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:
on Tuesday, January 11, 1966, at 9:30 a.m.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Balderston
Daane
Ellis
Galusha
Maisel
Mitchell
Patterson
Robertson
Scanlon
Shepardson
Messrs. Bopp, Hickman, Clay, and Irons, Alternate
Members of the Federal Open Market Committee
Messrs. Shuford and Swan, Presidents of the
Federal Reserve Banks of 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
Messrs. Baughman, Garvy, Holland, and Koch,
Associate Economists
Mr. Holmes, 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. Reynolds, Adviser, Division of International
Finance, Board of Governors
Mr. Williams, Adviser, Division of Research and
Statistics, 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
1/11/66
Mr. Heflin, First Vice President, Federal
Reserve Bank of Richmond
Messrs. Eastburn, Mann, Parthemos, Brandt, Jones,
Tow, Green, and Craven, Vice Presidents of
the Federal Reserve Banks of Philadelphia,
Cleveland, Richmond, Atlanta, St. Louis,
Kansas City, Dallas, and San Francisco,
respectively
Mr. MacLaury, Assistant Vice President of the
Federal Reserve Bank of New York
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Anderson, Financial Economist, Federal
Reserve Bank of Boston
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meeting
of the Federal Open Market Committee held on
December 14, 1965, were approved.
Upon motion duly made and seconded, and
by unanimous vote, the action taken by avail
able members of the Committee on December 28,
1965, approving payment of 1/8 per cent com
mission in a transaction undertaken to acquire
guilders to pay off the System's $25 million
August 1965 drawing on the Netherlands Bank
and to liquidate the remaining guilder/mark
swaps with the Bank for International Settle
ments in amount of $12.5 million each for
System and for Treasury, was ratified.
Under date of December 27,
1965, there had been distributed
to the members of the Federal Open Market Committee copies of the
report of audit of the System Open Market Account and of the report
of audit of foreign currency transactions, both made by the Board's
Division of Examinations as at the close of business September 24,
1965, and submitted by the Chief Federal Reserve Examiner under date
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of November 1, 1965.
Copies of these reports have been placed in
the files of the Committee.
Upon motion duly made and seconded,
and by unanimous vote, the audit reports
were accepted.
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 December 14, 1965, through January 5, 1966, and a supplemental
report for January 6 through 10, 1966.
Copies of these reports have
been placed in the files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
said that the Treasury gold stock would remain unchanged again this
week.
The $75 million decline announced during the last statement
week of December more than covered the French purchase of $67 million
in that month, and the Stabilization Fund holdings appeared to be
in pretty good shape to withstand anticipated drains during the
remainder of January.
As the Committee would recall, the Russians
had made a sale of $31 million in gold through the London market on
December 28.
That proved to be a timely contribution to the Pool's
holdings in view of the continuing gradual drain resulting from
persistent private demand combined with smaller than normal amounts
of new gold production coming to the market.
For the future,
indications were that South Africa would continue to rebuild its
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gold reserves by withholding from the London market some part of its
new production.
As a result, supplies to the Gold Pool would be more
than usually dependent on Russian sales, the timing of which was, of
course, quite uncertain.
Mr. MacLaury noted that the year-end pressures on the
exchange markets that had come to be expected in recent years pro
duced fewer problems this year than in the past.
resulted from a combination of factors.
That welcome change
One of the most important,
of course, was the smaller deficit in the U.S. balance of payments
in the closing months of the year.
And, in marked contrast to last
year, the covering of short positions in sterling this year offset
to a considerable extent the usual year-end repatriation of funds
from London, which last year was greatly exaggerated by the specu
lative pressures on sterling.
On the continent there was no massive
repatriation of funds to Germany at year-end as there had been in the
past, partly because funds had been moving into Germany in preceding
months in considerable volume under the stimulus of the tight money
market conditions in Germany.
(The year-end pressures in Germany
were relieved to some extent by the Federal Bank's action in
temporarily reducing bank reserve requirements.)
As a result, the
Federal Bank was not required to take on sizable amounts of dollars
and, indeed, as the year-end approached funds began to move out,
thus permitting the underlying payments deficit to be reflected in
reserve losses for the first time.
Since December 27 the Federal
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Bank had used $100 million in supporting the mark rate.
The only
instance in which the usual year-end pattern showed up was in
Switzerland, where during December the Swiss National Bank took in
a total of $385 million on a swap basis from Swiss commercial banks.
Since those funds were immediately channeled back into the Euro
currency market via the Bank for International Settlements, the
effects on exchange and money markets even of that sizable movement
were largely neutralized.
Reflecting the calmer atmosphere in the markets this year
end, Mr. MacLaury said, the System had not only been able to avoid
taking on new commitments to finance over-the-year-end swings, but
had actually been able to make substantial progress in reducing
outstanding commitments.
System drawings of Belgian francs under
the standby arrangement with the Belgian National Bank were reduced
during the period from $50 million to $25 million equivalent, as
the Belgian National Bank used dollars to support the franc in its
market.
As Committee members had been informed on December 27, the
Netherlands Bank found itself in a position to sell guilders to the
System in sufficient amount to liquidate all outstanding commitments
for both System and Treasury.
As in the case of Belgium, the
Netherlands Bank found that it had to provide more support for the
guilder during the closing weeks of the year than it had anticipated
and thus could sell the System $50 million equivalent of guilders on
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a wholesale basis--$25 million equivalent to liquidate the System's
drawing under the swap arrangement, and $12.5 million each to reverse
System and Treasury swaps against marks through the BIS.
In addition,
the Treasury was also able to pay off the remaining $17.5 million
equivalent of maturing forward Swiss franc contracts, thus completely
liquidating market commitments that had first been taken on in
July 1963.
As indicated in the written reports, Mr. MacLaury continued,
there was a good demand for sterling in the early part of the period
since the Committee's previous meeting, reflecting both covering and
current commercial needs.
Then there were a couple of days of mild
pressure, associated primarily with the year-end demand for dollars
which resulted in some swapping out of sterling.
On December 20 and
21, when sterling eased down from its previous level of about $2.8030
to $2.8013 or so, the New York Bank put bids in the market for System
Account to indicate to the market that the central bank support for
sterling--which had made such an impression on the market on
September 10--was still available.
That had the effect of stabilizing
the market, and only a small amount of sterling was in fact bought
before the market turned around.
Demand picked up once again in some
volume following the Christmas holidays.
During the whole period
since December 14, the Bank of England took in a total of more than
$200 million, and for the month of December it was able to show a
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reserve gain of $16.8 million after repayment of $75 million on
swap drawings from the System and liquidation of further forward
commitments.
As the Committee knew, the $275 million drawing by
the Bank of England that matured on December 30 was rolled over for
four days and then paid off on January 3.
At this point, it was
expected that the remaining $200 million drawing, scheduled to
mature on January 28, would be rolled over for a few days into
early February, at which time it, too, would be liquidated--thus
putting the entire $750 million swap arrangement back on a standby
basis.
The good performance of sterling in the markets during the
past few months and over year-end, Mr. MacLaury said, should not be
taken as an indication that Britain's problems were by any means all
solved.
The third-quarter U.K. balance of payments deficit was a
rather disappointing performance.
While there was no specific reason
to expect trouble in the next few months, one could not write off
the possibility that market sentiment could again turn against
sterling, even during its period of seasonal strength.
For that
reason, he felt it was vitally important that the arrangements worked
out for providing a defense for sterling be in full readiness.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
December 14, 1965, through January 10,
1966, were approved, ratified, and
confirmed.
1/11/66
Mr. MacLaury noted that two swap arrangements would mature
during the early part of February:
the $250 million, six-month
arrangement with the German Federal Bank matured on February 9, and
the $100 million, three-month arrangement with the Bank of France
matured on February 10.
He requested the Committee's approval of
renewal of both arrangements, neither of which was in use at present.
Renewal of the standby swap arrange
ments with the German Federal Bank and
the Bank of France was approved.
As he had mentioned earlier, Mr. MacLaury observed, the
drawings under the arrangement with the National Bank of Belgium were
now down to $25 million equivalent, having been reduced since the
last meeting of the Committee by $25 million.
The remaining drawing
would come up for its second renewal on February 10.
With the
Belgian franc under some mild pressure, he would hope that at least
part of the drawing could be off the books before maturity, but he
requested Committee approval of renewal of the drawing for an addi
tional three months, should that prove necessary.
Possible renewal of the $25 million
equivalent drawing on the swap arrange
ment with the National Bank of Belgium,
maturing on February 10, 1966, was noted
without objection.
Mr. MacLaury said that he would note one final technical
point in connection with the Belgian arrangement, for information of
the Committee.
December 22,
At the time that arrangement was renewed, on
1965, the Belgian National Bank had requested that the
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interest rates applicable to drawings be adjusted upward to take
account of the rise in U.S. bill rates since the previous renewal.
After checking with the Treasury, it was agreed that the rate on
three-month drawings under the standby portion of the arrangement
be increased to 4-1/4 per cent from 3-3/4 per cent, and that the
rate on the fully-drawn portion, with a term of six months, be
increased to 4-3/8 per cent from 3-7/8 per cent.
As the Committee
knew, the Belgian arrangement was unique in a number of respects,
and it was now the only arrangement under which interest rates were
adjusted periodically rather than being linked automatically to the
U.S. Treasury bill rate.
Mr. Hayes said he would like to add a footnote to
Mr. MacLaury's remarks concerning repayment by the British of their
drawings on the swap arrangement.
As the members would recall, the
Committee had discussed the matter at its December meeting and there
had been general agreement that it would be desirable for the draw
ings to be cleared up as promptly as possible.
He had sent a note
to Lord Cromer of the Bank of England conveying that view of the
the Committee.
At the time of writing it had already been agreed
to roll over for just a few days the $275 million drawing that came
due at the end of December.
With respect to the $200 million
drawing due in late January, he had pointed out to Lord Cromer that
the Committee placed a high value on emphasizing the short-term
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nature of swap drawings both by word and by practice, and that an
effort to repay the drawing would be useful.
He (Mr. Hayes) had
just received a reply from Lord Cromer thanking him for the infor
mation on the views of the Committee and expressing full agreement
with the Committee's position.
Lord Cromer went on to say that the
Bank of England might well ask for renewal of the drawing due on
January 28, but they intended to repay it in the first few days of
February.
Mr. Hayes thought it was well that the Committee had
taken the position it had.
There was no doubt in his mind that the
Bank of England viewed the matter in the same way as the Committee
did.
Chairman Martin commented that the matter evidently was
working out in a satisfactory fashion.
The Chairman then noted that
Mr. Daane had been abroad at the time of the Committee's previous
meeting to attend a meeting of the Deputies of the Group of Ten,
and he invited Mr. Daane to comment.
Mr. Daane remarked that the Deputies had met in Paris on
December 14 and 15,
1965, to continue the discussion begun during
the meeting early in November of some rather basic questions on
various aspects of the subject of deliberate reserve creation that
had been posed by Chairman Emminger.
Those questions concerned
(1) the need for new reserve assets, (2) who should be responsible
for their creation and distribution, (3) what types of assets should
be created, (4) the rules for decision making, and (5) the matter of
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multilateral surveillance.
The discussions so far had been exploratory,
involving a relatively free exchange of views and with no hard and
fast positions taken.
The general atmosphere, carried over from the
November meeting, was one of actively seeking a basis for agreement
that could be presented to the Ministers and Governors of the Ten
sometime this year--perhaps as early as June, although that might be
optimistic.
On the first question, Mr. Daane said, he thought that to
date no one had come up with a good, clear measure of what the
reserve needs were or might be.
Some people had attempted to make
an analogy to a domestic economy but others had rejected that
approach.
One country took the view that the concept of "global
reserve needs" was, after all, a "political" concept.
Mr. Daane
noted incidentally that the International Monetary Fund was engaged
in a parallel study of the needs for international reserves and
liquidity.
The second question, Mr. Daane said, came down basically to
the issue of whether responsibility for the creation and distribution
of reserves should lie with the Group of Ten--or perhaps the Group
plus two or three other countries--or with the IMF.
Except for the
French, the Deputies seemed to be generally agreed that reserves
should be created "in close association" with the IMF.
How individual
members would define "close association" varied, but it seemed fair
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to say that the Group was moving closer to the view that the IMF
definitely should be in the picture and perhaps in the central role.
On both the questions of who should create and distribute
reserve assets and what sort of assets were envisaged, Mr. Daane
continued, at the November meeting the British had recommended a
dual approach, with some support from the U.S. side.
Under this
approach reserves would be created by and for a limited group of
countries and also more widely within the structure of the IMF.
The
former could involve a variety of techniques but would, perhaps,
come close to the "collective reserve unit" that had been under
discussion over the past few years.
The latter could take the form
of a "floating tranche" for all IMF members, or could involve a self
qualifying principle under which those countries that had already
drawn their gold tranche would not be immediately eligible but would
be potentially eligible.
At the December meeting there was consider
able sympathy for this dual approach around the table, which meant
that the possibilities of both a new reserve unit and of additional
reserve asset creation through the IMF were still very much in the
deliberations.
Beyond that point, Mr. Daane said, some specific problems
arose.
One major problem was the question of whether the distribution
or use of any new asset should be linked to gold.
There was general
agreement, except on the part of the French, that there should be no
gold link in the creation and distribution of the new asset.
The
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majority view seemed to be that there also should be no gold link
in connection with use of the asset, except that of a gold-value
guarantee.
If the no-gold-link route was chosen, however, the
question arose of what sort of limit should be applied; some sort
of creditor limit would seem to be required.
At that point the
issue began to shade into some of the other more technical problems
that were being considered, related to the acceptability of the
asset.
The French had consistently taken the position that their
own proposals--which were unchanged from those they had made to
the U.S. representatives at the beginning of the deliberationswere on the table, and that they were awaiting the proposals of
others.
Related to this, the Deputies were scheduled to have a
3-day meeting near the end of January, in which they might well come
a bit closer to the negotiations stage.
There would be another
meeting in March, probably in Paris, and then a longer meeting in
Washington, most likely in April.
Mr. Hayes asked if Mr. Daane felt that enough consideration
had been given in the discussions to the possible adverse effects of
a new reserve asset on the use of the dollar as a reserve currency.
Mr. Daane replied that the question of the relation to
existing reserve assets was one of the basic questions considered in
November and again in December.
The French said at the December
meeting that they had never recommended eliminating the dollar as a
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reserve currency.
They recognized that many countries would want to
maintain working balances in dollars and also that within a reserve
currency "bloc" of countries there would be larger holdings of reserve
currencies.
They felt, however, that the Group of Ten countries
should normally hold only working balances in reserve currencies and,
at a minimum, not hold any more reserve currencies in their reserves
than they did now.
In Mr. Daane's judgment that was a somewhat milder
position than they had taken at earlier meetings.
Most of the other
Deputies emphasized the role of the dollar in international transac
tions and its use in exchange markets.
There was considerable
sentiment on the continent for a tightening of the multilateral
surveillance process, which now was rather loose, involving mainly
WP-3 discussions, but the dollar's continued status as a reserve
currency was clearly envisaged.
Mr. Hayes said he had raised the question because he thought
there was a real risk that the U.S. might lose some of its financing
flexibility, not only in connection with deficits but also when its
payments were in balance.
Even with over-all balance, there would
always be some countries with respect to which U.S. payments were in
deficit.
It would be disadvantageous if a trend should develop abroad
toward unwillingness to accumulate dollars to deal with swings in
payments between the U.S. and individual countries, as well as
between third countries.
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In response to a question by Mr. Mitchell, Mr. Daane said
it was his personal feeling--which would not necessarily prove to
be the official U.S. position--that it would be undesirable for any
new reserve asset created to bear interest, particularly if the
asset carried a gold guarantee.
In his judgment any new asset
should stand on its own feet;and without interest it would offer
minimum competition to the dollar.
On the other hand, there were
those who felt that a newly-created reserve asset should carry some
nominal interest in order to insure its attractiveness to potential
holders.
That would result in three types of reserve assets:
gold,
bearing no interest; the new asset with a gold guarantee, offering,
perhaps, a 2 per cent return; and dollars, now offering about a
4-1/2 per cent return.
The question was not closed and, as he had
noted, the view he had expressed was a personal one.
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. Gov
ernment securities and bankers' acceptances for the period
December 14,
1965, through January 5, 1966, and a supplemental
report for January 6 through 10,
1966.
Copies of both reports
have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
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The four weeks that have elapsed since the Committee
last met have been turbulent ones for financial markets
and for System open market operations. The period encom
passed the December tax date, the year-end statement
date, a three-pronged Treasury cash financing operation,
and a transit strike in New York City which still
threatens the efficient operation of the financial
markets themselves. During the period there were
conflicting interpretations of the course of developments
in Vietnam, concern and uncertainty over the likely
shape of the budget, growing recognition that inflation
was of major concern for 1966, and a potential conflict
between the Administration and industry over steel
prices. At the same time, banks in the money centers
came under increased seasonal pressure and loan demands
were heavy at a time when financial markets were still
in the process of adjusting to the change in the discount
rate.
While there were conflicting movements during the
period, the net impact of all these developments was to
put short-term interest rates under heavy upward
pressure, while rates for intermediate Government
securities also rose substantially. In the long-term
area, however, rates on Governments actually declined
slightly, while the corporate and municipal markets,
under the influence of a seasonally light calendar,
were generally steady.
Given the turbulence of the period, which, inciden
tally, made reserve projecting a more than usually
hazardous occupation, open market operations were
conducted with a view to moderating the pressures on
bank reserve positions and the money market. In view
of various alarms and excursions that occurred during
the period, it is difficult to summarize Federal Reserve
operations. Generally speaking, however, it can be said
(1) that operations supplied a large volume of reserves
to accommodate a far greater than seasonal expansion of
required reserves, resulting from a strong rise in bank
credit and a change in deposit mix as bank CD's ran down
over the tax and dividend dates, and (2) they mitigated
the upward pressure on short-term interest rates. One
measure of this reserve supply can be seen in nonborrowed
reserves, which rose at an annual rate of 21 per cent
in December. Heavy use was made of repurchase
agreements during the period, helping to moderate
average dealer financing costs in the light of higher
commercial bank lending rates. Measures of net reserve
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availability, as the written reports point out, varied
widely over the period. The net borrowed reserve figure
of $180 million published for last week was apparently
taken by the market in stride, without creating the
impression of any tightening of monetary policy. The
results were admittedly a higher net borrowed reserve
figure than we had aimed for, but it was a week in
which reserves consistently fell short of projected
levels by a large margin and which was thoroughly com
plicated by the year-end statement date and by the
impact of the transit strike.
The transit strike in New York has brought to the
forefront many of the technical aspects of financial
market transactions that most of us normally take for
granted. The dependence of these markets on bookkeepers,
security handlers, and messengers was brought sharply
into focus a week ago yesterday when, despite elaborate
preparations, many of the employees of New York City
banks and security houses were prevented from getting
to work. The breakdown of mechanical arrangements
resulted in a fairly large number of failures to deliver
securities early in the week, but as a result of heroic
efforts by banks and dealers, and individual employees,
the flow of securities and money has been kept going.
Early in the week the New York Reserve Bank, after
consultation with the market, requested dealers to
avoid trades for cash delivery while the emergency
existed, in order to avoid the last minute transfer of
securities and funds that such trading entails. Since
last Thursday the market, following the lead of the
stock exchanges, has generally been closing at 2 o'clock,
and this has also helped. There is no doubt, however,
that the strike has reduced the efficiency of the market
and tended to make dealers very cautious. It has also
limited the System's ability to operate ona normal basis.
While the market continues to function, and we have not
been unduly hampered in our operations, we will all
breathe a sigh of relief when we can return to the normal
hazards of bus and subway travel in the City.
As mentioned in the Board staff blue book 1/, Federal
funds, which had traded mainly at the discount rate for
1/ The report, "Money Market and Reserve Relationships," prepared
by the Board's staff for the Committee.
1/11/66
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two weeks after the rate was raised, have again generally
traded at a premium. This has not been due to any general
shortage of reserves (as mentioned earlier non-borrowed
reserves have risen substantially) but to the convergence
of reserve pressures on money center banks, where basic
reserve deficits more than doubled in the three weeks
ending January 5 compared with the three weeks ending
December 15.
On Friday, New York City banks were running
a basic reserve deficit in excess of $1.4 billion, and in
addition were borrowing heavily from non-banks in the form
of repurchase agreements, promissory notes, and Federal
funds purchases. These pressures should subside as
January progresses, but CD maturities are large and loan
demands appear to be continuing contraseasonally. Until
the pressures on money market banks subside, pressure
can also be expected in the funds market (and on CD rates)
as individual banks try to avoid excessive use of the
discount window. I might mention that at least one large
New York City bank went to 5 per cent on 6-month CDs
yesterday.
The various written reports that the Committee has
received have commented extensively on Treasury bill and
other short-term rate developments in recent weeks. In
yesterday's auction, enlarged by $100 million for the
second week, $1.3 billion in 3-month bills sold at an
average issuing rate of 4.58-1/2 per cent, while the six
month rate went to 4.74 per cent. Bidding for the new
three-month bill, in particular, has been quite cautious
in recent weeks, owing to the increased size of the
weekly offering and the return flow of shorter bills as
investors reversed pre-year-end window dressing opera
It seems also that, in the light of current
tions.
uncertainties and wider rate movements, the market is
exacting a larger underwriting spread from the Treasury
in compensation for the increased risks and higher
financing costs.
The books were open yesterday on the final stage of
the Treasury's cash financing operation. The offeringof $1.5 billion 10-month certificates having a coupon of
4-3/4 per cent and priced to yield 4.85 per cent--has
been very well received by the potential subscribers.
With the tax and loan account privilege estimated to be
worth an additional 20 basis points to the banks, a
heavy oversubscription is expected, with the market
estimating allotments of no more than 10-15 per cent.
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As far as the outlook is concerned, I can merely
echo the Board staff in saying that it is difficult
to assess the potential degree of money market and rate
pressures and the likely inter-relationships among money
variables in the immediate future. The weeks ahead will
provide a further testing period for the interest rate
adjustments that have already been made. While basic
market expectations at the moment appear to lean towards
a further upward drift in interest rates, the present
level of interest rates could prove quite attractive to
investors, particularly if seasonal pressures show some
signs of abating, and if other unsettling developments
do not occur. At the higher rate levels, dealers have
had considerable success in selling Government securities
out of their portfolios. Since December 29 they have
sold nearly $240 million coupon issues maturing in over
one year, moving into a net short position of about $50
million by last Friday. Some of the corporate funds
going into Governments appear to represent proceeds of
bank loans that will not be needed for operational
purposes until later in 1966.
Whether or not the rally that started in the Gov
ernment bond market last week can be sustained is as
yet unclear, although the market appears to be in a
better technical position than it has been in for some
time and the success of yesterday's Treasury financing
is heartening. With its January cash needs now arranged
for, the Treasury will be turning its attention to the
refunding of $4.8 billion notes maturing on February 15th,
of which $2.5 billion are held by the public. The
Treasury will have hard decisions to make as to coupon
and maturity for the new issue or issues to be offered,
and much will depend on the circumstances prevailing at
the time terms have to be set. A successful refunding
operation could help restore a greater measure of
stability in the market.
The System should, of course, give the Treasury as
much support as it can in the refunding. But a definition
of "even keel" at a time when the market is more susceptible
to general economic, military, and budgetary developments
than to small changes in monetary variables is not easily
come by.
Perhaps the most we can do is to be a moderating
influence in what now appears to be a highly uncertain
situation, but one which may settle down as the month
goes on.
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Mr. Mitchell asked Mr. Holmes if he thought that the Desk
had given any leadership to the money market in the recent period.
Mr. Holmes replied that the Account Management had made a
substantial volume of repurchase agreements on almost every trading
day of the last 2 weeks.
In his judgment the market understood
that the System would act, and act promptly, to provide needed
reserves, although it did not expect reserves to be supplied to
finance any rate of credit expansion, however high.
In response to further questions by Mr. Mitchell, Mr. Holmes
said he did not believe the market assumed the Committee had any
specific interest rate target in view, and he doubted that a new
increase in the discount rate was widely anticipated.
The market
was impressed by the strength of the business situation and the
fact that the Administration now seemed more cognizant of the
possibility of inflationary developments than it had earlier; and
banks were impressed by the strength of loan demand in January and
by the outlook for a substantial increase in loans in the first
quarter.
Mr. Mitchell observed that at its last meeting the Committee
had chosen not to give the Manager very much in the way of detailed
instructions while waiting for conditions to settle down, and he
gathered that the Manager thought some progress had been made in
the latter respect.
Was there anything the Committee could do now
to tranquilize the present state of expectations?
1/11/66
-21-
Mr. Holmes commented that in his judgment announcement of
a rather restrictive Federal budget would be more reassuring to the
market than any action the System might reasonably take.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, the open
market transactions in Government securities
and bankers' acceptances during the period
December 14, 1965, through January 10, 1966,
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. Koch made the following statement on economic conditions:
New information on past economic developments and
on prospective spending plans serves to confirm the
existence of a strong expansion currently and its likely
continuance. As a matter of fact, both developments in
the recent past and future prospects suggest a rate of
economic expansion that could be creating problems of a
destabilizing nature--first inflation and subsequently
readjustment.
The significant upward revision in GNP in the first
three quarters of 1965 that the Commerce Department has
just announced has already led to marked upward revisions
in GNP forecasts, not only in level but also in rate of
increase. Prior to last summer, a common forecast for
GNP in 1966 was $700 billion. After a worsening of
conditions in Vietnam in mid-summer, forecasts were
generally raised to the vicinity of $710 billion. Now
they range from $720 to $730 billion. A $725 billion
GNP this year would mean a rate of increase similar to
that last year--about 7-1/2 per cent in current dollars
and 5-1/2 per cent in real terms. And this is to be
achieved with fewer unused resources available to draw
upon than there were a year ago.
1/11/66
-22-
The two critical elements in one's prediction of
likely economic things to come remain developments in
Viet Nam and business investment--and their repercussions
on the economy generally.
As for the likely impact of Viet Nam on fiscal policy,
the Administration has dropped specific hints over the
last week or so as to the prospective size of the admin
istrative budget in both the current and the next fiscal
year. The total expenditure figures on an administrative
budget basis most frequently mentioned are around $105
billion for fiscal 1966 and up to $115 billion for fiscal
1967. Even with no tax rate increase, the rise in revenues
resulting from further growth in the economy will be large.
But it is not likely to quite match the jump in spending.
It is difficult to translate these fragmentary clues
on the budget into national income and full employment
terms, which are more meaningful for economic analysis.
Nevertheless, they suggest some increase in the net
stimulative nature of fiscal developments this year. With
a booming private economy and with the full employment
budget likely to be in deficit under current tax rates
and prospective Federal spending, even a modest increase
in net fiscal stimulation this year might prove excessive.
One major uncertainty in this area is the possibility
of peace in Viet Nam. In event of such a happy development,
private expectations and spending plans would no doubt be
deflated, but Federal fiscal policy might well remain
stimulative. Defense spending would likely continue
higher than in the recent past and expenditures on the
Great Society programs would increase. However, there
is every indication that, with current and prospective
military spending as large as it is, every effort is being
made to limit other Federal spending programs. A sharp
worsening of the situation in Viet Nam, on the other hand,
could lead to speculative buying on the part of consumers
as well as businesses.
As for business investment, the recent GNP revisions
raised earlier figures sharply for both fixed outlays and
inventory accumulation. According to the revised figures,
business fixed investment in the third quarter of 1965
was 15 per cent higher than a year earlier. It amounted
to about 10-1/2 per cent of the GNP. In the current
quarter, this percentage may edge up further. Such per
centages are similar to those that prevailed during the
investment boom of 1956 and 1957.
The relationship of these fiscal and capital spending
1/11/66
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developments to monetary policy lies mainly in their
likely effects on expectations, resource utilization,
and prices. Here the situation looks better from the
point of view of current employment and output levels
but more troublesome from the point of view of longer
run economic stabilization. We have been achieving
our goals of an increased standard of living and reduced
idle resources. But the closer we get to full utiliza
tion of resources, the more we have to watch out that
the pace of economic expansion remains sustainable and
its character balanced and the more we may have to
worry about the trade-off between reduced unemployment
and price stability.
Assuming a rate of increase in dollar and real
GNP this year roughly comparable to that last year,
capital utilization rates are likely to edge up further,
employment should continue to advance rapidly, and the
unemployment rate should decline significantly more.
To illustrate, total manufacturing capacity might well
increase 7 per cent or more this year if current
spending plans are realized. This would not likely
be quite as large as the projected rate of increase
in manufacturing output, assuming the specified rise
in GNP. Moreover, pressures would be more acute in
some specific manufacturing lines where utilization
rates already exceed 90 per cent of capacity.
In the labor field, the armed services and the
anti-poverty programs alone could push the unemploy
ment rate down 2 or 3 tenths of a percentage point
and a rapidly increasing employment should contribute
3 to 4 more tenths to the decline, depending on the
rate of labor force growth. Thus, the overall
unemployment rate might well drop to, say, 3.5 per
cent by summer from the 4.1 per cent rate in December.
These likely developments in resource use would no
doubt put additional pressure on wages and prices.
Recent wage increases in some nonmanufacturing lines
have already been exceeding the Administration's
guideposts. Moreover, the rate of rise in productivity
in the total private economy appears to have slowed
somewhat. The average increase in the years 1961 through
1964 was 3.8 per cent, but the rate last year fell to
3 per cent or lower.
Although the rise in prices in general continues
to be moderate and selective, it is persistent. The
increase in the wholesale price index for industrial
-24-
1/11/66
commodities, for example, amounts to 2 per cent now
since the upcreep began about 15 months ago. Continuing
shortages of supplies of copper and other materials, and
the most recent steel price flare-up, suggest growing
pressure on the guideposts.
From the point of view of the domestic economy, the
actions increasing discount rates and Regulation Q
ceilings last month look to have been more and more
appropriate and timely with each passing day and each
available new statistic. As for the policy over the
next three weeks, current Treasury financing suggests,
although it probably does not dictate, one of an even
keel nature. Even in the absence of Treasury financing,
however, such a policy would seem to me appropriate.
First, we need to know more about the lagged effects
of last month's actions in dampening the growth in
reserves, deposits, credit, and spending over the
longer run. Second, and even more importantly, we
need to know more about the course of nearby develop
ments in Viet Nam, and whether, if inflationary forces
appear strong, the Administration will attempt to seek
some fiscal restraint through a tax increase and/or
expenditure limitations.
Mr. Holland made the following statement concerning financial
developments:
In the tightening money market of recent weeks,
one contributing factor of key importance has been the
powerful groundswell of credit demands. Statistics are
gradually becoming available to reveal just how strong
and pervasive those demands have been.
By way of perspective, newly available figures for
the fourth quarter show total net funds raised by the
nonfinancial sector mounting above an $80 billion annual
rate.
This is sharply higher than the reduced third
quarter rate, and reflects the fourth-quarter concentra
tion of Treasury financings that helped to aggravate the
money market pressures.
Private borrowing also climbed
back up in the fourth quarter to a $67 billion annual
rate, matching the peak of last spring that was swollen
by borrowing to stockpile steel. At this level, private
borrowing equaled 11 per cent of private GNP, extending
theslowly rising trend in this ratio that has prevailed
1/11/66
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since 1962. The chief reason for this uptrend in
private borrowing is not hard to pinpoint:
it
parallels very closely the vigorous rise that also
has been taking place in the total of net private
physical investment. Viewed against the perspective
of the new GNP figures, these latest borrowing and
investment figures do not suggest a sudden new out
burst of activity so much as a fairly steady,
substantial, almost inexorable-appearing rise in
private investment and its financing to places of
importance in the over-all economic picture that have
not previously been touched except near the peaks of
cyclical surges in the earlier postwar years.
It is trite to say that bank credit expansion has
contributed importantly to this over-all credit expansion.
It is not as trite to point out that bank credit growth
in the fourth quarter does not appear to count for any
greatly different share of total credit flows than would
be true for the preceding nine months of 1965 taken as
a whole. While this comparison implies a continuing
very vigorous bank credit expansion, I daresay it
sounds less imposing than the recent flow of bank
reports might have led one to expect. On reflection,
I think three elements have been at work enhancing our
sense of a very expansive banking performance.
To begin with, detailed weekly figures suggest that
the increases in bank balance sheets are being concentrated
particularly in two items that are accorded special
cyclical significance: business loans, and the money
supply. Business loans were up by a seasonally adjusted
$1.4 billion in December, and the first January week
also looks strong. Meanwhile, the demand deposit
category also started to expand more sharply during
December. Both of these are magnitudes that might be
expected to be moderated a bit, I think, by higher interest
rates being paid. Their brisker growth, in the face of
such added rate disincentives, therefore, is probably a
tribute to short-term customer desires for cash for trans
actions purposes--and perhaps indirectly reflective of
the vigor of current spending intentions.
A third special development affecting appraisals
has been the sharp step-up in the ratio of reserve use
by the banking system. On average, banks needed con
siderably more in the way of required reserves to support
each dollar of deposit expansion in December and early
1/11/66
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January than was true in previous months. This resulted
partly from the slowdown of time deposit growth and the
pickup in demand deposit expansion. In addition, within
the demand deposit total, there was a deposit shift that
favored higher-requirement reserve city banks more than
low-reserve-requirement country banks. As can be judged,
therefore, such an increased "consumption ratio" for
reserves has both some purely technical overtones and
also some underlying policy implications.
The combination of these influences on reserve use
added up to a striking total, and the Desk responded by
injecting nonborrowed reserves at an annual rate above
20 per cent during December. Nearly as high a rate of
reserve rise seems to be persisting into January. Our
standard reserve projection and estimation procedures
fall short of allowing for so great a reserve appetite
on the part of the banking system, and consequently the
Manager, as he has already indicated, repeatedly found
himself faced with after-the-fact downward revisions in
net reserve availability. Time after time during this
interval the market ended up with less reserves than
either it wanted or we intended. The result was to
compound the prevailing degree of market tightness.
In the event, given the strength of money and loan
demands that were contributing to the increase in reserves
demanded, I would argue that the more or less automatic
additional degree of reserve restraint resulting from
the misses in reserve projections was a constructive
outcome--and one that might work to similar advantage
in the weeks immediately ahead. However, whether or
not individual members of the Committee might agree that
these reserve shortfalls can be constructive, it seems
to me and to some others of the more embattled members
of the staff that it would be helpful if the Committee
could take a more explicit stand as to whether the
tendency for reserve misses to be more or less automatic,
and approximately countercyclical, should be acquiesced
in, or perhaps even welcomed; or, alternatively, whether
the Committee would prefer an adjustment of reserve
projection procedure that would try to minimize such
misses by "aiming ahead of the banking system," so to
speak, whenever we sensed that its demand for reserves
was beginning to rise or fall by more than seasonal
proportions.
I would not presume to attempt to crowd all the pros
1/11/66
-27-
and cons regarding such a proposal into a briefing such
as this. If this suggestion finds favor, however, perhaps
some kind of staff or Committee study of the matter could
be undertaken.
Mr. Galusha commented he did not understand the proposal
Mr. Holland had advanced.
Was he suggesting that the Committee
should encourage imperfection in the projections of reserve
figures?
Mr. Hickman said that, as he understood it, Mr. Holland
would like to attempt to reduce the rate of growth of nonborrowed
reserves by encouraging misses of deeper net borrowed reserves.
Mr. Holland replied that that was in fact what had
happened recently.
He was suggesting that the Committee might
want, not to encourage such misses, but to acquiesce in them.
The result would be symmetrical; if reserve needs turned down
suddenly, the misses would be in the opposite direction and
policy would in effect be eased more rapidly than if there were
no misses.
Mr. Ellis said he gathered that what Mr. Holland actually
would like was some guidance as to how the Committee felt on the
matter, and Mr. Holland agreed.
Mr. Holland also concurred in Mr. Mitchell's observation
that one burden of his (Mr. Holland's) comments was that the
Committee's posture was tighter than it would have been if there
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1/11/66
had not been a relative shift of deposits from country to reserve
city banks.
Mr. Reynolds presented the following statement on the
balance of payments:
Along with the news that the domestic economy has
been expanding more rapidly than earlier supposed has
come news that U.S. foreign trade was also expanding
surprisingly rapidly during the second half of 1965.
This news has both favorable and unfavorable aspects for
the balance of payments; merchandise exports as well as
imports have shown unexpected buoyancy.
Acceleration in the growth of exports last fall
fits with other information suggesting that the pace of
economic expansion in the rest of the world as a whole
was still rapid and may have been accelerating after an
earlier slowdown. If this expansive world economic
situation persists into 1966, as now seems likely, it
will present the United States with new opportunities
for balance-of-payments improvement.
But, at the same time, the gathering boom at home
and the consequent buoyancy of imports emphasize the
standard caveat of recent years:
that fundamental
improvement in our international transactions depends
heavily upon the avoidance or containment of domestic
inflationary pressures. In my view, the main link
between monetary policy and the balance of payments now
runs more clearly than ever through costs, prices, and
the current account, rather than through interest rates
and capital movements. Domestic expansion seems to have
removed whatever conflict there was earlier between
domestic and international goals of economic policy.
From the third quarter to October-November, U.S.
merchandise exports increased at a 15 per cent annual
rate, and in the latest 5 months for which we have dataprobably a more representative period--exports were up
8 per cent from a year earlier. Thus, annual reviews that
dwell on the increase of only 4 per cent from the full
year 1964 to the year 1965 tell us mainly about the set
back in the first half of last year rather than about the
recent trend.
1/11/66
-29-
Agricultural exports--about one-fourth of total
exports--were at near-record levels in October-November,
having rebounded in the summer. The rapid advance in
October-November came in exports of nonagricultural goods.
Data on the geographical destination of exports
through October show that shipments to Canada were
expanding particularly rapidly, and a renewed expansion
of exports to continental Europe seemed to be getting
under way, no doubt related to recent upturns in French
and Italian imports and continued strong demand from
Germany. Exports to Britain, like total U.K. imports,
remained at about year-earlier levels. And U.S. exports
to Japan also showed no significant recent increase,
although total Japanese imports began to expand again
last summer.
U.S. imports did not rise as rapidly as exports in
October-November. But they rose pretty fast nonethelessat an annual rate of more than 10 per cent--thus dis
appointing hopes of a marked slowdown after the steel
settlement. Total imports in the latest months were up
one-sixth from a year earlier. Steel imports, though
down a little from the second-quarter peak, were up by
about 50 per cent from a year earlier, or by about
$1/2 billion at an annual rate. Machinery imports were
up by more than 40 per cent, and imports of non-ferrous
metals and of consumer goods were each up about one-fourth.
What is the range of possible developments for
On the most
exports and imports in the months ahead?
optimistic assumption, that further intensification of
domestic inflationary pressures can be avoided, I think
we could expect to see an appreciable slowing down in
the rate of import expansion. Steel imports might fall
back half-way toward their year ago level, and even if
other imports continued to rise somewhat faster than GNP,
the total might not go up at an annual rate of more than
about 7 per cent. In that setting, exports would probably
rise somewhat faster than imports in percentage terms,
and even more in dollar terms. Acceleration of expansion
in Japan, Italy, and France might about offset possible
slowdowns in Britain and in such important peripheral
countries as Australia and South Africa, to keep our
total exports rising fairly steadily, though probably
not at the very rapid rate of last fall.
This cheerful combination of events could improve
the trade balance by $1 billion or so over the year from
1/11/66
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last October-November, and produce an even larger improve
ment between the full year 1965 and the full year 1966.
The more pessimistic possibility is that there will
be little if any improvement in the trade balance. If
boomy conditions should be accentuated in this country,
both our exports and imports would do less well. Even
if price changes were not markedly adverse, lengthening
of delivery dates and reduced eagerness of U.S. producers
to cultivate foreign and domestic markets could have
important adverse effects.
Evidently, the Administration's target of a further
substantial reduction in the U.S. payments deficit in
1966 implies a foreign trade performance near the
optimistic end of the range I have given--an improvement
much nearer to $1 billion than zero. This is so because
no substantial improvement on capital account is to be
expected, and there may instead be some net deterioration
from recent levels, as explained in the green book.1/
Despite the stress in official statements on the benefi
cial effects to be expected from voluntary programs,
they represent a holding operation this year--an effort
to hold net capital outflows down to roughly last year's
reduced rate, rather than to achieve further net
improvement in this area.
Mr. Maisel remarked that it seemed to him from the statements
of Messrs. Koch and Reynolds that there was a real conflict between
the country's domestic and balance of payments goals.
increase in exports be inflationary?
Wouldn't an
Where would the real resources
needed to improve the trade surplus come from if the domestic
economy would be in a state of over-full utilization of resources?
Mr. Reynolds replied that the importance one attached to
that problem would depend on how one weighed an improvement of,
say, $1 billion in the trade surplus.
The effect obviously would
1/
The report, "Current Economic and Financial Conditions," prepared
for the Committee by the Board's staff.
1/11/66
-31
be in the inflationary direction, but an export increase that
would result in a large improvement in the balance of payments
would involve a very small part of total domestic activity.
Mr. Mitchell commented that if the economy was really
struggling to meet domestic demands and the demands related to
Viet Nam he thought there would be little room left for an increase
in exports.
He was somewhat surprised by the fact that exports
had been expanding recently, but in any case the country was now
in a new situation.
Mr. Reynolds remarked that if the point was reached where
exports could not rise because of the pressure of domestic demands,
the inflationary environment that would exist would be unfortunate
wholly apart from balance of payments considerations.
Mr. Daane asked whether, on the whole, Mr. Reynolds expected
the U.S. balance of payments in 1966 to be improved over 1965, and
if so whether he thought a position within $250 million of equilib
rium would be attained.
Mr. Reynolds replied that he was optimistic about the
balance of payments in 1966 in the sense that he expected some
improvement in the trade surplus, but he was not prepared to say
how much improvement there was likely to be.
Given the changed
situation abroad, and assuming there would not be inflation in this
country, he certainly was not worrying much about deterioration in
the trade surplus, as he had been a year ago.
1/11/66
-32Chairman 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:
In a few days the President's Economic and Budget
messages should shed some light on the way in which
the Administration proposes to handle the demands of
the Great Society programs and the war in Viet Nam.
This does not necessarily mean an end to the
uncertainty and sensitivity that have characterized
financial markets since the discount rate action was
taken. Budget estimates for fiscal 1967 will clearly
be predicated on uncertain judgments as to the future
course of events in Viet Nam. They will, in any case,
for some time be exposed to critical scrutiny pending
Congressional action. It is not unlikely that
explorations of a possible Viet Nam settlement will
drag on for some time, giving rise to divergent and
shifting expectations and judgments. Moreover, the
impressively strong note on which the economy comes
into the new year and the exuberant outlook are bound
to raise questions about the possibilities for
continued orderly expansion in 1966.
I will not try to add to the staff's penetrating
review of the closing phase of the past year. This
makes it easier to focus on the problems and possible
perils of the future. Clearly, we are entering a new
phase in which economic balance is likely to be
endangered by converging demand pressures more than
at any time since this expansion started almost five
years ago. I am encouraged by the new evidence
suggesting that productivity has in 1965 increased
somewhat more than originally estimated, and I am
hopeful that this favorable development will continue.
The cumulative effect of the recent flow of fixed
investment, supported by substantial expenditures
for research and development, promises to continue
increasing the capacity of our industry and of the
economy as a whole. But right now there remains little
slack in plant capacity and in the labor force. The
easy absorption of excessive steel inventories, the
continuous rise in the backlog of unfilled orders, and
the further decline of inventory-sales ratios all testify
1/11/66
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to the fact that the economy is avidly absorbing the
ever-rising output of final products.
In the current economic climate of an unexpectedly
favorable profit experience and strong consumer demand
without any significant problem areas, businessmen and
market participants tend to become exuberant. Add to
this the near-certainty of a substantial Treasury deficit,
and you have a situation in which inflationary expec
tations are almost bound to win the upper hand. Recent
stock market performance reflects this atmosphere.
Prices of goods and services are now clearly
reflecting the pressures of demand, the existence of
supply limitations, and the search for opportunities to
improve or protect profit margins. Consumer and whole
sale prices, and prices of industrial raw materials,
have risen in 1965 more rapidly than in the immediately
preceding years. Wage guideposts have served a useful
purpose in helping to preserve price stability, but
experience, here and abroad, shows that a taut labor
market is conducive both to over-generous wage
settlements and to less publicized wage advanceswhat the British call "wage drift."
Yet, preservation of cost stability is essential
both for sustained growth and for further progress in
moving toward international balance. In 1966 we will
have to work harder to protect, and, indeed, expand
our trade surplus. But the over-all outlook for the
balance of payments is not good, even though the
December performance looks encouraging on the basis of
fragmentary data. In the immediate future we shall be
living with theeffects of postponed Canadian issues
held over from the fourth quarter; and this factor,
together with larger imports and larger military
spending abroad, will probably offset gains painfully
made in reducing direct investment outflows and in
keeping other capital movements tending in the right
direction.
All the economic data that have become available
since the discount rate action add to its justification.
Indeed, public criticism of it has ebbed considerably,
with increased public and Administration recognition of
the problems of maintaining a balanced expansion in
1966. But the adjustments in the financial markets
have been turbulent, prolonged, and complex. It is
always difficult to disentangle the different influences
1/11/66
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affecting market psychology and expectations. Certainly
our action came at a time when business expectations
were in the process of widespread upward revisions, as
exemplified by the successive escalations of the
"consensus estimates" of 1966 GNP. The implications
of a prolonged conflict in Viet Nam for the economy and
for the budget are now more broadly recognized. Credit
demands continue strong even at the higher costs that
have been established in all sectors of the market and
for all maturities and instruments.
Something of a
scramble has developed among financial institutions in
various parts of the country to hold and to attract
funds, thus compounding pressures and causing chain
reactions. Banks continue to bid aggressively for
time deposits, apparently in the belief that credit
demand will continue to expand strongly. In recent
days, the chaos created by the New York transportation
strike has added to difficulties in estimating reserve
positions and needs, and has threatened the technical
ability of securities markets to perform in the
efficient manner which we normally take for granted.
I believe that in these difficult and confusing
circumstances the Desk has done the right thing in
deemphasizing marginal reserve measures and by focusing
on market performance. Rates have risen more rapidly
than some of us expected, but no useful purpose would
have been served by trying to block the kind of market
pressures that actually developed.
We must look forward to a trying period immediately
ahead. The Treasury is now engaged in a series of
refunding and new money operations. Even aside from
the usual even-keel considerations, the proper policy
appears to be one of "steady in the boat on a rough sea."
The Manager will need again to have more than usual
latitude in conducting operations in a period when
official pronouncements, actual Treasury operations,
and the ups and downs of peace explorations in Viet Nam
buffet the market. At the same time, market participants
will try to assess the longer-run outlook for the supply
of and demand for funds at a time when bank loan demands
normally decline. This will be a difficult period and
we will have to tread a narrow path between resisting
market pressures that might tend to drive rates up
further and providing reserves in such a way as to
reduce, rather than to stimulate, the rate of bank
credit expansion. The continuing objective should be
to maintain net borrowed reserves, but given the
1/11/66
-35
uncertainties of demand and of technical factors we
should be prepared to see larger swings in weekly
reserve figures.
The draft of the directive proposed by the
staff 1 / seems entirely satisfactory.
Mr. Hayes added that he was not sure he understood all the
nuances of Mr. Holland's suggestion, but he believed the Committee
had been doing the right thing in tending to cushion some of the
effects of the exuberant credit demand, given the recent discount
rate and Regulation Q actions and the various uncertainties
existing in the market.
A certain amount of cushioning also
would be appropriate in the period immediately ahead.
For the
longer term, he would question the desirability of letting
reserves go up as rapidly as they had recently, but for the time
being the Committee was locked in.
Mr. Hayes then reported briefly on the effects of the
present New York City transit strike on the operations of the
New York Reserve Bank.
He indicated that the Bank had been
successful in performing all essential operations but at the cost
of a great deal of staff inconvenience and fatigue.
Chairman Martin said he thought everyone was proud of the
manner in which the New York Reserve Bank was performing during
the present difficult period.
1/ Appended to these minutes as Attachment A.
1/11/66
-36
Mr. Ellis remarked that the accelerated pace in
manufacturing activity appeared to color the New England economic
picture more and more.
As expected, rising defense expenditures
were showing up in subcontracting and research and development as
well as in direct procurement contracts.
The factory workweek
increased contraseasonally in November to register a 5.3 per cent
year-to-year gain and the manufacturing index chalked up an 8 per
cent corresponding gain.
By far the largest gains had been
registered by aircraft manufacturers.
With the exception of
apparel factories, each of the compiled industry groups showed
substantial year-to-year increases.
Looking to non-manufacturing activities in the region,
Mr. Ellis said, the overriding impression was of prosperityperhaps even expectant prosperity in the sense that it was here
to stay.
Construction contracts, paced by both public works and
residential awards, posted a 10 per cent year-to-year gain in the
average for the three month periods ending in November.
Total
employment was up contraseasonally, and unemployment declined
more than seasonally.
Department store sales over the four
weeks including Christmas registered a 6 per cent gain.
In the banking sector, Mr. Ellis continued, the dominant
theme had been adjustment to higher rates and the year-end
financial turbulence.
During the first half of December the four
1/11/66
-37
Boston money market banks made fewer short-term business loans
than in the first half of September, but a substantial increase in
average loan size brought a 40 per cent gain in new loan volume
compared with a 17 per cent gain by their New York City counterparts.
Their average interest rates rose 9 per cent compared with the
7 per cent rise in New York in the same period.
Of the banks responding in the First District rate survey,
Mr. Ellis said, 24 per cent had increased or planned to increase
their interest rates on deposits.
Even after such changes,
however, only a handful of banks--mostly the larger ones--paid more
than 4.75 per cent on negotiable CDs and only a handful--mostly
small--paid more than 4.5 per cent on non-negotiable CDs.
Three
banks had announced rates of 5 per cent or higher, one non-member
going to 5.375 per cent on 5-year CDs with $5,000 minimum deposit
size.
Savings bankers, for their part, had been raising their
rates reluctantly and with loud complaints, Mr. Ellis remarked.
The Massachusetts Banking Commissioner had requested the Federal
Reserve Board to limit CDs to a minimum amount of $30,000.
The
manager of the savings bank pool for investing in mortgages
outside of New England reported that his normal placement of
$10-$20 million in an average week had been reduced to almost zero.
He blamed that reduced outflow on slower deposit growth due to
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competition from commercial banks.
So far, only three of 80
reporting savings banks paid 4-1/2 per cent.
The great bulk paid
4-1/4 or 4 per cent.
Turning to monetary policy, Mr. Ellis remarked that
conventional wisdom over the past few months had progressively
matured into a view that virtually all major segments of the
economy would be expanding in the next several months.
In the
absence of data on total credit flows--and he was grateful to
Mr. Holland for beginning with that subject in his remarks todayit appeared safe to judge that demands for credit would be
swelling to a point where the banking system would be under
pressure to secure expanding reserves to support continued rapid
credit expansion.
In that context it was refreshing to be able
to agree with those who concluded that further efforts to reduce
unemployment by monetary policy would incur a serious risk of
a faster upcreep in prices.
From that viewpoint, the realistic
alternatives were to hold policy unchanged or to seek some
lessening of reserve availability.
The realities of present
Treasury financing and prospective refunding counseled an effort
to maintain a facilitating even keel.
As he read the market
reports, however, the even harder reality was that it was difficult
to define the component parts of an even keel policy.
1/11/66
-39
To the extent that the reserve projections were reliable,
Mr. Ellis continued, failure to take any action to offset currency
return flow would result in net free reserves for the next several
weeks.
Such an outcome would by itself be both confusing and
misleading to the market.
The meaningful question, therefore,
concerned the volume of reserves the Account Management should seek
to absorb by sale of securities into a market where short-term rates
already were substantially bolstered by expanded Treasury offerings.
Once more, Mr. Ellis said, the answer had to emerge from
judgments based on imperfect information and comprehension.
For
his part, he liked Mr. Holland's concept of "constructive
shortfalls."
Bank needs for reserves were met in December, as
indicated by the rise in nonborrowed reserves at an annual rate of
over 20 per cent.
But, except for the last statement week, those
needs were met against an objective of not showing a sharp drop
in net reserve availability.
In his judgment the Manager should
not work solely with a rate objective in mind.
The historic
pattern of a seasonal weakness in bill rates in January might be
overridden by the expanded Treasury bill action and by the current
increases in other rates.
Although the present rate level
exceeded earlier expectations, he saw no reason to attempt a roll
back in rates.
action
Secondly, during the current Treasury financing
the Manager should strive not to lose too much ground, and
should hold as a target net borrowed reserves averaging near
1/11/66
-40
$150 million.
Finally, for the immediate future, the principal
objective of operations should be to preserve orderly conditions
in the money market by moving to resist sharp movements of rates
in either direction.
Mr. Ellis added that he had enjoyed Mr. Holland's analysis
today and hoped that similar analyses would be included in future
green books.
Also, he would like to see a study of the type
Mr. Holland had suggested the staff might undertake in connection
with his proposal.
Mr. Irons reported strong optimism in the Eleventh District
on the part of businessmen and bankers.
All of the main economic
indicators were at high levels and tending to inch up.
Economists
were upgrading their forecasts for the coming year for sectors
ranging from industrial production through trade into agriculture,
where the returns were coming out very favorably.
Bankers generally reported heavy demands for loans in all
categories, Mr. Irons said, and they expected loan demands to
continue strong.
Banks had reduced their holdings of Governments
but had increased holdings of other securities.
Last month there
was a slight decline in negotiable CDs, but demand deposits
continued up.
The demand for Federal funds was very strong in the District,
Mr, Irons continued, with banks tending to relieve their liquidity
1/11/66
-41
bind by purchasing Federal funds rather than by borrowing at the
discount window.
Last week purchases of funds amounted to about
$1 billion and sales to about half that sum.
Borrowings from the
Reserve Bank were small; the larger banks, which tend to have
most need for borrowing, were meeting their requirements
primarily through the Federal funds market.
In his judgment it
would be desirable to have more borrowing at the discount window
as an alternative to purchases of funds.
It seemed to him there
had been a change in the banks' concept of appropriate use of the
Federal funds market.
A short time ago banks would enter that
market to make an adjustment for one day--or perhaps a few daysand then they would move out.
But now, with banks operating with
a built-in deficit, they needed funds on a continuing basis and
used the Federal funds market to obtain them.
might be leading to problems.
That situation
He would not want to have the
current practice changed suddenly, but he would like to see some
move taken with respect to the administration of the discount
window that would result in greater reliance on borrowing from the
Federal Reserve.
With respect to the consequences in the District of the
recent change in Regulation Q, Mr. Irons said, there had not been
much disturbance in the attitudes of savings and loan associations
or banks.
Only one bank had moved its time deposit rate up to
5-1/2 per cent, and that rate applied to deposits with some
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1/11/66
contractual limitations.
cent rate.
A few small banks had gone to a 5 per
On the whole, the situation seemed to be quieting a
bit, although the adjustments had not all been made.
Over the
past several weeks there had been very few direct or indirect
contacts on the subject made with the Reserve Bank.
On the national situation, Mr. Irons remarked that it was
unnecessary to review in detail the elements of strength in the
economy, which were outlined in the green book.
In general, there
was virtually full employment and production, and further demands
were being and probably would continue to be placed on the economic
system.
From the standpoint of economic factors alone, one might
conclude that a slightly firmer policy and some additional restraint
were warranted.
However, if one looked to financial developments,
and also took account of the fact that Administration policies
would be set forth in a number of messages over the next few weeks,
it would seem that the System's policy should be one of moderating
changes in financial markets.
Interest rates had risen sharply
recently, and more than he had wished at the time of the last
meeting.
He had expressed the hope then that the discount rate
would serve as a ceiling for other short-term rates, but the other
rates had broken through that ceiling.
For the next three weeks, Mr. Irons continued, an even
keel policy was called for by the Treasury financing schedule.
1/11/66
-43
He was inclined to gear policy largely to rates, trying to moderate
any further strong upward movements.
He recognized that with the
Treasury adding to bill supplies there might be difficulties in
achieving that objective, and he would be satisfied for the time
being with smaller net borrowed reserve figures than had occurred
last week; he would not be disturbed by marginal reserve figures
in a range of $50 million around zero, if that was necessary to
moderate rate movements and to help maintain orderly conditions
in the market.
In concluding, Mr. Irons said that the Manager should be
given a considerable amount of leeway with respect to his operations.
The draft directive submitted by the staff was acceptable to him.
Mr. Swan commented that in the Twelfth District, as in the
rest of the country, business seemed to be expanding strongly even
though the District unemployment rate continued to be one percentage
point or so above the national level.
Despite the still high,
although declining, unemployment rate, there were reports of
increasing difficulty in obtaining skilled workers--including not
only scientists, engineers, and the like, but production-line
workers as well.
That situation might present some problems to
the aerospace industry in realizing the employment increases it
hoped to make in 1966.
One Seattle company had announced that it
would like to add some 1,500 workers a month in 1966 because of
1/11/66
-44
its backlog of non-Government orders, but there was some question
as to whether that could be accomplished, given the labor situation
in the Seattle area.
Mr. Swan noted that there was considerable interest on
the West Coast in the adjustments of product prices recently
announced by the U.S. Steel Company--not so much in the price
increases, but in the decreases that were announced in prices of
cold rolled sheets, amounting to $9 per ton or about six per cent.
That reduction was particularly interesting because imports of
cold rolled sheets and strip had amounted to about one-fourth
of West Coast consumption in 1964.
Figures for 1965 were not yet
available but the import proportion probably was still higher in
that year.
The price reductions should improve the competitive
position of domestic production in the western market relative
to Japanese imports.
District banks entered the new year under considerable
pressure, Mr. Swan said.
As Mr. Irons had indicated was the case
in the Eleventh District, Twelfth District banks were net buyers
of Federal funds on quite a consistent basis.
Loan demands were
strong and there were no signs as yet of the seasonal decline that
usually occurred early in the year.
The response to the increase
in Regulation Q ceilings had been quite widespread.
A few banks
raised their CD rates to 5-1/2 or 5-1/4 per cent, and more went
to 5 per cent.
1/11/66
-45
By and large, however, those were smaller banks.
So far, the
larger banks had not increased CD rates to that extent, nor were
they pushing savings certificates in one form or another very
vigorously.
As to policy, Mr. Swan agreed in general with the views
already expressed.
It seemed to him the Treasury financing schedule
required an even keel posture.
With the Budget Message just ahead
and with the possibility that some of the existing uncertainties
might soon be resolved, the best course for the Committee to follow
in the next few weeks would seem to be to seek again to moderate
any of the changes that might develop in financial market conditions.
He agreed with Mr. Irons that in the coming period some attention
had to be paid to interest rates.
He thought that a posture of
even keel, however defined, would not necessarily call for a roll
back of rates from their present levels, but it would seem to call
for doing what could be done to prevent further rate increases.
He hoped that could be accomplished with net borrowed reserves in
the area of $50 million--or, more broadly, in a zero to $100 million
range.
But if it became necessary to introduce a little more ease
in marginal reserves in order to keep the bill rate in the upper
4.50s, or somewhat below that level, he would not be disturbed.
Mr. Swan was not sure whether or not Mr. Holland's
prescription for a "constructive shortfall" involved a contradiction
1/11/66
-46-
in terms, except for the isolated case.
In other words, although
the Committee might happen to feel that the consequences of an
individual miss were desirable, he did not see how it could
utilize possible shortfalls in the reserve estimates systematically,
as an operating device.
He saw no objection to further attempts
to improve the estimates if it was thought that something could be
accomplished in that direction.
Such improvements would, of course,
reduce rather than increase the possibility of shortfalls.
Mr. Galusha observed that the response of Ninth District
commercial banks to the December change in Regulation Q had of
necessity been uneven.
Some District banks--those in South Dakota
and those with Minnesota charters--were at the moment precluded
from paying more than 4 per cent on time and savings deposits.
He
understood that many Minnesota chartered banks were quite anxious
to have their ceilings raised, but the South Dakota banks, feeling
themselves to be at sufficient remove from Twin Cities competition,
evidently were urging that their ceilings remain unchanged.
Among District banks legally able to respond to the change
in Regulation Q, many had already done so, Mr. Galusha said.
Nearly
all Twin Cities area banks were offering 4-1/2 per cent on 90-day
(non-negotiable) time deposits and 4 per cent on savings deposits.
One of the smaller banks in the area had gone to 4-3/4 per cent
on 90-day time deposits.
Also, the Twin Cities banks were
1/11/66
-47
aggressively seeking, by major advertising campaigns, very small
denomination time deposits.
Twin Cities area savings and loan associations, Mr. Galusha
continued, had generally responded to bank deposit rate changes
by increasing their share rates to 4-1/2 per cent.
The one mutual
savings bank in the District, which had over $400 million in
deposits, had increased its rate for six-month time deposits to
4-1/2 per cent and reported a much greater than normal year-end
loss of funds.
That report--highly impressionistic, he suspected-
was among the few thus far received.
Most banks had indicated that
it was much too early to tell how their deposit totals were
changing under the new rate structure.
One bank reported consid
erable gains, particularly in large time deposit accounts.
As yet, Mr. Galusha said, not all District country banks
that were legally able to respond to the Regulation Q change had
done so.
Many had, of course, and he thought many of those that
had not would before very long.
Casual evidence suggested that
country banks would be bothered more by competition this time
than they had been following the changes of mid-1963 and late 1964.
There was an indication that structural changes in the District
banking industry were being accelerated.
Mr. Galusha's impression
was that, to hold deposits, country banks as a group would have to
increase deposit rates relatively more than they had last November
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1/11/66
and December.
Then, too, those banks were apparently not in as
good a position to increase gross earnings as they were late last
year.
The once-over shift to longer-term, higher-yielding assets
was largely an adjustment of the past.
And excess cash had, to a
considerable extent, already disappeared.
Seemingly, therefore,
the profits of District country banks would be squeezed more
relatively than those of city banks in the year immediately ahead.
Not that there was any longer anything the Federal Reserve could
do about that.
But he thought it would, perhaps, be well to keep
in mind the possibility of increased resentment among banks which,
even before the revision of the Regulation Q ceilings, weren't
altogether happy with System membership.
Among all the innovations being seen for the first time in
the Ninth District, Mr. Galusha said, the guaranteed time deposit
rate appeared to be the most serious.
One large bank presently
was advertising a five-year guarantee of 4-1/2 per cent on time
deposits which could, at the owners' option, be liquidated any time
after 90 days.
The advertisements were hasty and ill-considered,
with innocent but unfortunate conflicts between the claims made in
them and the instruments involved; the Minneapolis Reserve Bank
had called those conflicts to the attention of the bank, and they
had been corrected.
Were that practice of long-term rate guarantees
to spread now, while interest rates were very high by historical
1/11/66
-49
standards, the Federal Reserve could find itself in something of
a dilemma the next time the economy sagged and the need for monetary
ease became apparent.
Giving consideration to precluding long-term
rate guarantees on short-term borrowings might therefore be worth
while.
About open market policy, Mr. Galusha said, it was possible
to be very brief this morning, reiterating what had been said
already.
He was impressed by the fact that the Committee's policy
would be only one influence, and a relatively minor one, on
developments ahead, and that its posture would be a reactive one
in the period to come.
So it would appear that the Desk would
have to have a considerable degree of latitude.
That was how he
would define "no change" in policy; and with that interpretation
in mind he was agreeable to the staff's draft directive.
Mr. Scanlon said that recent weeks had produced further
evidence that Seventh District business activity had moved very
close to practical capacity.
Labor turnover had increased and
hiring standards had been lowered.
Delivery lead-times on new
orders had lengthened, particularly in the machinery and equipment
industries.
Since early December, there had been a pronounced
revival in steel orders--much earlier than had been generally
expected--from virtually all steel-using industries.
Allowing
for the holiday let-down, there had been an upswing in steel output
1/11/66
-50
since mid-November.
Even in the week ending January 1, output of
steel ingots was at a 114 million ton annual rate despite continued
inventory liquidation by some steel users.
Production of autos in
January was scheduled at 830,000 units, slightly above the number
for the year-ago month when strike-depleted inventories were being
replenished.
New claims for unemployment compensation in the District
were far below the previous year's low level in December,
Mr. Scanlon reported.
The usual year-end rise in the proportion
of covered workers receiving unemployment payments was much less
than usual.
In the week ending December 18, insured unemployment
in the District ranged from 1.3 per cent in Indiana and Iowa to
2.0 per cent in Wisconsin, compared with 2.8 per cent for the U.S.
Those totals were far below other recent years.
In the comparable
week of 1955, the previous record low, the range for District
States was 1.9 to 2.6 per cent, compared with 3.1 per cent for
the U.S.
Labor market classifications for November, recently released
by the Department of Labor, showed that Milwaukee was raised to
the "B" category--"relatively
low unemployment" of 1.5 to 3.0 per
cent, Mr. Scanlon continued.
Of 23 District centers only Chicago,
Detroit, South Bend, Terre Haute, and Muskegon were placed in the
"C" category--"moderate unemployment" of 3.0 to 6.0 per cent.
1/11/66
-51
Classifications for Chicago, Detroit, and South Bend appeared
inaccurate; in each of those centers local agencies rated unemploy
ment at less than 3 per cent.
A careful review of all the
available evidence lead to the conclusion that District labor
markets probably were the tightest since World War II.
Mr. Scanlon went on to say that evidence of continued
strong demand for credit, especially by businesses, was contained
not only in the loan figures but also in banker comments about
full loan portfolios, tight money, and--in some cases--rejections
of loans that would have been made a few months ago.
However,
apparently there was little inclination to cut back on term
lendings, and a substantial part of the demand seemed to be for
term loans.
Despite the fact that money market conditions had generally
been described as tight, Mr. Scanlon remarked, borrowing at the
discount window had not been very heavy or very general.
The
large banks in the District appeared to have been generally
unaggressive in selling CDs.
Nationally, Mr. Scanlon continued, monetary and credit
expansion had occurred at a rapid pace even though interest rates
had been increased, indicating a strong demand for credit, probably
a strengthening demand.
In light of the anticipated continuation
of heavy credit demands in the near future and the threat of
1/11/66
-52
accelerated price increases, it appeared desirable in the long run
to moderate the rate of monetary expansion.
However, the Treasury's
January cash financing program was yet to be completed, financial
markets were still in process of adjusting to the discount rate
change, and announcements on important Government decisions were
forthcoming.
All of those factors seemed to dictate an even keel
posture for the next three weeks.
Mr. Scanlon said that while he would prefer to have the
directive call for "maintaining current conditions in the money
market," he could accept the staff's draft if it was clear to the
Manager that its wording did not suggest a forced roll-back.
He
agreed that the Manager should continue to have more than the
usual amount of latitude in moderating any pressures that might
develop in financial markets.
Mr. Clay said that in the months ahead the formulation of
monetary policy, and public policy more generally, would be based
on an economic situation markedly different from that prevailing
during the previous years of the current business upswing.
The
military developments and expenditures imposed upon an economy
already operating with relatively small margins of unutilized
resources had brought about a pronounced change.
The exact outline
and proportions of those economic developments could not be fore
seen, quite apart from the possibilities of the military situation
1/11/66
-53
changing in either direction.
On the basis of present indications,
it was reasonable to assume that the processes of orderly economic
growth would be much more difficult to maintain than earlier, and
the risk of price inflation would be distinctly greater.
Monetary policy in the period immediately ahead would be
conditioned substantially by Treasury financing already under way
and forthcoming, Mr. Clay remarked, and that would point to main
tenance of "even keel" conditions over the period.
Apart from that
fact, it would appear logical to maintain money market conditions
compatible with the recent discount rate action.
Significant
easing in the money market from seasonal forces appeared doubtful,
and there was a possibility that market forces pushing rates
upward might prove to be more powerful.
it was difficult to state policy targets.
Under those circumstances,
A range of 4.45 to 4.60
per cent would appear appropriate for the Treasury bill rate.
The
draft economic policy directive appeared satisfactory to Mr. Clay.
Mr. Heflin reported that Fifth District business remained
strong through the final weeks of 1965.
In the Richmond Bank's
latest survey, manufacturers on balance reported further small
gains in orders, shipments, employment, wages, and prices, and
declines in finished-goods inventories.
The panel, however,
displayed somewhat less optimism than in previous surveys.
Defense Department recently announced intentions to purchase
The
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1/11/66
120 million linear yards of textiles in the first quarter of this
year, instead of the 6.6 million yards announced in September.
Military needs would amount to only about 3 per cent of the total
first-quarter output of broad woven cottons, but apparently would
take from one-third to three-fourths of the normal output of a few
specified fabrics.
Since virtually all of the industry's antic
ipated output of such goods had already been sold, producers
undoubtedly would be forced to ration available supplies of those
fabrics, and the upward pressure on prices would probably increase
significantly.
There was little he could add to what had already been
said about the national economy, Mr. Heflin commented.
Activity
continued brisk and the over-all business environment appeared
even more buoyant than it had before the discount rate was raised.
Despite sharp upward rate adjustments, bank credit had continued
to climb rapidly in response to strong loan demand.
It also was
reasonably clear that market expectations had shifted more in the
direction of rising rates, and that might be encouraging some
anticipatory financing.
Over the past few weeks the market had
been subjected to a number of random and extraordinary influences,
including the New York transit strike, which complicated the
problem of evaluating the market relationships that would emerge
from the System's recent rate action.
1/11/66
-55
Mr. Heflin thought that for the coming period the Treasury
financing was clearly the controlling factor in the policy area.
In the light of recent market conditions the important question
now appeared to be what constituted "even keel."
It seemed to him
that a policy of "no change" for the period should be interpreted
primarily in terms of feel and tone of the market, although he
would expect that bill rates would not be allowed to rise above
their recent highs.
Over a longer period, however, it seemed
important to bear in mind that if the recent restraining moves
were to be effective, they had to be reflected in reduced rates of
expansion in bank credit and the money supply.
Mr. Robertson then made the following statement:
I, for one, have been much impressed by the signs
of a stronger and stronger business situation that have
reached us in the last few weeks. Both the contents of
the green book and the briefing this morning reinforce
my feeling on this score. GNP has been marked up
sharply, both in terms of current dollar levels and
past and prospective rates of advance. Employment is
up significantly further, and the long-hoped-for
breakthrough to an unemployment rate below 4 per cent
is finally said to be "just around the corner" of the
next month or two's reports. Thus far, our price
performance has continued on the moderate side, despite
our narrowing margins of unused resources, but I note
that in looking ahead (in the green book) the staff has
now come to say flatly, "...upward pressures on prices
appear likely to be strong."
My own judgment is similarly shifting in this
direction. Accordingly, I am prepared to have monetary
policy make a substantial and positive contribution to
damping such inflationary pressures as they emerge.
1/11/66
-56-
Precisely how much--or perhaps I should say, how
much more--monetary policy might need to be tightened
to serve this purpose depends importantly on two issues
that are still up in the air at this moment:
(1) how much counter-inflationary help we will
get from the Federal budget, and
(2) how much restraint is resulting from the
monetary tightening that has already taken
place.
We now have accomplished a significant second round
of money market tightening, at least from a "rate" point
of view, layered on top of the earlier firming of condi
tions that began last summer. Regardless of whether the
System was right or wrong in its policy actions, and in
the timing thereof, the wise thing to do now is to try
to gain all the positive benefits we can by holding
firmly to this posture of restraint for the time being.
Consequently, I would favor the adoption of a policy
designed to hold money market conditions at about their
current degree of firmness until the next meeting of the
Committee. This kind of policy should serve three
(1) preserving an "even keel"
immediate objectives:
posture in connection with the Treasury financing; (2)
permitting a careful judgment of the content of the new
Federal budget and of public reaction thereto; and (3)
allowing time to appraise the effects of the current
degree of monetary tightness.
By perhaps two meetings from now, these immediate
objectives should be fulfilled and a hard look at the
future course of policy should be possible. While I
favor a pattern of interest rates as low as possible,
compatible with sustainable growth in the economy and
price stability, if credit demand prospects at that
time still appear excessive, we may have to tighten
even further. With interest rates already near historic
highs, such further tightening should not be undertaken
lightly. We shall have to be especially watchful for
signs that our restrictive actions might be having
cumulative effects that could give rise to a credit
crisis and even an eventual recession. These consid
erations ought to make us careful, but not timid or
inactive when the proper time for action arrives.
With these thoughts in mind, I would favor a
directive that called simply for maintaining about the
current degree of firmness in money market conditions
until the next meeting of the Committee.
1/11/66
-57Mr. Robertson added that he would prefer language such as
he had suggested to that contained in the second paragraph of the
staff's draft directive.
In his judgment it would be desirable to
place emphasis primarily on net borrowed reserves rather than on
short-term interest rates.
The current Treasury financing was a
relatively minor operation and he would not be disturbed if short
term rates moved higher.
As he had indicated, it seemed to him
that the Committee should be holding firmly to the degree of
restraint that had developed.
Mr. Shepardson said he had little to add to the discussion
of the general economic situation.
He thought the staff reviews
of that situation in the green book and in this morning's presen
tation were excellent.
They pointed clearly to a strongly expanding
economy at near-capacity levels with increasing possibilities of
price advances.
In that light the Committee certainly should be
looking not toward maintaining but to further restraining the rate
of credit expansion.
He recognized, however, that with the
Treasury financing situation no active change in policy could be
made at the moment, and the directive proposed by the staff seemed
appropriate.
If he understood Mr. Holland correctly, Mr. Shepardson
continued, as a result of market pressures rather than deliberate
action the situation in the money market was a little tighter
than might have been envisioned at the last meeting; and the
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proposal was that the Committee should contemplate accepting the
same kind of tightening in the future if the pressures of demands
were strong.
In other words, while the Committee would not act
to create firmer conditions, if the market firmed by itself the
Committee would expect to moderate the change but not to roll
conditions back.
Similarly, in a situation in which demand
pressures eased significantly, the reaction would be moderated.
If an alternative interpretation was put on the proposal--namely,
of asking the Desk deliberately to overshoot when the market
tightened--he would not favor it.
He did favor what had been
done in the recent period--working to moderate expansion when
demands outran the projections.
Mr. Mitchell said that the country was in a period of
inflamed expectations and it was that fact that had made it so
difficult for the Desk to deal with the problems facing it recently.
Current expectations ranged from a belief that the economy was
heading for a Korean-war type of inflation, involving increases in
wholesale prices of about 15 per cent over a six-month period, to
a belief that there would be some acceleration from the recent
rate of price change but no increases as spectacular as those
during the Korean period.
Whether or not either of those expecta
tions were valid no one could say at the moment.
The Manager had
implied that monetary policy could do little to tranquilize such ex
pectations, and he (Mr. Mitchell) also saw little that could be done,
1/11/66
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so perhaps the Committee had to lay the problem aside for the
moment.
The real economy was performing well, Mr. Mitchell continued,
and perhaps too well, when judged against the standard of moving
on to a full-employment path.
The present climate of expectations
was vulnerable to change as a result of the President's Budget
Message.
He agreed with Mr. Hayes that an absolute reading on
fiscal policy would not be obtainable from the Message, because the
budget proposed would have to be considered by Congress.
Neverthe
less, he did expect a tough budget, and he thought that it would
have a substantial effect on psychology and expectations.
Under those conditions, Mr. Mitchell said, he was willing
to go along with the staff's draft directive.
However, he would
be inclined to advise the Manager to expect that marginal reserves
would have to be positive rather than negative to implement the
directive.
He would favor bill rates under the discount rate--in
the 4.35-4.45 per cent range--rather than in a 4.50-4.60 per cent
range.
He thought the former was likely to prove a better operating
range, and that rates in that area would be easily arrived at if
the budget was as restrictive as he expected.
If the budget was
not restrictive, the Committee would be faced with a serious problem
and might find it necessary to reconvene to adopt a somewhat dif
ferent policy.
He agreed with Mr. Robertson on the possible need
for restraint on credit growth.
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Mr. Mitchell indicated that he was somewhat dubious about
Mr. Holland's suggestion.
But Mr. Holland had alluded to a very
real problem in commenting on the reasons for the recent market
firming.
An environmental change had developed gradually over
the past few years, involving progressive reductions in the
liquidity of banks and businesses.
The staff analyses tended to
be short-run in nature, implying no change in the general envir
onment.
What troubled him was that if the Committee made decisions
on the basis of such analyses when the environment had in fact
changed, it might take actions that were extremely damaging to the
economy.
It was necessary to be careful, for example, in using
growth rates in bank credit and the money supply as criteria for
policy actions.
When banks were extremely illiquid the alternatives
before the Committee might be to act to ease that illiquidity or
to face a financial crisis, and the first was obviously the better
choice.
Mr. Daane said he had little to add to what had been said.
It seemed to him in the light of the Treasury financing schedule
and the uncertainties as to the shape of the Administration's
projected fiscal policy--whether it was achievable or not--the
Committee should follow an even keel policy at this time.
He had
a great deal of sympathy for Mr. Robertson's statement and like
Mr. Robertson he, too, was somewhat unhappy with the staff's draft
directive.
1/11/66
-61From time to time, Mr. Daane continued, at least some
members of the Committee had expressed dissatisfaction with the
final clause of the first paragraph, which read "while accommodat
ing moderate growth in the reserve base, bank credit, and the
money supply."
He was particularly unhappy about that clause in
the current context;
it should read "by moderating growth in the
reserve base, bank credit, and the money supply" if the Committee
was trying to ward off incipient inflation.
In the second paragraph
he would prefer to use the customary language, calling for "main
taining about the current conditions in the money market," rather
than language calling for resisting further firming and possibly
implying some rollback in market conditions.
The danger of
incipient inflation was clear, and the Committee's main task was
to keep monetary policy sufficiently flexible to do what it could
to contain inflationary pressures.
Mr. Maisel commented that the monetary picture since the
Committee's last meeting seemed most disheartening.
Interest rates
on most money market instruments rose by nearly the full amount of
the discount rate change.
On the other hand, the expansions of
reserves, of the money supply, and of bank credit were far larger
than in most recent months and far above the average for the prior
policy period.
Thus, it seemed, the worst of both possible worlds
had been experienced, with higher rates and an increased money and
credit availability.
1/11/66
-62The Committee was now pausing temporarily in a period of
even keel.
It was important that it look ahead and consider what
sort of policy made sense for the next quarter or six months.
Since the final fiscal picture was lacking, the Committee could
only make tentative plans.
Contrary to Mr. Mitchell, Mr. Maisel
would expect that there would be a tendency to look to the Federal
Reserve System for maximum constraint, since the Committee had
made it evident that it preferred to take the lead in that matter.
It offered the choice of a high interest rate-higher deficit
economy.
If that policy was picked, he did not think the Committee
should be too concerned with the height of the interest rate
necessary to support such a policy.
Mr. Maisel felt, therefore, that the Committee ought
immediately to start to consider, looking toward the next meeting,
the question of how large a cutback in the level of credit expansion
was feasible.
Mr. Holland's report was particularly worrisome.
In the light of that type of credit movement, the Committee ought
to determine what types of quantitative goals it thought were
necessary for monetary policy in the period.
He would hope that
in choosing its policy the Committee would put more stress on the
indexes of nonborrowed reserves, money supply, bank credit, and
total deposits of all financial institutions.
It seemed to him
necessary that the rate of expansion in those series be cut back
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sharply from that of 1965 and particularly its last month toward
or below the rates that had prevailed in the policy period prior
to December 3.
expectations.
The present seemed to be a period of overly high
The Committee should ask what attitude or action it
could take to cut back on expenditures based on those expectations.
While it was thinking about credit flows, Mr. Maisel
continued, it might be proper for the Committee to consider the
required reserve ratios.
He recognized that was the ultimate
responsibility of the Board, not the Committee.
However, in order
to curtail the rate of expansion in credit while at the same time
getting the best possible distribution between small and large
users, the Committee ought seriously to consider the advantages of
moving as far as legally possible to a graduated reserve system.
Mr. Galusha had alluded to a problem that might be ameliorated by
such a change.
In addition, the monetary advantages of moving to
such a system in the next month or two were likely to be so clear
that many fewer complaints would be encountered than if the move
was made at other times.
Mr. Maisel noted that his remarks had been aimed primarily
at planning for the period immediately following that of "even keel."
For this meeting he agreed generally with the directive as submitted,
but he would judge that more stress should be placed on the quantity
of reserves created than on interest rates, particularly in the
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period ahead before the impact on the next Treasury financing
became critical.
If Mr. Daane's suggestions did that, he would
go along with his proposed wording.
Mr. Hickman said it was now clear that the economy was
moving forward at an accelerated pace and was rapidly approaching
the limits of its capacity.
The forward momentum of recent months,
coupled with new higher estimates for GNP for 1965, had caused
most analysts to make almost daily revisions in their projections
for 1966.
The Cleveland Reserve Bank's latest reading (already
out of date) showed that most GNP forecasts for 1966 clustered
around $720 billion, with the more sophisticated forecasts usually
well above that, including Walter Heller's, which was announced in
advance of the revised GNP figures for 1965.
Since last year's
rise in GNP brought forth some upward price pressure, and since
there was now less slack in the labor force, any rise on the order
of last year's increase of $47 billion (i.e.,
to a GNP of about
$723 billion) would imply a risk of serious price inflation, on
the basis of information now available.
While prices were relatively stable during the summer
months of 1965, Mr. Hickman continued, there were renewed signs
of rise in the autumn, as reflected in all of the major price indexes.
In the most recent three months, consumer prices had risen six-tenths
of an index point, wholesale prices about one index point, and the
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industrial component of wholesale prices about one-half of an index
point.
Spot prices of raw industrial materials had moved up at a
very rapid pace since early December, with the index in early
January at a 14-year high.
The latest diffusion indexes for spot
prices and manufacturers' prices also showed sharp increases.
In addition to the recent record of price advances,
Mr. Hickman said, expectations regarding future prices had clearly
been on the rise.
For example, Dun and Bradstreet's most recent
quarterly survey showed that the percentage of businessmen expecting
price increases was the highest since early 1957.
Steel magazine's
fall survey of metal-working industries indicated that selling
prices were expected to rise by a larger amount in 1966 than in
any year since 1959.
Walter Heller, in his GNP forecast, assumed
that the price deflator would increase by 2.1 per cent, which was
high by recent standards except possibly for 1965.
Incidentally,
Paul Samuelson's forecast, published yesterday, stated that the
country would be lucky if prices rose by no more than 2-1/2 per cent.
Against that background of rising output and price pressures,
the accelerated pace of monetary expansion that had characterized
the past month or so seemed clearly inappropriate to Mr. Hickman.
As a matter of fact, most major monetary variables--bank credit,
money supply, and nonborrowed reserves--showed larger gains in the
month following the latest change in the discount rate than in
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comparable periods following other recent discount rate advances.
Moreover, the annual rates of increase of those variables over the
past month had equalled or exceeded the annual rates of increase
since World War II.
He deduced from all of that that the current
thrust of monetary policy--as distinct from the intent of the
Committee--was inflationary.
Admittedly, Mr. Hickman said, it was difficult to determine
the appropriate course for public policy in the weeks ahead.
With
an apparent administrative budget of $110-$115 billion, it now
seemed fairly evident that the burden of restraint had to fall
either on increased taxes, on tighter monetary policy, or on some
judicious combination of the two.
Because of the range of alter
native choices involved in a major policy move at this time, and
because of the errors that were inherent in the basic economic
information, it would be extremely helpful if the Committee had
before it a continuing review of the Administration's position on
the economic outlook and the appropriate mix of fiscal and monetary
policy.
Perhaps brief statements on that subject could be included
in the green book from time to time; it was difficult for those
outside of Washington to obtain such information directly.
In the weeks immediately ahead, Mr. Hickman remarked, the
Treasury financing schedule suggested "even keel" as the appropriate
policy guide.
Nevertheless, the perils of further overheating of
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the economy seemed to him to be so great as to outweigh the short
run objectives of the Treasury.
If the Committee did nothing until
the Treasury was out of the market, in, say, mid-February--which
implied that it continue to pump up bank credit and the money supply
at current inflationary rates--the Committee might find itself in
the position of being able to do too little, too late.
He, therefore,
recommended some moderate tightening, with an immediate objective
until the next meeting of the Committee of moving toward net
borrowed reserves of $200-$250 million.
The staff's policy directive implied to Mr. Hickman that
market rates would be pegged around current levels, with the result
that credit availability might expand excessively.
He would prefer
to reduce the current rate of expansion of the credit base even
if it meant higher interest rates and deeper net borrowed reserves.
Mr. Bopp remarked that it seemed only a few months since
forecasters were predicting a gross national product in 1966 of
not much more than $700 billion.
dramatically.
Now expectations had changed
The recent revision of the figures on last year's
performance, coupled with the swelling of expenditures in Viet Nam
and expectations of a rapid forge ahead in capital spending, made
the staff prediction of a $707 billion GNP (annual rate) for the
first quarter seem quite reasonable.
The rapidly changing business environment also was evident
from the summary of forecasts compiled and published by the
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Philadelphia Reserve Bank, Mr. Bopp said.
A median figure drawn
from that Bank's collection of forecasts produced a GNP in 1966
of $710 billion.
Considering only the more recent of those
forecasts, a GNP of around $713 billion emerged.
Now even that
figure appeared too low, perhaps in the order of $10 billion.
With such a rapidly changing business environment, Mr. Bopp
observed, the question arose of how quickly monetary policy should
respond, particularly during a period like the present, when a
strong economic advance seemed likely to be accompanied by pressures
on labor markets and prices.
For the next few weeks, however,
prospective economic messages and Treasury financing called for a
policy of even keel.
The draft directive seemed appropriate to
Mr. Bopp with the modifications suggested by Mr. Daane.
Mr. Patterson reported that by almost any measure business
activity in the Sixth District was booming.
In fact, it topped
the national performance where it counted the most.
Not only was
the District's insured unemployment less than the nation's, but
every category of manufacturing employment had shown a larger
increase than nationally.
For reasons cited around the table, Mr. Patterson said,
the national business picture had taken on boom proportions.
Nor
could the universal prediction that another substantial rise of
GNP lay ahead be ignored.
The Committee members were all aware
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that such an advance, however desirable, might also harbor serious
problems.
As others had noted today, price pressures had been
increasing.
And they would become even more intense as the economy
got closer to the limit of productive capacity.
The role the Federal Reserve should play in the broader
public effort directed against inflation had, to Mr. Patterson's
way of thinking, been made a matter of public record.
The System
committed itself on that score when the Board, in taking action on
the discount rate, indicated that the move was intended to back
the Government's efforts to prevent inflationary excesses.
In his
opinion, those efforts had received a considerable setback in
recent weeks.
First, it seemed clear that Federal spending and
credit needs would be very much higher than the Committee was made
aware at the last meeting.
Secondly, the failure to achieve a
complete rollback on the price increase of structural steel under
scored the difficulty of using direct pressure to hold down prices.
Under those circumstances, the System would bear greater respon
sibility in coping with inflationary pressures than one might have
concluded a few short weeks ago.
Short-term rates had increased more than many of the
Committee members had expected, Mr. Patterson continued, especially
when viewed against the liberal supply of reserves provided by the
System.
Therefore, strong credit demands rather than System action
1/11/66
-70
seemed to account for the rate adjustments.
In that context, the
Desk had allowed interest rates to go higher without trying to
curtail the growth rate of bank credit.
Since most people chose
to pay a higher rate rather than do without the funds, that would
not restrict credit very much.
And yet, if his interpretation of
the economy and credit climate was correct, the growth in total
credit had to be held down.
accomplishing that?
How should the Committee go about
If bills were sold, short-term rates would
be pushed up further and the System might eventually feel obligated
to raise the discount rate again.
If reserve requirements were
raised, in meeting the higher requirements banks would be compelled
to sell off coupon issues.
Yields on such securities currently
were about 5 per cent and under those conditions would go even
higher.
As interest rates increased, banks would be compelled to
bid for CDs at increasingly higher rates, unless the banks were
prepared to curtail their lending or to see their corporate customers
put CDs into other money-market instruments.
On the other hand,
interest rates might not push upward at all, if the relaxation of
seasonal pressures at this time of year could be counted on.
Since the dust had not yet settled from the two December
actions and the Treasury's financing calendar permitted little,
if any, overt action today, Mr. Patterson favored maintaining the
"status quo," with the idea that the Desk should absorb reserves
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quickly and to a greater degree than was usual for this time of year,
unless that disturbed the Treasury financing and pushed up rates unduly.
Mr. Shuford commented that as noted by the staff and others
at the table, national economic activity had continued to expand at
a rapid pace.
The current rise in activity appeared to be on a broad
front, with significant gains occurring in most major lines of busi
ness.
In view of the strong upward momentum and the great optimism,
it appeared that total spending would continue to rise in early 1966.
Economic activity in the Eighth District had continued to
expand since summer, Mr. Shuford said, with significant gains in
manufacturing.
Since August, employment by manufacturing firms had
risen at a 4.8 per cent annual rate, and manufacturing output had
risen at a 6 per cent rate.
Total deposits at District banks had
risen at a 6 per cent rate in the same period.
Demand deposits,
which had remained on a plateau during early 1965, had risen at a
4 per cent rate since late summer, and time deposits had increased
at a 9 per cent rate.
Nationally, demands for goods and services appeared to
Mr. Shuford to be excessive, as evidenced by price developments.
In recent months, prices had been rising at an accelerated rate.
Consumer prices rose at a 2.2 per cent rate from October to November,
despite no change in the food price index.
That was the third
consecutive monthly increase at the advanced rate of 2.2 per cent.
Wholesale prices rose at a 4.8 per cent rate from October to
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November, with increases occurring in most of the major components.
Preliminary data for December indicated a further increase in
wholesale prices.
Rising prices, in conjunction with a high level of resource
utilization, indicated that expansion in total demand for goods and
services was outrunning the nation's capacity to meet such an
expansion, Mr. Shuford continued.
When prices rose moderately, a
case might be made that the increases were a calculated cost of
encouraging fuller employment of the economy's resources.
However,
when spending was rising so rapidly that price increases began to
accelerate, there was little doubt that the country was experiencing
undesirable inflation, and that steps should be taken to curb the
excessive demands.
Fiscal and monetary actions were contributing significantly
to increase the total demand, Mr. Shuford said.
The Federal budget,
as measured by the full-employment surplus, turned more stimulative
in the last half of 1965 and was expected to be still more expan
sionary in early 1966.
The nation's money supply had continued to
rise sharply since the increase in the discount rate.
Money rose
at a 7 per cent annual rate from June to December, the highest rate
for any six-month period since 1952.
Such a rapid expansion of
money operated with a lag and its main effect might yet be felt.
In view of the exuberant economic situation and the expan
sionary Governmental actions, Mr. Shuford believed that some further
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-73
monetary tightening would be desirable.
More restraint also
would be beneficial to the U.S. balance of payments, both because
of interest rate effects and restraint on the price level.
How
ever, because of the factors others had mentioned--the Treasury
financing, conditions in financial markets, and forthcoming
economic messages--it was clear that a change in policy would not
be appropriate at the present time.
In his judgment, however,
unless the rates of reserve injection and money growth slowed, the
Committee would have to take another tightening action soon.
As
far as the directive was concerned, he thought that either the
staff's draft or the revised version proposed by Mr. Daane would
be satisfactory.
Mr. Balderston commented that the Committee had had the
task, following the discount rate action of December 3, of easing
the economy over the year-end seasonal bulge.
But actual events
at the turn of the year differed markedly from what either the
Committee or the Desk had reason to anticipate; history did not
repeat itself.
The chart of Federal Reserve credit (weekly
averages of daily figures) from 1957 to date revealed a sharp
decline starting either at the beginning of each year or just prior
to that time.
Moreover, Federal Reserve float exhibited a peak at
the end of each year, followed by a rapid decline immediately
thereafter.
The Committee and the Desk had reason to expect that
such a seasonal pattern would be repeated.
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But the demand for bank credit apparently overwhelmed and
distorted the usual seasonal behavior, Mr. Balderston continued.
On December 14, 1965, the Committee had directed the Desk to
moderate "any further adjustments in money and credit markets that
may develop."
He would interpret "adjustments" to include not only
rates of interest but the volume of credit.
Rates had increased
considerably, with bill rates some 20 basis points higher, but
what had really got out of hand was the flow of reserves, bank
credit, and money.
Nonborrowed reserves increased at an annual
rate of 20.7 per cent in December, total reserves at 18.8 per cent,
bank credit at 10.9 per cent, and money supply at 12.3 per cent.
Those rates were clearly unsustainable and prompt correction was
indicated even though the Treasury was in the midst of a financing.
With payment scheduled for January 19, there were just a few days
to get those percentages back on the beam again before the important
Treasury refunding to be announced January 26.
In short, he hoped
the Committee would not feel it necessary to hold the keel even
for the current financing, which was modest in size and involved a
rich offering.
He would prefer to see such action as was indicated
taken despite the financing, and then anticipate achieving stability
for the February refunding.
The year-end escalation of reserves, bank credit, and
money supply, Mr. Balderston said, reflected the increase in the
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System's portfolio between December 15 and January 5 of about
$2 billion of repurchase agreements in addition to the acquisition
of some bills.
On a net basis, the portfolio grew during the
period by $3/4 billion, whereas in the comparable year-ago period
it had shrunk by $1/4 billion.
In the light of those actions,
the Committee needed to restrict bank credit to the amount required
for growth in output without adding to inflationary pressures.
With mounting war demands superimposed on private demand, it would
appear that current market forces would continue to press interest
rates upward.
from rising?
Should the level of interest rates be prevented
Even if the System could succeed in keeping such
rates stable in the present climate, the effort would tend to
induce inflation.
On the other hand, monetary policy needed the
support of higher taxes if the current war-supported demand was to
be curbed.
However, the System should not shirk its part of the
task, which was to assist the forces of the market to determine
new rate levels in an orderly fashion.
The data now coming to light seemed to confirm that the
discount rate action was in the nick of time, Mr. Balderston
commented.
That event drove home once again that the System's
success turned on its luck in doing the right thing at the right
time and often before all the facts were available.
Now that the
economy had passed the Christmas hump, it would seem appropriate
1/11/66
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to rediscover what level of reserves would keep the economy strong
without overheating, without relying on the Administration to curb
spending or to increase taxes sufficiently.
In wartime actual
spending tended to outrun budgets, and tax increases--if made in
an election year--were tardy in both adoption and effect.
Mr. Balderston would, therefore, permit any further increase
in demands for reserves to firm money market conditions.
By the
word "conditions" he meant not only short-term interest rates but
also excess reserves and bank borrowing.
Hopefully, a return flow
of funds in late January and in February would be of assistance,
but even with such aid the System needed to act.
As to the directive, Mr. Balderston said that Mr. Daane's
proposed change in the first paragraph was acceptable to him, but
that he would like to submit for the Committee's consideration
the following substitute wording for the second paragraph:
"System open market operations until the next meeting of the
Committee shall be conducted with a view to permitting any further
increase in demand pressures to firm money market conditions."
Chairman Martin asked Mr. Holmes what implications he
thought Mr. Balderston's proposed language would have for operations.
In reply, Mr. Holmes said that one problem was that it was
not easy to sort out demand pressures from other forces that might
be tending to firm money market conditions, particularly over short
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-77
periods; over longer periods it could be done more accurately.
He
would be willing to try, but he could not guarantee the results.
The underlying principle--letting net borrowed reserves deepen and
money market conditions firm in a period of strong credit demandscertainly could be a useful one, and was similar, he thought, to
the objective of Mr. Holland's proposal.
Mr. Daane said that as much as he sympathized with
Mr. Balderston's view, and with the view Mr. Robertson had expressed
earlier on the desirability of deriving all possible advantages
from the System's recent rate action, he did not think the Committee
could ignore a Treasury financing even though it was a modest one.
He asked Mr. Holmes whether a deviation from even keel at present
would lead to difficulties for the Treasury.
Mr. Holmes replied that any operations that were interpreted
by the market as signifying an overt change in policy would tend to
confirm the extreme view in the present range of expectations regard
ing future interest rate levels, and might make things quite
difficult for the Treasury in connection with the February refunding.
The refunding could be important in bringing greater stability to
the interest rate structure, if the issue was realistically priced.
At the same time, if overriding forces were pushing interest rates
up efforts by the System to offset those pressures would not be
helpful to the Treasury in pricing the new issue.
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In response to a question by Mr. Daane, Mr. Holmes said
that on the basis of the discussion today he would not interpret
an "even keel" decision as calling either for rolling back rates
from their present levels or for preventing them from rising
further if market conditions worked in that direction.
Mr. Mitchell commented that the Committee lacked the facts
necessary to define the circumstances that were likely to prevail
in the coming period.
There would be no great problem with respect
to bill rates if market psychology changed because a restrictive
budget was announced, and it might be difficult to hold bill rates
up at a reasonable level if developments suggested that the peace
offensive was likely to be successful.
It seemed desirable to him
to give the Manager more leeway than usual until some of the present
uncertainties were resolved.
Mr. Balderston noted that the second paragraph of the
staff's draft directive called for "moderating any further firming
of money market conditions that may develop."
At the same time
the blue book cited the unusually large percentage increases in
financial aggregates in December that he had quoted in his earlier
comments.
Future historians might well ask what firming the
Committee had in mind today when they noted that nonborrowed
reserves, for example, had increased at an annual rate of over
20 per cent in December.
1/11/66
-79Mr. Robertson then suggested calling for operations "with
a view to maintaining about the current conditions in the money
market."
He noted that at least some members had indicated a
preference for placing primary emphasis on net borrowed reserves
rather than on interest rates as such, if it proved necessary to
make a choice.
Mr. Balderston indicated that he was agreeable to
Mr. Robertson's suggestion.
Chairman Martin said he thought the wording Mr. Robertson
had proposed for the second paragraph was appropriate.
He continued
to be impressed by the difficulties posed for the Committee by the
fact that particular words meant different things to different
people.
The longer he worked in the area the more perplexing he
found the problem of specifying the Committee's intentions.
On the whole, Chairman Martin believed that monetary policy
had performed well during the past year.
As he had indicated in
his memorandum to the President that he had read to the Committee
on October 12, the flow of funds was being constricted in an
undesirable way.
The role of interest rates was being viewed
wholly out of perspective, and unwarranted claims about the power
of interest rates were being made by people on both sides of the
policy debate.
There had been real progress in freeing the flow of funds
during the last six weeks or so, Chairman Martin continued.
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one had expected the December rate actions to work miracles; but
it was clear that there had been factors constricting the flow of
funds, and that the rate actions had alleviated the problem.
Fiscal policy, debt management policy, incomes policy, and
monetary policy all were in play all of the time, the Chairman
said, and all four were fluid.
Developments could not necessarily
be attributed to any one of the four, and judgments might differ
on their interrelations at any one time.
Business outlays on
plant and equipment were moving up rapidly and if Federal expen
ditures rose substantially further there would be a sizable full
employment budget deficit about which something would have to be
done.
Certainly monetary policy alone could not cope with that
problem; at some point action might be called for on all four
fronts.
He agreed with Mr. Hayes that the proper course for
monetary policy now was "steady in the boat"; the best the Committee
could do at the moment was to maintain conditions as steady as it
could, and contribute as much as possible to the maintenance of
reasonable flows of funds through the markets.
It was not the Committee's job to tell the Administration
what policies it should follow, the Chairman continued, but debt
management was in a knot at present.
Because of the 4-1/4 per cent
interest rate ceiling on Treasury bond issues, any new Government
financing had to involve maturities of five years or less.
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Chairman Martin observed that he felt more and more humble
as time went on about what really could be accomplished in the area
of monetary policy.
He often had remarked that he did not fully
understand the role of the money supply in the economy, and he had
to say now that after having been concerned with the subject for
many years he understood it less than he had twenty years ago.
One was dealing with human choices and value judgments, and that
required the ability to change one's conclusions from day to day
and month to month.
He did not mean that one should not have
convictions on the subject, but that there should be flexibility
in views.
In his judgment one ought to worry most about the man
who was sure he knew the answers; the nature of the policy problem
was such as to preclude fixed positions.
He, for one, did not
think he had the answers, any more than anyone else.
It was
necessary to maintain an open mind and to probe constantly for
new approaches, new devices, and new instruments.
Chairman Martin thought the Committee was more or less in
agreement on policy today.
The members might best concentrate on
what policy would be appropriate in the future, in light of the
new factors in the situation and considering the contents of the
coming Budget Message.
The System now would be operating in an
entirely new environment--one that had not been contemplated a
year ago--of full employment generally and over-full employment of
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skilled workers.
He personally would favor a little inflation if
he thought it would benefit the unemployables, but he did not
think it would; rather, it would do them harm.
He had debated
that issue for years with academicians, some of whom, he believed,
had an emotional bias on the subject.
In his opinion there was
some justification for their view in the short run but not in the
longer run.
The Chairman then suggested that the Committee vote on a
directive consisting of the staff's draft with amendments along
the lines of those proposed by Messrs. Robertson and Daane.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, the Federal
Reserve Bank of New York was authorized and
directed, until otherwise directed by the
Committee, to execute transactions in the
System Account in accordance with the follow
ing current economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that domestic economic expansion
has strengthened further in a climate of optimistic
business sentiment and with some further upward creep in
prices. Interest rates are higher in most markets in
response to strong credit demands and recent official
rate actions. Our international payments position
improved considerably during 1965 but further progress
is needed to attain effective balance. In this situation,
it is the Federal Open Market Committee's policy to resist
the emergence of inflationary pressures and to help restore
reasonable equilibrium in the country's balance of payments,
by moderating the growth in the reserve base, bank credit,
and the money supply.
In light of the Treasury financing schedule, System
open market operations until the next meeting of the
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1/11/66
Committee shall be conducted with a view to maintaining
about the current conditions in the money market.
Mr. Swan said that it would be useful if the staff could
provide some indication of the effects on seasonal factors for
financial series as the economy approached full utilization of
resources.
In particular, he would like to know whether seasonal
fluctuations tended to be damped under those circumstances.
Mr. Holland replied that the staff would develop information on
that subject.
It was agreed that the next meeting of the Committee would
be held on Tuesday, February 1, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
ATTACHMENT A
CONFIDENTIAL (FR)
January 10, 1966
Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on January 11, 1966
The economic and financial developments reviewed at this
meeting indicate that domestic economic expansion has strengthened
further in a climate of optimistic business sentiment and with some
further upward creep in prices. Interest rates are higher in most
markets in response to strong credit demands and recent official
rate actions. Our international payments position improved con
siderably during 1965 but further progress is needed to attain
effective balance. In this situation, it remains the Federal Open
Market Committee's policy 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.
In light of the Treasury financing schedule, System open
market operations until the next meeting of the Committee shall be
conducted with a view to moderating any further firming of money
market conditions that may develop.
Note: The second paragraph of this draft directive is intended
as one possible interpretation of an "even keel" policy stance under
the conditions existing at present. Alternative possible interpreta
tions might involve instructions to maintain "about the current
conditions in the money market" or "about the same conditions in the
money market as have prevailed on average since the preceding meeting"
with guidance given to the Manager as to whether emphasis should be
placed primarily on net borrowed reserves or on short-term interest
rates if the current or recent relations prove inconsistent.
Cite this document
Federal Reserve (1966, January 10). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660111
@misc{wtfs_fomc_minutes_19660111,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Jan},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660111},
note = {Retrieved via When the Fed Speaks corpus}
}