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For the Record
ce: Messrs. Heller, Gordon, Solow

May 30, 1961

Janes Tobin
Luncheon Conversation with Chairman William McC. Martin
on Hay 29, 1961
On May 29 Messrs* Heller and Tobin had lunch with Chairman Martin
in his office at his invitation in order to discuss the difficulties which
he said were confronting Federal Reserve in the bond market. So one was
present other than these three individuals* The luncheon lasted from 1:00
p*m. until 3 ! # and many topics were discussed* Z will not attempt to
give a report of than in chronological sequence, but Z will try to cover
the main pointB aade.
Martin began the conversation, after the amenities, by dis­
cussing his political position and his tenure of his Job as Chairman. He
said that he was a registered Democrat and had voted for Stevenson in 1952*
Subsequently he has been completely out at polities and has not let any­
one know his political prefere* ’
JMs. Be recalled that he had been appointed
to his position by Truann, and he described his attempt to resign when
President Eisenhower cane in in 1953* He said that he had a fine private
Job offered to him at that tiae, and he let it be known in the White Bouse
that he was quite willing to resign. However, General Clay told hln to
hold on far a while, and finally there was arranged an interview with
Elsenhower. Be expressed his willingness to resign to Elsenhower, and
Eisenhower asked tor tiae to consider the oatter. Subsequently Martin was
informed that the Administration and the President desired for bln to con­
tinue. Martin aade elear that he had told the President that he was a
Deoocrat. In 1956 the matter did not cone 19.
During the Presidential eaapaign of i960 there were stories be­
ginning in Eewsweek in June that the Kennedy Administration, if elected,
would wish Martin to go* Also, during the eaapaign Monetary policy was an
^Bsue, with the Democrats criticising tight money. For these reasons Martin
felt that a matter of principle was involved, and he decided that he should
not offer his resignation to President Kennedy. Is felt that he had an
obligation to his supporters in the System and to those persons in private
life who have been defending the System to rsweln in his position until
the end of his tea* this he still intends to do. For essentially the
same reascn he believes that the Federal Reserve and the Chairmanship
should be nonpolitical and he regards the best demonstration of this prin­
ciple to be for him to remain in his position until his term is over. He
mentioned this because he had heard indirectly of seme sentiments in the



-2White Bouse that he should resign and he wanted to Bake it clear that he
did not Intend to do so. Be did not associate the Council with these
rumors, and he concurred with Heller's explicit dlsas30
elation of the
Council frcn them. The Challenge article was rather obviously in the
background of this discussion, but it was not mentioned explicitly on
either side. Martin did not explain why he changed his aind about
proper procedure for the Chairman between 1953 and 1961, and we did not
ask him.
Martin was concerned about the growth of rumors of severe dis­
agreement between the Council and the Federal Reserve, and he was con­
cerned with Council statements about the monetary policy. Apparently he
found these rumors extremely frequent in Sew York while he was there on
the "desk" last week. In scoe way which was not very clearly defined, he
believed that these rumors were disrupting the bond market; and I take
it that his main message to us was to ask us to be careful about public
statements for fear of the effect we might have on the market. Be acknowl­
edged that we had a perfect right to disagree with him and with the
Board about monetary policy, and moreover a perfect right to express our
views publicly. But he pointed out that policy is made by the Open-Market
Ccnmittee and the Board, and not by us. Be referred specifically to re*
ports that Tobin had advocated a reduction in the discount rate. Be
regarded this as a legitimate difference of opinion, but he referred to
the continuing international problem. Tobin pointed out that he bad
aald in testimony before the Joint Zcononic CcoBdttee that the 3 percent
discount was a deterrent to recovery, but he had recognised the need to
consider the balance of payments In making monetary policy. Martin also
referred to reports that the Council would like to see the bill rate go
down even below 2 p e rc e n t. We replied that we believed the bill rate
might be pezmltted to fall closer to 2 percent now that international
pressures had abated, but that we had not suggested that it oould now go
below 2 percent. Martin referred to Seller's Calvin Bullock renarks on
Council-Treasury-Federal Reserve differences in emphasis within the
context of general consensus on monetary policy and said that these remarks were widely quoted throughout the market. Heller showed Martin
the article In the May 27th Iconcmist and suggested that the Frees and the
market liked to exaggerate differences. Martin agreed to this and said
that these things did not bother him, as he had long eaqperlence In Govern­
ment with the Press and with manors.
3> Martin turned to the current prctblos in the government bond
market. Be said that the Federal Reserve was now the sole buyer in
the market and that many holders were willing to dump large holdings
into the hands of the Fad since the market was convinced that government
band yields must rise. Be said there was a real problem of maintaining


-3government bond prices without engnglng In "pegging.” Be did not wish,
nor did bis Boards to put more money Into the market than was needed to
execute the established monetary policy; that Is, mare than was needed
to maintain free reserves at $500 Billion* He did not believe that this
quantity would be sufficient to keep bond yields frees rising. Se attributed
the recent change In the psychology of the bond market to several factors:
first, the signs of recovery; second, the nnors of advanced refunding;
third, the anticipation of increased government spending and borrowing
needs; and fourth, the general resumption of Inflationary expectations,
associated in part with the stock market boom. Be contended that bank
reserve positions have been kept easy, so be did not attribute the de­
cline in the bond market to shortage of bank liquidity. He vas asked
whether the Fed could not purchase additional bonds and obtain the funds
by selling bills in order to prevent reserves from expanding above their
target. His response was partly that this would be pegging and partly
that the federal Reserve vas short of bills to sell. Tobin suggested that
the federal Reserve might pursue a policy of providing enough reserves
to keep the recovery fras automatically tightening the money credit
markets, as gauged by the short-term rate, and not worry too much about
what week-to-week expectations are doing in the bond market. Martin said
that in that case bead yields would surely rise, and he wanted us to be
prepared for that.
This led into a discussion of the appropriate monetary policy
during the expansion. As suggested above, the present policy of the ltd
is to keep free reserves at half a billion dollars. Martin believed it
would be very difficult to persuade his Ccaulttee to adapt an easier
policy than this* He, himself, was certainly in favor at continuing
this degree of ease, at least for the time being. Tobin said that banks
should be kept supplied, by purchases of longs and intermediates, with
enough reserves during the expansion so they eould finance it without
selling off their bills and other goverment securities, at least as long
as we were short of full employment and inflationary pressures had not
become evident* Be suggested that there was less reason now to worry
about expansion of bank reserves pushing the bill rates too low for our
international purposes; first because the international constraint itself
was relaxed, and second because the expansion would be tending to tighten
bill rates, and the action of tbs Federal Reserve would be required to
keep them from rising* Martin regarded this as too expansionary a credit
policy* Bis interpretation of a policy of "ease" does not extend to
offsetting the natural tendency of the market to tighten credit. If the
market tightens credit while the Federal Seserve is following an unchanged
policy with respect to reserves, Martin does not regard that as restrictive
policy, but rather as a continued policy of ease. Be believes that banks'
loan-deposit ratios have been tending to rise dangerously and be •
fchinWi it


-k -

would be unsound to permit then to rise unchecked during an expansion.
He believes that credit is like a rubber band. It can be stretched Just
so tight, then It inevitably snaps. It was suggested that the federal
Reserve has a lot to do with whether it snaps or not, and that what the
Federal Reserve does, It can also undo. Martin regarded this as a hope­
lessly naive renark and point of view. He does not believe the Federal
Reserve has that much power over the market and over the batiks* He
thinks the banks can if they want to sustain a tremendous expansion of
credit without Increase In reserve base*
5* There was seme discussion about the appropriate level of
Interest rates. Tobin and Heller expressed their concern that U. 8*
Interest rates were not only cyclically too high but .secularly too high
for the domestic economic position. They cited the almost unanimous
concurrence of the Treasury's consulting economists in this point of view.
Martin cited the fact that the U. 3. interest rates were the lowest In
the world among major industrial countries, and he quoted European senti­
ment that the U. S. Interest rates should be higher for purposes of the
international balance of payments equilibrium In order to relieve the
pressures on Germany, for example, to have low Interest rates with in­
flationary risks. Tobin responded that the productivity of capital, which
was related to the size of the stock of capital relative to the labor
force, was quite possibly lower in the U* 8. because we had developed
further, and that interest rates oust be adjusted to this basic natural
rate. There followed a discussion of the extent to which the government,
including the Federal Reserve, has any control over rates. Martin was
at pains to mqphasize that the government does not control the demand for
securities of various kinds* But he was constrained to agree that the
government does control supply*
6* There was discussion and disagreement about the present
danger of inflation. Martin was greatly concerned about the revival of
inflationary psychology in the last couple of months. Be regarded inflation
as a fairly Inartnent danger. Be referred to talk, of increases in steel
prices and wages. Be referred at seme length to his long record as the
opponent of inflation in the government. Be was proud of the fact that
although every other policy of the government * fiscal, market structure,
etc. - had abdicated responsibility for inflation during the last 10
years, the Federal Reserve had fought it. f e referred to the fact that the
dollar was only worth 65 percent of wbat it was worth in 191*6. Martin's
moral objection to inflation extends to the point that he was unhappy that
the Germans were having inflation, even though this was helpful to our
balance of payments.

7* Martin was greatly concerned about the damage that has
been done by inflation to the "credit of the government •" He contended
that the problem he's encountering in the bond market Is just a part
of the long run problem that people don't want to hold government bonds
anymore because the credit of the government has been damaged. Be re­
garded it as a real problem hov to keep people willing to hold the
Federal debt. Tobin suggested that in the recovery period we vish to
encourage people to hold more private securities and real capital
relative to Federal debt and other liquid assets, in order to encourage
expansion in the private eoonaay, and that that vas the reason why we
were trying to keep the attractiveness of holding government debt down.
Martin didn't buy this theory of the purpose of monetary policy at all.
8* Discussion about unemployment revealed that there really is
a basic disagreement between the Council and Martin with regard to
structural unemployment. Martin does believe that a large part of the
growth in unemployment is technological and structural and is not
susceptible of remedy by expansion of money and credit. Be believes
that appropriate policy should aim at labor mobility and price reductions
to pass on technological gains* Tobin and Heller attempted to get
Martin to specify the percentage of unemployment that he would regard as
a safe non-inflationary full employment Israel, but he would not do so.
Tobin and Heller pointed out that a considerable expansion could occur
during the casing year without getting belcxr 5 percent unemployment,
which would surely be enough to include structural and technological
unemployment. Martin did act concur that a 10 percent expansion of
output during the year could happen without eausing inflationary pressure.
9* Martin feels that the Kennedy Administration is mailing the
same mistake as the previous Administration In placing too great a burden
on monetary policy. Be had hoped that more use would be made of fiscal
policies in both cases* (Prcsunbly he means Elsenhower should have had
tighter budgets to fight inflation, and Kennedy a sore expansionary budget
to fight recession.)
ID. Martin referred to the strong pressure in the System
against tha policy of Vttniary £0, Ba said that at least 7 fmtiirrs of
the joint group, Board plus Bank Vresldents, 19 in all, voted with him
for the policy against their own conviction. He said that tha Advisory
Council (private bankers) vas against the new policy frcm the beginning
and at Its last meeting suggested that It be abandoned. Be esqpected
sentiment within the Bystem for abandoning the new policy to become
stronger now. Many people favor returning to dealing In bills to provide
the bank reserves that the Open Market OandLttee deems appropriate.

Heller raised the question of the Presidential Message
and referred to the political problem - the President is casnitted to
the continuation of monetary ease and to getting interest rates down,
at least keeping them frao. rising. Martin expressed his concern for
this problem too. He said that he had an equal desire to keep the
President fraa enfbarrassnent an this point. Seller pointed oat that
ve had left the whole task of clearing language for the message to the
Treasury. Martin said so many draft versions bad passed over his desk
that he could not really say that he bad "cleared" the language that
finally appeared* She only phrase that distressed him in it vas the
phrase about choking off recovery. Heller and Tobin pointed out that
this vas added without the Council's knowledge as veil*
12* Martin referred several times to the claim — by Arthur
Burns, by the present Council, and by many others •- that monetary
restriction vas In large part responsible for the premature i9 0 down­
turn and far choking off the previous boon. Oils thesis has clearly
stung h x and he does not agree vith it. Els own theory of the downturn
Is that It vas due to distortion of the cost and price structure owing
to continuing cost push. B e also defended the Board's actions In the
preceding years, explaining that inflation vas proceeding at an intoler­
able rate in spite of slackness In the economy.
13* Several times Martin referred
sconoBtlc training* but h t
market - he is a bond man. He repeated the
sane time on the "desk” In 5ev York to gain

to his m Innocence of
b& doM knotf the bond
suggestion that ve spend

lh. In response to probing by Heller tor explicit assurances on
fixture policy, Martin said he vill continue to operate the new policy
(of buying long-term hoods) a d to maintain conditions of ease, provid­
ing hank reserves as necessary to maintain free reserves at the level
of half a billion dollars end providing them mainly through the longterm market. Be does not have, he points out, complete power and there
may he restiveness In his Open Market Canalttee, hut he does not antici­
pate as early return to hills only* He does not think It possible to
get an easier policy, and he probably vould not favor one himself* As
stated above, l e does not believe that this policy vill prevent Increases
in govaraaent hood yields* And he does not agree vith the Council as
to the length of time during the upswing during vtaich It vill be possible
and desirable to pursue the present policy of ease.
15- At the end, Tobin and Seller ejpressed their gratitude for
the chance to have a real exchange of substantive views, and Martin said
that this should he repeated every three weeks and that he vould arrange
to have Balderston at the next such luncheon.

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