A History of the Federal Reserve, Volume 2 (61 page)

The gold outflow continued at a higher level. Marget’s report to the January 10, 1961, FOMC showed sales of $1.2 billion in the fourth quarter (excluding the purchase from the IMF), and $130 million in the first week of January. Almost all the sales were to Europe, principally Britain and Switzerland, where gold markets were active. He now described the outflow as “flight from the dollar,” language he rejected earlier (FOMC Minutes, January 10, 1961, 10). Foreign governments had begun to convert dollar holdings into gold using the London and Zurich markets. The change occurred while the deficit on current and long-term capital transactions had fallen to an annual rate of $1 billion.

Few positions on FOMC changed. The consensus was to maintain the status quo without explaining what that meant. Robertson wanted more expansive action, but he did not dissent.

Martin changed the schedule in view of the new administration taking office. The FOMC met again two weeks later. Between meeting dates, President Kennedy signed an order prohibiting United States citizens from holding gold abroad, and the German Bundesbank lowered its discount rate to narrow the interest rate differential with the United States.

The FOMC was almost equally divided between raising short-term interest rates despite the continuing recession and maintaining the status quo, described in various ways. Only Bryan (Atlanta) and Robertson favored more expansive actions. Martin preferred less ease, but the consensus favored the status quo. He added that if the bill rate fell below 2 percent, the FOMC would hold a telephone conference to raise it.
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Soon after the new year the recession ended, and the gold outflow abated from $440 million in December to $320 million in January. A staff economist, Guy Noyes, told the FOMC at the February 7 meeting that the recession was near its trough. He anticipated decline for one additional quarter, followed by the start of recovery in the second quarter. Hayes disagreed.
He expected the recession to deepen, and to further put pressure on the dollar, if the budget deficit exceeded projections. In fact, real GNP rose at an annual rate of 4.2 percent in the first quarter. The price deflator was unchanged for the quarter, and the budget deficit was $3.8 billion for the year. FOMC members divided almost equally between those who favored a free reserve target and those who preferred to target an interest rate, usually the Treasury bill rate. Robertson objected to this reasoning. Raising short-term rates harmed the domestic economy. He believed that the capital outflow would reverse when the economy recovered and interest rates moved up, and he was skeptical of efforts to lower long-term rates while raising short-term rates. No one commented on his statement.
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74. The manager reported that the International Monetary Fund sold the United States Treasury $300 million in gold and invested the proceeds in Treasury securities. The New York Federal Reserve acted as fiscal agent with the Board’s approval. The Treasury agreed to resell the gold to the IMF at the price prevailing at the time of resale. The IMF did not have earnings sufficient to cover its expenditures. Some Board members expressed concern that the market might interpret the sale as support for the dollar. Previous transactions had been done in 1956 and 1959 (Board Minutes, December 5, 1960, 5–8).

75. President Frederick L. Deming (Minneapolis) reported onhis trip to Asia and Europe. Asians were not concerned about the dollar, but they feared a reduction in foreign aid for balance of payments reasons. Europeans were much more concerned, although concern had lessened recently. Confidence was delicately balanced (FOMC Minutes, January 24, 1961, 27–28).

Martin said the consensus was to keep the bill rate and the discount rate unchanged. He added that “free reserves may have outlived their usefulness” (FOMC Minutes, February 7, 1961, 41). Robertson dissented from the action. He agreed that Martin’s consensus reflected the group discussion, but he disagreed with the decision. Johns (St. Louis) was not a voting member, but he disagreed with the consensus also. He wanted faster growth of total reserves to speed recovery.

Despite the restrictive fiscal policy, the very modest rate of increase in nominal base money, a gradual reduction in short-term interest rates, and a hesitant and divided FOMC, the recession had remained mild. Zarnowitz and Moore (1986) score it as one of the mildest recessions in Federal Reserve history. Although the new administration was slow to recognize its end, the recession trough came in February one month after they took office. By December 1961, industrial production was 10 percent above the previous year.

END OF BILLS-ONLY

Following the election, pressure on the Federal Reserve to abandon billsonly increased. Critics again called the Federal Reserve doctrinaire and gave more attention to this aspect of the System’s operating procedure than seems warranted. Some of the pressure to change came from a desire to experiment with a policy of reducing the capital outflow by raising short-term rates while encouraging investment and recovery by lowering long-term rates. The Federal Reserve had taken some tentative steps in
that direction the previous November by buying some longer-term issues while generally keeping the bill rate above 2.25 percent and by formally eliminating the bills-only operating procedures in December 1960, a few weeks after the election.

76. This was the last meeting for Hugh Leach, president of the Richmond bank. He had served for twenty-five years. He praised the System’s actions since the spring then added, “[T]here was much room for improvement in the manner of handling the directive to the New York bank” (FOMC Minutes, February 7, 1961, 30). Edward A. Wayne succeeded him. George H. Ellis replaced Joseph Erickson at the Boston bank, and George Clay replaced H. G. Leedy
at Kansas City.

The timing was not accidental. The Democrats in Congress and Kennedy in his campaign had criticized bills-only sharply and repeatedly. Prior to his inauguration, President Kennedy appointed domestic and international policy task forces, chaired by Paul Samuelson and Allan Sproul respectively. Sproul had opposed bills-only from the start, so it was no surprise that both committee reports favored abandonment. Samuelson’s report also favored “operation twist,” an effort to change the relation of short- to long-term interest rates by buying one and selling the other and restricting the Treasury to sell only Treasury bills. Sproul’s report expressed concern about changing the average maturity of Treasury debt
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(Oral History Interview, 1964, James Tobin, August 1, 208–9).

The next step was to get an agreement with the Federal Reserve. “Before the inauguration, Kennedy asked me [Heller] to go over and visit with Bill Martin to assess whether he would be cooperative or obstructionist. . . . I met Bill and was just enormously taken with him. He pledged, ‘I’m not going to give up the independence of the Fed.’ I said, ‘Well I’m sure that’s not what the President’s going to ask you to do.’ But Martin added ‘There’s plenty of room here for cooperation’” (Hargrove and Morley, 1984, 189).
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Separately, Treasury Secretary–designate Douglas Dillon told the president-elect about the regular meetings that President Eisenhower held
with Chairman Martin, the Secretary of the Treasury, director of the Budget Bureau, and chairman of the Council of Economic Advisers. These meetings, without a formal agenda, gave “the President an opportunity to hear at first hand the views of the senior officials of the government most intimately connected with economic problems [and] also served as a mechanism tying the Federal Reserve Board more closely in with the executive branch” (memo, Dillon to Kennedy, Dillon papers, Box 33, January 17, 1961).

77. George W. Ball headed a third task force on gold and the balance of payments. “I have always assumed that Bob Roosa got Doug Dillon to get JFK to appoint the Sproul task force. Bob and his friends were afraid about what the Samuelson task force might say about domestic policy and what the Ball task force might say about gold and the balance of payments. . . . I think the idea was to have a sound committee which would reassure the financial community here and abroad. . . . I went to see him [Roosa] at least once in New York at the Fed bank [before inauguration]. He was an old friend and I expected we could work together. But it was soon apparent that he regarded me as an enemy and a threat” (Oral History Interview, 1964, James Tobin, August 1, 208–9). Tobin added these remarks when he reviewed his oral history transcript. My own experience supplements his interpretation. Shortly after the Kennedy administration came into office, Robert Roosa became Undersecretary of the Treasury. He hired me (about February) to serve on his staff to counter the staff work at the Council. I arrived in late May or early June after classes ended. By that time, Roosa was confident of the Treasury’s influence in the administration. He did not have much for me to do, so he gave me mail to answer. I had excluded this assignment when I agreed to come. I resigned and became a part-time consultant for a year or so.

78. Heller added that he came to Washington dubious about Federal Reserve independence but came out believing that world was prone to inflation, so it was very useful to have an independent central bank not subject to elections. This is very much in the spirit of Rogoff’s (1985) case for a conservative central banker.

In a memo soon after the new administration took office, Heller reminded the president of the proposal. “The current task of monetary policy and debt management is to achieve the credit expansion our domestic economy requires without impairing our ability to hold and to attract internationally mobile liquid funds. Reduction of long-term interest rates relative to short-term rates is within the present capacity of the Federal Reserve System and the Treasury” (Heller to the president, Heller papers, Box 19, January 25, 1961).
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Martin and Roosa tried to weaken the commitment in the president’s statement, and Dillon warned that “there are limitations to what can be accomplished” (memo to the president, Dillon papers, Box 33, January 31, 1961). He reminded the president that the Federal Reserve would make the change; “it would seem advisable to avoid any public implication that they are taking these new steps as a result of outside pressure” (ibid.). President Kennedy did not take that advice. In his first economic message on February 2, he asked for lower long-term and higher short-term rates. Martin had agreed to the language in the statement, although the FOMC had not yet acted (Oral History Interview, 1964, Tobin, August 1, 212).

Martin had to get his colleagues on FOMC to accept the change. He presented the issue in executive session as a political issue. The System was under attack for being uncompromising. It had to show that it was open-minded and willing to experiment “to enable the System to escape from the charge of doctrinaire commitment to a laissez faire, free private market position” (FOMC Minutes, February 7, 1961, 45). He was doubtful about the outcome, but he saw no other way to respond.
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This was a

79. Heller also proposed that the Treasury should borrow at the short end, that regulation Q ceiling rates should be removed, and that special issues of short-term securities should be offered to foreign central banks and governments. Heller gave Robert Roosa (not James Tobin) credit for proposing the “twist” of the yield curve (Hargrove and Morley, 1984, 190). The New York bank had favored such operations during the bills-only years. Heller reminded the Federal Reserve frequently about the importance of purchasing long-term securities. Apparently, he failed to convince the Treasury. In 1962, they used advanced refunding of debt to lengthen average maturity of the outstanding government debt.

80.
Newsweek
sent one of its editors to question Martin about his commitment to the

step back from his 1953 speech about free markets and further evidence of willingness to reduce independence.

Robert Rouse, the manager, had prepared a report of a subcommittee on these issues. It called for authority to trade in securities of up to 10 years maturity, concentrating at first in the 1- to 5.5-year maturities. Transactions would not affect reserves. He described the actions as an experiment, with quantities limited to “$400 million securities maturing beyond fifteen months and up to five and one-half years, and an additional $100 million securities maturing . . . up to ten years” (FOMC Minutes, February 7, 1961, 50). Rouse suggested that they announce the change “in the light of changes in the international and domestic situations” (ibid.). Ralph Young, a senior adviser to Martin, opposed the change as a return to pegging.
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Allen (Chicago) commented first. Since this was an interim report, “he welcomed the opportunity to study the recommendations which he had just heard on such an important subject” (ibid., 51). Martin had made a commitment, however, and wanted no delay; he responded that “a decision would have to be made at the present meeting” (ibid., 51). Allen did not have a vote, but he said he was opposed. He added that if the committee voted to make the change, they should announce it.

Martin spoke early, an unusual step taken only when he wanted a specific action. He favored the change and opposed the announcement. Hayes (New York), Johns (St. Louis), Bopp (Philadelphia), Robertson, and Shephardson favored announcing the change, but Martin resisted with uncharacteristic force. Several of the members expressed doubt that the change would have much effect. No one mentioned that the FOMC in the 1930s had considerable experience with buying long-term and selling short-term securities.

The committee allowed the alternate members to vote. The vote was fifteen to one, with one president absent. Robertson voted no. His principal reason was that the FOMC had based its existing procedures on careful
analytic and empirical work. These procedures worked. By making the change, the FOMC “was asserting, without reason or conviction, that it made a critically incorrect judgment eight years ago and had pursued incorrect operating procedures since” (ibid., 59). He objected, also, that the new procedures gave “practically unlimited authority to the Manager . . . for the stated purpose of affecting rates as distinguished from providing or withdrawing reserves” (ibid., 60).

administration’s policy. Martin told him that he took the initiative to cooperate with the administration. “I will wholeheartedly make an effort to see that this new policy is operating. . . . There are 12 bank presidents and six other board members . . . and some of them are quite unhappy about this” (memo to the files, Heller papers, February 23, 1961). Martin said he was not certain that the policy would reduce long-term interest rates, but “he did not want the Fed to be considered ‘obstructionist.’” (ibid.)

81. After the meeting, Rouse sent a memo suggesting that the FOMC could control the yield curve (relation of short- to long-term debt.) Young opposed on two grounds. It would become a movable peg, and the relation of investment to long-term interest rates was not as close as Rouse claimed (memo, Young to Martin, Board Records, Februar
y 20, 1961).