As finally approved, Congressional Resolution 133 required the Federal Reserve to reduce long-term interest rates and to report quarterly to the House and Senate Banking Committees on its planned rate of money growth.53 This requirement became part of the Federal Reserve Reform Act of 1977. Most commentary on these targets points to the way in which the Federal Reserve evaded congressional intent by announcing four targets for one-year growth—M 1, M2, M3, and the Bank Credit Proxy (total deposits)—revising the announcement each quarter, and shifting the base. The last, known as base drift, was probably the most serious. When money growth exceeded the target, the new target started from the overshoot (or undershoot). Thus, maintained money growth bore little relation to the target until the Volcker years after 1980–81.
After some experimentation, the FOMC set its target as the four-quarter rate of change beginning in the most recent quarter. Most, but not all, the errors were excess growth. Table 7.7, adapted from Broaddus and Goodfriend (1984, 7), shows the ranges and the errors for 1975 to 1984.
On average the error was 1.3 percentage points compared to an average 5.6 midpoint, or 23 percent. Most of the errors are positive; actual growth exceeded the target midpoint. Some of the errors arose because of changes in the composition of M1; NOW accounts are an example.
Nevertheless, Resolution 133 was a step toward increased transparency. For the first time in the Federal Reserve’s history, after more than sixty years, Congress tried to supervise its agent more effectively, and the public had a noisy indicator of intended future System policy. Additional steps eventually produced meaningful increases in transparency at all major central banks. Since the Federal Reserve had not replaced the gold standard rule with an alternative rule, greater transparency was needed to improve private forecasts of inflation or disinflation. The Federal Reserve was able to evade this step, but the issue was now open and would return.
52. In a comment on this section, Jerry Jordan described the outcome of a meeting held at the FOMC about this time. Four recommendations for a target came to a vote. Money growth received seven votes. Three money market measures (federal funds, free reserves, nonborrowed reserves) each received four votes. Burns ruled that a majority opposed money growth, so he eliminated it and revoted on the other three.
53. The legislation owed much to the efforts of the late Robert Weintraub, a staff member of the Banking Committee. Weintraub persuaded Senator Proxmire of the need for monetary targets.
In testimony on May 1, Burns announced a target of 5 to 7.5 percent for M 1 for the year ending March 1976. The announcement of explicit targets was a first. Unfortunately, the Federal Reserve chose to undermine Resolution 133 instead of using it to reduce inflation and maintain price stability.
Internally, members expressed concern about the unreliable control of monetary aggregates. In July 1973 the FOMC reactivated the Subcommittee on the Directive. The subcommittee’s first report, on March 10, 1975, recommended use of nonborrowed reserves (total reserves minus member bank borrowing) in place of RPDs. The claim was that the manager’s control of the instrument would improve. The report recognized that none of the reserve aggregates permitted precise short-run monetary control. It proposed setting a nonborrowed reserve target for the interval between FOMC meetings (memo, Subcommittee on the Directive to FOMC, Board Records, March 10, 1975). This was the apparent basis for choosing nonborrowed reserves as the target when the System adopted reserve targeting in October 1979.
Dewey Daane gave another prominent view of thinking within the FOMC. Daane served as a governor from 1963 to March 1974. A year later, he gave a speech expressing his personal views and responding to many of the Federal Reserve’s critics. His emphasis on fiscal policy errors is familiar from many members’ statements.
Daane said that the “recession-depression was an inevitable concomitant of the inflation that preceded it, and that is far from being eliminated. . . . [M]y best judgment of the present recession is that it traces primarily from the earlier inadequacies of stabilization policies, particularly fiscal policy although I would not altogether absolve monetary policy, of which I was a part, in contributing to an inflation that could not go on uncorrected” (Daane “The Other Side of the Looking Glass,” Burns papers, Box K7, Ford Library, April 9, 1975, 6; emphasis added). Daane did not explain how inflation induced recession as an inevitable concomitant. Much of the rest of his speech sharply criticized “the simplistic view that M 1 growth rates are the sole determinant of economic activity” (ibid., 8). Simplistic is right!
The FOMC continued to use the federal funds rate as its principal target. A careful study at one of the reserve banks summarized its actions during September 1974 to September 1, 1979. “This period is unique in that the Fed controlled the funds rate so closely that market participants could identify most changes in the funds rate target on the day they were first implemented by the Fed, and these changes were reported by market participants in the financial press the following day” (Cook and Hahn, 1987).
REGULATION 1974–75
In 1975, Congress considered and eventually approved legislation requiring greater openness and access to government decisions. As originally proposed, the bill would have required that meetings of FOMC and the Board be open to the press and the public. This constituted a very large change from the tradition of secrecy.54
Burns wrote a strong letter to Abraham Ribicoff, chairman of the Senate Committee on Government Operations, requesting exemption from the act. He argued that FOMC and Board meetings discussed problem banks and “sensitive materials relating to businesses, financial institutions, and foreign central banks and governments” (Burns papers, WHCF, Box BE1, Ford Library, June 17, 1975, 1). As a conciliatory gesture, Burns accepted that open meetings remained feasible for discussion of various consumer regulations such as Truth in Lending, Equal Credit Opportunity, and the like.
54. Kenneth Guenther (2001) was an assistant at the Board doing political liaison in this period. His first assignment was to organize the Federal Advisory Council to work against “government in the sunshine legislation,” later called the Freedom of Information Act. Legislation of this kind had become law in Florida. Florida’s senators pushed for similar legislation for the federal government. The Federal Reserve had help from the Federal Communication Commission because it, too, wanted an exemption. Congressional discussion shows the typical confusion between decision making and its consequences.
Burns’s efforts succeeded. FOMC and most Board meetings remained closed to the public, though reports of the meetings became available sooner than in its past, and some meetings were open to the public.
As usual, the Board discussed and approved many regulatory changes. Attempts to circumvent regulation Q ceilings raised new issues every year. Defining the powers permitted to bank holding companies raised issues repeatedly. Also, 1974 provided an opportunity to end the Voluntary Foreign Credit Restraint Program on January 29, 1974. Truth in Lending legislation required many interpretations of banking actions.
Legislation in 1974 ended the forty-year ban on private ownership of gold. The Board sent a letter to the reserve banks urging them to send letters to district banks warning them that gold was not a reserve, it was a speculative commodity, and urging them to adopt precautions against price fluctuations if they made loans or sold gold to their customers.
Growing regulatory responsibility under consumer protection legislation and the Bank Holding Company Act encouraged the Board to divest some of its responsibilities. On several occasions in 1974, the Board directed responsibility for holding company acquisitions, bank mergers, and one-bank holding companies to the reserve banks. It restricted reserve bank decisions to actions similar to those on which the Board had ruled previously.
The Board made a policy decision to encourage longer-term time deposits by lowering reserve requirement ratios on certain types of deposits. For example, on October 16, 1975, it reduced from 3 to 1 percent the reserve requirement ratio for time
deposits with four years initial maturity. The Board also reduced reserve requirement ratios on euro-dollar deposits to equality with domestic certificates of deposit. This action recognized that adoption of floating exchange rates reduced the need for restrictions on capital movements.
POLICY ACTIONS IN RECOVERY
The recovery that began in second quarter 1975 was moderately robust, 6.1 percent average real growth in the next four quarters. Growth then slowed to 1.7 percent in second and third quarter 1976. Consumer price inflation fell from 9.8 percent in March 1975 to 4.8 percent at the 1976 election. Money wage growth declined from 8 percent in March 1975 to 5.7 percent in October, then rose to 7 percent at the election. Real wage growth turned positive. Unemployment reached 9 percent in May 1975, then declined to 7.8 percent at the election. Inflation declined as output rose and the unemployment rate fell. The Society of Professional Forecasters’ forecast for four-quarter inflation remained in a narrow range, 5.9 to 6.2 percent throughout. Ten-year Treasury yields rose from 8 to 8.5 percent at the start of the recovery, then declined to 7.4 percent in November 1976. This measure of real yields remained positive.
The temporary tax cut increased disposable income at the start of the recovery, stimulating spending. The Federal Reserve followed a relatively cautious path, holding the federal funds rate between 4.8 (February 1976) and 6.2 percent (September 1975). At the election, the funds rate was 5 percent, slightly lower than at the end of the recession. Burns and a majority of the FOMC seemed determined to avoid another surge of inflation during the recovery. Twelve-month average growth of the monetary base fell from 7.9 to 6.8 percent during the recovery to November 1976. Although Burns professed admiration for President Ford, monetary policy did not turn highly expansive in 1976 despite slow real growth after first quarter 1976 and a 7.8 percent unemployment rate. The Federal Reserve had learned from its experience after 1972 not to repeat the 1972 stimulus despite an unemployment rate that was two percentage points higher in 1976.
William Simon became treasury secretary in May 1974, when George Shultz left. Simon opposed most stimulus programs and emphasized tax reduction and tax reform to increase productivity and encourage investment (MacAvoy, 2003). The Democratic majority in Congress did not share his views. They added spending and increased tax reduction, enlarging the budget deficit. Simon encouraged the president to veto a large number of spending programs, but despite the economic recovery, the budget deficit reached $60 and $76 billion in 1975 and 1976.
Congressional Democrats and many economists urged counter-cyclical fiscal actions. Simon generally opposed. Instead of viewing government spending as a means of stabilizing the economy, he argued that spending became permanent, increased deficits, and crowded out private spending. Simon renewed the claim that the economy would do a better job of restoring full employment with low inflation if left on its own. He favored fiscal policies that “were business cycle neutral” to increase long-term growth (ibid., 214). He told the Congress: “[F]ree competitive markets are the most effective way to increase output” (ibid., 215). Congress had not heard such comments from a treasury secretary since Secretary Humphrey in the Eisenhower administration, twenty years before. Like Humphrey, Simon did not convince a majority that short-term stimulus was both undesirable and possibly counterproductive.55
55. A milder version of the difference in approach was the discussion of the 1977 budget in Lynn and Schultze (1976). Lynn was the budget director in the Ford administration; Schultze had been budget director in the Johnson administration and became chairman of the Council of Economic Advisers in the Carter administration. In the question period, Robert Weintraub pointed out the large difference between forecasts and outcomes in 1975 (ibid., 35).
The Federal Reserve was more determined than in the previous ten years to reduce inflation while reducing unemployment rates. Between the end of the recession and the 1976 election the FOMC changed course five times, judged by the federal funds rate. Table 7.8 shows these changes, the twelve-month moving average of monetary base growth, consumer price inflation, and the monthly unemployment rate.
The inflation rate fell to the level prevailing in March 1973 under price and wage controls. The FOMC showed itself capable of substantially reducing inflation while the unemployment rate slowly fell, contrary to the Phillips curve. Growth of the monetary base fluctuated around 6 percent. As the table suggests, base growth began to rise late in 1976.
Burns responded more to the inflation rate than in the past, but he was aided by rising economic growth and falling unemployment.56 Although several of the Keynesian economists had left the FOMC since 1972, and he influenced the choice of replacements, his policy met opposition.57 President Eastburn (Philadelphia) dissented at the April 1975 meeting.58 Governors Bucher and Coldwell dissented to an interest rate increase intended to slow money growth at the June meeting. Money growth continued to increase, so Burns had a telephone meeting to vote on an additional increase in the upper limit of the funds rate to 6.25 percent. This time Governors Bucher, Holland, and Mitchell dissented. This is another of the very few times when three governors dissented together. Alan Greenspan’s weekly memo to the president noted the rapid growth but did not express concern. Money growth soon slowed. The action showed that at this time Burns watched money growth rates but did not attempt control.59 The Federal Reserve lost much of its remaining credibility as SPF inflation forecasts rose.
56. Alan Greenspan did not accept the Phillips curve as a useful tool. “Unemployment was never seen as a necessary condition for bringing down the rate of inflation. . . . [S]ince the unemployment rate and inflation rate both went up together, we always argued it was possible to bring them down together. Over the longer run there’s no question that that’s right. The question is whether we could succeed in doing it over the shorter run” (Hargrove and Morley, 1984, 445). Greenspan retained this view later when he served as chairman of the Board of Governors.
57. At the time, the Shadow Open Market Committee (SOMC) blamed the Federal Reserve’s operating procedures for the slow rate of money growth (reported 1.5 percent from June 1974 to February 1975). The March 1975 SOMC statement explained the decline in money growth (M 1 ) as a counter-cyclical mistake arising from the failure to recognize that the decline in market interest rates resulted from the weak economy, not from expansive Federal Reserve policy.
58. More than previous chairmen, Burns influenced the choice of reserve bank presidents. The law gave the Board final choice of the candidates that the Banks selected. Burns took a more active role in the selection process than Martin had.
Governor Holland dissented to an increase in the funds rate at the July meeting. M1 growth slowed.60 The FOMC kept the federal funds rate unchanged, but it raised the top of the range to 7 percent. The FOMC rejected a reduction in the funds rate because the reduction “might have to be reversed shortly—a sequence that could seriously compound uncertainties in financial markets” (Annual Report, 1975, 222).61 The Federal Reserve has usually been averse to reversing its actions in a short period. Five changes up and down in the federal funds rate in 1975–76 were unusual.
Misled by data suggesting modest economic growth that was later raised and rising inflation, the FOMC promptly voted for a modest increase in the funds rate at the September 16, 1975, meeting. By October 2, the committee recognized that money growth had slowed. It voted to reduce the funds rate from 6.36 percent toward 6 percent or lower. At the October meeting, it voted to further reduce the funds rate to 5.75 or possibly 5.5 percent.62
59. M1 and M2 grew 11 and 13 percent in the second quarter. The announced intention called for 5 to 7.5 and 8.5 to 10.5 for the year to June 1976. The FOMC changed the target base to second quarter at its July meeting. It set the near-term growth rates to 3 to 5.5 and 8 to 10.5 percent. Also, the Board reduced discount rates by 1.5 percentage points in three stages— January 6, February 5, and March 10. On March 10, the discount rate was 6.25 percent. These changes followed the market.
61. A principal uncertainty was the possible default by New York City on its debt. The Ford administration refused assistance at first because New York did not offer a credible plan to achieve budget balance. At first Burns agreed with the president, but a New York default would damage the New York banks as debt holders. Also, the dollar declined, alarming the Europeans. After the state and city acted, the Ford administration agreed to lend several billion dollars, repayable by 1978. Congress approved (Wells, 1994, 175–77). Burns’s reasoning again confuses the Federal Reserve’s responsibility for sustaining the market, not the banks.
62. Twelve-month monetary base growth had declined from 8.8 percent in December 1974 to 5.7 percent in October 1975. At its September meeting, the SOMC urged the FOMC to maintain a 5.5 percent rate of money growth. This was within the 5 to 8 percent shortterm range and the 5 to 7.5 percent medium-term range set by the FOMC. The minutes report a staff estimate of 11 percent nominal growth in the third quarter. Actual growth was 16.2 percent.
Opinions about appropriate policy differed as 1975 ended. A change in regulations permitted businesses to hold interest-bearing savings accounts up to $150,000 at member banks. This reduced measured M 1 growth. But monthly reported average hourly earnings rose rapidly (10.5) percent in November, even as CPI inflation rates continued to fall.
A History of the Federal Reserve, Volume 2 Page 30