A History of the Federal Reserve, Volume 2 (32 page)

The committee voted nine to one to change the directive to “fostering sustainable growth . . . without inflation, by moderating the pressure on bank reserves” (FOMC Minutes, November 12, 1957, 53). Martin and several others favored a 0.5 percentage point reduction in the discount rate to 3 percent within a few weeks and free reserves of –$100 to –$250 million.
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Governor Robertson cast the dissenting vote. He called attention to “inflationary potentials” and the need for continued restraint (ibid., 54).

The reserve banks did not wait weeks to vote reductions in their discount rates. The day after the FOMC meeting Undersecretary Baird met with the Board to express concern that the Board’s upcoming action would not be known in the market when the Treasury announced its securities offering that afternoon. He wanted the Board to announce the easier policy so that he could get a lower rate on his sale (Board Minutes, November 13, 1957, 1–2). The Board would not make an announcement, but it agreed to announce the discount rate changes, if the reserve banks voted for them. The Treasury agreed to delay its offering. The following day, Richmond, Atlanta, and St. Louis voted to lower their discount rates to 3 percent. New York voted for 3.25 percent, but the Board would not approve. New York reconsidered and voted “reluctantly” for a 3 percent rate (Board Minutes, November 14, 1957, 8). By December 2, a uniform 3 percent rate prevailed. Rates at the weekly Treasury auction declined very little.

Governor Robertson voted against the reductions.
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He did not see the need for a lower rate. The “dangers of continuing inflation are as great today as the dangers of deflation” (ibid., 8). He also disliked the assistance given to the Treasury by reducing the rate just before the Treasury offering. Although he acknowledged that “fiscal and monetary operations must be appropriately coordinated, the facilitation of Treasury financing operations should never be the sole motive” (ibid., 9).

191. At about this time, the Federal Advisory Council reversed its earlier position, recognizing that a moderate decline had begun. They anticipated that the decline would continue for the rest of the year and the first half of 1958. They blamed “international events,” probably a reference to the increase in oil prices and the Soviet Union’s achievement in space. Several members criticized the discount rate reduction made the previous week. They wanted more reserves. Although they did not say so, lower interest rates and increased reserves had opposite initial effects on bank earnings (Board Minutes, November 19, 1957).

192. The staff reported an unemployment rate of 4.6 percent, a 0.4 percentage point increase, and rapidly rising claims for unemployment compensation. Consumer prices continued to rise at a 4.2 percent annualized rate in November. The twelve-month rate of inflation had fallen to 3.2 percent from a peak of 3.7 percent in March and April 1957.

193. In an unusual gesture, Robertson dissented again, when the FOMC renewed the directive without change at the December 3 meeting.

The last comment drew a response from Martin. He defended the action as preemptive against a “deteriorating trend” in the economy. The System acted to “play fair and open with the investing public” (ibid., 9–10). Clearly, the Treasury, not the public, would benefit directly. The action was a direct attempt to lower interest cost and, therefore, inconsistent with the usual even keel policy and the principles of the Accord. Chart 2.8 (above) shows the decline in the federal funds rate that began at this time. Growth of the monetary base increased in December.

The next move came in mid-December. For the first time, Ralph Young described the decline as a recession, and Woodlief Thomas warned that reserves should be increased. Chairman Martin did not wait to speak last. Following the gloomy staff reports, he proposed a change in the directive. This was the last meeting of the year, so the change would appear in the Board’s Annual Report for 1957 (FOMC Minutes, December 17, 1957, 12). Hayes agreed and proposed mentioning recession in the action clause so the System would appear alert when the report appeared in the winter.

The statement called for “cushioning adjustments and mitigating recessionary tendencies” (ibid., 44). Although the members had expressed different opinions, no one dissented. Martin then agreed with the slim majority that favored zero free reserves, a less restrictive position than many wanted. Only Watrous Irons (Dallas) expressed reservations.
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During the winter, the recession worsened considerably. In November, December, and January, industrial production fell at about a 25 percent annual rate. Unemployment rose to 5.8 percent, more than two percentage points above its trough and the highest rate in nine years. Monthly consumer price inflation rates fluctuated, but the annual rate remained between 3 and 3.5 percent. The System faced a simultaneous rise in prices and unemployment, later called “stagflation.”

The FOMC took no action at the January 7 meeting. Opinion was divided. The staff and some members said the recession had worsened, but they expressed concern about inflation also. Others opposed any policy change. Lacking a consensus, Martin proposed to err on the side of ease but keep the directive unchanged.

Free reserves increased as banks repaid their indebtedness. At first, short-term market rates remained in a narrow range unrelated to the level
of free reserves. As Chart 2.12 shows, this changed in the winter of 1958. Interest rates fell as free reserves rose. Expost real, short-term rates became negative.

194. Since this was the last meeting of 1957, the chairman looked back and forward. Despite the recession, he described himself as more optimistic than a year earlier. The main reason he gave was that a year earlier, the Federal Reserve had stood alone against inflation. It had been in danger of becoming too narrowly focused on that one goal, becoming “a crusader against inflation and . . . [unable] to reverse its posture in time” (FOMC Minutes, December 17, 1957, 40–41). The reason for optimism was that the System had responded flexibly.

A main reason for the change was an increase in growth of the (seasonally adjusted) monetary base in February and a reduction in discount rates. The latter started as a decision by the Philadelphia directors, on January 16, to reduce their rate to 2.75 percent.
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The Board’s staff favored the reduction. They expected the economy to continue declining. The Treasury would soon be in the market, but there was time to make the change. With the bill rate almost 0.5 percentage points below the discount rate, the market anticipated the move. Governor Szymczak wanted to wait until after the Treasury financing; Governor Mills wanted to act. The Board postponed its decision but agreed to notify all other banks of Philadelphia’s request.

Four days later it approved the reduction on a four-to-two vote with Szymczak and Robertson opposed. Treasury bill rates declined by 0.5 percentage points (to 2.59) at the next weekly auction. Szymczak opposed because the Treasury would soon offer securities for sale. The Board had accommodated the Treasury in December. Another reduction timed before a Treasury offer risked “giving the impression that that is a pattern to be followed” (Board Minutes, January 21, 1958, 11). Robertson’s reasoning differed. In a prescient warning about the problems of the 1970s, he pointed to the risk of continuing inflation. “Up to this time there has been no general downward readjustment of . . . prices, and if we move too rap
idly to ease the downturn, we will be in a position of placing a floor under existing high prices and our country’s history will be one of moving from one high price level to another” (ibid., 12).

195. Boston, New York, and Minneapolis had voted for no change.

Within a few weeks all banks except San Francisco reduced their discount rates to 2.75 percent. Earlier in January, the Board reduced stock market margin requirements from 70 to 50 percent. The vote was unanimous. These actions, signaling the Board’s intention to respond to the recession by reducing interest rates and encouraging higher asset prices, produced the first monthly increase in the S&P index in six months.

The FOMC minutes continued to report deepening recession, mainly in the capital goods sector. As the decline deepened, attitudes within the System began to change. Hayes now told the FOMC it should “give major attention to the unfavorable realities of the present rather than the possible resumption of an inflationary threat in the future” (FOMC Minutes, January 28, 1958, 9). Later in the meeting, Hayes added that the New York directors believed that “the System had not done enough in the way of open market operations or otherwise” (ibid., 42).
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Erickson (Boston), Williams (Philadelphia), Bryan (Atlanta), Johns (St. Louis), and Fulton (Cleveland) supported Hayes. There was strong opposition from Robertson and Shephardson at the Board, and Irons (Dallas). Allen (Chicago), Deming (Minneapolis), and Mangels (San Francisco) made a spirited defense of inaction. Allen said he opposed the recent reduction in discount rates and urged the committee to give more weight to price stability.
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Hayes criticized use of free reserves as a target. If retained, the level should be raised but, in a statement showing that he chose the arguments that made his case, he cautioned that “we might find ourselves successfully maintaining this target while total reserves and the total money supply were still shrinking. Therefore, I would urge emphatically, as suggested by Malcolm Bryan at the last meeting, we try to devise a new type of guide for open market policy under present conditions that will focus attention on the
total reserve and the money supply rather than the amount of free reserves” (ibid., 11). Martin took no part in this discussion. The Treasury would soon come to market. The System followed an even keel until the next meeting.

196. Martin’s response seems uncharacteristically sharp, reflecting his sensitivity. “We should never get into the record that the directors of a reserve bank were recommending a change in reserve requirements since many directors are also bankers. . . . [T]his had come up on the Hill a number of times. . . . He was defending all of the Committee members and the presidents against the charge of being dominated by the bankers” (FOMC Minutes, January 28, 1958, 43).

197. Allen correctly saw that the market would recognize that unemployment was the primary concern. “I do not feel that the Committee’s actions of the past several months have made the contribution which they might have made in that direction. . . . [We would have] a better chance of winning out against inflation if our easing policy were not proceeding so rapidly today” (FOMC Minutes, January 28, 195
8, 20).

Staff reports remained bleak. There was no sign of an upturn, but there was also no consensus within the FOMC. The division that emerged in January remained in February. Hayes opposed reducing the discount rate. Robertson argued that the System had done as much as credit easing could do, pointing to the decline in nominal short-term interest rates as evidence. He urged the members to “give our previous actions a little time to take effect.” Using words reminiscent of the 1920s, he worried that excessive ease (“overease”) “would so contribute to misguided financial decisions that it would enhance the likelihood of the economy having to go through a protracted period of severe liquidation and structural realignment before it recovers” (FOMC Minutes, February 11, 1958, 18).

Martin summarized the consensus as relatively optimistic. He opposed another reduction in discount rates because it would suggest that the System was in a panic. He favored continuing the even keel policy, leaning toward ease. Despite expressed differences no one dissented.
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Congress was likely to hold hearings to highlight differences.

Neither Congress nor the Federal Advisory Council was optimistic about recovery. During the winter the Board received letters, and undoubtedly verbal suggestions, from members of Congress urging more aggressive action.
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The FAC favored moderately easier credit, including a reduction in reserve requirement ratios. Most members argued that lower interest rates should be reinforced by increased availability of reserves. The proper action would be open market purchases; it recognized that lower reserve requirement ratios, with interest rates unchanged, would increase bank earnings but not bank reserves.
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198. The FOMC discussed the preliminary report of a System committee that studied float. One recommendation called for less attention to fl oat—offset only “unusual fluctuations,” leaving the market to adjust to others. The manager, Rouse, was hesitant. Another recommendation called for a longer period of deferred availability credit, basically an interestfree loan to the banks during the check collection process. The only decision asked the manager to provide daily data for further study. The discussion did not join the issue between those who wanted to focus on the main goals of policy and those who believed the System should concern itself with daily or hourly fluctuations in the money market.

199. One letter from Congressman Wilbur Mills, chairman of the Ways and Means committee, reflected the agreement with the administration to work together on tax reduction. Mills reminded Martin that he had asked that the “monetary authorities should be given an opportunity to cope with recessionary trends before tax reduction was undertaken” (Board Minutes, January 20, 1958, 2, letter, Mills to Martin). Mills reported also that bankers believed that “Federal Reserve actions had not been sufficiently vigorous” (ibid., 2).

200. The FAC preferred monetary to fiscal measures. “A substantial reduction in taxes
and a sharp acceleration in the rate and magnitude of government expenditures might curtail and soon reverse the continued downtrend in business which the Council anticipates. However, the ultimate cost to the economy of such extreme measures might be significantly greater than the short-run advantages” (Board Minutes, February 18, 1958, 2).