Some of the New York directors continued to press for expansive action. They instructed Harrison to inform the Board that they wished to purchase government securities. Governor Young suggested a meeting of the conference so that “all Federal Reserve Banks may be informed of the program which the New York Bank seems to have in mind” (Board Minutes, May 15, 1930).
34. At a May 1 meeting with his directors, Harrison discussed an ambiguity in the (March) agreement with the Board. The agreement did not make clear whether the new procedure applied to bill purchases (acceptances). This oversight is surprising given previous disputes about whether the Board’s approval must be secured before an announcement could be made.
New York was not the only bank dissatisfied with the conduct and achievements of open market policy. At the May meeting, Governor Young presented five suggestions that had come before the Board. Two called for open market sales; two called for purchases; and one bank wanted to maintain the prevailing policy but provide from $350 million to $400 million for seasonal requirements through open market purchases and increases in bill holdings during the fall.
Several features of the Federal Reserve’s approach to policymaking are mentioned to support or justify the three proposals. Some governors, following one aspect of the real bills doctrine, regarded the end use of credit as the most useful guide to appropriate policy. They believed open market sales would “check speculation” and help the banks to liquidate security loans. Their main evidence of speculation at this time was the increased volume of brokers’ and dealers’ loans that had accompanied the increased volume of security purchases and rising stock prices in the months before the meeting. Others, concerned about the distribution of the Federal Reserve’s earning assets, wanted to sell $200 million of securities and reduce discount rates “so that rediscounts might be approximately equal to the total of government securities and bankers acceptances held.” This proposal reflected a different aspect of the real bills doctrine, the view that a main purpose of monetary policy was to respond to changes in the demand for reserve bank credit. Some governors believed that open market sales would ease credit by encouraging banks to reduce interest rates and force them to borrow on real bills. The proper policy, they claimed, was to lower discount rates and sell securities.
Poor timing was one reason the proposal for open market sales and lower discount rates did not receive more widespread support. The provision of the Federal Reserve Act calling for an “elastic currency” was interpreted as a requirement to meet the seasonal “needs of trade.” One governor who favored seasonal expansion in the fall expected the seasonal demand for bank credit to be larger than the current (May) demand. He expressed the view of several governors when he suggested that open market purchases would have more effect if they were made at a time of increased demand for bank credit and for reserve bank credit.35
35. By fall the contraction had become more severe. The System’s purchases were smaller than the $350 million to $400 million estimate of seasonal demand. They were made mainly in response to the bank failures that came late in the year.
Of the two banks proposing purchases, one favored monetary expansion and the other had the traditional concern about reserve bank earnings. Since interest rates had fallen and member bank borrowing had not been fully offset by an increase in bills and securities, the reserve banks’ income had fallen. Some of the banks faced losses. The conference agreed that supplementing the income of a reserve bank was not a “proper reason for the purchase of government securities,” and the matter ended. This issue arose again in the middle thirties.
The committee could not find any “proper reason” for engaging in either purchases or sales at the time. It was too early to provide for a seasonal demand that would not arise until fall. The only agreement reached was the empty statement that “conditions merit continuous careful observation of the Federal Reserve System in order that the System will be prepared to act promptly in the event that conditions further develop in such a way as to make actions seem advisable.”
No one attempted to set out the conditions that would make open market purchases advisable. Nevertheless, Harrison’s advocacy of purchases contrasts with the views expressed by several others. He believed that the “possible necessity for the purchase of government securities might be imminent at any time.” Another member called for immediate purchases “to remove every possible restraint from business as far as credit was concerned.” Still another suggested that the conference agree on a formula for the total amount of reserve bank credit as a guide to the desirable volume of purchases. None of these suggestions received much attention.
The minutes described money conditions as slightly “easier” because of the inflow of gold, the further decline in the amount of currency in circulation, and the reduction in member bank borrowing. But no one mentioned or appears to have noticed that the money supply (or demand deposits) had declined by more than $1 billion in the previous two months. Since most of the decline was in deposits, there must have been some recognition of the decline at major banks.
The governors not only were aware of the worldwide scope of the depression, they sensed that there was a connection between the depression and the New York money market. Harrison gave the standard explanation of the economic decline and the central role of real bills. There had been overproduction of “certain principal commodities,” accompanied by a “shortage of working capital and thus a restriction of purchasing power.” In the previous year, funds had been used for speculation, mainly in New York but in other markets as well. The recovery of world trade appeared to depend “in no small degree on a restoration of purchasing power through the medium of foreign borrowers on the New York money market, just as the recent recovery of domestic trade appeared to be much dependent on the new financing for domestic enterprise in the United States.”
This statement places Harrison well within the mainstream of Federal Reserve thinking and accounts for his failure to mention the substantial decline in demand deposits. However, within the common framework there are two main differences between New York and other parts of the System.
One is the minor point that New York developed more information and expressed more concern about current money market conditions and was more eager to take action to correct or offset money market changes. The second and more important difference within the committee concerns the interpretation of changes in member bank borrowing and interest rates and the System’s responsibility for bringing about further reductions in both. Some governors argued that the Federal Reserve should attempt to lower interest rates further by reducing discount rates and, if that failed, to lower interest rates and encourage member bank borrowing by engaging in open market purchases. Others—McDougal of Chicago and Norris of Philadelphia were leaders of this group—wanted to wait for the member banks to demand more reserve bank credit. In their view, the decline in borrowing meant that the System should sell securities to force an increase in member bank borrowing. With the possible exception of Governor Black, none of the governors argued for an aggressive purchase policy, and none professed a belief that such a policy would succeed.
Although the Board’s minutes indicate that the meeting was called to discuss New York’s program, Harrison did not present a program and, at the meeting, seemed most concerned about matters of timing and procedure, particularly the Board’s failure to agree quickly to requests for reductions in the buying rate on acceptances and discount rate changes. Young told the committee that “he had hesitated to vote favorably on the New York application for a three percent discount rate because of the position of the governors at the OMPC meeting on March 25.” This reopened a continuing disagreement. Harrison replied that decisions about discount rates were primarily the responsibility of the individual reserve banks and that “he did not believe the action of the Open Market Policy Conference should be regarded as in any way restricting freedom of action on discount rates.” Several governors agreed with Harrison, a
nd the conference voted that discount rates “were not within its proper province and that the directors of any Federal Reserve Bank must feel free at any time to change the discount rate of their bank subject only to the review and determination of the Federal Reserve Board.”
This was a partial victory for New York. It removed any control that McDougal, Norris, or other governors might have had over the decisions about the discount rate at New York. Since New York’s 3 percent rate was one percentage point lower than the rates at ten of the eleven other banks, the banks with higher rates could not press New York to raise its rate by a formal vote of the conference. But it left New York, as before, dependent on the decisions of the Board.
To further strengthen New York’s position, Harrison argued for greater control of the acceptance rate by the reserve banks. The Board’s delays in approving applications for lower bill buying rates had left New York without “downward flexibility.” The committee voted to support Harrison, and after the meeting the Board sent a letter to all the reserve banks accepting the conference’s decision.
Although most of the decisions at the May meetings concerned operating procedures, they show that New York was no more isolated from the rest of the System in regard to procedure than in regard to policy. The conference was willing to support New York on day-to-day policy and to provide discretionary “flexibility” in managing the account. The Board and the conference were unwilling to allow New York to purchase and sell government securities on its own initiative and for its own account, but it is not clear that most would have opposed a program of open market purchases for the System if Harrison had supported the program vigorously. In fact, the members responded to Harrison’s statement that “the possible necessity for the purchase of government securities might be imminent at any time” by voting to reconvene or to act promptly on the recommendations of its five-man executive committee, which Harrison headed. When Harrison proposed open market purchases only ten days later, a majority of the conference voted in favor.
New York Seeks Expansion
Harrison’s approach to policy comes out clearly in the decision to purchase $50 million of securities early in June 1930. The discussions leading to the decision show the importance he attached to short-term factors affecting interest rates and money market conditions and his failure to develop a long-term program.36 They also show Harrison as a broker trying to reconcile differences between opposing groups. Three points stand out. First, Harrison twice changed his mind about the desirability of purchases. Both changes coincide with changes in the technical position of the money market. Second, Harrison did not suggest a program of steady expansion. In fact, he did not propose as expansive a policy as some of the New York directors urged on him. Third, Harrison never answered, and at times appears to have accepted, the main criticisms of the policy of expansion made by Norris and other opponents.
36. My interpretation of this episode is based on the minutes of the New York directors for May 8, 19, and 26 and June 5, the Board’s minutes for June 3, 1930, and a telegram on June 5 from Harrison to the Board that is part of the Board’s minutes.
The first suggestion that purchases should be made came at the May 8 meeting of the directors of the New York Federal Reserve bank. Several of the directors spoke in favor, but others opposed on grounds that recovery in bond prices had been delayed by the floating of a large foreign loan—the $300 million German annuities loan. The directors who opposed purchases expected interest rates to resume their decline once the offering was sold. The directive recommended that Harrison discuss the possibility that open market purchases “may become desirable” with other governors and the Board. On May 19, two days before the Governors Conference, the executive committee of the New York directors remained divided. Most agreed that purchases of open market securities would be “inflationary” (which to them often meant that bond prices would rise), but some believed this danger should be faced “to check a decline in commodity prices.”
The following week, Harrison reported on the results of the Governors Conference to the executive committee of the New York directors. One of the directors remarked that there had been a net withdrawal of Federal Reserve funds from the money market during the preceding six months.37 He urged that these funds should “now be restored to the market by the purchase of government securities,” and he suggested that if this were done bankers would be encouraged to make loans to business borrowers. Then, in a statement that is considerably at variance with the real bills and Riefler-Burgess doctrines, a director pointed out that “if government securities should now be purchased in sufficient amount so that member banks would no longer be able to use the funds thus made available to pay off advances and rediscounts, expansion of bank investments would be forced and business would perhaps be stimulated.”
Support for purchases was rising in New York. Harrison reminded the directors that the governors had considered purchases but had voted not to take any action. Some of the directors disagreed with this policy. In their opinion, “it would be unfortunate if the banking system would not be used to facilitate recovery.” Three days later, on May 29, the full meeting of New York’s directors unanimously approved the report of the Open Market Policy Conference, then seized on the section that permitted the committee’s decision about open market policy to be reopened. Although only a week had passed, they voted that “it now seems desirable to undertake the purchase of government securities in moderate amounts.”
37. Member bank borrowing had fallen $800 million since August. See table 5.6. These and similar remarks suggest that some directors did not equate low borrowing with monetary ease.
During the next few days, Harrison and Burgess telephoned the other governors to discuss their directors’ recommendation. Frederic H. Curtiss (Boston) believed that the situation had “retrogressed,” so he favored purchases of $20 million to $25 million for the next few weeks to test out the situation, “feeling that no harm would result and some good might be accomplished.” E.R. Fancher (Cleveland) also favored purchases, “believing that it might possibly help and that in any event it would be preferable to err on the side of ease rather than on the other side.” McDougal (Chicago) believed purchases would “do little or no good,” so he preferred not to purchase. Black (Atlanta) was very much in favor; Norris and Calkins were opposed.
Early in June, Harrison telegraphed the results of the canvass to the Board. Seven of the governors favored purchases if limited in magnitude and duration, four were opposed, and one “interposed no objection.” On a divided vote, the Board approved purchases of not more than $25 million per week for two weeks, the first open market purchases since the middle of March.38 New York began purchasing almost at once.
Four main reasons tipped the balance in favor of limited purchases. First, some long-term bond yields, particularly on lower-rated bonds, had risen at the time the German annuity was announced and had not returned to the April level. Second, discounts show a sharp increase during the week ending May 28. On the Riefler-Burgess interpretation, the rise in discounts meant that demand for reserve bank credit had increased, so open market purchases were justified as a means of providing “productive credit” and preventing an increase in short-term rates. Third, as Harrison explained to the Board on June 16, the directors at New York believed recovery would not occur for several months and perhaps not for a year, but they “are particularly concerned about the export trade which has such a direct effect upon commodity prices and feel that a revival of our foreign trade depends largely upon the bond market and that hopes of getting a strong bond market rest upon the continued ease in the short time money market more than anything else.” Fourth, and possibly most important, none of the opponents of expansion believed that the purchases, if limited, would be “inflationary” in the circumstances then prevailing in the money market, that is, the increased volume of member bank borrowing.
38. The original vote, three to three with Vice Governor Platt abstaining, would have
defeated the motion. After further discussion, Platt voted in favor. The executive committee of governors was more evenly divided than the full committee, since two of the opponents, McDougal of Chicago and Norris of Philadelphia, were members of the five-man executive committee. Another opponent of the purchase program, Governor Calkins of San Francisco, refused to participate, so the San Francisco bank did not accept a pro rata share of securities. The positions taken by the individual governors and their reasons are taken from a memo Harrison wrote to his files on June 30 (Harrison Papers, Office Memoranda, vol. 2).
Harrison’s reasons for supporting a limited program of purchases and his opposition to a more expansive program came out clearly at a June 5 meeting with the New York directors. To a director who urged a reduction in the discount rate to 2.5 percent as a means of encouraging banks to reduce the rates charged on bank loans, Harrison replied that banks already had “sufficient reasons for lowering rates.” To another who pointed out that the decline in the New York bank’s bill portfolio in the most recent week more than nullified the $50 million purchase of securities, Harrison gave the standard Riefler-Burgess argument that the banks had been “placed in the position to pay off a substantial part of their borrowings, . . . the money market is definitely easier than it was before our purchases.” He reminded the directors that the quarterly Treasury financing and the German loan made the timing unfavorable.
A History of the Federal Reserve, Volume 1 Page 45
