A History of the Federal Reserve, Volume 2 (29 page)

President Nixon appointed a Commission on Financial Structure and Regulation, called the “Hunt Commission” after its chairman, Reed Hunt. The commission recommended equality of reserve requirements achieved by requiring all institutions that issued demand deposits to join the Federal Reserve System. The Board did not ask for universal membership but it favored uniform reserve requirements for all banks (including savings banks) that offered demand deposits or NOW accounts (letter, Tynan Smith to William E. Simon, Burns papers, Box B_B24, April 5, 1973).
⁹⁷

The Hunt Commission also proposed eliminating interest rate ceilings on time and savings deposits. The Board favored delay and “a controlled phase-out” at the Board’s discretion (ibid., 2). Nothing happened. The “right time” for removing ceiling rates had not come.

Release
of
Policy
Decisions

Chairman Burns appointed a subcommittee of four members to recommend how much and what kinds of information the System should release to the public. The subcommittee could not agree. Brimmer and Morris (Boston) favored the most liberal policy. They argued for the release of information on targets for growth of the monetary aggregates after a ninety- day delay and claimed that this would reduce uncertainty. They also favored release of the federal funds constraint. They hoped that release of information would increase the quality and relevance of criticism by outsiders.

Daane opposed release of any quantitative information such as target growth rates or interest rate constraints. He argued that the quantitative data served as guides to the manager. They developed out of a general discussion, which the manager heard. The policy decision included the nuances and qualifications that members offered in their statements. Releasing the data without the qualifications would be misleading. And
the quantitative data on RPD growth and the federal funds target were, at times, inconsistent. The inconsistencies could be reconciled within the members’ discussion, but this would not be available.

97. Tynan Smith was secretary of the Board of Governors; William E. Simon was deputy secretary of the Treasury and later secretary. I served as adviser to the homebuilders and their representative on the Hunt Commission.

A fourth member, Robert Mayo (Chicago), proposed to publish only the longer-term targets for M
₁
and M
₂
and the bank credit proxy (total deposits). This information would help the market and other observers to understand the thrust of policy action.

A month after the report, Burns responded. He opposed publication of the six-month targets for the monetary aggregates at the end of each three months because it would permit outsiders to know what to expect in the next three months. Despite qualifications stating that these targets could change monthly, the information would affect interest rates. “The risk of misinterpretation . . . is great” (Board Minutes, November 15, 1973, 2). He was less concerned about publishing short-run targets, but he remained cautious. No one proposed that explanations accompany the data to reduce misinterpretation. There were few changes at the time, but the issue returned.

Watergate

During the 1972 election campaign, agents connected to the Republican Party and President Nixon’s campaign were arrested when they broke into Democratic Party offices at the Watergate. The police found Federal Reserve notes in the possession of the criminals arrested at the crime scene. Senator Proxmire and other Democrats conjectured that the Federal Reserve might be involved. The money was in $100 bills and totaled $6,300. Banks had to record large transactions, so there was a record somewhere showing who withdrew the currency. In a letter to Burns, Proxmire asked for information about the issuance of the notes, the name of the person receiving the notes, and how they were paid for.

Burns replied that the Board had no information. He promised to cooperate as fully as he could.

A week later, Congressman Patman asked for the information. Governor Robertson replied. He did not disclose any information or admit to having any. But he refused to answer questions because the U.S. Attorney had advised them that early release of information “would impede the investigation and, in the event of prosecution, could jeopardize the defendants’ right to a fair trial” (letter, Robertson to Patman, Board Minutes, June 28 1973).

Although the exchanges became more rancorous, the Board did not release the information.

CONCLUSION

Experience from 1971 to 1973 points up the advantages of keeping the central bank independent of government and able to choose its actions to maintain the internal or external value of money. More than any other president, President Nixon tried to use monetary policy to create conditions favorable to his reelection. In Arthur Burns, he had a chairman who shared his views and was willing to accommodate his president.

As chairman, Burns had a powerful role, but he required the votes of at least a majority of the FOMC. He could secure these votes because several members always voted with the chairman. But politics and authority alone do not explain what happened. Burns encountered little opposition, and he cited only two opponents—Governor Andrew Brimmer and New York bank president Alfred Hayes. Brimmer’s memo in April 1972, cited above, explains one of the principal reasons for policy failure. They never developed and implemented a long-term or even six-month program.

Ideas had an important role. Several members favored Burns’s expansive policies because there were idle resources. Their main concern was to achieve full employment; preventing inflation or maintaining the internal value of money was of lesser interest. The external value of money was neither an important goal nor a Federal Reserve responsibility. Proponents of ease drew support, or took comfort, from prevailing Keynesian doctrine that taught that it was possible to trade off a bit more inflation to reduce unemployment and that the tradeoff could be improved by controlling prices and wages. They favored government-administered guidelines and guideposts, and they welcomed the president’s decision to adopt price and wage controls. Surprisingly, Arthur Burns, who had earlier pointed out the flaws in this reasoning, became the main proponent of controls or guidelines in this period. He pressed the president to adopt guidelines.

Pierce (1978, 365) quoted Burns’s testimony in 1973 that in 1972 “monetary and fiscal policy moved in the right direction . . . [but] in retrospect it appears that restraint should have been greater.” That was as much error as he would admit while he remained chairman. But those who criticized him after inflation rose included many who had urged more expansive policies in 1972 using much the same reasoning as those who supported the expansive policies. Prominent members of Congress took this position.

The mixture of politics, analytic error, and unwillingness to defend central bank independence was not restricted to the Federal Reserve and the administration. Many economists and members of Congress shared these views. The errors were costly. The surge in inflation took the annual measured rate of consumer price inflation from about 4 percent when
price and wage controls began to more than 10 percent in 1974, when the administration gave up these efforts (except for oil). Wage increases, less subject to the one-time effects of food and energy prices, rose from about 6 to 8.5 percent annual rate.

Other errors contributed. The Federal Reserve did not distinguish between one-time price changes and long-term rates of change. The one-time changes in food and oil prices would pass through, leaving the maintained rate of inflation unchanged if policy remained non-inflationary. Reported inflation rates would decline after a year at most. By failing to distinguish between temporary and permanent changes, the Federal Reserve misdirected its policy and increased unemployment. The underlying problem was failure to decide, or even discuss, whether its objective was price level stability or zero or low inflation (rate of price change). The former required action to roll back or roll up one-time price level changes. The latter did not.

Sherman Maisel made notable efforts to give more attention to longerterm consequences and to improve operating procedures. He had very limited success. The FOMC formally adopted reserve targets, but it constrained its actions within a narrow band of short-term interest rates. The account manager gave most attention to the interest rate constraint. The staff recognized the problem and informed the FOMC, but policy action did not change. After Maisel’s term ended, Andrew Brimmer raised some of the same issues with even less effect.

The Great Inflation continued and increased in these years for two main reasons. First, political concerns weakened whatever independence the Federal Reserve had just at the time when an independent central bank was most needed. The Federal Reserve accepted the political goal of achieving low unemployment even if it risked increased inflation, as it did. Second, analytic errors and inappropriate operating procedures supported these choices. Both problems continued for the rest of the decade.

Members recognized political concerns. Burns told Congress that “it is the expansion of the money supply over the long run that will be the basic cause of inflation” (quoted in Wells, 1994, 111). But he told the members of the Bank for International Settlements that Congress and labor unions disliked “high” interest rates, and Congress was likely to legislate ceilings. And he told the FOMC that “to achieve price stability it was necessary to avoid recessions” (FOMC Minutes, June 18–19, 1973, 34).

Governor Brimmer told the FOMC that its concentration on short-term changes neglected longer-term goals. Reading the minutes, one notices a striking difference between the major effort given to deciding on small
differences in the federal funds rates or the money growth target and the much greater difference between the target and actual money growth. Discussions at the meeting presume that the manager would control money growth carefully though everyone knew that this was not so.

Behind most of these errors lay a political concern. As Burns, Frank Morris, and Charles Partee reminded the members, they could try to reduce inflation only as long as unemployment remained low. Once unemployment rose, they would be urged to expand and the government would take fiscal actions. Burns recognized that no country had succeeded in reducing inflation without increasing the unemployment rate. That made the Federal Reserve cautious and quick to abandon anti-inflation policy.

From 1971 to 1973 the country experienced the consequences of one of the major errors in economic policy—the attempt to control the price level by controlling most, but not all, relative prices. The proponents of the policy, Arthur Burns and John Connally, did not understand that unless monetary policy became less expansive, spending would continue to rise, raising prices. President Nixon had chosen controls to reduce employment enough to win the 1972 election. He pressured Burns frequently to increase money growth. Burns did so with the support of a majority of the FOMC urged on by prominent members of Congress. At a time when central bank independence was most needed to safeguard the value of money, the Federal Reserve failed the test.

By the time that Burns recognized that inflation was a major problem, it had become well entrenched. Too many promises had been broken, so credibility was impaired. The cost of a major reduction in inflation had increased. And President Nixon in his last days in office wanted easier monetary policy (Matusow, 1998, 298).

Poor forecasts added to the problem. Chart 6.6 compares the private Society of Professional Forecasters forecast to reported inflation. The forecast is consistently lower than actual inflation. Federal Reserve staff projections were usually close to the survey. Largest errors include periods with oil price increases, but large errors are not limited to these periods. Emphasis on short-term changes and neglect of longer-term consequences contributed to the poor performance both in this period and its continuation. Orphanides (2001, 2002) developed these points.

Herbert Stein (1988, 206), who participated in many of the policy decisions, put greater emphasis on political pressures. “Everything turned out to be more difficult than it seemed in advance. That was notably true of the effort to check inflation. No one knew how much the anti-inflation fight
would cost. When they got some inkling of the cost, they—the President and his advisers—were unwilling to pay it and also thought the public was unwilling to pay it.”

APPENDIX TO CHAPTER 6

The results of the vector autoregressions shown in Chart 6.A1 differ in several ways from the results for other periods. Among the off-diagonal responses, the response of discounts to the base is much stronger than in the 1950s or other periods. (Compare Chart 2.A1 in the Appendix to Chapter 2.) This likely reflects, in part, policy action during 1979–80, when the FOMC set targets for nonborrowed reserves and forced the banks to borrow to meet required reserves, and during other periods of reserve targeting in the 1970s. A less important change is the disappearance of a response of the gold stock to the monetary base, government securities, or discounts. Under floating rates, the gold stock rarely changed. The Federal Reserve rarely sold gold from 1968 until the floating in August 1971. Growth of the base was driven by open market operations in government securities. Discounts leave no significant effect on the base, but discounts reduced government securities.