A History of the Federal Reserve, Volume 2 (57 page)

Congress did not pass the 1976 Humphrey-Hawkins bill. Instead, in 1977 it amended the Federal Reserve Act to incorporate the provisions of Resolution 133.

The following year, Congressman Henry Reuss introduced legislation that added to the reporting requirements of Resolution 133, restricted Federal Reserve officials from encouraging banks and financial institutions to support or oppose legislation, and regulated potential conflicts of interest of reserve bank board members. The bill called for a Federal Reserve forecast of interest rates and monetary velocity for twelve months ahead and quarterly projections of the System’s portfolio composition.

Burns testified against these new requirements and endorsed the practice under Resolution 133. The Board accepted the provisions broadening the categories of individuals being considered as directors of the reserve banks and providing for Senate confirmation of the chair and vice chair of the Board. But Burns objected strongly to prohibiting discussions of pending and proposed legislation with representatives of banks and financial institutions. And he opposed the provision putting reserve bank officers and directors under the conflict of interest provisions of the criminal code on grounds that they should not be treated distinctly (“Statement to Congress,”
Federal
Reserve
Bulletin,
August 1977, 717–21).
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The final bill reflected many of Burns’s and the Board’s objections.

Efforts by Congress to make the Federal Reserve more accountable and to reduce unemployment and inflation continued. By 1978, the HumphreyHawkins Act had become less inflationary. The target unemployment rate was now 4 percent; government was no longer the employer of last resort, avoiding inflation received greater attention, but reducing unemployment remained the principal objective. The House passed the bill without adding a numerical inflation target. The Senate bill set the target at 3 percent or less to be achieved by 1983. Both the House and Senate bills required the Federal Reserve to set targets for monetary policy that it believed were
consistent with the act.
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Administration direction or guidance for monetary policy did not remain.

180. In May, Chairman Burns testified in the hearings under Resolution 133. Senator William Proxmire pointed to a change in the Humphrey-Hawkins bill. The goal was a 3 percent adult unemployment rate. Burns rejected the proposal or any numerical proposal (Senate Committee on Banking, Housing, and Urban Affairs, 1976a).

181. The restriction on lobbying bankers was a response to the Banking Committee’s access to minutes of the reserve bank directors meeting where much information about lobbying appeared (House of Representat
ives, 1977, 15).

In spring 1978, William Miller replaced Arthur Burns. He testified in favor of the general objectives of the act. Like his predecessor, he opposed numerical targets. And he emphasized the importance of reducing unemployment and inflation (Senate Committee on Banking, Housing and Urban Affairs, 1976a, 210).

Governor Partee testified for the Board (ibid., 215). He praised the increased attention to inflation in the 1978 House and especially Senate bills, removal of the government as employer of last resort, and elimination of the 3 percent goal for the unemployment rate, but he objected to the numerical targets that remained.

The Board was particularly pleased that the legislation allowed greater flexibility to monetary policy. Objectives for monetary policy could change during the year as economic conditions changed. And Partee, in a break with the past, emphasized that “performance with respect to inflation has a critical bearing on the chances for actually achieving meaningful and sustainable full employment” (ibid., 214). He insisted that the improvements did not go far enough. Inflation control continued to take “a back seat” to unemployment.
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The 1978 legislation amended section 2A of the Federal Reserve Act by requiring the Board to report in writing to Congress by February 20 on its and the FOMC’s objectives for the monetary and credit aggregates for the year ahead. In July, the Board had to report on its plans for the following year. This forced the Board to give more attention to medium-term objectives, a potentially important change. Also, the Board’s report had to relate its plans to the administration’s economic program for the year and to congressional goals.
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182. The goals specified in the act included more than unemployment and inflation rates. They included balanced growth, productivity growth, full parity income for farmers, and other objectives. Many of these objectives were outside the competence of the Federal Reserve. The 3 percent unemployment rate for adults twenty years and over remained in the bill (Senate Committee on Banking, Housing, and Urban Affairs, 1976a, 21).

183. One sign of change is the absence of discussion of guideposts and guidelines for wages and prices. Since the early Kennedy administration, officials and others argued that a market economy could not achieve full employment and low inflation without intervention in labor and product markets. This reasoning no longer appeared in official or congressional statements. Partee rejected it explicitly (Senate Committee on Banking . . . , 1978, 723). Partee insisted, however, that training programs would be needed to reach 4 percent unemployment rates.

184. News reports at the time suggest the intense struggle over the provisions of the act. Republicans in Congress wanted more emphasis on reducing inflation and government spending. Union lobbyists wanted more spending
(Washington
Post,
October 13, 1978, A2).

By the time President Carter signed the legislation, a common belief was that the act would not achieve its stated goals. That proved to be correct. For its part, the Federal Reserve was no better at achieving announced monetary targets than before, and it continued to allow year-to-year base drift. In 2001, Congress repealed Humphrey-Hawkins, eliminated targets for money growth, but retained semiannual oversight hearings.
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The Subcommittee on the Directive proposed several changes in response to the new mandate. It recommended eliminating two FOMC meetings, in January and June, and moving the February and July meetings earlier in the month to allow time to prepare the statement for the oversight hearings. Also, the subcommittee proposed to state short-run targets for the aggregates as three-month moving averages centered on the month of the meeting to reduce the volatility of reported growth rates and to reduce the width of specified ranges.
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The act, like Resolution 133, explicitly absolved the Federal Reserve from responsibility for achieving its announced ranges. If it claimed that conditions had changed, it had to explain to Congress the reason for the change. In effect, this provision weakened the act. The System rarely achieved its targets for the monetary aggregates, and Congress eventually repealed the required announcement.

At the time, the Subcommittee on the Directive proposed changes to reduce “base drift”—building the next growth rate on the excess or shortfall in the previous year—and announcing calendar year growth rates twice a year instead of moving one quarter at a time. The committee saw the new legislation as offering an opportunity for dealing more directly with problems widely believed to inhere in the existing system (Federal Reserve Bank of New York, 1978, Box 110282, FOMC, 1970–78).

Other memos prepared at the time accepted many of the monetarists’ criticisms. One recognized that lower money growth was a necessary condition for lower inflation and that targets for monetary aggregates were a
more useful measure than interest rates of the thrust of monetary policy. Another memo proposed use of a single aggregate target. Still another recognized that policy was often procyclical. “The need for serious adjustments is often deferred because of the procedure of shifting the base. The tendency for monetary growth to be procyclical is strengthened. The delayed adjustments are ultimately enlarged” (memo, “Perspectives on Controlling Monetary Aggregates over Time,” Federal Reserve Bank of New York, Box 110282, November 21, 1978, 4).

185. Passage of the act stimulated internal discussion of changes. Presidents Baughman (Dallas) and Roos (St. Louis) proposed steps to focus on longer-term consequences of policy actions. “The economic problems we are attempting to address now require attention to the longer consequences to a degree not heretofore experienced since the 1930s” (letter, Ernest Baughman to FOMC, Board Records, April 20, 1978). Both presidents proposed a three-year horizon. The letter concluded by recognizing the procyclical thrust of Federal Reserve policy actions. “We would be hard pressed to find a persuasive rationale that monetary policy in the past three years has been countercyclical” (ibid., 2).

Neither Burns nor many others were ready to make the needed changes in procedures to control inflation and make policy counter-cyclical.

186. Chairman Volcker dissented because the moving averages would “convey an exaggerated impression to the public of fine-tuned precision in the setting of ranges” (Federal Reserve Bank of New York, 1978, Box 110282, FOMC, 1970–78).

Recognition did not influence decisions. Federal Reserve actions continued to be procyclical on average until 1994. Base drift continued, as did the announcement of multiple targets for monetary aggregates and inflationary monetary growth. Recognition of excessive attention to shortrun changes was a large forward step. Unfortunately, it did not produce the required changes.

The importance of this memo should not be underestimated. It shows that internal memos reinforced external criticisms of policy and procedures. And it established that decisions to continue the procedures and policies had to be explained some other way than by claiming misunderstanding. Most likely is the primacy given to unemployment and the misinterpretation of interest rate changes. But underlying these errors was the influence of Congress and the general public. The FOMC continued to interpret a decline in interest rates as evidence of easier monetary policy even if money and credit growth slowed in recessions. Similarly, it interpreted higher interest rates as evidence of tighter policy despite more rapid growth of money and credit. This was the main reason for procyclical policy actions and the low or negative real interest rates found during the Great Inflation.
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REGULATION

The 1970s were a period of active financial regulation. The Federal Reserve’s responsibilities increased under the Truth in Lending Act, the Community Reinvestment Act, and the Equal Credit Opportunity Act (non-discriminatory). These changes required rulings and interpretations to keep up with new congressional legislation and practical problems.
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187. Tax policy became an active political issue in 1978 with the introduction of bills by Senator William Roth (Delaware) and Representative Jack Kemp (New York) that proposed large reductions in individual and corporate tax rates. Individual rates would be reduced from the prevailing 14 to 70 percent to 8 to 50 percent by 1980.

188. The Community Reinvestment Act of 1977 (CRA) responded to complaints that some banks did not lend adequate amounts to meet demands of low- and moderate-income
borrowers. Studies showed that the CRA reduced the spread between loans to such borrowers and other home buyers and that the loans were profitable (Laderman, 2004). Interest groups used the CRA to intervene in banks’ proposals to expand, merge, etc.

The 1970s were a time of dissatisfaction. Truth in Lending and the diversity of banking practices raised many issues, for example disclosure of discounts for cash or surcharges for the use of credit cards (Annual Report, 1977, 132). Administration of margin requirements continued to raise issues about matters such as substitution of securities in margin accounts and the extension of margin requirements to new instruments in a rapidly changing market. These seem remote from core Federal Reserve responsibilities. Inflation required changes in nominal values. For example, in 1998 the Board permitted banks to increase the limit on credit card loans to executive officers from $1,000 to $5,000. Congress proposed or passed legislation to restrict System practices, release additional information, change the regulatory structure, and regulate the growing number of foreign banks operating in the domestic market.

Potential default by New York City induced Congress to seek emergency loans from the Federal Reserve. The Federal Reserve Board attempted to draw a line between assistance to potential bankrupts and service as lender of last resort. It agreed to a temporary increase in bank discounts in the event of a major default, but it opposed loans to New York City. In the event of losses “that would seriously impair the capital of some banks,” it argued that the Federal Deposit Insurance Corporation had statutory responsibility
(Federal
Reserve
Bulletin,
1975, 635–36). In 1979, the System acted as fiscal agent for Treasury loan guarantees to Chrysler Corporation.

Support for housing in Congress induced the Federal Reserve to buy agency debt issues for its open market account. Between 1972 and 1976 System holdings of obligations of the Federal National Mortgage Association (FNMA) rose from $500 million to $2.9 billion. Between 40 and 60 percent of all agency issues held were FNMA obligations (memo, Stephen Axilrod and Alan Holmes to FOMC, Board Records, May 19, 1976, 9). FNMA was in part a private corporation; its shares were held by the public, but it retained some characteristics of a government agency, as Congress intended. The staff memo recommended continuing purchases, but it proposed to reduce the relative size of FNMA holdings. The memo showed concern for the effect on the interest rate paid by FNMA on its stock price, and on “the impression that the Federal Reserve is significantly reducing its activity in housing-related agency securities” (ibid., 1). Also, “there is a risk that Congress may come to believe that the System is not conforming
to the intent of Congressional legislation . . . [S]uch action would be interpreted as a significant change in the System’s attitude toward the residential mortgage market” (ibid., 7).