Published in Winter 2001, this special issue of the Richmond Fed's quarterly journal commemorated the 50th anniversary of the Accord.
An accord for Fed credit policy should supplement the monetary policy Accord of 1951 and should be based on three principles: (1) credit policy should not fund insolvent institutions, (2) credit policy should not fund expenditures that ought to get congressional authorization, and (3) Congress should not direct the Fed to transfer assets to the Treasury to reduce the federal deficit. The proposed accord is discussed with regard to three Fed credit policies: liquidity assistance to depository insitutions, sterilized foreign exchange operations, and the transfer of Fed surplus to the Treasury.
After the Accord: Reminiscences on the Birth of the Modern Fed
by Robert L. Hetzel and Ralph F. Leach
William McChesney Martin became Chairman of the Board of Governors of the Federal Reserve System at the time of the March 1951 Treasury-Fed Accord and, in effect, created the modern Federal Reserve System. The authors recount some of the early events that shaped the modern Fed. They also relate how Chairman Martin helped to create a viable, free market in government securities whose stability did not require Fed intervention and how he reinvigorated the original federal structure of the Federal Reserve System.
The Fed's asset acquisition practices should adhere to two closely related principles that would support monetary policy by strengthening the Fed's independence: asset acquisition should respect the integrity of fiscal policy and minimize the risk of political entanglements involving Fed credit allocation. Restricting Fed assets to Treasury securities conforms well to both principles. By extending its credit to the Treasury, the Fed minimizes its participation in private credit markets and transfers directly to the government all the revenue (net of the Fed's operating expenses) from money creation. The authors propose that the Fed and the Treasury cooperate, under the auspices of Congress if need be, to enable the Fed to continue to rely on Treasury securities even as the publicly held debt is paid down.
Until March 1951, the Treasury compelled the Federal Reserve System to continue the pegging of government security prices that had begun in World War II. To break free from that obligation, the Fed would have to win a public confrontation with the President of the United States. Such an outcome appeared improbable given the historical context of the Korean War. The authors chronicle the dramatic confrontation between the Fed and the White House that ended with the March 1951 Accord.
The 1920s saw the Fed reject a state-of-the-art quantity theory framework for a flawed real bills one. The quantity theory framework featured the money stock, price level, and real interest rates as policy guides. By contrast, the real bills framework featured nominal interest rates, volume of discount window borrowing, and type of commercial paper eligible for discount. When the start of the Great Depression put these rival sets of indicators to the test, the quantity theory set correctly signaled that monetary policy was sharpley contractionary, while the real bills set incorrectly signaled that money and credit conditions were sufficiently easy and needed no correction. This experience shows that policy guides originating in a theoretically flawed framework can lead the policymaker astray.
Amanda L. Kramer