Life During War Times and Before the Treasury-Fed Accord

This ain't no party, this ain't no disco,

This ain't no fooling around

No time for dancing, or lovey dovey,

I ain't got time for that now

"Life During War Times" - Talking Heads 

Fed monetary and fiscal policies are the same that would apply to a war economy and currently going beyond anything from the Great Financial Crisis. Saying that we are at extremes has clearly been stated by many. We want to think about what happens next. What happens when the war is over? 

A short history of the Fed during WWII and the period afterward can be found here. 

When the United States entered the war, the Board of Governors issued a statement indicating that the Federal Reserve System was “. . . prepared to use its powers to assure at all times an ample supply of funds for financing the war effort” (Board of Governors 1943, 2). Financing the war was the focus of the Federal Reserve’s wartime mission. This mission differed from the mission of the System before and after the war...
To enable the Federal Reserve to accomplish its wartime tasks, the Board of Governors asked Congress to amend the Federal Reserve Act. One amendment enabled the Board to change reserve requirements in banks in New York City and Chicago, known as central reserve cities, without changing requirements for other banks. A second amendment authorized the System to purchase government securities directly from the Treasury. A third amendment exempted war loan deposits from reserve requirements for the duration of the emergency. 

The president also issued a series of executive orders that shaped the System’s wartime roles. Executive Order 9112, issued on March 26, 1942, established a program of guaranteed loans to industry for war production. Executive Order 9336, issued on April 24, 1943, expanded the scope of the program.

In the post-WWII world, rates were held artificially low so that the cost of the war debt would not sink the early post-war economy. The Fed would take its lead from the Treasury Department. There was an 3/8% interest peg for Treasury bills from 1942-1947 This "financial repression" of submarket rates was imposed given the debt to GDP was well above 100%. 

However, as the distance from the war grew and inflation increased, there was increasing tension between the Treasury and Fed. This period was fraught with political battles between the central bank and the Treasury Department which thought monetary policy should be an extension of Treasury policy. The Treasury wanted pegged rates to continue even in the face of increasing inflation and rising bonds yields. Rising rates would hamper the Treasuries ability to fund the debt. 

In 1951, the FOMC refused to follow the Treasury lead or the desires of President Truman creating a well reported break in policy agreement. The Treasury-Fed Accord of 1951 laid out the new agreement between Treasury and the Fed: “reached full accord with respect to debt management and monetary policies to be pursued in furthering their common purpose and to assure the successful financing of the government’s requirements and, at the same time, to minimize monetization of the public debt” from the Fed history. This marked what many consider the end of the WWII financing polices, the beginning of free bond markets, and a central bank following goals independent of the Treasury.

Right now, the Fed is taking the lead over Treasury with stimulative policy, but clearly, we are in a war financing pegged rate environment. As Treasury debt grows, there will be more pressure on the Fed to follow a low rates policy even in the face of inflation. History will repeat itself, but the answers this time may not be the same.