THE FEDERAL RESERVE SYSTEM';S “BILLS ONLY” POLICY*

Abstract

THE CENTRAL PROBLEM of the present study is a policy initiated by the Federal Reserve System in March, 1953, and followed, with brief interruptions, until February, 1961. The principal provisions of the policy were: (1) restriction of Federal Reserve open market operations to the purchase and sale of short-term United States government securities, preferably Treasury bills, except for the correction of disorderly markets; (2) conduct of Federal Reserve open market operations solely to influence the reserve positions of member banks, with no attempt to influence particular yield structures in the market; and (3) discontinuance of Federal Reserve support of Treasury financings, a provision which carried with it a corollary prohibition against System swapping operations either to clear the way for new Treasury issues or to affect the yield curve on government securities. These three principal provisions were embodied in the Federal Reserve System's only policy. The present study attempted to discover the appropriateness of such a policy for the effective execution of the responsibilities of the Federal Reserve in its role as the nation's central bank. Examination of the historical setting of the bills policy revealed that the policy was the product of several factors, including: (1) System reaction to years of subservience to the Treasury; (2) a concept of free markets; and (3) a desire by the Federal Reserve to strengthen the government securities market. Early defenses of bills centered largely around its desirability as a means of strengthening the government securities market; but later defenses also emphasized the compatibility of the policy with the primary responsibilities of the Federal Reserve. A review of the arguments and 'empirical studies dealing with various aspects of bills suggests that the opponents of the policy have the stronger theoretical and empirical case. The subject of the term structure of interest rates was examined because neither the Federal Reserve nor other proponents of bills have stated explicitly the theory of the determination of the interest rate pattern which bills assumes. The factors which determine the prevailing rate structure at any given time were examined in an effort to discover the implications for the execution of monetary policy. The theory of the term structure accepted in the present study emphasizes both expectations and the preferences displayed by both issuers and investors for certain types of securities. A review of economic conditions and monetary policy during the 1953-1962 interval provides empirical support for the accepted theory of the term structure of rates, and examines the appropriateness of monetary policy within that context. The review suggests that there were numerous instances when a departure from bills would have seemed advisable. Both the inability and unwillingness of the Federal Reserve to take what would seem to have been the