The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
/
V
(Q .
C\
>A ^ '
k 1
FEDERAL RESERVE S Y S T E M /
(j
Office Correspondence
T 0--------Chairman Burns_________________
F rn m
S.
H. Axilrod
c o H v b r - G te . w
^X'/raJ r<?f>o*-df.
PrTC^t'Wi/'
r€ArrrX\ tv
^CCO^
^
Date Au8ust 2o> 19/0
___
S ub ject:______ Comments on Friedman
______ ._______ ______________________ letter
^
r e s e r v e ^ c c c c ^ t-fy
(i)
I think the main point to be made with respect to. Milton's.
^etter on various changes in reserve settlement and computation techniqi
lu e s
A ljS.
is that they are minor matters in relation to the conduct of monetary
policy.
He makes the point that they are not of "decisive importance"
but would make an "appreciable contribution toward more precise control of
monetary aggregates".
I would downgrade them in importance more, though
I am sympathetic to some aspects of them.
You might like to know, however,
that some of these same proposals were considered by a staff ad hoc sub-
Photocopy from Gerald R.
’
^ * S 5 ena4,
committee on reserve proposals, whose report (dated May 13, 1966) was un-
TJ
§
sympathetic to points 2 and 3 in Milton's letter.
£
3s
&3
This subcommittee was
the source of the proposal on lagged reserve accounting.
(2)
With respect to lagged reserve accounting, my impression
from watching the money market day to day, is that there has been more
fluctuation in (say) the Federal funds rate since the new accounting pro
cedure was put into effect.
At the beginning, this would have been
related to transitional problems as b a n k s 1 money managers became used to
the new methods.
has persisted.
But I believe that a certain amount of greater variation
One would expect somewhat more variation because, with
required reserve fixed by lagged accounting, any unexpected deposit flows
at a bank would not be associated with an accompanying fractional change in
required reserves during the statement week; as a result, a bank would havi
-2-
somewhat larger reserve surpluses or deficiencies than otherwise.
It
is difficult, however, to isolate this source of variation in day-today money rates from changes in the pattern of Desk operations as a
resuLt of greater emphasis on the aggregates in open market operations.
As a highly significant factor, this greater emphasis on the aggregates
would not be dated much, if any, before the early part of this year.
The supposed advantages of lagged reserve accounting are a
long story.
For a while they had to do with reducing the potential
revisions in the published net borrowed, or free reserve, number.
Toward
the end of the debate in the System, greater emphasis was put on enhancing
the ability of banks to manage their reserve positions more efficiently.
Banks would know for certain, so the argument went, at least one important
element--required reserves--in judging their demand for or supply of money
market funds . ^
Photocopy from Gerald R. Ford Library
Chairman Burns
Many banks, particularly country banks and banks with
large branch systems, did feel that lagged reserves would in fact be of
help to them in that respect.
We have not followed up systematically to
see if feelings have changed as a result of experience, but I would suspect
that they h a v e n 1t changed much, partly because i t fs really a pretty minor
matter to have strong feelings about.
As to the relation between lagged reserves and control of
monetary aggregates, I would think that they do not hamper our ability,
Banks would also know vault cash for certain, since this too is lagged
two weeks, a point that was of particular importance for large branch systems.
1/
such as it is under current institutional arrangements, to control the
money supply over the intermediate- or longer-run.
But lagged reserves
probably do loosen the already loose relation between money and reserves
in the short-run.
For example, if the System reduces the reserve supply
through open market operations, banks without lags would adjust by reduc
ing loans and investments and thus deposits and required reserves, assum
ing excess reserves are already at a minimum and the discount window rate
and administration provide no incentive to increase borrowed reserves.
Even with lags, banks may still reduce deposits currently, and required
reserves two weeks hence, as the System holds back on reserve provision,
but they do have more options open; an individual bank, for example, can
delay its adjustment for two weeks partly because it now may think there
is some probability that reserve costs would not be so high two weeks hence.
Photocopy from Gerald R. Ford Library
-3-
Chairman Burns
In general, uncertainty becomes a larger factor in bank reserve adjustments,
and this reduces the short-run predictability of the deposit-reserve
relationship.
(3)
A working day basis for reserve computations (i.e. a five
instead of seven day basis) has its appealing aspects now that practically
all banks are open only five days a week (although Saturday openings would
present a complication).
But
I fm not sure that it too might not
introduce a Friday distortion, although the special importance of Fridays
has been, in my view, long over-estimated as a problem for open market
operations or for the money market itself.
However
that may be, a five
day calculation would enhance the value to banks of larger deposits on
Friday relative to the rest of the week.
Under such conditions,
if deposits bulged on Friday, the bank could invest for a three day
rather than a one d^y return though the effect on required reserves would
be no different from a bulge on any other weekday.
The opposite would
be the case for another bank who lost the deposits on Friday, but for.
the banking system as a whole there would be some incentive to attempt
to obtain deposit funds on Friday to the extent this was in their
control.
Whether Friday would be any more or less of a problem (it
would probably be a different kind of problem) under these circumstances
seems open to question.
(4)
Staggered reserve settlements have always seemed to be
a pretty good idea to me, although again it is a minor aspect of reserve
control and operations.
But any such staggering need not be done on the
five working day basis suggested in Friedman's letter.
For example, if
we lengthened the reserve period to two weeks, half the banks could settle
one week and half the next.
This simple proposal would reduce some of the
need for Federal Reserve intra-monthly "defensive" operations.
However,
the whole issue of defensive operations requires a much broader analysis,
including their role when the System is on an aggregate target and an
appraisal of the marketfs capacity further to develop a mechanism to
provide for day-to-day variations in money market demands without excessive
short-term interest rate fluctuation.
There is no way to find this out
without beginning to test the water, though.
(5)
Forcing banks to meet required reserves daily would seem
to introduce an unnecessary rigidity into the banking system.
And, in
Photocopy from Gerald R. Ford Library
-4-
Chairman Burns
-
-5-
practice, such a method of reserve computations and maintenance might
very well increase the need for. Federal Reserve daily open market
operations as banks each day scramble for reserves because deposit
funds (which to an. individual bank are a source-of reserves)-fall
short of expectations, or in the opposite case dispose of unexpected
surpluses*
Such a daily reserve requirement would probably require,
for efficiency, a large allowance for carry-over reserve surpluses and
deficits and easier access to the discount window.
Photocopy from Gerald R. Ford Libraiy
Chairman Burns
K-kri^
THE U N I V E R S I T Y
CHICAGO
P r r v c { t /uQ/i
OF C H I C A G O
• ILLINOIS
Qa }
60637
D E P A R T M E N T OF E C O N O M I C S
{
. Udvember 2c, 1970
Dr. Arthur, F. B u m s
Federal Reserve Sys tea JLr r
W a sh in g to n ,
D. 0 .
„
«ccv s^ : S o t t e d
^
-
»
«
♦
»
*
■
.
'
Seaa* A r & u r :
AU*
-M
b iU *x < x i
c m * * , +*.«**
*
c*~
***
A
*,
k+v-
«Ui*>
-Third, I have been scratching my head about a less misleading terra than
“
incomes policy" for what you have in mind* Re the meaning of that terra,
a particularly clear indication of how misleading for your purposes it
is came out in Henry Wallich's Newsweek column of liov. 23, wheii he wrote:
"The fact is that incomes policy is a catchall jShrase for everything
from guideposts to jawboning to a temporary freeze to permanent pdasc: wa^e
and price controls," not even mentioning market-oriented policies.
Unm Ocndd It Ford Libmy
Second, I an enclosing a second letter dealing with the suggestion that
I made re revising operating procedures at the desk, because I thought
you would rather have that separately.
fhoiocdpjr
First and nost important, let me report progress on Rose's eye problem.
Ae are by no means' out of the woods as yet, imd I still r.ave .vy fingers1
crossed, but they have adjusted the contact lens, used drops eec., so
that she has been able to tolerate the lens for some days and is gradually
lengtliening the period of use, So we are hoping for the besw with somewhat
acre rsason.
Market-oriented policy is perhaps most descriptive but not very catching.
Of the other alternatives I have thought of "free market policy”seejns
to me the best, though it still does not quite ring the right bell.
The others that I toyed with and that I might list just in case one sets
you off are: Structural Policy; Karket-flexi’
oility policy, which has a
Japanese ring ("income-doubling policy". Somehow, one would like to get
in the idea of breaking roadblocks, removing frictions, greasing the ways,
etc., but I have been able to come up wAth no ada catchy slogans that do
so.
Yesterday, I attended part of a consultants' meeting at the Treasury (the
first one if the last four I have been invited to). Despite your good efforts,
one of the other academics invited, though he did not jcoezx a ooOnCkf was
Paul Saauelson. lie was on the list of those expected, so must have can
celled at last rainute. How suicidal can we be?
Rose joins in sending our best to you and Helen.
Cordially yours,
tA n~< dAvm XJLlAj
Y *+ v tJ
h
y
: fi)
Cj^ J L
mf r A f h
ViwV
&
S E V E N T Y - F I F T H A N N I V E R S A R Y YEAR
*1
H
@FedFRASER