A History of the Federal Reserve, Volume 2 (14 page)

The second immediate effect was to shorten the policy horizon. A decision could always be postponed for three weeks to get more information or reduce uncertainty. Occasional efforts to focus on long-term inflation failed, displaced by near-term considerations, especially Treasury finance. Meeting every three weeks gave members an opportunity to delay decisions until they had more information.

Managing
the
Manager

Martin’s 1952 ad hoc subcommittee also recommended that the account manager become an FOMC employee, instead of vice president of the New York bank. The open market account would remain in New York, but the manager would be responsible only to the FOMC and would have his own staff.

Sproul objected strongly when the FOMC discussed the issue in 1953, so the FOMC did not make a decision. After alerting Sproul by letter, Martin returned to the issue in February–March 1955. The Board’s general counsel pointed out “the Committee is neither specifically authorized nor forbidden to employ its own staff” (memo, George B. Vest to Board of Governors, Board files, January 4, 1955, 2). However, counsel raised questions about whether the FOMC could use its earnings to pay a staff. He
recommended that the Board get Congress to legislate, a step the Board usually was reluctant to take.
³⁶

35. Sproul’s intensity of feeling and distrust of Martin’s motives showed up in an exchange of letters about visitors from the Board to observe desk operations. Sproul accused Martin of sending “watchers” and argued that New York had “no other allegiance than to the Federal Open Market Committee, and no other purpose than to give effect to its policies” (Sproul to Martin, Sproul papers, FOMC Correspondence, January 4, 1952, 1). He then explained the reasons why a “watcher” would not work and should not be tried, ending with: “I would not want to have a ‘watcher’ in the house” (ibid., 3). Martin replied that he was “amused” by Sproul’s comments, that he had not used the word “watcher,” and that he did not intend to change the site of open market operations. Martin explained that he wanted more Board members and staff to understand how the market operated, and he included Treasury staff among the people who would gain from observing (Martin to Sproul, ibid., January 11, 1952). By June 1953, Sproul was “ready to accommodate such persons . . . [and] place them on our staff and payroll” (Sproul to Powell, Sproul papers, FOMC Correspondence, July 16, 1953, 3).

Martin placed the issue on the agenda for the March 2, 1955, FOMC meeting. He reiterated the importance of having a manager who was responsible to the FOMC and not to the New York directors.
³⁷
Further, “I want the whole Committee really to be responsible. I don’t want operational responsibility limited to the New York Bank or to the manager of the account. That is the fundamental reason I make this proposal” (FOMC Minutes, March 2, 1955, 64). Martin then moved that the manager “be made more directly responsible to the Open Market Committee as a whole” (ibid.).

Sproul argued that the proposal did not raise an issue of principle. The manager was responsible to the FOMC. The FOMC reviewed the budget and accounts relating to the manager’s work and, if it chose, could participate more fully in the budget process, the details of the manager’s operations, and supervision of the account. He argued that all major issues could be resolved without making the manager an FOMC (or Board) employee. Further, Sproul objected that Martin’s motion did not address operational issues. New York operated as fiscal agent of the Treasury and as agent for foreign central banks. He doubted that the manager’s open market operations could be kept entirely separate from these operations of the New York bank. Also, someone had to supervise the manager’s operation. Historically, New York had the responsibility. How would that change? Who would supervise? Finally, he questioned whether the System needed a new organization to make changes that would accomplish Martin’s objectives or to remove any special advantage that New York’s directors might have (ibid., 66–71).
³⁸
Rather, the change would be taken as evidence that New York had lost the confidence of others in the System.

36. Martin sent Vest’s letter to Sproul on February 14, 1955. Suggesting the state of relations, the letter addressed “Dear Mr. Sproul” and carried Martin’s full name (letter, Martin to Sproul, Sproul papers, FOMC Correspondence, February 14, 1955). Martin also sent a letter to all the presidents outlining the proposed change. He planned a two-step procedure, first, a decision in principle to make the change followed by appointment of a subcommittee to recommend how the change should be made (ibid.).

37. “His selection is put up to us by the Board of Directors of the Federal Reserve Bank of New York as the man they have selected, one whom they believe to be satisfactory” (FOMC Minutes, March 2, 1955, 62).

38. “From the beginning of the Federal Open Market Committee they [New York directors] forswore any knowledge of open market operations which is not available to the directors of other Federal Reserve banks, and the by-laws of the Federal Open Market Committee would not permit them to have such knowledge” (FOMC Minutes, March 2, 1955, 71). One reason for the intensity of feeling was that the issue reopened a conflict that had been present from the start of the System but had remained below the surface after the 1930s. From earliest times, the Board regarded the reserve banks as representative of bankers, and some of the banks regarded the Board as overly political. Martin’s claim that New York banks gained spe
cial advantage put New York on the defensive. Sproul cited the rules adopted by the New York bank that stated explicitly that “the board of directors under the by-laws and present practices of the Federal Open Market Committee cannot be informed adequately of the reasons for, or the possible extent and duration of, transactions in United States Government securities for account of the System Open Market Account” (letter, Sproul to Powell, Sproul papers, FOMC Correspondence, July 6, 1954). Sproul summarized New York’s procedure: “They [directors] have been told what has been done—in effect what appears in our weekly statements” (ibid., 1). Affirmations of this kind did not change Martin’s mind; he continued to press his argument. Possibly he remembered his father’s experience in the 1920s, when directors voted on open market purchases and sales decisions for the individual reserve banks. The Banking Act of 1933 removed that decision and with it the need for directors to know (and take) a decision. See also Sproul’s letter to Senator Paul Douglas (Sproul papers, FOMC Correspondence, March 11, 1954). Sproul wrote to object to Douglas’s reference to “private bankers” making decisions at FOMC. Sproul’s letter insisted that a reserve bank president was not the “representative of private bankers.” He closed by saying: “I represent nothing but the public interest when I sit in meetings of the Federal Open Market Committee” (ibid., 2).

A heated discussion followed in which Martin maintained that the current arrangement was unacceptable, and Sproul urged that they vote on a specific proposal, not a vague sense of dissatisfaction. He insisted that the manager was responsible to the whole committee and objected strenuously when Board members claimed the contrary.

Sproul moved that a committee study the status of the manager and his responsibility to the FOMC. The FOMC defeated the motion by a seven-tofour vote with one president voting with the Board. The committee then approved Martin’s motion to make the manager “more directly responsible to the open market committee” and appoint a subcommittee to bring back proposals to implement the new arrangement. This motion passed six-tofive with all presidents voting no (FOMC Minutes, March 2, 1955, 89–90). Subsequently, Martin appointed Canby Balderston, Watrous Irons (Dallas), Hugh Leach (Richmond), Martin, Robertson, and Sproul to propose a “structural and operating organization that will best implement the policies of the FOMC.” The new committee contained three members who had voted in favor and three who had opposed.

Martin proposed that the FOMC choose the manager and set his compensation. The manager would be an employee of the FOMC and responsible to its members. Operations would remain in New York, but the New York bank would lose its special position (memo, “Status of the manager of the System Open Market Account,” Board files, May 10, 1955). In October, Robertson went further. He endorsed Martin’s proposal, but he also partly addressed a problem that Sproul emphasized and Martin neglected. The twelve members of the FOMC could not supervise the manager. They would often disagree about what the loose wording of the FOMC directives
meant.
³⁹
Robertson proposed giving supervisory responsibility to the secretary of the FOMC, Winfield Riefler at the time. If the secretary and the manager disagreed, the FOMC would be asked to decide.

The special committee considered these and other proposals, but it could not agree on any. The manager remained a vice president of the New York bank.
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GUIDING PRINCIPLES

The Riefler-Burgess version of the real bills doctrine, which dominated policy decisions in the 1920s and 1930s, faded in the 1950s. It did not disappear entirely. Vestiges remained in concerns about speculative use of credit for housing and the stock market. Aside from stock market margin requirements, selective controls had expired. The Board used its authority to change stock market margin requirements more frequently from 1951 to 1960 than in any other decade.

Several factors contributed to the reduced role of the real bills doctrine. Government debt had grown in size. No one expected the government to retire a large share of the debt by running budget surpluses, as in the 1920s. Banks had become accustomed to holding government securities and, in a major departure from the principles embodied in the Federal Reserve Act, using Treasury bills instead of acceptances (real bills) to adjust their portfolios. Open market operations in governments had become the dominant means of changing bank reserves and the monetary base. Although discounting remained an important source of reserves in the 1950s, most often Treasury bills, not acceptances or commercial paper, served as collateral for discounts. Real bills declined in importance.

Changing
Views
about
Discounts

The Riefler-Burgess framework minimized the role of the discount rate. Banks borrowed only if necessary to meet reserve requirements. They did not borrow to take advantage of differences between the discount rate and lending or open market rates. The Federal Reserve ignored evidence con
tradicting this assumption until 1952, when banks borrowed relatively large amounts to take advantage of the spread in after-tax rates. Sproul summarized the then current position in a letter to Professor Elmer Wood.
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39. As long as the FOMC gave instructions such as “lean against the wind,” “resolve doubts on the side of ease” (restraint), and the like, the manager could exercise discretion, and he did. The eventual resolution of the problem came in the 1970s, when the FOMC began to give more precise instructions.

40. To increase scrutiny and monitoring of the manager’s daily decisions by FOMC members, Sproul responded to a suggestion by Governor Robertson and began a daily telephone call from the desk to the Board and to a reserve bank president currently voting on the FOMC. Calls began on June 1, 1954, and have continued to the present (Sproul papers, FOMC Correspondence, May 17, 1954).

Most often the discount rate and open market operations can be used together; the discount rate to symbolize the policy adopted, and open market operations to keep market rates and member bank borrowing in appropriate relation to the discount rate. At times of credit ease, this would mean sensitive money market rates below the discount rate and infrequent and minor borrowing in response to temporary needs of individual banks. At times of credit restraint, it would mean sensitive money market rates (except federal funds) at or maybe above the discount rate, with member banks having to borrow fairly frequently and in relatively large amounts so that, in the aggregate they would be in debt more or less continuously. (Sproul papers, Correspondence S–W, November 5, 1954, 2)
⁴²

The core concept remained. Sproul does not mention that advances against collateral had replaced borrowing on commercial paper. He retained the idea that restrictive policy drove banks to seek advances from the Federal Reserve. The Federal Reserve encouraged and might subsidize borrowing or advances by letting market rates rise above the discount rate. Conversely, when market rates declined in recession, the Federal Reserve penalized borrowing by making the discount rate a penalty rate.
⁴³
Thus, discount policy contributed to procyclical growth of money and bank credit.

41. Wood wrote to Sproul supporting Sproul’s opposition to the bills-only policy and urging the Federal Reserve to use the term structure of interest rates on government securities as the main policy guide. Sproul based his reply on a lengthy analysis by Robert Roosa, one of his staff (Sproul papers, FOMC Correspondence, October 26, 1954).

42. Sproul added a statement that makes sense only in the Riefl er-Burgess tradition. “There are different kinds of reserve dollars and differences in the response of the banking system to their availability. We should take advantage of these differences” (Sproul papers, Correspondence S–W, November 5, 1954, 2). In Riefl er-Burgess, the composition of reserves mattered. Banks used reserves supplied by open market operations to repay borrowing and expand. Reserves acquired by borrowing induced banks to contract, because they disliked indebtedness. In contrast, Madeline McWhinney (1952, 8) explained use of the discount window as a choice based on the cost and length of time for which the bank required additional reserves. Short-term demands could be satisfied by purchases of federal funds if they are “available in adequate volume at a satisfactory price.”

43. Another oddity is the treatment of uncertainty. Both Roosa and Sproul said that, at times, the Federal Reserve should create uncertainty about future interest rates as a substitute for changes in rates. “[I]f for any reason . . . it proves impracticable or impolitic at times to exert influences that will lead to sizeable changes in the rates themselves, then by working on the uncertainty band instead the central bank may be able to maintain something like the desired degree of pressure upon the availability of credit” (Sproul papers, FOMC Memo, Roosa to Sproul, October 26, 1954, 11).