Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

After the Accord: Reminiscences on the Birth of the Modern Fed

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

After the Accord: Reminiscences on the Birth of the Modern Fed

Article excerpt

The 1951 Treasury-Federal Reserve Accord marked the birth of the modern Fed. However, that fact became apparent only in retrospect. The language of the announcement that accompanied the Accord left unresolved the issues that had created the discord between the Treasury and Fed in the first place. It read:

The Treasury and the Federal Reserve System have reached full accord with respect to debt-management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government's requirements and, at the same time, to minimize monetization of the public debt.1

This statement left unsaid how the Fed and the Treasury would reconcile these conflicting goals.

William McChesney Martin, who became FOMC Chairman at the time of the Accord, created the idea of a modern central bank. Specifically, he made macroeconomic stabilization the rationale for central bank independence. Martin put this ideal into practice in three ways. First, as summarized in his phrase "leaning against the wind," he developed the practice of moving short-term interest rates in a way intended to mitigate cyclical fluctuations and maintain price stability. Second, he helped to create a viable free market in government securities whose stability did not require Fed intervention. Third, he reinvigorated the original structure of the Federal Reserve System by moving monetary policy decisionmaking out of an Executive Committee and into the Federal Open Market Committee where all the Board governors and regional Bank presidents could participate fully.

1. CREATING THE MODERN FED

Before the Accord, the New York Fed had run the market for government securities with an iron fist. A government securities dealer who wanted to change the price of a government bond by even a minuscule fractional amount would call Robert G. Rouse (head of the Fed's New York Trading Desk) for permission, and Rouse would probably say no. With the exception of a few academics at places like the University of Chicago, people could not imagine the Treasury placing the huge amount of debt created during the war without the assistance of the Fed. Board economists and policymakers, however, realized that the only way to avoid continued pressure by the Treasury on the Fed would be to make completely clear that the Fed would not intervene to control bond prices.2

Under the leadership of Chairman Martin, the Fed worked hard to develop an independent government securities market. During the summer of 1951, Fed staff including Leach held a series of meetings at the Federal Reserve Board with each of the government securities dealers. All 12 regional Fed Bank presidents plus members of the Board of Governors were invited to these sessions. The main purpose of the sessions was to ascertain the dealers' ability to support a free market in government securities. With some of the larger firms, Fed staff also explored the possibility of organizing the dealers into a self-governing association that would set minimum capital standards and assure low trading spreads.

During 1951, Leach made a number of visits to the New York Trading Desk and listened to dealers' questions and traders' replies. In discussions with the traders he tried to explain that continued market intervention by the Fed prevented the development of a strong market. He felt that each intervention by the Fed simply caused buyers and sellers to pull away from the market and wait for the Fed's next move.

As long as the Fed's New York Trading Desk was pegging the price of government securities, there was no need for the market to develop the capacity to smooth price fluctuations. Dealers did not take speculative positions. People extrapolated from that situation and concluded that, without regular Fed intervention, the government securities market would exhibit destabilizing price swings. In contrast, the Board staff believed that the market, if left alone, would work. …

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