Much of Burns’s program called for interference in price and wage setting. He urged President Ford to pledge a balanced budget for 1976, avoid price and wage controls, reconstitute the Cost of Living Council and the Construction Industry Stabilization Committee, and pursue a tough antitrust policy. He favored “temporary restraint on export of grains” (ibid., 5) in the event of rising food prices. And he proposed an enlarged public service employment program to absorb some of the unemployment caused by the anti-inflation policy.
Burns returned from a meeting with the president and legislative leaders on August 20. He told the FOMC that the president had said he would like a new Cost of Living Council and that he would avoid price and wage controls. The president hoped to keep total outlays under $300 billion in fiscal 1975. And he announced a “summit meeting” on inflation to solicit advice and focus attention on the problem.44
42. Concern about leaks from the meeting arose periodically throughout System history. To limit or prevent leaks, beginning in August Chairman Burns limited attendance to Board members, presidents, the managers, and a few essential staff members during the part of the meeting devoted to monetary policy and the directive. Customary attendees would remain at other parts of the meeting (Board Records, August 1, 1974).
43. Burns’s advice was not uniformly accepted within the administration. Old and mistaken ideas do not disappear. David Packard, undersecretary of defense, sent a memo giving his views of the causes of inflation. He recognized that “tight monetary policy is about the only real pressure on inflation.” But it had become counterproductive because it increased costs, delayed investment, and caused “serious, even dangerous distortions.” He agreed with Burns that the administration should reestablish the Cost of Living Council (David Packard to the president, White House Central File, Box 31, Ford Library, August 20, 1974).
The president announced his ten-point program on October 8, 1974. It called for a one-year 5 percent tax surcharge on high-income taxpayers and corporations, an increase in the investment tax credit, increased unemployment benefits, public service jobs in areas with high unemployment, a budget ceiling of $300 billion for the 1975 fiscal year, and a voluntary program to control inflation—the WIN program (Whip Inflation Now). WIN initially captured the popular imagination, but the program did not have congressional support. The 1974 congressional election was only weeks away, so most Congress members would not support either a tax increase or reductions in spending, not even the $4.4 billion by which the president proposed to reduce the increase in the last Nixon budget (Greene, 1995, 72).
The rest of the WIN program was entirely public relations.45 It could do nothing to stop inflation; the opposition in Congress pointed to the neglect of a deepening recession. This doomed the tax increase and any other part of the program that required legislation. By the time the president announced the program, industrial production had fallen in three of the last four months. A 35 percent (annual rate) decline in November followed by a 50 percent decline in December doomed WIN.
44. Burns’s relations with President Ford and his administration were excellent. He described President Nixon as trying “to interfere with the Federal Reserve both in ways that were fair and . . . unfair. Mr. Ford on the other hand was truly angelic. I met with President Ford frequently, alone in the privacy of his office. He never inquired about what the Federal Reserve was doing. He never even remotely intimated what the Federal Reserve should be doing” (Burns, 1988, 136). Burns added that he was informally a member of the president’s economic team. “It was a one way street” (ibid., 138). He discussed administration policies but did not mention Federal Reserve plans. Alan Greenspan, who replaced Herbert Stein as chairman of the Council confirms Burns’s role (Hargrove and Morley, 1984, 429).
45. The president’s aide, Robert Hartmann, compared WIN to President Roosevelt’s Blue Eagle program, part of the NRA intended to show public support for higher prices and wages in 1933. Memos at the time compared it to the Army-Navy E (for efficiency) in World War II. Companies that pledged not to raise prices for one year would receive an IF flag (inflation fighter) similar to the E flags during World War II. Advocates suggested that “the American people would serve as policemen to make sure the program works” (memo to the president, Inflation Fighter Program, Robert T. Hartmann papers, Ford Library, August 30, 1974, 2). The name of the sender was cut out of the memo. A WIN song was written and recorded. The program began as independent suggestions from a Pennsylvania’s businessman, William J. Meyer, and a financial journalist, Sylvia Porter. Sylvia Porter became chair of a large voluntary citizen’s campaign.
That was the end of the WIN program. Annualized consumer price inflation reached a local peak of 11.5 percent that month. The following month the Ford administration replaced the 5 percent tax increase with a proposed 12 percent tax reduction in the form of rebates of 1974 tax payments. It also proposed to increase the price of imported oil. Congress passed a much larger tax cut and increased spending.
The economy and the Congress doomed Ford’s hope of reducing the budget deficit. Although he vetoed many spending bills, the budget deficit rose to $5.5 billion in 1975 and $70 billion in 1976, a new record. That left inflation control entirely to the Federal Reserve, displeasing Burns.46 Despite his many speeches about the dangers of inflation, policy gave pride of place to reducing unemployment.
During the fall, evidence increased that the recession would become deeper and last longer. Burns’s initial reaction was to lower the funds rate gradually. He typically said, “[A]ny drastic change . . . would be a great mistake, although some further easing would be appropriate” (FOMC Minutes, December 17, 1974, 85).
Henry Wallich proposed a temporary policy of increased money growth. To avoid another surge of inflation, the committee would later slow money growth. Burns opposed. In a clear statement of the time inconsistency problem, Burns said, “The members might plan now to slow growth later on, but when the time arrived, they would find it a difficult step to take” (ibid., 104).
In mid-November, the Board reduced reserve requirement ratios for demand and time deposits. The new demand deposit ratios applied only to banks with $400 million or more. Their ratio became 17.5 percent instead of 18. Adjustments to time deposit ratios lowered the ratio to 3 percent for most categories (Annual Report, 1974, 95–96).
Table 7.5 shows the decisions and approximate outcomes reported in the FOMC minutes from September to December 1974. By the November meeting, the committee had an estimate of −3 percent for third-quarter growth and a projected faster decline in the fourth due in part to a coal strike. Inflation in wholesale and consumer prices showed no evidence of decline until 1975.
The table shows, as usual, that the manager always met the funds rate target but met the money target only occasionally. In September and October, the dissenters wanted slower money growth or higher interest rates to lower inflation. In December, Wallich and Mitchell’s concern was the deepening recession.
46. The CEA chairman, Alan Greenspan, explained that inflation and other instabilities increased the risk premium and reduced investment. “[T]he only way to [reduce risk and inflation] in the long term was to bring down the rate of increase in money supply, which in turn required that Federal financing be brought down” (Hargrove and Morley, 1984, 418). Greenspan explained that the Federal Reserve controlled a short-term rate. Increases in the deficit, therefore, resulted in faster money growth and more inflation.
William Fellner, a member of the Council of Economic Advisers, sent a weekly memo to the president to inform him about monetary policy. Most of the memos supported the reduced growth of monetary aggregates as the way to reduce inflation. By November, reported M1 growth had fallen to 3.7 percent annual rate for the most recent twenty-six weeks. Fellner said, “The numbers . . . are compatible with a reasonable degree of anti-inflationary pressure” (memo, Fellner to the president, Burns papers, WHCF Box 1, November 8, 1974). When Burns praised President Ford for not inter
fering in monetary policy, he did not note that William Fellner and Alan Greenspan generally approved of what he did. Greenspan was the new chairman of the Council of Economic Advisers, replacing Herbert Stein.
Support changed in the winter of 1975. Money growth (M 1 ) fell to −0.6 percent from December to February. Fellner recognized that the Federal Reserve had “vigorously to expand money in periods of falling interest rates and economic decline” (ibid., February 14, 1976). Fellner cautioned against treating the decline in short-term rates as evidence of ease. Greenspan repeated this point in a memo prepared for a meeting between the president and Burns in early March. Soon afterward money growth rose. In July, Greenspan warned the president about upward pressure on interest rates (ibid., July 7, 1975).
Beginning in 1975, borrowing declined and the federal funds rate came down rapidly. Once the oil price surge ended, reported consumer price inflation slowed. The decline in reported inflation induced an increase in growth of the real monetary base (Chart 7.4 above).
Judged by the decline in the federal funds rate, the Federal Reserve eased policy decisively in 1975. The change coincided with the rapid increase in the unemployment rate in the winter of 1975. Table 7.6 outlines changes in some principal variables in three Decembers. Using CPI inflation shown in the table, the real federal funds rate was negative throughout. Real base growth turned positive early in 1976. Unemployment was not affected, most likely because the public expected easier policy and higher inflation.
The manager summed up experience in a difficult year. “The use of aggregate targeting has probably contributed to the clarity of monetary policy discussions, but policymaking itself has not proved easier. Evidence of structural change in the financial system has reduced the policymaker’s confidence in the stability of the linkage between operational instructions and desired long-run economic goals” (Holmes, 1975, 207). Among the major changes he mentioned were the end of ceiling rates for large CDs that made banks more confident about sources of funds, and thus more willing to lend, and belief that inflation would continue. Banks included adjustment clauses in loan contracts and adopted a floating prime rate. The manager did not oppose the use of monetary targets, but he asked for greater flexibility in the choice of particular monetary targets.
At the FOMC meeting, the New York bank began with relatively pessimistic news and forecasts. The Council and the Federal Reserve staff predicted that the recession would continue for the first six months of 1975. In fourth quarter 1974 output declined at a 9.1 percent annual rate. Later revisions changed the decline to 1.6 percent, an extreme example of the cost of reliance on current data.47
The president’s advisers recommended a $91.5 billion tax cut, threefourths to individuals in the form of a one-time rebate. They also proposed an increase in the investment tax credit from 4 to 12 percent for utilities and 7 to 12 percent for all other corporations. The advisers proposed to decontrol oil prices and impose a windfall profits tax on oil companies. There would be no new spending programs, but the Treasury and the Federal Reserve would prepare legislation for an agency like the Depression-era Reconstruction Finance Corporation to take over failing financial institutions. Congress approved only tax reduction and added additional spending for low-income individuals.
47. Data are from Runkle (1998, 5). Business Conditions Digest for October 1988 reports the decline as 3.5 percent. Runkle shows that in the sample he used, 1961 to 1996, initial estimates are biased estimates of the final data. For real GNP the difference was as large as the 7.5 percentage point underestimate in 1974 or a 6.2 percentage point overestimate. This raises an issue to which I will return in chapter 10: Why base policy actions on noisy shortterm data? See also Orphanides (2001) and Meltzer (1987).
The Federal Reserve began the year by reducing the federal funds rate target to 6.5–7.25 percent, intending to maintain money growth at 3.5–6.5 percent. On January 20, the Board reduced reserve requirement ratios by 0.5 percentage points for demand deposits of $400 million or less and by 1 percentage point above $400 million effective February 13. The new range ran from 7.5 percent to 16.5 percent based on size of deposits. Also during the first quarter, the Board rejected several requests to reduce discount rates, but it approved 0.5 percentage point reductions on January 3, February 4, and March 7. The discount rate declined from 7.75 to 6.25 percent.
By March, the monthly average funds rate was down to 5.5 percent, a 50 percent decline from the previous September. This was hardly the slow, deliberate ease that Burns claimed he wanted. Growth of the monetary base declined from 7.5 percent for the fourth-quarter average to 6 percent for the first quarter, a tightening of policy. First-quarter M1 growth, reported at the time, was 3.9 percent. Once again, the federal funds rate and nominal base growth gave different signals. However, CPI inflation declined, so growth of the real base rose. In the second quarter, the recession ended.48
Keynesian economists had learned about the importance of money growth. In congressional testimony and public statements, they urged much more expansive monetary policy, 10 percent money growth or higher, and predicted dire consequences if the Federal Reserve did not accept their advice.49 Burns resisted. The FOMC M 1 target was 5 to 7.5 percent. He dismissed the Keynesian critics: “Most economists who move from platform to platform these days . . . pay very little attention to the business cycle. They have never studied it thoroughly, or, if they have, they have forgotten what they once knew” (quoted in Wells, 1994, 158). Burns claimed that in the first year of recovery, velocity growth rose above trend. He relied on velocity growth to end the recession. He was right. Recovery began in April 1975.
48. In the weekly memo to the president on monetary policy dated February 14, 1975, Alan Greenspan and William Fellner noted that the System’s easier policy, including lower reserve requirement ratios, had not raised money growth rates. The memo recognized that the decline in interest rates reflected weak credit demand. “Movements in the monetary aggregates will also tend to reflect the business cycle instead of countering it unless the Fed moves vigorously to expand money in periods of falling interest rates and economic decline” (Fellner and Greenspan to the president, Ford Library, WHCF FI Box 1, February 14, 1975; emphasis in the original). Burns’s efforts to reduce inflation brought strong criticism of Federal Reserve policy from the labor unions and some members of Congress. But he also received support from others in Congress (Wells, 1994, 137).
49. Wells (1994, 158–59) cites James Tobin and a “committee of prominent Keynesians” as the authors of these claims.
In March, President Ford met with Arthur Burns to express his concern about money growth and to get Burns’s assessment of the recession and recovery. The president stressed the importance of having recovery in 1975 without a new surge of inflation in 1976 (briefing paper, Greenspan to the president, Ford Library, WHCF FG, Box 156, March 10, 1975).50 Soon after M 1 growth rose.
The Board’s staff recognized by May that the decline in output had slowed or stopped. They did not recognize that recovery began until August. By that time, growth was at a 7 percent annual rate after rising 4 percent in the second quarter.
CONGRESSIONAL INTERVENTION
Reports of deep recession, sustained inflation, historically high interest rates, and a 9 percent unemployment rate brought heightened attention to Federal Reserve policy. Although the Constitution gives Congress power over money creation, few members found the details interesting enough to learn about the processes. Usually they relied on a few interested members to inform them when an issue arose. Periods like the deep recessions of 1920–21 or 1929–33 brought more attention. In the 1970s, many people shared Poole’s conclusion that “the 1972 boom was purchased at the cost of the 1974–75 recession” (Poole, 1979, 482).
These criticisms and the economic problems in 1974–75 renewed public and congressional interest. Burns’s active lobbying against Congressman Patman’s efforts to bring more direct control succeeded. Despite strong resistance, however, Congress
passed a resolution in March 1975 over Burns’s strong objections.
Members of Congress expressed annoyance at Burns’s refusal to tell them the planned rate of money growth.51 One response was a bill requiring the System to make M1 grow 6 percent or more in 1975 and to allocate credit toward national priorities. Burns argued that M1 was not a good indicator, that velocity changed erratically so that the System could not rely on a specific target.52 He properly opposed credit allocation as impossible, a new type of real bills notion. The System could not know what the final use of credit would be.
50. As Council chairman, Alan Greenspan held meetings of the treasury secretary, budget director, and Federal Reserve chairman with a small group of business and academic economists. At the February 1975 meeting, I urged Chairman Burns to recognize that monetary base growth was procyclical. He made clear that his concern was to lower interest rates and did not want a large decline required to get an increase in base growth. The March 7, 1975, statement by the Shadow Open Market Committee made the points public. At the White House meeting, Chairman Burns asked me to tell him what would happen if he adopted my proposal that he make up the shortfall of 8.5 billion in M1 and return to a 5.5 percent growth rate. Burns’s letter of April 12, 1975, said that would be unwise. In fact, he increased M1 about as much as I suggested by the end of March (Burns papers, Box K24, Ford Library, April 12, 1975).
51. Burns’s desire for secrecy and his idea of independence were probably central. However, in an interview, James Pierce, an associate director of research at the time, explained that the Board’s forecasts did not relate money and output. Lyle Gramley prepared the green book forecasts of the real economy. They were independent of money growth. “Here was the central bank making forecasts without knowing what its monetary policy was. I’d make myself very unpopular going into that meeting saying what’s your monetary policy assumption? . . . They wouldn’t listen because they were old-fashioned business economists” (Pierce, 1998, 9).
A History of the Federal Reserve, Volume 2 Page 29
