A History of the Federal Reserve, Volume 2 (36 page)

The staff’s conclusion was that the FOMC’s major problem was to “curb inflationary and speculative developments before they gain headway” (ibid., 12). The FOMC took no further action. Monthly rates of consumer price increase showed no evidence of rising inflation; the twelve-month increase of consumer prices had reached a peak (3.65 percent) in April. By August, the rate of increase had fallen to 2.22 percent. Free reserves remained about $100 million through September and October, and the federal funds rate remained about 1.75 percent. However, the Board again increased stock market margin requirements, to 90 percent, effective October 16. Robertson voted no.

The Livingston Survey of inflationary expectations gave a bit of support to Martin’s concerns. In 1958, the one-year ahead inflation forecast began to increase. Chart 2.14 shows that the survey underestimated the change. The forecast did not rise above 1 percent at this time, a modest rate of increase that leading central banks and governments would later dismiss as non-inflationary.

Tensions at the FOMC relaxed after the Treasury’s October offerings moved to “substantial premiums.” New York continued to favor an easier policy, but all accepted no change in policy at the October 21 meeting.
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Differences arose, however, over a change in the discount rate. Treasury bill yields were almost a full percentage point above the discount rate. Most members regarded a 0.5 increase in the discount rate as a technical correction. New York expressed the concerns of its directors that an increase would be considered a step toward restraint. Only Mills and Mangels (San Francisco) favored delay. Following the meeting, five banks increased the discount rate to 2.5 percent. In the following two weeks, all others followed, with New York acting last, on November 7.
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221. Treatment of Treasury refunding was a major topic at this meeting. The Federal Reserve could not legally buy more than $5 billion directly from the Treasury. Counsel ruled that the limitation did not apply to refunding of expiring issues. Like most regulations, the rule could be circumvented. The Treasury sent a letter outlining two procedures for carry
ing out the exchange, one of which was more favorable to the Federal Reserve than to other holders. The FOMC rejected favorable treatment but accepted its counsel’s opinion that the $5 billion limit did not apply to refundings.

The economy continued to expand and, toward year-end, the unemployment rate began to fall with no sign of rising inflation. The FOMC in November and early December left decisions to the manager’s judgment about the “feel” of the market. On December 16, it voted for more restraint over the objections of President Hayes. These meetings were less contentious, but the basic division remained. Most of the Board, and its senior staff, expressed concern about the budget deficit and inflation. New York remained unconvinced.

Woodlief Thomas spoke of the “ominous nature of many aspects of prospective economic developments,” citing the budget deficit, the gold outflow, stock market speculation, and “the retreat from fixed return investments” (FOMC Minutes, November 10, 1958, 10). Hayes replied, citing recent moderation and urging continuation of current policy. The only troubling aspect for him was the loss of gold. On a recent trip abroad, foreign central bankers had raised the same issues as Thomas, but Hayes was not convinced. “I would think it unwise to let the gold outflow itself affect our monetary policy directly” (ibid., 15).
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Chairman Martin, referring back to Thomas’s “ominous notes,” said that he favored more restraint than the consensus, but left the decision about more restraint to the manager.
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222. The staff report called the committee’s attention to the sizeable decline in the gold stock. In the year to October, the stock declined $2 billion, 9 percent. The staff report noted a $500 million decline in the most recent three months and estimated future losses at $100 million a month (FOMC Minutes, October 21, 1958, 16–17). The October level was $20.7 billion.

223. Of course, he added words about the “heavy responsibility to encourage confidence in the dollar and the stability of the gold standard,” but he did not propose any action (FOMC Minutes, November 10, 1958, 15). Governor Mills referred to “the almost morbid discussions of inflation emanating from financial circles in this country that tended to promote distrust abroad” (ibid., 24–25).

224. The manager, supported by the Board’s staff, again requested an increase in the acceptance portfolio to $75 million. He argued that acceptance purchases could be used to influence the loan market and to encourage foreign trade. Robertson, as usual, opposed the increase, citing the shifting arguments, the lack of evidence, the steady progression from an
initial portfolio of $25 million to $50 million and now to $75 million. Allen (Chicago) sided with Robertson, but the majority voted for the increase (FOMC Minutes, December 2, 1958; Memo Board staff to FOMC, November 17, 1958).

The manager allowed free reserves to decline and the federal funds rate to rise by 0.5 percentage points in November and an additional 0.25 by year-end. The latter followed an FOMC decision in mid-December to let the market move toward negative free reserves. The committee voted to change the directive to eliminate “recovery” and emphasize “fostering conditions . . . conducive to sustainable economic growth and stability” (FOMC Minutes, December 16, 1958, 43). Hayes voted no.
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A new element entered at year-end. The principal European currencies became convertible on current account. The Board and the FOMC did not consider letting their commitment to the $35 gold price under the Bretton Woods Agreement take precedence over domestic policy concerns, as Hayes’s November remarks suggest. This seems an accurate reading of congressional and administration sentiment that gave most emphasis to the unemployment rate.
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The System continued to sterilize gold movements.

By year-end, the federal funds rate and all discount rates were at 2.5 percent, with bill rates 2.75 percent. Several reserve banks discussed raising the discount rate before the Treasury reentered the market, but none voted to do so. On December 29, 30, and 31, the Board voted to renew discount rates without change. Governor Robertson voted with the majority but inserted this statement in the record:

Failure to act now coupled with an action to increase the rate after the Treasury financing seems to me to be unfair to the Treasury Department as well as to the individuals who purchase the securities that will be issued during the early part of January. (Board Minutes, December 29, 1958, 2–3)

The statement questioned the rationale for “even keel” policies, without saying so explicitly. The policy continued.

Also at year-end, the administration announced that the budget for fiscal
1960 would have a small surplus instead of a projected $9 billion deficit. Martin’s and the Board members’ concerns about the inflationary effect of persistent large budget deficits no longer applied. Martin recognized that “some hazards in the situation . . . were not real,” but he continued the policy of restraint without apparent chan
ge (FOMC Minutes, December 16, 1958, 37). Annual monetary base growth remained between 1 and 2 percent and, as reported at the time, growth of the M
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money stock slowed after mid-year 1958 (Council of Economic Advisers, 1959, 37).

225. On November 30, 1958, Governor James K. Vardaman, Jr., resigned after nearly thirteen years of service. Investigation of “leaks” pointed to Vardaman. This was a serious scandal for the Federal Reserve. Confronted with the evidence by an irate chairman, Vardaman chose to leave. President Eisenhower appointed G. H. King, Jr., to fill the rest of the term.

226. Eisenhower’s diary reports his discussions of gold and debt finance in 1958–59. Secretary Anderson “believes that, unless we have a balanced budget, we are going to have very bad effects in foreign banking circles because of diminishing faith in the dollar. Saulnier believes there is very little danger of this at the moment. Moreover, he is not particularly concerned about the accelerated outward movement of gold. . . . [B]oth agree that a balanced budget would have the most salutary effect on our fiscal situation that could be imagined”
(Ferrell, 1981, 359).

The staff report for the first meeting in 1959 urged the FOMC to decide “what rate of monetary expansion would contribute best to the sustainability, without inflation, of prospective economic expansion” (FOMC Minutes, January 6, 1959, 5). The report described the long postwar decline in average cash balances per unit of income and the rise of inflationary psychology before concluding that monetary expansion should be moderate.

The recommendation had no visible effect. The FOMC did not define moderate economic growth or constrain its actions to achieve it. Hayes continued to emphasize near-term changes and restored free reserves as his indicator of the System’s stance. Although several presidents mentioned an additional discount rate increase, Martin did not believe that would increase saving enough to get the public to finance the Treasury deficit out of current saving. “He hoped that inflation would not get out of hand to such an extent that a very serious price would have to be paid for its correction” (ibid., 37). This explicit recognition that disinflation was costly was not followed by a proposal to take additional actions to prevent an increase in inflation.

This is one of the rare meetings up to that time at which a participant mentioned international considerations. Hayes reported on the first days of convertibility of foreign currencies (on current account) and the devaluation of the French franc as part of the move to convertibility. He favored the change and thought it would “bring significant benefits to the United States in the long run.” He did not expect much near-term effect (FOMC Minutes, January 6, 1959, 7). This prediction was soon falsified by increased gold loss.
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Indeed, at the same meeting, Governor Mills ruminated about whether the System should raise the discount rate and end the policy of sterilizing the effects of gold movements so as to “subject the domestic economy to the discipline that is implicit in the gold outflow by
terminating a policy of acquiring U.S. government securities to offset gold withdrawals” (ibid., 18).
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227. The move to convertibility brought out the major change in New York’s role that had occurred since the 1920s when Governor Strong of the New York bank was directly involved in negotiations leading to a return to convertibility. In the 1950s, the Federal Reserve was an observer; responsibility had shifted to the Treasury.

The System remained on an even keel through the next two meetings, so the federal funds rate remained near 2.5 percent, and the discount rate did not change. Several members expressed concern about the frequency of Treasury offerings that forced a delay in raising the discount rate.

Pressed by members’ comments at the February 10 FOMC meeting, the staff prepared an explanation of policy guides and measures. Of particular interest, Delos Johns (St. Louis) had asked why the FOMC did not use the money stock directly as the main policy guide.
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His question and others brought forth the most complete statement of operating procedures in many years. Emphasis was on control of money. “The money supply is the principal
quantitative
end of Federal Reserve policy, because System operations exercise their influence primarily through the money supply, although there are broader and more complex ultimate objectives” (Memo, Thomas to FOMC, Board Records, February 25, 1959, 1). The memo went on to explain that both the money stock and reserve measures varied unpredictably, so precise control of money was not feasible. Money stock projections influenced projections of required reserves and, in this way, affected projections for free reserves. The memo added that data on money were not available promptly but “perhaps more attention should be given to the customary broad seasonal changes than has been the practice” (ibid., 4). The memo indicated that control was subject to large errors both because of random fluctuations in free reserves, the variable link between the level of free reserves and the stocks of money and bank credit, and changes in velocity that alter the quantitative relation between money and ultimate goals such as output and the price level.

The memo also discussed the use of free reserves, money rates, and “feel of the market.” Free reserves served as both an indicator of the policy and a target, or in Thomas’s words, a “signal of policy objecti
ves and an instrument for obtaining them” (Memo, Thomas to FOMC, Board Records, February 25, 1959, 7). They were a measure of the degree of ease or tightness, not an objective. Monetary policy could change the degree of ease
or tightness by making banks borrow or by providing excess reserves. “No other data can so effectively serve this purpose” (ibid., 7). Changes in Treasury bill rates or the general tone of the market provided supplementary information. Often they indicated pressures that would later be reflected in measures of reserves and money. “Feel” may suggest that the distribution of free reserves between country and city banks made the market tighter or easier than suggested by the level of free reserves. The memo then considered the control problem. The manager controlled free reserves within a margin of ±$100 million. Further “response of credit markets to any particular level of free reserves may vary considerably from time to time, depending upon pressures for monetary expansion, shifts in anticipations, and other factors difficult to detect or measure” (ibid., 10).

228. See the Appendix for evidence of persistent sterilization of gold movements.

229. Several members asked why estimates of reserve needs made by the Board’s staff differed from New York’s estimates. The main reasons were that they used different measurement procedures. The Board used seasonal factors based on past history, where New York used predictions of the trend of deposits. Also, each used its own method of projecting Treasury deposits. The memo commented also on the control problem, emphasizing the difficulty of knowing whether a change is a temporary or persistent change in free reserves. Regrettably, this concern was not taken up.