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. C.,
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
on Tuesday, December 14, 1965, at 9:30 a.m.
Martin, Chairman
Hayes, Vice Chairman
Balderston
Ellis
Galusha
Maisel
Mitchell
Patterson
Robertson
Scanlon
Shepardson
Messrs. Bopp, Hickman, Clay, 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, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Baughman, Holland, Koch, Taylor, and
Willis, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open
Market Account
Mr. Solomon, Adviser to the Board of Governors
Mr. Molony, Assistant to the Board of Governors
Mr. Partee, Associate Director, Division of
Research and Statistics, Board of Governors
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors
Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
Mr. Axilrod, Associate Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
12/14/65
Messrs. Link, Eastburn, Mann, Ratchford, Jones,
Fossum, Tow, Green, and Craven, Vice
Presidents of the Federal Reserve Banks of
New York, Philadelphia, Cleveland, Richmond,
St. Louis, Minneapolis, Kansas City, Dallas,
and San Francisco, respectively
Mr. Meek, Manager, Securities Department,
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 Committee held on
November 23, 1965, were approved.
Upon motion duly made and seconded, and
by unanimous vote, the action taken by members
of the Federal Open Market Committee on
December 6, 1965, amending paragraph 1 (a) of
the continuing authority directive to increase
the aggregate amount by which System holdings
of U.S. Government securities can be changed
between meetings of the Committee by $500 million,
from $1.5 to $2.0 billion, was ratified.
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 conditions and on Open
Market Account and Treasury operations in foreign currencies for the
period November 23 through December 8, 1965, and a supplemental
report for December 9 through 13, 1965.
Copies of these reports
have been placed in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs
said the Treasury gold stock probably would remain unchanged again
this week.
The French seemed likely to buy about $70 million in
gold from the Stabilization Fund, reflecting their November surplus.
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That would just about exhaust the Stabilization Fund's gold holdings,
and unless the Russians made sales in the market, it probably would
be necessary to reduce the Treasury gold stock by $50 or $75 million
before the year end.
It was his impression that the heavy gold sales
the Russians had made earlier in the fall--about $300 million--had
left them in a relatively comfortable foreign exchange position.
Thus, there might not be as much help from that source as had been
hoped.
The London gold market had been in reasonable balance
recently, with the fixing price fluctuating in a $35.11-$35.13
range.
The basic supply and demand situation in that market was
not good, however, and there was a possibility that it would get
worse rather than better during the coming year.
On the exchange markets, Mr. Coombs continued, there was a
minimum of disturbance on Monday, December 6, following the System's
discount rate action.
bottomed out.
Sterling declined on the news but quickly
The Bank of England intervened to a limited extent-
about $9 or $10 million--and the Federal Reserve put in a bid for
sterling at the New York opening.
to stabilize the market.
Those actions were sufficient
Since then sterling had moved up and the
Bank of England had taken in dollars.
Mr. Coombs noted that the British trade figures for November,
released this morning, showed relatively small increases in both
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exports and imports and some minor narrowing of the trade gap.
Those figures were likely to have little effect on market psychology.
The total improvement in the British position since September now
came to $1.4 billion, of which about $400 million had been added to
reserves, $415 million used to repay short-term debt, and about $600
million used to liquidate maturing forward contracts.
The British
were now moving into what in the past had been a seasonally strong
period running from January into May, and the seasonal increase in
their earnings could be greatly accentuated by reversals of leads
and lags.
As to the Euro-dollar market, Mr. Coombs continued, useful
results were flowing from the Federal Reserve suggestion at the
Basle meeting in October that central banks make a joint effort to
control or offset window dressing operations by commercial banks.
The Swiss commercial banks had already been doing a good deal of
window dressing but, under an arrangement worked out by the Swiss
National Bank and the Bank for International Settlements, money
flowing to Zurich was being channeled back into the Euro-dollar market,
thus limiting rate increases there.
The Dutch and Germans also were
being helpful in this connection, and he expected the Italians to
take similar steps before the year end.
As the Committee would recall,
a number of the drawings the System had made on its swap lines last
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year were required because of commercial bank window dressing.
Insofar as European central banks could cake care of the matter
themselves it was all to the good.
In response to Mr. Balderston's question about the outlook for
the U.S. gold stock during the coming year, Mr. Coombs replied that
much would depend on the size of the French surplus, which this year
was running even larger than last year--it probably would come to
over $1 billion in 1965--and their policy with respect to it.
If
the French continued their present policy, there would be a one
to-one relationship--every dollar the French took in during 1966
would result in a drain on the U.S. gold stock.
As far as the other
European countries were concerned, there were not likely to be any
serious drains, assuming that the U.S. balance of payments did not
slip back into a heavy deficit.
There would, of course, be shifts
of dollars among the various countries, but if U.S. payments were
close to balance the countries taking in dollars probably would feel
under :ome obligation not to convert them into gold but rather to
deal with the situation through such means as the swap network or
the facilities of the International Monetary Fund.
One other pos
sibility of large gold drains was through the London market; as the
Committee knew, the U.S. was responsible for covering 50 per cent of
any sales in that market, and if there were difficulties there it
was conceivable that the operations could be costly.
On balance,
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however, he would say that if the French did not run a large
surplus or if they changed their policy the outlook for the U.S.
gold stock for next year would be relatively good.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
November 23 through December 13, 1965,
were approved, ratified, and confirmed.
Chairman Martin noted that Mr. Hayes had just returned from
a BIS meeting in Basle, and invited him to comment.
Mr. Hayes reported that solid and enthusiastic approbation
of the System's recent rate actions had been expressed at the meeting.
Several of the participating central bankers had assured him that
despite serious inflationary pressures in their own countries they
did not intend to increase their discount rates further in the near
future.
They thought the System's actions would lend support to the
effort to achieve equilibrium in the U.S. balance of payments, and
they recognized the danger that prompt offsetting rate increases
abroad would seriously weaken the effects of those actions.
Mr. Hayes said he might mention one other subject, of a
highly confidential character, that had been discussed in Basle.
For some months there had been a widespread view among central
bankers that some effort should be made to analyze the problem
posed for the United Kingdom by the existence of large sterling
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balances abroad.
Possible shifts in those balances continued to
pose a threat to the stability of international financial markets,
apart from the difficulties arising from U.K. deficits.
They
recognized the danger that information to the effect that the subject
was under study might encourage speculative movements of funds, and
the Bank of England had asked that any study be confined to the group
of central banks represented at the meeting and to as small a number
of individuals as possible.
There had been some discussion of the
matter at the special meetings of technical experts in Basle in
October and November, and at the meeting of the Governors in October.
However, the discussions at the earlier meetings as well as at that
held during the past weekend had been confined entirely to procedural
questions regarding when and by whom suggestions should be made as to
possible courses of action.
Mr. Hayes was hopeful that if the matter was handled wisely
some kind of British swap network, roughly
comparable to the U.S.
network, might be developed with the principal continental countries
in due course.
in.
It was not clear at the moment how the U.S. would fit
A British network of that kind was not imminent; presumably there
would be further discussions at the monthly Basle meetings, and quite
a few months might elapse before anything concrete was heard on the
subject.
Mr. Hayes concluded by stressing the confidentiality of the
fact that such discussions were in progress.
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Mr. Coombs then recommended renewal of the twelve-month,
$250 million standby swap arrangement with the Bank of Canada,
maturing on December 28, 1965, and three six-month, $150 million
arrangements maturing on January 20, 1966.
The latter included the
standby arrangements with the Bank for International Settlements
and the Swiss National Bank, under which the System could draw Swiss
francs, and the standby arrangement with the BIS under which the
System could draw other European currencies.
At the moment there
were no drawings outstanding on any of the four swap lines.
Renewal of the four swap arrange
ments, as recommended by Mr. Coombs,
was approved.
Mr. Coombs then noted that the Bank of England had $475
million currently outstanding on its swap line with the System, in
addition to a debt of $200 million to the BIS.
On December 30, 1965,
a $275 million drawing on the System, which had been renewed once,
would again mature.
The Bank of England probably would want to
request a second renewal of that drawing in view of the desirability
of showing a reasonably good reserve position at the end of the
month, during which there had been a number of disturbances, including
those resulting from developments in Rhodesia.
On January 28, 1966, Mr. Coombs continued, the remaining
$200 million of the $475 million outstanding would reach a six-month
maturity, and the question would arise as to whether that drawing
should be renewed.
As he had mentioned earlier, the British were
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heading into what had been a seasonally strong period in the past.
Conceivably, they could repay all of their debts to the U.S. and
the BIS out of their reserve gains, although in view of all the
uncertainties in the world today that expectation might be somewhat
optimistic.
The question was whether the British should not make
a special effort to clear up their debts in January or February by
using part of the portfolio of U.S. securities that they had been
progressively liquefying.
He personally was persuaded that that
would be a useful thing for them to do--for the sake not only of
their own credit rating but also from the point of view of the
integrity of the whole swap system.
Otherwise, it was possible that
the drawings in question would run on through the spring and summer
months.
Among other disadvantages, such a development might harden
the position of those central banks that saw serious dangers of
abuse of international credit facilities.
Moreover, by repaying
the System and the BIS within the next month or two, the British
would greatly improve the chances of negotiating swap arrangements
with some other countries, along the lines that Mr. Hayes had
mentioned.
In sum, Mr. Coombs said, he saw many compelling arguments
for the British to make a special effort to clear up the swaps in
January or February of 1966.
The question currently was being
debated by the U.K. authorities.
In accordance with his understanding
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of the Committee's views he had taken the position that, while
the Committee had a one-year limit on drawings under its swap lines,
once any drawing extended beyond six months the Committee became
concerned and assumed that the other central bank involved did also.
Mr. Coombs said he was bringing the matter to the Committee's
attention in order to obtain guidance.
In effect, he recommended
that the Committee approve second renewals of the $275 million
drawing maturing in December and of the $200 million drawing matur
ing in January if requested by the Bank of England, but with the
hope expressed that the drawings would be cleared up as soon as
possible.
Mr. Mitchell commented that repayment of the drawings
appeared desirable not only for the reasons Mr. Coombs had mentioned
but also because window dressing of central bank accounts made their
true financial situation difficult to determine.
There had been
many discussions within the System of the need to make its own
accounts fully reflect the true state of its affairs.
Whether the
Bank of England should engage in window dressing was for that Bank
to decide, but the Committee should examine carefully any policy
of its own that accommodated such actions by other central banks.
Mr. Coombs remarked that he shared Mr. Mitchell's concern.1/
1/ Four sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported further
observations by Mr. Coombs concerning factors bearing on recent
British transactions.
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Mr. Hayes expressed sympathy with the comments of both
Messrs. Mitchell and Coombs.
While be assumed that there was no
need for formal action on the subject,
he thought it
Coombs to know whether it
helpful to Mr.
would be
was the general sense of
the Committee that the British should be encouraged to clear up
the swap lines soon,
Mr.
Shepardson noted that he had raised questions on a
number of occasions concerning drawings that appeared to be running
on for extended periods.
He concurred fully with Mr. Coombs'
recommendation.
Chairman Martin commented that the observations
been made should prove helpful to Mr.
Coombs,
that had
and the latter concurred.
Possible renewal of the two swap
drawings by the Bank of England was noted
without objection.
Mr.
Coombs'
final recommendation related to the System's
swap with the BIS of German marks against Swiss francs, in the
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amount of $40 million.
He recommended renewal of this swap,
which matured on January 10, 1966, for another three months.
Renewal of the German mark-Swiss
franc swap with the Bank for International
Settlements for a further period of three
months was noted without objection.
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System
Open Market Account covering open market operations in U.S.
Government securities and bankers' acceptances for the period
November 23 through December 8, 1965, and a supplemental report
for December 9 through 13,
1965.
Copies of both reports have
been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
The general reaction of the securities markets to
the change in the discount rate announced on December 5
was one of relief that the air had been cleared by a
decisive move indicating that market forces of supply
and demand had been taken into account by official action.
There was some surprise at the timing, a measure of concern
over the inevitable loss that dealers incurred in their
portfolios, and some fear that competitive factors might
tend to put continuing upward pressure on short rates.
The initial rate reactions, which were swift and
orderly, have been spelled out in the written reports.
Government securities dealers marked prices 1/2 to 1
point lower in intermediate- and long-term securities
on Monday morning after the change had been announced,
with some modest improvement in prices over the remainder
of that week. A sizable bulge in the yield curve developed
with issues in the 2-5 year area rising to about 4-3/4 per
cent (up about 20 basis points), tailing off to about 4-1/2
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per cent (up about 6 basis points) in the longer area.
The greater yield rise in the shorter area of coupon
issues reflected the market's knowledge that the 4-1/4
per cent interest ceiling will force the Treasury to
confine its financing within a maturity span of 5 years.
Treasury bill rates also reacted sharply, with
most issues rising by 15-20 basis points. The timing
of the discount rate announcement gave the market a
chance to make its initial adjustment before the auction
on Monday, December 6, when average rates of 4.34 and
4.47 per cent were established for 3- and 6-month bills,
respectively. Subsequent trading was carried on close
to these rates before the weekend, although some heavi
ness developed in the longer bill maturities.
In the corporate and municipal markets, prices also
declined by about a point, raising yields by 7-10 basis
points. At the new levels, new issues coming into the
market met with good reception and distribution of older
issues improved, with a moderate price recovery in
process towards the end of the week. Rates on bankers'
acceptances, commercial and financial paper, and certif
icates of deposit also were adjusted upward. At this
juncture, it appears that most commercial banks are using
their new-found freedom under Regulation Q with restraint,
although there has been much speculation about the future
course of CD rates. Most banks in New York City were
paying about 4.40 to 4-1/2 per cent on 30-day CDs, 4-5/8
per cent on 3-month CDs and 4-3/4 per cent on 6-month or
longer deposits. One large bank, however, has moved its
3-month rate to 4-3/4 per cent.
System operations after the discount rate change were
directed first to the provision of ample reserves to
facilitate the market adjustment and then to a cautious
absorption of reserves in the general context of stable
and orderly markets. At the opening of the market on
Monday, December 6, the System bought $270 million
Treasury bills in a market go-around, with purchases well
distributed among the dealers. The reserves thus supplied
subsequently led to a very comfortable tone in the money
market; Federal funds, which initially traded at 4-1/2 per
cent, moved to 1 per cent or below by Wednesday. With a
steady atmosphere prevailing in the securities markets by
then, and with a market scarcity of shorter-dated bills
for which there was a good demand, the System sold $139
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million December and January bills in a modified market
go-around.
In a similar operation on Thursday, an
additional $100 million short bills were sold. Last
week's free reserve figure of $9 million was interpreted
by the market, as we expected, as reflecting only a
temporary extra supply of reserves to cushion the market
adjustment.
Thus, by last Friday the market seemed to have
settled down substantially, and, based on our then current
estimates, net borrowed reserves of over $100 million
appeared likely for the statement week ending December 15.
Yesterday, however, a further professional reassess
ment of the rate structure took place, stemming, as far
as we can gather, from market letters stressing the
potential inflationary tendencies in the economy and from
reports that led some market participants to believe that
a further U.S. buildup in Vietnam would be necessary before
our objectives there could be achieved. Prices of Government
notes and bonds fell by 1/4 to 3/8 points, with yields in
the 2-5 year area reaching as high as 4.80 per cent; prices
of corporate bonds also moved lower. Treasury bill rates
also moved higher, and bidding in yesterday's auctions was
extremely cautious, with the three- and six-month bills
averaging 4.39 and 4.55 per cent, respectively. A tighter
tone also prevailed in the Federal funds market, while
dealer lending rates at New York banks moved higher, after
demonstrating surprising stability before the weekend.
Before the market reaction set in, wire reports had
indicated that reserve availability on Friday had been some
$300 million in excess of expectations, and that, as a
consequence, about $50 million free reserves were now being
projected for the current statement week. Despite this,
we felt it desirable to supply the market with about $180
million in reserves through over-night repurchase agreements
as market tightness began to contribute to the deterioration
in atmosphere before the Treasury bill auctions. In the
auction itself System tenders were submitted, as noted in
the supplementary report, at marginal prices to guard against
an unusually sharp rate adjustment. In the event, the System
was awarded $112 million Treasury bills, while $145 million
I would hope that the new reserve figures
were redeemed.
that became available today, together with market developments
as the day progresses, will permit a more satisfactory assess
ment of the situation than now seems possible. Further
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adjustments may be necessary before market participants
regain confidence in the tenability of rate levels. On
the other hand, a technical reaction that would move
rates lower cannot be ruled out.
To leave an immediate perplexing period and return
to an earlier one, I should confess that my colleagues and
I at the Trading Desk were somewhat apprehensive on Sunday
and Monday a week ago about the reserve absorption job
that lay immediately ahead. At that time projections
indicated that we would have to absorb about $600 million
in reserves by the week ending December 22 in order to
get back to a net borrowed reserve position of $100 million.
With the extent of the market reaction still uncertain, we
had some doubt about its ability to absorb outright sales
of bills in that magnitude without producing substantial
additional upward pressure on rates, and we did some
intensive thinking about possible modification of operating
techniques that might be useful in carrying out System
objectives. In the event no innovation has yet proved
necessary; the sales last week already noted, plus the
runoff of $145 million bills in yesterday's auction, have
accomplished much of the job to be done. Nevertheless,
it seems worthwhile to give further study to possible changes
in System operating techniques that could prove useful in
such special situations. With this in mind we are preparing
a paper to be discussed with the Committee staff and eventually
submitted to the Open Market Committee if this appears desirable
after further analysis.
We are, of course, moving into a period of active
Treasury cash financing. It appears likely that the Treasury
will announce the broad outline of its plans to raise new
money within a week to ten days, with the first stageprobably an additional issue of June tax bills--under way
before the year end. Market developments will determine
whether there can be a note offering in addition to the tax
bill offering and an increase in the regular Treasury bill
cycle.
In response to a question by Mr. Swan, Mr. Holmes said that
the Treasury's tax bill offering probably would be in the neighborhood
of $1 billion.
The market had been on notice that there would be an
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additional offering of tax bills.
The various offerings would
probably be for payment in January, but the first stage would be
announced before the end of the year.
In reply to Mr. Mitchell's question as to what kind of
directive might be appropriate in the current unsettled state of
the market, Mr. Holmes remarked that it was necessary to recognize
that the relations among the various money market measures were in
a state of flux, and that further experience was necessary before
patterns of consistent relations could be discovered.
Mr. Mitchell
then commented that he did not understand from Mr. Holmes' earlier
statement how a directive could best be formulated.
If he understood
Mr. Holmes correctly, after the discount rate action the bill rate
initially settled down at about 4.35 per cent, and that situation
persisted for a week.
nature was developing.
Now, however, a new situation of an unclear
Presumably a bill rate in, say, the 4.35
4.40 range would no longer be an appropriate guideline.
At the same
time he gathered that a net borrowed reserve target of, say, $100
million also would not be reasonable now.
Mr. Holmes said he hoped that some better clues as to where
the market was going would be available before today was over.
In
his judgment the bill rate guideline that Mr. Mitchell had mentioned
probably would be too narrow at present, while the market was still
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in process of finding its way.
His personal view was that a
combination of the factors used in measuring market conditions,
including rates, should be taken into account.
Thus, if bill rates
were tending higher, there would be a move toward greater reserve
availability; if bill rates were tending down, reserve availability
would be reduced.
Mr. Hickman asked whether a succession of net free reserve
figures in the next few weeks might not confuse the market with
respect to the Committee's intentions.
Mr. Holmes replied that
such a risk would exist unless there was continuing upward pressure
on short-term rates.
If bills continued to press higher the market
probably would not be misled by free reserve figures.
Mr. Maisel commented that in the study Mr. Holmes had
mentioned he hoped there would be some consideration of the relations
between money market variables and developments with respect to bank
credit and money.
He recognized that in its day-to-day operations
the Desk had to concern itself with such variables as marginal reserves
and bill rates, but it was important that the relations between these
operating variables and the Committee's more fundamental objectives
be clarified.
Mr. Holmes agreed that such analyses were highly desirable,
but as the Committee knew it was difficult to assess credit develop
ments on a month-to-month basis, and far more difficult on a shorterterm basis.
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Mr. Hayes remarked it often might take several months to
determine the existing relations between conditions in the money
market and developments with respect to money and credit.
Mr. Mitchell then asked how Mr. Holmes would interpret the
second paragraph of the proposed directive drafted by the staff.1/
Specifically, would he view it as calling for operations to "moderate
further adjustments" in either direction?
Mr. Holmes replied in the
affirmative, saying that he would interpret the draft as calling for
reducing reserve availability if rates were going down and increasing
reserve availability if rates were tending higher.
In response to a question Mr. Holmes said that at the
moment the Desk estimated free reserves of about $70 million for
the statement week ending tomorrow(December 15), assuming no further
operations.
The figure, of course, was subject to revision.
Mr. Hickman said he thought that publication of such a figure
would be bound to have a psychological effect that might be viewed
as unfortunate later on.
Chairman Martin commented that he thought the situation
would change after seasonal pressures ebbed later in the month.
period immediately ahead was the difficult one.
1/ Appended to these minutes as Attachment A.
The
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Mr. Hickman said he would be inclined to let rates move up
during the period of seasonal pressures since free reserve figures
were bound to cause comment.
Mr. Hayes observed that excessive
fluctuations in the bill rate might lead to exaggerated views of
what the Committee was attempting to do
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 November 23 through
December 13, 1965, were approved, ratified,
and confirmed.
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. Holland made the following statement on economic
conditions:
The key business statistics becoming available since
the last meeting of the Committee can be divided into two
chief groups: (a) those historical numbers that indicate
the economy has been growing more vigorously than previously
thought this fall; and (b) projected numbers that also imply
a more expansive course for the economy in the months ahead.
The first group has to be called noninflationary, for
they show mainly that, given the credit and price performance
to date, a somewhat larger amount of real production, invest
ment, and employment was taking place than had previously been
surmised. Three developments are particularly noteworthy.
First is November's widely spread increase in nonfarm employ
ment, which amounted to the biggest net creation of jobs of
any month in 1965. Second is the striking increase in the
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industrial production index in November to a level of 145.5.
This number, confidential until tomorrow, is more than a
point higher than the revised October level, which has in
turn been marked up nearly 1 point above the preliminary
October estimate. Third is the upward revision in the
extimated[sic]
level of business plant and equipment expenditures,
amounting to $1.5 billion in the third quarter just past
and carrying through in somewhat larger dimension into the
current quarter. Clearly we have managed to employ more
resources, add more to our capacity, and turn out more
product that we thought we were doing earlier.
In the price arena, meanwhile, the most significant
single index, that for wholesale prices of industrial
commodities, has continued to edge up through November at
about the rate prevailing since midyear. Small and
selective increases continue to be the principal ingred
ients in the advance in this price index.
The focus of concern has been shifting, however, from
how prices have performed thus far to how they might perform
in the future. This shift reflects the impact of the second
grouping of business statistics released in recent weeksthose showing strong business, consumer, and Federal Government
spending intentions over the months ahead.
The new Commerce-SEC survey shows business plant and
equipment expenditures moving on up from current levels
(that were themselves revised upward) at a 13.5 per cent
annual rate in the first quarter of next year and a 15.2
per cent rate in the second quarter. Even assuming no
further increase after mid-1966, these numbers imply rates
of expenditure significantly higher than the McGraw-Hill
survey takkn one month earlier. The just-released commerce
estimates for next year's construction outlays show plant
construction figures that seem broadly consistent with these
stronger expectations as to capital outlays.
The other major area of spending prospects on which
attention should be focused this morning is the Federal
budget for the remainder of fiscal 1966. Spending, partic
ularly military spending, is headed higher, and the only
question is how much. The Administration's release of a
global estimate of budget expenditures in the $105-$107
billion range galvanized analysts everywhere into agonizing
reappraisals; for expenditures thus far this year seemed to
be running so far below such a level that the implicit
step-up in spending for the remainder of the year appeared
incredible. Our own Government finance analysts dutifully
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-21-
(but skeptically) built a $105 billion assumption into the
table following page III-15 in your "green book,"1/ but
we stubbornly held to an implicitly lower rate of increase
in the GNP projections shown on page II-3.
At the moment, the latter approach seems to run closest
to what might be called the "maximum likelihood" estimate
within the Government as to the level of Federal activity
over the next two quarters. Such estimates currently
might imply total budget expenditures for fiscal 1966 of
just under $104 billion, a net cash deficit to be financed
of $4 billion, and--perhaps most significantly from an
expansionary point of view--a full employment surplus
over the next half year of around $1 billion, little
changed from the second half of calendar 1965 and $2.5
billion more stimulative than that portrayed only three
weeks ago in the green book and the chart show.
Insofar as timing is concerned, higher Social Security
taxes effective January 1 will introduce a transitory
degree of fiscal restraint, but before the first quarter
is over that effect will be more than counterbalanced by
rising Federal purchases. Moreover, some further enhance
ment of this fiscal stimulus cannot be ruled out, either
from further escalation in outlays for Viet Nam, or
failure to realize some hoped-for slowdowns of the Great
Society programs--all this despite possibly greater
resort to financial asset sales that could serve to reduce
the deficit on paper but in fact would only change the
form of its financing.
I have dwelled on the possible future shape of the
Federal budget and business capital outlays this morning
because of their special significance for the future.
In our chart show three weeks ago, we concluded,
".
..
new
price pressures could develop if military activities
increase substantially or investment spending rises much
faster than is now indicated." The evidence received
in the ensuing weeks would seem to suggest that, in both
these crucial categories, projections are now straining
and very possibly exceeding the tolerances of that earlier
model. Avoidance of enhanced upward price pressures as
1966 progresses would seem, from this viewpoint, to depend
(1) more success
upon either or both of two factors:
1/ The report, "Current Economic and Financial Conditions,"
prepared by the Board's staff for the Committee.
12/14/65
-22
by Administration deficit-cutters than I, for one, now
expect, and/or (2) a gentle but pervasive moderating
influence on spending growing out of the higher credit
costs that have evolved this fall, capped by the reaction
to the discount rate increase.
Immediate spending patterns seem to me to be such
as to give policymakers a little time co appraise the
interaction of these two moderating influences; but only
time can tell whether they will prove sufficient to the task.
In
the discussion following his statement, Mr.
Holland
said that the $104 billion figure for Federal budget expenditures
for fiscal 1966,
to which he had referred, was believed to be the
current "maximum likelihood" estimate by technical experts within
the Government.
The Board's staff concurred in
this estimate
although, of couse, it contained a large element of conjecture.
Mr. Brill noted that the figure of $105 billion implied an increase
in the estimate of Federal spending for the second calendar quarter
of 1966 of nearly $3 billion.
In further discussion Mr. Holland
indicated that the results of the recent Commerce-SEC plant and
equipment survey would imply upward revisions
in
the GNP figures
for the third and fourth quarters of 1965 of about $1 billion, but
those revisions had not yet been made in
Mr.
the ofiicial figures.
Brill made the following statement concerning financial
developments:
The initial responses in financial markets to the
discount rate and Regulation Q changes last week have bee
ably described in the Manager's report to the Committee,
Further, it would seem prema
and I have nothing to add.
ture to offer any predictions now as to what may ultimately
be a more permanent equilibrium level for credit flows
12/14/65
-23-
and interest rates. Certainly we can't assume that we're
over the hump of market reactions. Pa-ticipants are still
exegetically examining our statements, particularly the
commitment for ". . . the continued provision of additional
reserves to the banking system in amounts sufficient to
meet seasonal pressures as well as the credit needs of
an expanding economy without promoting inflationary
excesses .
.
The first week's rise in marginal reserves to a small
net positive figure was apparently accepted for what it
was--a partly accidental result of attempts to cushion the
immediate impact of the official rate and ceiling actions.
The market certainly doesn't expect a string of positive
numbers for this variable. But what isn't clear to the
market is how far back into the negative marginal reserves
may slip or, for that matter, what any given marginal
reserve measure will mean under the new rules of the game.
The market is not alone in this confusion, because
it's not evident to me that we're all in accord on how
the usual policy variables ought to behave under a policy
of higher ceiling rates and somewhat increased monetary
restraint.
Since I've nothing to add to the review of
the recent past, and have little basis for predicting the
near-term future, I thought it might be helpful to explore
the general subject ofpolicy guides this morning.
Let's begin with aggregate flows and, in particular,
bank credit. I have argued often that bank credit changes
are imperfect guides to, or targets of, policy under
regulatory conditions which foster bank competition for
savings flows. The Board's actions last week make the
bank credit total more difficult than ever to interpret
for policy assessment. If banks do take advantage of
the flexibility under Regulation Q to bid more aggressively
for corporate and consumer saving, some acceleration in
bank crecit growth is likely, but this could well be en
tirely consistent with the System's effort to increase
monetary restraint. A diversion of saving flows from
other intermediaries into banks is not per se inflationary.
In fact, depending upon the composition of credit demands
and on System attitudes toward the provision of reserves,
it can prove to be quite restrictive. Therefore, if one
has to look at some credit flow measures as gauges of
policy, one had better include total credit flows, not
just the bank component. If we focus on slowing the
expansion in bank credit, while at the same time encouraging
banks to become more important credit intermediaries, we'll
really see interest rates soar.
12/14/65
-24-
I must confess that, while I expect some acceleration
in time deposit growth, I don't expect a rise on the order
of that which followed earlier increases in Regulation Q
ceilings, when banks responded fairly promptly and the
public responded to the banks. For one thing, corporate
liquidity is much lower, and business needs for funds to
finance real investment are growing rapidly. Banks may
find it rather expensive to add significantly to their
negotiable CD totals.
They may also be reluctant to push
harder in the competition for consumer saving. Banks have
been doing very well against their competitors, even under
existing pass book ceiling rates which weren't raised last
week.
And the devices available to apply the new higher
ceilings to consumer saving--savings bonds and savings
certificates--usually carry long-term commitments to pay
these higher rates, commitments which may cause more
prudent bankers to reflect a bit before joining in the
competition.
But whether banks do or do not go after a
larger share of the savings flow--or whether or not they
are sucessful--is more a matter of supervisory concern
than a test of the effectiveness of monetary policy.
Credit diverted through, rather than created by, the
banking system is no cause for inflationary alarm.
Turning to another of the commonly used policy ar
iables, I wouldn't expect that, in the short run, changes
in the money supply would be useful in assessing the
effectiveness of the recent policy moves. Previous
experience with Regulation Q ceiling changes suggest that
reaction of savers bears on their holdings of
the initial
demand deposits as well as on market instruments and on
not be
It would
the obligations of other intermediaries.
surprising to experience a sharply lower growth rate in
money balances after the turn of the year, perhaps per
This development alone
sisting for two or three months.
would not signal to me an exceptional degree of restraint.
Despite the rise in recent years in income and transactions
velocity, I would hesitate to assume that the economy has
already achieved maximum economization
of cash
balances
and, therefore, some spurt in velocity would not surprise
If it showed no sign of abating after two or
or alarm me.
three months, however, I'd get suspicious, but by then,
market rates of interest would probably have given all
the indication we'd need of the effectiveness of our
restraint.
The uncertainties that attach to interpretations of
changes in the rate of aggregate bank credit and deposit
12/14/65
-25
flows also limit the usefulness of aggregate reserve
targets in the months ahead, even abstracting from the
effects of Treasury financing and cash management on
reserve needs. Total reserve needs will be boosted by
banks' success in capturing "outside" saving flows, but
moderated to the extent that there is some switching or
diversion from demand balances to CDs or other time
accounts. Until we get a clearer picture of the response
of banks and savers to the new Q ceilings, it will be
difficult to interpret the changes in aggregate reserves.
Nor can we assume that the marginal reserve measures
have the same import now as they did three weeks ago.
Because the discount rate has been raised relative to
short-term market rates, we should expect to find bank
reluctance to obtain reserves through the discount window
reinforced; increased elbow room in the CD market should
also reduce the needs for borrowing. At the same time,
the cost of carrying excess reserves has been raised.
All in all, therefore, it would seem that a given level
of net borrowed reserves may carry a more restrictive
connotation now than before the recent policy action.
The question is how much more, and the answer is
we really don't know. In the "blue book"1/ distributed
Friday, the staff presented a guess that over the next
several weeks a target of $100 million net borrowed
reserves--not far from the average of the previous five
weeks--would likely be associated with some further
upward adjustment in bill rates, but not much change in
longer rates. Yesterday, the whole rate structure moved
up significantly even though projected marginal reserves
were still net positive, and even though the Desk put in
a substantial volume of RPs.
The point is that during periods of peak seasonal
pressure, and when a new structure of rate relationships
and new market attitudes are evolving, marginal reserve
measures are exceptionally difficult to predict. It may
be that a target of $100 million net borrowed reserves
will prove too restrictive for Committee aims. Given
all the uncertainties extant--as to how banks are going
to respond to both the new Q ceilings and the new
discount rate, as to whether the higher prime rate will
tend to force some bank borrowers into the capital
market, and as to the likely longer-term outlook for
Treasury financing needs--it would probably be most
1/ The report, "Money Market and Reserve Relationships," prepared
by the Board's staff for the Committee.
12/14/65
-26-
appropriate at this juncture for the Committee to stipulate
how large and how rapid an adjustment in money market
rates it is willing to tolerate, and let the marginal
reserve measures fall out of this decision.
Mr. Hersey presented the following statement on the balance
of payments:
It occurs to me that it might be useful to stage a
minor rebellion against the tyranny of the calendar,
throw away the score card for the calendar year 1965,
half of which is by now pretty ancient history, and
take a look this morning at the record and prospects
of the balance of payments in the July-to-June year.
The first full statement for the July-to-September
quarter will be published two weeks from now. You may
recall my saying six weeks ago that no one knew yet
whether the direct investment outflow in that 3-month
period would be nearer a billion dollars, as it had
averaged in the first half of 1965, or half a billion
as in most of 1964. We have now been informed that
the returns are in, and that the figure is encouragingly
low: only $515 million, after seasonal adjustment.
(I must ask that this figure be treated as confidential
until published.)
The July-to-September deficit on regular trans
actions, seasonally adjusted, was about $650 million.
Without the U.K. security liquidations it would
apparently have been around $450 million. Six weeks
ago it was difficult to explain so large a deficit
unless the direct investment outflow had been large.
As it turns out, the mystery of the large deficit has
an entirely different explanation, which is that U.S.
imports were a great deal larger than the monthly
statistics were telling us. What had seemed an
encouraging leveling off of imports was not really
happening--at least not yet then.
The story is a complicated one. It starts with
an effort to speed up the compilation of accurate
import statistics from last June onwards. But there
seem to have been some monumental failures in carrying
out the new prccedures. Trouble was suspected when
unexplainably low figures came out fo; coffee imports
in August and September.
The Census Bureau then made
12/14/65
-27-
a special tabulation of all documents processed for
the October statistics that referred to shipments
that actually came in at any time before October.
The upshot now is that the balance of payments
statistics for the third quarter to be published in
a fortnight will show imports much larger than the
monthly Census Bureau figures indicated--larger by
more than $300 million, or 6 per cent. Compared
with the third quarter a year ago, the corrected
figure is up 17 per cent, a very large rise.
The import figure for October recently published
by Census shows what looks like an alarming jump over
the preceding months, but the true October import
figure, excluding pre-October imports, was probably
below the true third-quarter level; we will not know
for sure until another special tabulation is made to
see how many October imports will have been included
in the forthcoming statistics for November. Ironically,
the speed-up effort has only delayed our getting an
accurate knowledge of the facts.
Thus far in the fourth quarter the balance of
payments seems to have remained in deficit, despite
some improvement. On the "official settlements"
basis, weekly indicators suggest a repetition in
November of the October deficit of about $100 million.
On the "liquidity" basis, the October deficitof about
$300 million may have been followed by a surplus in
November--or if not, by a quite small deficit, and the
weekly figures would then imply that December got off
to a good start. But these figures are all seasonally
unadjusted, and experience in past years suggests
that within the fourth quarter October is usually a
poor month, November a good one.
Moreover, it is
worth noting that $75 million of the November improve
an
ment this year was due to a special transaction:
Italian prepayment for military equipment.
Evidently,
taking October and November together, regular transactions
have been more favorable than in the third quarter, but
it is too soon to speak of surpluses on any but the
very shortest time scale of a couple of weeks.
Now, if we look ahead a few months, can anything
be said as to whether the average level of the deficit
for December through next June will be appreciably
lower than it was in July through November?
12/14/65
-28-
I believe we can discern three or four adverse
factors, and on the other hand at least three favorable
factors. But I am unable to weigh these against each
other quantitatively.
On the unfavorable side, at the year-end the
seasonally adjusted accounts will be adversely affected
if the U.K. defers its debt payment. Second, bank
credit outflows may begin to resume, since the banks
are well below their aggregate ceiling, and since
they now know what the program is for 1966. Third,
we can hardly hope that direct investment outflows
next year will hold to the relatively Low $2 billion
annual rate recorded for the July-to-September quarter.
Despite all efforts of persuasion by the Government,
capital expenditures by foreign affiliates in 1966 will
be far above the 1964 level. Their capital expenditures
in 1964 were accompanied by financing outflows that
year of $2.4 billion from parent companies in the
United States, and in the absence of the voluntary
program the 1966 figure would tend to be much higher
than that. What a sizable number of companies are now
doing to comply with the Government's request for
cooperation is to set up special subsidiaries to
borrow at long term in Europe, often with the parent
corporation's guaranty.
It may be that several
hundred million dollars can be raised n this way
over and above the very considerable amounts that
would be borrowed for working capital in the usual
course of events. But the greater the demands made
in this way on European capital markets, the longer
the present high interest rates in Europe will stay
high, and the stronger the forces making for leakage
For
of capital from the United States will be
example, foreign investors holding U.S. domestic
bonds may switch to high-rate U.S. bonds newly issued
in Europe; they may sell the domestic bonds to U.S.
residents, since the I.E.T. would not apply on these.
These are some of the adverse factors one can
foresee. Another is likely to be a rise in military
expenditures abroad. On the favorable side, we may
assume that the U.K. Treasury has now stopped
liquefying its security holdings. Secondly, U.S.
investment income receipts will undoubtedly continue
to rise. Thirdly, it seems reasonable to count on
some increase in the U.S. trade surplus from its
12/14/65
-29
recent level of $5-1/2 billion a year. It is hardly
necessary to say to this Committee that the lower
U.S. prices remain, the better the chances of an
upward trend in the trade surplus.
Finally, some encouragement may be drawn from
the prospect that U.S. interest rates will be higher
rather than lower. However, as we have already seen
last week, rates in closely related markets, as in
Canada or in the Euro-dollar market, are quick to
change when rates change here. Any net impact of
Federal Reserve actions on private capital movements
of various sorts may well depend more on what happens
to the growth of U.S. bank credit in the aggregate,
domestic and foreign, and on the basic ease or tightness
of U.S. financial markets in general, than on interest
rate changes per se.
Chairman Martin then called for the go-around of comments
and views on economic conditions and monetary policy, Mr. Hayes,
who began the go-around, made the following statement:
The rise in discount rates and the revision of
Regulation Q ceilings have demonstrated that the
Federal Reserve can still act when the situation
warrants action, and should have a salutary effect in
removing some of the uncertainties which have hung
over financial markets in recent months. I have no
doubt that these measures will prove valuable both in
extending the duration of the present business upswing
and in bolstering the international position of the
dollar. Today I think we must explore the extent to
which open market policy should be used to back up
recent official rate action. In an economy as
buoyant as this one, the influence of higher interest
rates alone could turn out to be entirely inadequate,
if availability considerations were neglected.
The domestic economy is, I think, stronger both
currently and prospectively than when we net last.
First, the apparent strong rise in industrial
production in November should remove any lurking
worries concerning the short-term adverse effect of
steel inventory liquidation on the economy.
Second,
the sharp upgrading in both actual and planned capital
12/14/65
-30-
spending leads me to feel that next year this sector
of the economy may turn out to be even stronger than
in 1965; nor do I believe that the interest rate
advances that have already occurred will in themselves
significantly change the implications of the most
recent capital spending survey.
Third, it seems to
me that developments in Vietnam, and the guesses
concerning the budget estimates publicized since
our last meeting, have added to the already buoyant
psychology of the business community. Residential
construction is the one questionable area.
But
consumer spending generally continues to look as
strong, or stronger, than earlier. All of this
adds up to a prospective rise in total output that
is likely to equal, and may even exceed, the advance
of the past year.
Such an outlook--in the context of both the rapid
rise in resource utilization and the current high level
of resource use--suggests that further pressures on
prices are likely and might well lead to price
increases exceeding those of the past year.
So far at least, unit labor costs in manufacturing
have been relatively stable. But the outlook suggests
that a continuation of such stability is now very
questionable.
It is hard to see how productivity can,
at best, do more than maintain its recent rate of
growth. Yet it seems clear that wage increases have
been larger so far this year than earlier.
Add to
this the upward push that will be exerted by the
increase in social security taxes, and the prospects
for continued cost stability seem doubtful--especially
in an environment where unemployment is declining and
the over-all unemployment rate is approaching 4 per
cent.
Any threat to reasonable price stability also
has serious implications for our balance of payments
deficit. For the past, as against the future, the
latest balance of payments figures appear to show a
sizable surplus in November. The liquidity deficit for
the fourth quarter may turn out to be at an annual
rate of about $1.1 billion, down from $1.9 billion in
the third quarter. However, this apparent improvement
is more than accounted for by the deferral of payment
dates into 1966 on a substantial volume of new
Canadian bond issues and by the issue of a $75 million
12/14/65
-31-
nonmarketable, nonconvertible bond to Italy.
For
the year as a whole, this would imply a deficit on
the old regular transactions basis of $1.6 billion,
or a liquidity deficit of about $1.2 billion--with
each figure $0.5 billion less if the influence of the
liquidations of official British long-term portfolio
holdings is removed. This is progress as compared
with 1964, but it reflects primarily the short-term
effectiveness of the restraint program, and could
easily be wiped out if the prospects for a rising
export surplus were erased by acceleraced price
increases in this country.
It is in the context of a very strong domestic
economy and a continuing need to achieve balance in
our payments position that I turn to the policy
questions before us.
In analyzing the question of where we go from
here, I think it is useful to draw a distinction
between underlying policy objectives and the temporary
posture that may be necessary in the weeks immediately
ahead.
Let me start by considering the question of
underlying policy objectives. (Parenthetically, I
should note that we are presumably all against sin:
that is, in favor of a growing economy that will
absorb a growing labor force into active employment,
without price increases that would make such progress
unsustainable. Rather, when I speak of underlying
policy objectives, I am referring to what are some
times called "intermediate" objectives.) It seems
to me that we have at least three choices before us.
First, we might continue a policy of providing
sufficient reserves to support a continued growth
in credit at the same rapid pace as in the recent
past. Second, we might adopt a policy that would
attempt to moderate whatever demands for credit do
develop, which would in effect leave open the
question as to what change in pace, if any, as
compared with the recent past was being sought.
Finally, we could deliberately attempt to reduce the
rate of growth of credit from what it has been in
the recent past.
As to the first of these possible policies, it
seems to me that, once the inflationary potential
12/14/65
-32-
in the economic outlook is recognized, it is necessary
to back up recent rate adjustments with a more positive
open market policy. If we continue to permit credit
to grow at the rapid rate so far chalked up this year,
we would be doing less than is necessary. We could
also be subject to the criticism that the System has
acted only to raise interest rates and has done nothing
to affect the availability of credit.
The second possible policy, that of merely moderating
the pace of credit advances from what would otherwise
have been the case, runs up against the difficulty that
the objective is unclear. We would in fact never find
out whether anything at all had been done to back up
the rate changes already made. On the one hand, the
rise in interest rates that has already occurred might
be expected to reduce somewhat the demands for credit.
On the other hand, the apparent growing strength in
the economy could more than offset this effect. Merely
moderating the demands that might otherwise occur could
actually result in a stepped-up rate of growth of credit.
As you can see, I am in favor of third alternative
policy objective--that which would deliberately attempt
to reduce the rate of growth of credit from the rapid
pace of the past year. For several years I have been
critical of a rate of growth of bank credit that was
running around 8 per cent. This year, however, the
pace has mounted to almost 10 per cent. I would not
want to set any precise figure on the magnitude of
growth that is warranted and sustainable in the present
economic situation. But I would argue strongly that
recent growth rates have been excessive, particularly
in the context of cumulatively large increases in
previous years. Parenthetically, I might add that in
making these comments I have fully taken into account
data with respect to total credit flows.
If the forthcoming weeks had no special and unusual
characteristics, an underlying objective of reducing the
rate of growth of credit could be implemented in a
straightforward manner by putting the banking system
under somewhat greater pressure. This might mean a
movement in net borrowed reserves to over $200 million
as a definite signal that open market policy was not
out of step with discount rate policy
My only caveat
would be that such a move should be undertaken in a
cautious and flexible fashion. It would be undesirable,
12/14/65
-33-
for example, to see the Treasury bill rate move so close
to the 4-1/2 per cent discount rate as to set off
speculation as to a further hike in the discount rate.
In fact, however, the forthcoming weeks will see
a convergence of a number of factors that may make it
difficult to achieve the underlying objective that I
favor. In particular, it is still uncertain to what
extent financial markets have fully adjusted to discount
rate changes and the revision of Regulation Q ceilings.
There is still considerable uncertainty as to what may
happen in the CD area, where there is a risk that
competitive pressures may push up CD rates to an
inordinate degree and, as a consequence, exert undue
upward pressures on other rates. Moreover, there are
the usual end-of-the-year money market pressures and
uncertainties to contend with; and, in addition, a
forthcoming Treasury financing which will reintroduce
even keel considerations.
In view of these factors, it seems to me important
that the Account Manager have more than usual latitude
over the next few weeks. In particular, net borrowed
reserve figures will be difficult to interpret, but I
would hope that we would not show positive free reserves.
I believe that our chief focus should be on money market
tone ard short-term rates. A three-month bill rate
ranging between 4.30 per cent and 4.45 per cent, combined
with a firm money market tone, would seem to be about
right. If, in this context, it is possible to move net
borrowed reserves to over $200 million, I would consider
it highly desirable as a means of achieving the under
lying objective that I favor. The suggested directive
is acceptable.
Mr. Shuford reported that in the Eighth District economic
activity had continued to expand at a rapid pace since early summer.
During the past five months, payroll employment in the District had
risen at a 4 per cent annual rate, slightly faster than for the
nation as a whole.
District manufacturing activity had been very
strong in the last half of the year.
Since June, employment by
12/14/65
-34
manufacturing firms had risen at a 5.4 per cent rate, markedly
higher than in the first half.
Manufacturing output in the
District's metropolitan areas had increased 6 per cent over the
past twelve months, the same as for the nation.
Unemployment
as a per cent of the labor force had decreased significantly
since the end of last year in all of the District's States and
in mo;t of its major labor markets.
Business loans at District banks had continued to rise
at a rapid rate, Mr. Shuford said.
Deposit growth had been strong,
with virtually all of the growth centering in time deposits.
While only a few days had passed since the discount rate
and Regulation Q maximums were raised, Mr. Shuford continued, it
was evident that the economy had taken those developments in
stride.
Sentiment appeared optimistic, the stock market had
remained strong,
and money market movements had been reasonable.
Interest rates had risen, but when viewed within the
the past five months the rise was not unusual in
context of
lignt of both
seasonal and cyclical pressures.
New data since the Committee's last meeting indicated
continuing growth in economic activity, with some stengthening,
Mr. Shuford remarked.
Total civilian employment rose at a 5.6
per cent annual rate from September to November, twice as fast
as over the past twelve months.
Weekly data
for November indicated
12/14/65
-35
that industrial production was continuing to expand.
Retail sales
also appeared to have been strong in November.
Labor resources
had come under added pressure since September.
The unemployment
rate was below the level recorded at the peak of the previous
business expansion and was near the level
expansion.
reached in the 1957
Further price rises had accompanied the expansion
in business activity since the Committee's last meeting, as weekly
wholesale industrial prices had continued to advance.
With respect to policy, Mr. Shuford said, money market
conditions had firmed over the last week but not more than might
have been expected.
On the other hand, for the next four weeks
he would not like to see any additional firming, especially in
view of the prospective Treasury financing.
That would call for
maintaining essentially the same conditions in the money market
as had come to prevail during
the last several days but moderating
any further upward adjustments for the time being.
Mr. Shuford felt the Desk had to have considerable
latitude during the coming period.
He was glad that Mr. Brill's
remarks and Mr. Mitchell's questions had pointed up the difficulty
He
in trying to establish guidelines under present circumstances.
had never been satisfied with attempts to quantify the Committee's
directive and the problems of doing so would be particularly
great at present.
For purposes of general guidance, however, he
12/14/65
-36
was inclined to agree with Mr. Brill that in the main the
Committee should think in terms of rates rather than free
reserves or other measures.
He also concurred with the
suggestions by the staff and Mr. Hayes of a 4.30-4.45 per cent
range for the 90-day bill rate.
He would not like to see the
bill rate go over 4.45 per cent, and he certainly would not
want it to go above the discount rate.
He would hope and
expect that the Federal funds rate would be around the discount
rate and, to the extent possible, he would like to see it under
the discount rate--although he was aware that in one or two
instances it had already moved above that rate.
He was not
sure what such objectives would imply for marginal reserves
but he did not believe that the latter could be relied on for
target purposes during the next few weeks.
Mr. Patterson reported that in the Sixth District, as
he was sure had been the case in other Districts, the changes
in the discount rate and Regulation Q had generated a tremendous
amount of interest and comment.
Many persons outside the financial
community seemed to be bewildered, possibly because of the news
paper stories that came out prior to the official Board release.
The question he most often got from laymen
was, "What effect
will the Federal Reserve 'order' raising interest rates have on
the cost of buying an ice box or TV set?"
-37
12/14/65
Among the more informed, Mr. Patterson commented, there
had been a mixed reaction to the Federal Reserve's action.
Most of the large banks had endorsed the move, and an informal
survey of a group of about 25 officers of the largest business
firms in Alabama, made by the Chairman of the Board of the
Birmingham Branch, indicated that all of them also approved
the move and many thought it long overdue.
Last Wednesday the
large city banks in Atlanta announced an increase in their prime
rate, and the large banks in the District's other cities had
made similar moves.
Although one of the larger banks in
Atlanta had announced a slight upward adjustment in its CD rate,
he did not as yet have information about what the banks in general
expected to do.
Some officers of the smaller banks, however,
feared that, as the result of the increase in the Regulation Q
ceiling, it might become more difficult for them to retain their
time deposits without raising the rates paid, a step they were
reluctant to take.
As to contemplating changes, the smaller
banks and the savings and loan associations apparently were
postponing any action until they saw what happened.
It was even more difficult to determine whether or not
the general economic conditions had been or would be affected,
Mr. Patterson said.
Certainly, the most recent statistics for
the District indicated an expansion strong enough to weather a
12/14/65
-38
slightly higher cost of credit.
In practically every category,
the record for the District during 1965 would be better than
that of the nation generally.
Until the dust had settled, Mr. Patterson continued, the
Committee could not tell very well to what extent the new interest
rate structure reflected expectational factors.
The problem of
judgment would be compounded as the economy entered the period
when pressures on bank reserves were reduced because of seasonal
factors.
Meanwhile, the Committee might be hemmed in by having
to maintain an even keel because of Treasury financing.
Under those conditions, it seemed best to Mr. Patterson
to allow the Desk to be guided chiefly by the behavior of rates
even if, because of expectational and other forces, the Committee
ended up with a somewhat lower net borrowed reserve position
than prevailed prior to the discount rate increase.
like to see the rate structure move upward
He would not
but neither did he
think the Committee should attempt to offset all tendencies
toward softening that might develop because of seasonal influences.
By the next meeting the Committee might be able to determine more
precisely the level of reserves needed to support the appropriate
rate of credit expansion.
tory to Mr. Patterson.
The staff draft directive was satisfac
12/14/65
-39
Mr. Bopp remarked that now that the discount rate action
had been taken, additional reserves should be supplied to the
banking system, as the Board phrased it in its December 5 press
release, "in amounts sufficient to meet seasonal pressures as
well as the credit needs of an expanding economy. . . ."
Looking
further ahead, the rate at which money and bank credit would be
allowed to grow should depend on the degree to which the economy
became subject to the stresses and strains accompanying near
full-employment levels of activity.
One measure of those would
be the extent of pressure in the labor market.
As noted in the
green book, prospective increases in real GNP early in 1966 and
expansion in the armed forces rendered further tightening in the
labor market very likely, despite gains from the anti-poverty
program.
During the past week, Mr. Bopp continued, the Philadelphia
Bank had looked into the data to get a better feel of pressures
in the labor market and had discussed the situation with personnel
departments of several large industrial and governmental units
in the Third District and with some of the larger employment
agencies.
From the data, he got the impression that some
cushion existed over-all, but that pressures were considerable
in certain skills and areas, especially durable manufacturing.
On an over-all basis he found that, compared with the similar
12/14/65
-40
phase of most other postwar business upturns,
the labor force
presently was expanding at a relatively rapid rate, which should
help offset pressures to some extent.
In addition, participation
rates were lower than in other postwar expansions, suggesting
that there was more leeway for a further rise in the labor
force.
Finally, the over-all unemployment rate and that in most
subgroupings by age, sex, and so on, now provided a greater cushion
than in
the Korean War period and about the same leeway as in
the
similar phase of the 1953-1957 business upswing.
Focusing on the manufacturing sector, Mr.
pressures or the labor force became more evident.
Bopp remarked,
The average
workweek in manufacturing had now exceeded the highs of 1953-1957
and 1958-1960 and was near the highest level of the Korean War
period.
Overtime in manufacturing was much higher than in
1956-1957
or 1958-1960 (there were no data for the Korean War period) with
pressure particularly severe in
durable goods manufacturing.
The Reserve Bank's survey of the third District labor
market bore out what was found in
the national data, Mr.
In durable manufacturing industries, most
Bopp said.
firms were feeling
definite shortages of skilled machinists and technical and
professional help.
Several firms in Philadelphia and Wilmington
had had to send out recruiting teams or advertise elsewhere for
engineers, machinists, and technicians.
Nondurable and non
manufacturing industries were split about half and
half
between
12/14/65
-41
those reporting conditions no tighter than usual for this time
of the year and those saying that definite shortages existed in
most occupat ons.
Labor pressures in the manufacturing sector had particular
implications for the behavior of unit labor costs, Mr. Bopp
observed.
Not only was there likely to be some upward pressure
on wage rates next year, but the kinds of pressures now being
felt--reaching near the bottom of the skilled labor barrel for
generally less efficient workers and extending overtime hours
and the workweek--had an important bearing on efficiency, tending
to raise unit labor costs.
Meanwhile, if public policy was
successful in holding down prices, any rise in unit labor costs
would tend to eat into profits.
Past behavior would suggest in
turn, that when unit labor costs rose faster than prices, the
economy was entering a cyclical danger period.
What all that added up to was pressure building in specific
areas, Mr. Bopp said, particularly durable goods manufacturing,
but some cushion in the over-all labor market.
As to monetary policy, Mr. Bopp thought the draft
directive was appropriate.
Mr. Hickman remarked that a basic justification for the
recent discount rate action was to prevent excessive additions to
the money supply and to moderate demands for bank credit, thus
12/14/65
-42
reducing the risk of inflation.
On the basis of information now
available, continuation of the recent rate of increase in bank
credit would not appear to be consistent with that aim, assuming
that the response of savings flows to the change in
was not great.
Regulation Q
Following that line of reasoning, the Committee
should supply less, not more, reserve availability.
Looking
ahead a bit, it should validate the discount rate change by
forcing the banks to the discount window, thus making the new
rate effective.
Since a Treasury financing was imminent, and since the
markets were in the midst of the heavy tax and dividend period,
even-keel considerations seemed to Mr. Hickman to be dominant at
the moment.
There was, of course, some problem of defining just
what "even keel" meant in view of the recent gyrations of the
reserve figures.
$100
He suggested net borrowed reserves of about
million as a rough target during the period of Treasury
financing, shifting to a somewhat deeper level--say, $200 to
$250 millior--when the financial markets settled down after the
turn of the year.
To avoid misleading the market he would try
to avoid, if at all possible, positive free reserve figures
during the next few weeks.
Mr. Maisel said that the concluding statement of the
draft directive, calling for operations with a view to "moderating
12/14/65
-43
further adjustments of money and credit market conditions in a
period of widely fluctuating seasonal pressures,"
to him.
seemed proper
He felt that as a result of the statements in the Board's
press release at the time of the discount rate change it was
evident to the market that an objective of letting things settle
down would dominate the Committee's thoughts.
As a result the
level of the marginal reserve figures was comparatively unimportant.
Between now and the next meeting the question of market conditions
should be dominant; at the next meeting the Committee would have
a better picture of the nature of underlying supply and demand
forces and would be able to work out its longer run objectives.
He favored adoption of the directive as drafted by the staff.
Mr. Mitchell commented that having been in the minority
position on the discount rate question, he found it difficult
to adjust his thinking to the present situation.
He would say,
however, that he thought there was a tendency to underestimate the
amount of restraint that had come about in the past several months,
not only in terms of interest rates but also in terms of credit
availability.
Also, the weekly money supply figures had shown
little growth in the past two months, which meant that something
had happened; he was more inclined to agree with Mr. Shuford's
general position on that subject than with that of Mr. Brill.
Total bank credit had expanded at a 12 per :ent annual rate
-44
12/14/65
in the first quarter, but at only a 5 per cent rate in the third
quarter.
The growth rate so far in the fourth quarter was above
the third, but as far as loan demand in October and November was
concerned, to quote from Mr. Eckert's remarks at the Board briefing
last Friday, "Excluding security loans, total loans increased only
a little over half the average monthly rate for the first three
quarters.
Recent slackening from earlier growth rates occurred
in business, real estate, and nonbank financial loans.
Business
loans rose somewhat more in November ;han the small October
But for the two months combined, the annual rate of
advance.
growth was about 11 per cent, a little less than the much reduced
third quarter rate."
The figures indicated that there had been evidence of
restraint in the money supply, interest rates, and credit
availability, Mr. Mitchell said, and now there also had been a
direct signal in the form of the discount rate increase.
his judgment that was enough for the time being.
In
He knew the
Desk would face difficulties in getting through the rest of
December.
As to the directive, he found that he could not
improve on the staff's draft and would accept it.
Mr. Shuford commented that he agreed the money supply
had shown little change in the recent period.
That probably
was a short-run development, and he would hope the money supply
12/14/65
-45
would soon begin to rise again, preferably at an annual rate
in the 2-4 per cent range.
Mr. Shepardson said he did not think it was necessary
to make extensive comments on the economic situation; apparently
all of the indicators pointed to continued rising activity.
At
this season of the year the situation in financial markets usually
was a difficult one, and this year the problems were compounded
by the recent discount rate action.
For that reason it would
seem :o him that the proposed directive, as he understood it,
would be appropriate for the coming period.
He hoped that in
implementing the directive there would be no attempt to roll
back the rate changes that had deve'oped.
The general guides
that had been suggested appeared appropriate to him, and he
shared the hope that free reserve figures would not result.
Mr. Robertson then made the following statement:
With all the events that have been jammed into the
three weeks since this Committee last met, I expect it
will be some time before we can see either the recent
developments or their future implications in clear and
dispassionate perspective.
I think it is a good idea at this juncture to
distinguish between what actually has happened and
what is projected. The latest statistics on what
has happened (mostly in November) are gratifying. They
show a further small reduction in unemployment, a
vigorous increase in production, a price performance
still confined to small and selective advances, and a
balance of payments position that is appreciably
improved, even if part of that improvement may prove
temporary. No pressing call for a tighter policy
emerges from these facts concerning developments to
date.
-46-
12/14/65
Future prospects, however, must now be regarded
as stronger, in view of the latest surveys of business
capital expenditures and the announcements as to the
future rates of Government spending. Were they to be
taken at face value, these spending rates could seem
high enough so that they might be expected to begin
generating some real inflationary pressures in the
country. But there are two big uncertainties as to
these prospects. First, the Federal Government is
now trying to hold spending well below the tentative
estimates for 1966 first released. Second, the
climate of significantly higher costs of credit
resulting from the discount rate increase may very
well serve to dampen some of the more optimistic
spending intentions.
As these uncertainties begin to be resolved,
we should be able to decide with some greater degree
of assurance whether the next turn of open market
policy should be toward further tightness or toward
some relaxation of pressures. In the meantime, a
policy of maintaining relatively steady money market
conditions seems to me to be in order.
A steady course for policy is also desirable
for two technical reasons--the onset of peak seasonal
pressures in the money market and the schedule of
Treasury financing activity between now and the next
Recognizing that some
meetin, of this Committee.
churning in the markets is probably inevitable over
this period, I would be satisfied if the Manager
could maintain money market rates within the ranges
mentioned in the blue book (4.30-4.45 per cent three
month bill
rate, Federal funds around 4-1/2 per cent).
I assume this may necessitate a somewhat lower level
of member bank borrowing, and if the result is a few
fairly small net borrowed reserve figures--or even
small net free reserves for some individual weeks- I
would not object.
I would vote in favor of the draft
directive distributed by the staff.
Mr.
Wayne reported that the orderly advance of Fifth District
business continued.
In manufacturing generally, backlogs remained
heavy and the volume of new orders was still
rising.
The textile
industry had been operating close to capacity all year in an
12/14/65
-47
effort to keep pace with expanding demand, and now new defense
orders were putting even more pressure on production facilities.
Reports from all around the area indicated that the already tight
labor markets were becoming tighter and that wages had risen in
a number of industries.
In the agricultural sector, less over-all
strength was evident, although livestock was experiencing strong
demand and rising prices.
In the national economy, Mr. Wayne said, there was not
much news except more of the same as business activity moved
ahead with sustained momentum.
New and revised data which had
become available in recent weeks showed a continuing buildup of
inflationary pressures as reflected in higher consumer and
wholesale prices, increasing labor shortages, higher wage rates
and hourly earnings, a faster growth in personal income,
accelerated capital spending, sharp increases in new and unfilled
orders for durable goods, and a considerable increase in the
deficit in the cash budget.
The expected extension of the
budget deficit into the early part of next year despite a sharp
increase in payroll taxes meant that it would not be possible
to use fiscal policy to counter inflationary pressures.
The System had now made a decisive and perhaps historic
move, Mr. Wayne said, and there should be no turning back at
this point.
The question now was how to implement the new policy
-48
12/14/65
and what pattern of money market rates would be consistent with
the new level of the discount rate.
The Committee was committed
to supply sufficient reserves to meet seasonal pressures and the
needs of an expanding economy.
The generous supply of reserves
made available in the past week was probably necessary and
desirable in facilitating the transition to the new level of
rates.
But the peak of seasonal pressures would pass within
the next two weeks and immediately thereafter open market policy
should change to validate the change in the discount rate.
Otherwise, the move which had been made would be nullified.
As
yet very little was known about the relationship that would
prevail between the level of free or net borrowed reserves and
money market
rates under the higher discount rate.
In those
circumstances, Mr. Wayne suggested that for the period ahead the
Committee place primary emphasis on the bill rate and attempt
to hold it within a range of 4.25 to 4.40 per cent.
In view of
the great uncertainty which prevailed and the large seasonal
movements which would occur, the Manager should have som what
more discretion than usual.
The draft directive was acceptable
to him.
Mr. Clay commented that both the current and the prospective
performance of the domestic economy were strongly expansionary.
With the national economy functioning at high levels and at
12/14/65
-49
substantially reduced margins of unutilizd resources, it
became increasingly evident that Federal Government expenditures,
notably defense outlays, were the key to the forthcoming pattern
of economic events.
Those Federal outlays carried not only a
direct impact upon economic activity but also indirectly
influenced private demand sectors such as the stepped-up rate
of business capital investment.
Thus, that growth in aggregate
demand relative to the expansion in the resource base also was
the key to future price developments and would determine whether
the recent pattern of selective price increases became more
general.
Despite budget data recently released it appeared,
however, that there was not a clear picture yet of the magnitude
and time pattern of those expenditures.
The monetary policy decision to be made today, Mr. Clay
said, was one of planning the accommodation of open market
operations to the actions already taken in
rate and modifying Regulation Q.
raising the discount
The initial adjustment of the
money and capital markets had taken place in an environment of
substantial cushioning action through open market operations.
There was no way of knowing how much additional adjustment
would take place in the weeks ahead.
There were so many
uncertainties in the financial picture over the next several
weeks that it was difficult to foresee the various financial
12/14/65
-50
relationships that would develop an
targets.
to determine System policy
It would appear appropriate to provide sufficient
reserves to meet the credit needs for orderly economic growth,
to stand ready to avoid any credit stringencies that might
develop, such as in connection with the runoff of CD's, and to
temper further adjustments in the money and credit markets.
The
draft economic policy directive appeared satisfactory to him.
Mr. Scanlon reported that conditions in the Seventh
Federal Reserve District remained excellent with indications
that both consumers and businessmen
were very optimistic.
Labor
markets were exceptionally tight--in part, of course, because of
the seasonal demand for labor.
One automobile manufacturer had
recently announced a cutback in production to balance dealer
inventories.
But that development had been expected and did
not appear to indicate any weakening of over-all demand for
automobiles.
Recent conditions in the money and capital markets had
been dominated by the increase in discount rates, Mr. Scanlon
commented.
The rate increase unleashed a host of expectational
and other forces and the immediate impact might prove
over-adjustment.
tobe an
Because of the uncertain relation between money
market conditions and aggregate supply measures at the present
time, and the evidence of the slowing in growth of total reserves
12/14/65
-51
and money in the past few months, care .hould be exercised to
assure that total reserves did not fail to increase at least
seasonally.
It seemed to Mr. Scanlon that it was imperative that
the Committee follow a policy that would reinforce the language
in the release made by the Board at the time of the announcement
of the discount rate change.
He believed a 4.25-4.40 per cent
range for short-term bill rates ws consistent with that policy.
If the draft directive accomplished that, he favored it.
Like
others, he believed the Manager should have ample latitude to
moderate any market adjustments during the coming period.
Mr. Galusha reported that all indications were that the
Ninth District had continued to enjoy a remarkable prosperity
in recent weeks, and the outlook for coming months was bright.
There were signs of some slow-down in the pace of economic
advance.
Thus, retail sales increased at a lower rate in the
third quarter than over the first half of the year; and District
measures of real output for October, while still well above
year-ago levels, suggested a slight decline from those for the
third quarter.
Despite this objective evidence, business
sentiment by all accounts remained bullish.
The optimism might
be due in part to the outlook for agriculture, which was quite
rosy, and to the visible impact the Vietnam escalation was having
12/14/65
-52
on the District economy.
Certain depressed areas in the
District were now getting military contracts and only a few
days ago plans were announced for re-opening a Twin Cities
area arsenal and putting on 1,000 employees.
Mr. Galusha said that District bank credit growth
was considerable in November, far greater than seasonal.
Non
weekly reporting banks showed the usual increase, but weekly
reporting banks showed a much larger than seasonal gain--which
could be traced to an increase in business loans beyond anything
past Novembers would have led one to expect.
The reason for
that large increase in business loans was not altogether clear.
The heads of the largest District banks were reportingon the basis of their own experience and conversations with
colleagues in other areas--that CD money was getting hard to
come by, Mr. Galusha continued.
Evidently corporations, and
particularly those with ambitious investment programs under
way, were finding less and less cash to lend out.
Rates were
generally 4.5 per cent for 30 days, 4.6 per cent for 60 days,
and 4.7 per cent plus for 90 days.
One major savings and loan
association had moved to 4-1/2 per cent on passbook savings.
Mr. Galusha remarked that he had nothing to add to what
had already been said on the issue of monetary policy.
not understand the draft directive.
He did
Perhaps the best the Committee
12/14/65
-53
could do today would be to give the Desk a vote of confidence
and let it go at that until there had been a re-establishment
of a pattern of relationship among customary target variables.
He thought the Committee was faced with the necessity of framing
an objective in qualitative terms of tone, color, and feel.
Mr. Galusha added that he would like to compliment the
authors of the green book again; he had found the explicit
discussion of likely future developments most helpful.
He
hoped that the Board's staff could now be coaxed into sticking
its collective neck out not one but two quarters into the
future.
Mr. Swan said he had no significant changes in recent
business trends in the Twelfth District to report.
Loan demand
at banks continued strong and bank credit expanded sharply in
the Last three weeks of November.
However, banks had not been
substantial borrowers from the Reserve Bank, even during the
four days when the San Francisco discount rate was lower than
in some other Districts.
Last Thursday, however, some major
banks with which he had checked indicated that in the current
week they expected to be quite heavy borrowers in the Federal
funds market, and he understood that that had developed.
As to responses to the change in Regulation Q, Mr. Swan
continued, major banks in the San Francisco and Los Angeles
12/14/65
-54
areas had indicated that they were planning some upward
adjustment in CD rates.
They all emphasized that the new
rates--which were 4-1/4 per cent for 30 day money, 4-1/2 per
cent for 90 day money, and 4-5/8 per cent for deposits of
6 months, or more--were still tentative; they had not been
announced publicly, and were subject to modification.
In
the other three reserve cities of the District--Seattle,
Portland, and Salt Lake--none of the banks reported plans to
raise rates but they had not made final decisions on the
subject.
The savings and loan associations had, of course,
expressed concern about the effects of the Regulation Q change
on their situation, Mr. Swan said.
However, the District's
major banks had not been pushing savings certificates for
individuals and it
seemed to him unlikely that they
change their attitude in
that regard.
Mr.
Brill's
would
point that
commercial banks generally were doing well this year ii
attracting ordinary savings deposits certainly applied in the
Twelfth District.
Despite the rather wide margin between
by
paid
their rates and those of around 4.85 per cent
savings
and loan associations, savings accounts at weekly reporting
banks increased 8 per cent in the first ten months of 1965, as
compared with a 6.4 per cent rise at savings and loan associations.
12/14/65
-55
In the same
period in 1964 the rise was 4-1/2 per cent at banks
and 13-1/2 per cent at savings and loan associations.
In terms of policy, Mr. Swan agreed generally with the
comments that had already been made.
He was not inclined to
argue with what had been said regarding the relationships that
were likely to prevail, but he would come back to what he thought
was the Manager's original point, that adjustments in market
conditions should be moderated so that they did not feed on
themselves.
He favored a bill rate in the 4.25-4.40 per cent
range, with possible swings in the net reserve figures.
He felt,
however, that the first and second paragraphs of the directive
were somewhat inconsistent.
In his judgment the directive could
be made a little more straightforward by deleting the word "current"
in the last sentence of the first paragraph, and by replacing the
second paragraph with language along the following lines:
However, taking into account the forthcoming Treasury
financing activity and widely fluctuating seasonal pressures
at this time of the year in addition to the recent increase
in Reserve Bank discount rates, System open market operations
shall be directed to moderating any further adjustments in
money and credit markets that may develop.
In response to Mr. Robertson's question as to whether the
import of Mr. Swan's suggestion was any different from that of the
staff's draft, Mr. Swan said he thought the two came out at the same
point but that the language he proposed was somewhat clearer; it made
more evident the nature of the problem in the period immediately
12/14/65
ahead.
-56
The Committee's underlying policy was to "complement other
recent measures," as the first paragraph said, but the instruction
given in the second paragraph to "moderate further adjustments"
was not intended to implement that underlying policy.
Rather, it
was related to the forthcoming Treasury financing, year-end seasonal
pressures, and the fact that the discount rate had just been changed.
Mr. Mitchell commented that if yesterday's market deterioration
had not occurred one would have assumed that it was developments of
that type that were to be "moderated."
He asked Mr. Holmes whether
he would interpret yesterday's events as "further adjustments" to
be moderated, or whether he would start with the situation as of
the close cf business yesterday.
Mr. Holmes said that he assumed the Committee would intend
the latter interpretation, and Mr. Swan commented that he had
proposed the words, "any further adjustments .
.
. that may develop"
to clarify that point.
Chairman Martin commented that perhaps Mr. Swan's proposal
involved some grammatical improvemcnt over the staff's draft, but
to his mind it did not differ in substance.
The go-around then resumed with remarks by Mr. Irons.
Mr. Irons reported that business activity in the Eleventh
District was very strong and seemed to be gaining in strength.
There
was a marked undertone of confidence, and there were references at
12/14/65
-57
times to elements of speculative activity in the picture.
The
outlook w.s viewed bullishly, especially with the Vietnam war
and the likelihood of further increases in Government spending.
Practically all of the District's major indexes were showing
increases and the probability Of further increases.
Employment
had grown further; the District was almost in a state of full
employment, with the unemployment rate a little over 3 per cent
in the District as a whole and at 2-1/2 per cent in some of the
larger cities.
Auto sales, and retail trade generally, were
strong, and retailers were expecting heavy seasonal buying.
Despite some concern earlier, it looked as though agricultural
conditions this year, with respect to both volume and prices,
would be the most favorable in some time.
Also, the crude oil
outlook was good.
Mr. Irons remarked that the System's recent actions on
the discount rate and Regulation Q appeared to have been well taken
in the District.
The comments he had received generally reflected
favorable reactions except, perhaps, on the part of savings and
loan associations.
He hoped that banks would not let competitive
considerations cause them to increase rates on CD's and other time
deposits unduly.
There were no reports so far of such developments
in the Eleventh District, although two small country banks were
raising the question of the need to raise their rates on grounds of
competition.
-58-
12/14/65
Bank credit had increased further, Mr. Irons continued,
and District banks were fairly fully loaned up.
had risen quite sharply.
Demand deposits
On the other hand, there had been some
slipping off of time deposits and CD's.
Larger banks in the District
were net buyers of Federal funds, averaging about $200 million.
There had been little borrowing from the Reserve Bank.
It was not necessary to comment in detail on the pattern
of national developments, Mr. Irons said
He noted that the
Commerce-SEC survey of capital spending and other recent data had
led to higher estimates of activity in the period ahead.
Mr. Irons remarked that he recognized the framework within
which policy would have to be carried out in the coming month.
The adjustments so far to the recent rate actions had been satis
factory, but further adjustments probably lay ahead.
With strong
seasonal demands and with the need to provide for normal growth,
and with the Treasury also in the picture, market conditions would
be uncertain and difficult to deal with.
In general, he would like
to have the discount rate viewed as a ceiling for the bill rate and
the Federal funds rate for the time being.
It might be necessary
later to take steps to validate the new discount rate, but he would
not favor them in the next month.
He would be satisfied to see the
Federal funds rate around 4-1/4 to 4-1/2 per cent, and the Treasury
bill rate ranging from a low of 4.25-4.30 per cent to a high of
4.45 per cent.
12/14/65
-59
Certainly, Mr. Irons said, the Manager had to be given
considerable latitude during a period such as lay ahead.
He
would not favor setting a target in terms of net borrowed or
free reserves; he would accept the marginal reserve figure that
developed from an effort to keep the rate structure in line with
the discount rate.
And he would not wart to see any reluctance
in meeting seasonal and other needs for reserves.
He did not
advocate a policy of ease, but as the Board had implied in its
recert press release, reserve availability should be adequate to
meet requirements.
Mr
He would accept the draft directive as written.
Ellis said that business in New England continued to
warrant the "ebullient" label.
Manufacturing production and
employment were rising and upward
trends in new orders continued.
Construction contracting had paused in total but was feeling the
impact of sharp surges in highway building.
Unemployment declines
continued and evidence of labor shortage had widened.
Consumer
spending slowed its increase in November but department store
sales were running 3 per cent better than in the pre-Christmas
season last year.
Mr. Ellis remarked that he had been watching the District's
weekly reporting member banks for signs of any trouble in meeting
their needs in December, when 30 per cent of their CD's maturedas compared with 21 per cent for the U.S.
So far, the evidence
suggested they were making the switch smoothly.
To be specific,
12/14/65
-60
they had rot had to reach out and match the rates announced by
Chase Manhattan last Friday (December 10).
to expansion of negotiable notes.
Nor had they resorted
As of last Friday
rates
quoted on negotiable notes matched CD rates up to 90-day maturity
and then
shaded below the CD rates by 5 and 10 basis points out
to one-year maturity.
Mr. Ellis welcomed Mr. Brill's discussion of guideline
interpretation, and agreed that it was necessary to start with
consideration of total credit flows.
He therefore expected the
next green book to reflect the results of such analysis.
The
green book was good but could be better.
Since the last meeting of the Committee, Mr. Ellis said,
the weight of evidence seemed to have supported the judgments
reached then.
The Federal budget outlook had turned toward
deeper deficits and stepped-up outlays; the balance of payments
news emphasized the need for further action to achieve a solution;
manufacturing output had increased vigorously and defense orders
were helping to bolster it; capital sperding and its outlook had
strengthened; the labor supply had tightened; and price trends
continued to show an upward tilt.
As expected, Mr. Ellis continued, the discount rate action
had drawn out many vocal reactions.
In Boston the Reserve Bank
kept a finger to the academic pulse as a matter of practice.
He
12/14/65
-61
was a little surprised by the intensity of disapproval voiced by
some academicians.
The sting of their lashes was tempered somewhat
by the more balanced views of others, who concluded that it was
a close decision that could be tipped either way by personal
judgment.
The latter offered the view tat one salutory result
of the action would be to force public attention to the problem
of financing the expected added costs of the Vietnam conflict and
the Great Society program without simple and automatic resort to
higher deficits.
In his basic position on policy, Mr. Ellis found himself
in agreement with the statement by Mr. Hickman that the Committee
should establish and preserve an even keel through the year end.
Since the discount rate increase the markets had been so influenced
by the ease in reserve availability that it was hazardous to attempt
an identification of compatible intermediate goals of policy.
Perhaps because he had been participating in the daily telephone
conference call since the Committee's previous meeting, he believed
that the Manager should be provided with some goals of policy in
addition to an indication to preserve orderly conditions in the
market as it adjusted to new rates.
He would recommend dealing
with the difficult alternatives by picking a likely combination
of intermediate goals--one that had some prospect of being compat
ible--and then suggesting to the Manager some priorities within
that package to be followed if choice was forced upon him.
12/14/65
-62
To be specific, Mr. Ellis said, he was prepared to accept
the staff estimates as a starting pcint.
He believed that a bill
rate in the range of 4.30-4.45 per cent might well prove compatible
with net borrowed reserves averaging around $100 million, borrowings
holding around $550 million, and a Federal funds rate generally at
4-1/2 per cent.
It struck him that such a pattern would be
acceptable to the market as not being a further turn of the reserve
availability screw, recognizing the positive free reserve figure
of last week as temporary.
He would direct the Manager to seek
such intermediate targets unless short-term bill rates unexpectedly
tended to move above 4,45 per cent, in which case he would want
him to abandon temporarily the reserve target in favor of holding
rates below 4.45 per cent.
On the other hand, he would not expect
the Manager to seek higher levels of net borrowed reserves in
order to hold bill
establish today.
rates up to any level the Committee might
The underlying objective,
of course, was to
allow markets to find their own new level.
In view of the Committee's disposition not to specify
intermediate goals of policy, Mr. Ellis continued, he wa
prepared
to accept the staff's draft directive with the understanding that
the Committee was not establishing a single rate objective as the
principal goal of policy.
However, he liked Mr. Swan's proposed
rewording of that draft; he shared the view that there was some
inconsistency in the staff draft.
12/14/65
-63
Mr. Balderston said he would divide the four weeks
between this meeting and the next into two parts.
As the
Committee knew, bill rates tended to be seasonally high during
the Christmas period and then to decline.
He would hope the
Desk would dampen any bill rate increases during the first two
weeks and then, if necessary, support bill rates in the two weeks
remaining before the Committee met again.
For both intervals he
would use the 4.30-4.45 per cent range suggested by the staff as
a guide.
The staff had indicated that a net borrowed reserve
figure of $100 million might be consistent with such a bill rate
objective over the next four weeks as a whole, and he was merely
suggesting that the Desk might need to treat the two parts of
the period separately.
In any case, it now appeared that there
would be net free reserves for a second successive week,
would hope that such figures could be avoided in
and he
the future.
Otherwise the public might well be confused with respect to the
System's intentions in
raising the discount rate.
Chairman Martin said he had little to add to what already
had been said.
He thought the discussion today provided good
evidence of the futility of trying to project developments under
the circumstances of the moment.
In due course the storm was
likely to be followed by a calm in which the Committee could
remold its policy.
He had always found the year end a partic
ularly difficult time to assess conditions.
12/14/65
-64
The Chairman said he thought that the members of both
the majority and minority had conducted themselves well through
the recent period, and that the System had played a constructive
role in 1965.
Of course, no one could be absolutely certain that
his judgments were correct in every detail.
Chairman Martin then turned to the question of the
directive.
As he had indicated earlier, to him Mr.
Swan's proposal
did not differ in substance from the staff's draft, but that was
a matter of judgment.
In any case, he saw no objection to the
proposal and he suggested that the Committee vote on it.
Mr. Galusha asked whether the Manager thought the proposed
directive gave him room to deal with all of the changes that could
occur in
the period until the next meeting,
including the possible
shift in
the direction of seasonal pressues.
Mr.
Holmes replied
that seasonal pressures might well ebb during the interval and
the Desk would certainly have that possibility in mind.
The period
ahead was a highly uncertain one, however, and he did not think
that all possible developments could be articipated.
Mr. Galusha
then noted that as he understood the general consensus
would be no attempt through open market operation
impact of the discount rate change,
was clear in
the proposed directive.
there
to reverse the
and Mr. Holmes replied that
12/14/65
-65In the course of further discussion the Committee agreed
to some language revisions in the directive proposed by Mr. Swan.
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 ir.the System
Account in accordance with the following
current economic policy d.rective:
The economic and financial developments reviewed at
this meeting indicate that domestic economic expansion is
gaining in strength in a climate of optimistic business
sentiment, with continuing active demands for credit and
some further upward creep in prices. Although there appears
to have been some recent improvement in our international
payments, the need for further progress remains. In this
situation, it is the Federal Open Market Committee's policy
to complement other recent measures taken to resist the
emergence of inflationary pressures and to help restore
reasonable equilibrium in the country's balance of payments,
while accommodating moderate growth in the reserve base,
bank credit, and the money supply.
Until the next meeting of the Committee, and taking
into account the forthcoming Treasury financing activity
and widely fluctuating seasonal pressures at this time
of year in addition to the recent increase in Reserve Bank
discount rates, System open market operations shall be
directed to moderating any further adjustments in money
and credit markets that may develop.
It was agreed that the next meeting of the Committee would
held on Tuesday, January 11, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
be
Attachment A
CONFIDENTIAL (FR)
December 13, 1965
Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on December 14, 1965
The economic and financial developments reviewed at this
meeting indicate that domestic economic expansion is gaining in
strength in a climate of optimistic business sentiment, with con
tinuing active demands for credit and some further upward creep in
prices. Although there appears to have been some recent improvement
in our international payments, the need for further progress remains.
In this situation, it is the Federal Open Market Committee's current
policy to complement other recent measures taken to resist the
emergence of inflationary pressures and to help restore reasonable
equilibrium in the country's balance of payments, while accommodating
moderate growth in the reserve base, bank credit, and the money
supply.
To implement this policy, and taking into account the recent
increases in Federal Reserve Bank discount rates and forthcoming
Treasury financing activity, System open market operations until the
next meeting of the Committee shall be conducted with a view to
moderating further adjustments of noney and credit market conditions
in a period of widely fluctuating seasonal pressures.
Cite this document
Federal Reserve (1965, December 13). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19651214
@misc{wtfs_fomc_minutes_19651214,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Dec},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19651214},
note = {Retrieved via When the Fed Speaks corpus}
}