Full text of Papers of Allan Sproul : [FOMC Comments]
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^ O ftfC A.S. 6/11/53 X.* Since the last meeting of th« Federal Open Market Gosmittee we hairs been operating under two prohibitions adopted by th« Coswittee, ths general prohibition Halting operations to short-term securities at all tines, and the special prohibition Halting operations, during periods of Treasury financing, to exclude the purchase of naturing issues, vhen-issued securities, sad outstanding issues of co*parable maturity to those being offered in exchange. 2. In ay opinion, the present situation and the likely situation during ths Mxk three smiths require that we remove these prohibitions sod restore to m m e&fte greater freedom of action. Private demands for capital and credit continue strong, and the Treasury is going to be a large wad neces sitous borrower. Our policy, in the elrcujastences, is one of maintaining restraint in credit expansion, while trying to prevent that restraint frraa being intensified by Treasury demands on the banking system. If this con tinues to be our policy, and if we continue to confine our operations to purchases of Mils, X do not think we can walk the tightrope successfully. Our policy of restraint will be intensified at a ti»e when it should be levelling off with the bom* 3. On what grounds would we continue to deprive ourselves ©f freedom of aetion? With respect to the prohibitions we adopted at our last nesting, (a) we wear* told that the market should be reli— ed of the threat of our intervention in the longer terra areas so that it sight develop breadth, a n d p e e ilta rm a r. (b) we have not intervened in these areas for some month* and, in one way or another, the market has acquired the idea that we are not going to intervene. let seldom has the market shown leee breadth and depth while quotations have shown, If anything, too such resiliency. / 1 "" '■ (c) I think it has been demonstrated that if apprehension concerning our intervention in the market was once the cause of uncertainty^ it was a transient phenomenon. Other factors have sines been at work. Eeoently there has been ear restrictive credit policy, continued hsaYF private demands £er funds, and mounting Treasury cash needs. These have generated the expectation of a decline in government security prices (and private security prieee) and a rise in interest rates of unknown extent and duration. (d) Under such conditions a market of the sise and present vulnerability of the Government security aarket doesn't develop real breadth* depth, and resiliency, and the Treasury*s necessitous financing c&n be made un necessarily difficult and onerous. (e) Insofar as credit policy is responsible for this, the problea is how to direct open market operations with sufficient flexibility and versatility to minimise the adverse effects of the general policy without sacrificing the general objective. ii. I don't think we can do it if we continue, as we have been doing, to Confine ourselves at all times to operations in Treasury bills. We have ~ ~ ~ \ __ ---...—- been told that operations is bills would have prompt and persuasive effecte throughout the narket. That was the theory of perfect fluidity — perfect arbitrage. I think historical records and current observation indicate that a prompt and invariable response between short and long markets can not i'& s t -3- always be expected. Under present conditions operations solely in bills stay relieve the reserve position of the banks without giving tiiaely relief from the complex pressures in the credit and c apital markets created by large treasury borrowing operations. 5» If the threat of our intervention lsn*t the source of lack o t hreadth, depth, and resiliency in the Oovenment security Bsarket, and if that market and the whole capital market isn't as fli*Ad as the theory of perfect arbitrage would suggest, why do we deprive ourselves of freadeaa of action? It awsm to m that we wast either still be seacting violently against market pegging or anbameiag a somewhat doctrinaire attitude on free markets* 6* There is a middle road. So one here wants to rstwm to pegging nor to try to substitute our judgsaent as to prices and yields ftor those of the market. Bat if our credit policy calls for putting funds into the market, as it does, and if at the sane tise we can assist the Treasury with its very difficult task of debt mnageasent, we should do it. It would be in accord with the resolution we adopted on relations with the treasury and it would contribute •to economic stability, We should be free, particularly at times of Treasury financing, to make purchases in whatever area of the market is under most pressure, so that there will not be an unnecessary erosion of rates, affeeting adversely investor and banking psychology and intensifying the restrictive effects of our credit policy at the wrong tisae, 7* We have made it clear to the market that we are not interested in pegging prices, and the Treasury has wade it clear that it wants to price its obliga» tions in the market, not on us. Within this fraaework, I think we should re serve for ourselves ®aj&B&na freedo® to operate in any way which, without —1^— sacrificing credit policy* sao ort the treasury*9 program and the stability of the market. 8* To withhold the Systea portfolio from participation in the mrket, except for bill transactions, in the light of the present econos&e situation and the Treaamry*s needs, seems to »e to be sacrificing credit policy to untried theory* to go further, and to withheld the System portfolio from participation in the t**e®»endo«* redistribution and capping proems whieh takes in p la m the market during the short period of a Treasury financing is likely to pwv* %@ be irresponsible* 9* I suggest the elimination, fro® the instructions of the full Co**nittee to the executive coj®dttee, of the present prohibition against open market operation* in other than Short-term securities, and against operations in certain kinds of securities during Tre&aury financings* 10* 1vm though our operations continue to be largely in bi^ps, effective f credit policy om r m / f j bssit be achieved, in ay ©pinion, by -igfeaiMng the /S**e»ent flexibility of action 7 to sseet the ^predictable cirmmstances which are al ways arising* To freese the System into a pattern of behavior which involves not doing ©eat*tain things could be Just as harmful to the ammms of credit policy a s s frozen cawd.t®©nt to do certain things# We ean*t afford a sue* session of black Mondays and Treasury near-failures over the next few months and the oaens are none too good* .....