A History of the Federal Reserve, Volume 2 (73 page)

The staff of the New York bank considered several ways of offsetting large temporary changes in float. It rejected frequent changes in reserve requirement ratios, offsetting changes in Treasury balances, and purchases and sales of federal funds. It proposed a new instrument—reverse repurchase agreements with government security dealers. The Federal Reserve could absorb reserves by selling securities with a fixed term for repurchase. This would avoid dealing with individual firms other than dealers.
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The New York bank would pay interest on the “loan” from the dealers, just as it received interest on repurchase agreements. The New York bank did the transaction for its own account and did not share interest paid and received with other reserve banks.

All the major concerns of 1961 continued in 1962. The FOMC became more divided between those who wanted to tighten and those who favored greater ease. Hayes led the first group. Although people shifted position, usually Deming (Minneapolis), Fleming (Cleveland), Shephardson, and Ellis (Boston) joined him. This group emphasized the balance of payments deficit and the gold outflow. Mitchell and Robertson, later joined by Mills, led the opposition. They favored lower interest rates to stimulate domestic growth. Each side had a legislated mandate, the Bretton Woods Agreement on one side, the Employment Act on the other. Martin tried to balance the two groups, although he often agreed with Hayes’s concerns. His own position, stated many times, was that the domestic and international problems were inseparable. The balance of payments problem was “the biggest single shadow looming over the domestic business picture” (FOMC Minutes, December 18, 1962, 61).
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Greater ease would destroy confidence in
the dollar, damaging the economy and reducing employment. Raising the short-term interest rate would improve confidence (ibid., 62).

178. The System did not do repurchase agreements with dealer banks, only with nonbank dealers. The latter could recall the securities that the desk repurchased at any time, but the new proposal called for fixed duration of the reverse repurchase agreement. The desk could not use the securities in the open market account since the account was the property of all reserve banks while reverse repurchases were done for the New York bank’s own account.

179. Administration economists continued to press Martin for more expansion and more purchases of long-term debt. Early in the year, they forecast 7.5 percent growth of the real economy in 1962. The Board’s staff forecast called for 5 percent. Actual growth for the four quarters was 3.2 percent. Note that the Board’s staff started to forecast GNP growth and inflation, a marked departure from earlier practice. Although Martin had little confidence in forecasts, he permitted the staff to make them, possibly as a defense against the administration.

Some FOMC members shifted sides with changes in employment, output, balance of payments, and factors such as the Cuban missile crisis (October), stock market collapse (May), floating of the Canadian dollar (June), and the president’s decision to call for lower tax rates followed by his decision to postpone tax rate reduction until 1963. At year-end 1962, the FOMC remained closely divided. It approved maintaining current policy (status quo) by nine to three on September 11, and seven to five on December 4. The November 13 meeting voted six to five to tighten policy, until Robertson changed his vote to support no change.
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Five dissents was rare.

Status quo, no change, or slightly less ease did not have a common meaning shared by all FOMC members. Some used free reserves, others interest rates or total reserves. Several used more than one target without mentioning how to resolve discrepancies between them. This left the account manager to decide. “Color, tone and feel” also gave the manager discretion.

If the desk failed to carry out the instructions that the members approved, did a vote for “no change” mean no change from the outcome or no change from the policy that members intended? Martin claimed no change in intention, but Mills thought it should mean no change in outcome (FOMC Minutes, December 4, 1962, 55–56). The difference was large at times because outcomes differed from intentions.

Ambiguities in the discussion and the directive and failure to define terms like “ease,” “restraint,” and “no change” also gave considerable discretion to the manager. Nevertheless, changes in free reserves remained broadly consistent with the FOMC’s intent, and bill rates remained in a narrow range.
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Actual policy was a compromise. The narrow range for the Treasury
bill rate (2.7 to 2.9 percent) reflected the decision to reduce short-term capital outflows, and the positive level of free reserves showed the FOMC’s intention to encourage growth of bank reserves, bank credit, and money. Although Martin said that policy wasn’t effectively carried out by small and indecisive moves, policy for 1962, using the principal indicators on which the Federal Reserve relied, was both cautious and indecisive. The minutes note, however, that the monetary base and the money stock, currency and demand deposits, rose more rapidly than in the recent past. For the year to December 1962, monetary base growth reached 3.79 percent, the highest annual rate of growth in a decade. The money stock did not increase until the second half of the year, but the rate of increase then reached 6 percent.
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180. At the November 13, 1962, meeting less ease lost seven to four, with Martin, Balderston, Fulton (Cleveland), and Hayes voting for less ease. Martin was in the minority, an exceptional outcome. The next vote was for more ease. It lost seven to three, with one abstention (Bryan). Mills, Mitchell, and Robertson favored greater ease.

181. Treasury bill rates changed very little but in the direction consistent with FOMC decisions. The decline prior to the June 19 meeting reflects possible market response to the large (percentage) stock market decline on May 28 and the manager’s decision to let free reserves increase. The decline in the stock market was the largest since 1929, with 9.4 million shares traded. This was considered large volume at the time. The FOMC voted on May 29 to keep policy unchanged. As noted in Brunner and Meltzer (1964), the manager often moved ahead of the FOMC in the early 1960s. On May 29 President Kennedy asked Chairman Martin to reduce stock market margin requirements (FOMC Minutes, May 29, 1962, 39). Martin told Kennedy that the Board had decided the day before to leave margin requirements unchanged. Kennedy accepted its judgment but he asked for a public explanation. The FOMC
was reluctant. The Board acted soon after, on July 9, reducing margin requirements
to 50 from 70 percent.

Outside the Federal Reserve, many business leaders expressed concern about prolonged easy money. The Federal Advisory Council told the Board to give greater weight to the balance of payments and “the threat confronting the dollar” (Board Minutes, May 1, 1962, 7). The vice chairman of the Dallas Federal Reserve Bank warned the Dallas board and the Board of Governors about excessive ease (FOMC Minutes, June 19, 1962, 14). Comments of this kind strengthened the case for tighter policy without immediate effect. Martin made the same case. “Monetary policy has done what it can do to help the recovery. . . . [I]t was easy to get into a pattern of activity where we think that, by just easing money or increasing expenditures or raising a deficit, we can achieve certain things (FOMC Minutes, July 10, 1962, 42).
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By midsummer, concerns about recession began to be reflected in private forecasts and FOMC members’ statements. The division between those
who emphasized the balance of payments and others principally concerned about the domestic economy prevented any action. Martin argued that easy money could make matters worse by fostering lax loan standards and borrowing for unprofitable projects (FOMC Minutes, July 31,
1962, 34).

182. Opinions about the role of money covered a wide range. Bryan (Atlanta), Woodlief Thomas, and at times others wanted reserves and money to rise at the rate of growth of output. Ellis (Boston) said reserves had increased at an unsustainable rate. Mitchell thought money growth was not important but because people paid attention to it, the Federal Reserve had to be concerned about public relations (FOMC Minutes, December 18, 1962, 39 and 57).

183. Heller arranged a meeting of the Quadriad on July 30, so that President Kennedy could talk to Chairman Martin about Heller’s concern that the Federal Reserve had become more restrictive. According to Heller’s memo, Martin said that policy had not changed. Later, when asked by the president when the change occurred, Martin said June 19. He explained that European developments had led to a run on the dollar that ended when the president spoke to the Europeans on television via satellite (for the first time.) Martin denied that domestic policy was restrictive and said he was more optimistic than his staff about prospects for the economy (Minutes of the Quadriad, Heller papers, Box 19, July 30, 1962). Heller may have misunderstood Martin because earlier Martin told the FOMC that “there had been a great deal of ease, and . . . lately there had been a little less ease” (FOMC Minutes, July 10, 1962, 42–43).

Concerns about recession stimulated discussions of a quick tax cut to increase spending instead of a permanent tax cut to expand economic potential. Early in June, President Kennedy announced that he would ask Congress to reduce individual and corporate tax rates.
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To get support Kennedy met with Congressman Wilbur Mills, chairman of the House Ways and Means Committee, with businessmen and with his advisers. Mills did not support tax reduction, nor did Senator Harry Byrd and many other members of Congress. Mills said he would not rely on economic forecasts but would consider tax reduction if a recession occurred. The businessmen favored higher interest rates to attract foreign capital, tax reduction to increase domestic spending, and a limit on government spending to hold down the budget deficit
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(Kennedy, 2001b, 337–38). They favored separating tax reform from tax reduction to avoid long delays while Congress debated tax reform. In a television address on August 13, Kennedy retreated temporarily. He withdrew the proposal for a quick tax cut but reaffirmed his request for a permanent tax cut and tax reform in January 1963.
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The timing would strengthen the economy in the 1964 election year.

184. Kennedy rejected tax cutting at the start of his administration to avoid conflict with his call for sacrifice in his inaugural address. He had not yet accepted the argument in favor of a large budget deficit during a recession. By spring 1962, he reconsidered, and on June 7, 1962, he announced his intention to seek a tax cut that would increase the current deficit. On June 11, at Yale, he accepted the Keynesian logic, taught to him by his economic advisers, arguing that deficits and government debt were not always bad and not to be avoided in recessions (Kennedy, 2001b, 363).

185. The group was led by Allan Sproul, formerly president of the New York Federal Reserve Bank. They told the president that his administration’s balance of payments program did “not add up to a program which is easily understood and which gives assurance of strong purpose and ultimate success” (Kennedy, 2001b, 338).

186. In 1962, the administration changed depreciation schedules (Bulletin F) to permit faster write-off of equipment, and Congress approved an investment tax credit to encourage investment by permitting companies that invested to reduce tax payments. These programs added $2.5 to $3 billion to corporate cash flow (Kennedy, 2001b, n. 27). The investment tax credit had not been used before. The Federal Advisory Council was skeptical about the effectiveness of such measures. They explained that most large companies had “a depreciation rate equal to or in excess of that provided by the bulletin. There was not much enthusiasm for the tax credit” (Board Minutes, September 18, 1962, 10). Real investment in equipment rose 12.8 percent in 1962 and 7.2 percent in 1963, but profits rose 10.7 percent in 1962 and 5.7 percent in 1963. The FAC was much more enthusiastic about tax reform and tax reduction (Board Minutes, November 20, 1962, 2). The members preferred tax and spending reduction, but most wanted tax reduction even if the budget deficit increased.

When some Federal Reserve officials argued that monetary policy could do nothing to increase output, they often used a structural argument. Automation and the use of computers left the labor force unable to fill jobs that became available. By extension, the balance of payments deficit resulted from inability to produce exports at competitive prices. Such arguments were very common in the early 1960s. At the September 11 FOMC meeting, President Edward Wayne (Richmond) was explicit. The committee faced less than satisfactory domestic expansion and a persistent external imbalance. The fact that neither problem disappeared meant that they could not be solved by monetary policy. They were “structural elements not susceptible to solution through purely monetary and credit action.” Attacking one problem only made the other worse (FOMC Minutes, September 11, 1962, 24–25). Shephardson, Balderston, and King agreed.
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No one pointed out that the last part of Wayne’s argument contradicted the claim that monetary policy would have no effect.

Mitchell, Robertson, and Mills offered an alternative interpretation, one that coincided with administration views.
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They regarded unemployment and slow growth as a consequence of insufficient demand. They regularly called for more monetary expansion or lower market rates. In addition to this clash of views, a third group led by Hayes, probably reflecting views of principal New York bankers, wanted to give priority to the balance of payments. He regularly called for tighter policy. Martin often joined with him in principle, but he faced opposing pressures from the administration and the Congress.
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187. Martin held a different but related view at times. He claimed that the United States was not competitive. The problems were structural and could not be solved by monetary policy, but he often put more emphasis on confidence than on structure. Fulton (Cleveland) “did not pretend to know exactly what was wrong with the economy or the specific cure, [but] the policy that had been followed seemed to be favorable to the general situation” (FOMC Minutes, September 11, 1962, 34). Another remark came from Governor King: “The Committee’s policy was to permit a further increase in the money supply, whereas the narrowly defined money supply had been static or contracting. . . . [H]e felt that some change [in the directive] was in order” (FOMC Minutes, October 2, 1962, 19).

188. Heller sent a memo to the president on November 17 to brief him on a meeting the three members of the Council of Economic Advisers held with George Mitchell, described in the memo as “your one-man minority on the Board of Governors” (memo for the president, Heller papers, Box 19, November 17, 1962, 2). Mitchell had provided Heller with a copy of his statement at the FOMC meeting earlier that week in which he warned about the effect of a sudden run on the dollar. Mitchell warned that if the run occurred, the Federal Reserve would tighten credit “drastically.”

189. Martin was never doctrinaire and often claimed not to know what to do. He relied on his judgment more than on statistics or economic analysis. And he praised Robertson, Mitchell, and Mills for clear statements of their position, though he did not agree with them. An example is his lengthy statement in FOMC Minutes, September 11, 1962, 41–42. This is a longer version of several statements made at the time.