A History of the Federal Reserve, Volume 2 (81 page)

Then he added:

I wouldn’t care where the interest rates were if the economic situation looked a little better—and if we weren’t going to have to deal with a succession of sick foreign countries in this time period, if the dollar were not rising into the wild blue yonder right now, and if I thought that all the accumulating problems that we face could wait for a while, we’d have a much easier decision. Under present conditions, four weeks looks like one hell of a long time to me. (ibid., 51)
¹³³

Volcker was indifferent about whether they specified a range for the funds rate or left it to his judgment. If they wanted a range, he favored 7 to 10 percent. The weekly Treasury bill yield rose in the week of the meeting, but it remained between 7.5 and 7.75 percent for the rest of October. The monthly average federal funds rate declined 0.6 percentage points in October to 9.7 percent. The M 1 money stock rose at almost a 14 percent annual rate, but the increase was heavily in NOW accounts. However, the monetary base rose about 10 percent (annual rate) in August and September and 13 percent in October.

The good news was that the CPI rose at annual rates between 2 and 3 percent monthly from August through October; by October the twelvemonth moving average was below 5 percent. But the unemployment rate rose above 10 percent for the first time in the postwar years. The S&P index rose strongly in October, probably on evidence that the Federal Reserve would try to prevent a possible crisis.

Discussion turned to whether the System or Volcker would announce the policy change. Volcker seemed hesitant. An announcement would make the change seem “more grandiose” than he intended (ibid., 53). But Ford argued for a more explicit statement “saying that the fed funds rate will not rise above 10.5 percent. Isn’t that what we mean? Why not say what we mean?” (FOMC Minutes, October 5, 1981, 67). But Volcker did not accept that description.

Presidents Black, Ford, and Horn were not persuaded. They voted against the directive. Wallich voted in favor, although he had expressed concern during the discussion. The nine-to-three vote expressed a preference for discretionary action and an imprecise directive in the face of pos
sible crisis. Members’ confidence in Volcker’s judgment played a decisive role, as several said.
¹³⁴

133. Volcker then explained why he was less concerned than some about a negative market reaction. “They have assumed that we moved as alertly . . . as we did during the summer because we were operating against the background of Penn Square and Drysdale and accumulating international problems. This [referring to the FOMC’s statement] is in a sense a confession, good for the soul, in making that a little more explicit” (FOMC Minutes, October 5, 1982, 51).

Prior to the meeting, the Board deferred several requests from Chicago to reduce its discount rate to 9.5 percent. After the meeting, New York, Philadelphia, Minneapolis, San Francisco, and Atlanta joined Chicago. The Board approved the 9.5 percent discount rate. It denied Dallas’s request for a 9 percent rate. By the end of the year, the discount rate was 8.5 percent everywhere. Following the meeting, the federal funds rate declined from a 10.3 average for September to 9.7 and 9.2 percent for October and November. Long-term Treasury rates fell almost one percentage point by the time of the November FOMC meeting.

A few days after the FOMC meeting, Volcker spoke to the Business Council, made up of CEOs of large corporations, and gave a press conference on recent policy actions.
¹³⁵
He emphasized no change in policy and pointed to the progress on reducing inflation. He avoided any reference to the problems of foreign governments and financial fragility. He warned the Business Council not to interpret the lower discount and funds rates as evidence of easier policy. “Lower interest rates in an economy in recession are not unusual, and are consistent with the need for recovery. But lower interest rates do not in themselves indicate a change in basic policy approach” (Volcker speeches, Board Records, October 9, 1982, 2). Most of the rest of the speech explained the reasons for reduced attention to changes in M
₁
.

Volcker was not ready to show his hand. In his press conference, Volcker referred to the October 5 decision as “a small, technical matter.”
He again emphasized the unreliability of current data on M
₁
, but as in his talk to the Business Council, he mentioned sluggish real growth, the strong dollar, and evidence of increased demand for liquidity. The Federal Reserve, he said, remained committed to lowering inflation. It would “not force interest rates lower. We welcome declines” (press conference, Board Records, October 9, 1982, 2). He did not say that the System would resist higher interest rates.

134. The Federal Advisory Council reported at its September 17 meeting with the Board that the Drysdale, Penn Square, Lombard-Wall, and Mexican problems increased caution. Regional banks received CD money that would have gone to money center banks. Markets experienced a “flight to quality” and reduced lending to Latin America. The FAC disagreed with Volcker’s assessment of risk. “The failures of Drysdale and Lombard-Wall were not signs of general instability in financial markets. Nor do they threaten to impair the normal, efficient operation of these markets” (Board Minutes, September 17, 1982, 4). They praised the Federal Reserve for supporting the market and taking “no action to rescue the unfortunate participants in the incidents” (ibid.). The FAC agreed with the Federal Reserve policy of allowing money supply growth to exceed the targets and reduce market interest rates. Then they added: “There is concern in the marketplace, as reflected by high real interest rates, about the continuance of the Federal Reserve policy of restraint in the face of political pressures and the unresolved problem of the Federal budget deficits” (ibid., 6). At about the same time, the Shadow Open Market Committee urged a restrictive policy to reduce inflation accompanied by a policy of permitting financial failures but protecting the market from the effects of the failures.

135. The
Wall
Street
Journal
published a story on the Thursday before the Business Council meeting. Coyne said the story was accurate. “That stirred a lot of interest”
(Coyne, 1998, 16).

Reporters asked if the October 5 decision and the FOMC’s statement that it would tolerate growth in M
₂
above the target reflected concern about bank failures. Volcker was cautious, denied concern about bank failures, and referred to increased liquidity preference. He pointed to the premiums on interest rates as evidence.

The New York staff reported that M
₁
rose at a 20 percent annual rate in October. “Rapid M
₁
growth was essentially accommodated through periodic adjustments of the reserve path in line with the Committee’s decision at the last meeting” (FOMC Minutes, November 16, 1982, 1).
¹³⁶
The System explained that expiration of the All Savers Certificate made money growth data unreliable. It accounted for half the growth in M1 (FOMC Minutes, November 16, 1982, 1). There was no reliable way to judge how much of the growth in M1 was temporary and how much represented a permanent increase in transaction balances.
¹³⁷

Staff forecasts remained pessimistic about 1982, but the early forecast called for 3 percent growth in 1983. Actual growth for the four quarters was 6.5 percent, double the estimate. Volcker asked if any of the members saw evidence of recovery in November. Most said that there were faint signs especially in housing. The dollar exchange rate against most currencies continued to rise.

Volcker summed up his position. “We will keep the same general framework we had last time [deemphasizing M
₁
] . . . A much more fundamental problem, implicit or explicit in the earlier conversation, is that the business situation doesn’t look red hot” (ibid., 20). He then discussed the large shift down in velocity and the uncertainty about whether the shift was temporary or permanent.

Most of the members w
anted lower interest rates and were willing to
act to bring that about. Roger Guffey (Kansas City) was most outspoken. “All the talk about targeting reserves and looking at M
₂
for some information content as to what policy should be I think is a bunch of boloney in the sense that we are targeting interest rates. And we ought to recognize that. . . . I am not suggesting that we do away with or abandon the regime of targeting reserves and money supply, at least for public consumption. But around this table it seems clear to me that [we are on] an interest rate regime and we ought to target on the interest rate we think is appropriate to get the economic recovery started again” (ibid., 23).

136. The manager agreed with a criticism by Robert Black (Richmond). “When you ask if it is effective to control M
₂
via this means, I would have to say I have some real doubts as to how good our control mechanism is on M
₂
” (FOMC Minutes, November 16, 1982, 3). Black was not satisfied. “I don’t think we can slow it [M
₂
] down except through affecting M 1 and those few assets in M
₂
that are subject to either reserve requirements or interest rate ceilings” (ibid.).

137. Once again, there was a report of “leaks” from the meeting. Volcker sharply reduced the number of participants.

Volcker interrupted him. He was not ready to concede that he had abandoned reserve targeting permanently, but his statement partially confirmed Guffey’s point. “I don’t think that’s quite accurate, Roger. . . . I would have lower interest rates if these aggregates weren’t rising so darn [fast]” (ibid.). This suggests that growth of the aggregates was no longer the target. It had become a constraint on the interest rate level.

The facts bear out Guffey’s comment. The federal funds rate remained in the range specified throughout 1982. All of the monetary aggregates were above the annual range throughout the year.

Volcker’s subsequent statement brings out the experimental aspect of the September–October policy change. Ten-year interest rates had declined from 11.8 to 10.5 percent since September. “What we have to balance is how much we think we can get away with, even if we recognize the dangers in the business situation and want to get interest rates lower. . . . I think one would have to conclude from what has happened in the market that people haven’t been that upset by what they’ve seen so far. . . . I suppose that what the market is telling us is that people are not going to get worried about that when they have a sense that the economy, if anything, is still declining” (ibid., 29–30). Most of the other members shared his objective of lowering interest rates.

President Ford (Atlanta) was an exception. He cited the next stage of the tax cuts and the rapid growth in real money balances. “We are sitting here reading each other the gloom and doom report, but unless we are at a historically discontinuous point in our economy . . . we are at a high risk of throwing both of the throttles in our economic airplane fully to the wall and the plane has to take off” (ibid., 33). Governor Partee supported him and urged delay, but Volcker cited the precarious international situation, the very strong dollar, and the world recession to bolster his position. Teeters, however, warned that “our interest rates, the lack of recovery in this country, and the high international value of the dollar are creating a situation in the international field that could lead us into something very similar to the 1930s” (ibid., 23). Although she did not recognize it, the recession
was ending; the National Bureau of Economic Research dates the end of the recession in November.

On an eleven-to-one vote, the FOMC approved a directive calling for 9.5 percent M
₂
growth and a 6 to 10 percent federal funds rate. Ford dissented. The December average funds rate was almost six percentage points below the February value. The ten-year rate stabilized at about 10.5 percent, but the stock price index continued to rise as signs of recovery increased.

Teeters proposed publishing the directive right after the meeting to prevent leaks and provide information. She received considerable support, but Volcker opposed and did not ask for a vote. He argued that if the FOMC released the directive, Congress would schedule a hearing in the afternoon.

With M
₁
distorted, the committee was at a loss about how to operate. It continued to set a path for nonborrowed reserves, but it recognized that it had little control over M
₂
growth. Policy had become discretionary, based mainly on Volcker’s judgment. Members disliked that arrangement but did not propose another. Volcker explained again that his goal was lower interest rates, but the size of the decline depended on slower money growth in M
₂
especially. His policy was opportunistic; he would lower interest rates as opportunities appeared.

Several members commented on monetary velocity. It was far below its old trend. No one offered an explanation, and neither the governors nor the staff suggested that velocity growth should decline with expected inflation and interest rates.

The December directive repeated November’s. This time, Black joined Ford in dissent, so the vote was ten to two. The discussion brought out market concerns about future inflation, but it did not seem to cause any change in voting or action.

Much of the December meeting commented on a staff report on the choice of target. The main conclusion was that each of the targets had important disadvantages at the time. The staff, however, agreed that M
₁
was the best target once the economy completed adjustment to new monetary instruments and institutional changes. The staff believed the adjustment would be over by mid-year. Several FOMC members expressed doubt.

The report set off a lengthy but inconclusive discussion. Axilrod proposed using the broader aggregates during the transition. An important reason was to assure the public that the FOMC “is continuing on the antiinflationary course set earlier, even while taking steps to stimulate economic recovery. This is particularly important at this time in view of the doubts that seem to be emerging, at least in the bond markets, about the Federal Reserve’s intentions” (FOMC Minutes, December 20–21, 1982, 11).

Black (Richmond) wanted the FOMC to commit to a return to M
₁
tar
gets by mid-year 1983. Wallich agreed, but Morris described the proposal as “extremely unrealistic” (ibid., 20). Several members favored M
₂
. There was no agreement. Teeters described the committee as close to “the feel and tone of the market as we’ve been in thirty years” (ibid., 35).