25. The Board’s March order differs from the January order by recognizing that the OMPC was a voluntary association, that banks could withdraw or refuse to participate in purchases and sales, and that members of the OMPC would be appointed by each bank’s board of directors (Board of Governors File, box 1452, March 31, 1930). These were the conditions New York had demanded earlier.
26. Harrison’s position at this meeting does not fit well with the view that he recognized the need for expansion at an early date but was hampered by the Board. The minutes state: “Governor Harrison stated that the proposal for a reduction in the buying rate for bills was made by the Federal Reserve Bank of New York in order to prevent a decrease in the bill portfolio and an increase in rediscounts such as might lead to a firming of money rates or at least an interruption to the natural downward trend of interest rates. It was not suggested as a program which would artificially force a more rapid easing of credit conditions, although it seemed likely that the directors of the New York bank might also wish soon to reduce the discount rate” (italics added). The italicized statements might be interpreted as an attempt to win support from those governors who viewed the contraction as a “natural” reaction. But Harrison did not couple his statement with a proposal for purchases after he obtained the support of the committee for the proposed reduction in the buying rate on acceptances. In January Harrison had written to one of the governors that “in view of the progress we have already made and in view of the uncertainties . . . there is no need at this time for any further purchases” (Harrison to Governor Seay [Richmond; copy sent to all Governors], Harrison Papers, Letters and Reports, vol. 1, January 10, 1930).
Although the committee recognized that changes in loans and investments of reporting member banks were smaller “than the usual growth of credit required by the country’s business,” it voted only to “avoid the hardening of rates which might result from a seasonal demand for additional reserve credit.” Its statement urged caution and restraint. The reasons that prompted most members to proceed cautiously are developed more fully in the committee’s policy statement:
The majority opinion was that what had already been done has set in motion a trend which should result in lower rates. Between a reduction of discounts and large purchases of securities and a reduction of rates to business there is always a lag and that lag is likely to be greater at this time because the appetite of the bankers has been whetted during recent months, and they are slower about coming down. There is every reason to anticipate that the reduction will occur, so that it is believed that the current is set in the direction of easier rates.
We feel we should not interfere in that movement either in the direction of halting it or attempting to expedite it. . . . [It] is inexpedient to exhaust at the present time any part of our ammunition in an attempt to stimulate business when it is perhaps on a downward curve . . . in a vain attempt to stem an inevitable recession. . . . The majority of the Committee is not in favor of any radical reduction in the bill rate or radical buying of bills which would create an artificial ease or necessitate a reduction in the discount rate. (Open Market, Board of Governors File, box 1436, January 30, 1930)
The empirical basis for the committee’s conclusions is more clearly set forth in a memo that Harrison had read to the Governors Conference more than a month earlier.27 The memo contained two charts. One showed the relation between member bank borrowing and market interest rates. The other compared the rate of increase in bank credit with the volume of member bank borrowing. Harrison interpreted the charts as showing that “generally speaking the trade and business of the country require an increase in bank credit somewhere in the neighborhood of 4 to 5% a year, and the chart indicates that the rate of increase in bank credit has usually exceeded this rate when the Federal Reserve discounts were under 400 to 500 million dollars, and usually falls under this rate when discounts are over 500 to 600 million dollars.” The memo goes on to spell out these central notions of the Riefler-Burgess framework and, after mentioning some qualifications, concludes that “these charts show in general that under conditions that have prevailed in recent years an amount of member bank borrowing somewhere in the neighborhood of 500 million dollars [the level then current] may be considered a normal at which commercial paper rates have tended to average 41/2% and at which the volume of bank credit has tended to increase at the rate generally proportionate to the needs of business.” Since the volume of member bank borrowing had been reduced by $450 million in less than two months and was now within the range Harrison spoke of, it is not surprising that he did not favor or propose an aggressive policy of open market purchases.
27. Report of the Chairman of the Open Market Committee to the Governors Conference, December 11, 1929. The memo dated December 4 is in Governors Conference, vol. 1, December 11, 1929. Here as elsewhere, Harrison does not distinguish real and nominal rates.
When the Board met the next day to discuss the committee’s recommendations, Treasury Secretary Andrew Mellon repeated several of the arguments that had been made in the policy statement. The Board voted to carry out the policy recommendation and approved a minimum effective buying rate of 3.875 percent for any Federal Reserve bank wishing to establish that rate. By a tie vote, the Board followed the OMIC majority and refused to reduce the discount rate at the New York bank to 4 percent. The reasons for the Board’s refusal are not clearly stated in the report, although there is some indication that it regarded the request as premature.
The governors’ statements at this meeting provide a clear indication of their reasons for failing to take more expansive action at the time and throughout the period. Since short-term market interest rates had fallen and were expected to fall further as member bank discounts declined, most governors saw little reason for the Federal Reserve to “interfere” or to hasten the decline in rates. Words like “artificial stimulus” and “inevitable decline” reflect the dominant view that speculative excesses had to be purged. Once that happened, the economy would recover, and the System would be able to expand based on rediscounting of real bills.
Virtually all the governors used the level of market interest rates as an indicator of current policy. Differences between them at the meeting were largely matters of detail. Some opposed the 0.125 percent reduction in the buying rate for bills on the grounds that the reduction would cause the System to acquire bills in much larger quantities temporarily and thus cause market rates to fall faster than they believed desirable. Others opposed the reduction on the similar grounds that the reduction in the buying rate for bills would “force” a decline in the discount rate by contracting the amount of member bank discounts (reducing the demand for reserve bank credit). Only Governor Black advocated a policy of open market purchases.28
After the January meeting the Board approved reductions in the minimum buying rate for bills on February 11 and 24 and on March 5, 6, 11, 14, 17, 19, and 20. By the March meeting, the buying rate was 3 percent. The Board also approved further reductions in the discount rate to 3.5 percent at New York and to 4 or 4.5 percent at the other banks. These changes did not receive the unanimous support of the Board members, and those who voted for the reductions often expressed doubt about the efficacy of a “cheap money” policy.29 No one mentioned that wholesale prices had fallen 7 percent in seven months or that real rates had increased more than nominal rates had fallen.
Despite the nominal rate reductions, the System’s holdings of acceptances had declined since the January meeting, and the volume of member bank discounts was at the lowest level since early in World War I. Long- and short-term interest rates continued to decline, as shown in table 5.5. Although nominal short- and long-term rates had fallen to the levels reached in the recessions of 1924 and 1927, the term spread between short- and long-rates had doubled in the two months to March.
This was the last meeting of the committee for more than two years at which the seasonally adjusted money supply showed a rise from the previous meeting. The in
crease in money from January to March was largely the result of a gold inflow from Brazil and Japan and the higher base money multiplier produced by the continued decline in the public’s demand for currency in both nominal and real terms.
Much of the discussion at the meeting was about New York’s decision to purchase $50 million of government securities early in March. Although the committee had voted against further purchases at the January meeting, New York explained, as it had in a letter earlier in the month, that the purchases had been made, after consultation with the Federal Reserve Board, because it had been “impossible to maintain the bill portfolio” in the face of an increasing demand for bills by banks and financial institutions. The “unfavorable business situation” was also mentioned as a factor in the decision to purchase.30
28. The new OMPC overrepresented the smaller banks in the System, but it is not clear that it was more or less inclined toward expansion. Black (Atlanta) was the most expansionist of the new members, but the new committee also included Calkins and Talley, who usually opposed purchases as “artificial” stimulus. At the time, the seven new members held only 25 percent of the System’s portfolio.
29. For example, one Board member, Cunningham, stated that he voted aye but had hesitated to do so because at 4 percent “money is cheap.”
30. In fact, the Board proposed the purchases on the grounds that “no harm and some good might be accomplished” (Case to Young, Board of Governors File, box 1435, March 7, 1930). J. Herbert Case replaced Gates McGarrah as chairman at New York on February 28. Case had long been an officer of the New York bank.
The discussion makes it clear that the main reason for the purchases was to correct a problem that the members regarded as technical. An inflow of gold—from Japan and South America according to the minutes—had increased the reserves of the New York banks. The banks used the new reserves to purchase acceptances, forcing the Board to lower the buying rate for acceptances or allow the acceptance portfolio to decline. At first the Board reduced the acceptance rate, but the acceptance portfolio continued to fall in early March because the gold imports continued and the Treasury’s balance at the reserve banks declined. The falling acceptance rate was regarded as a technical reaction because a rise in the rate on other short-term instruments—for example, stock exchange collateral loans, particularly brokers’ and dealers’ loans—accompanied the decline.31
The preliminary memorandum prepared for the meeting noted that the recession was probably more severe than the recessions of 1924 or 1927 and that unemployment had increased. However, it also observed that “the effects of easy money and freely available credit have been, in the first place, to stimulate a vigorous recovery in the bond market. Bond prices have risen to the highest points in more than a year.” This was a particularly important piece of information within the framework that most of the members used. The rise in bond prices and the reduction in member bank borrowing seem to have provided the entire basis for the decision to make no further purchases of government securities. In the committee’s words, “The steps already taken by the Federal Reserve System in easing the money market through open market operations have gone as far in providing the stimulus of easy money for business use as seems desirable at this time.”
With hindsight, it is clear that this was an important meeting. The decision to avoid further expansive action because monetary policy was judged to be “easy” came just as there were signs of a turning point or a bottom of the recession. The preliminary memorandum prepared for the meeting noted a slight improvement in “business and trade” between December and January and further slight improvement from January to February. The data now available partly confirm the observations made at the time. Industrial production, seasonally adjusted, rose in January and declined very little in February. More important, there was a slight drop in industrial production from March to April and larger declines in May and June. The index of common stock prices had restored approximately 25 percent of the October decline in the value of common stocks by the end of March, but the rise in stock prices ended in April.
31. Total bank credit had risen by $300 million from the end of February to the date of the meeting. Loans to brokers and dealers had risen to the level of the previous November, but more of the loans were held by New York banks. The rise in brokers’ loans was accompanied by a rise in stock prices. Standard and Poor’s Index (1935–39 = 100) increased from 159.6 in November to 182.0 in March. Data on total bank credit are from the minutes; other data are from Board of Governors of the Federal Reserve System 1943, 498, 481.
If the governors of the Federal Reserve had used the stock of money instead of interest rates as an indicator of monetary policy, they would not have concluded that monetary policy was “easy.” Additional open market purchases at this time would have contributed to the expansion. Instead, the further contraction of money contributed to the decline in output and to the bank failures that came with increased frequency after this meeting.
The striking fact about the meeting is that although there was little dissent about the size of the recession, there was little support for a policy of monetary expansion. The committee’s main recommendations were designed to prevent a further reduction in bills: it voted to reduce the buying rate for bills to 2.5 percent, but not to purchase below 3 percent except in an emergency, and to engage in no open market purchases. A memo prepared for the meeting and made part of the record showed that the System’s earning assets were lower than in the previous year, largely as a result of the fall in member bank discounts.
The discussion at the meeting showed no evidence of disagreement between New York and Washington. On March 14 New York reduced its discount rate to 3.5 percent, with Board approval. Other banks remained at 4 to 4.5 percent. In a letter to Governor Young, J. Herbert Case described the 3.5 percent rate as a possible danger, but he urged the Board to approve the step “in the hope that business may be benefited” (Board of Governors File, box 1435, March 17, 1930). He hoped that the System would act promptly to prevent excessive credit expansion.
Outside New York, reserve banks remained skeptical about additional ease. Although he saw “plenty of evidence . . . that what had appeared to be an upturn in January has not held,” Governor Talley (Dallas) wrote opposing any additional expansive actions.32 “Everyone seems to want to keep business jazzed up all the time and have it run along at boom figures. . . . [T]he sounder course to pursue . . . is to catch up and let the public pay some of its debts or at least acquire larger equities in its automobiles, radios, and real estate (Talley to Case, Board of Governors File, box 1435, March 13, 1930, 3).33
32. “Frankly, we were very much disappointed over your reduction [of discount rate] to 3.5 percent last Thursday. We feel a little bit better about it today, because the stock market has regarded the action as an unfavorable symptom and seems to recognize it as a panacea for business depression (Talley to Case, board of Governors File, box 1435, March 13, 1930, 2).
33. Talley also refers to governors who vote for open market purchases, then refuse to participate in the purchase. (Only eight of the twelve banks participated in the purchase of $50 million in March.) His bank participated fully. As a result, they had taken 7 percent of the allocation instead of their usual 3.3 percent. He withdrew from his pro rata share of the nonparticipating banks acquisition by limiting Dallas’s purchases to its standard 3.3 percent (Talley to Case, Board of Governors File, box 1435, March 13, 1930, 3).
Between the March and May meetings of the Open Market Policy Conference, the Board considered a request from New York to lower the discount rate from 3.5 percent to 3 percent. At first the Board unanimously disapproved. The Board’s minutes for April 24 record a “considerable variance of opinion between the New York Bank and the Federal Reserve Board with regard to Federal Reserve policy.” The Board favored “the maintenance of stability rather than further easing through Federal Reserve action.” Within a week, however, Governor Young changed his mind and
announced that he favored reducing the discount rate and the buying rate for bills. On May 2 the Board approved New York’s request, and in the following weeks the effective buying rate for bills declined to 2.5 percent, below the rate that the March conference had suggested as a minimum.
New York’s request was a response to the deteriorating economy. At a meeting on April 24, Harrison reported to his directors that production and trade had declined in March and that preliminary figures for April, covering building contract awards and railroad car loadings, showed a further decline. Harrison also reported that commodity prices had fallen, that foreign trade had declined during the first quarter, and that gold continued to flow in. He recommended a reduction in the discount rate as a means of improving the bond and mortgage markets, which “historically and logically appear to be a precedent or a necessary accompaniment of recovery in business and prices after a period of depression.” The following week Harrison again discussed a discount rate reduction with the directors. This time the Board approved.34
The data for this meeting, in table 5.6, show the renewed decline in industrial production and the fall in wholesale and farm prices. Although bank lending (at weekly reporting banks) had increased since March, commercial paper and banker’s acceptances had fallen. The data also show that standard policy actions were not having their expected effect. Lowering short rates had not reduced long rates. Rates on Aaa bonds were only twenty-four basis points below the August 1929 peak, while prime banker’s acceptances had been reduced by 2.625 percent. The term premium had increased by a factor of three, from 0.7 to 2.1 percent since the end of January.
A History of the Federal Reserve, Volume 1 Page 44