A History of the Federal Reserve, Volume 2 (64 page)

A few weeks later, Malcolm Bryan (Atlanta) wrote to Woodlief Thomas: “We can defend the actual policy; what I am afraid we can’t do is to explain what we mean by the instructions we give” (Board Records, January 14, 1961, letter, Bryan to Thomas). Bryan continued his effort to improve procedures. In April 1961, he urged the FOMC to “[m]anage the reserve position . . . with a great deal more precision, and with a steadier hand” (FOMC Minutes, April 18, 1961, 22). Bryan argued that total reserves should grow at a 3 percent trend rate based on growth of population and transactions. The chart he presented at the meeting showed that the growth rate fell below trend before each of the postwar recessions and rose above trend during the late stages of economic expansions. Bryan concluded that “we have tended to overstay our position of tightness and to be too tight, and then to overstay our position of ease and to be too easy” (ibid., 22).

Governor King supported Bryan and welcomed his analysis, but Governor Robertson wanted more expansion than 3 percent growth. He argued that the demand for money changed over time, so he opposed using any “historical trend line as a strategic objective of policy”
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(FOMC Minutes, May 9, 1961, 42). Bryan’s proposal attracted support from one or two presidents, but both Martin and Hayes disliked “mechanical rules” and preferred to rely on judgments made at the time.

The directive to the manager usually changed when policy changed. Although the members discussed changes in the directive vigorously, they did not refer to the directive when commenting on policy operations. The directive became public when the Board published its Annual Report, from
three to fifteen months after the FOMC’s decisions. The directive’s role was to show that the FOMC responded promptly to changes in the economy. It did not fully succeed.

97. Robertson’s argument did not rule out the use of a trend rate. He favored discretion and opposed formal restrictions, but he also opposed loosely worded directives that allowed the manager to make the decision. In an exchange with Szymczak on this issue at the March 7 meeting, he could not contain his irritation, asking why not abolish FOMC and let the manager decide? Hafer (1999) develops Bryan’s views and shows his charts and his use of growth rate bands, a technique the System used when it adopted money targets in the 1970s. A year later the FOMC attempted to force “an expansion in demand deposits adjusted and time deposits at an annual rate of 4 percent” (memo, Mills to Albert Koch, April 23, 1962). The memo accepted that growth in terms of the gross national product depends importantly on a constant expansion in the money supply defined to include time deposits” (ibid.). He doubted that the relation was causal and that economic growth could be increased by increasing money growth.

In June 1 and 2 hearings before the Joint Economic Committee, Congressman Wright Patman (Texas) criticized the directive. “I do not see how the ordinary, average person could possibly interpret what the language means” (FOMC Minutes, June 6, 1961, Attachment A).
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Robert Rouse, the manager, testified about his role on June 1. He described the consensus reached by the FOMC as “in somewhat more concrete terms [than the directive], but still in a relatively general way” (Board Records, June 1, 1961, 2, Rouse testimony). He added that he relied also on the oral statements made at the meeting, but he emphasized the importance of judgment about market factors such as float, Treasury and foreign accounts, and availability of short-term funds in the country (ibid., 5).
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A more substantive problem was lack of continuity and the weak influence of long-term objectives. Each meeting considered and responded to the most recent data. Most members did not have a framework to relate current changes to longer-term developments.
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Many of the changes to which they responded were transitory, often random movements. Martin
(and others) recognized that their policy “must be tailored to fit the shape of a future visible only in dim outline” (letter, Martin to Patman, FOMC Minutes, July 11, 1961, 68). They lacked a formal or common means of doing so. Martin always remained properly skeptical about economic models and model-based forecasts, but he did not propose a general guideline as a substitute.

98. Congressmen Patman and Reuss wanted the Federal Reserve to release the 1960 FOMC minutes to the Joint Economic Committee. The FOMC considered the verbal request on June 6. It decided to ask Patman for a letter formally asking for the minutes. It released the 1960 minutes after Patman sent a second letter on June 14.

99. Patman used the question period to claim that having all presidents at FOMC meetings violated the law and over weighted private interests in discussions (memo, Jerome Shay to Martin, Rouse Testimony, Board Records, June 1, 1961, 1). Subsequently, Patman criticized the presence of the non-member presidents because they did not take an oath of office. Patman also asked why changes in discount rates could be announced immediately but not open market operations. The System had no answer. This issue remained until the 1990s.

100. Later in 1961, Governor Balderston made a long statement about the absence of procedures for achieving long-term objectives. He recognized that a series of decisions loosely related to a long-term objective was sub-optimal and used the growth rate of total reserves to illustrate his points. “The guiding philosophy that I favor for the Committee’s decisionmaking is to proceed steadily, week by week, toward whatever goal seems appropriate . . .

“The point I am making is that monetary policy should be flexible but not erratic. . . . [Recently] the Committee may have changed its objective from a 5 percent growth rate to a 3 percent growth rate [of total reserves] without full realization as to what had happened, and since the last meeting the implementation of Committee policy has resulted in a radical departure even from the lower growth rate” (FOMC Minutes, August 22, 1961, 47–48).

When the Board asked the members of the Federal Advisory Council to discuss open market operations in long-term securities, they learned that the bank presidents on FAC thought that the experiment had failed. One thought the Federal Reserve had reverted to pegging interest rates. Another said that most market participants disliked the new policy. Governor Mitchell objected that, although long-term rates had increased, they might have increased more without open market purchases, but his comments and those of other governors did not seem to change any opinions (Board Minutes, September 19, 1961, 15–23).

Early in 1961, the FOMC considered a memo suggesting changes in the directive. The memo started a discussion that continued through the year. It showed considerable awareness of the need for change and the reasons for using vague directives. The discussion had two objectives: improving control and public relations. Several members wanted to publish reports of their actions more frequently.

The members debated three substantive issues. First, some FOMC members wanted to remove all standing rules from the directive in the interest of flexibility in operations. They did not make this change. Second, Young and Rouse proposed separating the directive into two parts. One would contain all the standing procedural rules; the other would have only current policy objectives. This, too, was not done.

Third, the FOMC made the current instruction to the manager slightly more explicit by adding a paragraph to the directive. Members of the FOMC, at this time, used different measures or variables to describe the current policy target. Martin did not attempt to reconcile these differences, so the manager (or whoever guided the manager) retained control of policy action.
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The FOMC did not adopt some of the more explicit instructions suggested by the staff (Board Records, September 6, 1961, Young to FOMC, Attachment II). George Clay (Kansas City) gave the reason: “lack of agreement among the Committee members” (Board Records, November 13, 1961, 2, letter, Clay to Young).
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Hayes (New York) favored a proposal by Irons (Dallas) that would allow FOMC members to comment on a “statement of the general economic policy position of the Committee as it developed out of the discussion” (letter, Hayes to Young, Board Records, November 3, 1961, 3). The secre
tary and the manager would prepare the statement immediately after the meeting. Following a review by the chairman, members would review, approve, dissent, or propose changes. The statement would appear with thepolicy directive in the record for the meeting. Hayes emphasized that the policy statement would be short, no more than “three or four sentences to express the main points integral to current policy” (ibid., 3).
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101. Bryan, Balderston, and Johns favored total reserves. George Mitchell, who joined the Board after mid-year, favored an interest rate target. Others continued to use free reserves or tone and feel.

102. New York liked the suggestion by Carl Allen (Chicago) that the FOMC did not have to agree on a statement of operating procedures because they met every three weeks. “The absence of a public statement of procedures would leave the Committee’s hands untied and permit it to take whatever future actions it might indicate as desirable without setting off the magnified and exaggerated reactions in the market and in the press that would ensue if its actions were an exception to a published statement of formal rules” (letter, Hayes to Young, Board Records, November 3, 1961, 1).

Eliot Swan (San Francisco) wrote: “We need some economic analysis of policy on a fairly current basis, done within the System, and presented regularly to the public.” This would give the public a sense “of what the System is trying to do, how it tried to do it, and what seems to have been accomplished” (letter, Swan to Young, Board Records, November 10, 1961, 3). Swan added that this statement would not be an official statement endorsed by the FOMC.

George Clay (Kansas City) recognized one problem with proposals like Swan’s or any attempt to make the directive more explicit. There was a “lack of agreement among the Committee members . . . [E]fforts to be completely explicit may make it more difficult to arrive at a consensus. But a lack of specific directions shifts the responsibility of interpretation to the Trading Desk . . . Attempts to be specific also are hampered by the fact that individual members of the Committee differ in the measures through which they express their choices—using free reserves, interest rates, credit expansion, and other terms that cannot be interchanged” (letter, Clay to Young, Board Records, November 13, 1961, 2).

A remaining problem was to agree on the purpose served by the directive and statement of procedure. Public relations, a public record, and directions to the manager received different weights from each of the members. The more astute members recognized that any substantive statement restricted future actions. Several agreed that procedural rules, such as bills-only or not supporting bond prices, “are unnecessary and can prove to be administratively embarrassing at times” (letter, Deming to Young, Board Records, November 24, 1961, 1). The problem in rewriting explicit rules was that “they may be limiting at times and thus force hard-to-explain deviations; if they are written so broadly as to escape these difficulties, they become almost meaningless” (ibid., 1–2). Deming opposed an explicit target because the FOMC would have to explain why it
deviated. He insisted that the directive “could not be couched in terms of a guide or guides such as free reserves, money supply, total reserves, federal funds or bill rates . . . I simply do not believe that any one indicator is . . . good enough to use all of the time and I fear that should we attempt to use one (or more) in the directive itself, we will spend a great deal of time subsequently trying to explain why we did not get quite the precise results that these apparently precise indicators would imply we sought. I also feel that an attempt to write directives in specifics would push uncomfortably close to mechanistic policy-making” (ibid., 3).
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103. Hayes attached an example of the type of directive and policy statement he envisaged. The directive maintained the familiar vague language and made no mention of a quantitative target. The general policy statement improved on the old directive. It was similar to the statements issued to the press and public in the 1990s, after the FOMC agreed to announce the reasons for its decision (letter, Hayes to Young, Board Records, Enclosure B, November 3, 1961).

The letters show clearly that one major purpose that the old flexible and imprecise directive served was covering up disagreements within the FOMC. Bryan and Hayes did not agree about a quantitative target for total reserves, but both agreed with Irons that the FOMC should maintain procedural rules. Bryan differed with several of his colleagues by recognizing the problem that a vague directive posed. Unlike the majority, he believed the FOMC would be well served if it adopted a quantitative target, but he understood that his proposal did not attract much support.
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The discussion at this meeting, many subsequent discussions, and failure to adopt a quantitative objective suggest that a majority did not favor precise instructions and explicit objectives. One reason is that ambiguity provided opportunities for Martin, Hayes, or the account manager to change directions. Unambiguous policy objectives and operating procedures to achieve the objectives at lowest cost required a commitment to consistent, predictable behavior that many on the FOMC were not willing to make.
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Following the December 19 meeting, Young drafted some suggestions for the chairman summarizing the discussion at the meeting. The proposed directive called for “a somewhat slower increase in total reserves than during recent months. . . . Operations shall place emphasis on continuance of the three-month Treasury bill rate at close to the top of the range recently prevailing. No overt action shall be taken to reduce unduly the
supply of reserves or to bring about a rise of interest rates” (memo, Young to Martin, Board Records, December 20, 1961). Martin approved it.

104. Deming favored the type of unofficial explanation by the staff that Swan proposed. Its intent was to provide more information to reduce criticism while avoiding full responsibility for what was said and the difficult process of achieving agreement on what they intended to do. The discussion shows how much the Federal Reserve had begun to change from the secretive central bank of the 1920s to the more transparent bank we find after the mid-1990s.

105. “If we ever attain clear, quantitative directions to the Desk, the present hairsplitting shifts of linguistic emphasis in the directive will be reduced to a lesser and more proper importance, and we shall have a better guide to when a change of language is called for” (letter, Bryan to Young, Board Records, November 24, 1961, 4).

106. Cukierman and Meltzer (1986) and Cukierman (1992) later showed the advantages of ambiguous policy for the policymaker who wanted to fool the public.