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, D.

PRESENT:

C.,

on Tuesday, April 13, 1965,

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Mr.

Martin, Chairnan

Balderston

Bryan

Daane

Ellis

Mitchell

Robertson

Scanlon

Shepardson

Clay, Alternate for President of Minneapolis Bank

Treiber, Alternate for Mr. Hayes

at 9:30 a.m.

Messrs. Bopp, Hickman, and Irons, Alternate Members

of the Federal Open Market Committee

Messrs. Wayne, Shuford, and Swan, Presidents of the

Federal Reserve Banks of Richmond, St. Louis,

and San Francisco, respectively

Mr. Young, Secretary

Mr. Sherman, Assistant Secretary

Mr. Kenyon, Assistart Secretary

Mr. Hackley, General Counsel

Mr. Noyes, Economist

Messrs. Baughman, Biill, Garvy, Holland, Koch,

and Willis, Associate Economists

Mr. Holmes, Manager, System Open Market Account

Mr. Coombs, Special Manager, System Open Market

Account

Mr. Molony, Assistart to the Board of Governors

Mr. Cardon, Legislative Counsel, Board of Governors

Mr. Partee, Adviser, 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

Miss Eaton, General Assistant, Office of the

Secretary, Board of Governors

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Messrs. Patterson and Strothman, First Vice

Presidents of the Federal Reserve Banks

of Atlanta and Minneapolis, respectively

Messrs. Eastburn, Mann, Ratchford, Jones,

Parsons, Tow, and Green, Vice Presidents

of the Federal Reserve Banks of Philadelphis,

Cleveland, Richmond, St. Louis, Minneapolis,

Kansas City, and Dallas, respectively

Mr. Lynn, Director of Research, Federal Reserve

Bank of San Francisco

Mr. Sternlight, Assistant Vice President,

Federal Reserve Bank of New York

Upon motion duly made and seconded,

and by unanimous vote, the minutes of the

meeting of the Federal Open Market Commit

tee held on March 23, 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

March 23 through April 7, 1965, and a supplemental report for April 8

through 12, 1965.

Copies of these reports have been placed in the

files of the Committee.

In comments supplementing the written reports, Mr. Coombs

stated that the U.S. gold stock would probably be reduced by $150

million this week in order to replenish the Stabilization Fund.

would bring the total decline to $975 million for the year.

This

During

the month of April, he expected that total gold sales would come to

about $240 million, offset by purchases totaling about $94 million,

including $50 million from the United Kingdom.

He anticipated that

the Stabilization Fund would end the month with a balance of roughly

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$70 million.

For May, gold sales of somewhat more than $40 million

were already in sight.

The total could go to $150 million or more,

which would mean a further sizable reduction in the gold stock.

On the London gold market, Mr. Coombs continued, there had

been continued private buying in some volume, although less than

before.

The Chinese Communists still were coming in occasionally;

their purchases were now in excess of $50 million this year.

On the

other hand, there had been a fairly good inflow from new production,

and losses of the Gold Pool during March were no more than $26 million.

This brought accumulated Gold Pool losses to $206 million against

resources of $270 million.

But the agreement reached at the time

of the March meeting of the Bank for International Settlements to

continue Gold Pool selling if necessary, even if the Pool's resources

should become exhausted, was reaffirmed at the time of the meeting

held this past week end.

On the exchange markets, Mr. Coombs noted that sterling had

experienced a number of ups and downs.

Prior to the announcement of

the British budget, there had been devaluation rumors resulting in

speculative pressures.

The Bank of England suffered sizable reserve

losses in dealing with those pressures in the spot and forward markets.

Drawings on the swap with the Federal Reserve were increased to $370

million, and borrowings from other central banks and the Bank for

International Settlements to more than $800 million.

Since the

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announcement of the budget, which was fairly well received in the

markets, sterling had recovered, both spot and forward, and the Bank

had taken in moderate amounts of dollars.

But the March trade figures

showed no significant increase in exports and a rise in imports.

The sterling rate was immediately affected, and the situation remained

highly uncertain.

It had not been possible, Mr. Coombs said, to make ary net

reduction in the Federal Reserve swap drawings on various central banks,

and the total drawings had increased from $515 to $585 million.

He

suspected that the continuing inflow of dollars to continental central

banks was mainly attributable to U.S. direct corporate investments,

aggravated by continuing tight money conditions in continental markets.

At the recent Bank for International Settlements meeting,

Mr. Coombs said, there were three rather important developments.

First,

there was a great deal of discussion of the British situation, with

more or less general agreement that the British should go to the

Monetary Fund for the entire $1.4 billion left in their quota and a

general feeling among most of the central bankers that any appearance

of dissension should be avoided.

There was a feeling on the part of a

few of the bankers that the budget was not sufficiently strong, and a

rather general view that it was a pity the budget had not been accompanied

by further measures on the monetary side.

But the budget was a fact,

and it was thought essential to make the best of it.

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Secondly, there were indications of some softening in the

French line, Mr. Coombs continued.

Aside from the reduction in the

discount rate, there were other evidences of some shifting, which

meant that the French might be pressing less harshly than before.

Third, there were a number of indications that the European central

banks were beginning to respond to the need to ease up somewhat in

their monetary policies in order to compensate for the pulling back

of U.S. corporate short-term investments and the curtailment in U.S.

bank foreign lending.

The Bank of Italy had put into the Euro-dollar

market a total of $750 million in the last month or so.

This was the

reason the Euro-dollar rate had been coming down and a disruptive

situation averted.

He thought that the Bundesbank would shortly

institute similar swaps with German banks, and that a number of others,

including the French and Dutch, might take actions that would result

in a movement of funds into the international credit markets.

Thereupon, upon motion duly made and

seconded, and by unanimous vote, the System

open market transactions in foreign

currencies during the period March 23

through April 12, 1965, were approved,

ratified, and confirmed.

Mr. Coombs noted that the $100 million swap arrangement with

the Bank of France would mature on May 10, and he recommended its

renewal for another three months.

Renewal of the swap arrangement with

the Bank of France for another three months

was approved unanimously.

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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 operations in U.S. Government securities

and bankers' acceptances for the period March 23 through April 7, 1965,

and a supplemental report for April 8 through 12, 1965.

Copies have

been placed in the files of the Committee.

In supplementation of the written reports, Mr. Holmes commented

as follows:

The noney market tone was a bit firmer during the past

three weeks. Net borrowed reserves were perceptibly larger,

member banks were obliged to borrow in greater volume in

order to meet a level of required reserves that ran con

sistently in excess of our expectations, and Federal funds

traded quite frequently above the discount rate. Indeed,

the effective rate was 4-1/8 per cent on eight of the past

fifteen business days. Nevertheless, bill rates have

barely moved from the lower levels reached a few weeks

ago. In yesterday's auction the average issuing rates on

three- and six-month bills were about 3.94 and 3.99 per

cent, respectively. Three weeks earlier the comparable

rates were 3.92 and 3.98 per cent.

In conducting System operations during this interval,

an effort was made to supply reserves with minimum reliance

on Treasury bill purchases in the market. A net of $446

million reserves was supplied, in good part through re

purchase agreements; outright holdings of Treasury issues

increased by $222 million, including $170 million of bills,

the latter largely reflecting purchases from foreign

accounts.

In reviewing developments at the last Committee

meeting, Mr. Stone suggested that the tendency for bill

rates to decline while other short-term rates were steady

or rising might be explainable in good part as a result

of repatriation of corporate short-term funds from abroad;

there seemed to be a tendency for such funds to go

initially into the bill market even when this offered

a relatively less attractive return than other short-term

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instruments. Repatriation flows probably have remained

a factor, although it is very difficult to pinpoint the

extent or form of such inflows with any precision. An

additional factor in recent weeks has been the sub

stantial demand for bills by various public funds, partly

with the proceeds of tax receipts, which run heavy at

this time of the year. At the same time, commercial

bank liquidation of bills, which might have been expected

to have been substantial under the sustained condition

of firmness in the money market and vigorous loan demand,

has occurred to some extent but has apparently been

inhibited somewhat by banks' needs to hold Treasury

securities for collateral purposes.

In the meantime, other short-term rates have shown

little change on balance. Three dealers raised their

acceptance rates by 1/8 per cent shortly after the last

meeting, as inventories approached record levels, but

then rescinded the increase a few days ago as inventories

had worked down. Similarly, some commercial paper rates

briefly mcved higher during the period and then returned

to the late March level. New York City bank new CD

rates have also changed little--if anything, edging

slightly lower as tax date pressures receded. On the

whole, therefore, the further slight firming of bank

reserve availability seems to have had little noticeable

impact beyond the very shortest term area of day-to-day

reserve availability.

The bond markets also showed little net change through

the interval--exhibiting some hesitancy in the early portion

while awaiting the British budget and appraising weekly

banking statistics that pointed to strong loan demand and

lower reserve availability, and then regaining some confi

dence in the wake of the British budget proposals and the

French bank rate reduction. The publication of a second

week's net borrowed reserve level greater than $100

million did generate some caution; most observers now

feel that a further modest shift in policy has occurred,

but this produced no significant selling pressure and

prices were off only 1/32 or 2/32 since Thursday's close.

The corporate and municipal markets have continued

rather uneventful. New high-grade corporate issues reached

the market in light volume, were priced in the same area

as in other recent weeks (roughly 4-1/2 per cent for Aa

rated utility issues), and tended to move out slowly to

investors. The supply of new tax-exempt issues continued

fairly sizable and these, too, moved out slowly for the

most part.

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As was mentioned at the last meeting, the next item

on the Treasury financing calendar is the refunding of

May 15 maturities, of which some $4.1 billion are held

by the public. The Treasury will meet with its advisory

groups on April 27 and 28, and probably announce the

terms of their refinancing on the latter day. A number

of market observers expect that the Treasury might offer

preemptive rights to holders of the maturing issues, and

perhaps sell an intermediate issue as well as a short

"anchor" issue in an exchange operation.

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 March 23 through

April 12, 1965, were approved, ratified,

and confirmed.

Chairman Martin then referred to the memorandum dated March 18,

1965, from Mr. Stone, former Manager of the System Open Market Account,

which was prepared as the result of a question raised by Mr. Mitchell

at the March 2 Committee meeting and held over at the March 23 meeting

at Mr. Robertson's request.

The memorandum presented a breakdown of

the Federal Reserve Bank of New York's holdings, as of end of

December 1963 and 1964, and of February 19 and March 12, 1965, either

for own account or for foreign accounts, of third-country bankers'

acceptances (acceptances created to finance third-country trade, that

is, goods stored in or shipped between foreign countries).

The Chairman called for comments, and Mr. Robertson made the

following statement:

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The question raised by Governor Mitchell as to whether

the System should purchase third-country acceptances in view

of the low priority assigned them in our voluntary restraint

program is a marginal one--and I do not mean that in any

depreciatory sense. It is my judgment that System activity

in bankers' acceptances is quite marginal to the health of

the acceptance market, but this is not the time to argue that

on such grounds the System shoul desist from operations in

acceptances. A broad range of questions--dealing with cri

teria for market performance and desirable characteristics

of a free market--would have to be discussed if such were the

fundamental issue before us.

We do not really have to deal with so fundamental a

problem, though, because System operations in third-country

acceptances are also marginal to the success of the voluntary

restraint program. Still, I would be reluctant to give up

whatever marginal value to the program might be gained from

the psychological impact on banks of some limitation on

System activity in third-country acceptances. And I do

recognize, of course, that the bulk of third-country ac

ceptances involve Japan, a country where application of

the program is involved in high diplomacy.

I am not speaking of any written limitation from this

Committee, and definitely not of any limitation announced

in the market. Rather, I would simply like to see the

System make an effort in its transactions to avoid third

country acceptances--which were reported to be about two

fifths of the portfolio on March 12--and emphasize others.

I am not advocating at this time that we necessarily

cut down our already limited total activity in acceptances.

I would expect that the System would continue to be able to

make repurchase agreements or buy outright in volumes not

much different from recent experience, but with relatively

more emphasis on U.S. import and export paper and relatively

less on third-country paper.

The idea, in other words, would be to reduce that two

fifths gradually, and certainly not build it up. In the

process, acceptance dealers will find that the System is

less willing than formerly to buy third-country paper,

even under repurchase agreements. The System would, for

instance, tell a dealer that he should make a reasonable

effort, in packaging acceptances to be purchased or

financed, to hold down the amount of third-country paper

involving Japan, Canada, or the underdeveloped countries,

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and to exclude paper financing transactions between

other developed countries. Such news should have some

psychological benefit in terms of our whole voluntary

restraint program--not merely the third-country acceptance

part of it. And I do not think that so moderate an

action will, as such, hurt the acceptance market. If

that market is going to be hurt, it is going to be hurt

by the very existence of the voluntary restraint program,

given the fact that almost half of outstanding acceptances

are third-country acceptances.

Mr. Treiber commented that if he understood Mr. Robertson's

proposal correctly it would involve the New York Bank's indicating to

the dealers that it had some question about third-country acceptances

and therefore they should cut down on such acceptances presented to

the Bank.

This would quickly permeate the market, and there would be

a lesser degree of marketability of that type of acceptance than others.

The market would get a clear signal that the System was concerned in

this respect.

The New York Bank's approach under the voluntary

restraint program had been that acceptances, for whatever purpose, were

included in the 105 per cent ceiling when created by a bank, and that

once the acceptance had been created it stilt fell within the 105 per

cent figure whether the accepting bank held the security in its

portfolio or sold it in the market.

The Reserve Bank felt that the

accepting bank must be the judge under the voluntary restraint program

as to whether an acceptance was in accord with the program; and once

that judgment was made the acceptance should be able to circulate freely.

If that was not true, there would be a cloud on the marketability of

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third-country acceptances of even the most scrupulous bank operating

within the voluntary program guidelines, and the voluntary nature

of the balance of payments program would be vitiated if the Federal

Reserve declined to purchase those acceptances.

The commercial banks

should be relied upon to comply with the guidelines in the creation

of acceptances.

After this had taken place, there should be no

restriction on their free marketability.

Mr. Holmes commented that he did not see how Mr. Robertson's

suggestion could be carried out without some announcement to the

market, even though informal.

Neither did he see how a fine degree

of discrimination could be accomplished in the market very easily.

Mr. Robertson said that even if the word got out to the marketand he thought it would rather quickly--he did not think it was going

to occasion any cloud on the acceptance market.

would be almost entirely psychological.

He thought the impact

The Federal Reserve would

continue to acquire acceptances in the ordinary course; it would just

give a little push to the desirability of holding down third-country

acceptances, without eliminating the Japanese paper.

Mr. Wayne observed that while he was quite sympathetic to the

views Mr. Robertson had expressed, he hoped the Committee would be

slow in implementing Mr. Robertson's suggestion.

Not only would it

permeate the market rather quickly but also, as he was sure all members

of the Committee were aware, some of the spokesmen and writers for

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the New York City banks, particularly those most outspoken in

pressing for a greater reliance on restrictive monetary policy, had

alleged in recent weeks that the Federal Reserve was likely to act

through the discount window to support the voluntary restraint program.

In other words, the idea was spreading through the banking community

that the voluntary program was likely to become something less than

voluntary through denial of access to the discount window to banks

that failed to cooperate.

He hoped the Committee would not make a

move that would appear to validate any such idea.

Implementation of

Mr. Robertson's suggestion no doubt would be interpreted by those

who had been pressing strongly and continuously for more reliance on

a restrictive monetary policy as the first move.

He was sympathetic

to Mr. Robertson's views; he would not like the System to appear as

saying restraint was good for others but not for itself.

For the

time being, however, he saw merit in Mr. Treiber's position.

He would

hope for restraint at the point of creation of acceptances and wait

a little longer before making any move. even "quietly."

Mr. Mitchell said he had examined Mr. Stone's report and noted

that less than a third of the third-country acceptances in the New York

Bank's portfolio were held for its own account, two-thirds being held

for foreign accounts.

He would be reasonably well satisfied if con

tinuing analysis indicated that such acceptances were not being un

loaded on the System; that the System was not getting the type of

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acceptances it was trying to discourage commercial banks from making.

If the New York Bank was not, in these operations, adding to its

portfolio and also getting a different mix, namely, a larger proportion

of third-country paper, he would be satisfied.

If the Bank, however,

appeared to be getting an unusually large proportion of third-country

paper or a larger portfolio, he would take this to be evidence that

the Federal Reserve was doing the sort of thing it was requesting the

commercial banks not to do.

Mr. Daane commented that the System had had an active interest

in the growth of the acceptance market over a period of time.

He

would not want to see the System interrupt its posture of general concern

for that market unless this was really essential.

The comment had

been made that restraint should be exercised under the voluntary

program at the point of inception, and with this he agreed.

He concurred

generally with Mr. Mitchell's position; he would not like to see a

growth of third-country paper in the portfolio.

He suggested keeping

a close look at the figures in the light of the whole voluntary restraint

effort.

Chairman Martin commented that he, too, thought the point of

inception was the place to work on this.

He had one real conviction

on this matter, which was the System should not say anything "quietly"

to anybody.

This type of thing was certain to go right through the

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market, to be nisconstrued, and to be self-defeating.

If the

Committee was going to change its pattern of activities in the

acceptance market, it should do so openly.

Mr. Robertson said he would not object to a formal statemert

if that was the best way to go about it.

He then inquired whether

the best way to approach the matter might not be to ask the Desk to

analyze the situation over the next few weeks and report back to the

Committee.

Mr. Wayne commented that it might be appropriate also to try

to determine what effect the voluntary program was having on acceptances

at the point of inception.

Chairman Martin then suggested that the matter be carried over

until another meeting, on the basis indicated, and no disagreement

with this suggestion was expressed.

Chairman Martin called at this point for the staff economic

and financial reports, supplementing the written reports that had been

distributed prior to the meeting, copies of which have been placed in

the files of the Committee.

Mr. Koch made the following statement on economic conditions:

Business activity thus far this year has been

exceptionally good, better than expected by most of us.

Not only have the data on March developments been very

strong but many estimates of activity in January and

February have been revised upward substantially. More

over, the expansion has been broadly based, although the

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high rates of activity in autos and steel are no doubt

having secondary expansionary effects on other industries.

The index of industrial production for March, to be

released Thursday, stands at 140.1, as against 138.9 for

February. The March figure represents about an 8 per

cent increase from a year ago.

We have also made some progress with our sticky

unemployment problem. The increase in employment, par

ticularly in manufacturing and among production workers

as well as nonproduction workers, has been striking in

recent months. The first quarter's average unemployment

rate of 4.8 per cent reflects real improvement rather

than a temporary fluctuation around the 5 per cent level

that prevailed in the second half of last year. Further

progress in reducing the unemployment rate after the next

month or two will be more difficult, however, as the high

current rate of overall expansion inevitably slows down

somewhat and as an expected more rapid growth of the labor

force occurs.

There remains the need to assess the relevance of

the great first quarter strength in overall economic

activity to the two basic questions that have been

plaguing us for some time:

first, the possible over

heating of the economy in the near-term future and, second,

its possible slowdown after the steel strike threat has

passed.

The likelihood of the economy overheating in the near

term future can, I think, be discounted a bit more now that

we have gotten through several months of unsustainably

rapid rate of economic expansion with few additional out

ward signs of inflation. We are, of course, using our

resources more intensively now than earlier, but the

expansion of plant capacity in many lines is likely to

equal or even to exceed that of output over the next few

quarters, and the potential supply of bcth employed and

unemployed labor susceptible of training to meet shortages

of higher skills remains large.

In the price area, at first glance it seems difficult

to reconcile the list of specific increases that have been

announced recently with the exceptional stability of the

overall indices, particularly the important industrial

wholesale price index. This development, however, illus

trates again the limited and selective nature of the

increases and the lack of publicity given to offsetting

price declines. The recent renewed strength in nonferrous

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metals prices, at a time when supplies are being augmented

by withdrawals from the stockpiles, is a cause for concern,

although it may be due in large part to special temporary

factors.

In the area of business costs, the big question, namely,

the wage settlement in steel, remains unanswered. The

steel industry costs the initial demands of the union at a

7.5 per cent annual rate of increase for the 3-year period

of the proposed contract, but this was an asking price that

is reportedly already being reduced by the union. An

eventual settlement not far from the 3-1/2 per cent in

crease recently achieved in the can industry is still a

real possibility. A wage increase of this magnitude might

involve some steel price increases, but they would probably

be selective and not well publicized. The can companies

have announced small price increases following their wage

settlement.

With regard to the relevance of the recent pickup in

the rate of overall economic expansion to its likely sus

tainability, the dependence of the expansion on very high

auto sales and heavy inventory accumulation does raise

doubts as to its likely duration. Consumer spending on

new autos declined 8 per cent to a seasonally adjusted rate

of about 9-1/4 million units (including imports) in March,

but this rate is still no doubt unsustainable for a long

period of time.

In the area of business inventory accumulation,

available data on production and shipments certainly

suggest that accumulation of steel since last spring has

been substantially greater than the direct dollar inventory

figures suggest. If this is so, settlement of the steel

wage dispute will no doubt mean a sharp reduction in steel

output, and probably also a significant decline, at least

temporarily, in the rate of growtn of total industrial

production and the GNP.

Total business inventory accumulation has also no doubt

been proceeding at an unsustainably high rate in recent

months. The seasonally adjusted annual rate approximated

$10 billion or more in the 3 months ending with January.

After falling off in February according to preliminary figures,

which may very well be revised upward later as have been

those of earlier months, accumulation no doubt rose sharply

again in March if available production and sales figures are

correct.

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In conclusion, although the recent sharper rate of overall

economic expansion is welcome as a step toward a more satis

factory level of employment, it warrants careful watch. This

is because the current long-lived expansion is beginning to

show signs of imbalances which have in the past often been

preludes of slowdowns or recessions.

A further burst of activity is possible, particularly

if extension of the period of steel wage negotiations engenders

even more inventory build-up. But this would only accentuate

the imbalances that threaten maintenance of satisfactory

growth later this year and in 1966. Meanwhile, the current

less easy monetary posture adopted at the Committee's last

meeting might well be maintained for the next few weeks

pending a clearer view of prospects in the steel industry.

There followed comments by Mr. Koch, in response to a question

by Mr. Mitchell, concerning the degree of significance that it would

seem appropriate to attach to the decline to 4.7 per cent in the un

employment rate in March.

The purport of Mr. Koch's comments was to the

effect that he would not be inclined to over-emphasize the March figure

taken by itself.

Instead, he would base a judgment more on the March

figure's relationship to developments in the employment and unemployment

statistics over a period of months, which indicated steady improvement

in employment and a break away from the unemployment rate plateau that

had persisted earlier.

He added a note of caution concerning anticipated

labor force developments later this year that would militate against

further reduction or even maintenance of the current unemployment rate.

Mr. Noyes made the following statement concerning financial

developments:

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We are accustomed to some difference between the

rate of growth in total deposits, on the one hand, and

total loans and investments on the other, because of

problems of seasonal adjustment and because we generally

use daily average figures to measure deposit changes

and end-of-month figures when we look at bank credit.

But we expect to see them move in the same direction and

by roughly the same order of magnitude.

In February, for example, total deposits increased at

a seasonally adjusted annual rate of $2.6 billion, and bank

credit at $2.4 billion--a reasonable and understandable sort

of difference. But in March the rate cf deposit expansion

dropped to $1.3 billion, and the rate of credit growth

soared to $3.5 billion.

If we look at the first quarter as a whole, I think

we get a better picture of what has been going on. For

the quarter the annual rate of increase in the money supply

was 1 per cent; time deposits rose at an 18.7 per cent

rate; and money supply plus time deposits was up 8.8 per

cent. This latter figure is almost the same as the rate

in the fourth quarter of 1964, and only moderately above

the 7.7 per cent for all of last year.

For the first quarter the rise in total bank credit

was at a 12.8 per cent annual rate--up considerably from

either the 6.6 per cent in the fourth quarter or the 7.9

per cent for the year 1964.

But it was in loans--and especially business loansthat the rise has been most spectacular. In March, loans

rose by a record $3.9 billion. This brought the quarterly

annual rate to almost 20 per cent, and the rate for business

loans for the quarter was a whopping 28 per cent.

Some of this credit growth at banks was undoubtedly

at the expense of competing institutions. It will be quite

a while before we have any reliable estimates of total credit

flows for the first quarter, but it is interesting that the

annual rate of expansion in total liquid assets for the

first two months was only 6.5 per cent, as compared to

6.9 per cent for last year. Hence, we may find that the

rise in total funds raised in the first quarter was not

nearly so spectacular as the bank credit figures.

It is also important to keep in mind that the rise in

real output was unusually large in the quarter. The increase

in real GNP that is now generally anticipated translates

into an annual rate of over 8 per cent, as compared to a

4.1 per cent increase over the year 1964. Thus, the rise in

bank credit in relation to GNP was not as large in comparison

to earlier periods as the credit figures alone might suggest.

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It is hard to account for the strength of credit

demand solely in terms of transitory factors. Certainly,

some of the demand can be related to steel inventory

accumulation and some to the belated build-up in dealers'

auto stocks. But both the expansion of the economy and

the size and structure of bank credit extensions suggest

a broader basis for the surge in demand for bank loans.

There is no prima facie reason why it should subside

quickly even if the steel inventory build-up slows or

reverses.

As one would expect in a period of strong credit

demand, the rate of increase in total reserves has been

high during the quarter (over 8 per cent), despite

progressively tauter money market conditions.

In the

first quarter free/net borrowed reserves averaged $240

million less than the preceding quarter, and the increase

in nonborrowed reserves was down to only a 3.5 per cent

annual rate.

In the last few weeks most money market interest

rates have remained close to their recent highs and the

bill rate has edged up a little from its "out of line"

position. Long-term yields have moved back and forth

in response to day-to-day developments and are generally

a few basis points above the levels prevailing at the

time of the last meeting.

In summary, we see a fairly clear picture of strong

credit demand pulling out a near record volume of bank

credit in the face of more reluctant reserve provision at

the System's initiative and, of course, a corresponding

rise in member bank borrowing.

As the Manager has indicated, the Treasury will be

engaged in a major refunding in about two weeks. Therefore,

an "even keel" is almost inescapable. Especially in light

of the fact that the change in policy at the last meeting

may not yet be fully reflected in market yields, the

precise meaning of this term in the circumstances would

seem to be the major question at issue today.

Mr. Swan referred to the strength of business loan demand and

earlier discussions about a firming of credit terms and lessening signif

icance of the prime rate.

This did not seem to square with the March

quarterly interest rate survey, which showed a reduction in the average

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4/13/65

rate on short-term business loans and an ircreased dollar volume of

loans made at the prime rate.

In discussion of this point it was noted that there was no

doubt some volume of borrowing around the tax date on the part of

prime borrowers

that may not have been otherwise active in

the market.

If there was increased loan demand by larger corporations that were

eligible for the prime rate, with perhaps some drop-off in less de

sirable credits for which the rates were necessarily higher, this

would have the effect of lowering the overall rate.

Mr. Daane recalled that at the recent Princeton meeting

sponsored by the American Bankers Association there had been some

comments by ba.kers about giving the prime rate to parties who never

before would have gotten it.

The reason was not entirely clear, given

the existing credit demand, but it appeared to reflect strong compe

tition for loans.

Mr. Balderston remarked that with a Treasury financing in the

near offing the Committee might conclude that an even keel posture was

indicated for that reason.

He suggested that perhaps the central

issue this morning had to do with what was meant by an even keel in

the present circumstances.

Mr. Noyes replied that it was not entirely clear whether the

current rate structure reflected full market understanding of the pre

sent posture of monetary policy.

The question, then, was whether an

4/13/65

-21-

even keel posture was one that would allow market adjustments to

continue to take place or one in which an attempt would be made to

hold at bay ary further adjustments.

While it was only a guess, he

rather felt that there would be a tendency for yields to adjust upward

somewhat further in light of the present reserve position of the

banks and the present levels of borrowing and net borrowed reserves.

The question was whether such a further adjustment should be allowed

to take place during a period of Treasury financing.

Mr. Reynolds then presented the following statement:

The large U.S. payments surplus recorded in March seems

to have persisted into early April, in contrast with last

year when there was a sharp March-April reversal. Thus

the new balance of payments program apparently continues

to bite into capital outflows. Also, exports are no doubt

still rebounding in the wake of the port strikes.

Little new information on our payments position has

become available since the "Green Book" was written. 1/

Therefore I shall direct my remarks this morning to what

seems to me the most important international financial

news of the past few weeks--the British budget. Mr. Coombs

has already commented on its early, mildly favorable,

effects on foreign exchange markets.

I should like to

consider it in the context of economic developments in

the United Kingdom, and of other U.K. policies.

An American analyzing British developments must

always guard against two opposite dangers. First, there

is a temptation to assume more similarity between the two

countries than actually exists. We are both reserve

currency countries, we both have payments problems, and

we both use the same language, including much of the same

economic language. Yet our circumstances and institutions

are in many ways very different. In particular, a budget

deficit can mean different things in one country than

in the other.

1/ The report "Current Economic and Financial Conditions," prepared

by the Board's staff for the Committee.

4/13/65

-22-

Secondly, however, it would be wrong to treat Britain

as a wholly unique case, beset by structual problems un

known elsewhere, and uniquely bedevilled by the gnomes of

Zurich (or of London). There has been some tendency in

the press to do this, and to forget that mundane things

like inventory cycles and plant and equipment outlays are

as important in Britain as they are here.

The U.K. economic context in which the budget was

announced last week was one of rapid economic expansion

and of strong inflationary pressures. Real GNP in

Britian rose 5 per cent from late 1963 to late 1964,

despite very slow growth in the labor force. The ad

vance both in plant and equipment spending and in

residential construction, again after allowance for

price increases, was 12 per cent. Expansion continued

into the first quarter of 1965, and plant and equipment

spending plans surveyed as of December--after the

emergency policy actions connected with the sterling

crisis--indicated a further 10 per cent increase this

year.

Inflationary pressures have been evident on every

hand. Wholesale and retail price indexes have been rising

at a rate of 4-1/2 per cent a year. The unemployment

rate has fallen to less than 1-1/2 per cent, with labor

shortages widespread, particularly in the heavy engineering

industries and in construction. The pressure of demand

against supply in the engineering sector has been

particularly important for the balance of payments. Ex

port order backlogs in this sector, which accounts for

about one-third of British exports, have risen 20 per

cent oer the past year, but export deliveries have

risen only 7 per cent. Britain's ability to sell has

been hampered by inability to deliver.

Thus, in framing the budget the Government did not

face any conflict between internal and external economic

objectives, even though it took courage for a Labor

Government to recognize and act upon this fact. There

was a clear need, on both counts, for a policy of re

straint. The need was widely recognized by British

economic analysts; it was not peculiarly the recommendation

of "international financiers."

It seems to me that the budget does provide some

considerable new measure of restraint. It had earlier been

announced, last November, that an increase in the standard

rate of income tax, and in social security contributions,

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would firance an equal increase in welfare pensions. Also

in November, taxes on motor fuel were significantly in

creased. Last week's budget imposed an additional 200

million pounds of new taxation on consumption--on tobacco,

alcholic beverages, auto registration fees, and postal

rates. In U.S. terms, the equivalent for our economy

would have been $3 billion to $4 billion of new taxes

and fees

The intent is to dampen consumer demand

without unduly dampening the rate of investment, since

investment is thought needed to insure continued growth

and improved competitiveness.

Some analysts, including several of my colleagues

here at the Board, are rather skeptical about the budget

because they notice that the overall budget deficit is

expected to be as large this year as last, even apart

from that portion of this year's expenditure which re

presents a mere shifting of local authority financing

from the market to the central government. Other

analysts, notably the London Economist, focus on the

above-the-line surplus, which is to be the largest for

15 years, and regard this budget as very severe indeed.

It seems to me that the truth lies somewhere in

between. The character of the below-the-line expenditure

matters a good deal here. A large increase is provided

for investment outlays by the nationalized industries,

particularly electricity. In the United States, such

expenditure would not be in the governnent sector at

all, but would instead represent private plant and

equipment spending. Allowing for this, and striking

the balance on the sort of items that would be included

in a U.S. Federal cash budget, there is to be a significant

reduction in the U.K. budget deficit--by roughly 200

million pounds.

It is always difficult to say exactly how much re

straint is needed to cure an inflation, particularly one

in which psychological uncertainties have played as large

a role as they have in Britain. The amount of new taxation

announced in the budget is about what had been recommended

by commentators of as diverse leanings as Professor Paish

of London and Professor Kahn of Cambridge, and was perhaps

a little more than had been generally expected by the

British press. It may be some time before we know whether

the budget has done the full job required. The Chancellor

first, by asking renewal of

recognized this in two ways:

his authority to use "regulator" taxes, i.e., to increase

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4/13/65

purchase taxes if more fiscal restraint should prove

needed; and second, by stating that monetary policy would

be used to the extent required. This last implies, to

me, that no early relaxation of credit policy should be

looked for, certainly not before the trade and payments

figures show a decisive turn for the better.

There are several indications that the credit squeeze

in Britain is having a useful restraining effect. There

was no significant net expansion of bank loans during the

first quarter, whereas earlier expansion had been very

rapid--20 per cent a year. Inventory accumulation slowed

some in the fourth quarter. Mortgage money is reportedly

in much tighter supply than before, which is important

since the residential construction boom has been an im

portant element in the inflation in Britain.

My summary impression of Britain's present financial

policies is that they represent significantly more re

straint than the policies of six months ago. While the

question remains open whether the British have done

enough, they have moved a long way in the right direction.

And what they have done may well prove to be enough,

particularly if they have any success at all with their

longer-run policies of moderating wage demands and in

creasing the flexibility of the economy.

Prior to this meeting the staff had prepared and distributed

certain questions suggested for consideration by the Committee, and

comments thereon.

These materials were as follows:

(1) Business activity--What do recent developments with

respect to production, sales, and inventories in steel,

steel-using, and other key industrie. suggest for the

sustainability of overall economic activity?

The economy continues to be characterized by vigorous

and broadly based expansion, with extraordinarily high

rates of production in the auto and steel industries.

Whether expansion can be maintained at close to the average

pace of recent quarters depends not only on the timing

and extent of the inevitable readjustments in these

industries but also on such factors as the developing

strength in business capital spending and prospective

changes in Federal fiscal stimulation.

4/13/65

-25-

Short-run prospects in the automobile industry appear

to be somewhat clearer than those for steel. Auto pro

duction in March rose to a new high, even though sales

failed to show the usual large seasonal increase. (A

downward readjustment in consumer auto purchases from

the exceptionally high January-February level was suggested

by the Buying Intentions Survey conducted by the Census

Bureau earlier in the year.) While dealers' inventories

consequently increased further, their stocks are still

low relative to sales, and production is scheduled to

remain at record levels throughout the second quarter.

Automobile producers are reportedly sufficiently well

stocked with steel to maintain output at advanced levels

until about midyear even if a steel strike occurs May 1.

If consumer purchases continue to lag behind output,

however, it is likely that production of this year's

models will be cut back sharply early in the summer (unless

an excise tax reduction rekindles consumer demands).

It

seems likely, though, that automobile production will

continue to contribute to high levels of economic

activity over the next few months.

The steel situation hinges on the wage negotiations

now under way, the outcome of which cannot be predicted.

Building of steel stocks continues, with data on physical

volume of production and shipments suggesting much more

accumulation than is indicated in the dollar value figures.

Current steel consumption rates are high, for in addition

to the record volume of auto production, output of business

equipment has been rising. Also, production of household

metal goods has been maintained at the advanced rates

reached in late 1964, even though retail sales of these

goods have leveled off this year.

An early settlement of the steel wage negotiations,

while steel-using industries are operating at such high

levels, would permit relatively orderly liquidation of

inventories. But it would likely be accompanied by a

sharp reduction in steel output, as in 1962 and 1963,

when settlements were reached without strikes. Such a

cutback in steel would obviously slow the rate of economic

growth, but expansionary forces in the rest of the economy

appear sufficiently strong at this time to maintain a

general upward trend in overall activity.

Extension of the contract beyond the May 1 termination

date would permit further inventory accumulation. While

it would tend to maintain the recent pace of business for

4/13/65

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some time, it raises the disturbing prospect of

concomitant and substantial cutbacks in production of

steel, autos, and household durable goods later in the

spring or summer.

(2) Prices and costs--To what extent has the step-up in

industrial output and the strengthenirg in the labor market

in recent months been reflected in unit labor costs and

prices?

Since the October-November auto strikes, industrial

output has increased sharply and has maintained a margin

of 8 per cent over year-earlier levels. The recent rise

has been accompanied by a substantial increase in employment,

a considerable lengthening of the average factory workweek

through increased overtime, and a decrease in the unemploy

ment rate. Nevertheless, total labor costs per unit of

output in manufacturing have remained essentially stable;

the first quarter level was down nearly 1 per cent from a

year earlier and more than 2 per cent from two years

earlier. The industrial commodity price level, after having

risen three quarters of 1 per cent in late 1964, leveled

off in the first quarter.

Most recently, increases have been reported for some

sensitive commodities. Upward price pressures still are

confined mainly to markets for nonferrous metals and

products, however. Within most other commodity categories,

price increases have been selective and of moderate size

or have been balanced by decreases. Over the past two

years of rapid expansion in output, discounts from list

prices nc doubt have been reduced or eliminated, but

increases in list prices have been neither large nor

widespread.

On the cost side, an important feature of the response

to expanding demand and output is the continued rise in

productivity. Although less rapid than earlier, the rise

in manufacturing productivity in recent, months has continued

to be great enough to offset the gradual increase in hourly

rates of pay, including the wage costs of overtime and

also the costs of fringe benefits.

Whether output and employment now have reached a

range where further expansion is likely to be accompanied

by significantly greater upward pressures on prices and

labor costs depends for the most part on the rate of growth

in the labor force and its adaptability, on the rate of

4/13/65

-27-

expansion in plant facilities, and on expectations for

market conditions. For some occupational groups, unemploy

ment rates have reached what might be considered frictional

levels. Therefore, further expansion in demands could

result in some labor bottlenecks and selective upward wage

pressures. With the overall unemployment rate still as

high as 4.7 per cent, however, and with the labor force

now increasing 1.2 million persons a year, further signifi

cant gains in employment could be achieved without widespread

labor cost pressures, assuming a reasonable settlement of

the current steel negotiations.

Continued growth in industrial capacity and prospects

of further large increases also have tended to restrain

upward piice and cost pressures. One feature that dis

tinguishes this from earlier postwar business expansions

is that capital outlays reached advanced levels long before

the development of pressures on existing resources, and

then outlays continued to increase. The increase in actual

and potential supplies has helped maintain expectations of

competition within markets and between products. At the

same time, the new facilities are holding down costs by

continuing the advance in productivity.

(3) Balance of payments--What significance is to be

attached to preliminary payments data for the first

quarter of 1965?

Preliminary payments data for the first quarter appear

encouraging. The restraint program has cut back bank

lending from the high rates reached late last year and in

the first six weeks of 1965. But too little is known about

other elements of payments and receipts to permit a judgment

as to how much and how lasting an improvement in the balance

is being achieved in comparison with the 1964 average.

The deficit on "regular" transactions appears to have

been roughly $2-1/2 billion, at a seasonally adjusted

annual rate, somewhat below the average rate for 1964 and

well below the fourth quarter rate. However, foreign

commercial banks made much smaller net additions to their

balances here than they usually do in the first quarter.

Consequently, on the "official settlements" basis the

first quarter deficit was very large--perhaps $3 billion,

annual rate, against last year's average of $1-1/2 billion.

There have been additional indications that net

outflows of U.S. private capital diminished sharply after

4/13/65

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the new balance of payments program was announced.

February statistics on long-term bank loans show a net

outflow of about $200 million, but the sharp drop in

new bank loan commitments after February 10 suggests

that most if not all of this net outflow occurred in the

first part of the month. Also, we have learned of the

cancellation or postponement of several nonbank loans and

inves:ments earlier planned. A number of large corporations

are reported to be letting their money market investments

abroad run off at maturity and to have told their European

subsidiaries that the latter must seek funds locally and

rely less upon United States financing. But no compre

hensive data beyond February are yet available on foreign

lending by banks, and none beyond January on liquid

asset holdings abroad of U.S. corporations. Data on

direct investment transactions during the first quarter

will not begin to become available for another month or

two. New foreign security issues sold here during the

quarter were at about the average rate for 1964.

The effects of the longshoremen's strike on

merchandise trade greatly complicate analysis of the

first quarter payments results. Exports slumped much

more sharply than imports in January-February, and the

trade surplus in those months was zero. Even though

exports are likely to have jumped up in March, the trade

surplus for the quarter must have been much below the

$7 billion annual rate of the fourth quarter, on the

trade statistics basis. On an actual payments basis,

too, the trade surplus was probably reduced, but it is

impossible to say by how much.

(4)

Bank credit and money.

A. What do recent developments in the major

categories of bank loans suggest for the

future course of lending activity?

The rapid bank loan expansion of recent months is

attributable not only to temporary factors--some of which

are still operative--but also to strong and continuing

underlying demands. While demands could slacken somewhatas a result of inventory liquidation following a steel

strike or settlement, for example--bank loan activity

over the next few months might still be expected to rise

at or above the late 1964 rates.

The dominant factor in recent bank loan developments

has been the sharp increase in business loans. Earlier

4/13/65

-29-

this year, the accelerated growth was due in large part

to temporary influences, particularly the dock strike,

the surge of foreign lending, and anticipation of a steel

strike. The first two of these factors receded in late

February and early March, and this was reflected in some

slackenirg in the business loan expansion.

Since then, loan growth has accelerated again.

Several of the industry groups recently showing the

strongest demand for bank loans also are markedly in

creasing their plant and equipment expenditures (e.g.,

food processors, chemicals companies, and certain metals

using industries). Since such expenditure programs will

be in process for many months, continued bank borrowing

by these industries may be in prospect. Also contributing

to near-term strength of loan demand is the need for

corporations to make partial payment on estimated 1965

tax liabilities in mid-April. On the other hand, borrowing

for steel inventory accumulation, which may have accounted

for close to one-fourth of the $1.1 billion rise in

business loans in March, could terminate after a few more

weeks. Borrowing by trade concerns, which also have been

making large additions to inventories, could also slacken

later in the spring.

Bank lending to consumers has been at a relatively

advanced rate in recent months, mainly reflecting high

rates of car sales. As the surge in auto sales abates

and after borrowing by individuals for income tax payments

is completed, some slackening frcm recent very high rates

of consumer credit growth at banks and elsewhere is

indicated.

City bank holdings of real estate mortgages have

increased at a considerably reduced pace so far this

year compared with 1964. Less bank interest in mortgages

and a leveling off in such financing demands appear to

be factors in this decline. A continuation of the recent

slower rate of acquisitions of mortgages appears to be a

reasonable assumption for the period ahead, particularly

in view of the strength of competing business credit demands.

B.

What factors have been mainly responsible for

the changing relationships among the rates of

expansion of total commercial bank credit,

time and savings deposits, and the money supply

in February and March?

4/13/65

-30-

In recent weeks, time and savings deposit growth

has slackened substantially from the high rate of increase

earlier in the year, while the money supply, though

fluctuating, apparently has begun to rise again. Bank

credit has continued to increase at an advanced rate.

Following the initial sharp inflow of time and

savings deposits in response to the introduction of

higher rates and new savings instruments around the

beginning of the year, the recent slackening was not

unexpected, as one-time transfers to time deposits from

other assets were completed. The slowing occurred some

what earlier this year than in 1957 and 1962--two previous

periods of substantial rate advances--probably because

banks adjusted their rates more promptly this time. In

addition, the advance in market rates of interest in

January and February may have created difficulties for

some banks in attracting CD funds even under the new

ceilings. Adverse publicity regarding CD losses in

recent bank failures also may have been a factor in

limiting net CD sales by smaller banks.

Accompanying the sharp rise in time and savings

deposits, the money supply declined from early January

through late February, but since then has moved higher

on balance. Temporary downward pressure on the money

supply, which was evident also early ir 1957 and 1962,

would normally be expected to accompany transfers of

funds from other assets, including demand deposits, into

time deposits.

But rapid growth in transactions needs

associated with the accelerated pace of economic activity

has helped stimulate a resumption of monetary expansion.

The first quarter increase in the private money

supply and time deposits combined, at an 8.8 per cent

annual rate, was about the same as in the fourth quarter

of last year. On the other side of the ledger, bank

credit expansion accelerated in the first quarter. The

difference in behavior is explainable in large part by

the sharp buildup in U.S. Government deposits in this

period.

The bank credit figures have reflected unusually

strong loan demands. Banks have been under moderately

increased reserve pressure, and have reduced their hold

ings of Governments and cut back on their acquisitions

of municipals and agency issues to help meet strong loan

demand. Nevertheless, a substantial increment of reserves

has been needed to accommodate growth in demands for bank

4/13/65

-31-

credit and deposits. About half of the reserve rise has

been provided through increased member bank borrowing,

and the remainder through a continued expansion in

nonborrowed reserves.

(5) Money market and reserve conditions--Assuming a

continuation of the monetary policy adopted at the last

meeting, what range of money market conditions, interest

rates, reserve availability, and reserve utilization by

the banking system might prove mutually consistent during

coming weeks?

Over the last week of March and the first week of

April, member bank borrowings at the Federal Reserve

rose to an average of more than $500 million and net

borrowed reserves averaged $130 million, as required

reserves showed more than usual strength. The Federal

funds market continued taut, and there was a slight

firming of bill rates in the early part of the period.

But a resurgence of bill demand in recent days has kept

the three-month bill rate in the 3.92-3.94 range. This

demand has been highlighted by seasonal buying on the

part of public funds, and also may have been enhanced by

corporate demand.

With net borrowed reserves above $100 million for

two successive statement weeks, the market is now beginning

to focus on the question of whether the Federal Reserve

has firmed policy somewhat further. This question is

being raised following some strengthening of the bond

market in reaction to the British budget and the reduction

in the French discount rate. The U.S. Government bond

market is in a fairly good technical position, however,

so that upward rate adjustments from a modest change in

expectations are likely to be minor. In the municipal

market the level of unsold inventories continues large,

but the calendar of new offerings is relatively light.

In coming weeks, continuation of net borrowed

reserves in the $100 to $150 million range would appear

consistent with Federal funds trading frequently at

4-1/8 per cent and with the emergence of some upward

pressure on bill rates.

Such upward pressure depends

importantly on continued strong bank loan expansion and

abatement of some of the recent special demands for bills,

since bill rates tend to be seasonally low at this time

of year. Firmness in money market conditions of this

order is unlikely to produce any appreciable upward rate

adjustments in the capital markets.

4/13/65

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In March, private demand deposits rose at a 6.7 per

cent annual rate, but these deposits seem likely to grow

more slowly in April.

Slowing appears especially likely

if tax collections from individuals (and to a minor ex

tent from corporations) are significantly larger than in

earlier years, although continued strong loan demand

could be an offsetting influence. While month-to-month

variability will undoubtedly continue to characterize

demand deposit growth, the money market conditions

postulated above would appear consistent with a rate of

increase over the next few months averaging around the

3.7 per cent rate of 1964.

Chairman Martin called next for the go-around of comments

and views on economic conditions and monetary policy, beginning

with Mr. Treiber, who made the following statement:

Business activity. The current business situation

is very strong. The first quarter of 1965 will probably

show one of the largest gains in overall output on record.

Even after allowing for some cutback in auto and steel

activity from the very high current levels, the outlook

is for h.gh and rising economic activity.

Reports from the steel industry suggest that lead

times for filling orders are now extended into June and

July, and that barring a quick wage settlement, the

present high levels of production should be sustained

at least through April and possibly May. While there

inevitably will be some downward adjustment in production

levels--but not necessarily in employment--in the

steel and auto industries, the latest indications suggest

a somewhat longer sustained period of strength than had

been thought possible a month or so ago. Any weakening

that might develop seems more likely to occur in the third

quarter rather than in the second quarter. There is good

reason to believe that the economy may turn in even a

better performance over the year than has generally been

projected.

Prices and costs. The step-up in industrial output

has helped to bring unemployment to the lowest level

since October 1957. There are more reports of shortages

4/13/65

-33-

of skilled workers in various occupations. Demands of

labor unions in current bargaining sessions are high,

but terms of settlement are customarily less than demands.

There has not yet been an increase in overall unit labor

costs in manufacturing. Profits have been well maintained.

Industrial wholesale prices continue their modest

upward creep. Producers are testing markets on a selective

basis. In the area of administered prices there continue

to be more increases than decreases.

The prospect of price increases is more imminent,

and the problem of keeping down unit costs is more

precarious, than they have been for several years.

Balance of payments. There has been a dramatic

improvement in the recent balance of payments figures,

which can be traced clearly to the voluntary restraint

program.

The March figures will probably show a large

surplus; yet that surplus is a good deal less than the

heavy outflows of February and January. In addition,

seasonal factors are customarily favorable in the first

quarter of a year; after allowing for them there is a

large deficit for the first quarter.

Much of the good showing in recent weeks is due to

large declines in the balances held by Canadian banks

with their New York agencies. Surpluses attributable

to a decline in short-term investments here by Canadian

banks in response to a loss of corporate time deposits

of U.S. concerns are not as important to the international

position of the dollar as surpluses resulting from trans

actions with Continental Europe.

So far this year the United States has lost more

than $900 million in gold; and we expect to lose more.

It is too early to evaluate fully the effect of the

new United Kingdom budget on sterling. Generally the

market response to the budget has been favorable; this is

all to the good. But, even if the budget proposals are

considered adequate, the longer-term position of the pound

depends heavily on further efforts to restrain cost and

price increases and to improve the competitive position

of the British economy. Hence sterling may remain quite

vulnerable in the short run and may be subject to repeated

periods of pressure.

Bank credit and money. In recent months, banks have

accounted for a larger share of total credit expansion

4/13/65

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than previously. Liquid assets held by the public have

continue to advance more rapidly than economic activity.

Bank credit continues its rapid advance. The pace

of advance in March exceeded that in January and February.

As in previous months, a broad-based business loan expan

sion has been the major contributor to the current strength

of bank credit. Figures for the first quarter of 1965

will probably show the largest advance in bank credit, in

both absolute and percentage terms, since early 1958. The

annual growth rate for the quarter just ended was 13 per

cent compared with the 8 per cent rate that had been

characteristic of most of the current expansion. Loan

deposit ratios have risen further, reaching post-1931

highs.

Loan officers of the New York City banks are impressed

with the strength of the loan demand. Two factors are

cited: first, after several years of financing investment

essentially from internal sources, more corporate treasurers

are now concerned with the need for cash for capital

spending plans; and second, bank loans are readily avail

able and relatively cheap. The present seems to be a good

time to borrow from banks, even as a protection against

future needs; there may be some expectation of lesser

availability and higher rates.

Recent surveys by the Federal Reserve Bank of New

York indicate a fairly widespread tightening of loan

terms, ircluding firmer rates, while at the same time

there has been a decline in the average interest rate on

both short-term loans and long-term loans. Apparently

prime-rate borrowers have been obtaining a larger

proportion of total loans.

The banks appear to be capturing an especially large

share of the total credit and deposit narket. The banks

have been able to improve their competitive position,

aided by rapid reserve growth. Total member bank reserves

grew at an annual rate of 8 per cent in the first quarter

of 1965 compared with 4.3 per cent in the first quarter

of 1964 and 4.2 per cent during all of 1964. The rapid

reserve growth has been accomplished in part by increased

borrowing from the Reserve Banks.

Money market and reserve conditions. Money market

conditions have been firm. The growth in bank credit and

deposits has been especially rapid in the light of these

-35-

4/13/65

money market conditions. The rapid growth has necessitated

frequent upward revisions in our estimates of required

reserves. Despite the heavy demands for funds by the

public and despite a general firmness in other money market

rates, the demand for U.S. Treasury bills has been strong

and rates on the three-month bill have remained several

basis points below the discount rate. We do not have a

complete explanation for the strength of the bill market.

But it does seem to be due in some measure to the invest

ment demand by business concerns that have withdrawn

deposits from abroad and by public bodies seeking the

temporary investment of tax monies.

On or about Wednesday, April 28, the U.S. Treasury

will probably be announcing the terms of its proposed

financial operations to refund the Treasury issues that

mature May 15, about $4 billion of which are held by the

public.

Credit policy. The current financial situationboth international and domestic--counsels some reduction

in the rate of growth of bank credit and some upward pres

sure on the Treasury bill rate. To meet these objectives

might require net borrowed reserves in a range of $50-$200

million.

While in recent weeks net bcrrowed reserves were

higher than expected, they were not inappropriate in the

light of the large expansion in bank credit. I would

suggest that our objective in the next four weeks, until

the next meeting of the Committee, be to maintain about

the same degree of firmness in the money market as has

existed in recent weeks.

I like the draft of directive prepared by the Staff.1/

Mr. Ellis remarked that perhaps the most notable aspect of

economic strength in New England was its generality.

Manufacturing

employment in almost all industries was strong, as were output and

capital spending plans.

1/

Service employment, while slackening in

The draft directive is appended to these minutes as Attachment A.

4/13/65

-36

February, had been a steady source of expansion; and construction

activity, paced by accelerated housing construction, especially of

apartments, had continued to provide strength.

With hours of work

rising, construction contracts rising, and new orders exceeding output,

the evidence was persuasive that the region was participating widely

in the national prosperity.

The same might reasonably be said of the First District banks

also.

Business loan demand remained strong, with District banks re

porting greater strength currently than the national pattern.

Perhaps

the evaluation by those banks of prospective loan demand reflected

their tighter position.

In spite of deposit growth that paralleled

the nation, the average loan-deposit ratio for weekly reporting First

District banks stood at 72.9 per cent compared with 68.4 per cent for

the nation.

Except for two weeks in January, New England reporting

banks had been net borrowers in the Federal funds market since early

December, and borrowings from the Reserve Bank had averaged slightly

higher in recent weeks, in the national pattern.

The two banks using

unsecured notes had gradually expanded their outstandings to a total

of $68 million.

Turning to monetary policy and the questions proposed by the

staff for discussion, Mr. Ellis noted the first question posed was

what recent developments suggested in terms of future developments.

Given the major impacts of the auto strike last fall, the dock strike

4/13/65

-37

in January, and the expectation of a steel strike, his reaction was

that the underlying strength of the economy must have been and

continued to be substantial to withstand the effects without spinning

off into inflation or tipping into recession.

That underlying

strength was reflected in the breadth of industries expanding output

and capital outlays and in the breadth of business loan demand.

This

basic attitude led him to expect continuation of strong business

conditions throughout 1965, with an expected dip traceable to the

steel settlement whether or not there was a strike.

The second question, Mr. Ellis observed, related to prices

and costs.

He agreed with the staff response, to which he would add

that there did not seem to be much evidence that rising labor costs

were having sufficient upward pressure to force upward price adjust

ments.

However, the strength of demand kept producers looking to see

if they could make price increases stick were they to announce them.

In short, the situation was very competitive, as it should be.

As to the question on bank credit and money, particularly the

changing relationships between bank credit expansion rates and deposit

trends, Mr. Ellis thought the staff memorandum fell short on explaining

why a pickup in credit expansion could be associated with no change in

the rate of growth of total deposits.

He suspected that an explanation

on a short-term basis was bound to be frustrating because what was

known about such relationships suggested multiple causations of variable

4/13/65

-38

consistency and strength.

He was inclined to look at a single month's

figures as be:ng merely confirmatory of previous trends or as a first

indication that a previous trend was changing.

From this viewpoint,

March data substantially confirmed the pre-existing trend of sharp

expansion in bank credit.

The numbers seemed to say that the first

quarter bank credit expansion averaged 13 per cent, annual rate, com

pared with 7 per cent for the fourth quarter of 1964 and perhaps

9 per cent for the year.

March data also confirmed that loan demand

was strong enough for such expansion to take place in spite of a

lessened availability of reserves.

The over-riding question was

whether the Committee was prepared to continue feeding in reserves to

support such a trend.

The last question, Mr. Ellis continued, asked the Ccmmittee to

postulate what range of money market conditions, interest rates, reserve

availability, and reserve utilization might prove mutually consistent if

the Committee were to continue the monetary policy adopted at the last

meeting.

Without knowing the exact strength and duration of the factors

that were causing the divergence between bill rates and what might

ordinarily have been expected in their trend in relation to other money

market measures, it would seem appropriate to move slowly though probing

actions to test out the effect of the Committee's moves toward attaining

higher bill rates.

Unless the bill rate were to move to perhaps

4.05-4.10 per cent, an upward move would not be likely to produce

4/13/65

-39

disturbing changes in the long-term market, nor should it lead to

expectations of a change in the discount rate.

If reflow-of-funds

pressure continued, net borrowed reserves near $150 million or more

might be required.

This would increase the frequency with which

Federal funds traded at 4-1/8 per cent, along with continuation of

the relatively high dealer loan rates and member bank borrowings at

about $450 million or above.

At the same time, probing toward $150

million net borrowed reserves would help slow the expansion of bank

credit.

With this objective in mind, Mr. Ellis favored continuation of

the monetary policy adopted at the last meeting of the Committee.

He

would renew the existing directive, with its instruction to conduct

operations "with a view to attaining slightly firmer conditions in

the money market," and he would probe toward net borrowed reserves of

around $150

million.

If the short-term bill rate tended to push above

4.05 per cent, he would be prepared to reverse direction as necessary

to forestall an abrupt cumulative effect of lowered reserve availability

if the supply of repatriated funds were to dry up suddenly.

Mr. Irons said that Eleventh District economic conditions

continued very strong and followed generally the pattern in effect over

the nation.

There had been little change from the conditions of three

weeks ago except that the expansion had continued and the figures were

at higher levels.

It seemed to him that prospects were favorable for

4/13/65

-40

further exparsion and for a high level of business activity throughout

the year.

With perhaps a little dip, the steel and auto situation

might well iron itself out.

In view of the high level of activity experienced and the

indications of further increase, it seemed strange that the imbalances

were so minor.

Prices, according to the indices, seemed to have

shown a rather high degree of stability.

There had been substantial

inventory accumulation, but probably not as substantial or damaging

as might have been anticipated in view of the dragging out of the

steel wage negotiations.

The steel and auto problems were still ahead,

but he was inclined to feel that the steel settlement might not be as

upsetting as had been thought.

He was not sure about the sustainable

level of auto consumption; it seemed to move up from level to level.

People liked automobiles and had the money to buy them, and a much

higher level might prove sustainable than many would have believed a

year ago.

Certainly the production of all goods and services was

running very high, and consumption was also high.

Mr. Irons observed that the demand for credit was exceptionally

strong.

could.

Banks were reaching for funds and deposits in any way they

Some banks seemed to be operating on a "planned deficit basis,"

presumably with the idea of coming to the discount window temporarily

if they got caught.

Many member banks in the Eleventh District were

less liquid than they were not too long ago.

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4/13/65

Mr. Irons got the impression in talking with bankers that

there had been a change in the quality of credit.

He was told that

while they had not changed their rates per se, they were negotiating

rates upward with individual customers wherever possible.

In their

judgment the quality of credit, all things considered, was not as

high as a year ago.

He understood that thi, question was considered

informally at the recent meeting of the Reserve City Bankers

Association, with general agreement that there had been some degree

of deterioration in credit quality.

As far as the international payments situation was concerned,

Mr. Irons noted that apparently there had been some improvement.

However, the available figures were scattered and hard to interpret

in the light of various developments, so he did not think one could be

sure just what was happening that might lead toward a basic improvement

in the balance of payments.

It might be two or three months before

a solid appraisal could be made.

During the past three weeks, Mr. Irons pointed out, there had

been a moderate firming in money market conditions, and he would be

inclined to continue the conditions that had prevailed.

It would seem

well to watch closely what went on over the next four weeks and maintain

policy as it was.

With considerable leeway for a margin of error, he

would be inclined to think that if net borrowed reserves fluctuated

around $100 million, this would probably be in order, with Federal

4/13/65

-42

funds more often at 4-1/8 per cent.

4 per cent would not worry him.

A Treasury bill rate under

As long as the bill rate caused

no more trouble than it had caused over the past month, he did not

know why there should be a particular objective of getting it up.

A range from around 3.95 to 4.05 would seem satisfactory.

He would

expect borrowings to average around the $450 million figure, and at

certain times rise higher.

He would want to avoid any change in

conditions that would put pressure on the discount rate, which he

would not like to see increased at this time.

On the directive, Mr. Irons did not favor the staff draft.

He preferred that the Committee not change policy but maintain the

degree of firmness of the past few weeks.

Therefore, he would use

the first paragraph of the current policy directive, which he found

more understandable than the staff draft, while changing the second

paragraph of the draft directive so as to call for open market operations

over the next four weeks to be conducted with a view to "maintaining

the slightly firmer conditions in the money market that have prevailed

in recent weeks."

Mr. Swan reported the general tone in the Twelfth District

seemed to be one of underlying strength, apart from the continuing

question of the course of defense and space-related employment, lack

of strength in residential building, and concern about some aspects

of agriculture.

In the lumber industry, which was affected by the

4/13/65

-43

residential building picture and the weather in other parts of the

country, orders were up in the last half of March but were still

somewhat slow, and prices remained soft.

On the other hand, heavy

construction was strong indeed in the District.

Mr. Swan remarked that he had been going to comment on the

dividend rate changes announced by some Southern California savings

and loan associations, but that had been covered in the green book.

Strength in loan demand was evident at Twelfth District banks, although

the major banks still were not under marked pressure.

They continued

to be net suppliers of funds to banks and securities dealers.

Although borrowings from the Reserve Bank were up a little in the

week of April 7, they still were not large.

On the other hand, one

of the larger banks had indicated that inquiries from smaller and

newer banks regarding the purchase of loans had risen considerably.

To some extent this might be a result of depositors' reaction to the

special situation in the Twelfth District; to some extent it might

reflect real tightness apart from losses of deposits.

Mr. Swan said he was in general agreement with the staff comments

on the economic and financial questions.

In terms of policy, he doubted

whether he could do better than to say that he agreed with the remarks

made by Mr. Irons.

In view of the strength of the current situation he

would continue present policy, but in view of the uncertainties he would

not like to see any further tightening or any probing in that direction

4/13/65

-44

for the next four weeks.

In terms of a definition of continuation of

the same policy, he agreed with the figures Mr. Irons had given.

He

favored putting no pressure on the discount rate, and he would be

happy if the bill rate did not go above 4 per cent at all.

He still

thought it possible that there would be a little increase in the bill

rate; in fact, he was surprised that there had not been more upward

pressure in the past three weeks given the lesser degree of reserve

availability.

Mr. Swan said he had the same comments on the directive

Mr. Irons.

as

When he read the first paragraph of the draft directive,

he thought it was going to lead into a move toward a tighter position

in the second paragraph.

He did not think the two paragraphs matched

up well, and therefore he would go back to the first paragraph of the

existing directive.

Mr. Strothman, on commenting on developments in the Ninth

District, said it was necessary to distinguish between the agricultural

and the nonagricultural sectors.

The agricultural economy seemed to be

doing rather poorly and prospects were not encouraging.

Farm prices

were still low, and in addition a particularly severe winter had hit

some parts of the agricultural economy very hard, raising costs and

reducing the prospective calf crop.

Nor could it be expected that

agricultural business would prosper this spring.

The most recent

Reserve Bank survey indicated that businessmen in rural areas were

expecting a less-than-normal spring expansion.

4/13/65

-45

However, expectations as to the District's nonagricultural

economy were for a better-than-average sprng.

This was what survey

respondents reported, and what preliminary labor market and output

statistics strongly confirmed.

Strong increases in construction

activity and retail sales, held back by a decidedly wet and cold

March, would help appreciably.

If there was any real bleakness in the Ninth District outlook,

it was for the longer term, Mr. Strothman continued.

There was the

possibility that the rate of economic expansion currently being enjoyed

would not be continued in the second half of 1965.

Present inventory

positions, for the most part of finished gods, were suggestive of this.

And a high enough

level of spending for business plants was becoming

somewhat less certain.

Loan expansion at District member banks continued to be impressive.

Among weekly reporting banks the January-March 1965 increase in loans

was far greater than seasonal, and so was the March increase taken by

itself.

Moreover, increases in commercial and industrial loans had

continued to lead the way.

Of course, Mr. Strothman said, the March increase in total

credit of weekly reporting banks, still stronger than seasonal, was

not as impressive as the increase in loans outstanding, for those banks

reduced their investments rather sharply, as did the nonweekly reporters.

The latter also appeared to have been faced in recent months with

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4/13/65

heavy loan demands.

Their loans outstanding increased through March

and over the first quarter of 1965 much more than seasonally.

It

appeared, however, that country bank loan demand had differed some,

at least in motive, from city bank loan demand.

Continuing high-level

country bank loan demand had to be explained, in some considerable

measure, by an unfavorable agricultural situation.

In closing, Mr. Strothman noted that the largest banks in the

Twin Cities area reported a firming in the loan market.

Whether for

good or bad, the cost of business loans had evidently increased slightly

in recent months.

Mr. Scanlon said he concurred with the staff judgment that an

upward trend in overall activity was likely to be maintained even

though

important sectors might experience substantial setbacks.

Steel producers in the Chicago and Detroit areas had been unable

to increase output appreciably since the start of the year, Mr. Scanlon

commented.

Mill inventories of finished steel were now declining; at

the manufacturing level, however, steel inventories were rising rapidly.

His observations regarding the steel and auto industries were similar

to those that had already been made.

Overall, it did not appear that

declines in output of steel and autos would do more than slow the advance

of aggregate economic activity in the months ahead.

Measures of employment and unemployment had continued to show

improvement in recent weeks in the Seventh District.

Unemployment

4/13/65

-47

rates in all District states continued well below the national average.

The volume of help-wanted ads for the Chicago area, seasonally adjusted,

had risen sharply in recent months and had now passed the level for

January 1957, which was the previous high on record.

Overtime had

increased in many industries since last year, and employment increases

had been fairly general.

Those developments were indicative of

greater pressure on the labor market and doubtless tended to increase

unit labor costs.

As the staff had noted, what lay ahead might be

determined largely by the adaptability of the labor force.

Doubtless there had been some moderate strengthening of upward

price pressures in recent weeks, Mr. Scanlon said.

Increases had

occurred for a number of commodities, although a number of declines

had been posted also.

On the balance of payments, Mr. Scanlon agreed with the comment

that too little was known to attach great

first quarter.

significance to data for the

Even a complete set of figures on the performance of

the first quarter could not be taken as significant and fully indica

tive of U.S

progress.

More time must be allowed for a reversal of

what had been a long-run trend in some of the accounts, and for a

sorting out and evaluation of the several unusual and nonrecurring

factors.

The Chicago Reserve Bank's analysis of probable loan trends

came out essentially at the same place as the staff analysis,

4/13/65

-48

Mr. Scanlon commented.

On balance, he felt that loan demand might

ease substantially after mid-April.

While he had little to add to the staff's explanation of

the changing relationships among bank credit, money, and time deposits

in recent months, Mr. Scanlon found it disconcerting to note the very

strong role attributed to changes in Regulation Q.

He thought the

changes had been effective, but not to the extent some apparently

believed.

On morey market and reserve conditions, Mr. Scanlon observed

that present policy was directed toward achieving slightly firmer

money market conditions than had existed before the last Open Market

Committee meeting.

While free reserves had declined and borrowings

rose, most money market rates changed only slightly in this period

of continued strong credit demand.

This seemed to him to leave open

the question whether the somewhat firmer money market conditions

specified in the directive had been achieved.

While he did not mean

to imply that the Desk had not done everything it should, he found

it difficult to reconcile the absence of more rate changes.

Chicago banks, Mr. Scanlon noted, remained in a relatively

comfortable reserve position for this time of year.

While New York

banks had continued to build up their outstanding certificates of

deposit rapidly, after adjusting for tax runoffs, those of Chicago

banks were still below their pretax date level.

Accommodation of

4/13/65

-49

the heavy credit demand at near-stable interest rates in March

resulted in continued rapid increases in total reserves, bank credit,

and total deposits.

As to policy, Mr. Scanlon favored striving to maintain the

slightly firmer conditions that had recently prevailed.

He would not

back away from

The positive

the position the Committee had attained.

statement in the draft directive about an improvement in the balance

of payments seemed to him a bit premature.

He would be satisfied

with the present directive as revised by Mr. Irons, also making refer

ence in the second paragraph to the impending Treasury financing.

Mr. Clay commented that the most noteworthy aspect of the

domestic economy was its impressive performance in absorbing the

strong surge of demand resulting from the automobile and steel contract

disputes and the rather broadly based general demand for goods and

services.

When consideration was given to the advanced stage of the

business upswing, the predominantly orderly developments in prices,

manpower. and industrial capacity were worthy of more than passing

notice.

The economy continued to be faced with important uncertainties,

Mr. Clay added, concerning some sectors of the economy, notably steel

and autos, and their impact on the aggregate level of economic activity,

as the staff statement analyzed effectively.

There was no way of

foreseeing the shape of those developments, but it was apparent the

4/13/65

-50

economy would need to absorb reductions of uncertain magnitude in

those sectors.

The economy did have substantial underlying strength

and its advance was broadly based, however.

While the trend of

productivity .n the manufacturing sector was favorable, the labor

contract settlements and commodity pricing resulting therefrom remained

the most serious threat on the price level front.

Obviously, it could not be known with any high degree of

accuracy what was happening to the international balance of payments

in view of several factors distorting the data and the incompleteness

of the more recent data.

encouraging side, however.

The limited evidence available was on the

So far as the payments balance was con

cerned, it was only reasonable to give time for the effects of the

present program to unfold within the existing framework of monetary

assistance.

Reserve availability had shifted considerably in recent weeks,

Mr. Clay noted.

While bank credit growth was still rapid, the role

of borrowed reserves had increased substantially.

The level of

interest rates had not changed much recently, but interest rates

already were high by historical comparison.

While judgments might differ as to the appropriateness of

moving toward a tightening of monetary policy, judgments presumably

did not differ as to the desirability of avoiding abrupt tightening

action.

System experience certainly demonstrated the importance

-51

4/13/65

of that position.

In view of the fact that interest rates were, as

already indicated, high by historical standards, it became particularly

important to be mindful of the degree and pace of reduction in credit

availability.

This was especially true inasmuch as the domestic

economy continued to grow in productive potential, which would permit

further orderly expansion in real output, assuming a satisfactory

settlement of the crucial steel labor contract negotiations.

In view

of the recent actions taken in the balance of payments area, it would

seem logical to await further observations of their effects, while

maintaining a monetary policy conducive to domestic economic growth.

For the period ahead, Mr. Clay felt that money market

conditions generally should continue essentially unchanged.

While

the Treasury bill rate should be permitted to rise toward the discount

rate if market forces brought that about, reserve availability should

not be further reduced in an effort to produce that result.

He

favored no change in the discount rate.

Mr. Clay agreed with those who felt it desirable to retain

a directive similar in the first paragraph to the outstanding directive,

with changes such as suggested by Mr. Irons in the second paragraph.

Mr. Wayne reported that business developments in the Fifth

District had approximately paralleled those in the nation.

In banking,

commercial and industrial loans in the District since the first of

the year had followed the recent seasonal pattern closely, whereas

4/13/65

in

-52

the country as a whole they had been much above that pattern.

This

was probably accounted for by the lesser importance of steel and

automobile production and foreign lending in the District.

Turning to the staff questions, Mr. Wayne said he would

incorporate comments without referring directly to each question.

Business activity in the nation seemed to be following the same trends

that were evident three weeks ago.

Inventory accumulation, especially

in steel and related industries, seemed to be restrained by limits

of productive capacity and unusually high consumption.

This meant

that if there was no steel strike the period of adjustment might be

shortened because the amount of inventories to be liquidated would

be smaller except to the extent that the present high level of con

sumption was due to the anticipation of a strike.

If there was a

strike, the fact that inventories were less than had been planned

would mean that steel-using industries would have to curtail activity

sooner as their supplies of steel were exhausted.

Such a slowdown

would cause a more rapid spread of the effects of the strike and might

well strengthen demands for political action to bring the strike to

an end.

Mr. Wayne noted that as the level of industrial production had

moved up in recent months, unit labor costs had declined somewhat

despite a rise in overtime with its higher labor costs.

Whether the

decline would continue in the face of a growing scarcity of skilled

4/13/65

-53

labor remained to be seen.

On the other hand, the prices of

industrial raw materials, which had drifted downward or held steady

between the end of October and the middle of February, had again been

moving up.

In the past two months the raw materials component of

the daily index had risen about 5 per cent.

Thus, the effects of

those two items seemed to have partially offset each other, the extent

depending on the cost structure of a given industry.

It seemed to Mr. Wayne that it was much too early to assess

the significance of balance of payments data for the first quarter

of 1965, which at this stage were quite fragmentary.

Even if complete

and detailed data were available, a careful and extended analysis

would be necessary to determine their significance in view of the

dock strike, the heavy outflow of funds before February 10, and the

voluntary restraint program since then.

In the meantime, there might

be some small basis for optimism in the continuing good progress of

the voluntary restraint program, the absence of covered flows of

funds to or from Europe, and some easing of credit conditions in

France and Italy.

Several factors suggested to Mr. Wayne that the unusually

rapid rise in bank loans might come to an end before long.

The effects

of the dock strike were receding, foreign lending had been greatly

reduced, the accumulation of steel inventories would reach a peak

soon, and the growth of automobile inventories would likely slow

4/13/65

down.

-54

The combined effect of all those factors should soon be

apparent in a slower rate of growth, or even, a temporary decline in

bank loans.

Higher rates on time and savings deposits, Mr. Wayne observed,

especially on certificates of deposit, had been a major factor in

changing the relationship between bank credit and the money supply

in recent months.

Those higher rates had apparently enabled commercial

banks to divert substantial amounts of new savings away from savings

and loan associations and the funds so obtained had been used to

make loans.

In the policy area, Mr. Wayne said, the indicators told that

money market conditions showed only minor changes from three weeks

ago despite progressively larger net borrowed reserves.

The growth

rates of total and nonborrowed reserves declined a little in March

but in both cases the absolute amount continued to rise.

The bill rate

had risen a little in the past three weeks, probably due in part to

an increased supply, but was still well below the discount rate.

If

it were not for impending Treasury refundings, the nature of loan

demand, and a good probability of its easing within the next month,

a further distinct move toward less ease might seem advisable.

As it

was, however, he believed that the Committee should retain its

present posture and keep the market steadily firm at about its present

level.

No change in the discount rate seemed appropriate now.

The

4/13/65

-55-

draft directive, including the first paragraph, appeared satisfactory

to him.

Mr. Robertson made the following statement:

Business activity is continuing at a very high rate,

with gratifying large recent increases in employment and

as yet no inflationary break-out of price increases, but

also with some clearly unsustainable rates of output in

a couple of major industries.

I remain optimistic that we can move through this

period without need for any major change in monetary

policy. But a key factor shaping the future course of

business will be the outcome of the steel wage ne

gotiations. A reasonable settlement ought to add to

the longevity of this already record period of non

inflationary peacetime expansion. On the other hand,

there is no gainsaying the possibility that an outsize

steel wage contract and accompanying price increase

might give rise to ramifying wage and price advances

in numercus other sectors of the economy where activity

is already high. The formal contract termination date

is now only 2-1/2 weeks away. Either a strike or a

settlement by that date would halt or reverse the

pressure of steel inventory accumulation. A temporary

contract extension would delay and perhaps even

aggravate the adjustment, but I see no substitute for

simply waiting to see how the issue is resolved.

Fortunately, a "wait and see" attitude also seems

quite appropriate to the international financial

situation. That there has been an improvement in

our situation since mid-February is undeniable; the

real imponderable is how long-lasting that improvement

will be. Here, too, only time will tell.

It does seem to me that the domestic credit expansion

accompanying these developments has been rather large.

Although a variety of factors help to explain this

credit rise, I do not want to be overly critical of the

size of the net borrowed reserve figures that developed

these past few weeks as banks kept putting more reserves

to work than we were expecting. Having moved to a more

restrictive policy at our last meeting--and believing

it unwise to shift back and forth too frequently--I

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4/13/65

would not object to a directive holding to the degree

of tightness achieved since the last meeting, so long

as the pressure of bank loan expansicn continues very

strong. Such a posture should also suffice as an

"even keel" during the Treasury financing period that

will occupy about half the time between this meeting

and next.

I would caution, however, against giving any special

attention to the three-month bill rate as a policy

target at this time. I cited my reasons for this feeling

at the last meeting, and I will not take time to re

iterate them here, but I feel them every bit as strongly

today as I did three weeks ago.

With these views, I would vote to approve the current

directive to the Manager as drafted by the staff if

the last sentence of the first paragraph were altered

to substitute "support" for "reinforce," and the last

two lines were left as they were. The changes suggested

by the staff seem to contemplate a further move toward

"reinforcing" or "moderating" that is not in accord with

a policy of "no change" as set forth in the proposed

last paragraph.

Mr. Shepardson remarked that the reports and comments so far

all seemed to agree that there was a high level of economic activity,

rather broadly based, recognizing the disturbances that might come

from the steel situation at some point in the near future.

The expansion

of credit seemed to go on at a higher rate than could be justified

over a long period of time.

The international situation, as several

had commented, seemed to be improving, but because of many conflicting

factors there was no definite answer as yet.

With all these things in mind, it seemed to Mr. Shepardson

that the policy the Committee adopted at the last meeting continued

to be appropriate.

In his judgment the Committee should press for

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slightly firmer money market conditions.

The actions of the past

three weeks hd been constructive, but he did not think the Committee

had probed as far as it might.

He was not in favor of any drastic

change, but he would favor probing toward a somewhat firmer position,

He agreed with the comments made about the draft directive as written,

for it seemed to him that the first and second paragraphs were not

consistent.

The first paragraph seemed to lead up to a continuation

of the attempt to achieve slightly firmer conditions, which he would

support.

If the impending Treasury financing would be impaired,

however, by not assuming an even-keel posture, then the maintaining

of present conditions might be required.

His personal preference

would be for the staff directive as written, with one minor change in

the first paragraph, unless that was inconsistent with the Committee's

usual policy of even keel during periods of Treasury financing.

If

it was inconsistent, he would be willing to go along with a directive

that called for maintaining the firmer money market conditions that

had prevailed in recent weeks.

Mr. Mitchell made the following statement:

At the last meeting I raised the question whether we

should, in light of the voluntary foreign credit restraint

program, regard a widening of the differential between

foreign and domestic interest rates brought on by rising

interest rates abroad as a reason for monetary tightening

by this Committee.

Fundamentally, I seriously doubt that, in the

environment of the mid-20th century, one is justified

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in assuming that capital flows between reserve currency

countries and their major trading partners and the

attendant balance of payments surpluses and deficits

which they generate can be adequately regulated by

adjustments in the monetary policies of the countries

involved.

The "stop-go" experience of the U.K. and the

recent reaction of exchange markets and their par

ticipants to the "crisis" bank rate in the U.K. and

the bank credit squeeze there add to the accumulating

bulk of evidence that the creation of artificial monetary

stringency is neither a sound nor practical way to

curtail capital outflow.

There is some logic in the presumption that a

country that is enjoying a surplus on current account

might benefit domestically from a somewhat easier

monetary policy, and that a country that is suffering

from a deficit on current account might be encountering

internal developments which would call for a tighter

monetary policy. Unless there are chronic maladjustments

of exchange rates, it is reasonable to assume that the

deficit country is erring on the side of ease and/or

the surplus country is erring on the side of tightness,

and that an appropriate adjustment by one or the other,

or both, would redound to everyone's benefit. There are

important exceptions to this logical sequence, even when

it is related only to the current account. When it is

extended, as it too often is, to the overall balance

including capital account transactions, it loses all

realistic logic.

It simply is not true that the capital exporter,

when his current account is in surplus or balance, would

necessarily benefit from the tighter monetary policy which

would be needed to bring his overall account into balanceand there is no prima facie reason to believe that the

capital importer, when his current account is in deficit,

would be better off with an easier monetary policy. This

would only be a valid logical conclusion if capital

were employed with the same intensity in all countries

in the first instance, and if the rates of saving were

approximately equal thereafter. That this is not the

case in the world today, even among the so-called

developed or industrialized countries, is obvious.

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The conclusion is also inescapable. Overall re

striction of credit growth is not a desirable or even

a feasible way to deal with our capital outflow problem.

It is not, as is often said, a fundamental or basic

approach.

The determination of the precise response of saving

in the U.S. to changes in interest rates is not presently

within our analytical capacity. But we do know one

thing. In recent years the flow of financial saving

here appears to have been significantly responsive to

the rate paid to savers. Hence, any effort to reduce

the flow in credit markets by more restrictive monetary

policies is offset, in part, by a diversion of the flow

of current income away from consumption and durable goods

expenditures into credit markets. Hence, we have every

reason to expect that the restrictive impact of a "tight

money" policy would be to reduce the relative profit

ability of investment in the U.S., slow up the rate of

domestic expansion, and not curtail substantially the

flow of funds seeking investment outlets abroad. Only

by bringing domestic activity to a virtual standstill

for a good many years could we hope to produce changes

in the basic rate of return on investment which would

"naturally" stem the outflow of capital. These are

the hard, basic facts that people are reluctant to face.

Tight money is not the "traditional" solution to a

capital outflow occasioned by intensive capital application

in one area, as compared to another. It is no solution

at all.

Then what can we do? In the longer run, we must

establish controls over capital outflows that do not

have to be "backed up" or "reinforced" by tight or

tighter money. Interest rate differentials are bound

to persist for some time between the U.S. and other areas

which are not as intensively capitalized, and which

have much lower savings rates than we do. We simply

must control this capital outflow so that we can "feed

out" capital to the rest of the world at a reasonable,

sustainable rate, compatible with our current account

surplus and foreigners' willingness to hold dollars.

This mechanism of control must be such as not to inter

fere with the availability of credit for continued

expansion in the United States.

The program we are now following for reducing the

U.S. balance of payments deficit relies on restricting

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the supply of dollars flowing abroad in various capital

transactions. The Federal Reserve's task is to cut

the outflow of bank loans. The Commerce Department

aims at corporate investment--both liquid and fixed;

that program may well be involving not only a slowdown

in the rate of outflow of U.S. funds but actual

repatriation of liquid balances by American corporations.

The entire program is a conscious attempt to reduce

the supply of dollars to the rest of the world by means

other than raising interest rates in the United States.

It rests on the soundly based fact that the advance in

interest rates necessary to eliminate that balance of

payments deficit would have had to have been so large

as to seriously injure domestic prosperity. A second

good reason for avoiding an increase in U.S. interest rates

as the instrument for reducing capital outflow is that

such action was much more likely to lead to an escalation

of interest rates throughout the industrialized world.

Whatever the technique we use to reduce capital

outflow, the result will be a tendency for interest rates

abroad to rise. This is a natural reaction to a reduction

in the supply of funds going from the United States to the

rest of the world. In fact, if rates abroad did not tend

to rise, we would have reason to doubt that our program

was being effective.

Now, if we had adopted the technique of raising

rates here--and assuming this action were successful in

cutting the outflow of capital--the consequent advance

in rates abroad would tend to undo the effect of our

initial increase in rates. Thus we would feel an

incentive to raise rates here again in order to maintain

the inducement for reducing capital outflows. In light

of our experience thus far in trying to cope with the

balance of payments deficit, it is easy to imagine an

upward ratcheting of interest rates back and forth

between the United States and Europe, to levels far

above those appropriate for a healthy domestic economy.

The great virtue of our present program is that

the natural reaction abroad--a tendency for rates to

rise--does not weaken the force of our own measures,

as would happen if we had used the interest rate weapon

in the first place.

The increase in rates abroad has appeared mainly

in the Euro-dollar market. This impact should be

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recognized as a favorable indication that our program

is biting. In view of the nature of our program, this

rise in Euro-dollar rates in no way requires a rise

in interest rates in the United States.

What we should look for are the further reactions

in Europe to this advance in Euro-dollar rates. In

the Euro-dollar market, our program is leading to a

reduced supply of U.S. funds and an increased demand

by foreigners who might otherwise have borrowed in the

United States. How will this help our balance of

payments and, in particular, how will it reduce official

dollar holdings in Europe?

There are various ways in which the higher Euro

dollar rates can act to reduce official dollar balances.

One way would be direct placement of dollars in that

market by European central banks. A second way would

be a diversion by European commercial banks of dollar

accretions into the Euro-dollar market instead of to

their own central banks. A third way would be that

European borrowers who had been tapping the Euro

dollar market will now borrow at home. If they need

dollars, they will acquire them in their own markets,

reducing the flow of dollars to their central banks;

if their need is for their own currency, their switching

from the Euro-dollar market to domestic sources of funds

will shut off a flow of dollars that previously went to

their central banks. (This is what is happening in the

U.K. to the extent that local authorities are repaying

Euro-dollar loans and refinancing in sterling.)

By these and other channels, our program will

tend to reduce the dollar buildup in foreign official

holdings. And, it should be noted, none of these

channels requires an increase in interest rates in the

United States. Each type of reaction results from the

cut in the supply of U.S. funds. As long as our program

is effective in reducing this supply, there is no case,

from the balance of payments side, for also raising

rates here.

Turning to the domestic situation, Mr. Mitchell said he was

disturbed about the effect on the economy generally of the beginning

of steel inventory liquidation.

He thought there was a tendency to

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underestimate the shock effect of this operation and that the economy

was a little more exposed to a cessation of growth, if not a small

downturn, than might be assumed.

The economy had only just now achieved

a reduction in the unemployment rate to 4.7 per cent, and he thought

the U.S. ought to be able to achieve a higher utilization of resources

while absorbing a balance of payments constraint.

He agreed with

what Mr. Irons and others had said about not giving too much attention

to the bill rate and felt that the Committee ought to be giving more

attention to the level of total reserves.

The longer-term market

may not have assimilated the change in policy at the Committee's

last meeting, he added, and in this sensitive area the adjustment

might have still some way to go.

Mr. Mitchell preferred the first paragraph of the existing

directive and a second paragraph along the lines suggested by

Mr. Irons.

Mr. Daane said he felt that the Committee's present policy

posture was clearly appropriate on both domestic and international

grounds and in terms of prospective developments, even if one made

the assumption that the economy possibly had passed the overheating

point.

In short, he was pleased that the Committee stood where it

did in its firming of money market conditions and its general policy

stance.

His general predilection against quantification and being

too precise as to targets had been reinforced in recent weeks by

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consideration of the problems encountered and dealt with successfully

by the Account Manager, so he would not want to set a precise reserve

target for the next month.

Nor would he wait to make a special effort

to bring the bill rate up to any higher level, although he would

be happy if it were to rise a few basis points.

The imminence of

Treasury financing reinforced the idea of a steady course in policy

and open market operations.

The Committee could not be oblivious to

the fact that there would be a Treasury financing of substantial

magnitude during the period prior to the next meeting.

In summary.

he would try to stay steady in terms of the tone and feel of the

market, recognizing that this might be difficult in light of the

growing market feeling that the Committee was in process of effecting

a change in policy.

On the directive, Mr. Daane said he shared the dissatisfaction

of those who did not like the suggested new first paragraph.

He

would prefer to retain the first paragraph of the present directive,

and he would accept Mr. Irons' suggestion for the second paragraph,

which would call for maintaining the slightly firmer money market

conditions that had prevailed in recent weeks.

Mr. Hickman said that in considering his answers to the

questions suggested by the staff he had drawn heavily on views ex

pressed at a Fourth District Economists Round Table held at the

Cleveland Bank on March 26, in which 23 economists participated.

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With reference to the first question, recent developments in

steel, autos, rubber, and aluminum reemphasized the reasons for

doubting the sustainability of the current level of industrial

production.

Some declines in the monthly index of industrial pro

duction were expected within the next six months, accompanied by a

slower rate of gain of GNP.

In forecasting the industrial production

index, only 6 of the 23 economists participating in the recent round

table expected the index to be higher in the fourth quarter of 1965

than in the first quarter.

Auto production was scheduled to decline in April, and auto

sales had trended downward from extremely high levels since late

On a seasonally adjusted basis, a cumulative drop could

January.

be noted of 20 per cent in sales between the last ten-day period in

January and the last ten-day period in March.

Adjusted monthly sales

had also declined since January, and were expected to drop further

in April.

In steel, Mr. Hickman noted that the strike-hedge buildup

of inventories continued, but there were wide variations in estimates

of the extent of the accumulation.

On the basis of estimates by

steel industry analysts, it appeared that the current buildup would

fall somewhere between the moderate accumulations of 1962 and 1963

and the high of 1959, with the amount varying directly with the

length of time required to reach a labor settlement.

One of the

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Cleveland Bank's directors, a major executive in the industry,

believed that the contract deadline would be postponed for a month

or two and that current levels of production could be maintained

throughout much or all of the second quarter.

Once a settlement was

reached, steel shipments might decline by as much as 25 per cent from

current levels and hold at that reduced level for two or three quarters.

Other key industries affected by the same or similar developments

included aluminum and rubber.

Labor negotiations in aluminum had a

strike deadline falling one month after that of steel.

An economist

for a major aluminum producer in the Fourth District expected that

shipments of ingots and mill products during the second half of this

year would average some 9 per cent below the first half.

Representatives

of three major rubber companies attending the recent meeting of the

Economists Round Table agreed that tire sales were being borrowed from

the future, and that there would be a second half slowdown, the extent

depending on autos.

So far as the question of prices and costs was concerned,

Mr. Hickman said, the consensus of the meeting of the economists was

that the high rates of output achieved thus far this year had not led

to serious inflationary pressures, although occasional price increases

were reported.

An a priori explanation was that expanded output had

lowered unit labor costs and raised profit margins.

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With respect to the balance of payments, Mr. Hickman believed

the preliminary data for the first quarter to be too fragmentary

for firm conclusions.

Indications that the deficit was less than

one-half that of the fourth quarter, after seasonal adjustment, and

that the March surplus was larger than usua: were encouraging, but

the dock strike settlement robbed the figures of much of their glow.

A return of ccrporate funds formerly held overseas was reported at

the recent meeting by several Fourth District business economists, and

this response was presumably nationwide.

Some, however, were puzzled

by seeming inconsistencies in the groundrules being used by the

Department of Commerce.

As to the fourth question, the behavior of bank credit and

deposits thus far in 1965 was basically what should be expected in

a period of strong business expansion, following a change in

Regulation Q.

In this connection, comparisons between the first

quarter of 1965 and the first quarter of 1962 were striking.

In the

earlier period the money supply increased at an annual rate of 1.4

per cent, while time deposits rose at a rate of 14 per cent; more

recently the money supply growth had been at an annual rate of one

per cent, and time deposits had increased at an annual rate of nearly

19 per cent.

The correspondence would have been even closer if it had

not been for the fact that Government deposits declined by $100

million in the first quarter of 1962 and rose by $600 million in the

first quarter of 1965.

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The business readjustments referred to earlier would be

associated with inventory liquidation and lower sales of consumer

durables, Mr. Hickman continued, and these in turn would restrain

bank loan expansion.

Such a development would be reinforced by the

return flow of funds from abroad under the voluntary credit restraint

program.

In

this environment Mr.

Hickman recommended a continuation

of the monetary policy adopted at the last meeting, in order to sop

up a redundant liquidity that might otherwise press interest rates

down and offset some of the favorable effects of the President's

balance of payments program.

In any event, the forthcoming Treasury

financing called for no change in money market conditions over the

next four weeks.

He therefore recommended a bill rate in the range

of 3.95-4.05 per cent, borrowings above $400 million on average, and

net borrowed reserves at whatever level was required to maintain those

objectives, say $50 to $150 million.

Because of his appraisal of tne

domestic business outlook, Mr. Hickman preferred to see figures at

the lower, or less restrictive, end of the range.

For that reason also, Mr. Hickman said, he would prefer the

words "while accommodating moderate growth" (in the reserve base,

bank credit, and the money supply) at the end of the first paragraph

of the current economic policy directive to the words "by moderating

growth" suggested in the staff draft.

The money supply was now barely

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back to where it was two months ago, and he would not like to "moderate"

that rate of growth further.

On the other hand, he thought the

Committee should refer to the forthcoming Treasury financing, as the

staff suggested in the second paragraph.

On the whole, perhaps the

first paragraph of the present directive and the second paragraph of

the suggested revision could best be used.

Mr. Bopp said discussions with a dozen large bus:.ness firms

in the Third District suggested that the larger-than-usual March

balance of payments surplus might indeed be associated with the voluntary

restraint program.

Each of the corporations with whom the Philadelphia

Reserve Bank spoke indicated a thorough awareness of the President's

program, and nine out of the twelve reported that a "plus" payments

position would be achieved in 1965.

Of those nine, five indicated

with a good degree of certainty that 1965 would be "more plus" than

1964.

A very large chemical company, for example, reported plans to

achieve a 15 per cent improvement over 1964's favorable balance.

As

for how the balance was to be improved, four firms were making no new

portfolio investments abroad and were pulling down existing portfolio

investments; four planned to finance expansion abroad either from foreign

borrowing or from earnings of subsidiaries; three planned to repatriate

additional earnings; and two had plans to defer direct investment

abroad.

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Turning to the steel situation, Mr. Bopp reported that a

survey of producers in the Third District indicated that the mills

were running as close to capacity as possible, that they were selling

all they could produce, and that they had added little inventory at

the mill.

The producers estimated that consumers had built up a three

to four week supply of steel in addition to their normal stocks as a

strike hedge.

They felt, however, that only a short strike would

occur, if there was a strike at all.

Hence the greatest economic

dislocation would probably come from a situation of protracted ne

gotiations during which further additions to inventory would be made,

with greater reductions of orders when a settlement was reached.

The

producers expected that the final settlement would result in some

increase in labor costs and perhaps some pressures on profits.

With respect to policy, Mr. Bopp commented that the economy

continued to exhibit basic strength, although some slowdown might result

from curtailed production in autos and steel.

He was pleased with

the improved employment picture, with the apparent response to the

voluntary restraint program, and with the continued stability in

prices and unit labor costs.

posture of monetary policy.

He saw no reason to depart from the present

Hence, he recommended using the first

paragraph of the existing directive and the second paragraph of the

proposed directive.

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Mr. Bryan reported that the economy of the Sixth District

seemed to be expanding vigorously.

In two States, Georgia and Florid,

the insured unemployment rate was now down to 2 per cent.

So far this

year the District's weekly reporting member banks had shown loan

expansion three times greater than in the corresponding period last

year.

As to the staff questions, Mr. Bryan found the comments on

them thus far, including the staff comments, quite satisfactory.

He

did feel there was a tendency to lay a little too much emphasis on

the unit labor cost as a statistic.

This was a figure that, if he

recalled correctly, covered only about, a 30 per cent sample of total

nonfarm employment in this country.

As far as monetary policy was concerned, it seemed to Mr. Bryan

that barring strikes or the unexpectec the economic news was reassuring,

with no adverse reaction, thus far at least, to the mildly firmer

credit policy that the Committee presumably had been following.

Indeed,

there was some question in his mind whether the Committee had really

been following a much firmer policy.

Total reserves in March, as well

as the first quarter as a whole, were up contraseasonally, and by a

large amount; required reserves were up contraseasonally, and by a large

amount; nonborrowed reserves were up contraseasonally, and by a large

amount.

Short-term rates had been somewhat firmer, to be sure, and in

the two weeks ended April 7 net borrowed reserves had been over $100

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million.

Yet there had also been a startling acceleration in the

growth of bank credit.

It seemed to Mr. Bryan, therefore, that the Committee had been

influencing the bank credit situation only marginally, although it had

moved into a position of net borrowed reserves.

In response to strong

loan demands, member banks apparently had been willing to borrow

enough to more than offset the modification in reserve availability

stemming from System operations and market forces.

If loan demands

continued to be as strong as they were in March and the Committee was

guided largely by the net borrowed reserve figure, it was likely to be

trapped into supplying more reserves than the country could tolerate.

Under conditions of strong credit demand, a given net borrowed figure

exerted less effect on reserve expansion than at other times.

There

fore, if the Committee was going to continue to use a net borrowed

reserve target and expect to allow only a moderate increase in bank

reserves, it was going to have to bring the banks into a further net

Just how large that should be, he did not

borrowed reserve position.

know, but he believed the Committee should be feeling its way toward

a further increase in net borrowed reserves and a further increase in

the use of the discount window.

It seemed to him there should be an

average of net borrowed reserves of around $150 million, fluctuating

between $100 and $200 million.

He would not consider this to be a

further tightening of policy but merely an effort to implement the

policy already decided upon.

4/13/65

-72Having said this, Mr. Bryan commented, he must recognize the

fact of the imminent Treasury financing and on that account vote for

an even-keel policy in the period ahead.

a change in the discount rate.

Certainly he would not favor

He preferred the existing directive,

with the second paragraph changed along the lines suggested in the

staff draft.

Mr. Shuford commented that, as had been pointed out by others

around the table, economic activity was at a high level and was con

tinuing to rise rapidly.

Most measures had gone up sharply in the past

three months, and aggregate demand appeared to be exerting some upward

pressure on prices, especially sensitive prices.

In the Eighth District

the economy had risen at an exceptional rate since last fall.

Thus far, Mr. Shuford continued, the economic expansion appeared

to have been accomplished without creation of sizable imbalances, but

at the same time he had a feeling that a slowing down of the rate of

economic advance would be a healthy development.

Continued increases

in the demands for goods and services at recent rapid rates could soon

become excessive.

With respect to the international situation, Mr. Shuford said

the evidence, limited and uncertain as it was, indicated that the

voluntary restraint program had been reasonably effective, at least

in its initial stages, but some of those early gains had been partly

the result of a one-time reflux of corporate funds and a possible

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catching up of exports in the wake of the port strike settlement.

Whether the improvement in the balance of payments could be maintained

remained to be seen.

Mr. Shuford went on to say that he had been considering whether

Committee policy had been restrictive enough or whether it should

become a bit more restrictive.

In view of the strength of the domestic

economy, more monetary restraint was needed now than a year ago, but

it appeared to him that the Committee had been achieving somewhat

greater restraint during the past four months than previously.

During

most of last year the three-month bill rate was about 3.5 per cent,

and recently it had been near 4 per cent.

While total member bank

reserves, time deposits, and bank credit had continued to rise markedly,

this did not necessarily indicate a lack of restraint.

The time deposit

growth reflected the high level of liquid saving accompanying the

economic expansion and the aggressiveness of banks in seeking those

funds.

Most of the reserves furnished to the banking system in recent

months had been used to support those time deposits.

Growth in bank

credit had in large part also been a reflection of the large share of

funds being attracted by commercial banks.

The money supply rose at a 4 per cent rate last year,

Mr. Shuford pointed out, and such a rate was appropriate then.

But

now, with economic activity pressing capacity, some moderation seemed

to be called for.

Since mid-December the money stock had been about

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unchanged on balance.

In view of the changes in Regulation Q and

other factors, this short-run

situation had probably been appropriate.

The spurt in time deposits, utilizing the reserves furnished, was

apparently temporary.

From February to March, time deposit growth

returned to the rate of last year, and the money supply rose.

With respect to policy, Mr. Shuford felt that the economic

situation called for continuation of some restraining influence.

He

favored maintaining the tighter money marke: conditions that now

existed, with the bill rate around 3.90-4.05 per cent and Federal funds

in the 4 to 4-1/8 per cent range.

This would necessitate net borrowed

reserves, of course, and he favored whatever magnitude was necessary

in order to reach the other objectives.

He hoped that over a period

of time, say four to six months, there would be a money supply growth

averaging around a 2 per cent rate.

He would leave the discount rate

unchanged at this time.

With respect to the directive, Mr. Shuford said there were

several alternatives with which he could agree.

The majority seemed

to favor the first paragraph of the current directive and essentially

the second paragraph of the draft directive, and he would accept such

a solution.

Mr. Balderston favored use of the first paragraph of the existing

directive and the second paragraph of the staff draft.

He was concerned,

in view of the increase in bank credit in the first quarter, that

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holding an even-keel during the next four weeks not mean retrogression.

In other words, he would not want the Committee to perpetuate rates

at the long end or relax the slightly tighter stance that it adopted

three weeks ago.

Chairman Martin remarked that at the last meeting he had

commented on the absence this year of the usual references to the

February doldrums, and it seemed clear that there were no March doldrums

either.

As to the directive, the Chairman said it appeared that a

majority favored the use of the first paragraph of the present directive

and the second paragraph of the staff draft

He inquired whether anyone

felt strongly enough to dissent.

There followed a discussion of some of the specific wording of

the proposed directive, at the conclusion of which Chairman Martin

remarked, as he had on previous occasions, that words meant different

things to different people.

With this observation, he suggested that

the Committee vote on a directive in the form that had been suggested.

Thereupon, upon motion duly made

and seconded, and by unanimous vote,

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:

The economic and financial developments reviewed at

this meeting indicate a generally strong further expansion

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of the domestic economy and the continuing need to improve

our international balance of payments, as highlighted by

heavy gold outflows in recent months. In this situation,

it is the Federal Open Market Committee's current policy

to reinforce the voluntary restraint program to strengthen

the international position of the dollar, and to avoid

the emergence of inflationary pressures, while accommodating

moderate growth in the reserve base, bank credit, and the

money supply.

To implement this policy, while taking into account

the forthcoming Treasury financing, System open market

operations over the next four weeks shall be conducted

with a view to maintaining the firmer conditions in the

money market that have recently prevailed.

It was understood that the next meeting of the Committee would

be held on Tuesday, May 11, 1965, with the following meeting scheduled

for Tuesday, May 25.

The meeting then adjourned.

Secretary

Attachment A

CONFIDENTIAL (FR)

April 12, 1965

Draft of Current Economic Policy Directive for Consideration by the

Federal Open Market Committee at its Meeting on April 13, 1965

The economic and financial developments reviewed at this

meeting indicate a continued rapid expansion of the domestic economy,

reflecting broad underlying strength as well as extraordinary de

mands for steel and autos. At the same time, with the persisting

drain in our gold stock, there is need to consolidate the recent

improvement in our international balance of payments. In this

situation, it remains the Federal Open Market Committee's current

policy to reinforce the voluntary restraint program to strengthen

the international position of the dollar, and to avoid the emergence

of inflationary pressures, by moderating growth in the reserve base,

bank credit, and the money supply.

To implement this policy, while taking into account the

forthcoming Treasury financing, System open market operations over

the next four weeks shall be conducted with a view to maintaining

the firmer conditions in the money market that have recently

prevailed.