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 Washington on Tuesday, February 2, 1965, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Balderston
Daane 1/
Hickman
Mills
Mitchell
Robertson
Shepardson
Shuford
Swan
Wayne
Messrs. Ellis, Bryan, and Scanlon, Alternate
Members of the Federal Open Market Committee
Messrs. Bopp, Clay, and Irons, Presidents of the
Federal Reserve Banks of Philadelphia,
Kansas City, and Dallas, respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Economist
Messrs. Brill, Garvy, Jones, Koch, Mann,
and Ratchford, Associate Economists
Mr. Stone, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Molony, Assistant to the Board of Governors
Messrs. Partee and Williams, Advisers, Division
of Research and Statistics, Board of
Governors
Mr. Reynolds, Associate Adviser, Division of
International Finance, Board of Governors
Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
1/
Entered the meeting at the point indicated.
2/2/65
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Miss Roberts, Secretary, Office of the Secretary,
Board of Governors
Mr. Strothman, First Vice President of the
Federal Reserve Bank of Minneapolis
Messrs. Eastburn, Baughman, Tow, and Green,
Vice Presidents of the Federal Reserve
Banks of Philadelphia, Chicago, Kansas City,
and Dallas, respectively
Mr. Lynn, Director of Research, Federal Reserve
Bank of San Francisco
Mr. Brandt, Assi:tant Vice President, Federal
Reserve Bank of Atlanta
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Anderson, Financial Economist, Federal
Reserve Bank of Boston
Mr. Kareken, Consultant, Federal Reserve
Bank of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of the
meeting of the Federal Open Market Com
mittee held on January 12, 1965, were
approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Account on foreign exchange market operations and on Open
Market Account and Treasury operations in foreign currencies for the
period January 12 through 27, 1965, and a supplemental report for
January 28 through February 1, 1965.
Copies of these reports have been
placed in the files of the Committee.
Supplementing the written reports, Mr. Coombs stated that
the gold stock would be reduced by $100 million this week in order
2/2/65
-3
to replenish the Stabilization Fund.
He estimated that gold sales
during the month of February would come to at least $85 million with
out taking account of the U.S. debt of $25 million to the Gold Pool.
Unless the Russians came into the market with heavy sales, therefore,
the U.S. probably would have to show another sizable reduction in
the gold stock towards the end of this month or early March.
On the
London gold market speculative buying pressure had continued although
in somewhat more moderate volume during the last week or so.
The
Gold Pool was now in deficit to the extent of $50 million despite the
fact that the flow of gold from South Africa had been running well
above normal levels.
Mr. Coombs thought continuing pressure on the
gold market could be expected until there was a decisive improvement
in both the British and the U.S. balance of payments.
On the exchange markets, Mr. Coombs continued, sterling had
held fairly steady with a minimum of intervention during the past
three weeks.
The report on January 18 of a much improved U.K. trade
position in December had contributed to a better atmosphere and he
assumed that the January trade figures, at least so far as imports
were concerned, would look even better.
Many of the market analysts
who had been predicting a sterling devaluation now were beginning
to take a more optimistic line and, in the absence of some new mis
adventure, the worst of the sterling crisis might have been seen.
During the past two days the spot rate for sterling had moved up
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2/2/65
fairly strongly and if this performance could be maintained for another
week or so the beginning of a return flow of funds might be seen.
This morning sterling was up to $2.7954 and the Bank of England had
taken in $70 million, making this their best day in some time.
However, Britain still owed $3.5 billion, and the situation remained
highly fragile.
Tne three-month credit facilites provided to the Bank of
England by various foreign central banks last November 25 would
reach the end of their term on February 25, Mr. Coombs said, and
some of the Common Market Central banks might be inclined to do
some bargaining over the terms and conditions of another three
month renewal.
This would be a prime subject of discussion at the
Basle meeting this coming weekend, but Mr. Coombs was hopeful that
it would prove possible to maintain the $3 billion package intact
for another three months.
As of the end of January, the Bank of
England had drawn a total of $200 million on the $750 million swap
line with the System and nearly $600 million on the credit facilities
made available
$800 million.
by the other central banks involved, for a total of
1/
It was obvious that they still
had a long way to go in restoring their position.
1/ A sentence has been deleted at this point for one of the
reasons cited in the preface. The sentence related to certain
other operations by the Bank of England.
2/2/65
So far as System drawings were concerned, Mr. Coombs said,
the most troublesome problem was in connection with the Dutch
guilder, where the System had drawn the full $100 million equivalent
under the swap line, and had joined forces with the U.S. Treasury
in executing a combined total of $50 million in sterling-guilder
swaps and $190 million in guilder forward contracts.
He noted that
at the last meeting he had requested approval of renewals of swap
drawings of $20 million and $10 million falling due on February 4
and February 10, respectively.
Since the Dutch meanwhile had
expressed some concern that a turn-around in their surplus position
might be delayed for a good many months to come, he had arranged
with the U.S. Treasury to pay off one-half of the $20 million drawing
maturing on February 4 in gold and to pay off the remaining $10
million of this maturity by buying guilders with dollars frcm the
Netherlands Bank.
Unless the Dutch took in many more dollars during
the next week or so, it might be possible to purchase enough
guilders directly from the Netherlands Bank to pay off the $10 million
drawing maturing on February 10.
In view of the fact that there
had not yet been a reversal of the inflows to the Netherlands it
was desirable to chip away at these outstanding debts whenever there
was an opportunity to do so, in his judgment.
More generally, Mr. Coombs said, there were widespread expecta
tions in the market of selective measures to limit bank lending and
2/2/65
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direct investment abroad.
New York banks were being deluged by
inquiries from commercial and industrial customers as to whether tney
should leave their earnings in foreign countries, and whether they
should move funds abroad before such measures were taken.
The com
mercial banks had stepped up their foreign lending in an effort to
get in under the wire.
Such market reaction to the prospect of
Governmental action in the lending and investment area pointed up
the necessity for moving as quickly as possible to bring the situation
under ccntrol.
In answer to a question by Mr. Mitchell, Mr. Coombs said the
deficit in the Gold Pool was being financed temporarily by the Bank
of England out. of its
gold reserves.
The British felt--in his judg
ment correctly--that they might have to sell gold in
any case; and
they were hopeful that within a month or so there would be a turn
around in the market situation that would permit liquidation of the
deficit.
There also was an advantage in deferring collection from
the members of the Pool.
As he had noted, the deficit stood at $50
million now, and the total of the Pool's resources was less than
$300 million.
This was a delicate situation, and if some country
wanted to throw a monkey wrench into the machinery a great deal of
damage could be done.
2/2/65
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
January 12 through February 1, 1965,
were approved, ratified, and confirmed.
Mr. Ccombs said he had no recommendations to make to the
Committee at this time.
He noted that on March 1 a $15 million swap
of sterling against guilders would mature for the first time and he
indicated that in his judgment a renewal of this swap for another
three months would be appropriate unless a major turn in the guilde:
situation made it possible to reverse the transaction.
The possible renewal for another
three months of the sterling swap
against guilders was noted without
objection.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operatiors in U.S. Government securities
and bankers' acceptances for the period January 12 through 27, 1965,
and a suplemental report for January 28 through February 1, 1965.
Copies of these reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Stone commented
as follows:
The market has experienced two distinct phases since the
last meeting of the Committee. On January 12 the Treasury
announced the results of its advance refunding. The extraor
dinary success of that operation was taken by the market as
confirmation of its generally optimistic view of the outlook
for interest rates. After a day or two of caution during
2/2/65
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which dealers waited to see if any significant volume of
speculative holdings would be offered into the market
(they were not), prices began to move higher, and rose
almost steadily for several days in the middle of the
recent period. Prices also moved up it, the corporate and
municipal bond markets. On January 19, an Aaa-rated
utility issue was reoffered at a yield of 4.37 per centlower than yields on such issues before the discount
rate increase. And on January 26 an A-rated corporate
issue was reoffered at 4.44 per cent--the lowest yield
on such an issue since February of last year. The
market had some awareness during that period of the
deterioration of the balance of payments in the fourth
quarter. But it was not fully aware of the extent of
the deterioration, and it felt that any official
action taken to deal with the payments problem might
well be confined to selective measures.
Early last week this situation changed. The market
began to focus on the fact that the 1964 payments deficit
might be in the neighborhood of $3 billion.
Putting
that fact together with the news that the President
was planning to submit a balance of payments message
to Congress in early February, the market drew the
conclusion that there would indeed be further official
action to deal with the payments deficit and that such
action was likely to include a moderate shift in
monetary policy toward less ease. In consequence,
dealers, who had made rather good progress in distributing
their large holdings of the issues acquired in the
advance refunding, became restive with their remaining
holdings and undertook to pare their inventories further.
They have been quite successful in this effort, although
they have had to make price concessions of 6/32 or so
to ahieve that success. As of last Friday night, dealer
holdings of over-20-year bonds in trading accounts were
$373 million, compared with $440 million two days earlier
and about $600 million at the time of the last meeting.
Their holdings of 5-10 year bonds in trading accounts
stood at $304 million as of Friday night, compared with
$351 million two days earlier and $565 million on January 12.
Rates on Treasury bills moved lower in the wake of
the advance refunding, but the decline was short-lived.
Dealers were cautious about acquiring additional inventory
at the 3.76-3.77 per cent level to which rates had fallen,
2/2/65
particularly since they expected their financing costs
for such bills to continue to range upward from 4 per
cent. Rates quickly moved to about 3.83 per cent and
stabilized around that level for several days.
With
the development last week of the feeling that monetary
policy might shift, the rate moved further upward, and
the average issuing rate in the auction yesterday was
3.89 per cent for the three-month bill (and 3.97 per
cent for the six-month issue). One may thus concludeas indeed the market has concluded--that in the bill
market, as well as in the market for longer-term
obligations, a slight shift in policy has been partly
discounted already.
It was in the course of the market's adjustment
that the Treasury sold yesterday its 21-month, 4 per
cent note for cash.
When the operation was announced
last week, the market reception was highly favorable,
and expectations were that allotments would be about
10 per cent. But with the erosion of prices during
recent days the initial
enthusiasm has dimmed, and by
the close yesterday expectations of allotments had risen
to the neighborhood of 15 per cent. We probably won't
know until late today or tomorrow how the financing
actually came out.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period January 12 through
February 1, 1965, were apprcved, ratified,
and confirmed.
The staff economic and financial review at this meeting was
in the fcrm of a visual-auditory presentation on balance of payments
developments, for which Messrs. Hersey, Katz, and Dahl joined the
meeting.
Copies of the text of the presentation and of the accom
panying charts have been placed in the files of the Committee.
The introductory portion of the review, presented by Mr. Hersey,
was as follows:
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The U.S. payments deficit--however measured--was smaller
last year than in any year since 1957. But for the seventh
successive year, the deficit was still substantial--$3
billion on the "regular transactions" basis and $1-1/2 billion
on the "official settlements" basis. Adjustment toward
equilibrium has been disappointingly slow. In view of the
sterling crisis, abnormal activity in gold markets, and
sharp worsening of the U.S. deficit in the fourth quarter,
it seems urgent that a substantial reduction in the deficit
be attained this year and next.
A much larger part of this year's deficit will have to
be covered by gold sales. Last year, as shown in the upper
panel of the chart, commercial banks abroad increased their
balances in this country by an unusually large amount--about
$1-1/2 billion, or 25 per cent. There was also a sizable
increase, shown in the second panel, in U.S. liabilities
to foreign official holders (including Roosa bonds). The
gold stock declined by only $125 million. For this year,
things look very different. Commercial banks abroad are
most unlikely to add another $1-1/2 billion to their assets
here. And European central banks are resisting further
increases in their claims on this country.
The U.S. gold stock has declined by $7-1/2 billion,
or one-third, in the past 7 years. To make clear that the
remaining $15 billion is available as needed to maintain
the present gold value of the collar the Administration
has proposed eliminating the statutory gold reserve require
ment against the deposit liabilities of Reserve Banks, thus
increasing the so-called "free" gold by nearly $5 billion.
But this will in no way lessen the importance of coming to
grips with the payments problem.
Large U.S. payments deficits have had their counter
part in payments surpluses of other countries. The combined
"official settlements" surpluses of the Group-of-Ten
countris other than the U.S. and U.K. (shown in the top
But this down
line) declined by half between '60 and '62.
The rest of the world
ward tr:nd was halted in '63 and '64.
(the bottom line in the chart) developed increasing surpluses
in 1962-63, but began last year to reduce them again. Reduc
tion in the U.S. "official settlements" deficit in '64 was
materially aided by increased exports to this last group,
as well as by the inflow of foreign commercial bank funds
mentioned earlier.
The dramatic new payments development last year was
the deterioration in the U.K. position. If both the U.S.
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2/2/65
and the U.K. positions are to be substantially improved
this year, there will have to be a reduction in the combined
surpluses of other members of the Grou; of Ten, and of
some large reserve gainers among the nonindustrial countries.
France has had the largest and most persistent payments
surplus in the past 5 years, adding more than $4 billion
to its reserves, including $2-1/2 bill.on in gold. This
year France is expected to take all its gains in gold, and
to hold its dollar balances near the level of approx
imately $1.1 billion to which they were reduced by last
month's gold purchase. Germany has taken more than half
of its reserve gains in gold since 1959, but, since early
last year, Germany has not been in over-all surplus. Spain
continues to run a large surplus, and :s currently buying
$210 million of gold in 7 monthly instalments. Other
continental European countries, and Canada and Australia,
also added to reserves last year.
We turn now to the British situation which has recently
been, the focus of international financial attention. Consid
eration of its elements makes an appropriate beginning for
today's review of the U.S. payments problem.
Mr. Daane entered the meeting during the course of Mr. Hersey's
remarks.
The concluding portion of the review, presented by Mr. Young,
was as follows;
The problem of bringing U.S. payments into balance has
become one of major international import. In contrast with
other international problems, it is one for which the United
States alone has primary responsibility. After seven years
of large disequilibrium, averaging on regular transactions
some $3-1/2 billion, it is surely vital to reduce this deficit
substantially this year, with a target of attaining tolerable
balance next year.
How can this be done? It will indeed be hard to improve
the current account surplus much in '65. An indispensable condition
for further satisfactory growth of exports is assuredly continued
U.S. cost and price stability.
2/2/65
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On Government account, large reduction in spending
abroad presents difficult military and political deci
sion. Spending in the European area is for military and
security ends, rather than for aid. Our economic aid is
mainly to less developed areas. Though largely tied to
U.S. exports, this aid does make it easier for such areas
to use their own export earnings to purchase European
products.
On private capital flow, there arc powerful economic
incentives in a wide range of credit markets to encourage
foreign residents to borrow dollars and U.S. institutions
to seek foreign business. The capacity and variety of
U.S. credit markets, the ample availability of our credit,
and the lower level of U.S. interest rates--all these
factors contribute to sustaining the various types of
private capital outflow.
U.S. bank rates charged prime domestic borrowers are
lower than rates charged by European banks to their
prime domestic customers. The rates quoted on the chart
are, of course, only crude measures, since they do not
allow for the cost to borrowers of the minimum balance
requirements of U.S. banks or for various commissions or
fees usually charged by European banks. Also, the rates
U.S banks typically charge foreign bo-rowers are above
the prime rate. In considering these loan rate differen
tials, it is well to have in mind that, as European and
Japanese businesses extend their interrational operations,
they are becoming better credit risks. U.S. bankers are
fully aware of this, which is another reason for the
recent extention of U.S. banking operations internationally.
Some narrowing of the gap between U.S. and European
interest levels could be achieved by a lowering of interest
rates abroad. But persistent inflatiorary pressures in
Europe, combined with strong financing demands pressing
on less-than-adequate supplies of savings and inadequate
capital market facilities, make it difficult to foresee
much easing of interest levels there.
So persistent, indeed, has been the creeping infla
tion problem in Europe that European financial authorities
increasingly argue the duty of a deficit country, such as
the U.S., to raise its interest level not only to solve
its payments problem, but also to help contain their own
inflationary pressures. While the European authorities
pride themselves in using fiscal policy to foster economic
2/2/65
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growth, they seem less persuaded of their ability to use
it in support of monetary policy to combat current
inflationary tendencies.
From the United States point of view, any judgment
made now about a less stimulative monetary policy and
higher interest levels domestically must weigh such help
as this would give the balance of payments against the
consequences it might have for domestic expansion. In
the past four years we have had a well-balanced economic
expansion that has raised real GNP by 20 per cent and
has reduced unemployment to 5 per cent. With the con
tinuing strength of consumer demand, with demand pressures
on capacity strong enough to encourage widespread plant
expansion with the present buoyancy of profit expectations
and also of the prices of equities as well as of many
goods, further stimulus to business and consumer invest
ment through ready availability of bank credit and low
long-term interest rates is no longer so desirable, in
my personal judgment, as it was at an earlier stage.
Whatever evaluation of domestic economic factors
may be arrived at individually, consideration needs also
to be given to what may happen if, to avoid any brake on
the currert cyclical expansion, no monetary action is
taken and the U.S. payments deficit continues large. In
that case, if and when economic downturn later sets in,
monetary policy may find itself unable to give much help;
in short, it may have surrendered, at last for the short
run, much of its countercyclical flexibility.
In his Economic Message, the President has emphasized
the urgency of full correction of the U.S. payments deficit
and has indicated that a special messag setting forth a
prog-am to this end will be forthcoming soon. Presumably,
selective fiscal and moral suasion actions directed at
reducing the capital account deficit will be primary
elements in this program. Presumably, too, monetary
policy will be asked to participate both in a selective
and in a generally reinforcing role. E:perience with
the IET points not only to temporary effectiveness but
also to erosion of that effectiveness through leakages
as borrowers search out new ways of getting the funds
they need. The bolstering of one selective measure by
another tends to suggest to the market a step-by-step
retreat toward more and more Governmental restriction on
financial transactions. The less effective the chosen
selective measures prove to be, the stronger and more
2/2/65
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generalized any subsequent actions, including those of
monetary policy, may have to be.
In essence, our payments problem is a matter of
bringing our total outpayments on Government and private
capital accounts within the limits set by our earnings
from exports and investment income, bearing in mind that
these earnings are partly generated by Government and
private capital flows. The Administration and the
Congress have some hard thinking to do to determine how
far action should be taken to cut back Government
spending abroad and how far in policies constraining
private transactions. Meanwhile, the Federal Reserve
is responsible for finding the monetary and credit
policies for coming months that will best serve the
two vital and interrelated objectives of maintaining
well-balanced economic growth and of sustaining world
confidence in the dollar.
Either action or inaction involves risks, but risks
of different kind. A failure tc take effective measures,
including effective monetary action, to strengthen the
U.S. payments position at this time would clearly involve
serious future risks for the U.S. economy. Recent
developments across the Atlantic warn us against allowing
an international currency to drift in:o a position where
really drastic and burdensome actions on the monetary
and on other fronts may be forced upon an unwilling
nation.
Mr. Hayes remarked he thought the presentation had been an
excellent one
He had a footnote to add to a comment by Mr. Katz
about the vital need for the British to free resources for produc
tion of export goods.
One aspect of the situation that was worrying
many people was Britain's program of public spending, and it seemed
to him that this was an area in which they might well exercise great
restraint.
Mr. Mitchell noted that one chart, relating to various
countries' shares of world export markets, had indicated that in
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2/2/65
recent years France and Germany had gained substantially and the
United States and Britain had not gained.
In the period covered
by the chart the Common Market had become effective and tariffs
among the member countries had been reduced.
He asked whether the
impression given regarding trends in the U.S. share of exports would
not have been quite different if the figures portrayed in the chart
had excluded exports of one Common Market country to another.
Mr. Katz replied there was indeed some statistical bias in
the figures charted because of the inclusion of trade among Common
Market countries.
However, it was worth noting that the tariff
reductions within the European Economic Community affected not only
the experts of member countries to one another but also to the rest
of the world.
The typical French or German business concern now
could compete more effectively in world markets because its costs
had been lowered through the greater competition within the Common
Market following the reduction in internal tariffs.
At the same
time, these concerns had a strong incentive to maximize efficiency
because of their knowledge that Italian firms, say, would displace
them if they did not.
Mr. Mitchell said he thought it was important to recognize
that the U.S. and Britain had been placed at a competitive disadvan
tage by the development of the Common Market.
2/2/65
-16Prior to this meeting the staff had prepared and distributed
certain questions and responses for consideration by the Committee.
These materrials were as follows:
(1) Business activity and prices--In view of the
strength in new orders for durable goods, the recent sharp
step-up in inventory investment, and the marked acceleration
of production of business equipment over the past year, what
are the prospects for sustaining economic expansion with
continued broad stability of commodity prices?
Production for inventory, partly to replenish stocks
depleted in last fall's auto strikes and partly in anticipa
tion of a steel strike this spring, has been contributing
support for recent advanced levels of industrial activity
and for continued strength in new orders for durable goods.
There are indications that current rates of output in some
industries exceed sustainable levels
While record auto
sales to consumers have limited the rise in dealer stocks
of new cars, output of other consumer durable goods has
continued to advance at a rapid rate even though retail
sales of these products leveled off some time ago. Inven
tory accumulation also is evident in some nondurable goods
areas, notably textiles, where mill production has risen
about one-tenth since mid-1964, much more rapidly than
consumption of textile products.
Over all, it is estimated that about 4 per cent of
total industrial production is now going into inventories
in constrast to a more usual volume of 1 per cent. There
is no evidence that inventory stocking will slacken before
Preliminary and
steel wage negotiations are terminated.
further advance in industrial
partial data suggest little
production in January, but this appears to reflect mainly
capacity considerations in autos and steel rather than
achievement of desired inventory levels.
Ba:ring an unlikely early settlement in steel, inventory
demands and strong consumer takings of new autos probably
will sustain a high level of production activity for the
near term. Whether final demands will be adequate to sustain
the pace of aggregate activity after inventory demands
subside in the late spring is less certain. Business
spending for plant and equipment, which exceeded expecta
tions last year, is now anticipated to rise at a somewhat
2/2/65
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slower rate in the second quarter, and Federal spending
is scheduled to remain at recent levels. Much will hinge
on consumers' willingness and ability to increase their
spending to historically high rates relative to available
incomes, on continued expansion of State and local govern
ment demands, and on the maintenance of housing activity
at levels no lower than the reduced pace of recent months.
One heartening aspect of recert developments is the
continued general stability of industrial prices, despite
peak strains on production resources. Upward pressures
have been evident in some commodity lines--most recently,
petroleum and textiles--but improvement in supplies has
reduced pressure in the nonferrous metals markets, where
the largest price advances occurred last year. Unit
labor costs in manufacturing declined in December to
their lowest level for this expansion period. The current
and prospective increases in materials supplies and
production capacity, and the continued public pressure
on both labor and industry to keep wage settlements within
productivity bounds, should help to maintain general price
stability.
(2)
Balance of payments.
A. What are the basic elements in Britain's longer
run payments difficulties, and are the measures
so far taken adequate to close their payments
gap?
B. What are the prospects for, and limitations on,
achieving a reduction in U.S. capital outflows
from recent record rates?
(Staff responses were given in course of chart presentation.)
(3) Bank credit and money--What do recent developments in
bank credit, money, and time deposits suggest with respect
to both demands for credit and changing liquidity needs?
How may banks be expected to adjust the structure of their
assets and/or liabilities if recent credit trends persist?
In January, there was a marked strengthening in
business loans at commercial banks, a sharp rise in the
inflow of time and savings deposits, and continued sub
stantial growth in the money supply. These developments,
along with the moderate volume of capital market financing,
2/2/65
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suggest (a) that the current pace and structure of industrial
activity--particularly the strength of inventory buying--are
focusing credit demands on the commercial banking system,
and (b) that commercial banks are competing successfully
for savin.s flows under the new higher Regulation Q ceilings.
The rise in business loan demands has been general,
with smaller than usual declines in loans to most seasonal
industries and increased borrowing by others. While inven
tory accumulation undoubtedly has been a contributing
factor, the industry distribution suggests that strength
of loan demands is more broadly based. Part of the rise
in loans may be attributable to increased foreign lending,
possibly related to expectations that the I.E.T. may be
extended .o banks.
The January acceleration in savings deposit inflows
to banks probably represented in large measure a diversion
of funds From other financial institutions. There has also
been a surge recently in the inflow of other time deposits
at commercial banks, about two-thirds of it in CDs. Reserve
pressures at some large city banks early in January and
anticipaton of large CD maturities later in the month may
have figured in bank solicitation of these funds. That
this inflow has been much larger than in the comparable
period of any other recent year suggests that funds
available for liquidity reserves, at least in some sectors
of the economy, are sizable.
Following a relatively small increase in December,
money supply growth was substantial in the first half
of January, reflecting in part a more-than-seasonal
decline in U.S. Government deposits. Some decline is
projected for the second half of January, and growth for
the month as a whole is likely to be about in line with
the pace since last July.
Banks are not expected to encounter significant
difficulty in satisfying continued strong loan demand
in the near term, in view of the likelinood of continued
large savings inflows and of seasonal repayments in some
lines of business loans. While banks ordinarily allocate
a large share of their savings inflows to such assets as
mortgages and municipals, they might not do so if strong
loan demands materialize, particularly in view of the
recent high rates of acquisition of municipals. Banks
might also make some further inroads in their liquidity
positions. This could involve run-offs of Treasury bills
2/2/65
-19
and sales of other short-term Governmerts, and for some
of the large banks, reduction in loans to dealers and
brokers.
Finally, banks still have some leeway to increase
the attractiveness of CDs. Most recently, offering rates
on CDs at New York City banks have receded a bit to a
range of 4 to 4-1/8 per cent. Even so. the cost of these
funds is relatively high, and some large banks have cut
back on their issuance of CDs. Most banks, however, would
willingly resort to this source of funds to meet the
credit demands of their regular customers.
In summary, banks appear to be well situated to meet
a strong loan demand in view of their large savings inflows
and their ability to compete more aggressively for CD
money, to reduce acquisitions of municipals, and to reduce
their liquidity positions somewhat further. Such adjust
ments, however, would have rate implicitions for both
short- and long-term financial markets.
(4)
Money and credit markets.
A. In light of recent and prospective demand and
supply developments in long-term credit markets,
does the current level of long-term yield appear
generally sustainable?
B. Taking into account the Treasury's recent advance
refunding and the mid-February refunding, what
market constraints, if any, will there be on the
conduct of monetary policy for the next few weeks?
A. Under current conditions of reserve availability
and savings flows, prospective demands for long-term credit
are likely to be met at about prevailing levels of long
tern interest rates. The large public exchange in the
Treasury's recent advance refunding and the subsequent
strong performance of bond markets suggest that the
dominant expectation of market participants was for stable
or perhaps declining yields. Most recently, however, as
is indicated under 4B below, some hesitancy has developed
as concern has increased over balance o f payments implica
tions for the future course of monetary policy.
Looking first at demands for long-term credit, at this
point in time any increase in the aggregate appears likely
to be moderate and to come mainly from the business area.
External financing needs of corporations were tending upward
in the latter part of 1964 as profits leveled off, inventory
2/2/65
spending accelerated, and funds needed for plant and equipment
outlays and accounts receivable financing continued to grow.
Although corporate profits are expected to rise in early
1965, partly reflecting the second instalment of the tax
cut, cash flows required to meet the speed-up in current
year tax collections will more than offset this gain.
However, much of the increase in external financing is
likely to be met by commercial banks, partly through
term loans, which should reduce upward pressure on
corporate bond yields.
Other capital market demand., are not expected to
increase significantly. Construction of 1-4 family housing
is projected to do little more than held its own, and funds
needed for new multi-family and commercial properties may
actually decline. Heightened competition among lenders
may encourage more refinancing of existing properties, but
such an increase is not likely to be large.
No additional supply of long-term Treasury bonds is
in prospect for the near term because the cash surplus in
the first half of this year is expected to be somewhat larger
than usual and because the recent: Treasury advance refunding
has already accomplished substantial debt lengthening.
State and local government financing has been heavy in re
cent months, and municipal demands for funds could mark
time for a period. Offerings thus far scheduled for
February seem on the light side, which should help municipal
dealers to distribute the sizable inventories accumulated
in recent weeks.
Long-term savings have continued large and there has
been some recent acceleration in flows to commercial banks,
perhaps in large part at the expense of other depository
institutions. Net inflows to institutions receiving savings
under cortractual arrangements, such as life insurance
companies and pension funds, are apparently continuing to
grow at a steady rate.
These savings flows, in conjunction with the prospective
credit denands outlined above, should result in fairly
balanced supply/demand conditions in capital markets and
relatively stable long-term interest rates. But a sig
nificant change in commercial bank capacity to acquire
long-term investments resulting from reduced reserve
availability and increased loan demands would upset this
balance.
B. There are no hard and fast rules for determining
how far into the period of market "digestion" of Treasury
2/2/65
-21-
issues the System's responsibility for even keel should
extend. This FOMC meeting takes place about three weeks
after the subscription books closed for the January advance
refunding and one day after the books were opened for the
small February refunding.
As noted in the Green Book. dealers have made somewhat
better progress in secondary distribution of the recent
advance refunding than they did over a comparable period
in July. As of January 26, they had a little over $900
million of securities maturing an over 5 years in portfolio,
including over $500 million in the over 20-year area. In
the past few days dealers have become more concerned over
the balance of payments and have undertaken to reduce their
positions further. As of January 28, their portfolio of
securities maturing in over 5 years was $719 million,
including $390 million in the over 20-year category. This
further reduction in their inventories involved price
declines running to 4/32 - 6/32 in the long-term area.
Constraints on monetary policy arising from the
February refinancing, payment date for which is February 15,
are clearly of a lesser order than those stemming from
the January refunding. This offering of a 21-month note
for cash to refinance $1.7 billion of publicly-held issues
should prove routine, except that dealer allotments in
the financing will represent a net addition to their total
holdings of coupon issues.
In a similar situation last August, when public
holdings of the maturing issues were $2.2 billion, dealers
took into position about $430 million of a new 18-month
note. These takings, together with the remaining large
holdings from the July advance refundings, began to be
pressed actively on the market later in August, and
interest rates on notes and bonds moved somewhat higher
until mid-September.
Given the combined overhang of the two Treasury
financings and the still bullish state of investor expecta
tions, any change in policy at this time could put some
upward pressure on intermediate- and long-term rates for
both public and private issues. Even a minor change in
policy could produce at least a short-lived reaction in
bond yields, but if it were put into effect gradually
(as in mid-August last year) the extent and duration of
such a reaction would be moderated.
2/2/65
-22-
(5) Monetary and fiscal policy--What does the Federal
Budget message imply for the impact of fiscal policy on
the economy in the first half and the second half of
calendar 1965?
The proposals contained in the January 1965 Budget
(outlined in the Green Book 1/) are likely to result
in a more stimulative fiscal policy during the second
half of 1965 than in the first
half.
For the current
January-June period, the surplus in the cash budget now
is estimated at $6.6 billion, somewhat more than in other
recent years. Expenditures are expected to remain steady
and tax receipts to rise more than seasonally.
Thus,
the impact of fiscal policy will be less stimulative in
the first
half of this year.
The first-half surplus will probably be followed by
a much larger than seasonal swing to deficit in the
second half of 1965--perhaps to a deficit of around $13
billion, one-fifth more than in July-December last year.
Because of the timing patterns of receipts and expendi
tures implicit in the proposed Budget, the second-half
deficit is likely to be followed by another sharp swing
Similar
half of calendar 1966.
to surplus in the first
swings in the degree of fiscal stimulation are shown
when the projected Federal activity is calculated on
the national income account and the full employment
surplus bases.
The additional fiscal stimulus expected in the
second half of this year stems mainly from increased
expenditures, and to some extent from proposed excise
tax cuts. Reduction in excise taxes is planned for the
beginning of the third quarter, but additional taxes to
pay for increased social security benefits and medicare
are not scheduled to come into effect until January 1,
1966. Practically none of the increase in expenditures
represents direct Federal purchases cf goods and services.
Rather, greater outlays are projected for transfer pay
ments (primarily increased social security benefits) and
grants to State and local governments (for increased
educational programs and public assistance). The largest
increase in expenditures is anticipated in the third
m essage
1/
The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
2/2/65
-23-
quarter, when the additional social security benefits
are scheduled to begin and when a lump sum payment to
cover retroactive benefits is expected to be made. But
expenditures still remain well above first-half levels
thereafter.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with
Mr. Hayes, who made the following statemert:
1. Business Activity and Prices. Economic activity
advanced strongly in December, as evidenced by data on
industrial production, retail sales, and new orders for
durable goods. January seems likely to have brought
further gains--new car sales especially appear to have
been extremely strong. The prospects for sustained
economic expansion in the comin months are very bright.
Indeed, barring a steel strike and taking into account
the stimulus that the Federal budget may exert in the
second half of the year, sustained expansion through 1965
seems likely--although perhaps at a somewhat slower pace
than in 1964. In this environment of business expansion,
there is a risk, still latent, that inflationary pressures
may develop.
2. Balance of Payments. The sharp deterioration in
the U.S. balance of payments in the fourth quarter is less
significant for its own sake than as a sobering reminder
that our chronic payments problem of the past seven years
is still far from solved. It appears that much of the
sizable December deficit was due to capital outflows which
were reversed after the end of the year--so that neither
the December nor the January figures are especially mean
ingful by themselves. But after full allowance for special
factors it is still clear that capital outflows have played
a large and growing part in producing the deficit in the
past year, and bank credit to foreigners has been especially
important, including substantial term lending to Europe.
Canadian issues were very heavy in the fourth quarter but
much more moderate in the year 1964 if the four quarters'
figures are spread equally over the entire year.
While I have reluctantly concluded that some form of
selective restraint to stem capital outflows is now warranted
2/2/65
-24-
as part of a many-pronged attack on our payments problem,
they are likely to prove ineffective urless we reduce the
availability of reserves. A move toward reduced monetary
ease would reinforce the impact of selective measures,
for it would improve our chances of containing the pres
sures that make funds seek higher returns abroad, whether
through bank loans, through investments in foreign money
markets, or through direct investments.
The relative calm in the exchange markets in the past
couple of weeks should not obsecure the fundamentally
dangerous situations confronting both the pound and the
dollar, and the vital need both here and in Britain to
take strong remedial and mutually supporting measures.
3. Bank Credit and Money. As for domestic credit
developments, business loans rose more rapidly in 1964
than in the preceding years, and partial data for
January suggest continuing strength. Moderate increases
in interest rates have been no hindrance to monetary
While
expansion in an optimistic economic climate.
loan-deposit ratios are high, and the banks do not have
as nuch of a Government securities cushion as they did
a couple of years ago, they do not seem to view the
historic measures of their liquidity positions as
calling for as much restraint on lending as such ratios
once implied--one reason being the change in the mix
Business and the public
of demand and time deposits.
are still in quite a liquid position; and while velocity
has been moving sideways for at least half a year, it
would not be wise to count on such leveling out as
much of a restraint while the business outlook is as
good as it is.
4. Money and Credit Markets. There would appear
to be a pretty general consensus that the current level
of long-term rates is sustainable. Were it not for
some expectation of a possible change toward a less easy
monetary policy, the weight of opinion would probably
be on the side of some net downward pressure on long
rates. With the yield curve as flat as it is, however,
it would seem probable that a moderate lessening of
monetary ease might find some reflection in higher long
term rates, but only slightly higher. Indeed, it is
likely that the market has already gone some distance
toward discounting a modest policy move.
The Treasury's February refunding is so small and
so routine in nature that it does not call for the
2/2/65
-25-
customary "even keel" restraint on the part of the System.
Of somewhat greater concern is the fact that dealer
holdings arising out of the January advance refunding
have not yet been worked down to satisfactory levels,
although the dealers have made particularly good progress
in reducing their holdings of bonds over the last few
days. But while this suggests the need for a gradual
approach in any policy move on our part, it does not
preclude some cautious change of policy at this time.
5. Fiscal Policy. As I have already indicated,
fiscal policy is likely to provide a quite substantial
stimulus to the economy in the second half of 1965, whereas
in the fi:st half the stimulus should be very small.
Our analysis suggests that the expenditures side of the
budget provides a moderate positive and rising stimulus
during the year. On the other hand, the tax side will
probably provide a powerful stimulus in the second half
as contrasted with a small drag on the economy in the
first half. The second-half stimulus could of course
be increased further, should this later appear desir
able, by enlarging the size of the proposed excise tax
cuts.
6. Monetary Policy. In the light of our serious
international problem, combined with the strong domestic
outlook, I believe monetary polic should move toward a
lessening of ease. A reduction in reserve availability
is desirable both to push the bil. rate gradually up
to the discount rate and to slow down the growth of bank
credit. Such a decline would tend to reduce the pace
of bank lending abroad and would not, in my judgment,
harm the domestic economy. On the contrary, it might
even prolong the life of the business advance by providing
some protection against excesses.
This is clearly an appropriat, moment for the System
to make some move toward less ease, especially as the
President's balance of payments message, due in a few
days will alert the public to the seriousness of the
whole balance of payments problem. It will be well
understood that the System should have some part to play
in an effective solution, and it would be desirable
for the record to show that we have been alert to our
responsibilities.
Open market operations should be conducted with a
view to permitting free reserves to decline gradually in
2/2/65
-26
the coming four weeks to about the zero level, with
fluctuations perhaps on both sides. Since Friday,
February 12, is a holiday, the arnouncement of lower
free reserve figures for the coming week ended
February 10 could not affect the market before Monday,
February 15, when the new securities will be delivered.
Hence a start could safely be made right away.
The directive should be amended to indicate that
priority is now being given to strengthing the dollar's
international position. Also, the specific reference
to Treasury financing is no longer needed, though the
Committee might wish to substitute a clause indicating
some desire on our part to moderate any impact of our
operations on the longer-term market. The staff's
alternative B seems to me eminently satisfactory. 1/
Mr. Shuford remarked that business activity had continued to
rise in recent months, and average prices had changed only slightly
and continued to be reasonably stable.
In any business upswing, he
noted, some sectors of the economy rose more rapidly than others.
Since early 1951, the over-all economy had expanded fairly smoothly
although there had been some spurts ard some reversals of production
and sales in individual lines.
There had been some precautiorary buying of steel, Mr. Shuford
continued, and recent data indicated a step-up in total inventory
investment and a rise in new orders for durable goods.
Those develop
ments, along with future wage and price developments, had to be
watched closely, and it might become necessary for monetary action
to become more restrictive.
But it seemed to him that it was premature
to say that the economy now was confronted with a general price rise.
1/
The two alternative draft directives prepared by the staff are
appended to these minutes as Attachment A.
2/2/65
-27
Turning to international developments, Mr. Shuford said the
rise of industrial production in Great Britain during October and
November and the favorable December trade figures suggested that a
turning point in the U.K. trade balance might be developing, although
this was not clear.
British imports might be expected to decline over
the next few nonths, reflecting the impact of the surcharge and a de
cline of inventory accumulation.
Over the longer run, however, theLr
basic problem was to raise exports, and whether they could do so
would depend in large part on whether there was sufficient flexibility
in the U.K. economy to permit the shift of resources from production
for home markets to production for foreign markets.
Capital outflows from the U.S. had been large, Mr. Shuford
observed, and considered in conjunction with the net balance
on other
U.S. transactions, they were of serious proportions for the U.S.
international liquidity position.
In his judgment monetary actions
had played a significant role in limiting capital outflows and addi
tional steps might still be needed.
However, it was doubtful that
any
general monetary actions which the Federal Reserve, standing alone,
might take could substantially reduce the capital outflows.
Although
he disliked the interference in individual market decisions that
followed from attempts at moral suasion or from selective controls,
under existing international payments mechanisms these actions might
be necessary if more fundamental actions to improve the balance of
payments were not taken soon.
2/2/65
-28
Total member bank reserves and the money supply had continued
to rise since the increases in the discount rate and short-term
market rates Last November, Mr. Shuford noted.
The higher short-term
yields had been desirable in view of the international situation, but
he also was pleased that the money supply, considered over a period of
time, had continued to expand at a moderate rate.
Long-term interest rates seemed to Mr. Shuford to have been
appropriate for domestic activity in recent months.
He believed,
however, that interest rates should remain flexible to adjust as
changes in the supply and demand for funds ccveloped.
In the short
term market there currently was a seasonal contraction in credit
demands, and maintenance of the present level of short-term rates
might be possible only by restraining the growth in bank reserves,
bank credit, and money.
He was not certain what position should
be taken with respect to the Treasury's recent advance refunding and
the mid-February financing, but it seemed that stability in the
money market would be desirable for a period unless a strong case
was made to the contrary at this time.
According to the standard measures, Mr. Shuford said,
fiscal policy currently was operating in a contractionary way on
the economy.
It appeared that a significant deficit would develop
later in the year if the Administration's programs were enacted.
However,
it
did not now appear that within the next few months the
2/2/65
-29
budget would move significantly toward greater stimulation to the
economy so that monetary actions could be more restrictive, permit
ting continued economic expansion with higher interest rates.
It seemed to Mr. Shuford the Committee again had come to
one of those periods in which the issue was one of timing.
There
was no question but that the balance of payments problem and the
international financial situation were sericus.
As he had indicated,
there might be a need for a more restrictive monetary policy at this
time.
On balance, however, he wculd favor no change in policy now,
partly in view of the Treasury financings--which, he observed, the
Committee customarily took into consideration--even though the
February financing was of minor proportions.
He noted that dis
tribution of the securities issued in the advance refunding was
still in process.
He would favor keeping money market conditions
at about current levels, with short-term interest rates ranging
between 3.75 and 3.95 per cent or even pressing up to the discount
rate.
He suspected that these conditions would be consistent with
continued moderate expansion in the money supply and bank reserves,
but probably at
reduced rates; at least, he would hope so.
For the
directive, he preferred alternative A of the staff's drafts.
Mr. Bryan said he had reluctantly concluded that the Committee
should move at least slightly in the direction of less ease.
Ac
cordingly, if he might abstract from the Treasury financing, he
2/2/65
-30-'
favored moving toward a lesser availability of reserves.
He came
to that conclusion partly because of the international situation
which,
while not disastrous,
was alarming; he was deeply concerned
about possible eventual developments in
that area.
His judgment
also was influenced by the belief that the recent growth rates in
the various reserve measures--since last August, for example--were
higher than the rates consistent in
the long run with a sound de
velopment of the economy and lack of inflationary pressures.
Accord
ingly, he would favor free reserves averaging about zero and
fluctuating in
the range of plus and minus $50 million.
longer run he thought the Committee should reduce its
the growth rate in
For the
sights for
total reserves to a maximum of 2 per cent or perhaps
even lower.
Mr. Bryan thought the questions and aswers prepared by the
staff for this meeting were extremely good on the whole.
However,
he would take exception to the staff responses on one point--he
was not as confident about the eventual stability of the average
price level as the staff was.
a little
He also thought his views differed
from those of the staff on the balance of payments.
Along
with others at the table, he felt that some selective credit controls
would be needed to deal with the balance of payments problem.
This
was a painful conclusion for him because he did not believe in
selective controls in principle, and he doubted that any member of
-31
2/2/65
the Committee did.
He was afraid that they would mushroom into a
full-fledged panoply of controls.
Nevertheless, he thought that
selective measures would be necessary because monetary policy, in
his judgment, could not be tightened sufficiently to deal with the
problem without doing great damage to the economy--although, as he
had indicated, he regarded some firming as appropriate.
Mr.
Bopp said he would limit his remarks this morning
principally to the question of bank liquidity rather than comment
on each of the questions prepared by the staff.
A survey recently
undertaken by the Philadelphia Bank indicated that some rather
fundamental shifts were taking place in country bank participation
in
the Federal funds market in
the Third District.
Those shifts had
interesting implications for bank liquidity and for monetary policy.
With almost 90 per cent of District country banks responding
to the survey, 121 banks, or more than one-third of the total, were
now found to be active in the Federal funds market.
This was a very
significant increase in participation in a very few years; before
1961, only 18 per cent of the banks now participating were in the
market.
Moreover, of the 121 banks now in the market, 37 per cent
first became active in 1964 and 32 per cent first became active in
1963.
Thus, the majority of country banks had never had experience in
the market during a period of tight money.
Another interesting finding to emerge from the study, Mr. Bopp
noted, was that 80 per cent of the banks now in the market only on
2/2/65
-32
the selling side indicated a willingness to buy funds if the need
arose.
Moreover, a sizable proportion of banks which had never been
in the market on either the buying or selling sides indicated a
willingness to buy funds if needed.
This large increase in country bank participation in the
Federal funds market, and the declining cushion of excess reserves
held by country banks, meant that a move toward greater restraint would
tend to result in a quicker and more pervasive tightening, Mr. Bopp
said.
Adjustment conditions might be strained for individual country
banks with limited experience in the Federal funds market, especially
for those expecting to purchase Federal funds when such funds in fact
were not available.
Larger correspondents might also be affected,
both as the availability of funds from country banks diminished and
as the larger banks were called upon to supply funds.
This could
create problems in the administration cf the discount window.
Turning to policy for the next four weeks, Mr. Bopp observed
that that the climate of business continued to be affected signif
icantly by the effort to build inventories.
Still, however, there
appeared to be no general over-heating of the economy.
Prices remained
unusually stable, as did unit costs; and, although capacity might be
strained in certain areas, this condition did not pervade the entire
economy.
On the financial front, credit demand had been strong and
growth of the money supply recently had been rapid.
Though the
2/2/65
-33
behavior of money and credit warranted close attention,
he would not
take restrictive action unless the rate of increase continued unduly
high for a longer period.
On the balance of payments front, Mr. Bopp said,
discouraging to see the marked increase in
fourth quarter,
the year.
was
the deficit during the
especially after the apparent progress earlier in
Without minimizing the problem,
it
was important to note
the temporary factors that were at work--a spurt
rowing,
it
in
Canadian bor
withholding of the British payment on the 1947 sterling debt,
and some outflow of short-term funds to meet year-end pressures in
Yet, beyond those temporary factors the
the Euro-dollar market.
fact remained that the U.S. payments deficit was large and continuing,
and many observers viewed the deficit,
if
not with apprehension,
Under those conditions,
certainly with concern.
then
a significant reduction
in the deficit during 1965 would appear the advisable course of action.
In Mr.
Bopp's opinion, however,
a general tightening of mon
etary policy to reduce capital outflows would be ill-advised.
assure a significant reduction in
nificant shift toward less ease,
seemed to him too great.
of selective controls,
To
capital flows would require a sig
and the risks to the domestic economy
Thus, even though he also disliked the notion
he thought it
avenues to reduce the deficit.
was important to explore other
2/2/65
-34
On balance, weighing both domestic and balance of payments
considerations, Mr. Bopp would make no change in the general posture
of monetary policy, even in the absence of need for an even keel.
He preferred alternative A for the directive.
In a concluding remark
Mr. Bopp observed that after the discussion this morning he was less
positive about this position than he had been for some time.
Mr. Hickman commented that business continued to expand, paced
by unsustainable levels of output in autos and steel.
Perhaps the
most important recent news had been the emergence of large-scale in
ventory building, a phenomenon that frequently occurred in the late
stages of business expansions.
The inventory expansion appeared
to
some degree to have been associated with some upward pressure on prices.
The increase in the industrial component of the wholesale price index
during the fourth quarter of 1964,
of about seven-tenths of a point,
was the largest for any three-month period
since late 1958.
A preliminary analysis of the Budget Message and Economic
Report left Mr.
Hickman with the feeling that more vigorous steps
would be needed than had been thus far proposed to avert a serious
slowdown in growth in
1965.
He personally welcomed the effort towards
countercyclical fiscal policy, but under the circumstances would prefer
greater stimulus for the second half of the year.
On the basis of
the full employment surplus figures provided by the Board's staff,
-35
2/2/65
he estimated that the Federal sector in the second half of 1965 would
provide only about half as much stimulus as needed to achieve desired
growth.
To him this suggested rising unemployment, lower industrial
production, and perhaps a larger budget deficit after all, unless
steps were taken to promote additional growth.
In respect to the near-term outlook, Mr.
Hickman continued,
the auto and steel sub-cycles that he had referred to at the previous
meeting appeared to be approaching their peaks.
Auto sales had about
made up the losses due to last fall's strikes.
Thus, total car sales
(including imports) over the four months October through January, when
expressed on an annual-rate basis, worked out to 8.1 million cars,
which was the same as actual total sales for 1964.
Even assuming that
car sales in 1965 would surpass 1964, it seemed clear that the recent
spurt had not much further to go.
Fourth District business activity had roughly paralleled the
national pattern thus far in 1965, Mr. Hickman said.
was still
strong.
Steel production
rising in the District and retail sales were still
very
He had just learned of another huge electric power project
on the order of a quarter of a billion dollars that soon would be
started in the eastern part of the District.
On the other hand,
slightly adverse changes in unemployment and electric power output
were common in
the District in January and were reflected in
national totals.
the
2/2/65
-36With reference to international developments,
Mr.
Hickman
said that the British balance of payments problem seemed roughly
divided between current account and capital account.
The trade bal
ance had improved in December, and presumably there would be some
further improvement as a result of steps already taken.
However,
the Labor Government's egalitarian proposals might not remedy the
fundamental difficulty of under-investment in
the United Kingdom.
It was difficult to see why or how the Labor Government's program
for nationalizing steel and adjusting taxes would attract foreign
capital.
Insofar as the U.S. was concerned, Mr. Hickman was pleased
to note that the Administration was coming to grips with the fact
that this country had a serious balance of payments problem and he
awaited the proposed remedy with interest.
One broad approach would
be the application of selective controls over many sectors of the
balance of payments.
Another approach would be the classical one of
monetary restraint coupled with, in this case, reduced military and
economic aid, and perhaps some use of moral suasion to reduce bank
lending overseas.
He leaned towards the latter approach, but without
much hope that it would be chosen.
On the domestic financial front, Mr. Hickman commented, the
apparent preference of the public to hold large amounts of time and
savings deposits rather than money had induced banks to purchase
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2/2/65
longer-term, higher-yielding assets.
In the Fourth District and in
the nation, banks had continued to add municipal securities,
mortgages, and longer-term assets to portfolios, and had reduced
shorter-term liquid assets.
Some light was shed on this matter by
the Cleveland Bank's most recent semi-annual survey of municipal
holdings of reporting banks in the District.
Preliminary figures
revealed that during the second half of 1964 banks continued to
acquire municipals in large amounts,
ith almost all the net change
occurring in the group with maturities of over five years.
So long as the public continued to shift from demand balances
to time and savings deposits, Mr. Hickman said, and so long as
monetary policy remained easy, banks would compete with other long
term investors for the limited supply of long-term investments.
Unc'er
those conditions, bond yields probably would remain steady or move
lower.
However, if the System were to tighen to the extent that
short yields moved above the ceilings under Regulation Q,
time and
savings deposit; would decline, banks would withdraw from the long
term market,
and long-term yields would rise.
As for policy over the next four weeks, Mr. Hickman thought that
the small magnitude of the Treasury's February cash refinancing provided
no serious constraint on System operations.
The money supply in
December and January seemed to have increased at a rate of 3.5 per cent
or so, which was in accord with guidelines that he had suggested
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2/2/65
earlier.
Bank credit,
on the other hand,
had shown considerable vigor,
and over the two-month period had expanded at a rate higher than he
thought desirable over the long pull.
For that reason, and also
because of his concern over the balance of payments situation, as
described so clearly by the staff this morning, he would prefer
slightly lower free reserves than had obtained recently (say, $50
million plus or minus $50 million) and a 91-day bill rate slightly
above its current level but below the discount rate.
The type of
change he had in mind would be so small as to be virtually imperceptible.
If the Committee made any change in policy before the next meeting,
he would prefer not to temporize by purchasing more than token amourts
of intermediate- and long-term bonds, and would therefore choose
alternative A of the staff's policy directive drafts rather than
alternative B.
Of course, a great deal depended on the Administration's
program for coming to grips with the balance of payments problem.
If that progran called for more drastic steps on the Committee's part,
Mr.
Hickman would be prepared to support them.
However,
he did not
think it would be appropriate for the System to lead the way at the
moment.
Mr. Daane remarked that, as the Committee knew, he had been
clearly among those who had resisted any move toward less ease, even
the "almost imperceptible" move of last August that had become quite
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2/2/65
perceptible later.
Now he felt strongly that despite Treasury
financing--and he would include not only the routine February
financing in process but also the continued large size of dealer
holdings of securities issued in the January advance refunding--that
the time had come for the System to move.
He agreed heartily with
those who had observed that monetary policy alone could not solve the
problems of the balance of payments and the position of the dollar.
He felt, however, that the Committee had to do its part in dealing
with what to his mind was largely a problem of confidence in the
dollar ard was becoming increasingly so.
In his judgment the Committee
should move in the direction of less credit availability as rapidly
as possible against the background of Treasury financing.
As to possible domestic repercussions of such a move, Mr. Daane
thought there sometimes was a tendency to exaggerate the consequences
of relatively marginal changes in reserve availability as exemplified
in the free reserve figures.
In particular, he did not think a shift
in free reserves from plus $50 million to minus $50 million would have
any drastic, or even perceptible, repercussions on the domestic
economy, which in his judgment was exceedingly strong at present.
He believed that such a change could be accomplished with no great
effects on the availability of credit for continued worthwhile ex
pansion of the economy.
Moreover, he sensed some speculative overtones
2/2/65
-40
in the economy at present.
This admittedly was hard to document,
but he thought there was evidence of it in the stock market; and
more generally, there seemed to be a growing feeling of ebullience.
In sum, he was inclined to discount the possibility of injurious
effects of a policy change on the domestic economy and he agreed
with the obseration that the Committee might in fact promote the
sustainability of the expansion by reducing credit availability at
this point.
But he favored a policy change mainly on the grounds
of confidence in the dollar and in the belief that the Committee
should participate in what clearly would have to be a national effort.
Operationally, Mr. Daane agreed in general with the objec
tives Mr. Hayes had described, but would perhaps go a bit further.
He would like to see the Committee make a perceptible move, with free
reserves fluctuating on the negative side of zero.
He would then
expect the short-term bill rate to be at the discount rate, and, from
time to time, a few basis points above it.
On the directive, Mr. Daane leaned toward the spirit of
alternative B cf the staff's drafts but: was not happy with the language.
He thought the directive should make it clear that the Committee was
moving in the direction of lessened availability of credit in the
interest of a strong dollar internationally and in light of the definite
strength of the domestic economy.
Also, he thought it would be unwise
to delete altogether the reference to Treasury financing, as in
2/2/65
-41
alternative B.
The Committee was concerned with both the February
financing and the continuing effects of the advance refunding, and
if it decided to change policy today it
as to take account of the financings.
should do so in such a way
In his judgment the directive
should reflect that fact.
Mr. Mitchell observed that the urge to do something to relieve
the balance of payments constraint or to remove the anxiety of a
continuing deficit seemed to mount at successive meetings of the
Committee.
It had been a bad time for both fears and hopes, so often
proved unfounded and unrealized.
Over the years since the "constraint"
became an overt factor in its deliberations the Committee had nudged
and ratcheted
through two 1/2 per cent increases in the discount rate-
Treasury bill rates from less than 2.5 per cent to nearly 4 per cent.
And under "operation twist" long-term Treasury rates had held to a
paltry 1/4 of a
per cent rise, while rates on tax exempts, mortgages,
and corporates had been unchanged or had declined.
Now there was an
unnatural relationship between long and short yield, with both
borrowers and lenders susceptible to official action.
Borrowing short
as U.S. banks were doing and lending long or longer might be precarious
business if a significant change occurred in the short-long rate
relationship.
The Committee was in a position to affect this relationship
dramatically by a careless or advertent boat rocking.
2/2/65
-42
Would an increase of 25 to 50 basis points bring long and
short Government yields together or would short rates rise above
long rates?
Or, Mr. Mitchell continued, had "operation twist" ex
hausted its twistability?
If the Committee moved now should it
expect a full reflection of its action in long rates?
What public
advantage was gained from maneuvers of this size?
On the side of the real economy, Mr. Mitchell said, recent
consumer buying rates and business inventory accumulations were ex
plainable as the effects of strikes and anticipation of shortages.
If there was more to them than that, it would only be that consumer
expenditures stimulated by the tax cut were showing a larger reaction
than had appeared likely, but not a larger reaction than sought when
it
was hoped tnat the tax cut might achieve a lower rate of unemployment
than 5 per cent.
If such a stimulus appeared to be evident in the
current figures, it should not be tranquilized by monetary restraint
in the face of the contractive effects of a steel strike or settlement,
a working-off of automobile demand, and a less expansive Federal budget
in the coming
months (cash or income accounts).
He did not expect
recession to begin in May of this year but it was not an unreasonable
possibility,
and he certainly would not like to see it
heralded or
triggered by a contractive maneuver by the Federal Open Market Committee.
The balance of payments deficit was something the Committee
could not remove without abuse of its
powers,
Mr.
Mitchell said,
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2/2/65
but he doubted that any member would want to withhold aid to
accomplishing that devoutly desired goal if the Committee could see
how it might help.
Developments over the past three years had
convinced him that the U.S. trading position was good and was con
tinuing to improve as Europe's prosperity inflated.
The figures
looked better than they were because of tied aid and compensatory
purchases, and in some degree they benefited from the direct and
indirect finarcing of exports.
tinued,
As long as the boom in Europe con
he would expect the U.S.
its own but to grow stronger.
trading position not only to hold
He could not judge how much additional
contribution to reducing the net outflow might take place as a result
of changing the Government's aid program, but he assumed it
would be
small.
In Mr. Mitchell's view the balance of payments problem today
was not one of making the U.S. more competitive in the sale of goods
and services, welcome as that might be.
Rather, it was one of dealing
with a capital outflow induced by interest rate differentials arising
from differences in the marginal productivity of capital in capital
short countries with rudimentary capital markets.
Those interest
differentials were not a temporary phenomena to be met by temporary
expedients.
One could not hope to match in the domestic interest
rate structure the earning opportunities offered in Western Europe or
in
the less-developed countries.
2/2/65
-44
It was possible, Mr. Mitchell said, for the problem to be
solved fortuitously by outbreaks of political unrest in Western
Europe, Communist expropriation, or other events which would arouse
fears for the safety of foreign investment.
the problem would not be solved in this way.
It was to be hoped that
It could be solved by
some dramatic change in U.S. saving propensities or investment
opportunities, which was possible but unlikely.
Mr. Mitchell expressed the view that if the United States was
determined to solve the problem with policy instead of chance it
really had only two broad alternatives.
The first was to raise
domestic interest rates drastically, with a sharp rise in the dis
count rate, an immediate contraction in the money supply, and a
consequent fall in the price of outstanding debt.
The ultimate goal
would be to make the contraction sufficiently drastic to reduce funds
available for business, housing, State and local governments, and
individuals, so that the rates that would have to be paid would be
competitive with those in Western Europe and less-developed countries.
He doubted that this action would be effective for long in
high interest rates and he was sure that it
maintaining
would drastically deflate
the economy.
The other alternative, Mr. Mitchell said, was to adopt a measure
or measures that either insulated the U.S. interest rate structure or
made it competitive with those in other countries.
Moral suasion was
2/2/65
-45
an effort to insulate U.S. from foreign interest rate levels by
restricting or barring foreign investments to U.S. nationals,
corporations, and banks.
For a short-run remedy it had much to
recommend it, he thought.
But the problem was likely to persist for a longer period,
Mr. Mitchell observed.
was more durable.
It was better to be armed with a device that
His preference was for something akin to the
interest equalization tax imposed on loans, direct investment, and
deposits of all U.S. citizens, corporations, and financial institu
tions.
The rate should be administratively flexible.
The only
exemption should be for the financing of U.S. exports and the burden
of proof should be on the taxpayers to show that that was the case.
With such a device the capital outflow could be regulated according
to the nation's capacity to support it by earnings on current account
and by the willingness of foreigners to hold dollars.
The balance of payments deficit doubtless would remain a
constraint on Committee actions for some time, Mr. Mitchell concluded,
but he hoped the Committee shortly could look to measures to solve it,
not to keeping it alive.
On these philosophical grounds he would
favor no change in policy now.
After observing that the staff presentation today had been
excellent, Mr. Shepardson said that the domestic economy at present
seemed to him to be in a vigorous, continuing expansion.
Admittedly,
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2/2/65
both anticipations of a possible steel strike and efforts to make up
the output lost in the automobile strike were having temporary effects
on activity, and there might be some let down in the not-too-distant
future when these effects ended.
fiscal progra
On the other hand, the Administration's
seemed to him definitely expansive for the rest of
the year and the period beyond.
In general, he did not see a prospect
of an immediate or near-term slackening.
In fact, Mr. Shepardson continued, present levels of activity
caused him to question the staff's optimism on the subject of price
stability, as Mr. Bryan had.
The pressure on wages continued and the
prospect that wage increases would not exceed the Administration's
guidelines did not seem promising.
Upward pressure on prices would
persist unless wage increases in goods-producing industries were kept
in better alignment with productivity gains and there were some
resulting price reductions in those areas to offset the inevitable
price crawl in service industries.
In his judgment the Committee would
have to continue to be concerned about price developments.
Mr. Shepardson thought the balance of payments problem was
acute and something had to be done about it.
He agreed that it was
not appropriate for the Committee to undertake monetary policy action
extensive enough to bring about a solution; the use of other measures
also was necessary.
But monetary policy had a part to play, not as
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2/2/65
the principal instrument but as a supporting instrument.
With busi
ness conditions as they were at present he thought the Committee
could take some step without impairing the domestic economy.
Therefore, Mr. Shepardson said, it seemed appropriate for
the Committee to make some move now toward a lesser availability
of funds; it had waited about as long as it could.
He did not favor
a sharp change, but rather a small adjustment made gradually.
He
had in rrind having the 90-day bill rate work up to around the dis
count rate and a free reserve level in the zero plus or minus $50
million range.
Mr. Shepardson favored the essence of alternative B for the
directive.
He doubted, however, that it was either necessary or
appropriate to include the final clause, reading "while moderating
the impact of these conditions in markets for intermediate- and long
term securities."
The Committee might want operations along that
line, but much would depend on the particular situation that developed.
Also, he was not particularly happy with the wording of the first
paragraph of alternative B and would prefer a somewhat different
emphasis.
Specifically, he suggested the following wording:
In light of the economic and financial developments
reviewed at this meeting including the generally strong
and continuing expansion of the domestic economy and the
continuing adverse position of our international balance
of payments, it remains the Federal Open Market Committee's
current policy to accommodate growth in the reserve base,
2/2/65
-48-
bank credit and the money supply but at a more moderate
pace than in recent months as it seeks to avoid the
emergence of inflationary pressures and to support other
measures that may be taken to strengthen the international
position of the dollar.
Mr. Robertson then made the following statement:
On the domestic scene there appear to be two principal
new developments recently, both of which may be potentially
disturbing. One is the clearer emergence of stepped-up
inventory accumulations, not only from steel but from other
output, and also an apparently unsustainable pace of auto
mobile sales. Another is the expansionary Federal budget
for fiscal 1966 presented to Congress, but with the fiscal
stimulus pretty much concentrated in the second half of this
calendar year.
These developments give me pause, but do not yet suggest
the need for changing the course of policy. The automobile
and steel situation is not being accompanied by any inflationary
price developments--or even, it seems from staff reports, by
any rise in labor costs. I doubt that basic demands are so
fragile that possible temporary overexpansion in automobile
and steel will be followed by a recession in activity. But
even if so, it is not clear that the situation would be
improved by a tightening of policy now.
As to the budget, while the persuasiveness of President
Johnson should not be underestimated, the programs still have
to be approved by Congress. In any event, they are six
months away and to that degree conjectural, while we are
still confronted with a larger than seasonal surplus in the
half of this year that has been generated out of the
first
current budget.
Finally, the expansionary effects of the
new programs are difficult to assess, involving as they do
excise tax cuts, transfer payments, and grants-in-aid rather
than what had been more usual, income tax cuts and direct
spending.
Our balance of payments news is less favorable than one
would have wished. As the Committee knows, I am not among
those who think we are doomed if we do not instantly bring
the outflow and inflow of capital into balance. As a matter
of fact, although I favor taking reasonable measures to deal
with the problem, I am not inclined to panic at the current
news. Nevertheless, I hope that the adverse character of
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2/2/65
the news serves to speed up the Administration's search
for a policy adequate to deal with the problem. At the
same time, I must say that I am not aware of any information
that would suggest to me that we shoulc risk a slowdown of
domestic economic growth through a more restrictive monetary
policy. I cannot go along with those who seem to feel we
must buy voluntary banker efforts to diminish their loans
abroad, by promising a tighter monetary policy with its
accompanying higher bank loan rates. Any beneficial in
fluence on our external payments that might stem from a
restrictive policy change, within the realm of reason, would
be too insignificant to warrant even a small risk to our
domestic economy. A change in monetary policy adequate to
reduce substantially the capital outflows--and hence have a
beneficial effect on our balance of payments--would have
to be so :arge as to unquestionably affect the domestic
economy severely. Thus, it is my view that the remedy or
remedies lie elsewhere.
Finally, the still sizable dealer oldings of long-term
securities after the advance refunding, the recent market
weakness, and the new mid-February financing all speak to
keeping policy on a steady course in the four weeks ahead.
Mr. Robertson added that he would prefer alternative A for the
directive.
Mr. Mills said that as he was counting on the adoption, at
long last. of fiscal measures as the chief plan for attack on the
balance of payments problem, his comments tocay would be directed to
the domestic situation.
He then made the following statement:
During thirteen years of service as a member of the
Federal Open Market Committee, I have been party to the
buildup of a mammoth credit inflation which in its present
stage reveals a topheavy and creaking superstructure of
credit carried on an all too narrow equity base. In order
to prevent at some future point of time an unfortunate credit
deflation, it is essential that a good-size proportion of
outstanding credits be terminated through the normal service
and performance of the obligors so that a broader and stronger
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2/2/65
equity base can be placed under the credit superstructure.
Incidentally, a Federal Reserve System credit policy geared
to attaining such an objective by virture of restraining the
expansion of credit would at the same time conserve the
underpinning given by our gold reserves to the entire credit
structure, and would thereby relieve the current concern
that has been expressed regarding the future credit expansive
limitations of our gold reserves.
I continue to believe that a policy shift toward
moderate credit restraint is overdue and, therefore, would
approve Alternate B of the proposed current economic policy
directive. Leaving aside the long-range factors bearing on
adoption of an appropriate monetary and credit policy, near
run factors also argue for credit restraint; namely, actions
to exert a cautionary influence at a time of latent infla
tionary pressures, overconfidence in business prospects, and
definite indications that the commercial banks are becoming
overloaned and illiquid.
Mr. Wayne noted that business activity was definitely high and
rising in December and the evidence seemed to indicate that the trend
had continued in January.
While steel and automobiles were responsible
for much of the strength, gains were widespread throughout nearly all
of the economy
A check of 11 major indicators for which December
data were available showed that ten moved favorably, several of them
by substantial amounts, while only unemployment moved in an unfavor
able direction
This record was equaled or exceeded in only two
months of the past three years, during which the economy was generally
moving upward at a fair rate.
Additional strength was reflected by
the large backlog of manufacturers' unfilled orders and the very sharp
rise in construction contract awards in the last four months of 1964,
which would seem to provide some assurance of high levels of activity
2/2/65
-51-
in manufacturing and construction in the months immediately ahead.
Several other major industries were operating at or near practical
capacity.
On the other hand, it seemed fairly clear that production
rates in steel and automobileswere not sustainable and must decline
before long.
The recent high rates of business activity had been
accompanied by only moderate price pressure and most price indicators
had probably been more stable in the past month than they were in
the closing months of last year.
Other domestic indicators seemed to be consistent with the
behavior of business activity and prices, Mr. Wayne said.
Bank credit
and the money supply apparently made significant gains in January
after fairly large average gains in the lat:er part of last year.
Both long-term and short-term interest rates had been generally stable
with nothing in sight to cause any significant change.
The Federal
budget was des:gned to contribute a substantial stimulus to the
economy in the second half of the year when some weaknesses might be
expected to develop in the automobile and steel sectors.
As a whole,
then, the domestic picture was one of strength and high activity
with a few sectors of the economy verging on overheating.
The domestic
economy could stand some moderate restraint if it did not actually
require it.
situation.
The deciding factor would seem to be the international
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2/2/65
The basic long-run elements in Britain's payments problem,
Mr. Wayne continued, were the large trade deficit and the capital
outflow, as the staff had pointed out.
The measures taken thus far
to correct them were largely short-run and of a stop-gap nature.
They might provide some respite but they did not offer a solution.
On the basic and longer-run problems there had been plans and talks
but little specific action.
British exports had not grown as rapidly
as imports in recent years, and the share of Britain's exports in
total world trade had fallen substantially.
Part of this could be
attributed to the formation of the Common Market (which had also
hurt Britain's long-term capital position), but the failure of
British exporters to hold their own in world competition was also an
important factor.
A solution to the letter problem would require
more fundamental changes in the British economy.
At the moment,
prospects for such changes did not appear good.
As for the U.S. position, Mr. Wayne said, the sharp deterioration
in the U.S. capital accounts was a matter of serious concern.
More
action than had been taken thus far was required but he was not sure
just what form that action should take.
Some reduction in reserve
availability might exert some influence toward curtailing bank lending
abroad and, if the interest rate effects of such action were allowed
to be transmitted to the long end of the market, some nonbank outflows
2/2/65
-53
might be reduced as well.
He was aware of the hazard involved in
disturbing the long end of the rate structure, but in view of the
persistence of the balance of payments problem and the magnitude
of the recent deterioration, he felt that this course of action had
to be given serious consideration.
Like Mr. Hayes, Mr. Wayne was reluctantly disposed to accept
some intervention in the market for foreign credits as necessary
under present conditions.
At the same time the Committee should, he
believed, support such efforts by moving toward a lowering of the
ready availability of reserves with moderate firming in the rate
structure.
He concurred fully with Mr. Mitchell about the hazards of
a drastic move, but that was not the kind of action that he contemplated.
Outside the area of monetary policy, Mr. Wayne remarked, a
number of courses, not necessarily mutually exclusive, might be con
sidered.
Extension of the interest equalization tax to bank term
loans had already been widely discussed.
that this woul
He was not entirely convinced
be wide, largely because he feared it might prejudice
the financing of some U.S. exports and because it would distort the
market mechanism.
Action to reduce taxation incentives that favored
foreign over domestic direct investment might offer a better hope.
Finally, it might be possible to alleviate the problem somewhat through
imposing limitations on the activities of Canadian agency banks.
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In the policy area, Mr. Wayne said, it seemed clear that the
money supply and bank credit had been growirg at high rates in recent
months.
Business activity was high and the price structure was finn
with some tendency to edge up.
The prospect was for a substantial
stimulus from fiscal policy later in the year, and that stimulus might
be moved forward somewhat by discounting.
All these domestic factors
suggested the desirability of a modest reduction in the availability
of credit and that suggestion was strengthened substantially by
international considerations.
The sharp deterioration in the U.S.
international payments position in December, which was caused to a
considerable extent by bank loans, indicated a definite need to reduce
the availability of reserves.
In recent months banks had had sufficient
reserves to enable them to continue increasing their loans at the sub
stantial rate which had prevailed over the past three or four years
and at the same time they had stepped up the rate at which they had
acquired investments.
Therefore, some reduction in the availability
of reserves should not impair their ability to make appropriate loans.
For both domestic and international reasons Mr. Wayne favored a some
what firmer policy for the next four weeks, with one goal being a bill
rate somewhere near the discount rate.
That would quite likely require
net borrowed reserves, which he would not oppose.
For the directive, Mr. Wayne preferred alternative B, but
Mr. Shepardson's suggested wording for the first paragraph appeared
to him to be worthy of serious consideration.
2/2/65
-55
Mr. Clay remarked that, following the developments of the
last quarter, the international payments problem had come to the center
of the stage.
Even so, its ramifications had been difficult to judge
adequately because of the limited information available as to the
factors involved in the enlarged deficit and as to the extent that
they might be of a temporary nature.
Nevertheless, Mr. Clay continued, it appeared clear that the
United States needed to take action to meet the situation.
Unless the
Committee was willing to risk severe repercussions upon the domestic
economy, the program for dealing with the deficit had to be formulated
primarily in terms of special measures rather than general monetary
policy.
That involved action largely by the Administration and pos
sibly the Congress rather than by the Federal Reserve.
In fact, a
program resting heavily upon monetary policy would appear to be out
of the question.
That did not mean that monetary policy could not be
changed at all, but the range of maneuver probably was quite narrow.
If monetary policy were used, Mr. Clay said, it probably
would involve some reduction in credit availability.
That could be
expected to stiffen interest rates all along the maturity scale.
Under present circumstances, the impact of such action both directly
and through its effect upon expectations could be severe and jolting
to the money and capital markets and to the economy, unless the
monetary policy move were of small proportions and deftly handled.
2/2/65
Apart from such an immediate risk of any pronounced move in
monetary policy, Mr.
Clay added,
the main concern over the impact of
monetary policy on domestic economic activity was with reference to
activity some months hence rather than now.
The strong push to
economic activity at the present time from steel, autos,
and inventory
stockpiling was not likely to be deterred by a small shift in monetary
policy.
The inevitable turn-around in those sectors later would put
the economy through a readjustment, however, and at that time monetary
policy would have to be a supporting and not a restraining influence.
Accordingly,
monetary policy would need to remain flexible in
the
weeks and months ahead.
Under the circumstances, Mr. Clay felt some firming of policy
probably was in
order,
although it
should be viewed as only one part
of a concerted attack on the international payments deficit.
Alterna
tive B of the staff drafts for the economic policy directive would
appear to serve that purpose.
In his judgment to go further than that
would be unwise in terms of the domestic economy, and even that shift
would need to be carefully implemented.
At the same time, it should
be recognized that that action by itself
would not solve the interna
tional payments problem.
Mr. Scanlon turned directly to the staff questions.
1.
Business activity and prices.
Available evidence indicated
that the advance in output, employment, income, and sales in the Seventh
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District had continued into 1965 with considerable vigor, Mr. Scanlon
said.
He suspected that the Midwest was concerned, even more than
the nation generally, with the fact that production of steel and
autos in January had been far above the most optimistic predictions
of rates for the year as a whole.
Even if estimates of the year's
total output proved to be on the low side, it was clear that sharp
cutbacks would occur in those important industries once inventories
had been increased to desired levels.
An inportant unknown in the
current picture was the extent to which the current inventory building
in those commodities was responsible for the buoyant flavor of eco
nomic activity in general.
Mr. Scanlon observed that producers of durable goods other
than automobile and steel--including most types of industrial machin
ery and equipment, railroad equipment, appliances, consumer electronic
products and, especially, furniture--looked forward to further gains
in output in 1965.
Farm machinery firms hoped to hold even with 1964
while construction machinery producers appeared reconciled to a
decline from the very high levels of last year.
There was little
concern in the District over prospective declines in defense orders
because very few firms there were heavily dependent upon that work.
Machine tool producers were running two and three shifts and would
increase output further if skilled manpower were available.
Reports
of the Purchasing Agents Association of Chicago reflected a continuous
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vigorous rise in output, inventories, employment, and orders.
New
order lead times had lengthened further.
Forty per cent of the Chicago purchasing agents reported paying
higher prices on the average for raw materials and supplies in
December, compared with 28 per cent a year earlier, Mr. Scanlon noted.
Announcements of price changes continued to show a ratio of increases
to decreases of about 2 to 1.
Prices of capital goods nevertheless
had not been increased appreciably on a broad front despite heavy
demand.
Certainly, the situation did not resemble that prevailing in
1956 and 1957.
Over-all, a moderate rise in the wholesale price index
appeared likely to him.
Thus, his views on the price outlook were
slightly different from the staff's.
Employment gains continued in the Seventh District, given
allowance for seasonal changes, Mr. Scanlon said.
Unemployment
compensation claims were well below a year earlier in all District
States in December and January.
than for the nation.
Decreases were appreciably greater
Want ads for employees in Chicago newspapers had
been well above last year in recent months and had been at the highest
level since early 1957.
Lists of specific labor shortages prepared
by local employment offices continued to emphasize the usual types of
skilled or semi-skilled office, service, and factory workers.
Employers
continued to report that the bulk of the unemployed who applied for
jobs or apprenticeship training were inadequately prepared in basic
2/2/65
-59
academic skills, including the "three rs."
Supervisors of programs
operating in the Chicago area under the Manpower Development and
Training Act reported good results.
However, those programs were
still on a small scale with only "several hundred" workers placed in
jobs as a result of their activities commenced over 18 months ago.
Mr. Scanlon noted that business failures had been at a low
level in recent months.
In the fourth quarter the number of failures
in the District was 21 per cent below the level of a year earlier,
compared to an 11 per cent decline for the United States.
For both
the District and the United States the number of business failures in
the fourth quarter was the lowest for the period since 1955.
Farm land values as reported by country bankers rose in the
fourth quarter, Mr. Scanlon noted, and were about 5 per cent above a
year earlier in January.
In contrast to expectations a year ago,
a majority of those bankers expected a further rise in farm land
values in the months ahead.
2.
Balance of payments.
Mr. Scanlon
views as supplemented by Mr. Hayes.
agreed with the staff
The long-run disequilibrium in
Britain's payments balance arose from her inability to improve the
balance on current account, where surplus was necessary for financing
of long-term capital outflow into the areas where Britain by long
tradition had been an investor, and for reduction of the liability
reserve ratio that since the war (and particularly since the return
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-60
to convertibility in 1958) had been a source of official concern.
Improvement in the current balance had to come from a greater com
petitiveness of British exports, the prices of which had been, since
early 1963, rising relative to those of her major competitors.
De
creases in costs through increases in productivity (new investment)
and dampening of domestic demand were essential.
Present measures,
although in the right direction, probably had to be intensified in
order to achieve this.
Additional selective controls to stimulate
exports and investment probably were necessary, to bring export prices
down.
A refinancing of the short-term financial assistance so far
given to the pound might be necessary to gain time for implementation
of these measures.
Mr. Scanlon said that the slower rise in industrial activities
on the continent that might be expected as a result of strong anti
inflationary policies of most countries there probably would bring about
some reduction of U.S. capital outflow due to decreasing profit prospects.
Also, measures by continental countries to restrict foreign investment
(such as adopted by Germany and proposed by France) might act as a
deterrent.
However, only an intensification of direct controls upon
capital outflows (such as an increase and broadening of the present
interest equalization tax) might be effective in reducing substantially
the U.S. capital outflow, since the rate-of-return differential probably
would remain in favor of foreign investment.
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3.
Bank credit and money.
Mr. Scanlon agreed in general
with the staff answer to the question on this item.
There had been
some further shift to commercial bank savings from other financial
institutions in response to increased rates--a number of Seventh
District banks had raised rates paid on CDs issued to individuals
above 4 per cent.
This shift represented a substitution of bank for
nonbank credit and some reserve growth was necessary to accommodate
it.
Additions to share accounts at savings and loan associations and
sales of savings bonds had been somewhat below the year-ago levels.
Those developments suggested that credit demands remained
strong, Mr. Scanlon observed.
Whether this would entail a liquidity
squeeze on the banks would depend on the rate at which reserves for
additional deposit growth were provided.
District country banks
responding to a recent survey expected a stronger demand for nonreal
estate farm loans in the first quarter than in the year-ago period.
Little change was expected in interest rates charged.
Country banks had
been increasing rates paid on savings deposits.
Chicago banks had shown fairly easy reserve positions in the
past two weeks.
That appeared to be largely attributable to the
issuance of a substantial amount of CDs after the turn of the year.
Those banks normally showed increasing reserve pressure through February
and March as they acquired the bills needed prior to April 1.
2/2/65
-62If recent trends persisted, Mr. Scanlon said, the larger banks
could be expected to continue to rely on CDs, and perhaps on increased
purchases of Federal funds.
If the current rate of reserve growth
was reduced, finds from those sources probably would be more difficult
to obtain and, of course, more costly.
Some further liquidation of
Governments was possible, although total holdings of Governments were
the lowest since mid-1960.
4.
Money and credit markets.
Mr. Scanlon commented that he
was more sanguine than the staff was that long-term rates would not
rise perceptibly even with a moderately less easy monetary policy.
In light of the recent and prospective demand and supply developments
in long-term credit markets, the current level of long-term yields
appeared vulnerable to downward pressure in coming months.
The
Treasury's posture probably would be seasonally passive in the first
half, mortgage demand probably would show little change, and business
demand for long-term funds was expected to remain moderate.
This left
State and local government uses of long-term funds as about the only
major category expected to display continued vigorous expansion.
Given those considerations, and the likelihood that savings growth
would continue during the period at its recent rate, long-term
interest rates could well soften somewhat.
The Treasury would borrow about $2.2 billion on February 15,
Mr. Scanlon noted, through cash sales of new 4 per cent notes maturing
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November 15,
1966.
The notes were to be priced below par to yield
4.09 per cent and could not be paid for by credit to Treasury tax
and loan accounts.
The funds would be used to redeem the maturing
2-5/8 per cent bonds which would be accepted at par in payment for
the new notes.
Books were open Monday, February 1, only.
With the
notes attractively priced (the 3-3/8 per cent bonds on November 15,
1966 yielded 3.88 per cent while the 4 per cent notes of August 15,
1966 yielded 3.98 per cent) and with the books closed before today's
Open Market Committee meeting, it did not seem that monetary policy
had to be greatly concerned with this financing during coming weeks.
Policy actions probably did not need to be restrained by the January
advance refunding any longer.
5.
Monetary and fiscal policy.
Mr. Scanlon's views on this
subject were consistent with those of the staff.
The President's
Budget Message described a generally expansionary fiscal program.
Reductions in Federal excise taxes and stepped-up benefits under the
Social Security program appeared likely to exert a distinctly stimula
tive effect once they took effect.
For the first
half of calendar 1965, however,
it
seemed probable
that the Federal sector would provide little additional thrust toward
economic expansion, Mr. Scanlon remarked.
For one thing, underwith
holding of individual income taxes last year meant that perhaps three
quarters of a billion dollars in 1964 tax payments would have to be
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-64
made by April 15.
Furthermore, the excise tax cuts that the message
promised were not to take effect until the beginning of fiscal 1966.
Uncertainty over which taxes would be reduced or eliminated might
induce some would-be buyers to postpone purchases until final action
had been taken, or until the second half.
Finally, the proposed
7 per cent increase in benefits under the O.A.S.D.I. program,
retroactive to January 1, was expected to be disbursed in a lump
sum at about mid-year.
Prospects for the second half of 1965 were that Federal fiscal
operations would be expansionary because of the factors mentioned
above, Mr. Scanlon continued.
The impact might be even greater than
the Budget Message and supporting materials implied if, as was widely
supposed, Congress widened the range of excise tax reductions, and if
expenditure programs now largely in the planning stage were firmed
up and adopted.
Thus, intensified emphasis upon the poverty program,
aid to Appalachia, education aids, and similar measures seemed likely
candidates for spending beyond that now proposed.
If the private
economy was headed for a sidewise movement after the first half of
1965, as many analysts appeared to believe, emergence of a strong
expansionary impulse from the Federal sector--after relative quiescence
during the continued upward thrust from the private sector in the first
half--should have a salutary effect.
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With respect to policy, in Mr. Scan..on's judgment there appeared
to be a close choice as this time between "no change" and "slightly
less ease."
He would favor a very
modest change in policy, but the
evidence of need for a change was not so persuasive as to call for
quite as severe a move as alternative B seemed to suggest to some people
around the table.
He agreed with the changes in the directive suggested
by Mr. Shepardson, but his ideas as to the appropriate degree of change
coincided more closely with those of Mr. Hickman and Mr. Wayne.
Mr. Strothman said his comments would relate primarily to the
first and third of the staff questions.
Information for the Ninth
District suggested that the economic outlook, for the coming few
months at least, was essentially encouraging.
The Minneapolis Bank's
District survey pointed toward continued economic expansion and price
A majority of the respondents believed that coming months
stability.
would bring advances in output, employment, and, to a lesser extent,
profits.
This sentiment seemed compatible with what available
statistics suggested.
There was one cautionary note with respect to the outlook,
Mr. Strothman said.
He seemed to detect the incipience of a "poor talk"
psychology based on apprehension about the results of underwithholding
on Federal income taxes.
Some of the comments suggested a possible
dampening of demand disproportionate to what would be justified by
the actual figures.
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As to District banking developments, Mr. Strothman noted
that bank credit, which typically declined in the beginning of the
year, actually increased rather considerably in the first half of
January.
Moreover, loans increased much more than investments.
The
increase in loans was concentrated in the commercial and industrial
category which, of course, usually declined in the first part of the
year.
Still, it appeared that District banks were not under undue
pressure.
The loan-deposit ratio for weekly reporting banks was well
below its post-1959 high and well below the national average for
such banks.
Similarly, District nonweekly reporting banks, if some
what tighter relatively than reporting banks, were less fully loaned
up than all U.S. nonweekly reporting banks were on the average.
Mr. Strothman noted that total deposits in the District
declined slightly over the first three weeks of January as a reduction
in demand deposits was almost offset by an increase in time deposits.
This behavior of deposits was much the same as in the like period of
1964 but was contraseasonal on a longer-term basis.
There was no evidence, Mr. Strothman said, that interest rates
on savings deposits had been increased.
Rates on corporate deposits
probably had edged up slightly, however, for there had been not a
loss of such deposits but a gain.
Mr. Strothman concluded with a comment on possible means of
improving the balance of payments situation, especially as it related
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to bank credit.
He shared the view of those who feared that hortatory
measures would not be truly effective in
pressures.
the face of competitive
Possibly, however, something along the lines of the old
Voluntary Credit Restraint program might succeed.
Through such a
program it would seem that lenders could act in concert without
being inhibited by anti-trust law considerations.
Mr. Swan observed that it was unnecessary to elaborate further
on the strength of the current expansion.
He would note only that
the indications given in the staff document of inventory accumulation
in addition to that of autos and steel struck him as significant.
The
strength of the expansion in the Twelfth District was indicated by the
fact that in December the employment figu::es rose faster than in the
nation and the rate of unemployment dropped somewhat more--although
he should add that the December figures were still tentative.
He
agreed that the economy could stand some lesser availability of credit,
whether or not it required it.
Mr. Swan said that weekly reporting banks in the Twelfth
District had shown a substantial further increase in savings and time
deposits in the first three weeks of January, although not as large an
increase as in the rest of the country.
However, if one considered
time deposics other than savings deposits and other than the negotiable
CDs of $100,000 and over, the increase since the beginning of the year
was much larger in the Twelfth District than in the country as
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-68
a whole.
The reasons for this were not entirely clear, but in part
it seemed to reflect some response by individuals and small businesses
to the offering of deposit certificates bearing higher interest rates
than straight savings accounts did.
Despite the fact that loan demand
had been holding up well in the first three weeks of January, District
banks had borrowed only modestly at the discount window and had been
active sellers of Federal funds.
Mr. Swan observed that he found it difficult to come to a
firm conclusion as to the best course for monetary policy at present.
He felt as Mr. Scanlon did that there was a narrow choice between no
change and a slight lessening of ease.
him on two grounds.
The latter alternative disturbed
First, as others had said, it was necessary to
look elsewhere for measures that would have a significant effect on
capital outflows; to attempt to do the job with monetary policy alone
would require much more drastic action than was desirable in terms of
the domestic situation.
But if the Committee made only a modest step-
which was all he would be prepared to do--the situation might not be
significantly improved, and the Committee then would have to take
another modest step.
He thought that less wculd be accomplished by two
such modest steps than by one larger step later.
Secondly, Mr. Swan said, a broader Governmental program to
deal with the payments problem, involving measures in other areas,
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-69
presumably would be announced shortly; moreover,
the Government was on
the eve of action with respect to the gold reserve requirement.
There
already had been some anticipatory reactions to the expected program,
including some firming in the money market--the bill rate currently
was close to 3.90 per cent compared with 3.77 per cent at the time of
the previous meeting.
He suspected that the reaction would proceed
further even if the Committee did not change policy, and thought it
would be wise not to try to offset it.
However, if a broad program was
announced promptly, at the next meeting the Committee would be faced
with the questions of what sort of market reaction had developed and
what sort of supporting action was needed, whatever decision it might
make today.
As he had noted, Mr. Swan continued, the issue came down to a
choice between r.o change and a modest move.
His feeling at this point
was that action might better be delayed until the next meeting.
Accordingly, he favored alternative A for the directive.
If, however,
the Committee decided that it was desirable to change policy today
and adopted alternative B, he would agree with Mr. Shepardson's proposed
revision of the first paragraph.
He agreed also with the proposal to
eliminate the reference to moderating the impact on intermediate- and
long-term security markets, both because he thought this would be
difficult to do and because, if policy was changed, in his judgment the
Committee had to expect some reaction in longer-term markets.
2/2/65
-70Mr. Irons remarked that the general picture of economic
conditions in
the Eleventh District was one of strength and optimism;
all indicators were at high levels or were showing further increases.
In that respect District conditions were quite similar to those in
the nation as a whole.
Nationally, there were some disturbing factors,
including the rate of inventory accumulation and the level of automobile
sales, but the outlook for several months and perhaps for a year was
on the strong side rather than on the weak on questionable side.
He
did not think the domestic situation called for a stimulative policy
at this time; money was so readily available that stimulation was
hardly necessary.
In his judgment the domestic situation did not call
for a restrictive policy either.
Mr. Irons noted that the Committee had to take international
developments into consideration along with domestic, and on international
grounds he had reached the conclusion that it might well attempt to
bring about a situation of less ease now.
He did not favor an overt
action--a sudden, sharp, or substantial move.
But he did favor a move
in the direction of somewhat reduced reserve availability, with free
reserves declining to about zero, give or take $50 million on either
side.
He would not be concerned if free reserves were negative.
He
would expect short rates to be slightly higher, pushing up toward the
discount rate.
2/2/65
-71Such action would not correct the balance of payments problem,
Mr. Irons said, but it was the only means the Committee had for
contributing to improvement with respect to capital outflows.
Other
measures might also be required, such as extending the interest
equalization t.x to banks and using moral suasion to limit foreign
lending.
But it was desirable for the Committee to act within its
own sphere, by taking a small step in the direction of making bank
reserves less readily available than they had been for some time.
Mr. Irons said he would accept alternative B for the directive.
He had not been particularly happy with the language of the staff
draft for the first paragraph, but Mr. Shepardson's proposed revision
met his objections.
paragraph.
He would delete the last clause in the second
The Desk probably would act to moderate the impact of the
policy change on longer-term markets in any case, but he questioned
the desirability of spelling out such an instruction in the directive.
Mr. Ellis reported that economic activity in New England
continued strong--somewhat stronger, in fact, than was normal for the
winter season.
The open winter that lasted through December advanced
construction projects and supported employment levels.
Machinery and
equipment manufacturing also expanded in December, reflecting continued
expansion in orders.
The late arrival of good snow cover had caused
serious concern in the many new ski developments, some of which had
2/2/65
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made substantial investments in new equipment and depended on liberal
bank credit.
Having lost the entire month of December, it would be
difficult for them to meet their debt obligations unless the ski
season lasted unusually late into the spring this year.
First District banks, matching national experience, were
finding their loan run-down so far this year substantially lessspecifically, 50 per cent less--than in 1964, which itself was a
year of strong loan demand.
With demand deposits declining, District
banks had looked to expanding time deposits and borrowings in the
Federal funds market to meet loan demands.
Short-term Government
securities had been sold off even more sharply than last year.
The
average loan-deposit ratios of District weekly reporting banks, at
70 or 71 per cent, were running 3 points above both the national average
and year-ago levels.
At Boston banks the ratio averaged 75 per cent
or higher in January.
Mr. Ellis said he would commen: on the first three of the
staff's agenda items.
The principal new development he saw in the area
of business activity and prices--a development that was well documented
in the staff materials--was a strengthening of the business outlook
for the second half of 1965.
The Federal budget proposals pointed in
that direction and seemed to have carried the outlook consensus along
the same path.
By the same token, immediate prospects seemed stronger
and the latent danger of acceleration of the gradual price rise seemed
somewhat greater.
2/2/65
-73With regard to balance of payments developments, Mr. Ellis
noted that the chart in today's presentation dealing with the
competitiveness of manufacturers in various countries had shown
recent trends in these countries' shares of world markets.
The main
thing the chart revealed, of course, was the difference in the trends
for Germany and France on the one hand, and the United States and
the United Kingdom on the other.
But he had been struck by the relative
trends for the U.S. and the U.K.--the British experience had been
quite similar to that of the U.S. in a period when the U.S. trade
balance had been strong.
He was more optimistic about the British
position than the staff had been in the presentation today.
Recently
several knowledgeable economists had expressed the judgment that
British products were not materially overpriced in world markets and
that resolution of their balance of payments problem rested more on
a slowing in their rate of income advance than on a roll-back of incomes
and dramatic productivity advances.
He was optimistically inclined
to the views that the 15 per cent import surcharge and related measures
would right their payments balance in the near term, and that their
longer-term problem would be tractable.
The U.S. balance of payments problem, Mr. Ellis said, now seemed
to require specific action if the capital outflow was to be slowed
down.
He was inclined to favor actions in the tax sphere, including
taxes on corporate investments abroad.
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Mr. Ellis observed that it was apparent from recent credit
developments that banks were competing actively and successfully
both in placing loans and in securing funds.
He noted that there
had been a sharp run-up in CDs so far this year.
As to policy, Mr. Ellis thought no one was suggesting that
monetary policy itself could do the whole job of correcting the pay
ments deficit.
But, as Mr. Shepardson had indicated, the Committee did
have a role to play; a move toward less credit availability would
help at the margin.
He had been thinking about the "moot question"
Mr. Holland had posed at the preceding meeting--whether or not a
reduction in credit availability would focus on foreign lending--and
had come to believe that banks generally would tend to meet the needs
of domestic customers first, and would be inclined to curtail their
foreign lending.
That conclusion--which was fortified by Appendix B
of the green book--coupled with the current surge in borrowing and
credit expansion, led him to favor a move toward less ease.
Such a
move would restore policy to a posture that could be relaxed if the
recession that had been mentioned did occur.
The Committee did not
now have a policy with sufficient leeway for it to be relaxed if
necessary.
Specifically, Mr. Ellis suggested lowering the free reserve
target to zero, plus or minus $50 million.
He would expect Federal funds
2/2/65
-75
to trade consistently at 4 per cent and higher; dealer loan rates
to rise slightly; the Treasury bill rate to rise to 4 per cent; and
member bank borrowings to average $400 million or higher.
Mr. Ellis urged the Committee to consider again the desir
ability of a second paragraph for the directive that specified its
intent in this direction.
The directive might call for operations to
be conducted with a view to reducing free reserves gradually to the
range from minus $50 million to plus $50 million, with freedom to move
outside that range if necessary to permit Treasury bill rates to rise
gradually to the level of the discount rate or even above.
He noted
that this language was patterned after alternative B of the "trial"
directive that had been prepared for this meeting, and he favored it
because it was a more direct description of the Committee's intent
than was contained in the draft of the regular directive.
favored retention of the concluding statement
He also
relating to markets for
intermediate- and long-term securities, because in his judgment the
Committee did want to moderate the impact of the policy change on those
markets.
If the Committee was asking the Desk to accept this as a
part of its instructions it was appropriate to include it in the directive.
Any concern about possible conflict in the instructions could be met
by inserting the words "while seeking to" before "moderate and impact
of."
Mr. Shepardson's suggested revision of the first paragraph was
acceptable to Mr. Ellis.
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Mr. Balderston noted that three weeks ago he had observed
that the time was approaching for a policy change, and in his view
that time now had arrived.
The U.S. representatives at the mid
February meeting of Working Party 3 in Paris might well be met by
strong and incisive questioning about American monetary policy.
It
was hard to see how their answers could carry conviction in the
light of U.S. inaction after seven years of high balance of payments
deficits, except for the actions of 1963 that had not borne much
fruit.
Perhaps they could sketch another paper program, but the facts
would seen to belie this country's determination to put its house in
order.
He agreed with Mr. Mitchell that higher returns on capital in
foreign countries would tend to draw resources abroad for a long time.
He also agreed that selective controls had to be used, as much as he
disliked them.
But the System had a responsibility of its own; after
all, the System and the Treasury were the two arms of the Federal
Government that were primarily responsible fcr the nation's financial
husbandry: and the Committee should not expect other agencies to take
the lead.
In his judgment the System should stand up and be counted-
it should lead the way with monetary policy.
Mr. Balderston thought that the policy action should be clearly
perceptible.
He favored a free reserve target around the zero level
with the expectation that there would be net borrowed reserves in some
weeks and that the bill rate would go to or above the discount rate;
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he would not consider a bill rate of, say, 4.10 per cent to be
undesirable.
He thought that Mr. Shepardson's suggestions for the
directive were appropriate to that end.
Such a policy action would
support by actual evidence the belief that the System was providing
such underpinning to the solution of the balance of payments problem
as was within the power of monetary policy.
The crisis was so serious, Mr. Balderston continued, that he
would recommend consideration of a further step--limiting Federal
Reserve discounting privileges of the banks that were pushing funds
abroad.
Nine banks apparently had accounted for 80 per cent of the
large volume of foreign term loan commitments in the fourth quarter.
In general, Mr. Balderston said, what he was urging was that the
Federal Reserve be not the last but the first to join in putting to
gether the package of measures that was required.
Chairman Martin commented that the Committee always was faced
with the problem of timing, and he personally was never sure that any
particular moment was the perfect time to take action.
He disagreed
with some members of the staff with respect to the domestic economy;
in his judgment there was some evidence of overheating in the economy
right now.
When he heard the question raised as to whether a small
policy change would help the balance of payments he recalled the issue
the Committee had faced 14 years ago, when it was working toward
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unpegging the Government bond market.
The argument had been made then
that a change of, say, 3/32 in bond prices would have no effect at all
on the economy, and that it would be necessary to raise interest rates
by three percentage points to have any effect.
As things worked out,
small changes in security prices did produce slight reactions all
along the line.
Everyone agreed that monetary policy alone could not deal with
the balance of payments problem, the Chairman continued.
Again using
the analogy to the situation in the early 'fifties, he noted that
then, after the domestic economic problem finally was widely recognized,
many had urged use of various types of selective controls but had opposed
use of general monetary policy.
However, without the support of general
monetary policy the selective controls had proved inadequate, and it
became necessary to use every weapon.
In his judgment, the Chairman said, there was a similar situa
tion today with regard to the payments deficit.
Both general and
selective measures were needed; and the quicker the country came to
grips with the problem the less painful would be its solution.
As to
the argument that a policy change would retard the domestic expansion,
he did not think that a change in interest rates of 1/4 per cent in
either direction would make or break the economy.
What was at issue
was the flow of funds, and one could make a good case to the effect
2/2/65
-79
that pulling the sails in a bit would make the boat go faster, rather
than the reverse.
This admittedly was a difficult area and one could
not be sure of his judgments.
Mr. Ellis had made a point that was in his own (Chairman
Martin's) mind when he suggested that the Committee should have a little
ammunition to deal with any recession that might develop.
Although
he of course did not favor tightening policy just to be able to ease
it if a recession came, he did think that policy had to have some
flexibility in both directions if it was to be effective.
In general, the Chairman said, he thought the present was a
good time for a policy change.
He assumed that the Administration would
announce a program of selective measures soon.
Most people who had
worked in this area seemed at one time or another to come back to the
point that selective measures had to be buttressed by general monetary
policy.
One or the other could be emphasized, and the present situation
seemed to require emphasis on selective measures; but without support
from general policy the latter were likely to be ineffective.
The
Administration had come to that conclusion in preparing the balance of
payments program of July 1963, and a reference to an increase in the
discount rate had been included in the President's message then.
In
the Chairman's judgment, if there had been no discount rate action at
that time the program would have been much less effective, and it still
had not solved the problem.
2/2/65
-80
What he advocated, Chairman Martin continued, was restoring
reserve availability to about where it was before the increase in the
discount rate in November.
The second paragraph of alternative B of
the draft directive appeared consistent with that objective, as well
as with a higher bill rate.
The Committee had tended to feel that
an easier policy was required after the discount rate action because
of the suddenness of that action and because of the sterling crisis
and it had deliberately permitted free reserves to go up.
That judgment
had been quite proper; while it was not possible to separate cost and
availability of credit entirely, it was nece.sary to take expectations
into account.
It would have been unwise to let free reserves become
negative following the discount rate increase in November because such
a development might well have upset the market drastically under the
conditions existing then.
But a restoration of the earlier level of
reserve availability was now required, he thought.
By adopting the
alternative B approach today the Committee would not be leading the
Administration; rather, it would be buttressing the actions that would
be taken.
Today's action could, of course, be reversed at the next
meeting if that appeared desirable.
The Chairman then noted that Mr. Shepardson had proposed both
a revision in the language of the first paragraph of alternative B
and deletion of the last clause of the second paragraph, relating to
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intermediate- and long-term security markets.
first paragraph.
He liked Mr. Shepardson's
However, the second-paragraph clause appeared to be
consistent with the way the Committee had been operating.
Mr. Swan commented that the question of consistency could be
argued both ways.
In view of the success thus far in keeping long-term
rates from rising, inclusion of the final clause now might imply that
no rise at all in such rates was expected.
He saw no point in taking
such a step.
In reply to a question by Mr. Hayes, Mr. Stone remarked that,
as he interpreted the discussion today, the Committee recognized that
if it adopted alternative B for the directive there would be some
reflection of its action in longer-term markets.
Accordingly, the
Desk would not attempt to offset such a development completely.
However,
he understood that the Committee would be concerned with the nature
and extent of the response and would not want conditions in the longer
term markets to degenerate or run away.
The Desk would make an effort
to moderate any movement that appeared to be proceeding too rapidly
or too far.
Mr. Hayes commented that the latter possibility arose mainly
from the fact that dealer inventories of securities issued in the
Treasury's advance refunding were still relatively large.
Mr. Daane suggested that the words "while taking into account
Treasury financing" be inserted after "To implement this policy," in
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the second paragraph.
This language, he thought, would convey the
desired implication that the Committee was aware of the current re
funding and the overhang of the advance refunding, and it should give
the Desk sufficient guidance on the matter at issue.
The final clause
then could be omitted.
Mr. Hickman remarked that he had some doubts about the phrase,
"the generally strong and continuing expansion of the domestic econ
omy" in Mr. Shepardson's proposed first paragraph.
He did not think
there was clear evidence that the expansion would continue.
judgment, the economy was over-heated,
In his
and a reduced rate of growth,
if not a turn-down, seemed likely.
Mr. Hayes replied that the phrase seemed appropriate to him
because the economy clearly was continuing to expand strongly at present.
He did not think
the phrase implied that the expansion would continue
indefinitely.
Mr. Swan asked what the Committee members meant to imply for
free reserves by the phrase, "moving toward slightly firmer conditions."
Chairman Martin remarked that there obviously were shades of difference
in the targets different members had in mind.
He personally was thinking
in terms of a range within $50 million of zero--the general range
prevailing before the discount rate action.
Mr. Daane noted that free reserves at present were in the
neighborhood of $50 million.
The important point in which he thought
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a majority concurred was that, against the background of Treasury
financing, free reserves should be moved cautiously in the direction
of zero, plus or minus.
He would prefer to see negative figures
appear only after the digestion of the advance refunding issues was
completed, but he favored a move in this direction and would be willing
to accept negative figures whenever they appeared.
Mr. Shuford asked Chairman Martin what level of bill rates
he had in mind, and the Chairman replied that he was thinking in te.ms
of bill rates around the 4 per cent discount rate.
Mr. Swan said he felt obliged to return to the question of a
numerical free reserve target.
If what the Committee had in mind
was a target range of zero to plus $50 million, he would find that
acceptable.
Mr. Balderston said such a range would not suit him.
Mr. Daane remarked that he would consider a $50 million range
to be too narrow.
If it was necessary to quantify he would favor a
range from minus $50 million to plus $50 million.
Mr. Wayne commented that alternative B of the directive called
for moving toward slightly firmer money market conditions, and he
thought such an instruction would suffice.
Mr. Hayes added that it
was not practicable to pinpoint a free reserve target narrowly.
Mr. Swan said he was prepared to grant that precise performance
could not be expected, but he was still concerned about the target
range to be aimed for.
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Chairman Martin said he doubted that it
was feasible to get
agreement on precise figures; the Committee had been facing this
problem all along.
He thought the Committee should have a full debate
on the subject of quantifying its instructions, but not in connection
with a discussion of the directive for a particular meeting.
Mr. Hickman said he understood that the free reserve estimate
for the week ending tomorrow was about $50 million at the moment and
Chairman Martin asked Mr. Stone whether this estimate was likely to
be revised.
Mr. Stone said he had just received a report from the
Desk indicating that there had been another "miss" on the low side
yesterday.
After taking into account an upward revision of $70 million,
the free reserve estimate for the current week was zero, and the Desk
had gone into the market this morning to buy more bills.
In connection
with the preceding discussion, Mr. Stone added, he quite agreed that
the free reserve figures could not be pinpointed;
vigorously.
they swung around
However, if the Committee adopted the directive before it
the Desk would undertake to move toward slightly firmer conditions ir
the money market.
In reply to Mr. Mitchell's question as to how he would interpret
that phrase, Mr. Stone said he would anticipate that the bill rate,
which was 3.89 per cent now, probably would move up to the neighborhood
of the discount rate; that the Federal funds rate usually would be at
the discount rate, and sometimes at a premium; and that member bank
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borrowings might average about $100 million above the levels at which
they had been running.
The level of free reserves that would be
compatible with those conditions would vary widely, depending on the
distribution of reserves and the intensity with which they were utilized.
Free reserves might come out at zero in one week, minus $25 million in
the next, and perhaps plus $45 or $50 million in the week following.
Mr. Shuford said that these guidelines were quite acceptable
to him, and Mr. Hickman also expressed agreement with them.
Chairman Martin then proposed that the Committee vote on a
directive consisting essentially of Mr. Shepardson's first paragraph
and of the second paragraph of the staff's alternative B, with
Mr. Daane's amendments.
Thereupon, upon motion duly made
and seconded, and with Messrs. Mitchell
and Robertson dissenting, the Federal
Reserve Bank of New York was authorized
and directed, until otherwise directed
by the Committee, to execute transactions
in the System Account in accordance with
the following current economic policy
directive:
In light of the economic and financial developments
reviewed at this meeting, including the generally strong
and continuing expansion of the domestic economy and the
continuing adverse position of our international balance
of payments, it remains the Federal Open Market Committee's
current policy to accommodate growth in the reserve base,
bank credit, and the money supply but at a more moderate
pace than in recent months. This policy seeks to avoid
the emergence of inflationary pressures and to support
other measures that may be taken to strengthen the inter
national position of the dollar.
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To implement this policy, while taking into account
Treasury financing, System Open Market operations over
the next four weeks shall be conducted with a view to
moving toward slightly firmer conditions in the money
market than have prevailed in recent weeks.
Mr. Mitchell said that he had voted against this action because
he thought the directive called for more than an imperceptible change
in policy and he found it difficult to believe that a perceptible
change would really aid the balance of payments situation or the
domestic economy.
Mr. Shuford, who had voted affirmatively, said he was not certain
that this was the proper moment to change policy.
However, he would
go along with the majority judgment on the question of timing.
Mr. Swan concurred in this statement.
Chairman Martin suggested, for reasons that he mentioned, postponing
the discussion of the general subject of specifying quantities in the
Committee's directives that tentatively had been scheduled to follow
today's meeting, and no objections were made to this suggestion.
The Chairman then noted that barring unforeseen circumstances
today's meeting of the Open Market Committee was the last that Mr. Mills
would attend.
He knew that all of the members had considered it a
privilege to work with Mr. Mills and everyone would miss him.
It was agreed the next meeting of the Committee would be on
Tuesday, March 2, 1965, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
Attechment A
CONFIDENTIAL (FR)
February 1, 1965
Draft Current Economic Policy Directives for Consideration by the Federal
Open Market Committee at its Meeting on February 2, 1965.
Alternative A
(No change in policy)
In light of the economic and financial developments reviewed at
this meeting, and taking Treasury financing operations into account,
it remains the Federal Open Market Committee's current policy to facil
itate continued expansion of the economy by accommodating moderate
growth in the reserve base, bank credit, and the money supply, while
seeking to avoid the emergence of inflationary pressures and to strengthen
the international position of the dollar.
To implement this policy, System open market operations over
the next four weeks shall be conducted with a view to maintaining about
the same conditions in the money market as have prevailed in recent
weeks.
Alternative B
In
(some firming of policy)
light of the economic and financial developments reviewed at
this meeting, it is the Federal Open Market Committee's current policy
to strengthen the international position of the dollar by accommodating
growth in the reserve base, bank credit, and the money supply at a
somewhat slower pace than in recent months.
The Committee also seeks
to facilitate continued expansion of the economy and to avoid the
emergence of inflationary pressures.
-2
To implement this policy, System open market operations over
the next four weeks shall be conducted with a view to moving toward
slightly firmer conditions in the money market than have prevailed in
recent weeks, while moderating the impact of these conditions in
markets for intermediate- and long-term securities.
Cite this document
Federal Reserve (1965, February 1). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19650202
@misc{wtfs_fomc_minutes_19650202,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Feb},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19650202},
note = {Retrieved via When the Fed Speaks corpus}
}