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A S letter to F O M C and
copy to Pres, not on F O M C

M r . Robertson - ans. 12/8
M r . Martin

jvir. ii.vans
Mr. Szymczak
Mr. Vardaman
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.

Erickson
Fulton
Johns
Powell
Williams
Bryan
Leach
Lee d y

M r . Gentry )first VP)
M r . Earhart
M r . Y oung

* M I S C . 14 0 C . 1 3 O M - I- 0 2

F

ederal

R e s e rv e B a n k o f n e w

Sent to all m e m b e r s of F O M C
not on Committee.

f !i;
"

.
.
J. A .

Y o rk

and Presidents

December 4, 1953

Hon. ffm, M c C . Martin, Jr., Chairman,
Federal O p e n Mar k e t Committee,
/'“B o a r d of Governors of the
/
Federal Reserve System,
Washington 25, D. C.
De a r C h a i r m a n Martin:

At the meeting of the Federal Open Market Committee on September 24, f
l
1953 we continued our discussion of System open market operations, in the lightN
of the report of the Ad Hoc Subcommittee first submitted to us in March 1953 > I
and discussed then and at our next meeting in June. In September most of our
discussion was on procedural aspects of our operations - the respective roles
of the Open Market Committee, its Executive Committee, the Federal Reserve
,Bank of New York and the Manager of the System Open Market Account. The
merits of the two general kinds of operations which were at issue were im'~**\plicit in this discussion but were not explicitly discussed. I think it is
| important that they now be discussed, particularly in view of the decision of
the full Committee that these are matters on which it should act directly, and
if necessary frequently, and on which each of its individual members should,
therefore, be fully informed.

In focusing attention upon the merits of different kinds of opera­
tions, I do not wish to suggest that we embalm the matter of procedure. Having
regard for the way in which human machinery functions, I think we shall want to
reexamine the role of the Executive Committee of the Open Market Committee from
time to time. For the present, however, I would only express my concern that
/ the kind of action taken by the full Committee in September may lead us into
: trying to discharge our responsibilities by means of simple formulas, instead
of by confronting complex situations with acute analysis, and determining policy
in the light of foreseeable circumstance each time we meetB
At our September meeting stress was laid on the fact that each in­
dividual member of the Federal Open Market Committee is responsible for our
open market operations. And I know that there has been concern, in the light
of our past procedure, as to how each individual member of the Committee might
defend his discharge of that responsibility if called upon to do so by the
Congress. We shall not satisfy our consciences nor the Congress, however,
merely by adopting resolutions such as the one adopted in September. What is
required on the part of each member of the Federal Open Market Committee, I




M . 1 03
ISC *1
(•"•ISC. 140 ' • —30M— - 32
8 )

2

/

" ' would say, is a continuing and absorbing interest in and attention to national \
•
\
credit policy in general and open market operations in particular.- There is
/
plenty of work for each individual member of- the-full Committee to do, and plenty
of responsibility to be assumed (whether or not the Executive Committee has
discretion in certain matters), if each member is to be prepared constantly to
diagnose a dynamic and complex business and credit situation, and competent to
prescribe the kind of monetary policy appropriate to it. This demands construc-j
tive, affirmative, imaginative development of individual opinions which can be
presented to, and discussed with, and debated with a group of equals.

'

*

/

Out of such deliberation general policy should emerge. Out of it also
would come that indication of "climate of opinion" which would condition the
exercise of whatever discretion may be granted to the Executive Committee, and
-to the Manager of the System Open Market Account. We need not then debate
sterile and misleading questions, such as whether the Executive Committee or
the Manager of the System Open Market Account should have "blanket discretion"
to operate in other than short term Government securities, or to purchase cer­
tain kinds of securities at the time of Treasury financings, or to do anything
lse. They should not have blanket discretion. They should have discretion
only within the limits of policies which the full Committee has determined and
which it has continuously under review.
\

I should like to consider on the merits, therefore, the kinds of
operations which led to our discussion of Committee procedure at our September
meeting. There were two kinds of operations involved, as set forth in the
motion offered by Governor Mills and subsequently adopted by the Committee.
-.-^One part of the motion required that operations for the System Account be con­
...’
fined to short term Government securities (except in the case of correction of
"^"^disorderly markets), and the second part required that during a period of
i
'Treasury financing there be no purchases of (1) maturing issues for which an
exchange is being offered, (2) when issued securities, or (3) outstanding issues
of comparable maturity to those being offered for exchange.
I assume that the most recent intellectual underpinnings for this
resolution are to be found in the letter and enclosures which the Chairman
addressed to members of the Federal Open Market Committee under date of
.■September 15, 1953. When the motion was discussed at our meeting on September 24,
I said that I would not attempt to answer the Chairman's analysis of open market
techniques during the preceding months, but that I would merely say I disagreed
both with his analysis and his conclusions. If we are to continue to consider
these matters, I should say something about why I disagreed, particularly as the
Chairman's statement took vigorous exception to views which I had expressed in
an earlier letter (dated July l6, 1953).
Much of the Chairman's letter was devoted to the performance of the
|
Government security market during the second quarter of this year. I had held
|
that the market had shown a serious lack of breadth, depth, and resiliency,
*
despite the fact that it had been weaned from the "fear" of System intervention
in the intermediate or long term market and that this disposed of, or disputed,
the Ad Hoc Committee's contention that the threat of our intervention was a
I
major cause of the market's previous lack of breadth, depth, and resiliency.
I




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M . 140 3
ISC
t

• r e . 140 B . 1“ SOM—6-821

I still hold that opinion. I believe that Judicious intervention in the
long term market for Government securities during the second quarter of this year
might well have prevented a distorted interpretation of credit policy by the fi­
nancial community, resultant incipient disorder in the Government security market,
and an unintended degree of credit restriction. The Chairman's letter laid great f
stress on the speculative subscriptions to the Treasury1s 3 1/4 per cent bond
U
issue, and to the weight of this "weakly held" issue overhanging the market. He I
seemed to take the position that the only alternative to confining our operations/
to Treasury bills would have been to purchase, at arbitrarily determined prices,
all of the new 3 l/4 per cent bonds offered for sale, particularly by speculators
who subscribed for the bonds only to turn a quick profit. I do not agree. There
was actual and latent demand for the new long term bond, (it never fell to a
*
discount of more than a point and a half, whereas prices of the 2 l/2 per cent u
/''“■'■^bonds of 1967-72 fell more than three points after they had adjusted to the pre-jj
‘
'liminary announcement of the offering of 3 l/4 per cent bonds.) The major in­
fluence in the market at that time, in my opinion, was not the weight of
speculative holdings of 3 l/4 per cent bonds overhanging the market, but the
development for a variety of reasons of an expectation of stringency in the money
/market and a further rise of interest rates of unpredictable proportions. I be' w ' lieve that judicious purchases of long term bonds during this period, certainly
S
no greater in amount than our aggregate bill purchases, would have been more
\effective in bringing about an improvement in market psychology than were our
purchases of bills, and that this would have contributed to both better credit
policy and better debt management.
i
1

/
Anticipating this view, the Chairman's letter of September 15 used the
S y/experience we had in the purchases of bonds for Treasury investment accounts to
1
1
refute the idea that bond purchases for the System Account would have been helpi
“"*sjful. In fact, he suggested that the pur chases we made for Treasury accounts may
j |even have been a perverse influence, accentuating weakness in the market. In
Isupport of this contention he cited as evidence the greater deicline in bond
/prices on the days in which Treasury purchases were made than on other days of
the period. The simple reason why the greater part of the decline in prices
occurred on days when there was buying for Treasury investment accounts was that
these purchases were made only on days when the market was especially weak and
after that weakness had expressed itself in quotations. They were "reluctant"
,
/purchases. It is perhaps significant that the turning point in the market came
on the day (June 2) when Treasury purchases were "aggressively" made and when i t f
\ ’ was incorrectly rumored that the Federal Reserve Banks had bought bonds for
/1 System Account. This suggests the possibility that if our public bank statements
j™ during May had shown purchases of Government bonds we would never have had the
near "crisis" of late May and early June. I am not here advocating - and I never
‘ 'phave in this discussion - that we try to substitute our judgment for that of the
market in terms of fixed yields and prices. But I do think that action taken by
the System has great weight in influencing market psychology and could be used,
at times, to give the underlying situation a chance to reassert itself when it
has been submerged by unwarranted fears of future credit developments. If under
some circumstances the Open Market Account is able to nip scattered pressures
as they arise, or to make swaps which facilitate the functioning of the market,
it may well be able to prevent unnecessary shocks to the market and to reinforce
credit policy.




4
MISC. 1 4 0

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140 B . 1—30 M —4-82)

V

I do not need to spend much time on the memoranda on "Experience During
Treasury Refundings." which accompanied the Chairman's letter of September 15.
They were a good illustration of what we all know - that statistics can be used
to support or illustrate a variety of opinions, including the Chairman's and mine.
The figures used in these memoranda need to be looked at in the light of the cir­
cumstances prevailing during the period covered, in order to see what they really
mean. As a general statement it may be said that in the earlier period covered
by the data, when attrition was high, the reserve position of the banks was being
kept under pressure while in much of the later period, when attrition was low,
the System was moving to ease its pressure on the banks. Actual or prospective
tightness of the reserve position of the banks, and of the money market, makes
for relatively high attrition and actual or prospective ease makes for a success­
ful refunding. That is the simple interpretation of the figures in these memoanda. They leave me still believing that at times aid can properly and
\
appropriately be extended to Treasury refunding operations by transactions in l
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"rights", "when issued" securities, and securities of comparable maturity; thatll
it can be extended, at times, more effectively in this way than by confining our\
operations to Treasury bills ; and that it can be done, at times, with no more
\
pad perhaps less net release of reserve funds than if we seek to help solely
'
through the bill market.
\
The question may be raised as to the need for raking over this "ancient"
history, but it must be in the light of our experience rather than in revelations
frbm on high, of policy "norms", that we adopt and adapt our open market policy,
lit introducing the motion which was adopted at the last meeting of the Federal
Open Market Committee, Governor Mills said (according to the minutes) he believed
;hat the action of the market and the operations of the Account had given a very
convincing performance that the motion proposed was a proper policy for the System
r ^ t o adopt. The final clause of the resolution recognized the fact that policy
1 Jpuld be changed by the Federal Open Market Committee, but there was an inference,
] E thought, that the policy then being adopted is the only "right" policy and that
jleviations from it should be considered only in extraordinary circumstances. The
I implication of timelessness in such an interpretation bothers mej I do not think <
\ we can afford to allow ourselves to drift into the soothing sleep of a "permanent"'
^ policy of this sort.

r
\

/
From the beginning of these discussions I have taken the position that
\ it is possible that, in most circumstances, the System will be able to attain its
\ /policy objectives by operating only in the market for Treasury bills and other
| short term Government securities.
(Except for swaps involving existing holdings
Iwhich I see no compelling reason permanently to proscribe.) But I have also con!tended that on some occasions the System might be better able to makes its pollJ cies effective by operating in other sectors of the Government security market and
that, consequently, the Federal Open Market Committee should avoid standing com­
mitments which would confine open market operations to "short term securities,
preferably bills". It has seemed to me that we could not afford to become frozen I
in our ideas, and that bearing in mind the uncertainties of the future we had
'
better keep our minds, as well as our hands, free to conduct System open market
I
operations in the light of conditions as they exist from time to time. The
attitude of the Committee in the recent past, with its undercurrent of pronouncing
permanent doctrine, strikes me as an extreme reaction to the extremes of market




M . 140 3
ISC

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( M iS C . 140 B . 1—3 0 M —8-52)

intervention which took place during and after the war, and which inhibited the
exercise of our powers of credit administration, 'The 'desire for unchangeable
nrules of the game" and a "free" market coiild similarly inhibit the exercise of
our powers. We need flexibility in operations and we want flexibility in markets,
but so long as our central banking system exists and performs its necessary
functions in a dynamic growing economy, we shall have to adjust our operations to
changing circumstances and we shall not be able to avoid "intervention" in the
Government security market. That market, and the expectations of the whole market
is conditioned by Federal Reserve* policy and the amount and type of our open
market operations.
There has been little occasion to raise these questions, as a matter of
practical operation of the System Open Market Account, since our meeting in
/^^September. It may be that restricting open market operations to Treasury bills
rfas caused some distortion in the structure of interest rates, and that the im­
petus given to a rapid decline in short term rates, by our operations, has
created some misconceptions as to our methods and objectives. If so, the evidence]
of harm is not clear when stacked against the evidence which our actions have pro^j
\^^vided of alertness to changing business conditions. It is not in periods such as
the past two months, however, that current policies are severely tested. Once it
, « ^ is made clear that bank reserves will be readily available, and once a downward
^-N
r
t^rend of interest rates has been established, and is part of market expectations,
changes in longer term rates may well follow changes in short term rates quite
promptly, and Treasury financing becomes relatively easy. The test of current
policy will probably come in other circumstances. Barring conditions of deep
depression, which fortunately we have not been forced to consider in recent years,
V ^ x l t is when monetary policy should be restrictive, or at critical turning points
in economic activity and credit policy, that we may most need to be ready to
r^Npperate over a wider range of Government securities and to assist Treasury financ­
ing by operations other than in Treasury bills (so long as this is consistent with
£redit policy). In this way we may be able to cut down the lag between our action
,and market reaction, in discharging our primary responsibility, and we may be able
to facilitate appropriate policies of debt management, in discharging a secondary
responsibility which we cannot escape and which, in fact, we have accepted.
It is of some significance, perhaps, that among those who at present
most strongly advocate confining our open market operations to Treasury bills, are
some of those who in 1949 (under admittedly different conditions) would have had
*us get out of the bill market entirely so that there could be free and independent
determination of bill rates by the market. Thejbhread that runs from this earlier
proposal to the present policy is that, no matter how you do it, credit policy
rests on System control of the volume of Federal Reserve credit outstanding and
that it need not - and indeed should not - be directly concerned with the level
or structure of interest rates. This represents an abrupt departure from the
traditional lines of development in modern central banking, a development which
had its origins in reliance upon the discount rate. Whether we have regard for
tradition and experience or not (it is interesting that the two foreign central
banks - the Bank of England and the Bank of Canada - which operate in a social
and economic climate most nearly akin to ours, definitely do not confine their
open market operations to Treasury bills, and do assist Treasury financing by
other means than trading in bills), it should be clear that rate policy and de­
termination of the volume of bank reserves have been and are opposite sides of




the same coin. We cannot formulate and understand credit policy unless we are
aware of its rate implications. While forces originating in the market set the
precise decimal points of rates each day, the System by its general credit policy
inevitably determines the significant characteristics of the rate structure. In
that sense you cannot have a "free" market for Government securities so long as
purposeful monetary control exists. Flexibility is what we want and what we
should aim to have; and flexibility is not synonymous with "freedom".
It is really because of these underlying considerations that I am dis­
turbed by the action of the Committee at its September meeting. Certainly it is
a matter of importance that the locus of responsibility for policy decisions be
defined, so that there can be no implication that the full Committee has abdi­
cated its responsibilities. And it is important that the Executive Committee
ind guides to its decisions in the consensus resulting from informed and infor­
mative discussion at the meetings of the full Committee. But more important
still is the definition of the area in which the Federal Reserve System has
responsibility for public policy. The report of the Ad Hoc Subcommittee relected a theory of central banking that would define the appropriate area of
central bank interest and responsibility in too narrow terms. By implication,
I thought the action of the Committee in September endorsed this definition of
the role of the central bank. It is my contrary belief that the monetary and
credit authorities are, and should be, directly concerned with any and all
developments that bear upon the cost as well as the availability of all types of
credit, to the extent that such concern can serve to promote economic stability.
These are not matters involving the position or prestige of individuals
in the Federal Reserve System; we are all equals on the Federal Open Market
Committee. They are not matters involving the relative weight of Washington and
New York in our councils; we are all seeking to develop credit policy to its
jiighest effectiveness in promoting economic progress. They are not matters to
-be decided on the basis of what Brother Patman may charge against the Federal
Reserve System at the next session of Congress. Once we stray from the straight
and narrow path of trying to meet our statutory and moral responsibilities for
credit administration, into the murky morass of individual prerogatives, spheres
of influence, and the reactions of particular members of Congress, we shall risk
pur existence as a "System".

/




Yours faithfully,

Allan Sproul, Vice Chairman,
Federal Open Market Committee.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102