FOMC Minutes

A meeting of the Federal Open Market Committee was held in the

offices of the Board, of Governors of the Federal Reserve System in Wash

ington on Tuesday, August 23, 1955, at 10:45 a.m.

PRESENT:

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Martin, Chairman

Mr.

C. S. Young, Alternate for Mr. Fulton

Earhart

Irons

Mills

Leach

Shepardson

Szymczak

Treiber, Alternate for Mr. Sproul

Vardaman

Messrs. Erickson, Johns, and Powell, Alternate

Members of the Federal Open Market Committee

Mr. Bryan, President of the Federal Reserve Bank

of Atlanta

Mr. Riefler, Secretary

Mr. Thurston, Assistant Secretary

Mr. Vest, General Counsel

Mr. Solomon, Assistant General Counsel

Mr. Rouse, Manager, System Open Market Account

Messrs. Daane, Hostetler, Rice, Roelse, Wheeler,

and Young, Associate Economists

Mr. Carpenter, Secretary, Board of Governors

Mr. Mitchell, Vice President, Federal Reserve

Bank of Chicago

Mr. Koch, Assistant Director, Division of

Research and Statistics, Board of Governors

Mr. Miller, Chief, Government Finance Section,

Division of Research and Statistics, Board

of Governors

Mr. Gaines, Securities Department, Federal Re

serve Bank of New York

Approval of the minutes of the meeting of the Federal Open Market

Committee on August 2, 1955, was deferred until the next meeting to afford

8/23/55

.2.

absent members of the Committee

who were present at that meeting time to

review the minutes.

Before this meeting there had been sent to the members of the

Committee a report of open market operations prepared at the Federal Re

serve Bank of New York covering the period from August 2 to August 17,

1955, inclusive, and there were distributed at the beginning of this meet

ing copies of a supplementary report prepared at the Bank covering opera

tions during the period August 18 through August 22, 1955.

Copies of

these reports have been placed in the files of the Federal Open Market

Committee.

Upon motion duly made and seconded,

and by unanimous vote, the open market

transactions during the period August 2

to 22, 1955, inclusive, were approved,

ratified, and confirmed.

Chairman Martin then called on Mr. Ralph Young for a statement on

the current economic situation.

Mr. Young made substantially the follow

ing comments which were a digest of a staff memorandum sent to the mem

bers of the Federal Open Market Committee under date of August 19, 1955:

The economic situation continues to be one of demand

pressure in the industrial sector and supply pressure in

the agriculture sector. Over-all price stability in this

country and abroad appears very much to be the product of

a compensation of demand and supply forces as between these

two major sectors of activity. In this country and in other

important industrial nations, the high levels now attained

by industrial output have generated such strong credit demands,

with accompanying upward pressures on interest rates, that

steps of restraint on undue monetary expansion have become

more general and overt.

8/23/55

-3

This economy's gross product for the second quarter has

been notched up one more time and is now put at 385 billions.

With the additional gains registered since then, a preliminary

guess for the third quarter figure is 390 billions.

The Board's index of industrial production for July re

mains uncertain, i.e., whether the final figure will be 140

or 141.

Preliminary data for August suggest another index

point rise, but this guess does not allow for the effects

of recent storm and flood damage along the central and north

eastern Atlantic seaboard, or for shutdowns in copper fabrica

tion due to copper shortage.

A feature of industrial output that merits special com

ment is that, after the general rise in activity which has

already taken place, more industrial groups seem to be produc

ing close to apparent capacity. This situation affords some

basis for expecting a slowdown of advance in the months ahead.

One needs to weigh such an expectation in the light of the

rising momentum of business plant and equipment expenditures,

the relative balance in this business upswing between expan

sion in finished goods output and materials output, and the

comparatively moderate growth thus far of business inventory

holdings. On the latter point, despite the rise of inventories

which has now occurred, average stock-sales ratios have been

relatively stable in recent months.

Retail sales, after seasonal adjustment, were 2 per cent

Sales of furniture

above June and 9 per cent over a year ago.

and appliances rose very sharply, a development finding sym

pathetic response in very recent output data for these areas.

Other large gains were made in apparel and general merchandise.

Department store figures for August suggest a fall-back in re

sales to May-June levels, but unfavorable shopping weather

tail

may account for this result.

Newspaper comment suggestive of some weakening in the auto

mobile sales picture calls for special examination of facts in

this area. Early August industry reports show sales of new

cars 40 per cent ahead of last year, and, while stocks are up

28 per cent and at a new high, stock-sales ratios are under

running 20 per cent over

Used car sales are still

a year ago.

last summer, although stocks are up 17 per cent. These figures

are roughly as of the industry's production cutbacks for model

changeover, with new model introductions from 30 to 60 days off.

Free market prices of used cars, i.e., prices at dealers'

auctions, have continued to show little change after allowance

for depreciation rates typical of this time of year.

8/23/55

With automobile sales relatively active and sales of

other hard goods up, consumer instalment credit in July is

estimated to have advanced by another half billion. The most

recent information reaching us about terms shows 36 months

maturities on new cars to be quite common in most sections of

the country, and the predominant maturity in industrial areas

along the eastern seaboard.

Customer equities on new cars,

from a historical standpoint, are generally running on the

thin side.

While over-all spending for new construction remains at

a high level, residential construction has been easing off.

With real estate markets continuing active, with few unsold

houses in builders' hands, and with vacancies reportedly low,

this development appears primarily related to a tightening of

mortgage credit, especially with regard to new lender commit

ments. However, shortages of building materials in some areas

and advancing construction costs have no doubt also affected

the slowdown in residential starts.

With demand for industrial products strong and costs

rising, prices of materials and finished products have both

been rising with price increases for finished goods much more

frequent than earlier. Average prices of farm products since

mid-June have fallen 4 per cent and currently are 8 per cent

below a year ago. The price for farm products declines have

been mainly in hogs and grains on the domestic side and in

cocoa and coffee on the foreign side. Cattle prices have

changed little over the past two months.

Strength continues to feature the labor market, with un

employment down to less than 4 per cent of the labor force.

Seasonally adjusted nonfarm employment is expected by labor

market specialists to show a further rise in August. Agree

ments negotiated in major industries are showing larger wage

rate increases than in other recent years. The impact on pay

envelopes of some of the more recent and more important of

these settlements is only beginning to be felt.

The materially improved business conditions of recent

months point to higher tax collections for the Government. Al

though expenditures may run above earlier estimates, a surplus

of 2 billion or better is now indicated for the current fiscal

year.

The capital markets remain active with corporate volume up

but with State and local government issues off, partly on account

of the rejection of bids on several offerings.

8/23/55

Common stock prices have leveled off, on reduced trad

ing volume about 4 per cent below July peaks.

Increases in

stock market credit for two months have been quite moderate,

and the number of margin accounts showing debit balances

changed little

in July, after many months of apparent in

creases.

Bank credit, as shown by the statements of weekly report

ing city banks, has increased considerably over the past month.

With security portfolios showing little change in balance,

the increase has reflected expansion in most types of loans.

Security and agricultural loans, however, have declined some

recently for special reasons.

The all important points about

recent banking developments are that private credit expansion

has been strong in the period of usual seasonal slack and like

wise there are indications that money supply growth has picked

up again. Turnover of demand deposits has continued at the

high levels reached in mid-spring.

Market interest rates, after an interruption of upward

movement early in August, recently have again shown an upward

tilt.

The movement, however, has been somewhat uneven as

between different types of paper.

Uncertainty with respect

to future levels of longer-term yields has tended to raise

liquidity preference of institutional investors and this has

evidently been a special factor in holding down yields on Treas

ury bills recently.

In connection with Mr.

Young's statement, Mr. Leach said that,

from conversations with businessmen in his district, it appeared that in

creases in minimum wages in

conformity with legislation recently approved

by the Congress to become effective next March were already beginning to

have some effect in industries in the Fifth District where increases made

in the furniture industry were creating pressure for increases at other

plants.

He added that since a very large proportion of the workers in the

furniture, textile, and other industries in the Fifth District have earned

less than $1 per hour in

the past there will be cost pressures in these

8/23/55

-6

industries as well as in the steel industry where prices have been in

creased as a result of recent wage agreements.

At Chairman Martin's request Mr. Koch made a statement with re

spect to the prospective member bank reserve situation as follows:

The reserve position of member banks has changed markedly

since the Treasury refinancing around the turn of the month.

During the last two full weeks in July the outstanding level

of free reserves averaged about a positive $250 million.

During the first three weeks of August, on the other hand, the

level averaged about a negative $175 million. The change oc

curred largely by allowing market forces, particularly an in

crease in currency in circulation and a decrease in float early

in the month, to have an effect in reducing reserves.

In addi

tion, however, the System reduced its holdings of Treasury bills

by allowing some to run off at maturity and selling others.

Currency in circulation increased in June, July, and early

August at a seasonally adjusted annual rate of about 5 per cent,

after having shown little

net change on balance for many months.

In the current week ending August 24 the average outstand

ing level of free reserves is likely to show a decline of ap

proximately $100 million due mainly to System operations, in

cluding another run-off of Treasury bills and the carry-over

effect on a daily average basis of last week's reduction in Sys

tem bill holdings. In the next week ending August 31 market

forces, particularly the usual end-of-month decrease in float

and the pre-Labor Day outflow of currency into circulation, are

expected to lead to a further reduction in bank reserves by

perhaps an additional $100 to $150 million. In the week ending

September 7 a continuing pre-Labor Day outflow of currency into

circulation may drain a further 200 million from bank reserve

positions.

In the week ending September 14 market forces are

likely to have little

effect on balance on reserves.

Thus,

assuming no further Federal Reserve open market operations,

market forces would likely produce a decline in outstanding

free reserves to an average level of approximately minus $600

million during the early part of September.

In the week ending September 21 the usual mid-month in

crease in float should produce a sharp temporary rise in bank

-7

8/23/55

reserves.

This review of prospective bank reserve develop

ments carries us past the next scheduled meeting of the

Committee.

In opening the discussion of system credit policy, Chairman Martin

stated that at times like the present the formulation of policy may be

largely a question of techniques and procedures and he doubted that it

was possible completely to separate over-all policy from techniques and

procedures.

He said he had reviewed the minutes of the last meeting of

the Committee, which he felt was a very useful and constructive meeting,

and was impressed that the differences of opinion were in the area of the

degree of restraint to be applied rather than in the over-all policy that

restraint was necessary.

He inquired whether any member of the Committee would wish to

change the current policy as stated in the directive issued to the Federal

Reserve Bank of New York at the last meeting which provided among other

things, that open market transactions would be for the purpose of restrain

ing inflationary developments in the interest of sustainable economic

growth.

Upon an indication from all of the other members of the Committee

that no change was called for in the policy stated in the directive, he

turned to the problem of actions to be taken to carry out that policy and

in that connection made substantially the following statement:

The important questions have to do with techniques and

I have reviewed my statement at the last meet

procedures.

ing of the Committee and would like to comment on my remarks

8/23/55

-8

at that time. What I say will not change the general basis

of what I said then. I think the wage cost push is still

with us and the psychology that that creates is still

with

us.

I would emphasize a point that I think we exaggerated at

the time of the last meeting. We used the terms "theatrical"

and "dramatic" in connection with the amount of the discount

rate increase. I question whether an increase of either 1/4

of 1/2 per cent could be characterized in that way. What I

was trying to say at the last meeting was that the action

should be decisive and clear. We might have differing views

as to whether an increase of 1/2 per cent is dramatic or

theatrical.

I would not want to imply that the action was

either dramatic or theatrical but rather that it would be

clear and decisive.

One of the points I made in my statement at the last meet

ing was on inventories. I think inventories are rising much

more rapidly than we realize. Our inventory data is the

poorest we have and the lack of adequate information will be

come apparent at a time when it will cause us the most trouble.

I realize that that comment is in the area of projection but

I think it is true.

I want to comment on the philosophy of restraint. Behind

the wage cost push is a sort of general conviction, one that

has been growing for a number of years, that inflation, if not

desirable, is something that it is not politically feasible to

hold down.

There are those in Wall Street who assume it will

not be politically feasible to restrain inflation, that the

economy has an inflationary bias, and that they might as well

resign themselves and relax and enjoy it. I want to present

my own thinking on that point. I have been in the Government

now for 10 years and I am fully aware of Government pressures.

There are margins of error in all these things, but it is

perfectly clear to me that it is politically feasible and

practicable, if judgment is sufficiently wise, to restrain a

situation before it develops. It is much more difficult in my

judgment to restrain a condition after it has developed. I

believe we should approach the problem of credit policy with

that philosophy. In other words, it is possible to restrain

a person before he does something, and while he may not like

to be restrained he will forgive you for it later, but if he

goes ahead and does something and then you act to pull him

back your action becomes a form of punishment for what he has

done that is not feasible in a democracy.

8/23/55

-9

We can never recapture the purchasing power of the dollar

that was lost because of the war. That is not politically

feasible or economically desirable. Such a loss usually occurs

in a relatively short time. In the present circumstances, when

we are faced with another period of increasesin prices, I be

lieve that any margin of error should be resolved in the direc

tion of tightness until we are certain that the policy should

be changed. No one can project the future. We don't know

whether we are going to have the high level of fall and Christ

mas trade that we think we are but the production picture is

moving upward and confidence is projected all along the line.

If we let it get out of hand we may be in a position of "too

little too late" for a long time to come and may be faced with

the inevitable "bust" that some people think will come in any

event because of the inflationary bias in the economy. We

have reached a point in the present phase of the economy where

there are going to be a good many bearish statements. These

are the "dog days", i.e. this is the end of August. This is

the season when there is usually a certain amount of bearish

ness.

The contribution that the members of the Committee are

making in their statements in these meetings is very helpful

and useful. It is important to get the various points of view

on the table and analyze them. There will be differences of

opinion because no one has perfect wisdom or judgment particu

larly in this field. Therefore, it is a question of exercising

the best judgment we can bring to bear.

There are differences of opinion on the discount mechanism

and how it should be used, whether the System should lead and

make the market or otherwise. That question should be discussed

this morning. I am going to ask Mr. Riefler and Mr. Ralph Young

to present their thinking on this subject. I happen to agree

with their views. Mr. Young's statement may appear to some pre

sumptuous because of his direct advocacy of a point of view but

the presumption is mine. I did not have time to write a state

ment but I agree with what he will say. It is important that

we get on the table the question of the relationship of the dis

count rate to market rates and whether we should proceed to make

the discount rate effective by negative free reserves of say

,400 or 500 million or whether it would be wiser to pursue the

course of increasing the discount rate as a lead factor. That

involves problems that are inherent in the history of monetary

policy. To cite one such problem, one of the points in the

8/23/55

-10

Treasury-Federal Reserve accord was that it was agreed that

there would be no change in the discount rate for the balance

of the year 1951 unless conditions radically changed and that

the discount rate would be used as a pivot for Treasury re

financing.

That is typical of the framework in which some of

our views get shaped from time to time when we make compromises.

Sometimes they are wise and sometimes unwise.

We never should

be carried away by pure logic.

We should always taink in terms

of the statement in the foyer of this building that we do not

have, and we will never have, a clean sheet of paper to write

upon.

I will now call on Mr. Riefler and then Mr. Young, after

which the meeting will be open for any comments that any of

the members may wish to make.

Mr. Riefler's statement, during which he referred to a flannel

board chart which he had prepared for use in another connection, was sub

stantially as follows:

If you are going to exert further restraint on the market,

the question is how to apply the restraint. In the past, the

procedure has been to initiate restraint through open market

operations by reducing available free reserves. When the mar

ket rate finally went above the discount rate as a result of

this action, it constituted an almost automatic signal for an

increase in the discount rate. If pressure is kept on free

reservesunder these conditions, the market rate will climb up

again, probably above the discount rate. In this approach,

there is always a problem of circular reasoning as to the rea

son for raising the discount rate.

Almost each time in the past when the System has followed

this procedure of restraint, namely, of leading with open mar

ket operations, thus producing negative free reserves and a

firming market, we have gotten into a position where the dis

count rate was not a penalty rate, i.e., it was below yields on

short-term open market obligations. This creates an incentive

for member banks to adjust reserve deficiencies through dis

counting rather than through disposal of securities in the mar

ket. It also makes it technically possible for banks to borrow

from the Federal Reserve and use the funds to buy highly liquid

market paper at a profit. While most banks do not do this, the

absence of a penalty rate has created a problem for us of

8/23/55

-11

administering the discount facility in such a way as to pre

vent member bank abuse of the discount privilege by over

borrowing. Historically the record is quite uniform with

respect to that problem. If you go through the Board's rec

ords covering the five times when the System has acted to

firm the market--1920, 1923, 1926, 1928-9, and 1952-3there are long discussions about over-borrowing. It was

particularly acute in 1920-21. I do not recall the problem

arising in 1923, but it became active again in 1926 and led

to the discussion in the 1926 Annual Report which more or

less promulgated the philosophy embodied in the recent revi

sion of Regulation A, "Advances and Discounts by Federal Re

serve Banks", as to when it is appropriate for member banks

to borrow.

In 1929 there was the "knock down drag out fight" within

the System about direct action and forbidding borrowing member

banks to carry brokers' loans. In 1953 we had the problem

again in the form of borrowing for the purpose of avoiding

taxes. The point I want to make is that serious problems in

administering the discount mechanism have arisen recurrently

during periods of restraint when the discount rate was not

a penalty rate.

There is another approach to restraint that the System

has never taken. Under this approach the System could avoid

exerting so much pressure through open market operations as

to raise market rates actually above the discount rate. Rather,

open market operations would be used to maintain a volume of

negative free reserves sufficient to make market rates of in

terest highly responsive to the discount rate, but not in such

large volume as to raise, say, the bill rate above the discount

rate. That procedure would always keep the discount rate in

the position of being a penalty rate, something like it is at

the present time. Under this approach, the discount rate would

be used to lead in applying a policy of restraint. Market

rates would still move up but after the discount rate was in

creased. I think bill rates would move up proportionately with

the discount rate but not above it if the negative free reserve

position were maintained between $200 and $300 million. Bill

rates would move up with the discount rate because it would be

less costly for banks to adjust to temporary shortages by sell

To summarize, under this approach

ing bills than by discounting.

we would lead with changes in the discount rate and market rates

would firm following the change, instead of the traditional ap

proach of bringing pressure through open market operations until

market rates rose and then raising the discount rate.

8/23/55

-12

(Indicating on the chart.) Since the Treasury-Federal

Reserve accord in 1951, we have had positive free reserves

in every year except one. June 1952 to June 1953 was a

year of negative free reserves. This chart shows that it

takes a very large volume of negative free reserves to put

the market bill rate above the discount rate. During that

one year we had very large negative free reserves and we had

bill rates moderately above the discount rate. We changed the

discount rate once in that period, and as a result the bill

rate moved up also. That year, however, is an exception. The

normal position has been for the bill rate to be below the

discount rate and to remain there in the absence of a very

heavy negative free reserve situation. What I am suggesting

is that the Committee might consider the possibility of keep

ing the discount rate a penalty rate during a period of

restraint. With a discount rate of 2 per cent and a somewhat

firmer market than we have now the bill rate would average

1.80 - 1.90. With a 2-1/4 per cent rate and the same general

level of negative free reserves, the bill rate could be ex

pected to go to 2.10 - 2.15. Other market rates would adjust

to that level of bill rates. As a result, we would be exert

ing as strong restraint on the credit situation as we would

if we operated first through the open market to raise bill

rates above the discount rate, but we would not lose the posture

of a penalty discount rate and would have less difficulty in

administering the discount function.

Mr. Ralph Young read the following statement:

Aside from questions of timing of action and of market risks

incident to a stronger vs. more moderate action, one of the

points of emphasis in the last meeting's discussion was the

danger of getting "the discount rate and open market operations

out of tandem." Mr. Sproul made this point, but it was also ex

pressed, if I am not misinterpreting his remarks, by Mr. Bryan.

Underlying the point, I would gather, is the view that a proper

or normal level for the discount rate in this sort of economic

situation is one more or less continuously in touch with short

term market rates, and that no discount rate should be estab

lished at a level higher than the one to which we are prepared

to see short-term rates rise or moderately exceed. Any other

rate level would be anomalous, inconsistent with the discount

rate practices and traditions of the System, and misleading to

the market. In other words, we would not be "meaning what we

8/23/55

-13

say," as Mr. Bryan put it, if we had had a discount rate level

of 2-1/4 per cent and a market rate level for Treasury bills,

say of around 2 per cent.

I want to say here that I recognize that this viewpoint

has a case in its favor and agree fully that it finds some au

thority in historical patterns. But the System is feeling its

way in a new and different situation and it must be experimental.

I personally feel that the Committee ought to reexamine this

traditional view and, if considerations of merit warrant, de

part from it. I would suggest that there are some considera

tions of merit which ought to be weighed.

The basic tradition of central banking is that the dis

count rate in boom times ought to be a penalty rate. In the

System's formative period, as I recall the record, a central

question of System credit policy was how to make the discount

rate a penalty rate. In this connection, it is rewarding in

vestment of time to reread the discussion of discount rate

policy in the Board's annual reports of the Twenties.

The broad conclusions of System experience in the Twenties,

the record shows, was that in this country it was not feasible

to attempt to make the discount rate function as a penalty rate.

Our banking conditions were too unique. It was more practical

to rely on the bankers' tradition against borrowing and reluc

tance to remain continuously in debt, and to set the discount

rate level in close relationship to the rates on the most

liquid paper in the market--generally just under 90-day col

lateral and 4-6 months commercial paper rates and slightly

over bankers acceptance and short-term U. S. security rates.

Because of the tradition against member bank borrowing and re

luctance to stay in Reserve Bank debt, the discount rate was

made effective by open market sales which occasioned increased

discounting. Conversely, the effectiveness of the discount

rate was relieved by open market purchases which decreased dis

counting. Discount rate policy was a matter of adjusting rate

levels to changes in market rate levels in response to pres

sures on, or relaxation of pressures on, member bank reserve

positions. Reserve Bank discount rate levels, therefore, fol

lowed but did not lead the market. They were never, or practi

cally never, penalty rate levels.

I appreciate that this generalized description of Federal

Reserve discount rate principles as they took form over the

Twenties is an over-simplification, and there are facets of the

matter, such as Federal Reserve influence over the bankers ac

ceptance rate, and perhaps other interrelations between open

market policy and discount rate policy which I am leaving out

of account.

8/23/55

-14

It suffices for the moment to emphasize two things:

first,

this pattern of discount rate operation crystalized

by trial

and error experiment.

Second, there is a vast dif

ference between banking conditions now and what they were

then. The System needs some trial

and error experiment in

the light of present banking conditions.

It needs in this

period to reevolve a pattern of discount rate policy.

Today, the money market does not present to financial

institutions and corporate investors a cluster of alternative,

liquidity forms of varying rate attractiveness.

Instead, we

have a market in which a single kind of paper, the Treasury

bill,

is serving as the dominant or pivotal liquidity instru

ment.

The Treasury bill

serves not only as the main liquidity

instrument for the operating adjustments of banks, but also

as a common instrument of adjustment for other financial in

stitutions and for business corporations.

Moreover, today

the large corpus of intermediate and long-term Federal debt

in the market makes for a sensitive, sympathetic value re

lationship between Treasury bills and other Federal debt.

This in turn makes for a whole market more closely integrated

value-wise than during the Twenties. Consequently, instead

of a systematic array of short-term market rates for refer

ence in discount rate policy as in the Twenties--none of which

could be accurately described as dominant, we have today a

single short-term rate that is a pivot in a very realistic

sense. Other short-term rates, as I observe the market, most

rate.

often take their cue in movement from the Treasury bill

The System needs to give some thought to another impor

tant difference in financial environment between the Twenties

and the present. In the Twenties discount rate policy had to

find a compromise solution in part because of continuing large

volume of member bank discounts--in a sense a legacy from war

and postwar finance of World War I. The present banking situa

tion follows a long period of little or no reliance on discount

ing, and discount experience since the accord has shown a high

degree of credit sensitivity to a relatively small volume of

member bank borrowing. And thanks to the System's careful

review of its discount window experience and its reformulation

of discount principles based on that experience, this sensi

tivity seems likely to be extended.

This all leads up to the suggestion that the System is

now in a situation where it can deliberately experiment with

a penalty discount rate. By that I mean a discount rate that

is kept a margin above the Treasury bill rate in the market.

8/23/55

-15

As a student of Federal Reserve history, I would not regard

this as getting "discount rate policy and open market opera

tions out of tandem" or as "not meaning what our discount

rate says." Rather, I would regard it as taking advantage

of the current financial environment for the System to get

into the tactical position with respect to the pivotal short

term market rate that central banking percepts, developed

out of long experience indicate that the System ought to es

tablish and to maintain in boom periods, if at all practicable.

The System discount rate policy in relationship to Treas

ury bill rates in the 1952-53 episode was most certainly ex

perimental.

It was definitely an experiment, I should say, in

the pattern of System discount rate tradition. In retrospect,

the System treated the Treasury bill

rate for reference pur

poses as one of a number of related liquidity rates, though

not clearly as the dominant liquidity rate. The System followed

the market rather than leading it and penalizing the use of Re

serve Bank credit by means of the discount rate. It relied on

the tradition against borrowing and the reluctance to stay in

debt to restrain undue credit expansion. And the System was

surprised that borrowing for profit went on and that monetary

expansion during the period of build-up in member bank debt

was so rapid. Future historians of System policy will cer

tainly find reason to question whether the discount rate policy

pursued two years ago was the wisest one that could have been

followed.

In the present situation, it seems to me, the System's

discount rate policy can well be different. The System should

experiment with another approach. It should establish a dis

count rate level and maintain a level that will make the rate

a penalty rate in relation to the Treasury bill rate, the

dominant short-term rate in the market.

It can then broadly

govern the volume of reserves needed for growth through open

market operations while at the same time restraining an undue

An

credit expansion financed primarily on borrowed reserves.

cannot

accompli

is

a

fait

that

expansion

undue bank credit

later be contracted by counter measures, at least, not with

out serious deflationary dangers of chain-reaction potential.

The argument is, then, that the System should act now, while

there is an opportunity to act, to assume and maintain a posi

tion of credit market leadership. It should not let the bubble

on top of the boom develop in so far as its tactics can help

to prevent it.

Psychologically in the market, it can be questioned whether

this approach would give rise to undue confusion. The market

8/23/55

-16

would quickly come to understand the meaning and common

sense of firm leadership.

The market is not now completely

free of confusion as to rate policy. Moreover, there will

always be some difference of views in the market as to cur

rent trends in credit policy, for differences in market

judgment are an attribute of a well functioning and healthy

market.

But to important segments of the market at the

present time, a penalty discount rate in the sense in which

I am using it here, would make System leadership in a volatile

economic situation crystal clear.

Chairman Martin requested that, if

there were no objection, the

two statements be incorporated in the record of this meeting.

He re

peated that he was in sympathy with the point of view that they expressed

and believed that the suggestion should be considered throughout the Sys

tem.

Mr. Earhart asked whether there was any reason why copies of the

two statements could not be given to the directors of the Federal Reserve

Banks for their use in considering the action to be taken with respect to

the discount rate.

It was his view, in which Mr. C. S. Young concurred,

that the two statements were the kind of material that could well be given

to the directors.

Mr. Mills made substantially the following comment on the proposal

presented by Messrs. Riefler and Young:

It is appropriate that, in reviewing their operations,

the Federal Reserve Banks should consider the suggestion

that Messrs. Riefler and Young have made. However, in making

those reviews the Banks should look at the question whether

the concept of a penalty rate to discourage member banks

8/23/55

-17-

from borrowing in order to take advantage of a rate differ

ential is applicable at this particular time. The question

of timing is what we should give our thought to and not to

the theory of the desirability of a penalty rate. We should

look at the penalty rate against the structure of yields in

the market and also against the position of member banks

which would be affected by the institution of a penalty rate.

We are very conscious of the fact that commercial banks,

taken as a group, are in a very less liquid position than

they have been accustomed to in recent years. In the past,

when the market rate rose above the discount rate, very few

member banks took advantage of the rate differential to ex

pand their holdings of bills. Of course, there were some

shining exceptions but under present conditions a bank will

look hard and twice before borrowing from a Federal Reserve

Bank to expand a bill portfolio. If that was done, when the

bank's statement was published, it would be revealed to

analysts and others that its liquidity had dropped and that

Federal Reserve funds were being used to sustain operations.

You will find that, by and large, banks are not inclined to

do that.

You have another situation to consider in this connec

tion and that is that the structure of rates in the short

term area of the Government securities market is leveling

out at a yield substantially above the discount rate. With

that condition as it now exists, if the bill rate should rise

above the discount rate, although it is unlikely that banks

would discount to buy bills, they could be tempted to discount

to maintain their asset position in other issues on which the

yields have risen over the last few months, or to avoid the

liquidation of those securities at a loss where faced with

depreciation. It seems obvious that under these circumstances

a penalty discount rate would have to be set at such a high

level in relation to the rates on 1956 to 1958 maturities that

in the process the market for U. S. Government securities would

be damaged.

So, my thesis is that although a penalty rate is eminently

desirable theoretically, before such a decision is made it is

essential to look at all of these other factors that inject

themselves into the problem. Again, for example, if the dis

count rate was raised abruptly at the present time before being

confirmed by a higher interest rate trend having been estab

lished in the market, the market might be seriously unsettled.

8/23/55

-18

And if it should then become necessary to correct a dis

orderly situation, you would undo the benefits sought from

moving precipitously to a penalty rate. In other words,

timing of a change in the discount rate would seem to be

the essence of the problem, and in considering timing it

is necessary to bear in mind the fact that System policy

is getting an increasing and accumulating assist from

public comments of what the System's intentions are, which of

itself is a restraining factor coming to our help in implement

ing the policies which we wish to make effective by reducing

any necessity for hurrying to make another change in the dis

count rate.

Referring to the question which had been raised with respect to

the statements of Messrs. Riefler and Ralph Young, Mr. Earhart said that,

on the basis of the discussions that had taken place, his directors would

be reluctant to move to increase the discount rate immediately because we

have not yet seen the effects of actions already taken.

Mr. Johns commented that the Young statement made reference to

the statements made by Messrs.

Sproul and Bryan at the last meeting of

the Federal Open Market Committee and expressed the view that the two

statements would not be as informative to the directors as they should be

unless they were accompanied by the Sproul and Bryan statements.

fore, he asked if

There

there would be any objection to the latter statements

being excerpted from the minutes of the Committee and furnished to the

directors of the Federal Reserve Banks.

This point was discussed in the light of the confidential character

of the proceedings of the Federal Open Market Committee and the difficul

ties which that created in

relation to the information that should be made

8/23/55

-19

available to the directors of the Federal Reserve Banks in their considera

tion of discount rate action.

It

was also considered in the light of the

fact that the Riefler and Young statements related wholly to the ques

tion of Federal Reserve discount policy which is

in the field of the di

rect responsibilities of Federal Reserve Bank directors.

The suggestion

was made that the Riefler and Young statements could be distributed as

proposals which they had made, that the reference in Mr. Young's state

ment to the statements of Messrs. Sproul and Bryan could be dropped, and,

if

necessary, the points with respect to the discount rate raised in the

statements by Messrs. Sproul and Bryan could be presented to the directors

without reference to the statements themselves or to the minutes of the

Committee thus avoiding the precedent of taking excerpts from the minutes.

If

that suggestion were followed, the statements of Messrs. Riefler and

Young would be handled in the same manner as other statements or memoranda

with respect to the discount rate had been handled in the past.

Chairman Martin stated that, in the light of the discussion, it

might be wiser not to circulate the Riefler and Young statements, that

the Presidents had the ideas presented therein and if they desired to use

them in discussing the question of the discount rate with their directors

they would be at liberty to do so.

He asked that the two statements go

into the record of this meeting since he felt it

was important that the

proposal be considered by those present as well as by the directors of

the Federal Reserve Banks.

8/23/55

-20

Mr. C. S. Young asked if there would be any objection to the

Presidents making a report to the directors based on the comments in the

four statements with respect to discount policy without reference to the

statements themselves and it was indicated that there would be no objec

tion to that procedure.

Chairman Martin also said that perhaps, by the

time of the next meeting of the Committee,

a document could be prepared

in a different form that might be useful.

Mr. Erickson expressed the view that member banks no longer had

the same reluctance to borrow that they had in the 1920s and 1930s and

that therefore a penalty rate would mean more today than in earlier

periods.

He inquired whether the other Presidents shared in that view.

Several questioned its

correctness, Messrs. Earhart and C. S. Young stat

ing that they saw no material change in the attitude of banks on this

point.

Mr. Earhart also said that his Bank's experience with a penalty

rate years ago was not at all good, that member banks were penalized

when the banks had to borrow,

to be waived.

and that the penalty rate eventually had

Mr. Leach said in his experience only a small number of

banks would borrow at a given time, that some were very willing to borrow,

that some borrowed reluctantly, that others would not borrow at all, and

that the number in the last category was still

large.

Chairman Martin then called for the views of the members of the

Committee on the open market policies to be followed pending another meet

ing of the Committee.

8/23/55

-21

Before discussing that subject, Mr. Treiber commented on the ques

tion of the use of the discount rate.

He observed that the differences

expressed at this meeting were differences in degree; the question is not

one of extremes.

He questioned whether the market rate on Treasury bills

should be looked upon as the focal point in the short-term market and

said that there were a number of other factors that should, be considered,

such as the degree of liquidity of the banks, the demand of corporations

and other nonbank investors for bills, the supply of bills in the market,

and the whole structure of rates.

such that if

The fluidity of the money market is

there were a discount rate substantially above market rates

there would be very little

use of the discount facility.

If banks were

not as reluctant to borrow as they were in earlier periods, as Mr. Erick

son has indicated, the banks were reluctant to stay in debt, and the ad

ministration of Regulation A has tended to encourage that reluctance.

If

the relationship of short-term rates and discount rates were such that the

banks were to borrow to obtain needed reserves, the borrowing would become

a restraining effect which would be lost if the discount rate were moved

substantially higher than short-term market rates.

He made the further

observation that in making intelligent decisions on the discount rate it

was necessary for the directors of the Federal Reserve Banks to know what

current open market policies are in order to bring about the necessary

degree of correlation between discount policy and open market policy.

8/23/55

-22

On the question of an appropriate discount rate at this time, he said

that the situation was not the same as in 1953 when bill rates and other

short-term rates were above the discount rate.

We might now approach

the problem by saying that the discount rate should lead in signaling

Federal Reserve policy as it had done a few weeks ago, and be followed

by open market action tightening the market so that short-term rates

would rise and fluctuate around the discount rate.

is

needed,

If

further pressure

a further increase in the discount rate might lead again.

He

said that in a period of restraint he would want to avoid having the dis

count rate "stick" much above short-term rates and unsupported by the

pressure of open market action.

With respect to the general question of current Federal Reserve

credit policy, Mr.

Treiber made a statement substantially as follows:

Since the last meeting of the Federal Open Market Commit

tee the economy has shown continued strength. Nevertheless,

recent statistics indicate a less rapid rise in the rate of

expansion in the third quarter of 1955 than in the first two

quarters. We will probably see more expansion in the fourth

quarter.

The present lessening of the rate of expansion should re

duce the pressure in the economic system and foster orderly

expansion later in the year. However, the possibility of a

price-cost spiral accompanied by speculative inventory accu

mulation and heavy credit usage are important threats.

There are encouraging developments in certain of the

The stock

special areas with which we have been concerned.

market has lost its head of steam, at least for the present.

As for residential real estate credit, declining applications

for home mortgages and a reduced willingness on the part of

8/23/55

-23-

lenders to make mortgages may be expected gradually to reduce

net mortgage extensions.

While there is no doubt that con

sumer credit has been expanding rapidly this year, with auto

mobiles playing the major part, the anticipated reduction in

automobile production should slow down consumer credit expan

sion.

The principal need for commercial bank credit will be

from business and industry for normal seasonal credit needs

and for increased inventory called for by the increased busi

ness tempo.

The higher discount rate at Cleveland has been inter

preted as an indication that the System would not hesitate

to increase the rates at the other Reserve Banks further if

such action seems called for. This has created uncertainty

which, in turn, has constituted an additional factor of re

straint.

Bank liquidity has been reduced; this will be a restrain

ing factor.

The Federal Reserve System should continue to exert a

steady pressure on credit expansion. Continuing steady pres

sure over a period of time actually brings increasing pressure.

Rates do not necessarily adjust immediately and fully. As

time passes, different groups take action or refrain from tak

ing action, and this in turn affects other groups.

We have not yet seen the full effect of the two increases

in the discount rate this year and the accompanying open market

policy. Our action has not yet been fully reflected in market

rates--both short-term and long-term.

Some of the additional reserves needed this summer and fall

should come through increased member bank borrowing. We have

already experienced increased borrowing--the highest sustained

borrowing since May 1953. In the last three weeks member bank

borrowing has averaged between $750 and 850 million, with ex

cess reserves of about $600 million confined largely to the

In the same period, free reserves have averaged

country banks.

between minus $100 and minus $200 million. As we experience in

creased member bank borrowing--with borrowing by a greater number

of banks although not always the same banks--and the accompanying

pressure on banks to get out of debt to the Federal, there will

be increasing credit restraint.

Projections for the next three weeks made by the New York

Bank show increasing reserve losses totaling several hundred

million dollars. Borrowing should play an important part in

If all needed additional reserves

supplying the needed reserves.

8/23/55

were to be acquired through increased borrowing, we would

have borrowing of between $1 and $1-1/4 billion. This

might put a severe strain on the banking system and partic

ularly on the central money markets.

Some outright purchases

of Government securities by the System may be called for.

Some repurchase agreements in the first

half of Septem

ber may also be in order, but the amount would probably not

be large in view of the small dealer positions.

There has been a strong demand for Treasury bills by

business corporations and other nonbank investors. Part of

the strength appears to be due to purchases by investors who

want to have their funds in short-term securities, having in

mind a possible decline in the market value of long-term se

curities. In the last few days there has also been a good

market for short-term Government obligations other than bills.

It would seem desirable in the first

instance to let

the banks get needed reserves by additional borrowing or by

selling securities to nonbank investors. As this process con

tinues, short-term Government securities are likely to become

available in the market in increasing amounts and at declin

ing prices; in this setting, outright purchases for the System

Account would be in order.

If the banks have to sell Government securities (primar

ily notes and short bonds) too rapidly, we might see an un

fortunate price erosion in the capital market. Timely pur

chases by the System should avoid such a development.

Because of the special situation keeping up the price of

Treasury bills and the dearth of Treasury bills in the portfo

lios of the city banks, the purchase by the System of short

term Government securities other than Treasury bills may be

desirable.

The present economic and credit situation calls for steady

and increasing pressure on the expansion of bank credit. The

program just outlined should produce the desired pressure.

Mr. Erickson stated that he liked very much Chairman Martin's ap

proach to the philosophy of restraint, and felt that we should lead rather

than lag in System actions.

He shared the Chairman's concern about inven

tory accumulations and about the wage cost factor and what might be happen

ing to prices.

He was also pleased with the degree of tightness that had

-25

8/23/55

been brought about in the market during the last few weeks.

He hoped that

greater use would be made of the discount facility and, in the present

circumstances,

he would not hesitate to tighten the credit situation

further.

Mr.

Irons concurred with the view that the System should lead in

its actions and expressed the opinion that the recent action increasing

the discount rate did lead to some degree.

ing steady pressure on the market.

He was pleased at the increas

He had hoped that the bill rate would

move closer to the discount rate, but he questioned whether in the peculiar

circumstances existing in the market it

that result or whether it

would be reasonable to expect

would be desirable to try to induce it

might unduly tighten the market.

as that

He believed that increasing pressure

should be applied as needed and he realized that judgment on that point

was the difficult question.

There were few signs of lessening activity

in the economy and he was concerned with the steady increase in consumer

credit and in the lengthening of instalment terms.

The economy was moving

into the season when there was a strong demand for consumer credit and,

in spite of the fact that the automobile industry was in a period of model

change, he questioned whether there would be any reduction in the growth

of consumer credit.

The economy is

going into the fall period with full

utilization of capacity, a tight labor market, a less liquid condition

in the banks, and a tighter money situation.

With the existing strength

in the economy a further tightening of the credit situation in his opinion

8/23/55

-26

would not have as damaging an effect as failure to bring about a further

tightening, and it

or another it

was his view that if

the System has to lead one way

should lead toward further restraint.

Mr. Earhart was in agreement that there should be a policy of

gradually increasing pressure and that this condition would result if

the System continued the present policy of not supplying reserves

through open market operations.

He was certain that if

conditions were

such that member banks had to borrow, the degree of restraint would be

increased.

His judgment was that the discount rate should not lead in

the sense of stepping up the rate to where it

would be a penalty rate

under all conditions, but that market rates and the discount rate should

be kept as close together as they have been during the last two weeks.

He felt that without further open market action there would be an increas

ing amount of restraint and that possibly within about two weeks the

discount rate might be moved up to 2-1/4 per cent.

He added that unless

something developed at this meeting that changed his mind, his recommenda

tion to his directors at their meeting tomorrow would be that they take

no action to increase the discount rate and that they consider the matter

again at the meeting two weeks later.

Mr. C. S. Young said that the discount rate was the only item on

the agenda for the meeting of his directors on Thursday and he was satis

fied that no change would be made at that time.

error was to be made it

He felt that if an

should be in the direction of increased tightness

-27

8/23/55

but that we have not yet seen the full effect of the increase in the dis

count rate to 2 per cent.

was a real market rate.

He questioned whether the present bill

rate

He had asked nonbank purchasers of bills whether

they would buy anything other than bills, and the reply was a negative

one because they wanted short-term bills which were liquid.

Even if

rates on other issues were as much as 1/2 per cent higher, he

people would not buy them.

the

said, these

There were a number of treasurers of big in

dustrial concerns that have funds to invest and they want to put these

funds where "they can get their hands on them."

He questioned whether

further action should be taken on the discount rate this week.

Mr. Leach explained that the fact that the Federal Reserve Bank

of Richmond was the last to increase its discount rate to 2 per cent did

not indicate any reluctance to make the change.

When he learned that

Cleveland had established a 2-1/4 per cent rate and some of the other

Banks a 2 per cent rate he felt he should not attempt to get action before

the next regular meeting of his directors at which time the matter could

be carefully reviewed.

When the meeting was held, he said, the decision

was made that the increase to 2-1/4 per cent should be in two steps rather

than in one.

However, he thought that, if the present expansion continued,

when the directors met in September they would favor a 2-1/4 per cent rate.

They would not favor such an increase now because it would be too soon

after the recent increase.

Speaking personally, he was very much pleased

with the System's policy in August when the pressure on the market

8/23/55

-28

gradually increased with the resulting change in the volume of free re

serves.

Representatives of his Bank had talked to a number of the larger

banks in the Fifth District to ascertain what effect System policy was

having and it

appeared that the banks are currently more selective and

are exercising more restraint in their lending policies.

tion of the relationship between the bill

On the ques

rate and the discount rate, he

felt the small supply of bills in the market, the unusual nonbank demand,

and the tendency of more people to purchase bills pending the rate adjust

ment in the long-term market, were tending to impair the usefulness of

the bill rate as an indicator of the present degree of market tightness.

He would like to see a substantial part of the additional reserves needed

in coming weeks supplied through the discount window because in his opinion

that would mean increased pressure on the borrowing banks because of their

reluctance to borrow.

Such a policy would also result in increased pres

sure on other banks because they would have to sell securities at a loss

to make additional loans.

In his opinion the Committee would have to get

accustomed to looking at larger amounts of negative free reserves.

Mr.

Vardaman referred to the comment made by Mr. Erickson about the reluctance

of banks to borrow and stated that the Federal Reserve Banks through their

educational programs should instill in their member banks that it is

no

disgrace to borrow, and that borrowing is a proper use of the discount

facility and is one of the best insurance policies in the System.

He

hoped that banks would be encouraged to borrow when it is proper to do so.

-29

8/23/55

On the question of timing of a further increase in the discount rate, he

expressed regret that all Federal Reserve Banks had not increased their

rates to 2-1/4 per cent following the last meeting of the Federal Open

Market Committee.

He felt that the pattern of fall and winter spending

was now taking form, that not only were inventories increasing in accord

ance with that pattern, but orders were being placed, and that these

orders would govern the borrowing needs of customers of banks later in

the year.

Unless the System gave some warning now it

would be unfair to

the economy to squeeze the banks too tight after the manufacturers had

put the orders into production and the local merchants were committed.

He had the strong hope that within the next two weeks the discount rate

would be increased to 2-1/4 per cent and,

if

that did not have the de

sired effect, a further increase to 2-1/2 per cent would be made.

Governor Mills expressed what he regarded as being the general

tenor of the meeting that it

three weeks.

He felt

same direction it

is difficult to look beyond the next two or

that over that period the System should move in the

had been moving or gradually increasing market pressure

and should be very alert and increase the discount rate when there is

con

vincing evidence of need of such action.

Mr. Shepardson concurred in the feeling that had been expressed

that continuing pressure should be applied.

declined somewhat,

While agriculture prices had

crop prospects were excellent and with the decrease in

8/23/55

-30

the number of farmers that has been going on he felt that the income of

the farmers was holding at a respectable level and that there was not the

weakness in the general agricultural picture that might be indicated by

the declines in prices. Farmers were in a strong position generally and

with other factors of the economy operating at a high level he saw need

for continuing restraint.

Mr. Bryan agreed that if further tightening action is to be taken

it

should be taken "sooner rather than later."

He would like to be able

to see more clearly the effects that were being produced by actions that

had already been taken.

It appeared to him that, because of Treasury

financing in October, the decision would have to be made to stay on a 2

per cent rate or to increase to 2-1/4 per cent without knowing the effects

of the recent discount rate increase.

tions had been too restraining.

game of restraint",

He did not believe that System ac

While banks were "talking an excellent

he said, there were evidences in

the reports of bank

loans and in other ways that banks are continuing to increase loans.

On

the question of the relationship of the discount rate and open market

rates, he would want to study the proposal made by Messrs. Riefler and

Young.

He did not think there was any theoretical solution that would

say at all times and under all circumstances what the relationship of the

discount and market rates should be.

There might be times when a market

rate well under the discount rate would serve a very useful purpose and

other times when a market rate which had been pushed above the discount

-31

8/23/55

rate would also serve a useful purpose.

He questioned the desirability

of referring to the rate as proposed by Messrs. Riefler and Young as a

penalty rate.

He was disappointed by the fact that during the past two

or three weeks open market operations had not been used with vigor to

force the bill

rate above the discount rate.

have several advantages.

If the market goes up, because of the demands

for funds or other reasons,

the entire market.

In his opinion that would

it

has a substantial arbitrage effect through

He regretted the fact that the Federal Reserve Banks

and the Board were contemplating a further rate increase without knowing

what the effects of recent increase were going to be.

The question at

this meeting, he said, regardless of whether the discount is

2-1/4 per cent,

is

to be 2 or

at what point and in what considerations will the Sys

tem begin to supply reserves to take care of the seasonal needs of the

economy.

It was his view that more vigorous action to tighten up on

the supply of reserves should be taken than has been the case.

He said

that statement not as a criticism of any individual but as a statement

of desirable policy.

Mr.

Johns concurred in the views expressed by Mr. Bryan that the

commercial banks are not pursuing tight loan policies.

He also expressed

the desire to study the suggestion made by Messrs. Riefler and Young.

One

of the things about the proposal that concerned him was that there were

still

something over $2 billion of Treasury bills in the hands of banks

8/23/55

-32

and a penalty rate as outlined would be a penalty rate for banks that did

not have bills while banks holding bills could obtain additional reserves

by foregoing a yield of what happened to be the current market rate on

bills.

He assumed that if the System adopted a penalty rate it would want

that rate to apply to banks that held bills as well as to banks that did

not.

Mr. Powell stated that in the Ninth District, which is predominantly

agricultural,

the Federal Reserve Bank had surveyed the retail sales in a

number of small towns and had found a very real reduction in the volume of

sales indicating that the farmer has been suffering from low prices when

industrial prices have been rising.

felt

that if

weeks it

On the question of credit policy, he

no action in the open market were taken over the next three

would have a very considerably restraining effect since it

increase substantially the amount of negative free reserves.

would

It was his

view that the Committee could maintain the desired degree of tightness by

supplying only a part of reserves that would be needed to meet credit needs

over the remainder of the year.

He referred to the various indicators of

the effects of tighter credit policy and stated that his Bank's appraisal

of the situation was that no action on the discount rate should be taken

at this time but that the System should see what the full effects of the

recent increase would be.

It was his view that probably open market opera

tions could provide the necessary amount of restraint.

8/23/55

-33

Governor Szymczak said that, regardless of the various points

made at this meeting, the Committee was faced with a practical situation

in which (1) one Federal Reserve Bank has already established a 2-1/4

per cent rate, and (2) the Treasury will have to come into the market for

additional funds in October and again in December for new funds and a

refunding operation.

In view of all of the factors in the picture he

favored a further increase in the discount rate to 2-1/4 per cent as soon

as possible.

The present level of negative free reserves, the fact that

the recent increase in the discount rate and even an increase to 2-1/4

per cent had been largely discounted by the market as indicated by market

reaction, the fact that the amount of reserves that will have to be sup

plied to the market between now and the end of the year to take care of

credit needs of the economy and Treasury financing can not be determined

at this time,--all these factors call for an increase in the discount

rate to 2-1/4 per cent, and he favored such action as soon as possible

so as to permit the market for Government securities to adjust--so that

the Treasury can determine the nature of its

financing in the latter part

of September.

Mr. Martin inquired whether there should be any change in the

directive to be issued to the Federal Reserve Bank of New York.

Mr. Rouse stated that if

there should be a further increase in

the discount rate or a bad effect from increased shortages of reserves,

a market situation could develop which would call for increased open

market operations.

For that reason, he suggested that the Committee might

8/23/55

-34

wish to increase to $1 billion the amount stated in paragraph (1) of the

directive.

Thereupon, upon motion duly made

and seconded, the Committee voted

unanimously to direct the Federal Re

serve Bank of New York until otherwise

directed by the Committee:

(1)

To make such purchases, sales, or exchanges (includ

ing replacement of maturing securities, and allowing maturities

to run off without replacement) for the System Open Market Ac

count in the open market or, in the case of maturing securities,

by direct exchange with the Treasury, as may be necessary in

the light of current and prospective economic conditions and

the general credit situation of the country, with a view (a)

to relating the supply of funds in the market to the needs of

commerce and business, (b) to restraining inflationary develop

ments in the interest of sustainable economic growth, and (c)

to the practical administration of the account; provided that

the aggregate amount of securities held in the System account

(including commitments for the purchase or sale of securities

for the account) at the close of this date, other than special

short-term certificates of indebtedness purchased from time

to time for the temporary accommodation of the Treasury, shall

not be increased or decreased by more than $1 billion;

(2) To purchase direct from the Treasury for the account

of the Federal Reserve Bank of New York (with discretion, in

cases where it seems desirable, to issue participations to

one or more Federal Reserve Banks) such amounts of special

short-term certificates of indebtedness as may be necessary

from time to time for the temporary accommodation of the Treas

ury; provided that the total amount of such certificates held

at any one time by the Federal Reserve Banks shall not exceed

in the aggregate $500 million;

To sell direct to the Treasury from the System ac

(3)

count for gold certificates such amounts of Treasury securi

ties maturing within one year as may be necessary from time

to time for the accommodation of the Treasury; provided that

the total amount of such securities so sold shall not exceed

in the aggregate $500 million face amount, and such sales

shall be made as nearly as may be practicable at the prices

currently quoted in the open market.

-35

8/23/55

Chairman Martin said that it

would not be possible to specify at

this meeting exactly the level of negative free reserves that should be

maintained over the next three weeks but that the level should be in the

direction of continuing restraint.

Mr. Rouse stated that the feeling of the New York Bank was to al

low free reserves to decline to a point where there would be quite ap

parent market effects before injecting additional reserves through open

market operations.

In that connection, he said that if

the Federal Reserve

Banks or the Board should sense any bad effects from open market opera

tions or that effects beyond those desired appeared to be developing in

any district the New York Bank would appreciate hearing about it.

He said

that the Federal Reserve Banks and the members of the Board might have

conversations which would disclose developments which might not come to

the New York Bank in a period which might involve a delicate market situa

tion.

In response to a statement by Mr. Riefler that, as he understood

it,

the New York Bank during the next three weeks would not purchase ad

ditional securities and would continue to allow maturing bills

without replacement,

Mr. Rouse stated that he had felt

that it

to run off

would be in

consistent with his understanding of the Committee's intentions to bid for

Treasury bills in the weekly refundings at a rate below 2 per cent.

ever, if

the situation should reach a point where it

How

was necessary to go

into the market to supply reserves it might be necessary to buy bills at

-36

8/23/55

less than 2 per cent.

Therefore,

much one of rates as it

the question as he saw it was not as

was one of the availability of reserves.

It

was brought out that the projections made at the Board and at the Federal

Reserve Bank of New York as to the future member bank reserve position

did not take into account any run off of the System's holdings of maturing

bills.

However, Mr.

Rouse said that the amount of System holdings of the

next three weeks were not large.

Mr. Martin stated that the question of the point at which re

serves would be supplied in the existing situation was the heart of the

present problem of open market policy.

He said he had not been able to

discern any meeting of minds at this meeting on that point.

He was in

clined to favor an immediate increase in the discount rate to 2-1/4 per

cent and felt that failure to increase the rate was a factor of confusion

and uncertainty in the market which complicates the problem with respect

to free reserves.

Under present conditions, with a shortage of bills in

the market, he would not like to rely solely on forcing the bill rate up

to the discount rate by increasing pressure through negative free reserves.

Therefore, he felt that the Committee should take something of a middle

course which was about all that could be done in the circumstances.

Mr. Rouse stated that his preference,

should a shortage of bills

develop, would be to purchase what the banks have to sell, i.e., short-term

securities other than December rights, instead of buying bills at the

8/23/55

-37

current rates.

Something could be accomplished, he said, through repur

chase agreements at some point if

He interpreted it

the severity of restraint increased.

to be the sense of the Committee that the New York Bank

should not buy bills at a rate below 2 per cent.

Chairman Martin stated that we faced a difficult problem, but that

he would have no hesitation to purchase bills below 2 per cent.

Mr. Rouse

commented that if the problem was regarded as solely a question of re

serves and acquisitions were looked at from that standpoint such purchases

would be fine.

Chairman Martin's response was that if the market tightens

enough bills would probably be available.

While the question was not

further clarified by further discussion, Mr. Rouse stated that he thought

the New York Bank could function satisfactorily in the light of the dis

cussion at this meeting.

Chairman Martin then stated that, if there was

no objection, the discussion would conclude on that uncertain, and in a

sense, rather unsatisfactory note.

He said that everyone should continue

to study the problem and feel free to communicate with Mr. Rouse at any

time.

Chairman Martin then referred to the replies to letters received

from Congressman Patman which were mentioned at the last meeting of the

Committee.

He said that the suggestion had been made that copies of the

letters be sent by the Board to the members of the Federal Advisory Council

and the Chairmen of the Federal Reserve Banks for their information and

that, in the absence of objection, that would be done.

8/23/55

-38.

Reference was then made to the understanding at the last meeting

that the authority to the New York Bank to enter into repurchase agreements

with dealers covering United States Government securities would be con

sidered at each meeting of the Committee.

Mr. Rouse stated that the range

of rates in the existing authorization was regarded by the bank as minimum

rates, that the going rate in the market on loans to dealers was 2-1/2 per

cent, and that if

the situation called for repurchase agreements during

the next three weeks, he would be inclined to make them at 2-1/4 per cent.

The ensuing discussion brought out the point that such action would be

within the terms of the existing authorization and no objection was made to

it.

At the conclusion of the discussion,

upon motion duly made and seconded, and by

unanimous vote, authorization to the Fed

eral Reserve Bank of New York was renewed

as follows with the understandings (a) that

the authority would be used sparingly in

entering into agreements at rates below the

discount rate, and (b) that the Federal

Open Market Committee will consider at each

meeting the extent to which repurchase agree

ments covering Government securities were

to be authorized and the rate or rates at

which such agreements are to be undertaken:

CONDITIONS FOR REPURCHASE AGREEMENTS

PRESCRIBED BY THE FEDERAL OPEN MARKET COMMITTEE

As Approved August 23, 1955

The Federal Reserve Bank of New York is hereby author

ized to enter into repurchase agreements with nonbank dealers

8/23/55

-39-

in United States Government securities subject to the following

conditions:

1. Such agreements

(a) In no event shall be at a rate below whichever

is the lower of (1) the discount rate of the

Federal Reserve Bank on eligible commercial

paper, or (2) the average issuing rate on the

most recent issue of three-month Treasury bills;

(b)

Shall be for periods of not to exceed 15 calendar

days;

(c)

Shall cover only Government securities maturing

within 15 months; and

(d)

Shall be used as a means of providing the money

market with sufficient Federal Reserve funds to

avoid undue strain on a day-to-day basis.

2.

Reports of such transactions shall be included in the

weekly report of open market operations which is sent to

the members of the Federal Open Market Committee.

3.

In the event Government securities covered by any such

agreement are not repurchased by the dealer pursuant to

the agreement or a renewal thereof, the securities thus

acquired by the Federal Reserve Bank of New York shall be

sold in the market or transferred to the System Open Mar

ket Account.

Chairman Martin stated that ordinarily the next meeting of the

Committee would be held on September 13 but that Governor Balderston would

not return from Europe until the evening of that day.

For that reason

he (Chairman Martin) suggested that the next meeting be held either on

September 14 or 15.

Some of the members having indicated that a meeting

8/23/55

-40

on September 14 would be more convenient to them, there was unanimous

agreement that the next meeting should be held on that date.

Thereupon the meeting adjourned.

Secretary