Against a backdrop of substantial federal debt burdens, elevated inflation, fiscal pressures stemming partly from military spending, and threats to Federal Reserve independence, the President appoints a new chairman of the Federal Reserve with close ties to the Administration. In a bid to reform key aspects of the Federal Reserve’s approach to policy, the new chairman immediately establishes a task force focused on balance sheet issues. A key goal for the task force is to diminish the extent to which speculation about Federal Reserve actions is the central focus in financial markets and to strengthen the role of market fundamentals in determining longer-term interest rates.
Story sound familiar? These are themes that run through the early days of the tenure of Chairman Warsh. As he noted in his recent speech at Jackson Hole, one of his major areas of focus has been aimed at avoiding the “hall of mirrors” problem—a circular situation in which the Fed looks to market prices as key signals about the state of the economy while market participants, conversely, look to Fed communications as a key factor determining market prices. As part of his efforts to reform this and other aspects of Fed policy, Chairman Warsh chartered five high profile task forces headed by outside experts from the private sector and academic institutions.
Familiar as these recent developments are to a modern ear, the trailer in the first paragraph above summarizes some of the opening scenes from the beginning of William McChesney Martin’s time as chairman of the Federal Reserve (1951-1970). Throughout WW II and for a number of years thereafter, the Federal Reserve was heavily involved in Treasury debt management decisions and conducted open market operations to enforce a graduated cap on Treasury yields across a full range of maturities.[1] In the early 1950s, a huge federal debt overhang from the war and significant financing needs left the Treasury keenly focused on maintaining low interest rates. At the same time, a surge in inflation, spurred partly by spending in connection with the Korean War, necessitated a monetary policy response and higher rates to contain inflationary pressures. After a bitter public confrontation, the Federal Reserve and the Treasury reached an agreement—the Fed-Treasury Accord of 1951—that freed the Federal Reserve from the WWII policy of capping Treasury yields and laid the foundation for the independent conduct of monetary policy to promote price stability.
William Martin was a key Treasury official at the time and was deeply involved in the negotiation over the Accord. As part of the “deal” around the Accord, President Truman appointed Martin to serve as chairman of the Federal Reserve. Truman apparently believed that Martin would be his point man at the Fed.
There are a number of parallels between the early days of Martin’s time as Fed chairman and the first few months of Chairman Warsh’s tenure. As noted in the opening paragraph, the economic and political backdrop was similar in many respects. While the Accord relieved the Fed of any obligation to cap longer-term yields, the Fed nonetheless remained active in supporting the long end of the Treasury market through open market operations. Immediately upon arriving at the Fed, Martin sought to make changes that would strengthen the “depth and resilience” of a “free market” for Treasury securities. A key concern was the extent to which FOMC operating policies continued to provide soft support to the Treasury, distorting market prices in the process.
Shortly after taking the helm at the Fed, Martin established an ad hoc subcommittee of the FOMC to review the Federal Reserve’s practices in conducting open market operations. Martin chaired the subcommittee and was joined by Malcolm Bryan, president of the Federal Reserve Bank of Atlanta, and Abbot Mills, a member of the Board of Governors. Allan Sproul, president of the Federal Reserve Bank of New York, was not included in the task force even though the work of the group was heavily focused on operations conducted by the Federal Reserve Bank of New York. That omission was not an accident. Martin was attempting to overcome entrenched views in the Federal Reserve about the appropriate conduct of monetary policy. President Sproul, in particular, was a strong proponent for the active use of open market operations in managing conditions in Treasury markets broadly. Rather than relying solely on Federal Reserve staff to support its work, the ad hoc committee hired a private sector expert, Robert Craft, to shepherd the project. As part of its efforts, the subcommittee formally consulted with a long list of private sector experts from firms that were active participants in Treasury markets.
The result of the Task Force was a remarkable memo to the FOMC that was ultimately made public in a senate hearing in 1954. Also made public was an equally remarkable rebuttal to the subcommittee memo from President Sproul.
The final report was very lengthy and technical but many aspects of the report seem quite modern. The discussion of the role of open market operations raises issues similar to the “hall of mirrors” problem that Chairman Warsh highlighted in the context of forward guidance. The 1952 study notes[2]:
“Arbitrary System intervention in the intermediate and long-term areas can hardly fail to create a degree of artificiality in those markets. [….] Only by permitting normal price and yield relationships to develop from an appropriate credit base can the value of an interest rate signal be realized. “ (p. 301)
And
“It is the unanimous view of the subcommittee that the Federal Open Market Committee should keep its intervention in the market to such an absolute minimum [….] The normal functioning of the market is inevitably weakened by the constant threat of intervention by the Committee.” (p. 266)
The work of the ad hoc subcommittee ultimately led to the so-called “bills only” policy for open market operations. Under the “bills only” policy, the FOMC acquired only Treasury bills when conducting open market operations to maintain the appropriate quantity of reserves in the banking system. This was viewed as an approach the Fed could follow to conduct policy in a way that minimized distortions in the Treasury market and further extricated the Fed from the Treasury’s debt management decisions.
So is Chairman Warsh reading partly from Chairman Martin’s playbook? Perhaps. Prior to rejoining the Fed, Chairman Warsh often spoke of the need for a new Fed-Treasury Accord. And the immediate establishment of task forces guided by outside experts is also reminiscent of Chairman Martin’s subcommittee task force. And Warsh’s focus on the possible adverse effects of “forward guidance” on the information value of financial market prices resembles the concerns expressed by Martin on the adverse effects of Fed interventions on the signal from interest rates.
Certainly, there is much to be learned from Martin’s tenure as chairman. Although Truman may have believed he was appointing someone that would remain aligned with the Administration’s views, Martin in fact turned out to be a staunch defender of Federal Reserve independence. During his 19 years in office, he endured repeated attacks from successive Administrations including blistering criticisms on the famous “trip to the woodshed” visit to LBJ’s ranch in 1965. Martin’s legacy as chairman was tarnished in the late 1960s when monetary policy failed to respond strongly enough to stem the onset of the “Great Inflation.” That said, without Martin’s courageous leadership over the entirety of his career, the Accord might have just been a piece of paper and Martin’s successors might not have been positioned to engineer the eventual return to price stability in later years.
One of the Fed’s buildings is named after Chairman Martin for a reason.[3]
[1] See Kenneth Garbade (2020), “Managing the Treasury Yield Curve During the 1940s.” Federal Reserve Bank of New York, Staff Reports, no. 913.
[2] See “United States Monetary Policy: Recent Thinking and Experience,” Hearings before the Subcommittee on Economic Stabilization of the Joint Committee on the Economic Report, December, 1954.
[3] There are many excellent historical accounts of monetary policy under Chairman Martin. For an extensive treatment, see Allan H. Meltzer “A History of the Federal Reserve,” Volume 1: 1913-1951, (2003) and Volume 2, Book 1, 1951-1969, (2010), University of Chicago Press. See also Robert L. Hetzel, “From the Treasury-Fed Accord to the Mid-1960s,” Federal Reserve History website.
