11.25 and 12.25 percent. By early July, the funds rate was between 13 and 13.5 percent, the highest ever reported to that time. The desk tried unsuccessfully to lower the rate, while remaining within the money targets. The desk explained that banks wanted to hold reserves because of the Franklin National and Herstatt failures. The FOMC decided to let the rate remain where it was. On June 10, Burns changed his mind. He wanted a lower funds rate, between 12 and 13 percent. Governors Bucher and Sheehan wanted more decisive action to lower the rate. President Winn (Cleveland) opposed any action to lower the rate. “Our experience indicates a bias for quantities to exceed upper limit of range of tolerance. Would like to see a few periods in which achievements were in lower end of range” (telegram, Winn to Burns, Board Records, July 10, 1974).

The recession was in its eighth month in July. At a 12.92 average for July 1974, the nominal funds rate was three percentage points above the rate at the National Bureau peak. The unemployment rate shows one likely reason; it rose only from 4.8 percent to 5.5 percent during this period. That was about to change. The unemployment rate reached 6 percent by October and 7.2 percent by December.

That ended the anti-inflation policy. The federal funds rate began to fall.
By December it was down to 8.5 percent. And it continued to fall for the next six months despite high and, until December 1974, rising consumer price inflation.
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In July the FOMC voted to reduce M 1 growth to the range 2 to 6 percent during July and August, but after reporting 1.7 percent for July, the FOMC raised the proposed M
₁
growth rate to 5.5 to 7.5 percent. Real base growth fell through 1974 and 1975. Real long-term interest rates also fell, but falling real base contributed to a large decline in real GNP (see Chart 7.10 above).

President Nixon resigned, and President Gerald Ford took office on August 9, 1974. Financial market rates rose with the heightened political uncertainty beginning in mid-July. In the month to August 9, Treasury bill rates rose 1.3 percentage points to 8.75. Long bond rates also rose by smaller amounts. Both rates began to fall after a month. The dollar strengthened, however.

Burns sent a twelve-page memo to President Ford outlining an antiinflation program. He told the president that “the nation is in the grip of a dangerous inflation” (Burns to the president, “Agenda for an Immediate Economic Program,” Burns papers, Box B_B24, August 12, 1974, 1).
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Monetary policy had borne too much of the burden. He urged the president to meet with the congressional leaders and agree on at least $5 billion in spending reduction. (Outlays for 1975 reached $332 billion.)

Much of Burns’s program called for interference in price and wage setting. He urged President Ford to pledge a balanced budget for 1976, avoid price and wage controls, reconstitute the Cost of Living Council and the Construction Industry Stabilization Committee, and pursue a tough antitrust policy. He favored “temporary restraint on export of grains” (ibid., 5) in the event of rising food prices. And he proposed an enlarged public service employment program to absorb some of the unemployment caused by the anti-inflation policy.

Burns returned from a meeting with the president and legislative lead
ers on August 20. He told the FOMC that the president had said he would like a new Cost of Living Council and that he would avoid price and wage controls. The president hoped to keep total outlays under $300 billion in fiscal 1975. And he announced a “summit meeting” on inflation to solicit advice and focus attention on the problem.
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42. Concern about leaks from the meeting arose periodically throughout System history. To limit or prevent leaks, beginning in August Chairman Burns limited attendance to Board members, presidents, the managers, and a few essential staff members during the part of the meeting devoted to monetary policy and the directive. Customary attendees would remain at other parts of the meeting (Board Records, August 1, 1974).

43. Burns’s advice was not uniformly accepted within the administration. Old and mistaken ideas do not disappear. David Packard, undersecretary of defense, sent a memo giving his views of the causes of inflation. He recognized that “tight monetary policy is about the only real pressure on inflation.” But it had become counterproductive because it increased costs, delayed investment, and caused “serious, even dangerous distortions.” He agreed with Burns that the administration should reestablish the Cost of Living Council (David Packard to the president, White House Central File, Box 31, Ford Library, August 20, 1974).

The president announced his ten-point program on October 8, 1974. It called for a one-year 5 percent tax surcharge on high-income taxpayers and corporations, an increase in the investment tax credit, increased unemployment benefits, public service jobs in areas with high unemployment, a budget ceiling of $300 billion for the 1975 fiscal year, and a voluntary program to control inflation—the WIN program (Whip Inflation Now). WIN initially captured the popular imagination, but the program did not have congressional support. The 1974 congressional election was only weeks away, so most Congress members would not support either a tax increase or reductions in spending, not even the $4.4 billion by which the president proposed to reduce the increase in the last Nixon budget (Greene, 1995, 72).

The rest of the WIN program was entirely public relations.
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It could do nothing to stop inflation; the opposition in Congress pointed to the neglect of a deepening recession. This doomed the tax increase and any other part of the program that required legislation. By the time the president announced the program, industrial production had fallen in three of the last four months. A 35 percent (annual rate) decline in November followed by a 50 percent decline in December doomed WIN.

44. Burns’s relations with President Ford and his administration were excellent. He described President Nixon as trying “to interfere with the Federal Reserve both in ways that were fair and . . . unfair. Mr. Ford on the other hand was truly angelic. I met with President Ford frequently, alone in the privacy of his office. He never inquired about what the Federal Reserve was doing. He never even remotely intimated what the Federal Reserve should be doing” (Burns, 1988, 136). Burns added that he was informally a member of the president’s economic team. “It was a one way street” (ibid., 138). He discussed administration policies but did not mention Federal Reserve plans. Alan Greenspan, who replaced Herbert Stein as chairman of the Council confirms Burns’s role (Hargrove and Morley, 1984, 429).

45. The president’s aide, Robert Hartmann, compared WIN to President Roosevelt’s Blue Eagle program, part of the NRA intended to show public support for higher prices and wages in 1933. Memos at the time compared it to the Army-Navy E (for efficiency) in World War II. Companies that pledged not to raise prices for one year would receive an IF flag (inflation fighter) similar to the E flags during World War II. Advocates suggested that “the American people would serve as policemen to make sure the program works” (memo to the president, Inflation Fighter Program, Robert T. Hartmann papers, Ford Library, August 30, 1974, 2). The name of the sender was cut out of the memo. A WIN song was written and recorded. The program began as independent suggestions from a Pennsylvania’s businessman, William J. Meyer, and a financial journalist, Sylvia Porter. Sylvia Porter became chair of a large voluntary citizen’s campaign.

That was the end of the WIN program. Annualized consumer price inflation reached a local peak of 11.5 percent that month. The following month the Ford administration replaced the 5 percent tax increase with a proposed 12 percent tax reduction in the form of rebates of 1974 tax payments. It also proposed to increase the price of imported oil. Congress passed a much larger tax cut and increased spending.

The economy and the Congress doomed Ford’s hope of reducing the budget deficit. Although he vetoed many spending bills, the budget deficit rose to $5.5 billion in 1975 and $70 billion in 1976, a new record. That left inflation control entirely to the Federal Reserve, displeasing Burns.
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Despite his many speeches about the dangers of inflation, policy gave pride of place to reducing unemployment.

During the fall, evidence increased that the recession would become deeper and last longer. Burns’s initial reaction was to lower the funds rate gradually. He typically said, “[A]ny drastic change . . . would be a great mistake, although some further easing would be appropriate” (FOMC Minutes, December 17, 1974, 85).

Henry Wallich proposed a temporary policy of increased money growth. To avoid another surge of inflation, the committee would later slow money growth. Burns opposed. In a clear statement of the time inconsistency problem, Burns said, “The members might plan now to slow growth later on, but when the time arrived, they would find it a difficult step to take” (ibid., 104).

In mid-November, the Board reduced reserve requirement ratios for demand and time deposits. The new demand deposit ratios applied only to banks with $400 million or more. Their ratio became 17.5 percent instead of 18. Adjustments to time deposit ratios lowered the ratio to 3 percent for most categories (Annual Report, 1974, 95–96).

Table 7.5 shows the decisions and approximate outcomes reported in the FOMC minutes from September to December 1974. By the November meeting, the committee had an estimate of −3 percent for third-quarter growth and a projected faster decline in the fourth due in part to a coal strike. Inflation in wholesale and consumer prices showed no evidence of decline until 1975.

The table shows, as usual, that the manager always met the funds rate
target but met the money target only occasionally. In September and October, the dissenters wanted slower money growth or higher interest rates to lower inflation. In December, Wallich and Mitchell’s concern was the deepening recession.

46. The CEA chairman, Alan Greenspan, explained that inflation and other instabilities increased the risk premium and reduced investment. “[T]he only way to [reduce risk and inflation] in the long term was to bring down the rate of increase in money supply, which in turn required that Federal financing be brought down” (Hargrove and Morley, 1984, 418). Greenspan explained that the Federal Reserve controlled a short-term rate. Increases in the deficit, therefore, resulted in faster money growth and more inflation.

William Fellner, a member of the Council of Economic Advisers, sent a weekly memo to the president to inform him about monetary policy. Most of the memos supported the reduced growth of monetary aggregates as the way to reduce inflation. By November, reported M
₁
growth had fallen to 3.7 percent annual rate for the most recent twenty-six weeks. Fellner said, “The numbers . . . are compatible with a reasonable degree of anti-inflationary pressure” (memo, Fellner to the president, Burns papers, WHCF Box 1, November 8, 1974). When Burns praised President Ford for not interfering in monetary policy, he did not note that William Fellner and Alan Greenspan generally approved of what he did. Greenspan was the new chairman of the Council of Economic Advisers, replacing Herbert Stein.

Support changed in the winter of 1975. Money growth (M 1 ) fell to −0.6 percent from December to February. Fellner recognized that the Federal Reserve had “vigorously to expand money in periods of falling interest rates and economic decline” (ibid., February 14, 1976). Fellner cautioned against treating the decline in short-term rates as evidence of ease. Greenspan repeated this point in a memo prepared for a meeting between the president and Burns in early March. Soon afterward money growth rose. In July, Greenspan warned the president about upward pressure on interest rates (ibid., July 7, 1975).

Beginning in 1975, borrowing declined and the federal funds rate came down rapidly. Once the oil price surge ended, reported consumer price inflation slowed. The decline in reported inflation induced an increase in growth of the real monetary base (Chart 7.4 above).

Judged by the decline in the federal funds rate, the Federal Reserve eased policy decisively in 1975. The change coincided with the rapid in
crease in the unemployment rate in the winter of 1975. Table 7.6 outlines changes in some principal variables in three Decembers. Using CPI inflation shown in the table, the real federal funds rate was negative throughout. Real base growth turned positive early in 1976. Unemployment was not affected, most likely because the public expected easier policy and higher inflation.