A History of the Federal Reserve, Volume 2 (63 page)

END OF THE RECESSION

The National Bureau of Economic Research places the trough of the recession in February 1961. By early March, the Board’s staff promptly recognized a slower decline and a month later described the recovery as under way; there were measurable gains in output and employment
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(FOMC Minutes, April 18, 1961).

The rate of decline of the real monetary base slowed almost a year earlier, in May 1960, but the growth rate did not become positive until January 1961, one month before the recession trough. Real base growth continued to rise but did not reach three percent for more than a year. As on several previous occasions, ex post real interest rates show no evidence of a cyclical decline. Chart 3.9 shows the slight rise in the real long-term rate near the cyclical trough in early 1961. Once again, most of the cyclical action is in real base growth not in the real interest rate.

Monetary expansion received no help from fiscal policy during the recession. The budget had a small surplus in 1960 resulting from $11 billion of increased tax collections and almost $2 billion reduction in outlays. The
budget went back into deficit in 1961 as spending and outlays increased. The increase came after the recession ended, although the public may have anticipated the change after the election.

90. The Federal Advisory Council did not think the recession had ended until its May meeting, but in February they believed the economy was approaching a bottom (Board Minutes, February 21, 1961, 2). The members considered most of the unemployment as structural, the result of technological change, so they did not favor more expansive policy (ibid., 7). Chairman Martin asked about lowering interest rates. He expressed his view that the Federal Reserve should give highest priority to the domestic economy (ibid., 20). This
was a change from 1960.

Real GNP rose at a 5 percent average for the first three quarters of 1961 and at a 9.3 percent annual rate in the fourth quarter. Consumer prices rose less than one percent in 1961. Unemployment reached a peak (7.1 percent) in May. By year-end it had fallen to 6.0 percent.

The recovery occurred during a period of deflation. Consumer prices rose between 0.6 and 1.2 percent from April 1961 to October 1962. Adjusted for the upward bias in the price index, consumer prices declined. This is the last sustained price decline in the postwar years. This experience does not support the prevalent view that monetary policy is impotent in deflation. As in earlier periods of deflation, the economy recovered. The monetary base rose and the federal funds rate declined during the early months of deflation. Thereafter rates rose as shown in Chart 3.6 above.

The FOMC was divided and uncertain about how to give directions in the first half of 1961. Some favored the “experiment” of raising short-term rates and reducing long-term rates, but others opposed any operations in long-term securities. Some continued to use free reserves as the target, but others used an interest rate, total reserves, or the ratio of money to GNP. Chairman Martin had committed to the administration to keep free reserves at about $500 million and to purchase longer-term securities, so discussion of the policy stance or the target had little if any effect on the
actions taken. Monthly average federal funds rates ranged from 1.16 to 2.02 percent during this period. Member bank borrowing remained below $100 million throughout.

Through the early months of the recovery, Robertson, usually joined by Bryan (Atlanta), and Johns (St. Louis), wanted a more expansive policy. Robertson urged the FOMC to let the Treasury bill rate fall as much as required to get free reserves up to $650 to $750 million. If gold flowed out when interest rates fell, it would return when rates rose. This reasoning, though correct, attracted little support.
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Mills placed most emphasis on supporting the dollar. Most others went along with the administration policy of maintaining Treasury bill rates and reducing long-term rates.

Controlling Treasury bill rates proved difficult while fulfilling the conditions on free reserves. Foreign central banks bought heavily in late March, so bill rates dropped to 2.25 percent from 2.45 percent at the previous meeting. At the lower rate, bill rates were the same in New York and London.

At the March 28 meeting, Rouse reported difficulties in buying coupon securities. As Martin had feared earlier, when the desk asked the dealers for quotations and offerings, traders stopped their activity to await the new prices (FOMC Minutes, March 28,1961). He asked for authority to operate in maturities beyond ten years. Allen and Robertson dissented. Robertson explained that this was a “further delegation of authority to the Manager of the Account without any plan or program to guide him. He did not believe the Manager could be expected to carry out the Committee’s unspecified objectives—whatever they were—solely on the basis of his own intuition” (FOMC Minutes, March 28, 1961, 59).

The committee could not agree on a target or state precisely what the policy was. Martin used words like “maintain moderate ease” and left it to the manager to implement as best he could. This grant of discretion pleased the manager and the New York administration. They could now operate as they did before bills-only. Martin, on his side, could take advantage of the FOMC’s lack of precision to fulfill his agreement with the Kennedy administration economists. Robertson and Allen (Chicago) continued to dissent at each meeting from authorization to deal in long-term debt.
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Foreign support continued. In April, the FOMC minutes report that
foreign governments reduced their interest rates to support the dollar, despite rising domestic demand. In May, West Germany repaid some of its debt early to reverse the capital flow.

91. I made the same argument to Robert Roosa and his deputy Dewey Daane when I worked in the Treasury in 1961. It had the same effect. Policy was firmly in the other direction.

92. At the March 28 meeting, however, Robertson argued that the experiment of purchasing long-term bonds was too cautious. If the System was going to experiment, he said, it should act decisively to show whether it can affect long-term rates. He surmised also that the market remained thin because no one knew the rules for System intervention.

Early in February, President Kennedy repeated his pledge to maintain the $35 gold price. The gold outflow slowed. Following announcements by West Germany and the Netherlands that they had revalued their currencies against the dollar by 5 percent, the gold flow reversed.
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Between February and June, the United States increased its gold holdings by $191 million, 1.1 percent of the February level. The temporary respite for the United States shifted pressure to the British pound. Despite continued restrictions on capital movements, the pound remained under periodic pressure until its devaluation later in the decade.

The March 7 FOMC meeting renewed the directives and authorizations, as was customary. Robertson continued to argue for free markets with minimum intervention, so he opposed repurchase agreements and intervention in the bankers’ acceptance market. The desk had not given evidence that these operations benefited the market, and he doubted that they did.
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The April 18 meeting, within two months of the cyclical trough, changed the directive to recognize that the recession had ended. The new statement called for “strengthening the forces of recovery that appear to be developing” (FOMC Minutes, April 18, 1961, 60). Generally, the System changed its policy when it changed its directive. Balderston, Robertson, and Eliot Swan (San Francisco) favored an easier policy, typically $150 million additional free reserves to bring the total to at least $650 million. With Martin and Szymczak absent, the committee voted seven to three to keep the same “degree of ease” with “leeway given to the Manager . . . to accomplish these purposes” (ibid., 60).

Differences of opinion grew stronger. Allen, Irons, Mills, Bryan, Swan, and Deming agreed that targeting free reserves was procyclical, although Swan and Deming did not think that procyclicality was currently a prob
lem. Balderston, Hayes, King, Robertson, and Wayne wanted to make full employment a policy goal. Irons, Mills, Shephardson, and Swan strongly opposed.

93. The Federal Reserve staff told the members that even if Germany eliminated its surplus, the United States would run a deficit to finance foreign assistance (FOMC Minutes, March 7, 1961, 35). Statements such as this strengthened the belief that the problem was not monetary. From Europe, Allan Sproul wrote that the revaluations revived concerns that par values would not stay fixed. Also, he reported concern that the United States would not control costs and prices (letter, Sproul to Hayes, Sproul papers, Correspondence, May 2, 1961).

94. There was intense concern in the 1950s and early 1960s about the threat of nuclear war. Each year the FOMC authorized system banks to operate autonomously in the event of a defense emergency. An interim committee could decide open market policy and accept a promissory note from a dealer physically unable to deliver securities. The System could purchase directly from the Treasury to supply credit to the Federal government.

There were differences of opinion about the strength of the recovery. Guy Noyes, the director of research, noted that the recession was moderate, and the recovery would be moderate. No recovery to that time had been terminated in its early months. Woodlief Thomas pointed to slow growth of money and credit. The money stock had fallen to 28 percent of GNP, almost as low as in the 1920s. With long-term interest rates back in the 1920s range, monetary velocity was in its earlier range also.
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OPERATING PROCEDURES AND OBJECTIVES

With the end of the bills-only operating procedure and the increased authority given to the account manager, issues surfaced about the directive, the target, and the objectives of monetary policy. Instructions to maintain the tone and feel of the market, achieve moderate ease, or err on the side of restraint gave little direction even when the members agreed on the action to be taken.
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When they differed, as in 1960–61, the manager’s discretion increased. Often the instructions in the directive and the stated consensus were so imprecise that one member would criticize the manager’s actions as inconsistent with his instructions. Another would follow with praise for the manager’s performance. Unable to agree on its objectives or how to reach them, the FOMC continued to offer little direction.

The use of free reserves as a policy target added to the dissatisfaction that some members expressed. Free reserves rose when member bank borrowing fell, and conversely. Borrowing rose and fell cyclically, so free reserves moved counter-cyclically. Also, free reserves often moved opposite to or independently of total reserves, the money stock or the Treasury bill rate (See Chart 3.8 above). Concerns about setting interest rate targets were mainly concerns about congressional pressure if the Federal Reserve claimed to control an interest rate.

In November 1960, James Knipe, consultant to the chairman, wrote a
memo criticizing the instructions that the FOMC sent to the desk. “The directives are cast as such pious expressions of intent that they convey . . . almost no meaning . . . One gets very little sense of progress from one meeting to the next, and not much of an account of what has just been accomplished or what the Committee believes ought to be accomplished during the next three weeks” (Board Records, November 14, 1960, 6, memo, Knipe to Martin). The memo suggested “some use of numbers” (ibid., 6).

95. This finding continued to hold in later years, strong evidence of the long-term stability of the demand for money. Thomas also made a statement about policy transmission. When the Federal Reserve increased bank reserves, banks invested in securities, lowering long-term rates. Governments and corporations took advantage of lower rates to increase new investment. This is one of the few statements of this kind to that time.

96. Martin explained that “color, tone, and feel” referred to the distribution of reserves among member banks (FOMC Minutes, June 6, 1961, 57–58). Earlier minutes did not define these terms but express a similar point. Country banks may each hold a small amount of excess reserves. The response to a given value of total excess or free reserves would increase if larger banks (reserve city banks) held these reserves.