A History of the Federal Reserve, Volume 2 (95 page)

Discussions gave little attention to international issues. Several speakers mentioned balance of payments equilibrium as one objective that might be added explicitly to policy goals or written into the Employment Act. But other speakers made similar arguments for income distribution, poverty reduction, or cleaner air and water. These differing claims about the use of real resources or the objectives of government suggest the increased politicization of monetary, or monetary and fiscal, policy. They point up the lack of consensus about what should be done and how best to do it.

Little more than a year later Paul Samuelson debated the role of guideposts as part of economic policy with Arthur Burns. Samuelson emphasized that he was not “a wholehearted enthusiast for guideposts” (Burns and Samuelson, 1967, 43). Strict adherence to guideposts everywhere would freeze the existing distribution of incomes (ibid, 49). Then he repeated the claim about inflationary bias. “Free markets do not give us a stable consumer price index at the same time that the rate of unemployment stays down to a socially desirable minimum” (ibid., 45).
⁵

Samuelson recognized that adjusting wages to one-time price level changes or adjusting prices to cyclical changes in relative income shares would cause problems, particularly if the government tried to tie wages to average productivity growth in a period of high employment (ibid., 53). But he rejected Friedman’s (1968b) argument that claimed that the Phillips curve relating inflation to unemployment was vertical in the long run (ibid., 65–66). In response to a question, Burns explained that the conventional Phillips curve gave the short-run response, but the long-run effect would reverse the reduction in unemployment. “You are likely to stir up inflationary pressures and create other imbalances” (Burns and Samuelson, 1967, 144).
⁶

Burns had earlier criticized the guideposts, if enforced on most firms, as a serious interference with resource allocation (Burns, 1965, 59). He repeated and amplified some of his earlier criticisms. He favored structural
reforms to improve the functioning of markets and introduce more automatic stabilizers and less attention to short-run, cyclical changes. A few years later, as chairman of the Board of Governors, he reversed his position and advocated first guideposts and soon after wage and price controls.
⁷

4. Heller criticized the Federal Reserve’s 1965 discount rate decision. “The Federal Reserve slipped out of the harness of monetary-fiscal coordination and touched off a wave of interest rate increases for both buyers and sellers of money, that must be surprising even to those who initiated the move” (Joint Economic Committee, 1966, 43). Heller called for temporary tax increases, including suspension of the investment tax credit and excise or income tax changes.

5. Samuelson attributed the original argument to Peter Wiles, a British economist, but cited John Kenneth Galbraith as a popularizer.

6. I am grateful to Athanasios Orphanides for insisting on this point.

Clearly, issues like guideposts and activist counter-cyclical policy divided economists at the time. Government officials were divided also. Administration economists and policymakers supported the activist approach. At the Federal Reserve, Martin did not accept Phillips curve reasoning, but several Board members did. As the number of Kennedy-Johnson appointees increased, Martin’s ability to persuade his colleagues to follow his leadership weakened.

Interpretation of interest rate changes and the importance of separating real and nominal influences divided economists. The Keynesian position at the time doubted that inflation increased interest rates. “This possibility has generally been neglected by Keynesians, but it is in no way inconsistent with Keynesian analysis. . . . The probability that nominal interest rates would be pushed above their initial level by this mechanism is very difficult to evaluate, however” (Smith, 1969, 118). Although there are a few references to the influence of inflation on nominal interest rates, neglect of this influence was much more common. Nominal interest rates above 5 or 6 percent were historically high rates and interpreted, incorrectly, as evidence of restrictive monetary policy.

In short, the simple Keynesian model as applied in the late 1960s had three major flaws. It did not generally distinguish between nominal and real interest rate changes. It presumed that the government could permanently reduce the unemployment rate by permitting the inflation rate to rise. And it did not distinguish between one-time price level changes and maintained rates of price change. Each of these errors continued throughout the 1970s. Later, the political decision to keep the unemployment rate near 4 percent and to underweight the cost of inflation added to the mistakes that maintained the Great Inflation in the early 1970s (Orphanides, 2002, 2003a,b).

PERSONNEL CHANGES

Canby Balderston’s term as a member and vice chairman of the Board ended in February 1966. Chairman M
artin proposed, and strongly urged, the appointment of Atherton Bean as his successor
⁸
(letter, Martin to John
son, WHCF, Box 283, LBJ Library, February 2, 1966). Instead, President Johnson chose the first African-American appointee, Andrew Brimmer, serving at the time as an assistant secretary of Commerce. Martin objected to Brimmer as another economist, after three previous economists. He cited Section 10 of the Federal Reserve Act, which called for “fair representation of the financial, agricultural, industrial, and commercial interests . . . of the country.” He objected that appointment of another economist “would damage confidence and gravely impair the ability of the Federal Reserve to carry out functions of vital importance to the economy and the government alike” (ibid., 2). Martin stressed that his reservation was to any economist, not specifically to Brimmer.
⁹

7. In the debate Burns did not dismiss any effect. “The net effect of our price and wage guidelines appears to have been slight” (Burns and Samuelson, 1967, 144).

8. Bean was a Minnesota industrialist who had served as a Director of the Minneapolis Federal Reserve Bank. Martin’s letter to Johnson indicated that he had discussed the appoint
ment with the president before writing the letter. Senator Russell Long (Louisiana) wanted one of his friends appointed. When Johnson told Martin, Martin said he would resign because the man was unqualified, “a Chevrolet salesman” (Martin oral history, May 8, 1987, I, 25).

The president appointed Brimmer as governor and promoted James L. Robertson to vice chairman. Brimmer served 8.5 years until August 31, 1974, and Robertson served until April 30, 1973, completing more than twenty-one years at the Board.

Martin’s fourth term as chairman ended on April 1, 1967. His fourteenyear term as a governor ended on January 31, 1970, so he could be renewed as chairman for only three years. At a private meeting with the president, Martin expressed a desire to retire. He had been in the job for sixteen years and, he said, that was “long enough for anyone” (memorandum of a conversation with President Lyndon B. Johnson, Martin oral history, March 14, 1967, 1).

The president told him, “The country has confidence in you and I will state categorically that I desperately need you to continue. I am going to have a very difficult time in the next two years” (ibid., 2). The president swore Martin to secrecy before telling him, “I have decided not to run again in 1968 . . . I am only asking you to stay with me, if your conscience permits, until the inauguration of a new President in 1969” (ibid., 3).
¹⁰

9. The president asked Walter Heller to find out about Brimmer’s views. Heller wrote a memo supporting the appointment, describing Brimmer as a “Johnson man” who believed in the “positive use of monetary policy for economic expansion with occasional restraint in tight situations like the present” (letter, Heller to Johnson, Henry Fowler Papers, Box 143, LBJ Library, January 25, 1966). Just to make sure, Johnson had Fowler and Ackley interview Brimmer to hear his view on the December 1965 discount rate increase and on monetary policy more generally. Johnson then conducted his own interview while he was in bed on the afternoon of December 24. According to Brimmer, in both interviews he said he would have supported the discount rate increase. Johnson talked mostly about his aspirations for civil rights (interview with Andrew Brimmer, March 2002).

10. This was a year before President Johnson made his surprise announcement that
he would not run. Martin told the president of his desire to retire six months earlier. Some speculated at the time that President Johnson’s decision to retire reflected the strength of the opposition in the New Hampshire primary election in March 1968. This suggests that the president had made (or considered) his decision more than a year earlier. The president then told Martin that Secretary Henry Fowler planned to leave by year-end, and that he would appoint Martin as Secretary of the Treasury. Martin demurred, but the president asked him whom he would recommend as his successor as chairman if he later accepted the Treasury position. Martin chose Robert Roosa (memorandum of a Conversation with President Lyndon B. Johnson, Martin oral history, March 14, 1967, 4–7).

Martin made two demands. New civil service regulations required Governor Charles N. Shephardson to retire on May 1 upon reaching age seventy-two. Martin asked that Shephardson be allowed to complete his term ending in February 1968 so that he could continue his work on the Board’s new building and other general housekeeping duties. The president agreed to let Shephardson continue as a consultant at an unchanged rate of pay.

Martin then asked for assurance that whoever was appointed to replace Shephardson would be “acceptable to me” (ibid., 5). After much discussion, Martin assured the president that he “didn’t want him to be the President’s man or my man but to be a man who approached matters with an open mind and with a desire to try to maintain harmony if it was at all possible” (ibid., 5). The president assured him that “he would not appoint anyone until [Martin] gave [his] approval” (ibid., 5). A few days later Martin accepted reappointment.

Shephardson resigned as governor effective April 30, 1967. His successor was William W. Sherrill, who served for only 4.5 years. Sherrill was a Texan and, at the time, a director of the Federal Deposit Insurance Corporation. Responding to Martin’s concerns and the president’s promise when Martin agreed to stay, Sherrill was not an economist. He had worked in the Houston city government and, later, had developed real estate. The background memo described Sherrill as favoring sound policies “including maximum availability of credit to the public at the lowest possible interest rates” (memo, John W. Macy, Jr. to the president, WHCF, Box 283, LBJ Library, April 19, 1967). Whatever that would mean in practice, the reference to lowest possible interest rates must have attracted Johnson.

This was Johnson’s last appointment to the Board and it replaced the last Republican appointee on the Board. Martin now had a Board dominated by Kennedy and Johnson appointees, many of whom were willing to tolerate higher inflation in the belief that it would bring permanently lower unemployment. In this, they shared Ackley’s strongly held views.

Sherrill developed a management system and modern budgeting process to improve cost control. This was a response to continued pressure
from Congressman Patman to subject the Board’s budget to the congressional appropriation process (Stockwell, 1989, 44). It also reflected the increased responsibilities and growing number of employees. Between 1963 and 1968, the Board added nearly 200 employees, an increase from 608 to 790. The number of member banks, however, changed very little, while the number of non-member banks continued to increase.

Between 1965 and 1968, the Board appointed six reserve bank presidents, two of them in Atlanta. Table 4.1 shows these changes. Although Malcolm Bryan and Darryl Francis did not overlap as members of FOMC, they shared a common view that Francis articulated during the Great Inflation.

The Board’s senior staff also changed. Ralph Young retired. Daniel Brill and Robert Solomon became responsible for the domestic and international research divisions respectively. Robert Holland, later a governor, became secretary of the FOMC and, subsequently, secretary of the Board. Brill introduced explicit forecasts into FOMC deliberations in 1966 and began staff work on an econometric forecasting model. He was a strong proponent of policy coordination and often aligned his views with the economists in the administration. He later served in the Carter Treasury Department.

THE MINI-RECESSION OF 1966–67

Martin had shown courage and determination by refusing to back down under intense pressure from the president.
¹¹
Then he retreated. Instead
of using the higher discount and ceiling rates as the first step toward price stability, the Federal Reserve allowed monetary base and money growth to remain at a 6 percent average annual rate during the first four months of 1966. The economy started the sixth year of expansion with a 3.8 percent unemployment rate. Industrial production rose at a 9.4 percent average annual rate. Inflation (deflator) rose 4.8 percent in the first quarter. Sherman Maisel described the positions at the Board and the FOMC.

11. Congressional hearings on coordination took the president’s position. Senator Jacob Javits (New York) introduced a resolution mandating Quadriad meetings six times a year and requiring the chairman of the Board of Governors to notify the president whenever any reserve bank requested an increase in the discount rate (reductions are not mentioned). Chairman Patman wrote to the president, declaring, “The Federal Reserve Board has seized powers which reside in the Congress and the President as the duly elected representatives of the people. . . . The Joint Economic Committee hearings clearly established that Mr. Martin violated section 2 of the Employment Act of 1946” (letter, Wright Patman to the president, WHCF, Box 50, LBJ Library, December 27, 1965). He, too, wanted the president to mandate regular meetings of an expanded group to replace the Quadriad.