Mr. MARTIN. We did moderate credit restraint on November 22. I want to point out we probably would have done it on November 1 except for the fact it was an even keel period for the Treasury. In other words, the Treasury was facing a financing there, and we do not as a rule make changes if we can help it, when they are going to finance, We want to be as helpful to them as we can. We do not try to make overt changes during such a period. you see. But I think the record of November 1 will show that we were tending in this direction at that time. We carried through on November 22 with the official change. Representative REUSS. I don't mean at this time to go into all of the reasons, which are well set forth in the policy record of why on November 22 you did ease credit. The fact that I happen to have agreed with that action is also irrelevant here. My question was whether, in the five-page record of policy action published in your annual report, there is any mention of the tax increase by the Congress, and your answer is "no, there isn't." Mr. MARTIN. I don't know whether there is or not, but I think you have got a point; it would have been wise to mention it, if we didn't mention it. But I am sure that that was an oversight as far as that is concerned. Representative REUSS. Then the next meeting of the Open Market Committee was on December 13. Mr. MARTIN. Might I just interrupt, Mr. Reuss? Representative REUSS. Yes. Mr. MARTIN. And say that Mr. Brill tells me we did mention it on November 1. Representative REUSS. Yes, it is mentioned briefly on November 1, you did not take action to ease credit on November 1. but Mr. MARTIN. The reason was primarily-I am not speaking for all my associates, but the reason primarily in my own mind was the Treasury financing on November 1, you see, the "even keel" considerations. Representative REUSS. Yes. Then, on December 13, you issued a directive, continuing your easing of credit-and here the policy record takes seven pages-and I find not a word about the tax increase. If I have overlooked anything, I would be delighted to have it called to my attention. My point, which I have probaby telegraphed by now, is simply this: Is it really a very likely assumption that, if Congress votes another increase in taxes next July 1, this will play any more part in the Fed's deliberations than the formal record shows was played in the Fed's deliberations after the last tax increase? And if the record is a true index of what was in the Fed's mind, there were a great many things in the Fed's mind in taking these salutary and wholesome actions other than the tax increase. Is there any reason to suppose it would be any different next July if we voted a tax increase? Mr. MARTIN. I wouldn't for a moment want to forecast what conditions will be next July, but we will certainly consider every aspect of conditions, just as we did in November. The tax increase would be one of the factors to be taken into account. Now on this tax increase, we have to realize that when we come to the budget that you are talking about-let's not argue about whether it is the administrative budget or the cash budget or the national in come accounts budget for the moment; let's just take the administrative budget-you have a deficit of $8 billion, roughly. If the tax increase is not enacted, that goes up by $4.6 billion. If they don't sell the participation certificates, it goes up another $5 billion. If they don't get the postal rate increase it goes up another $700 million. These are all things we have to take into consideration. (Chairman Martin submitted the following for inclusion in the record:) The record of policy actions of the Federal Open Market Committee includes five separate references to suspension of the investment tax credit, either specifically or by referring to the "fiscal program announced by the President" or "fiscal policy measures *** recently enacted by the Congress." The references may be found in the policy record entries for the meetings of September 13, October 4, and November 1. Representative REUSS. Your point is well taken. May I now turn to the record of the policy action of the Federal Reserve, with particular reference to the meeting of July 15, 1966, where I was most interested to learn the Federal Reserve Board turned down recommendations of various of the Reserve banks, to increase the discount rate from 412 percent to 5, and in some cases to 512 percent. Again, though it is not relevant to my question, I approve of the vote of the Federal Reserve Board in turning down that discount rate increase. But what concerns me is the whole business of the announcement effect of discount rate changes. As one reads the record of the Board meeting on July 15, 1966, one can't but be struck by the self-torture that the Board undergoes by the supposed necessity of setting discount rates. It worries and I would too if I were on the Board-at the announcement effect of a discount rate increase. There is some evidence in the record that the Board did not undertake an increase in the discount rate last July because of the so-called announcement effect. Reading the record over the years as I have, I find other occasions when it seemed to me that the announcement effect of a discount rate increase produced a result that the Fed would not have particularly wanted. Now to my question. Isn't it time for a thoughtful reexamination of our discount policy? I can see certain defects in the way we do it now. As I have said, the announcement effect frequently produces a result counterproductive to what the Fed in its judgment would have wanted. At other times, the overhang of an announcement effect keeps the Fed from doing what it otherwise would have done. Compounding this is the Fed's habit, which I am not undertaking to criticize, of moving the discount rate in rather a wide swing, half a percentage point, which is a big change, because quite understandably it doesn't want to make a lot of little shivering changes in the discount It uses it much as a Treasury does when it contemplates devaluation of the currency. "We might as well do this right, boys, so we don't have to do it again in a few weeks." rate. In the light of this, isn't there much to be said for the suggestions made by Warren Smith and other economists that the Fed would be better off if it said "From now on, we are trying the discount rate to the Treasury bill rate, perhaps adjusting it weekly, monthly, or quarterly"? And when the Fed wishes to announce something, it will use the English language and announce it. It probably won't want to do this very often, but when it has something to say, it will say it in English, not in the language of flowers that your discount rate change gives you. I am sure this concerns you and your associates. And let me say now, because the time you are doing to have to answer it in this morning is necessarily very brief, that I would appreciate it if in addition to what you are able to respond this morning, you would file at this point in the record as complete and thoughtful a statement as the Board of Governors cares to make, with such additional views and dissents as the Governors may feel. Now, would you respond, sir? Mr. MARTIN. My response to this would be that we are making a very careful study of the discount mechanism within the System at the present time. This is under Bob Holland, who is our specialist in this and who is the Secretary of the Open Market Committee now. He has been meeting with the discount officers of the 12 Reserve banks and others, and we have been reviewing this entire matter. As you stated, it will take a long time to go into the various aspects of it, but we hope to have that study completed before too long and give you the whole study. Representative REUSS. Meanwhile, pending the completion of the study, I would appreciate it if you could give me, and if the members of your Board could give me, the benefit of their thinking at this time, recognizing that it would be on a preliminary basis. Mr. MARTIN. We will do the best we can with it, but it is a very complicated and difficult research problem. Representative REUSS. I am glad you recognize, as I do, that it doesn't look as if it is perfect the way it is done now. Maybe we ought to consider improvements. Mr. MARTIN. Let me say, perhaps this is a needless comment, but never has the Federal Board in recent years claimed to be anywhere close to perfection in its activities. Representative REUSS. Thank you. (The following letter, responding to the request of Representative Reuss, was subsequently submitted for the record:) BOARD OF GOVERNORS, Hon. HENRY S. REUSS, House of Representatives, Washington, D.C. DEAR MR. REUSS: This letter is in response to your question, at the time of my testimony before the Joint Economic Committee on February 9, concerning the review of our discount mechanism. The Federal Reserve System has been engaged, for a little over a year, in an intensive and far-ranging examination of its discount operations and policy. This study represents the first such investigation since the early 1950's, at which time Regulation A, governing the discount operations of the Reserve Banks, was revised to its present form. The period following the Treasury-Federal Reserve Accord of 1951 saw the development of the Government securities market to an extent which permitted the bulk of monetary policy actions to be carried out in that market. At the same time, most banks held ample supplies of these highly liquid Government securities. These holdings were an aftermath of war financing and enabled banks to make most adjustments in their reserve positions by sales of these readily marketable assets. In this environment, the discount window served only a marginal role as a supplier of reserves. It was designed to give banks assistance over the peaks of temporary, emergency, or seasonal needs for funds that exceeded the dimensions that the banks themselves were capable of reasonably meeting out of their own resources. To foster this kind of bank use of the discount window, chief reliance was placed upon the tradition against bank borrowing, buttressed as when necesary by disciplinary contacts by discount officers. Given this kind of discount policy, open market operations could be undertaken with a new degree of vigor and precision, secure in the knowledge that only marginal reserve additions would be introduced through the discount window-in effect, just enough to lubricate the many joints in the banking machinery. The financial environment has changed markedly in the past decade, and increasing evidence suggests that the discount mechanism may be in need of modernization. Banks no longer hold large amounts of Government securities. In recent years non-Federal debt has increased far more rapidly than Federal debt, and bank portfolios have reflected this development. The supplies of liquid assets available for reserve adjustment have been further curtailed by the rise in the total of public deposits which typically must be collateralized by the hypothecation of these assets. In the absence of ample supplies of liquid assets, many banks find themselves adjusting their reserve positions more and more through the issuance of shortterm liquid liabilities. This can be seen in the rapid growth of the Federal funds market, the intense competition for certificates of deposit, and the heavy reliance of some banks on the Eurodollar market. Meanwhile, the preponderant System dependence upon open market operations for the execution of monetary policy, while still working generally well, has at times involved market strains of a type that might have been ameliorated by a different kind of discount window assistance. It was in the light of these developments, criticisms, and questions coming from both within the System and without, and the general belief that the tools of monetary policy should be periodically examined to evaluate their effectiveness in developing financial conditions, that the current study of the discount mechanism was undertaken. Participants in the study include the broadest cross-section of interests, opinions, background, and geographic assignments. The operation is headed by a Steering Committee composed of members of the Board and Presidents of Federal Reserve Banks. Under this Steering Committee was established a high-level staff Secretariat charged with the responsibility for conducting research and developing proposals for consideration by the Steering Committee and, in turn, by other principal System policy-making bodies. Approximately two dozen separate research projects are presently in various stages of completion. These projects cover a wide variety of issues, some exploring the past history of the discount mechanism, others examining the discount window and other aspects of the financial system as they operate and interact today, and still others evaluating various changes and improvements which have been proposed in the light of the economic environment today and that expected to exist in the foreseeable future. One segment of these studies is examining the discount mechanisms employed by central banks in the other major industrial countries and evaluating the guidance they can offer for our own window. In this connection, the officials of these central banks have been contacted both by letter and in some cases by personal visits from our staff. The views of a number of outstanding academic economists have also been obtained in connection with this study. One academic seminar on proposed changes in the discount mechanism has already been held, and another is contemplated shortly. In addition, a few academic economists have been commissioned to prepare papers on particular aspects of the subject. At the end of a year of concentrated effort on this ambitious undertaking, significant progress has been made. However, the time is only now approaching when the results of this research are being interpreted and evaluated in terms of policy alternatives. Hence it is premature to do more than touch on possible findings of a policy nature. Nevertheless, to try to be as responsive as possible to your inquiry, I can report that several possible implications of the findings have already begun to emerge, some of a general nature and others pertaining to more specific areas. Perhaps the most significant possibility is that the discount mechanism could be converted to a more active role. It could be more useful both to the Federal Reserve and to the member banks. This is likely to entail at least some increase in the proportion of reserves supplied through the discount window. A great deal of time and effort is being invested in the study and consideration of the control mechanism for the new window. If the more active role now contemplated for the discount mechanism is finally instituted, the present degree of reliance upon the tradition against bank borrowing will no longer be feasible. Therefore, a wide variety of alternative means for influencing bank borrowing actions is being examined. Included are some more positive variants of the primarily administrative control exercised today, preponderant reliance on the discounts rate as advocated by some academies, various proposals for quantitative controls, and possible combinations of these methods too numerous to list. Careful attention is being paid to the tied discount rate proposal that you mentioned in the hearings. In this connection the experience of the Bank of Canada between 1956 and 1962 is being evaluated, and the ideas of those academic economists advocating a tied rate are being studied. As you mentioned. a tied rate system can serve to minimize the kind of announcement effects that often attach to discretionary discount rate changes, even when the latter simply represents an action to maintain the rate in reasonable alignment with market rates. But there are also some serious difficulties that would confront any tied discount rate arrangement in this country. Some particular problems in this respect were outlined in some detail in the answers given by the Federal Reserve to the Commission on Money and Credit.1 With a banking system as diverse and fragmented as that of the United States, it is essentially impossible to identify any one rate which represents the cost of managing reserve positions in the absence of discounting. Yet to be an effective and equitable penalty, the discount rate would have to be tied to such a rate. In addition, the discount window will very probably continue to serve purposes (e.g. emergency credit assistance) for which a penalty rate is inappropriate or at best irrelevant. It should also be noted that a tied discount rate, unlike a fixed rate, exercises no moderating influence on money market fluctuations. Furthermore, it is by no means certain that the announcement effects of a discretionary change in an otherwise fixed discount rate are not oftentimes a constructive policy influence, or that such an influence could be effectively duplicated by varying the margin of the discount rate over the market rate to which it was tied. Each of these points at issue will have to be carefully weighed-along with the drawbacks of the present method of discount rate determination and announcement-in the light of the latest research before any definitive judgments as to future discount rate policy can be formulated. One early conclusion, suggested by review of both Federal Reserve experience and the discount mechanisms employed by various other central banking systems. is the wisdom of maintaining a degree of flexibility in the design and operation of the discount window to make it adaptable to changing circumstances. While few of the specifics of the new discount mechanism have yet become clear, it has been almost a foregone conclusion that the window will continue to supply emergency credit assistance. This is recognized as a basic responsibility of the Federal Reserve in its role as lender of last resort. Work in this area has been chiefly aimed at developing a better understanding and articulation of the System's responsibilities and objectives, and at discovering the most efficient and equitable means of providing emergency assistance, as regards both the institution requiring such assistance and the financial system in general. In closing. I might mention that the document attached as an appendix to this letter contains several answers to questions that reflected the thinking going into and growing out of the 1955 revision of the Board's Regulation A concerning use of the discount window. Many of the surrounding circumstances have since changed considerably, as described in the earlier part of this letter: therefore, the specifics of these answers may be to some extent outdated. Nonetheless, the general philosophy underlying these answers is still subscribed to, and they may be read in this light. We will continue to push forward diligently with this discount study, and we shall be glad to forward the results to you when it is completed. Sincerely yours, Wм. MCC. MARTIN, Jr. 1 The Federal Reserve and the Treasury: Answers to Questions From the Commission on Money and Credit, Prentice-Hall, Inc., 1963, pp. 140-147. |