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., on Tuesday, May 10, 1966, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Daane
Hickman
Irons
Maisel
Mitchell
Robertson
Shepardson
Messrs. Wayne, Scanlon, Francis, and Swan,
Alternate Members of the Federal Open
Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents
of the Federal Reserve Banks of Boston,
Atlanta, and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Easthurn, Garvy, Green, Koch, Mann,
Partee, Solomon, and Tow, Associate
Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Cardon, Legislative Counsel, Board of
Governors
Mr. Fauver, Assistant to the Board, Board
of Governors
Mr. Williams, Adviser, Division of Research
and Statistics, Board of Governors
Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
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Mr. Axilrod, Associate Adviser, Division
of Research and Statistics, Board of
Governors
Miss Eaton, General Assistant, Office of
the Secretary, Board of Governors
Mr. Forrestal, Senior Attorney, Legal
Division, Board of Governors
Mr. Furth, Consultant, Board of Governors
Messrs. MacDonald and Kimbrel, First Vice
Presidents of the Federal Reserve Banks
of Cleveland and Atlanta, respectively
Messrs. Eisenmenger, Parthemos, Baughman,
Jones, and Craven, Vice Presidents of
the Federal Reserve Banks of Boston,
Richmond, Chicago, St. Louis, and
San Francisco, respectively
Mr. Deming, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Duprey, Economist, 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 April 12, 1966, were approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Account on foreign exchange market conditions and on Open Market
Account and Treasury operations in foreign currencies for the period
April 12 through May 4, 1966, and a supplemental report for May 5
through 9, 1966.
Copies of these reports have been placed in the
files of the Committee.
In comments supplementing the written reports, Mr. Coombs said
that a reduction of perhaps $75 or $100 million in the Treasury gold
stock probably could not be delayed much longer.
The Stabilization Fund
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had only $39 million of gold on hand and there was a prospective
order from the French approaching $90 million.
The London gold market had been quiet recently, Mr. Coombs
remarked, with the price ranging around $35.11.
The very tight
money situation prevailing in all European markets appeared to be
having pronounced effects on the gold market.
High short-term
interest rates were not only discouraging new purchases of gold but
might even be stimulating dishoarding in some volume.
A number of
European commercial banks and industrial corporations usually kept
some part of their cash in gold, and with the Light money conditions
individual concerns tended to reduce their holdings somewhat from
time to time.
The effect, of course, was not a lasting one; but
for the moment, at least, it was keeping the market under a minimum
of pressure.
There still were no signs of Russian gold sales despite
the fact that the Russians now were in process of buying a substantial
volume of wheat from Canada.
At the same time, there was no evidence
that the mainland Chinese were buying gold.
Sterling continued to be the main focal point on the exchange
markets, Mr. Coombs continued.
In April, Britain experienced a
genuine reduction in its reserves of $53 million which was reflected
in the published figures.
In addition, $150 million of short-term
central bank debt fell due at the end of the month.
That debt was
covered by borrowings of $50 million from the Bundesbank, $50 million
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from the U.S. Treasury, and $50 million from the Federal Reserve under
the standby swap line.
The borrowings from the Bundesbank and the U.S.
Treasury were virtually over-night arrangements, and had already been
paid off.
The $50 million from the Federal Reserve was on the customary
three-month basis but might be paid off before maturity.
Mr. Coombs went on to say that the initial market reactions to
the British budget announcement on May 3 were unfavorable, and there
was a risk that sterling might drop sharply.
The New York Reserve
Bank bought two million pounds for Treasury account, and that seemed
to put a floor under the price of sterling.
Subsequently another two
million were bought for Bank of England account, pushing the sterling
rate up somewhat.
Those operations seemed to have a stabilizing
effect on expectations, and bridged the few hours required for the
market to digest the real significance of the budget.
As the details
became understood--particularly with respect to the payroll tax--the
market stabilized on its own.
It was Mr. Coombs' impression that the British budget did provide
for a rather strong restrictive effect on the economy, particularly in
the first year, although there were a good many unknowns regarding the
manner in which it would be administered.
1/
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material consisted of
further comments by Mr. Coombs on British economic policies, including
a comment on attitudes of others towards the British budget.
5/10/66
Elsewhere in the exchange markets, Mr. Coombs said, the mark
and guilder still remained under pressure.
Both central banks con
cerned seemed determined to resist that pressure to their full
ability, through tight money and other restrictive policies.
Neither
was making much progress in getting their Governments to take action
in the fiscal area.
strong.
The French franc and Italian lira continued
He had a feeling that the Italian surplus would gradually
disappear, and that such an event might be hastened by political
developments in Italy.
At any rate, the surplus that the Italians
had built up would prove to be a useful cushion against future
adversities.
different.
The outlook in the case of the French franc was somewhat
France's policy seemed to be geared to producing regular
and substantial monthly surpluses, and there was no indication on
their part of a willingness, such as was evidenced by other friendly
countries, to engage in swap operations or other technical operations
to cushion the impact of their surpluses.
As long as the French
continued that policy there would be attrition in the U.S. gold stock
and pressure on the U.S. generally.
Mr. Galusha asked Mr. Coombs to amplify his comments regarding
Russian purchases of wheat.
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Mr. Coombs replied that the Russians were buying wheat,
especially from Canada, as a result of the failure of the Russian
wheat crop.
The timing of the shipments was related to the opening
of the ship canals; shipments in volume began in April and were
scheduled to hit their peak in May.
Since the Russians were paying
cash, presumably there would be considerable inroads on their cash
position during that period, and they might have to replenish their
cash before long by selling gold.
As he had mentioned, however,
there still were no signs of such sales.
At the time of the previous
harvest failure the Russians had sold an amount of gold on the order
of $350 to $400 million, and it was hoped that their current purchases
would force the sale of an equivalent amount.
Of course, gold sales
would be required only if there was a net deficit in the over-all
Russian balance of payments position, and no information was available
on that subject.
In answer to a question by Mr. Ellis, Mr. Coombs said that
the Communist Chinese had bought roughly $150 million of gold in
1965.
There was no evidence of current purchases, and while they
might be buying secretly through Swiss banks, information on such
transactions ordinarily leaked out.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
April 12 through May 9, 1966, were
approved, ratified, and confirmed.
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Mr. Coombs then recommended renewal of two standby swap
arrangements that were scheduled to mature soon:
the $750
million arrangement with the Bank of England, having a term of
twelve months, and maturing on May 31, 1966; and the $100 million
arrangement with the Netherlands Bank, having a term of three
months, and maturing on June 15, 1966.
He noted that a $50
million drawing by the Bank of England was presently outstanding,
and that there were no drawings at present on the arrangement
with the Netherlands Bank,
Renewal of the two swap arrange
ments for further periods of twelve and
three months, respectively, was approved.
Mr. Coombs then noted that a so-called "third currency"
swap with the Bank for International Settlements of sterling
against Italian lira, in the amount of $50 million, had been made
on February 25, 1966, and would mature on May 25, 1966.
He
recommended renewal of that swap for another three months, noting
that it would be a first renewal.
In reply to Mr. Shepardson's question regarding the purpose
of the transaction, Mr. Coombs said that it had been a means of
clearing up swap drawings under the regular line with the Bank of
Italy.
The Account had acquired sterling on a guaranteed basis,
and it appeared desirable to make multilateral use of that sterling
by swapping it for another European currency with respect to which
the dollar was clearly under pressure.
5/10/66
Mr. Shepardson noted that it was the intention of the
Committee to have any swap drawings cleared up within a relatively
limited time.
He would be concerned if the transaction in question
was a device to avoid clearing up a drawing by changing the form
of the obligation to some other currency.
Mr. Coombs replied that he did not think the Committee
should consider itself imprisoned in bilateral patterns; rather,
if the System held a strong position in one currency it should use
it to offset a deficit in another currency.
Other countries
accomplished the same result by transactions in dollars.
While
there was no single foreign currency in which the U.S. could repay
debts to any of a number of other countries, the technique of
third-currency swaps gave the System an equivalent flexibility.
That technique had been employed successfully on a number of
occasions and he considered it highly useful.
Without it, the
System would be handicapped in its foreign currency operations.
Mr. Mitchell asked whether the System had a contingent
liability on the swap, and Mr. Coombs replied that since the
sterling was guaranteed by the Bank of England the System would
not suffer any loss in the event of a devaluation of sterling.
Renewal of the sterling-lira
swap with the Bank for International
Settlements for a further period of
three months was noted without objection.
5/10/66
Chairman Martin then noted that at its preceding meeting
the Committee had held a preliminary discussion of the new
foreign currency instruments that had been proposed by the
Secretariat, and of the memorandum by Mr. Baker, of the Board's
staff, reviewing System foreign currency operations in the period
1962-65.
A memorandum by Mr. Coombs, commenting on Mr. Baker's
paper, had been distributed at that meeting, and subsequently
the discussion had been continued in a memorandum by Mr. Furth
dated April 27, 1966.
Also, on April 28, 1966, the Secretariat
had distributed revised drafts of the proposed new instruments,
taking account of suggestions advanced at the April 12 meeting
of the Committee; and today a memorandum noting certain suggestions
by Mr. Mitchell for substantive revisions in the proposed new
foreign currency directive had been distributed.1/
In the
Chairman's judgment the various documents represented much useful
work, and the Committee was indebted to Mr. Maisel for his original
suggestion, at the meeting of November 23, 1965, that the staff
undertake an examination of the foreign exchange operations.
Chairman Martin then invited Mr. Maisel to open the discussion.
Mr. Maisel said he agreed that the several recent papers
constituted a useful review of the System's foreign exchange
1/ Copies of the documents referred to have been placed in the
Committee's files.
5/10/66
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operations.
He personally had no changes to suggest in the
proposed new authorization and directive, and he was prepared
to vote to approve them in the form submitted by the staff.
He hoped the dialogue begun in the recent memorandums would
be continued; in discussions with members of the Committee and
staff he found a good deal of uncertainty with regard to the
Committee's position on some issues.
For example, the Committee
had both long-run and short-run objectives, but its foreign
currency instruments tended to be formulated in terms of the
latter and it was not clear how they were related to the longer
run objectives.
The uncertainty on that issue was evident at
several points in the staff papers.
Chairman Martin then invited Mr. Mitchell to comment on
the substantive revisions in the proposed new directive that he
had suggested.
Mr. Mitchell said that his suggestions were not very
complicated.
First, he proposed that a paragraph be added at
the end of the directive for the purpose of making explicit a
position that had been implicit in the Committee's operations.
The paragraph was as follows:
5. The Committee, in authorizing the foregoing
operations, does not seek to conceal or distort the
real effects of underlying economic forces on the
currency of any country. When the magnitude or
duration of operations are presumptive evidence to
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the contrary the full extent of support shall be
made known promptly.
Secondly, Mr. Mitchell continued, he would strike the
reference to foreign official reserves in paragraph 2(A) of the
directive; in his judgment cushioning operations should be
authorized only if payments flows had potentially destabilizing
effects on U.S. official reserves.
With the deletion, the para
graph would read as follows:
A. To cushion or moderate fluctuations in the
flows of international payments, if such fluctuations
(1) are deemed to reflect transitional market unsettlement
or other temporary forces and therefore are expected to
be reversed in the foreseeable future; and (2) are deemed
to be disequilibrating or otherwise to have potentially
destabilizing effects on U.S. [strikeout]
or foreign [/strikeout]
official reserves
or on exchange markets, for example, by occasioning market
anxieties, undesirable speculative activity, or excessive
leads and lags in international payments;
Mr. Mitchell's third suggestion reflected a conclusion he
drew from Mr. Baker's memorandum; namely, that there was a risk
that operations undertaken to deal with situations originally
considered to be temporary might be permitted to persist for
undesirably long periods.
He suggested rephrasing paragraph 2(B)
of the directive as follows:
B. To temper and smooth out abrupt changes in
spot exchange rates, and to moderate forward premiums
and discounts judged to be disequilibrating. Whenever
supply or demand persits in influencing exchange rates
in one direction FOR A PERIOD OF THREE MONTHS, System
or
transactions should be modified, OR curtailed, [strikeout]
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eventually
[/strikeout]UNLESS
a
pending
discontinued
UPON REVIEW
AND reassessment OF THE SITUATION by the Committee [strikeout]of
supply
[/strikeout]
forces
demand
and
DIRECTS OTHERWISE;
In Mr. Mitchell's judgment the proposed new language for paragraph 2(B)
was consistent with the Committee's present practice.
He thought,
however, that the burden of proof that a development persisting for
more than three months was still appropriately considered temporary
should be placed on the Special Manager, and his objective was to
make that point explicit.
Finally, Mr. Mitchell said, he would amend paragraph 2(C)
by inserting "short-term" before the reference to interest rate
differentials, as follows:
C. To aid in avoiding disorderly conditions in
exchange markets. Special factors that might make for
exchange market instabilities include (1) responses to
short-run increases in international political tension,
(2) differences in phasing of international economic
activity that give rise to unusually large SHORT-TERM
interest rate differentials between major markets, and
(3) market rumors of a character likely to stimulate
speculative transactions . . .
The language of the affected clause had always been somewhat obscure
to him, Mr. Mitchell said, but if the interest rate differentials
mentioned related to long-term rates he thought the statement would
be fundamentally inconsistent with the Committee's announced
intention of dealing only with short-term fluctuations.
In response to Chairman Martin's request for comments on
Mr. Mitchell's proposed changes, Mr. Coombs noted that he had not
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yet had an opportunity to study them carefully, but could give
his initial reactions.
He though that if the proposed new
paragraph 5 was given a liberal interpretation it would not pose
a problem most of the time.
Under certain circumstances, however,
it might prove extremely restrictive.
For example, along with
the U.S. Treasury and other central banks, the System had rendered
substantial assistance in support of sterling over an extended
period, in an effort to counter strong underlying forces.
If the
proposed language had been in effect it could have been interpreted
to require making known the full extent of that support promptly.
But it had been deemed necessary to keep details of the support
secret for a time, because prompt disclosure might well have defeated
the whole purpose of the assistance given.
Similar emergencies could
arise in the future, in connection not only with sterling but with
other currencies as well, and perhaps the dollar; and the language
might be considered to call for prompt public disclosures of a type
that would be undesirable.
Accordingly, he would not recommend
adding the paragraph.
The suggestion to delete the reference to foreign official
reserves from paragraph 2(A), Mr. Coombs continued, raised a question
of principle:
were the System's arrangements with foreign central
banks intended to be reciprocal, or were they unilateral?
In his
view the arrangements would work only on a reciprocal basis; the
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System had to be willing to cooperate with its partners to the
arrangements if it was to expect cooperation from them.
As to the suggested revision of paragraph 2(B), Mr. Coombs
thought that three months often would prove to be a rather short
period in which to determine whether a problem was of a long-run
nature.
As Mr. Mitchell had recognized, drawings on the swap
lines were reviewed by the Committee every three months, at which
times the Special Manager presented his judgments on the prospects
for clearing them up.
Such judgments were necessarily rough since
it was not possible to forecast accurately the balance of payments
positions of both the other country and of the U.S., and since
international flows were strongly influenced by national policies
that were subject to change.
He did not think it would be fruitful
to impose an additional "burden of proof" on the Special Manager,
since the Committee now got his best judgment on the prospects for
reversals of drawings.
He continued tothink that the Committee's
best insurance lay in the fact that, despite the many unknowns in
each situation, the record showed that swap drawings had not been
allowed to run on for extended periods.
The risk existed, of
course; but it was always in the thinking of the Account Management,
and when the duration of drawings began to approach the one-year
mark some other mode of financing had always been arranged.
Further
insurance was provided by the fact that the view of the swap network
5/10/66
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as providing only short-term facilities was shared by the other
parties to the arrangements.
Mr. Coombs saw no problem with Mr. Mitchell's suggested
amendment to paragraph 2(C).
The description of the interest rate
differentials referred to in that paragraph as "short-term" was
consistent with the interpretation he had been placing on the
passage.
Chairman Martin commented that the changes Mr. Mitchell had
suggested appeared in large part to involve matters of language
only.
Mr. Wayne said he did not feel that was the case with
respect to the proposed new paragraph 5.
On first reading the
statement seemed to serve a useful purpose, but on reflection he
was not sanguine that the Committee would be able to hold to it
in a true emergency affecting some major foreign currency or the
dollar.
If that judgment was correct he would question the
desirability of including the
paragraph.
Mr. Daane agreed with Mr. Wayne regarding the proposed new
paragraph.
Nor did he favor the proposed revision of paragraph 2(B).
The question of what constituted a "temporary" situation was a
difficult one to answer, and he thought it was easy to ask too much
of the Special Manager in the way of forecasts of developments.
In
his judgment that criticism could be applied to Mr. Baker's memorandum
5/10/66
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and to some of the other documents that had been distributed.
It was recognized, not only in the Federal Reserve but at the
Treasury and at other central banks as well, that the System's
foreign exchange operations had made a useful contribution to the
international monetary system.
To impose an arbitrary three-month
time limit would run counter to the spirit of the operations and
would reduce their usefulness.
Emphasis should be placed on purposes,
and the Special Manager should be given maximum flexibility to achieve
the stated purposes.
He had no strong objection to adding the phrase
"short-term" to paragraph 2(C), but he saw no real need for doing so,
particularly after Mr. Coombs had indicated that he so interpreted
the present language.
Moreover, the Committee had assured its foreign
partners both by word and by deed that it had no intention of using
the swap arrangements to meet long-run problems.
In sum, he would
leave the directive in the form in which it was drafted by the staff.
Mr. Swan commented that he also did not favor revising para
graph 2(B) to specify a three-month time period.
He would, however,
eliminate the word "eventually" in the phrase in that paragraph that
read ". . . System transactions should be modified, curtailed, or
eventually discontinued pending a reassessment by the Committee of
supply and demand forces."
In his judgment that word carried
implications that were not consistent with the Committee's intentions.
Mr. Hayes said he agreed fully with Mr. Daane.
He also
concurred in Mr. Coombs' view that the record showed the System had
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done remarkably well in clearing up drawings within a short time.
The Committee, in effect, had been experimenting on the question
of what constituted the best interpretation of "short-term";
whether it was three, six, or nine months in a particular case
seemed to him to depend on the facts of that case, and he favored
a more flexible interpretation than three months.
He also agreed
that the suggested paragraph 5 could be very damaging in major
crises.
There had been two or three crises in the past few years
and there might well be others,
While he, too, felt the dialogue had been highly useful,
Mr. Hayes continued, he would repeat the point he had made at the
preceding meeting--he hoped the Committee would not overlook the
extremely useful character of the operations to date.
In his
judgment the Committee could be proud of its foreign currency
operations.
Mr. Mitchell commented that if there was any question on
the point he wanted to make clear that he had not intended to imply
any criticism of the Special Manager.
On the contrary, he had felt
that his suggestions were in line with the policies the Special
Manager had been pursuing and had been recommending.
He was con
cerned with the possibility that the Committee might eventually
come under attack from critics charging that it was distorting
market conditions and concealing facts.
If the directive contained
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5/10/66
language of the sort he had suggested for paragraph 5, it would
strengthen the Committee's position in meeting such charges.
He
had no particular pride of authorship in the specific wording and
was not wedded to it, but the substance seemed to him to be consist
ent with the way in which the Committee was trying to operate.
Mr. Wayne agreed with Mr. Mitchell's observation, but
thought that the purpose would be served by including the first
of the two sentences.
He would omit the second sentence, which
was where the problem lay.
Chairman Martin then suggested that the Committee defer
action on the proposed new instruments until the next meeting, to
give the members more time to consider Mr. Mitchell's suggestions
and the various points raised in the discussion today.
He thought
that discussion had been valuable, and that further consideration
would be constructive from the viewpoints of both internal operations
and the System's public posture.
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System
Open Market Account covering open market operations in U.S. Government
securities and bankers' acceptances for the period April 12 through
May 4, 1966, and a supplemental report for May 5 through 9, 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 period since the Committee last met has been
highlighted by generally firmer money market conditions,
by rising interest rates in the face of strong credit
demand, and by an exceptionally apathetic reception to
a--fortunately--routine Treasury refunding operation.
Over much of the period, market participants tended
towards a consensus that the chances for a tax increase
had diminished. But there was still a general element
of uncertainty, fed in part by events in the stock
market. At the moment both the bond and equity markets
appear to be trying to sort out conflicting public
statements, and their implications for the possible
future course of fiscal and monetary policy. While
markets appear to be discounting some further gradual
tightening of monetary policy, expectations as to the
future course of long-term interest rates are still
in a state of flux, and will be strongly influenced
by developments in the stock market and by specific
developments in the fiscal policy debat,.
Day-to-day open market operations were complicated
to some extent over the period by changing bank responses
to the shifting pattern of reserve availability within
individual statement weeks, and by the general problem
of reducing net reserve availability just before a
period of Treasury refunding. While I will not try
to recount the day-by-day problems that emerged, I
might note that an accumulation of reserve needs
necessitated very heavy bank borrowing from the Reserve
Banks on April 19 and 20--amounting to nearly $1.6
billion on the latter day, the last day of the state
ment week for reserve city banks. Dealers had a great
deal of difficulty in meeting their financing needs
on that day, and market participants generally
interpreted the tight money conditions as further
evidence that the Federal Reserve was keeping bank
reserve positions on a taut rein. Partly as a result
of this atmosphere, banks over-borrowed over the fol
lowing weekend, and as the statement week ending
April 27 progressed it became apparent that even with
high net borrowed reserves the funds market was almost
certainly bound to ease up as the excess reserves
accumula ted earlier came into the money market. As
the money market did in fact begin to ease on Tuesday,
April 26, a token sale of $100 million Treasury bills
was made as a psychological reminder to the market
5/10/66
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that easy conditions would be resisted. On Wednesday,
April 27, it was learned that there had been a
substantial reserve shortfall on Tuesday, and that
net borrowed reserves were estimated at $376 million
for that statement week. Although even such a level
of net borrowed reserves probably would have been
consistent with a comfortable money market on that
one day, the level was too high to be consistent
with an even keel policy at the very time that the
Treasury was announcing the terms of its refunding
operation. Consequently, a substantial volume
($420 million) of reserves was injected that daydespite the easier money market. Borrowing was
light early in the week ended last Wednesday, but
the money market firmed substantially after the
weekend with Federal funds trading at 5 per cent
for the first time and dealer loan rates rising
sharply. By last Friday the effective Federal
funds rate reached 5 per cent and there had been
some trading at 5-1/8 per cent.
I believe market participants have generally
interpreted System open market operations during the
period as designed to put as much pressure on bank
reserve positions as possible in the context of even
keel considerations. The very cautious attitude of
both bank and nonbank dealers in the Treasury refunding
reflected this interpretation. Market participants
now appear to feel that they have a crystal clear
reading of the System's views on fiscal policy, and
while they would not be surprised to see some further
reduction in reserve availability and some additional
firming of interest rates, they would not expect any
major monetary moves until it became virtually certain
that no fiscal action would be forthcoming.
As everyone knows, the Treasury refunding operation
met with an unusually apathetic response. It was indeed
fortunate that the February advance refunding had reduced
the public's holding of maturing issues to only $2-1/2
billion and that the Treasury's cash position is such
that the attrition can be handled without strain. The
issue was considered to be fairly priced in the market,
and although prices of the when-issued securities
dropped to below the Treasury offering price there were
few repercussions on the market for outstanding issues.
Dealers wound up with a net position of only $130 million
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in the new 4-7/8 per cent notes and, while they had been
expecting a heavier than usual attrition, the actual 43
per cent of public holdings to be turned in for cash is
without precedent. Nevertheless, the results were taken
in stride in yesterday's trading, with market participants
focusing on other factors affecting the demand for
securities.
Despite substantial market demand for Treasury bills,
rates moved higher over most of the period since the
Committee last met, as did other rates on short-term
instruments such as finance paper and bankers' acceptances.
Selective increases in posted rates on negotiable CD's
have also been reported during the interval, with banks
in New York and Chicago finding it more difficult to
roll over maturities, apparently largely because of
increased competition from other instruments as well as
from rates being paid on CD's by other banks. Demand
for Treasury bills picked up appreciably over the past
few business days, however, and was particularly strong
yesterday. Dealers are anticipating making sizable sales
of bills over the next several days as reinvestment demand
appears from a recent secondary stock sale and from the
funds obtained through attrition in the Treasury refunding.
In this atmosphere bidding was quite aggressive in yesterday's
auction, with average issuing rates set at about 4.63 per
cent on the three-month bills and 4.82 per cent on the
six-month issue, up 1 and 6 basis points, respectively, from
the rates set in the auction just prior to the last meeting
of the Committee.
Dealer loan rates at current levels, up about 1/4 to
3/8 per cent from four weeks ago, will, as the blue bookl/
indicates, tend to work against any seasonal tendency for
rates to decline. In fact, dealer financing could become
a serious problem in the weeks ahead. As you know, several
of the large money market banks have acted virtually as
lenders of last resort at penalty rates relative to those
paid by dealers on corporate RP's or to out-of-town banks.
Given the pressure on the money center banks and their
anxiety to avoid use of the discount window except in
1/ The report, "Money Market and Reserve Relationships,"
prepared for the Committee by the Board's staff.
5/10/66
-22-
rare emergencies, there is a risk that at some point
they may decide to withdraw entirely from what has
been an extremely useful market function. While an
abrupt withdrawal may be unlikely, we shall have to
be alert to avoid a panicky situation that could ensue
if normal channels of dealer financing were to be
disrupted.
In the Treasury bond market, rates also moved
higher over most of the past four weeks, although the
strength in the market over the past few days has
reduced the net changes in yields over the period as
a whole to small proportions. Activity in the market
was unusually quiet during the period. Surprisingly
little swap activity was generated by the Treasury's
refunding, with day-to-day fluctuations in prices
depending mainly on how the market interpreted the
most current statement on fiscal policy. The sharp
decline in stock prices following the series of cut
backs in automobile production was paralleled by a
rally in Governments over the past several days with
gains yesterday ranging up to half a point.
In the corporate market, a number of syndicates
formed early in the period had to be terminated with
concessions of 10-15 basis points in order to move
securities, but later on new issues were priced more
generously and were readily sold, leaving the market
in a better technical position. The calendar is
expected to grow, however, and we hear talk of a
large number of private placements that are getting
underway. Municipal bond yields have also risen,
under the weight of dealer inventories, while the
calendar remains quite large.
The Treasury has completed its financing activity
for the 1966 fiscal year, but will be raising cash in
July--presumably through an issue of tax anticipation
bills--with an announcement likely in late June.
However, a very heavy schedule of Government agency
financing and asset sales before the end of June is
apt to exert a great deal of pressure on the markets.
New money needs have been swollen by the heavy secondary
market mortgage activity of the Federal National Mortgage
Association and by the build-up of saving and loan
association borrowing from the Home Loan Banks--both of
which are further evidence of the general pressure of
credit demand and of bank competition in financial
-23
5/10/66
markets. The FNMA last night priced a new issue of
13-month notes carrying a coupon of 5.45 per cent,
designed to raise $400 million new money, at a discount
to yield about 5.50 per cent. Later this week the
Export-Import Bank will be announcing an issue of $500
million 7-year participation certificates, expected to
carry a 5-1/2 per cent coupon, which will be placed
through a number of the larger banks throughout the
country. While it is impossible to estimate precisely
the total amount of agency issues to be brought to
market before the end of the fiscal year, the new
money need estimated in the blue book is apt to fall
near or above the upper end of the range cited--that
is, somewhere around $3 billion.
Mr. Ellis noted that all of the draft directives prepared
by the staff 1/ included references to the "current Treasury
financing" but in his report the Manager had indicated that the
Treasury had completed its financing activity for this fiscal
year.
He asked whether Mr. Holmes thought the reference was
needed in the directive.
Mr. Holmes replied that the Treasury would not make delivery
on the new securities until May 16, and customarily the even-keel
period was considered to include the date of delivery.
The market
reception of the current financing had been apathetic from the
outset, however, and there certainly were no strong even-keel
considerations at this point.
Mr. Scanlon asked whether the Manager interpreted "even
keel" to mean relatively stable net borrowed reserve figures.
1/
Appended to these minutes as Attachment A.
-24
5/10/66
Mr. Holmes replied that the reserve figures were not the
only factor.
However, the Account Management had to be alert to
how the market would interpret the marginal reserve figures.
The
market might well have been seriously upset if net borrowed reserves
of, say, $400 million had been published for the week ended April 27.
Including the operations on that day, the Management had expected
the figure to be about $315 million--which, in his view, was just
about as high as was desirable.
Mr. Wayne asked whether the announced attrition rate of
43 per cent in the financing reflected operations by the Treasury
trust accounts.
Mr. Holmes replied that it did not.
Taking account
of such operations would have raised the figure for the attrition
rate to about 50 per cent.
Thereupon, upon motion duly
made and seconded, and by unanimous
vote, the open market transactions
in Government securities and
bankers' acceptances during the
period April 12 through May 9, 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:
5/10/66
-25-
There is somewhat more uncertainty about the
likely course of domestic economic developments today
than there was a month or six weeks ago. This is due
to a number of factors, topped perhaps by the continuing
doubt about the course of the war in Vietnam. Political
unrest in that country plus the absense to date of
additional requests for larger defense appropriations
have given some support to the idea that the rise in
military spending may taper off after mid-year.
In addition, there is a growing feeling that the
recent sharp rate of recent economic expansion cannot
be sustained. Both industrial production and retail
sales, for example, rose at about a 12 per cent
seasonally adjusted annual rate in the six-month period
ending with March, and the personal savings rate fell
to an abnormally low level in the first quarter. Both
industrial production and retail sales appear to have
expanded less rapidly in recent weeks. In the auto
industry, with dealer inventories high, some slackening
in sales in April has led quickly to a moderate reduc
tion in output.
Other factors tending to make some people feel
that future expansion is likely to be at a less frantic
pace than earlier have been the sharp drop in stock
prices, the growing complaints of those concerned with
housing and mortgage financing about the depressing
effects of tight money and higher interest rates, and
some slackening in the pace of the over-all price
advance. Industrial prices have continued to rise at
the earlier rate but there has been a turn-around in
farm and food prices from sharp rise to moderate
decline.
Granting all this, the over-all domestic economic
outlook still seems to me to be for further substantial
expansion in the foreseeable future. Indeed, some of
the doubt about likely future developments is due to
fears about the excessive rapidity of the recent rate
of advance and the maladjustments in resource allocation
that have already arisen in the current boom.
Moreover, the tapering off in expansion in activity
that has occurred thus far this quarter has been selective
and all in the consumer area. Federal Government spending,
both for defense and other purposes, continues to run
above earlier expectations, and business spending on fixed
5/10/66
-26-
investment and inventories has been in line with the
upper range of estimates for these types of spending
made earlier in the year.
Estimates of business expenditures on plant and
equipment in the first quarter, for example, were more
in line with the 19 per cent increase projected for the
year as a whole by McGraw-Hill recently than with the
16 per cent projected earlier by Commerce-SEC. To me,
a most significant finding of the McGraw-Hill survey
of business investment plans was that planned spending
for 1967 through 1969 is already very large as these
early estimates go.
The tapering off in the earlier unsustainable rate
of economic expansion has probably meant some plateauing
in the rate of over-all utilization of plant capacity.
The unemployment rate has also been at or near the 3-3/4
per cent level now for the past three months. Unemploy
ment of adult males, however, has dropped to the lowest
level since World War II, with teenage unemployment
drifting up again.
An important development in wage, price, productivity,
and profit relationships in recent months has been a
moderate pickup in wage increases. With some decrease
in the rate of productivity gains, unit costs have
increased on the average. Prices have risen relatively
more than costs, however, and as a result profit margins
have continued to widen.
This development poses some potential problems. In
the first place, it has a tendency to stimulate what
already is a type of current spending whose pace of
advance cannot be sustained at current rates of expansionnamely, business investment. And, along with rising
consumer prices, it will add fuel to labor's demands for
more generous wage settlements.
In addition to the situation in Vietnam and the
current high level of business investment, the development
that would most likely threaten the sustainability of the
current economic expansion would be excessive wage
increases. This makes the current course of the cost of
living and the forthcoming labor negotiations in the
electrical and communications industries of considerable
importance. Concern over forthcoming wage negotiations
is also a prime reason for the Administration's continuing
opposition to unwarranted price increases. Much of the
price rise so far is reversible--so long as cost levels
are not generally raised.
-27-
5/10/66
In conclusion, two schools of thought have
developed as to the relationship of current and
likely prospective domestic economic developments
to current stabilization policy. What might be
termed the "economic doves"--still by far the
minority group--put considerable emphasis on the
fact that likely future developments in military
spending and in business investment, in and of
themselves, will soon provide some dampening
influence on expansion in total economic activity.
They also feel that we have not yet seen the full
effects of fiscal and monetary measures already
taken. Therefore, they feel that little or no
further restraint is appropriate, particularly in
view of long lags in the effects of such restraint.
They feel that the risk of a policy that would weaken
demands in 1967--just when market forces may also be
operating in that direction--outweighs the risk of
inflation this year.
The "economic hawks," on the other hand, emphasize
They feel that
just the opposite course of events.
the continuing risk of a serious ratcheting and
acceleration of wage and price increases because of
excessive over-all demands that are likely to occur
if further fiscal and/or monetary restraint measures
are not taken outweighs the risk that such additional
restraint might contribute to recession later on. The
large first-quarter rise in GNP with its striking price
component certainly supports this point of view.
Peace-loving as I normally am, I still count myself in
the camp--or should I say the nest--of the hawks.
Mr. Partee made the following statement concerning financial
developments:
Conditions in the money market over recent weeks
have shown substantial and continuing firmness, as
discussed by Mr. Holmes and reported in detail in the
written material prepared for this meeting. And growing
pressure on bank reserve positions--at least at the marginis indicated by the rise in borrowings consistently above
the $600 million level and the deepening in net borrowed
reserves toward $300 million. Yet, in the face of these
pressures, all of the aggregate banking measures--money
5/10/66
-28-
supply, credit, and reserves--grew markedly faster
in April than in the earlier months of this year.
March to April annual rates of increase, on a
daily average basis, amounted to 13.5 per cent for
money supply, 17.5 per cent for total reserves,
and 18 per cent for the member bank credit proxy.
What do these aggregate measures, sharply at
variance with money market developments, tell us
about the posture of monetary policy? The answer
is, I think, not very much. First is the fact that
there is no necessary or dependable short-run
relationship between marginal and aggregate monetary
variables.
In fact, a major reason for framing the
Committee's directive in money market and marginal
reserve terms, as I have understood it, is to permit
unusual and unpredictable variations in demands for
credit and liquidity to be accommodated initially
by the banking system. As demands fluctuate in the
short-run, the associated reserves are permitted to
be created or absorbed in order to avoid destabilizingand, at times, possibly critical--changes in market
conditions.
April appears to me to have been just such a
period. In particular, the speed-up in corporate
tax payments brought an unusual demand for liquidityone, incidentally, that is not yet provided for in
our seasonal adjustment factors, so that the "true"
seasonally adjusted expansion was probably less than
that reported. This demand was accommodated by the
banks, not so much through direct lending to the
taxpayers as through purchases of securities and an
upsurge in loans to security dealers and finance
companies as corporations liquidated their holdings.
Presumably this credit and deposit bulge at the banks
will now be reversed, if the pressure on bank reserve
positions is kept up. Privately-held demand deposits
are indicated to have declined slightly on balance
over the last three weeks, though the banks have not
yet been forced to curtail asset purchases since
Treasury deposits have built up.
A second problem in judging the aggregate banking
statistics is the need to take account of changes in
banking's share of total credit and savings flows. Pre
liminary flow-of-funds estimates for the first quarter
show a substantial reduction in credit flows through
5/10/66
-29-
banks and other financial institutions, from $55 billion
in 1965 to an annual rate of $45 billion in the first
quarter of this year. This decline was more than offset
by a very sharp rise of security sales in the market,
which at the higher yields prevailing attracted direct
investment of funds that otherwise might have gone
through the financial institutions. Thus, deposit growth
diminished markedly, not only at the banks but also at
the specialized savings institutions.
In late March and April, however, the competitive
position of the banks improved abruptly. Higher offer
ing rates on CD's, posted after the prime rate increase,
widened the spread as against other market instruments,
and the banks were able not only to replace heavy
maturities but to add $1 billion to the amount outstanding.
And more vigorous competition for the savings balances
of individuals and smaller businesses--in rates, terms,
and instruments offered--produced a large net inflow of
funds in recent weeks for the banks, partly at the
expense of the savings institutions but probably also
reflecting diversions of funds from direct market
investment. The recent rapid rates of deposit inflow
from these sources will probably diminish as the initial
impact of higher bank rates wanes and also possibly as
rate differentials tend again to narrow. But to the
extent that more rapid bank deposit growth has simply
represented a diversion from other channels--and the
associated bank credit expansion merely a substitution
for credit expansion elsewhere--it seems to me that there
is little cause for concern.
If we look through the recent banking aggregates,
on the grounds that they have been influenced strongly
by temporary liquidity needs and a substitution of bank
for other credit sources, then I believe that the picture
that emerges for recent weeks is one of substantial
monetary restraint. The money markets are tight, and
they have been trending irregularly in the direction of
greater tightness for some time now. Long-term bond
yields have been moving up again in all categories, and
have now retraced about half of their corrective declines
from the extraordinary anticipatory peaks reached in
March. The price firmness of recent days seems directly
associated with the turbulence in the stock market.
Bank business loans rose at only a 10 per cent annual
rate in April, partly reflecting refinancings
5/10/66
-30-
in the capital market, and there are increasing
indications of tightening in bank lending standards
and other non-price rationing measures. Finally,
in the mortgage field a marked tightening appears
to be in process, reflecting both the shift in
funds flows away from savings institutions and also
apparently reduced participation in new mortgage
commitments by banks and insurance companies.
Nevertheless, in view of continued rapid
economic expansion and mounting strains on labor,
resources, costs, and prices, it seems to me
essential to keep the pressure on in financial
markets. Indeed, continued gradual tightening
appears warranted, given the strength of demands
for goods and services and associated credit needs.
If the Committee decides that further firming in
monetary policy is required, however, there are
several factors arguing for a "go slow" approach.
First is the very large volume of Federal agency
issues and asset participation sales in prospect
over the next two months, which could put con
siderable pressure on markets even in the absence
of Treasury cash financing. Second is the unsettled
state of the markets, particularly for equities; any
marked monetary tightening, given present uncertainties,
could bring unduly severe market repercussions. Third
is the problem of the current funds position of the
savings institutions and the related difficulties of
the mortgage market; further diversions of savings
flows should not be encouraged, at least for the
time being, in the interests of financial stability.
There is also the question of how much further
tightening can be induced in the money market without
putting severe pressure on the discount rate and
current Regulation Q rate ceilings. As for the
discount rate, it would appear that primary reliance
already rests on the discipline of the window, with
Federal funds trading as high as 5 per cent or above;
further market firming would serve to increase that
reliance, but this appears to me operationally
feasible. And Regulation Q ceilings are not really
under much pressure now, reflecting the fact that
permissible time deposit rates were raised a point
or more last fall. With prime bank quotes of 5 to
5-1/4 per cent for CD's in the 60-90 day range, there
5/10/66
-31
would seem to be room for banks to compete to retain
funds even if the 3-month Treasury bill yield were
to rise close to the 5 per cent level.
Mr. Hickman noted that Mr. Partee had described the recent
fairly substantial increase in time deposits at banks as being
partly at the expense of savings institutions.
He (Mr. Hickman)
thought that was true with respect to developments in April, and
he agreed that the shift in the channels of flows was not in
itself a cause for alarm.
However, the money supply had increased
at a seasonally adjusted annual rate of 13.5 per cent in April, and
private demand deposits at a rate of 16.3 per cent.
Those were
extraordinarily large increases, and he would not want to see them
continue.
He asked whether Mr. Partee was concerned about those
developments.
Mr. Partee replied that such large increases might often
provide grounds for concern.
He had tried, however, to make
several points in connection with the recent money supply increase.
First, there was an extraordinary demand for liquidity in April
because of the speed-up in corporate tax payments, and in the past
the Committee had operated in a manner that accommodated such
unusual bulges in demands to avoid disrupting markets.
Secondly,
the seasonal adjustment factors currently used did not make
adequate allowance for the tax speed-up, and presumably when the
factors were revised the increase in the seasonally adjusted
5/10/66
-32
figures would be less.
Third, the money supply was among the
series that tended to show sharp short-run fluctuations--there
were large rises in June and December 1965, for example.
Given
the nature of the series, he thought one should not overemphasize
developments in any one month.
As indicated in the blue book,
the staff estimated that there would be little net change in
private demand deposits over the two months of May and June taken
together.
If that estimate proved correct, the annual rate of
increase for the first half of 1966 would be on the order of 4.5
per cent, which was not very different from the earlier rate.
Mr. Hickman agreed that the money supply often showed
sharp monthly changes.
However, its annual rate of increase over
the December-April period was about 8 per cent, which to him
appeared to be far above the desirable rate.
He would much prefer
a growth rate on the order of 4 or 5 per cent.
Mr. Partee commented that the 8 per cent rate was obtained
by including two periods of peak growth--December and March-April.
If one considered a longer time span the rate would be lessalthough, of course, it might still be considered too high.
Mr. Hersey then presented the following statement on the
balance of payments:
Before I go to my main subject, I might mention
the recent indications of activity of the large banks
5/10/66
-33-
in making foreign loans. As you know, we had a
resumption of short-term bank credit outflow in
March. Also, new commitments for term loans,
which had become very small in February, were
somewhat bigger in March and April, and this
increase in commitments was not in the high
priority category of credits for export
financing. These facts warn us against
assuming that present monetary policy will
necessarily generate further net reflows of
bank credit like those of January and February.
In what I say this morning I want to focus
on monetary policy in relation to the long-run
development of the balance of payments. The
long-run outlook for our balance of payments
is dimmer now than it was a year ago, in my
opinion, because of the gradually accelerating
rise in U.S. industrial prices.
The real news about the balance of payments
is that there is no really good news to report.
In the last three calendar quarters the
deficit has averaged nearly $2 billion annual
rate on the liquidity basis and about $1-1/2
billion on the official reserve transactions
basis. Although exports recovered in March
from their previous dip, the quarter-to-quarter
increase was not so great as the rise in imports.
The trade balance therefore shrank further: it
had been over $6-1/2 billion in 1964 and about
$5 billion in 1965, and it was down to $4-1/2
billion annual rate in the first quarter of
1966.
For many years we have been taking palliative
measures to help the balance of payments in the
short run, and these measures have made sense as
ways of gaining time while deeper adjustments
slowly got made. But thus far any evidence that
adequate adjustments are being made in international
competitive positions is scanty. If inflation is
now going to take hold in the United States, even
so mild an inflation as a 2 or 3 per cent rise a
year in the general price level might make nonsense
of our hopes of an adjustment.
5/10/66
-34In the past several years, the timing of most
of the main changes in open market policy has been
dictated by domestic considerations. The need for
price stability, for the sake of the balance of
payments, gave a steady tilt toward a greater
firmness of policy than might have seemed necessary
otherwise, but this did not call for frequent
changes of policy on the basis of external
developments.
This approach was absolutely right, so long as
the tilt in policy in favor of price stability was
strong enough. But I think we should ask now
whether the time has perhaps come to bring more
sharply into the foreground the long-run need for
price stability for the sake of the balance of
payments.
If we were concerned only with the domestic
situation, the range of defensible diagnoses and
prescriptions right now could be rather wide,
leaving wide scope for judgment. For example,
one position could embody four propositions as
follows. The objective of sustainable economic
growth is being undermined by too much bunching
of business investment in the short run. Excess
demand is leading to a spread of price inflation,
and there is danger that a self-reinforcing spiral
of wage and living cost escalation lies ahead. It
is urgent to deal with these threats by tighter
policies that would cut excess demand, because
expansionary pressures will continue to be strong.
In the absence of any tightening of fiscal policy,
monetary policy must move vigorously to put a
squeeze on the liquidity of the large banks, along
with the rest of the economy.
If we were concerned only with the domestic
situation, a case might be made for a very different
analysis, highlighting the following four points.
Much new productive capacity is being created this
year. Lags in the impact of fiscal or monetary
policy are long. Until we can see clearly what the
effects will have been of measures already taken,
monetary policy should proceed by cautious steps.
The American economic and political system can
tolerate a good deal of price and wage inflation,
so long as expansion is maintained.
-35
5/10/66
If this second view seems indefensible today, it is
because it gives no weight to the problem of external
equilibrium. Price inflation has very different meanings
for the domestic economy and for the balance of payments.
In the modern world there is no such thing as a rollback
of an inflated cost-and-price level. Domestically,
tolerable adjustments can be reached if and when enough
prices and incomes can be brought into line with each
other at the higher level. The process may be painful
and disruptive, but when it's over, it's over. Inter
nationally, we cannot rely on foreign inflations to
accelerate along with ours. Maladjustments, once created,
are very difficult to remedy. Every step we take upwards
on the price scale is so much lost ground.
Chairman Martin then invited Mr. Daane to comment on the
recent meeting of the Deputies of the Group of Ten,
Mr. Daane said that the meeting had been held in Washington
on April 19-22.
However, discussion actually began on Monday, April 18,
in a session involving four or five key Deputies, including Under
Secretary Deming, devoted to developing an outline for the Deputies'
report.
As the Committee would recall, the Deputies had been
charged with reporting back in late spring of this year, although it
now appeared that it might be early summer before a report could be
agreed upon.
The outline developed on Monday in effect served as the
agenda for the meeting on subsequent days of that week.
The first item, Mr. Daane continued, was the introduction to
the report.
A draft introduction had already been prepared by the
Canadian delegation which mainly quoted the original communique and
had little substantive content.
It was decided at the meeting to add
some substance, pointing up both the need to strengthen the stability
-36
5/10/66
of the existing international payments system and the inadequacy
of the supply of new gold for meeting the needs for secular growth
of reserves.
The second section of the outline was entitled "general
improvements in the international monetary system," Mr. Daane said,
and included items on the adjustment process and on multilateral
surveillance.
Nothing really new developed in connection with the
first item, but there was a clear thrust on the part of the Europeans
for putting more bite into the surveillance process.
They laid quite
a bit of stress on the need to go beyond the expression of judgments
to the application of those judgments to countries' policies, in
cluding the coordination of reserve policies.
The U.S. delegation
did not subscribe to that view, but the increased emphasis on multi
lateral surveillance by the Europeans--which was related to some
extent to the skeptical view they took regarding recent U.S. balance
of payments developments--was significant.
The System's short-term
credit facilities came up for discussion, and received general
approbation.
The report probably would note the usefulness of those
facilities and look forward to their fuller development, but no
specific recommendations regarding them were likely to be included.
The third section of the outline, Mr. Daane continued,
concerned future reserve creation.
The U.S. delegation stressed the
wisdom of going forward with contingency planning, emphasizing the
5/10/66
-37
inadequacy of gold and foreign exchange for meeting the needs for
secular growth in reserves.
The U.S. representatives also made the
obvious point that the report had to be positive on the score of
reserve creation in order to reassure the world that the international
monetary system could be made viable.
The French view, an isolated
one, was directly opposite; they held that there was no need at the
moment for contingency planning, and that the real need was for a
demonstration that the U.S. and Britain could solve their balance of
payments problems.
Such a demonstration was described as a precondition
before the French would be prepared to go into contingency planning.
However, they were willing to give analytical consideration to
individual elements of a contingency plan, if not to a complete plan.
The discussion then turned to the form of the new assets
envisaged, Mr. Daane said, covering new units, drawing rights, and a
dual approach.
The views of the Europeans seemed to be coalescing
around a dual approach involving a new unit for a limited group of
countries and automatic drawing rights for the rest of the world.
In
his press conference on Friday, Chairman Emminger referred to a dual
approach, but what he had in mind was quite different from the U.S.
proposal.
There was a general awareness at the meeting that all countries
had needs for reserves, Mr. Daane said.
those needs should be accommodated.
The real question was how
Another major issue was who would
activate any new arrangement, under what circumstances, and how.
-38
5/10/66
With respect to procedures, Mr. Daane remarked, it was agreed
that a draft report should be prepared by Chairman Emminger, and in
fact Mr. Emminger's draft had just been received.
It would serve as
the basis for discussion at the next meeting of the Deputies, to be
held in Rome on May 17-18.
That meeting, in turn, would be followed
by a session in the latter part of June, hopefully to put the report
in final form, and the report would be considered by the Ministers and
Governors of the Group in July.
Mr. Daane observed that Chairman Emminger was trying, with
U.S. support, to develop a report that had a positive emphasis.
There
was, indeed, a wide area of agreement, and the French were relatively
isolated.
Thus, it was agreed that a new unit ought to be a part of
any scheme developed; and that the needs of other countries had to
be taken into account in reserve asset creation.
But when one got
down to some important details, such as whether there should be a
rule of unanimity in the activation process, and whether the new asset
should be linked to gold, the questions were unresolved at this stage.
Mr. Daane noted that Mr. Robert Solomon of the Board's staff
had attended the meeting as a member of the U.S. delegation and might
want to add some observations.
Mr. Solomon commented that Mr. Daane had noted, quite rightly,
that almost everyone at the meeting looked toward some sort of dual
approach.
At the same time, there had been an IMF proposal put forth
5/10/66
-39
by Mr. Schweitzer that would, in effect, involve a unitary approach,
with a new unit created for all countries.
The new unit would come
into being as the second step in a two-step procedure, the first of
which involved automatic drawing rights.
There was some chance that
the IMF proposal would prove to be a compromise more acceptable than
any of the proposals on the table now, including that of the U.S.,
and it might turn out to be more satisfactory than the European
proposals for a new unit.
A new unit along the lines of the IMF
proposal could not be linked to gold.
Mr. Daane added that the IMF proposals, as such, had not
received extensive consideration thus far.
They had been presented
originally at the March meeting by Mr. Polak on behalf of Mr. Schweitzer,
but had not come under discussion.
Chairman Martin noted that copies of the IMF proposal had been
circulated to the Committee early in April.
He thought the members
also would be interested in a speech made by Mr. Schweitzer at Kronberg,
Germany, on April 25, and he asked the Secretary to arrange for
distribution of copies.
Mr. Daane remarked that today's Washington Post carried a
report on an extemporaneous talk made by Mr. Schweitzer in Mineapolis
yesterday which might also be distributed for the information of the
members.
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5/10/66
Mr. Ellis asked whether the Group of Ten Deputies were
planning to make a single report or whether separate majority and
minority positions would be set forth.
Mr. Daane replied that the Deputies had not yet arrived at
the point at which that issue was faced.
reach agreement.
They were working hard to
It was likely that the report would take a positive
stance, stressing the areas of agreement and noting the remaining
issues.
Chairman Martin then invited Mr. Hayes to comment on develop
ments at the latest meeting in Basle.
Mr. Hayes said the Basle meeting was not particularly
eventful.
The subject of international liquidity was on everyone's
mind but was hardly discussed; and what discussion there was indicated
that the situation was confused.
A sad atmosphere was created by Lord
Cromer's imminent retirement as Governor of the Bank of England.
A
farewell dinner was held for him, and everyone felt keenly the prospec
tive loss of a person who had battled for firm policies and was deeply
respected by all.
Lord Cromer felt sure that the new team at the
Bank of England would take as firm a line as he had, and he thought
there was some advantage in having a team that did not have a heritage
of dispute.
In the discussion of the U.K. situation, Mr. Hayes continued,
the Basle group seemed to be willing to give the British the benefit
5/10/66
-41
of the doubt on the probable effectiveness of the budget, although
they were puzzled by the new payroll tax, which was a technique strange
to all.
Lord Cromer himself thought it was quite a strong budget that
would have rather significant deflationary effects.
He went so far
as to say that the credit squeeze--which was considerable, since the
banks had reached the limits of loans they could make--might have some
undesirable consequences, and that there might be some disposition
toward selective relaxation--for example, in connection with export
credits.
However, there was no disposition toward a general relaxation.
Removal of the surcharges on imports in November undoubtedly would
tend to raise imports but by that time, it was thought, the new budget
measures would be having a strong bite.
Mr. Hayes went on to say the Germans had reported that their
credit restraint was working more and more strongly.
was impressed by the inflationary problem in Germany.
Dr. Blessing
He noted that,
although the Federal Government had its finances under control at the
moment, local governments were borrowing substantially and the capital
market was in bad shape.
The Federal Government had agreed to stay
out of the market for the rest of the year.
The Germans had a
considerable balance of payments deficit on both capital and current
account but the deficit probably would not continue as high over the
rest of the year.
Dr. Blessing regarded the deficit as an assist in
his restrictive policy, and he did not mind having it as a warning to
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the country that it had to get its policies under control.
He did not
object to the loss of reserves Germany was experiencing currently but
he did not want to see that loss continue indefinitely.
Dr. Blessing
also pointed out that higher interest rates in the U.S. and in the
Euro-dollar market had been a distinct help to Germany because they
had virtually checked German companies from borrowing abroad.
As to the French, Mr. Hayes said, their internal situation
was good--with little inflation--and their balance of payments was
highly favorable.
Both their imports and exports were up sharply,
and their trade balance was quite favorable this year.
As Mr. Coombs
had pointed out, the French showed no disposition to help by offsetting
their reserve accumulations.
He (Mr. Hayes) had taken the liberty of
asking Mr. Brunet if it was not time to eliminate the restrictions on
long-term foreign borrowing in France, and had received the interesting
answer that Mr. Brunet thought so, and perhaps the Minister himself,
but there were others who did not think so.
There was some undertone of concern about the U.S. balance
of payments at the meeting, Mr. Hayes remarked.
Some cynicism was
evident on the part of certain central bank governors about the
credibility of U.S. assurances, since statements that balance or
near balance in U.S. payments would be achieved soon were followed
by statements that balance did not seem to be in sight as yet.
5/10/66
-43Mr. Hayes concluded by noting that some progress was being
made on the negotiations for short-term credit assistance to the U.K.
to cover run-downs of sterling balances.
Although there still were
some open issues raised by a few parties to the negotiations he
believed that the remaining details would be worked out.
Mr. Coombs
might have something to report to the Committee on the subject at
the next meeting.
Chairman Martin then called for the go-around of comments
and views on economic conditions and monetary policy.
Mr. Hayes,
who began the go-around, made the following statement:
The economy is increasingly displaying the charac
teristics of a typical cyclical boom aggravated by the
influence of Vietnam developments. The data that have
become available in the meantime suggest a stronger outlook
than at the time of the last meeting. The business reports
continue to picture an economy operating under conditions
of sharply expanding demand and progressively greater
resource limitations. We begin to see signs of a wage
drift rooted in spreading labor shortages. At the same
time industry is operating at close to capacity. It
would be comforting if one could anticipate a rise in
capacity and productivity sufficient to meet growing
demands. As it is, rising demands, supported by a bank
credit expansion of hardly diminished strength, are
clearly adding to price and wage pressures. We may say
that the patient is already running a low fever, and there
is a very big risk that the fever will rise, even though
recent stock market developments may provide some of the
much-needed dampening influence.
This would be bad enough from a purely domestic point
of view. But I am increasingly impressed by the implications
of rising costs and prices for our balance of payments
prospects this year. I had an opportunity in Basle to
observe the effect on European central bankers of the
change on our domestic scene from an orderly but vigorous
5/10/66
-44-
expansion to an atmosphere where everything is straining
at the seams.
Frequent contacts with commercial bankers
and financial and business leaders of various countries
confirm the impression that this is going to be a critical
year for the dollar. There is no need to stress in this
group the importance of maintaining a fully competitive
position in world markets and to avoid excessive demand
pressures which tend to stimulate imports and to discourage
exports. After last fall's ringing assurances by the
highest authorities in the Administration that payments
equilibrium will be achieved in 1966, our entire inter
national bargaining position--and not only in the economic
sphere--will be seriously hurt if 1966 shows a deterioration.
New reports on the probable size of direct investment abroad
are discouraging. Unless we make strenuous efforts to
redress this unfavorable prospect, we may find ourselves
in an even worse position than a few years ago, when the
dollar was subject to grave suspicion abroad. This time,
with several years of additional deficits in back of us,
our leeway in the form of potential foreign credit to the
U.S. will be considerably more limited.
Under these circumstances, the need for restraint
is clear. The classic methods for exercising restraint
under present conditions involve fiscal and monetary
policy. The latter has, of course, moved quite a distance
since last November toward tighter restraint, but our
policy moves have not as yet put a sufficient damper on
inflationary pressures. April credit figures, which reflect
a number of special factors and thus are not necessarily
indicative of the underlying trend, suggest nevertheless
that the economy continues to be supplied with credit at
a rate considerably in excess of the possibilities for
expanding real output. Restraint takes some time to
affect the various parts of the financial structure. Gradual
tightening has already produced some retrenchment and
moderation, but also some anticipatory borrowing as well as
strains and stresses on financial markets. While we could,
and probably should, move somewhat further in the direction
of greater monetary restraint, I think that caution is
called for. With many key interest rates higher than
at any time in the postwar years, the risks of forcing
monetary policy to carry the burden alone are not
inconsiderable.
I would also stress that it is hard to
think of any further action on the monetary side that
could have an important immediate effect in dampening
5/10/66
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the inflationary atmosphere without undesirable and
perhaps somewhat unpredictable effects on financial
markets.
The obvious need is for a significant and prompt
assist in the form of greater fiscal restraint.
I
have been very much disappointed to observe the great
reluctance of the Administration, probably in large
part for political reasons, to embrace the widespread
I am glad that the
proposals for a tax increase.
Chairman made such a forthright statement a few days ago
on the need for a prompt and adequate tax increase. We
probably all agree that restraint on Government spending
must be part of any move on the fiscal side, but it seems
fairly clear that sufficient restraint on spending is
not so far in the making.
I feel that the conscious use
of fiscal policy to affect general business conditions
represents a big advance in public policy, but if this
new weapon is to be used effectively it must be resorted
to in both directions.
Meanwhile, as I have already indicated, we should be
doing what we can in the monetary area to restrain the
rate of bank credit expansion, by pressing a little harder
on the availability of bank reserves. This might, of
course, mean somewhat higher interest rate levels, although
some degree of further tightening may have already been
discounted by the market.
After an appropriate short interval following the
delivery of Treasury securities on May 16, we should aim
at somewhat deeper net borrowed reserves. Given recent
market gyrations, it is more than ever difficult to
pinpoint a level of net borrowed reserves that would avoid
a sharp rise in open market rates and consequent expectations
of an imminent increase in the discount rate. But I believe
that a figure centering around $350 million would be
appropriate, with borrowings around $700 million. The
Manager should be given enough leeway to make adjustments
if market pressures threaten to become too intense. Even
a moderate and orderly upward movement in rates is likely
to push the Federal funds rate occasionally to, or even
above, 5 per cent, as banks are forced to make fairly
substantial adjustments in their assets position, in
particular if loan demands continue strong even though
some demands for funds have been rechanneled into the
capital markets.
5/10/66
-46
While I realize that conditions might develop which
would lead us to consider a further discount rate action,
I do not feel that we have reached the point as yet.
Clearly, such an increase would raise the complex question
of the proper action with regard to Regulation Q ceilings.
In the meantime, the contemplated goal of open market
operations for the next policy period does not seem to
require any change in the directive, and I therefore
favor alternative B.
Mr. Francis said that total demand for goods and services
had been rising excessively.
Gross national product, in current
dollars, had risen at a 10 per cent annual rate since the third
quarter of last year compared with a 7 per cent rate in the previous
year.
With the economy operating at virtual capacity, growth in
real output had not kept pace.
Since the fourth quarter real GNP
had risen at a 6 per cent annual rate compared with an 8 per cent
rate in the previous quarter.
As a result, prices as measured by
the implicit price deflator rose at a 3.6 per cent rate in the most
recent quarter, double the rate of the previous quarter.
That was
the largest quarter-to-quarter increase in prices in many years.
The rise was probably understated since the standard price measures
did not take fully into consideration elimination of discounts and
deterioration of quality.
There were indications that prices would
have risen even more without the Presidential guidelines, which were
becoming increasingly difficult to maintain.
The contribution of monetary policy to total demand for
goods and services had continued to be very great, Mr. Francis said.
pending had been facilitated by a continued rapid flow of bank funds.
5/10/66
-47
Total commercial bank credit, which rose about 10 per cent in 1965,
had continued to expand at about that same rapid rate in early 1966.
Since the expansion in bank credit had exceeded the volume
of saving in the form of time deposits, demand deposits had continued
to rise at a very fast pace, Mr. Francis noted.
Demand deposits had
risen since early February and also since last November at more than
three times the average rate of increase since 1956.
The money
supply of the country, reflecting primarily the jump in demand deposits,
had risen at an 8 per cent annual rate since early February and since
last November, and at a 6 per cent rate since a year ago.
Money had
not risen so rapidly over any other twelve-month period in twenty
years; the next highest rate of growth for a year was 5.6 per cent
during the Korean War.
It seemed inappropriate to add to the stock
of money so rapidly at a time when total spending was excessive.
The great increases in bank credit and the cash balances of
the public might have been fostered by a strong demand for credit,
Mr. Francis noted.
Yet, he felt the System had to assume responsibility
for the banking system's rapid expansion, since member bank reserves
to support the growth had increased at an advanced rate.
Net System
purchases of securities had been a chief factor adding to reserves.
Since February the System had not offset gains of reserves from other
factors, particularly Treasury operations.
In short, for almost a
year it had been feeding the extraordinary demand for loan funds at
5/10/66
-48
a rapid rate by a policy of permitting only slightly firmer money
market conditions.
Not only had monetary actions been expansive but the fiscal
situation was now in the fourth quarter of the most stimulative
high employment budget of the past 13 years,
Mr. Francis continued.
The outlook was for continuation and possible intensification of
fiscal stimulation during the rest of the calendar year.
That was
a highly expansive policy when the need was for public policy
restraint on total demand.
He believed cuts in Government outlays
and/or an increase in taxes would be appropriate.
At the same time, irrespective of what might be done fiscally,
there seemed to Mr. Francis to be no justification for continuing
monetary expansion at extraordinarily high rates.
A necessary step
in cutting back on the excessive monetary demand for goods and
services was to reduce substantially the rates of increase of total
member bank reserves, of bank credit, and of the money supply.
The Committee could control the quantity of those magnitudes
by appropriate purchases or sales of Government securities, Mr. Francis
observed.
He believed it should pursue such a course, with only
secondary consideration given to other objectives such as day-to-day
money market stability.
Preoccupation with such other objectives for
the past ten months had let the Committee to substantial monetary
expansion that he interpreted the directive to have said it did not
5/10/66
-49
want, and the Committee had thereby continued to contribute to
excessive total demand.
The wording of the directive might have been partly
responsible for the unintended monetary expansion, Mr. Francis
remarked.
There had now been ten or eleven months when the directive
had continuously called for a moderation or restriction of expansion
in bank reserves, bank credit, and money, and at the same time had
called for only slightly firmer money market conditions.
Those
instructions had been inconsistent in the face of the unusually
strong demands for credit, and there had been very rapid increases
in bank reserves, bank credit, and the money supply.
Mr. Francis suggested that the directive now clearly state
that the primary objective of the Committee was to obtain a slower
rate of growth in member bank reserves, bank credit, and money.
To
attain those goals, the Committee should be willing to accept the
levels of short-term interest rates, net borrowed reserves, or other
money market conditions that were necessary.
It seemed strange to Mr. Francis that some analysts had
implied that monetary policy had done about all it could to resist
inflation when the banking system had been expanding at record rates.
Also, fears of financial panics or other disruptive consequences of
a further rise in interest rates seemed exaggerated in view of the
fact that rates in foreign countries had been much higher and on
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occasion had risen faster than U.S. rates without serious consequences.
Any resultant higher interest rates might be beneficial to the U.S.
balance of payments.
If the Committee should now achieve restriction of monetary
expansion, and if that should lead to excessive difficulty in
administering the discount window, the System could then consider
raising discount rates, Mr. Francis said.
Of the three alternative
directives submitted for consideration, alternative C seemed to fit
best his idea of what policy should be.
Mr. Patterson reported that evidence of tightening financial
conditions in the Sixth District seemed to be concentrated in the
mortgage market and at related financial institutions.
Since the
South was a net importer of mortgage funds, the effects of the changes
in the availability of funds in the national markets were quickly
transmitted to the Sixth District.
Earlier in the year the inflow
of new mortgage funds was practically cut off.
Now that flow seemed
to have been restored somewhat, partly because of the raising of the
contract rate ceiling on FHA and VA mortgages.
Nevertheless, so far
as he had been able to determine, no mortgage bankers were originating
loans without specific commitments.
The chief local source of
mortgage funds, savings and loan associations, had also been reduced.
Net new savings growth at savings and loan associations in the District
States was about 12 per cent lower through the first three months of
5/10/66
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1966 than in the corresponding period last year, and loan repayments
were down 7 to 8 per cent.
Unofficial figures for April indicated
a much deeper decline with the outstandings at some associations
down from the end of last year.
The slowdown in the inflow of funds to the savings and
loan associations reflected, of course, competition for time deposit
funds by the District's commercial banks, Mr. Patterson said.
In
the large cities advertising campaigns were being pursued vigorously,
and it was understood that more of the banks in the smaller cities
were entering the competition by posting higher rates on savings
certificates.
More of the expansion in business loans this year was
accounted for by loans to trade concerns and manufacturers of
nondurable goods than was the case last year, Mr. Patterson noted.
That development, together with the high rate of consumer spending
that characterized the first quarter of this year and the growth in
consumer loans, suggested that the consumer
might be exerting a
stronger influence on the demand for credit than formerly.
figures pointed to one conclusion.
Banking
They gave little evidence of
any slowdown in bank credit growth in response to a more restrictive
credit policy.
Behind those District financial developments was a continuing
high level of economic activity, Mr. Patterson continued.
With the
5/10/66
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insured unemployment rate in the District down to 1.8 per cent
and with the scarcity of skilled workers, however, manufacturers
might find it more difficult to increase their production in the
coming months in accordance with the usual seasonal pattern in the
District.
Despite the generally rosy tone of the statistics, Mr. Patterson
remarked, a few businessmen saw some difficulties ahead.
Such straws
in the wind had not assumed major proportions and were generally
confined to possible slowdowns at individual businesses or types of
business.
For the District the picture remained one of buoyancy,
with demands pressing on resources and available credit.
When it came to the national scene, Mr. Patterson saw nothing
to show that the description found in the first paragraph of the
directive adopted at the last meeting of the Committee no longer
held.
The domestic economy was still expanding vigorously, industrial
prices were continuing to creep upward, and credit demands remained
strong.
Thus, the policy of restricting the growth in the reserve
base, bank credit, and the money supply still seemed to be appropriate.
What bothered Mr. Patterson was that the Committee had not
been at all successful in restricting the growth of the reserve base,
bank credit, and the money supply, even though it had moved toward
larger net borrowed reserve figures.
In the meantime, borrowing had
increased substantially and the reserve base, bank credit, and the
5/10/66
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money supply had gone on expanding--indeed, at accelerated rates.
Total reserves, which rose at seasonally adjusted annual rates of
4.6 and 3.3 per cent in February and March, respectively, rose at
a 17.9 per cent rate in April.
Other reserve measures and the
money supply behaved in a similar fashion.
If the demand for credit continued strong and member banks
continued to go to the discount window as they had in recent weeks,
operating to produce a net borrowed reserve figure of aroung $300
million would do nothing to prevent an accelerated rate of expansion,
Mr. Patterson believed.
At the very least, the Committee should
operate so as to return to the rate of reserve expansion that
prevailed in early 1966.
That would, of course, imply a much
deeper net borrowed reserve position than that of the last few weeks.
He favored alternative B of the draft directives.
Mr. Bopp said that, with no let up in the pressures of demand
and with hopes for a tax increase slowly dwindling, it appeared to
him that decisions on monetary policy assumed even more critical
importance than in the recent past.
It was especially important for
current policy to try to ascertain insofar as possible the impact
of measures already taken.
Five months had now passed since the increase in the discount
rate, Mr. Bopp noted.
During that time, a progressive tightening of
marginal reserve availability had occurred and significant upwar
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pressures on
interest rates had developed.
Evidence had also been
seen of a change in bank attitudes toward lending, occasional
postponements of issues slated for the capital markets, and an
increasingly slim margin--indeed, in many cases a disappearance of
the margin--between commitments of life insurance companies and
inflows of lendable funds.
A significant tightening had also been seen in the home
mortgage market, Mr. Bopp continued.
A survey just completed at
the Philadelphia Reserve Bank of Third District mortgage lenders
showed a dramatic change recently in both the cost and availability
of money.
Mortgage rates had jumped from a January range of 5-1/4
5-3/4 per cent, depending on downpayment, to 6 per cent generally
for all conventional home mortgages.
On FHA and VA insured loans,
the average discount was now 3 points, and by mid-summer FHA
expected the average discount to be 4-1/2 points.
So far lenders
had not made changes in percentage downpayments for mortgages;
however, lenders were more critical of credit standings, ability to
pay, and other obligations.
Mr. Bopp commented that money tightened during 1966 primarily
because insurance companies and savings and loan associations had
less to lend for home financing.
Half of the savings and loan
associations contacted no longer accepted mortgage applications from
non-depositors.
Many of those had recently experienced net deposit
5/10/66
-55
outflows for the first time in memory.
The association officials
blamed the high rate of interest and the small denomination feature
of commercial bank CD's for their plight.
Insurance company funds for home mortgages were reduced in
early 1966, Mr. Bopp said.
Among surveyed companies, three large
institutions had bowed out of home mortgages since January.
None
of the insurance companies foresaw a return to the home mortgage
business in the next couple of years.
One large institution was
over-committed for industrial loans through 1968 and now accepted
applications for 1969 delivery only.
Another was committed into 1967.
Yet, Mr. Bopp observed, despite those various examples of
credit tightening, the fact remained that bank credit, bank reserves,
and the money supply had continued to grow at a rate in excess of that
desirable in the present business environment.
Of course, the
Committee did not really know all it should about the linkages and
lags of monetary action and it did not know precisely how far it
could go in cumulating tightness without undesirable effects on the
capital markets.
However, in his judgment, some gradual move toward
further restraint was desirable to curb the excessive flows of money
and credit.
If the Committee moved gradually now, it might be able
to avoid sharper action sometime in the future and thereby prevent
a rapid shift in the credit environment and in market sentiment that
could be particularly unsettling.
Additional restraint should be
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imposed gradually and in a probing fashion.
He favored alternative B
of the draft directives.
Mr. Hickman observed that the latest information on the
business situation showed that excess demand continued in all major
sectors of the economy:
business, government, and consumer.
So
long as demand pressed on capacity, prices would continue to rise.
The latest rise in industrial prices between mid-March and mid-April
was simply another illustration of fundamental imbalances that now
existed in supply-demand relationships.
Despite widespread evidence of overheating, Mr. Hickman said,
several straws in the wind suggested some possible cooling off of
the situation, as Mr. Koch had indicated.
Painful as they were to
some, the weaker stock market and some slackening of auto sales and
output were highly desirable under present circumstances.
A serious
weakening of auto demand would have a retarding influence on steel
output--which, incidentally, showed no increase in April on a
seasonally adjusted basis, for the first time in many months.
If
defense spending leveled off, if capital spending moderated, and if
Congress held the line on nondefense spending, it might be that the
Committee would find in retrospect that the economy had already passed
the inflationary crest.
But he had been disappointed on that score
many times before; the weight of the evidence at the moment still
pointed to inflationary overheating.
5/10/66
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In that situation, and in view of the weakening U.S. balance
of payments situation, Mr. Hickman felt monetary policy should move
further toward restraint.
Since higher income taxes seemed unlikely
in the foreseeable future--whatever might be their economic logicmonetary policy had to fill the void.
In so doing, the Committee
should be willing to go as far as was needed to eliminate excess
demand and price inflation.
Unfortunately, the Committee had not
been too successful since the date of the last discount rate increase.
The rates of expansion of bank reserves, bank credit, and the money
supply that occurred in December and again in April were simply too
high to be tolerated.
The problem, as Mr. Hickman saw it, was that the Committee
had been paying too much attention to net borrowed reserves and
money market conditions, and not enough to aggregate reserve measures.
An attempt to maintain limited variations in net borrowed reserves
and interest rates had resulted in undue expansion in all key monetary
variables.
Given what was known about the relationship between money
and prices--which, despite the Chicago school, was far too little--it
would seem appropriate at this time to allow total reserves to expand
with real output at an annual rate of no more than about 5 per cent,
rather than the 8 per cent annual rate of increase that had occurred
since January or the 17.5 per cent increase of April.
5/10/66
-58
Mr. Hickman recommended that in the weeks ahead the Committee
try to hold the rate of increase in total reserves to 5 per cent or
less, even if that should mean further deepening of net borrowed
reserves to the $500 million or $600 million levels.
On the other
hand, the Board's staff suggested during last Friday's telephone
hookup, in which he participated, that roughly the desiredrate of
reserve growth might be achieved in May with net borrowed reserves
around the $300 million level.
In any event, the Committee should
seek to moderate reserve growth rather than to stabilize net borrowed
reserves.
The course of action he preferred seemed to be best
expressed in alternative C proposed by the staff, although he would
not vote against alternative B if that was the consensus of the
Committee.
The situation was so serious that he would forget the
current Treasury financing, and would get on with the main job of
trying to check price inflation.
Mr. Brimmer remarked that he would not comment extensively on
the strength of the current economic situation, which already had been
discussed at some length.
He would say, however, that he hoped the
Committee would not over-react to any dissatisfaction with the rate
at which it was exerting restraint.
He certainly would not want to see
the Committee attempt to make up now for whatever deficiencies there
may have been in its recent operations.
Mr. Brimmer shared the concern of Messrs. Hayes and Hersey
about the balance of payments situation.
Those working with the
5/10/66
-59
Cabinet committee on the balance of payments were extremely disappointed
by recent developments, and saw nothing in the policy tool kit that
would lead to much improvement over the rest of 1966.
If anything,
the situation had deteriorated in the last few weeks; as the evidence
came in, it looked as though the 1966 deficit might well be closer
to $2 billion than to $1-1/2 billion, although the figure could not
be pinned down firmly as yet.
The results of the voluntary restraint program by the business
community were particularly disappointing, Mr. Brimmer continued.
It
had been anticipated that the program, which began in 1965, would
result in a saving of $1 billion in 1966 in direct investments abroad.
While a clear reading was still not possible, it appeared that corporations
had saved substantial parts of their two-year quotas in 1965, and that
if they used their remaining quotas in 1966 the net gains through that
part of the voluntary restraint program would be disappointing.
The
results of the voluntary restraint program of banks warranted some
optimism, although, as Mr. Hersey had indicated, there were reasons
for not being overly-optimistic in that area.
However, he remained
rather optimistic about bank flows because he felt that the domestic
pressures on banks would hold down their outflows over the rest of
the year.
Other parts of the Government's present program did not
appear particularly powerful, although the Cabinet committee was
continuing to work on the problem and might well come up with some
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effective proposals.
In general, it was important that sight not
be lost of the developing seriousness of the situation.
With respect to credit policy and the directive, Mr. Brimmer
thought the Committee should not be insensitive to the conditions
now prevailing in financial markets.
He agreed that the condition
of markets should not be made a primary objective, but it was
necessary to recognize that--even aside from developments in the
stock market--the pressures on some financial institutions were
already severe.
The Committee should not overlook the parade of
agency issues that already was taxing the market and would tax it
further.
Those issues might well be disorderly as well as sizable.
Moreover, the Committee should remain sensitive to the situation of
Government security dealers who, after all, were an essential element
in the process of open market operations.
Personally, he would not
favor instructing the Manager to dump a large amount of securities
into the market, because it might be well beyond the capacity of the
dealers to absorb them.
The Committee members all had a sense of
history, and while it would not be desirable to be overly-concerned
with the possibility of a financial panic the members should remain
alert to the extremely sensitive situation in some markets.
Mr. Brimmer agreed that the Committee should proceed further
with tightening.
He was willing to suggest a net borrowed reserves
objective to the Manager, on the understanding that it would not be
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viewed as a rigid target for operations.
While there was no way
of knowing whether a net borrowed reserve figure of $350 million
would lead to a sufficient degree of restraint, it might be a
good proxy and he suggested that it be kept in mind.
Member bank
borrowings might well rise to $750 million or $1 billion.
He
thought the Manager should press ahead with those figures in mind,
on the assumption that the current Treasury financing was just
about completed.
Mr. Maisel agreed with previous speakers that the
Committee had to carefully examine its record for the past five
months.
It should decide whether it was or was not satisfied
with the manner in which it had shaped its open market operations
The question the Committee had to answer, Mr. Maisel said,
was how close its actual operations had come to meeting its over
all policy objectives.
He was not questioning the manner in
which the Desk had carried out its instructions.
He was concerned
with the sub-goals the Committee seemed to have adopted because
of a failure to specify its goals more completely; with the manner
in which the Committee had instructed the Desk; and with the
results of its actions.
credit growth.
In December the Committee chose to restrict
Since January 11, 1966, its policy directive at
each meeting had called either for moderating, maintaining low,
or restricting growth in the reserve base, bank credit, and money
supply.
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What had the facts been?
itself?
Had the Committee been kidding
In place of moderate or restricted growth, each monetary
or credit index showed a much sharper growth rate in the past five
months than it had in the previous five.
With the exception of
future mortgage funds, interest rates--which were not included in
the Committee's directive--were the major items that were tighter
and those, it was recognized, were a function of market expectations
even more than of the Committee's own action.
He disagreed rather
completely with Mr. Partee's analysis and he agreed with the
previous speakers.
The Committee had to differentiate between
moves caused by shifts in demand and those it allowed, or caused,
in supply.
It was not an answer to the claim that the Committee
alloweda very rapid credit expansion to say it rose only 70 or
90 per cent as fast as banks and businesses wanted it to expand.
He believed Mr. Partee's analysis led to a complete abdication of
the System's role in determining monetary policy.
Such analyses
and stress on marginal rather than total reserves led to the
conclusion that if businesses wanted loans and if banks wanted to
lend, the Committee had to go along with their desires.
Mr. Maisel said he hardly thought that the Committee
could conclude that it had done much toward combatting inflation
during the past five months.
Au contraire, when members looked
at total reserves or nonborrowed reserves, either of which he took
to be the principal measure of the Committee's actions, they must
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all be appalled at the Committee's results.
He found it difficult
to believe the figures but, if he read them correctly, in the five
months since December 1 the Committee had poured more reserves
into the banking system than were furnished in the entire previous
year.
In fact, if the figures were correct, since December 1 the
total increase in reserves had been larger than in any full year
since 1951.
The growth in the money supply, bank credit, and
business loans had been equally large.
In Mr. Maisel's view, those results did not accord with
either the Committee's intent, its statements, or sound policy.
While all members recognized that there might be a considerable
lag between changes in money and credit and changes in the world
of production and prices, the Committee had stressed that monetary
policy was flexible and therefore was able to move at least the
monetary variables in a fairly rapid manner.
seem to be the case.
Now that did not
The fifth month after the System's policy
change saw the largest growth of any in most of the money and credit
variables.
The Committee apparently had followed sub-goals such
as feel of the market, net reserves, or the need to offset shocks,
and as a result it had moved in a direction opposite to its real
policy aim.
Mr. Maisel believed that if the reserve picture were not
turned around at once, the point might well have been passed where
it made sense to talk of and use monetary policy as a method of
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restraining demand.
The System might well have generated all of
the costs of a publicized policy shift without gaining any of the
benefits expected from such a change in policy.
Since more than
a record year's supply of reserves had already been furnished, it
seemed clear to him that it was no longer sufficient to talk about
moderating growth.
The Committee should press for a reduction in
total reserve availability on a seasonally adjusted basis, even
if that meant a very sharp increase in net borrowed reserves.
would support alternative C for the directive.
He
If there was suffi
cient sentiment around the table, and there seemed to be, he would
be willing to try to redraft it in a considerably more emphatic
form and with stress on total reserves rather than with the present
emphasis on the marginal measures.
At the same time, Mr. Maisel urged again that the Committee
give more information to the market.
Since any real effort to
correct the present situation was going to have to be made obvious
to all, he thought that the use of a change in reserve requirements,
with its resultant publicity, might be a simpler and more certain
procedure than searching again for a level of net borrowed reserves
that would bring the Committee to its ultimate goal.
However, if
there was no agreement on a change in the reserve ratio, he thought
it should be made clear by official statements that the Committee
was trying to restrain credit through open market operations and
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that it did not think that either a change in the discount rate
or in Regulation Q need accompany such a decrease in reserves.
He did not think the Committee should feel constrained, as he
thought the Manager indicated it had been, to furnish reserves
because the market might misinterpret the published free reserve
figures in any week.
The Committee ought to improve its
communications instead.
Mr. Daane said he agreed essentially with the positions
of Messrs. Hayes and Brimmer and would not take the time to repeat
their analyses.
He thought the domestic economy was still over
heating, and he was perhaps even more pessimistic than Mr. Hersey
and Mr. Brimmer regarding the outlook for the balance of payments
this year.
He remained hopeful that fiscal policy action would
be taken, and he shared Mr. Brimmer's concern about the sensitive
state of financial markets and the implications of some existing
rate relationships.
He favored alternative B for the directive,
reminding the Committee that the Treasury had just completed an
unsuccessful financing that had yet to be digested.
Mr. Mitchell commented that for the most part he shared
the concern others had expressed in the discussion today and agreed
that it was important for the Committee to get control over the
rate of monetary expansion.
He did think, however, that the
Committee had accomplished a little more than had been acknowledged.
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There was a little evidence that the economy was getting some
tranquilization, and that was due partly to the efforts of the
System.
The psychological environment was much better at present
than it had been in February or at the end of January, and it
would be helpful to the Committee's objectives if the present
tone continued in the stock market and if additional auto companies
cut back their production schedules.
Mr. Mitchell still thought it might be possible to achieve
the necessary degree of restraint without a change in the discount
rate, but if a discount rate increase was required he would be
agreeable to it.
However, he was not in favor of any action that
would result in increasing the Regulation
Q ceilings.
The System's
policy actions had already put so much pressure on the housing
industry that it was writhing in anticipation of a serious cut
back later this year, and it would not be desirable to put additional
pressure on that sector at present.
As to the directive, Mr. Mitchell said, the modest steps
implied in both alternatives B and C seemed consistent with the
present discount rate.
Of the two, he preferred alternative C.
However, if he were to put his preferences in his own language
they would be, first, to keep bank lending conditions firm--to
discourage backsliding in the tight policies at many banks, and
to encourage the spread of such policies to other banks.
Secondly,
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he thought that growth in bank credit and the money supply as
projected by the staff was larger than desirable, and that another
bulge such as occurred in March-April should be avoided.
He was
sympathetic to the staff's view that the seasonal adjustments were
inadequate, and he thought Mr. Maisel might be interpreting the
figures too literally.
Nevertheless, he would make a slowing of
money supply and bank credit growth in the next few months the
overriding consideration.
He was uncertain about the level of net
borrowed reserves that would be consistent with that objective;
it might be $350 million, but if a deeper figure was required he
would not be concerned.
Nor would he be worried about the
of the Federal funds rate.
level
If banks were willing to pay 5-1/2 per
cent for deposits they would not balk at paying even more, if
necessary, for Federal funds.
It seemed to Mr. Mitchell that a good deal of what had
been accomplished in restraining bank credit growth had been the
result of discount window administration, and he thought the
System's discount officers should be congratulated on their work.
The informal talks that the Reserve Bank Presidents had held with
bankers also were helpful.
Hopefully, by these means the System
might at least temporarily keep a considerable degree of restraint
on banks of a type that might not even show up in the banking
statistics.
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In Mr. Mitchell's judgment the present was an extremely
critical period.
The economy might be at or near a turning point,
and it was quite likely that there would be developments soon
that would make a change in the Committee's policy desirable.
For
that reason he wondered whether the Committee should not consider
scheduling another meeting in Washington in two weeks.
Telephone
conference meetings were useful when some narrow action required
consideration, but they were not very satisfactory for purposes
of more general deliberation.
In concluding, Mr. Mitchell noted that he favored as firm
a policy as possible at present without a change in the discount
rate.
Mr. Shepardson said he also thought it unnecessary to
repeat views that had already been expressed.
He was particularly
impressed--and concerned--with the point made by Mr. Hersey and
implied by Mr. Koch that when ground was lost with respect to
prices and wage rates the situation might be irreversible.
Food
price increases ordinarily were reversible, since the country's
agricultural capacity was large and production could be expanded
rapidly.
Rises in food prices thus were not critical except as
they contributed to the cost of living and the latter was one of
the bases on which wage rates were determined.
But increases in
industrial prices were not as easily reversible; and, accordingly,
they should be prevented if possible.
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Also, Mr. Shepardson continued, like others he was
concerned that despite the Committee's statement in successive
directives that its policy was to restrict growth in reserves,
bank credit, and the money supply, the increases in all three
continued to be greater than desirable.
In his judgment the
Committee should be watching total reserve availability, which
was rising too rapidly.
Mr. Shepardson favored alternative C of the draft
directives.
He noted that Mr. Maisel had mentioned the possibility
of modifying the language of the draft.
He (Mr. Shepardson) would
replace the phrase "with a view to attaining some further gradual
reduction in net reserve availability," with the phrase, "with a
view to attaining a reduction in reserve availability."
The
staff's language implied that some reduction already had occurred
in reserve availability, and he did not think that was the case.
Mr. Wayne reported that business continued to show
considerable vigor in the Fifth District although there was some
evidence in the Reserve Bank's latest survey and in the statistical
record that the rate of advance might have slowed somewhat.
Declining
growth rates, for instance, appeared in both nonfarm employment and
factory man-hours in the two most recent months for which figures
were available.
The survey showed further increases in manufacturers'
new and unfilled orders, but fewer respondents reported gains than
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in surveys taken one and two months earlier.
Reports of higher
wages and prices, however, were more numerous than before.
Regarding general expectations, Mr. Wayne continued, the
survey showed some diminution of optimism among bankers but not
among businessmen.
Materials shortages had been reported with
increasing frequency by manufacturers and contractors, while
shortages of skilled labor had become an acute problem for some
of the District's principal industries.
Textile producers cited
their difficulties in retaining experienced workers, along with
low existing pay scales, as evidence that the 3.2 per cent wage
guidepost had questionable validity in their case.
Certain wage
increases to textile workers were mentioned in the press over the
past weekend.
He expected that that movement would spread through
out the industry rather quickly and that, including fringe benefits,
the effective increase would be nearer 5 per cent than 3.2 per
cent.
Furniture manufacturers reported that hardwood shortages
were forcing use of substitute materials to maintain production.
The evidence, briefly, suggested that output growth was being
slowed by resources limitations.
As for the national economy, Mr. Wayne said, fairly complete
statistics seemed to bear out the widely held impression that the
first-quarter rate of advance was not sustainable and that its
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persistence even into the near-term future would confront the
economy with serious overemployment problems.
It was disturbing to Mr. Wayne to consider the preliminary
figures on aggregate reserves and reserve related measures for
April.
According to those preliminary figures, the growth of
reserves, bank credit, and money, after allowance for seasonal
factors, was of the order of the unusual expansion that occurred
last December.
He was aware of the problems of seasonal
corrections in those data and he would not like to make too much
of a single month's figures.
Yet it might be appropriate to note
that such rates were hardly compatible with a declared policy of
restraint.
With respect to current policy, Mr. Wayne saw little
reason to interpret the fragmentary April figures as a reason for
any relaxation in restraint.
About one-third of the first-quarter
increase in GNP was attributable to higher prices, and pressures
of such a magnitude would not be quickly dissipated.
Moreover,
the prospect of any contribution toward restraint from fiscal
policy struck him as distinctly dimmer now than it was a month ago.
On the other hand, he would be eager to avoid stepping on the brakes
too hard.
He could readily agree that it was necessary to keep the
market under pressure and to hold reserve availability in check.
5/10/66
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Yet he wondered about the meaningfulness of free reserves and
market tone targets in the present booming business environment.
It seemed to Mr. Wayne that the present situation required
that the Committee take whatever action might be necessary to
keep the rate of growth of total reserves, credit, and money at
considerably more moderate levels than those prevailing last month.
In February and March the Committee succeeded in tightening, both
in terms of the marginal and of the aggregate measures, and those
tightening moves were wholesome.
He had a suspicion that April
might have unraveled some of the Committee's work, primarily
because of basic weaknesses in its policy criteria.
He believed
the Committee would be on firmer grounds if it observed the
movement of required reserves more closely and accepted a
relatively higher level of net borrowed reserves if required
reserves moved up more rapidly than normal for this time of year.
The approach suggested recently by Mr. Robertson appeared
particularly appropriate in the weeks ahead, Mr. Wayne said.
He
would be prepared to accept the risks of higher rates that such
a course might involve.
He emphasized, however, that he did not
refer to higher ceilings under Regulation Q for he feared that
some banks, including the money market banks, had failed to show
due prudence in shaping their current policies.
As to the directive, alternative C with the amendment
proposed by Mr. Shepardson appeared preferable to Mr. Wayne.
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Mr. Clay reported that business activity in the Tenth
Federal Reserve District was continuing to expand at a rapid rate.
Employment was growing, unemployment was low, and skilled labor
was very scarce.
Employment growth was particularly strong in
defense-oriented industries, such as aircraft, ordnance, and
explosives.
Agriculture was providing a substantial impetus to income
growth in the Tenth District, Mr. Clay said.
Cash receipts from
farm marketings continued well above year-ago levels, and the
District increase was much greater than for the country as a
whole.
Agricultural prospects for the current year in the District
continued distinctly favorable, despite the possibility that the
wheat crop might have suffered severe freeze damage in southcentral
and southwestern Kansas, northwestern Oklahoma, and southeastern
Colorado.
In the commercial banking field, Mr. Clay continued, both
loans and investments at District weekly reporting banks declined
more during the first 4 months of this year than in 1965.
Deposit
experience had been stronger, with demand deposits down only about
half the seasonal decline shown in 1965 but with time deposits
rising more slowly.
At the same time, however, member bank
borrowing had been in larger volume than last year, and reporting
banks had been net purchasers of Federal funds more regularly.
5/10/66
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On the national scene, despite recent developments in the
auto industry and the stock market, the resource-price squeeze
appeared to intensify rather than lessen, and the price inflation
problem was becoming more severe.
Accordingly, Mr. Clay felt that
further restraint was needed on the growing aggregate demand for
goods and services.
desirable.
Additional fiscal restraint would be highly
In fact, that was the action that should be taken, but
that could not be done by the Federal Reserve.
Within the limits
permitted by the maintenance of the present Federal Reserve discount
rate, the Federal Reserve should continue to apply pressure on the
commercial banking system and the financial markets in line with
the current directive's provision for "restricting the growth in
the reserve base, bank credit, and the money supply."
Unless economic pressures did lessen, it appeared highly
doubtful to Mr. Clay that a combination of such a monetary policy
and current fiscal policy would provide the necessary restraint
on inflationary pressures.
Unless additional fiscal policy action
was taken, the Federal Reserve System would probably face the very
difficult decision as to whether credit restraint should be
increased substantially further--balancing the need for restraint
on the growth in aggregate demand for goods and services against
the repercussions on the financial structure from substantial credit
tightening from present interest rate levels.
5/10/66
-75The draft economic policy directive with alternative C
for the second paragraph appeared satisfactory to Mr. Clay for
the period immediately ahead.
Mr. Scanlon remarked that, despite some reassuring signs
that the excessive growth of demand might be moderating somewhat in
some sectors, the evidence, over-all, indicated that inflationary
pressures remained dominant and should be subjected to somewhat
greater restraint.
Order backlogs continued to rise.
Most
businesses continued to report that they were paying higher prices
and receiving slower deliveries.
Labor stringencies were reported
from almost all Seventh District centers, large and small.
Virtually
all consumer goods remained in good supply and retail markets
appreared to be competitive although merchants reported that orders
for replacement stock often were at somewhat higher prices and had
to be placed with longer lead time.
Construction projects continued to utilize available
resources fully, Mr. Scanlon said.
In the first quarter, construction
contracts in the Midwest were up 32 per cent from last year, compared
with an 11 per cent rise for the U.S.
All major categories of
construction in the area, except public buildings, showed gains
ranging upward from 14 per cent.
Mr. Scanlon noted that farmers were buying machinery and
equipment at a rapid pace, well above that expected by most
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manufacturers.
Farm land values in the District showed a larger
increase in the first quarter than in any quarter of recent years.
Good farm land was now up about 10 per cent over a year ago, with
increases reported for all District States.
The growth of total loans appeared to Mr. Scanlon to have
slowed in April at District banks, especially at the largest banks
in Chicago and Detroit.
At most other banks expansion continued
at a fairly rapid pace.
Some net repayment of business loans at
the large banks was in keeping with the usual seasonal pattern.
It might reflect a more restrained lending posture on the part of
those banks, but repayment of bank loans by firms that had recently
raised funds in the capital market was also a factor.
All things
considered, the evidence did not suggest any easing of over-all
demands for funds.
Reserve positions of the major Chicago banks had shown
marked improvement over the past month reflecting both loan
reduction and deposit inflows, Mr. Scanlon observed.
In late April
both the number of banks and the amount of borrowing at the discount
window declined, but that now appeared to have been temporary.
The
figures on reserves, money, and credit for April all indicated a
substantial rise in the rate of expansion compared with either
March or the first quarter as a whole.
Part of that rise could be
attributed to temporary factors, seasonal adjustment difficulties,
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and reduction of Treasury deposits to an abnormally low level, as
Mr. Partee had pointed out.
Nevertheless, in his (Mr. Scanlon's)
judgment, under current conditions of resource utilization, recent
rates of expansion in money and credit were clearly too high and
should be reduced.
The recent period illustrated strikingly, Mr. Scanlon said,
that tighter conditions in the money market had not been sufficient
to avoid a sharp acceleration in monetary growth.
Nonborrowed
reserves had been supplied at a rapid rate and increased borrowings
had added further to reserve aggregates.
While some short-term
money rates had increased, other yields were still well below
early-March levels.
It seemed clear that if the Committee was
serious about slowing money and credit expansion to rates more
consistent with the growth of physical capacity to produce goods
and services, and, hence, with stable prices, and given a continua
tion of strong credit demands, it would be necessary to cut back
much more sharply on reserves provided through open market operations.
Such action probably would push interest rates up further and increase
borrowing pressure at the discount window, and it might well
necessitate another discount rate increase.
In Mr. Scanlon's view the large reserve expansion in March
and April resulted in part from the Committee's inability to foresee
the strength of credit demand and continued heavy reliance on free
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reserves and interest rates in setting policy goals and formulating
directives.
Viewed in retrospect, Committee policy might have
been better if total reserves or possibly some other aggregative
reserve measure had been given priority in policy guides and
directives.
He believed the growth rate of total reserves should
be cut back to a rate no greater than, say, 3 per cent, so long as
the economy continued to operate with fairly clear evidence of an
inflationary gap.
As to the directive, Mr. Scanlon was not entirely clear on
the reasons for the use of the term "net reserve availability" in
alternative C and "reserve availability" in alternative B.
But he
believed alternative C as amended by Mr. Shepardson came closest
to the policy he would like to see adopted.
While he would like to avoid an increase in the discount
rate, Mr. Scanlon would not resist such a move at any time it was
evident that the administration of the discount window was being
seriously complicated by the low rate.
Mr. Galusha commented there was little if anything that
needed saying this morning about economic conditions in the Ninth
District.
The District economy continued to grow very much in
the pattern of the national economy.
Recently a few reports had
been received of a rather sharp slowdown during April in the rate
of growth of retail sales.
But he could not at this time be sure
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how general the slowdown was and, in any event, he would not want
to read too much significance into it--any more than he would
want to read too much significance into the much publicized
temporary layoff by General Motors.
The business community was
becoming apprehensive about the pending minimum wage proposals,
which would have a significant impact on wage structures in the
Ninth District.
If there was a problem in the Ninth District, Mr. Galusha
said, it was in the continuing unhappiness of the country bankersan unhappiness which not infrequently found expression in notifica
tion of withdrawal from the System.
The situation was not a good
one and he would urge again that the Board give further consideration
to a reserve requirement "break" for small banks.
It might be, as
he had pointed out at the previous meeting of the Committee, that
now would be a good time to announce an increase in the average
reserve requirement and, in the same breath, a change in the
structure of reserve requirements.
With what might be parochial concern, Mr. Galusha continued,
he was very pleased to see the Board, in its Annual Report,
reiterate its desire for a reserve requirement structure based on
bank size and ask for the power to set reserve requirements for
all insured banks.
be solved.
Possibly that was the way the problem should
Still, some interim relief for small banks would be
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most helpful.
In passing, he would also compliment the Board on
its statement--again, in its Annual Report--on non-par banking.
Would that it had the desired effect, for that was not the least
of the obstacles to the millenium Mr. Mitchell had described in
recent public statements.
It was in part the problem of small banks, mutual savings
banks, and the politically powerful influential savings and loan
associations that made Mr. Galusha think now was a time for
proceeding cautiously in the direction of further monetary
restraint.
Of course, there were additional reasons, domestic
and international--most of which had been mentioned in Committee
meetings at one time or another--for believing that the overly
exuberant economy would be better checked by a tax increase than
by further monetary restraint.
That, it seemed to him, was
ultimately why the Committee should go slowly now.
A dramatic
move toward great restraint--involving increases in discount rates
and Regulation Q ceilings--could sharply reduce the likelihood of
a tax increase.
There might still, though, be room for increase in interest
rates and in the rationing of credit, Mr. Galusha remarked.
There
were indications in the Ninth District, at least, that System
policies were biting deeper.
Curtailment of the Minneapolis Reserve
Bank's discount window had forced the big banks into paying rates
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for funds in the 5 per cent area, and that in turn had a spill
over to their lending policies--there were indications that they
were making efforts to ration credit.
Mr. Galusha believed the Committee's goal, specifically,
should be a modest increase in open market interest rates over
the coming four weeks.
Possibly that could be achieved without a
further increase in net borrowed reserves; but if not, then, in
his opinion, the Desk's target ought to be on the other side of
$300 million.
Perhaps the $350 million figure mentioned by
Mr. Hayes was appropriate.
In sum, Mr. Galusha felt this was a time for applying
gradual further restraint.
"gradual."
And he would underscore the word
Accordingly, he favored alternative B of the draft
directives.
Mr. Swan reported that employment in the Twelfth District
rose further in March, although at a slightly lower rate than in
January and February.
Unemployment edged down one-tenth of a
percentage point to 4.5 per cent.
Aerospace companies again
added substantially to the number of their employees.
In lumber
markets, which had been under considerable pressure recently, new
orders declined in April but with substantial order backlogs prices
held firm.
problems.
Residential construction, however, posed substantial
Housing starts were up slightly in March but great
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concern was being expressed by builders and lenders about shortages
of funds and rapidly rising interest rates, resulting from competing
demands and the reduced availability of funds from savings and loan
associations.
In the four weeks ending April 27, Mr. Swan said, District
weekly reporting banks expanded their outstanding credit sharplyat a much higher rate than in the same period last year.
That
expansion was based on a very substantial increase in both demand
and time deposits.
The time deposit increase was due to a rise in
public deposits; the decline in savings deposits was greater than
the rise in other time deposits of individuals, partnerships, and
corporations.
As a result of the rise in total deposits, District
banks remained in a relatively easy reserve position during April
despite the increase in bank credit.
Banks maintained or increased
their net sales of Federal funds and did not borrow substantially
from the Reserve Bank.
However, that situation might be changing;
in early May Federal funds sales were down somewhat in the District
and there had been a slight increase in borrowings at the discount
window.
As to the national situation, Mr. Swan said he had little
to add to the comments already made regarding the strength in
demand and the price pressures existing.
In terms of policy, he
had felt that the February and March results were not at all
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unsatisfactory, given the unusual situation in January following
the discount rate increase.
As some others,however, he was
disturbed--and somewhat confused--by the April developments.
He
had to say that the discussion this morning had not lessened his
confusion, and he was at a loss as to how to interpret those
developments.
Consequently, he drew some hope from the conclusion
in the blue book that more gradual rates of growth in bank credit
and deposits were likely in May if pressures on banks continued
about as at present.
He joined those who would like to see some
further gradual deepening in net borrowed reserves, perhaps to
the $350 million level, with some recognition at the same time of
developments with respect to total reserves.
He favored alternative C
of the draft directives, both because he thought it was appropriate
in terms of the current situation and because, as a matter of
principle, he thought some account should be taken of total reserves
in the second paragraph of the directive.
He would prefer the
version of alternative C proposed by the staff rather than as
amended by Mr. Shepardson.
Mr. Swan said he would not favor an increase in the discount
rate, if one could be avoided, until it was clear that the action
was following rather than leading market developments.
But he was
not as sanguine as some about the possibility of maintaining the
existing discount rate, given the current levels of the Federal
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funds rate.
Sooner or later high Federal funds rates were likely
to lead to pressures at the discount window that would require the
System to raise the discount rate.
Mr. Irons commented that conditions in the Eleventh District
were somewhat typical of national conditions, with strength apparent
throughout the economy.
Such major indexes as employment, production,
construction, department stores sales, and new car sales were
continuing to move up more or less steadily or were maintaining
high levels.
The employment situation remained tight, with a very
strong demand for labor by the electronic and defense industries.
The most recent data for residential construction showed a little
improvement, but whether that would be lasting or not remained to
be seen; the District had the same problems in the mortgage area
that were being reflected in other parts of the country.
During the past few weeks, Mr. Irons continued, there had
been growing evidence of some firmness at District banks, similar
to the national situation.
Borrowing from the Reserve Bank tended
to increase from time to time, depending on conditions in the
Federal funds market.
Recent city bank borrowing usually was in
the $6-$8 million range and country bank borrowing in the $6-$9
million range, but the total would go up to $50 or $55 million
when some large city banks came in for a day or so.
It was
reasonable to assume that there would be continued pressure placed
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on the discount window by the larger banks if conditions in the
market firmed and the Federal funds rate rose further.
The
larger banks in the District had been net purchasers of Federal
funds recently, with their average weekly purchases running about
$800 to $850 million, and their sales about $200 to $250 million.
Demand deposits and time and savings deposits had both
increased during the past three or four weeks, Mr. Irons noted.
There was a net decline in savings deposits about equal to the
increase in time deposits, possibly indicating a shift of funds
into CD's.
Despite the fact that bank credit was increasing,
bankers said that they were being more selective in granting loans.
Most of the loan increase during the period was not in commercial
and industrial loans but in loans of a financial character and
other types.
On the whole, there was no change in the steady up
ward movement in theeconomic situation in the District, and some
evidence of firmer conditions in banking.
Nationally, Mr. Irons observed, the Committee recognized
that boom conditions were prevailing and that deterioration was
occurring in the balance of payments.
Thosecircumstances pointed
to the need for a firmer and more restrictive policy.
But he
thought the firming should be gradual; there should not be a
crash program, or a drastic change in policy.
Some attention also
should be given to the levels of interest rates and to the pressures
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and stresses in financial markets.
He would like to avoid an
increase in the discount rate as long as possible, but he thought
that if the Committee continued to tighten pressures would increase
for discount rate action as interest rates rose.
Mr. Irons agreed with those who had suggested that it would
be desirable to look to the aggregate reserve figures and not to
net borrowed reserves alone.
One reason for considering aggregate
as well as marginal reserves was that more restraint was exerted
on banks in the course of a transition to a deeper level of net
borrowed reserves than in maintaining that deeper level once it
was achieved.
He personally preferred alternative B for the
directive but would not object to alternative C.
Indeed, there
might be some psychological advantage to alternative C in that
it introduced a reference to required reserves.
Mr. Ellis said that three highlights might serve to
illustrate the taut conditions in the New England economy.
pervasive importance was the tightness in the labor market.
Of
The
March unemployment rate reached 3.5 per cent and insured unemploy
ment continued to decline in April.
In Boston, the Reserve Bank
participated with 36 firms in a group survey of the local labor
market.
In presenting the Bank's budget to its directors
yesterday, he had reported the possibility that the wage
projection incorporated might have been outdated by changes within
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the past two weeks.
Seven of the 36 participating firms had
increased starting rates for inexperienced personnel by $2.00 to
$5.00.
Five of the seven had also raised salary structures 4 to
6 per cent, and all seven had granted general or modified across
the-board forms of salary increases.
Undergirding the general strength, Mr. Ellis continued,
were both high volume operations and sharp expansion rates in the
durable goods industries, particularly those affected by defense
production.
The index measuring the region's electrical machinery
industry in March stood 15 per cent higher than a year ago.
Durable goods producers had reported plans to expand their capital
outlays by 38 per cent this year and to concentrate more on plant
expansion.
In reflection of those trends, Mr. Ellis said, loan expan
sion at District banks had been pervasive and violent if not
explosive--at an annual rate of 19 per cent in the past year and
25 per cent in the last six weeks.
First District banks as a
group had been net buyers in the Federal funds market since last
November.
Country banks had come to the discount window for
amounts running four and five times above year-ago levels.
City
banks had also become more frequent borrowers but were satisfying
most of their reserve needs by borrowing in the markets for
negotiable CD's, Federal funds, and short-term notes.
The bank
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that pushed the Federal funds rate to 5-1/8 per cent last Friday
(May 6) borrowed 207 per cent of its total required reserves in
those markets during April.
The average for eight New York City
banks for the same period was only 202 per cent.
Whichever way the Committee looked, Mr. Ellis said,
there were ominous aspects in the staff analysis presented in the
green book
1/
prepared for this meeting.
Committee was advised that:
Looking backward, the
(1) a third of the first-quarter GNP
increase represented higher prices; (2) industrial commodity
prices were rising at a rate between 3 and 3.5 per cent and
threatening to block any long-run improvement in the balance of
payments;
(3) labor costs per unit of output in manufacturing had
been edging up; and (4) in spite of longer hours, the real weekly
spendable earnings of factory workers with three dependents had
not increased in the past year.
Still looking backward, Mr. Ellis found that despite the
slight stiffening in reserve availability represented by higher
Federal funds rates and deeper net borrowed reserve positions,
nonborrowed reserves ballooned during April.
In effect, the
Committee lost ground in its long-run objective of moderating the
expansion of total credit and the money supply.
The report, "Current Economic and Financial Conditions,"
1/
prepared for the Committee by the Board's staff.
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The forward-looking observations, Mr. Ellis said, were equally
ominous:
groups;
(a) unfilled orders continued to rise in all major industry
(b) resurveyed capital spending plans suggested even larger
expansion plans than earlier reported;
(c) defense needs translated
into rising outlays beyond budgeted levels, and Congress was expanding
nondefense spending beyond Administration requests;
(d) the U.S.
balance of payments experience seemed more likely to worsen from the
weaker position in the first quarter than to improve.
Facing those prospects, Mr. Ellis found the arguments for a
tax increase to be overwhelming.
Yet a Presidential request at this
moment for such action might result in a self-defeating general
loosening of the purse strings in subsequent Congressional voting.
Tactics possibly called for delay in requesting a tax increase until
major Congressional actions were complete and Congress sought to
adjourn for campaigning.
On that line of reasoning, if business
conditions remained as inflationary in June as they were now, he would
consider it likely that the President would request and obtain a tax
increase.
In that context, Mr. Ellis said, the central issue of monetary
policy became a choice as to how far to proceed in further tightening
pending a decision on increased taxes.
For the past several meetings,
and especially yesterday, the Boston Bank's directors requested that
Mr. Ellis express in this forum their sense of urgency that monetary
policy was not adequately restrictive in view of lagging fiscal
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5/10/66
restraints.
While agreeing with them in analysis, he had persuaded
them that, in view of the present pressures on savings institutions
a further increase in discount rates, with a subsequent attendant need
to reconcile Regulation Q ceilings, should be postponed until a tax
decision was reached.
Meanwhile, it was appropriate to explore what
leeway remained for continued gradual lessening of reserve availability
in order to achieve the Committee's basic objective of restricting
growth in the reserve base, bank credit, and the money supply.
Experience last month demonstrated that if credit demands swelled
sharply they would overwhelm any modest barrier and reserves would
flood out--as they had in April, at a 17.5 per cent annual rate.
It
was attractive, therefore, to contemplate a directive such as alter
native C under which reserve availability would be somewhat conditioned
by the extent of demand for reserve expansion.
Employing the "phrases of art" identified by Mr. Holland at
the Committee's last meeting, Mr. Ellis remarked, he would define
alternative C to encompass a net borrowed reserve target of $350
million as a floor if reserves continued their sharp expansion; and
he would expect borrowings to consistently exceed $650 million on a
weekly average basis, and the Federal funds rate to ride in the 4-7/8 to
5 per cent range.
Since the use of Treasury bills in reserve adjust
ments had lessened the bill rate seemed less sensitive to reserve
positions, but he would still expect some stiffening of 3-month bill
rates, to 4.75 per cent and higher.
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5/10/66
Mr. Ellis observed that he wished the staff had expressed
alternative C in terms of pressure on bank reserve positions, noting
that Mr. Partee's analysis today had been expressed partly in those
terms.
He (Mr. Ellis) urged the adoption of alternative C, however,
because it called for considering the movements of required reserves
as well as net borrowed reserves.
He would omit the reference to the
Treasury financing because he thought it gave more than the intended
emphasis to even keel considerations.
Mr. Robertson then made the following statement:
Once again the materials presented to us by the staff,
and the comments around the table this morning, describe an
economy that is under even more upward pressure than was
foreseen a month or two ago. While the automobile industry
may be undergoing a bit of an adjustment at the moment, it
is clearly the exception. The general picture is one of high
demand growth, mounting pressure upon labor and plant capacity,
and continued industrial price advance.
This is the kind of situation in which we should be
using monetary policy to generate as much restraint as we
think it is reasonable and prudent to apply. All of us know
this is an easier objective to state in theory than to apply
in practice. We thought we were taking actions to firm up
conditions gradually in March and April--and probably we did
get some firming of bank lending conditions--but at the same
time over-all demand was so strong that bank credit expanded
rapidly and this gave rise to large additional reserve-injecting
operations by the System. The growth in bank loans, investments,
and deposits must be reduced to more modest proportions, and
the very recent signs of slowdown are not enough, in my own
judgment, to assure such a reduction in the absence of further
gradual tightening of bank reserve positions by System open
market operations.
Accordingly, I would direct the Manager to press net
borrowed reserves gradually deeper, beginning as soon as the
current Treasury refunding operation is concluded. In
giving a directive to the Manager, I think we should take
pains to guard against such developments as took place last
5/10/66
month, when we had much higher rates of expansion in bank
credit and money than we would willingly have sanctioned
ahead of time.
The staff noted that April would see rapid
rates of growth in the reserve and monetary aggregates, but
the growth rates turned out to be even more rapid. Economic
prediction is an art--not quite yet a science--and our staff
has, I believe, developed the art close to its outer limits.
I have only praise for their efforts in the green and blue
books and elsewhere, and hope their efforts continue.
All that being said, the fact remains that if we want
to be sure that growth in credit and money slows from its
recent rate, we should express our wishes more definitely
in the operative second paragraph of the directive. For
instance, although the staff analysis in the blue book notes
that growth in bank credit will slow over the next two months,
I would want the Account Manager himself actively to contribute
to this result if it does not appear that the market will do so.
To help slow down credit growth, I would want to deepen
the net borrowed number gradually by around $25 million a week
so that it would rise from $300 million to $400 million over
the next four weeks. If required reserve growth proves larger
than expected, I would hasten the rise in the net borrowed
reserve number and even let the number rise above $400 million.
On the other hand, if there were a definite weakness in
required reserves, I would let the net reserve position of
banks fall somewhat short of the aforementioned weekly goals.
I realize the Manager will have a difficult time making
the judgments involved in such an instruction. There are
two pieces of advice that might be helpful to him, however;
first, at the moment there is more danger in being too easy
than too tight; and second, if bank credit looks as if it is
rising noticeably above a 6 per cent annual rate, the banks
should be forced to borrow the additional required reserves,
even if borrowings turn out to have risen only temporarily,
unless this pushes net borrowed reserves above $500 million.
I assume that this kind of policy may foster a continued
upward adjustment in bond market rates, and I would not mind
seeing most of the effects of the March-April bond market
rally wiped out in the process. I would also expect that it
would gradually step up pressure in the money market, and I
hope we will not be too deterred by that kind of manifestation
of market restraint either.
I recognize that my net borrowed reserve suggestions
involve driving banks considerably deeper in debt at the dis
count window, and I regard that as part of the process of
restraint. I recognize further that this might trigger
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speculation about a possible discount rate increase, and I
am prepared to face up to such a change eventually if the
circumstances become compelling. What I am not prepared to
countenance is a further increase in the Regulation Q
ceiling on time deposits; indeed, it may only be by holding
the line on Regulation Q that we finally calm down the
bank credit expansion.
It appears to me that alternative C of the draft
directives might accomplish the ends I seek, although
it should be read to permit some flexibility on the
down side of net borrowed reserves as well as the up. The
market virtues of operating with a net reserve target can
thereby be combined with the anti-cyclical virtues of paying
close attention to the related aggregates--which means, in
the current environment, at least seeing that potentially
inflationary credit demands are not fully accommodated.
Mr. Robertson added that he favored the amendment to alternative
C proposed by Mr. Shepardson.
He had no strong view as to whether or
not the reference to the Treasury financing should be deleted.
He
would suggest an amendment to the final sentence of the first paragraph
of the draft directive; in the phrase, "and to help restore reasonable
equilibrium in the country's balance of payments," he would replace
the word "help" with the words "strengthen efforts to."
He suggested
that change because he thought the time had come at which monetary
policy had to take a more active role in the effort to improve the
payments balance.
Chairman Martin said that the views of Committee members did
not seem very far apart today.
note of caution.
He would like, however, to sound a
There was real turbulence in financial markets at
present--perhaps more than generally realized--and recent monetary
policy had been a major factor in bringing it about.
He did not
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think the Committee should be too dissatisfied with monetary policy
because of the recent trends in banking aggregates.
In his judgment,
the Committee should not press too hard in an effort to get more
precise results; it would take time to iron out conditions such as
existed at present in the stock market, at savings and loan associa
tions, with respect to the balance of payments, and with respect to
the current dislocations in the money market.
Although he did not
like the recent banking figures any more than others did, he felt
that patience was needed in getting the results desired.
Over the
weekend he had re-read the Committee's minutes for the period
subsequent to the 1957 reduction in the discount rate.
He noted
that for a long time then the Committee had sought actively to ease,
but the money supply figures had failed to respond.
Now the Committee
was trying to firm, and perhaps it was seeking to make the figures
respond more actively than the course of events would permit.
The
money stream was swollen now, as it had been in the latter part of
1965.
At that time, in his view, conditions in financial markets
had reached the point at which it was almost impossible to navigate;
the prime rate existing then had been a boulder in the stream.
The
flow of funds was better now, but there still were many dislocations.
For example, while according to a recent report the difficulties of
savings and loan associations in the Twelfth District were not as
great as had been feared, they were quite serious in one or two
cases.
5/10/66
-95
In sum, Chairman Martin said, he thought the Committee should
not press too hard now in the belief that monetary policy alone could
achieve price stability; it was just one important element in the
picture.
Perhaps all members of the Committee--and he included himself
tended to think at times that monetary policy could do more than it
in fact could.
He was not in disagreement with the policy that the
majority favored today, but he hoped that the System would not find
itself in the position of having raised the discount rate after the
crest of the cycle had been passed.
If it did, it was likely to bear
all the blame for subsequent developments.
The System had been through
that experience several times before and he hoped it would not be
repeated.
He thought the System had to brake the inflation in 1957,
and in his judgment the price stability that prevailed from 1961 to
1965 would not have been possible if the earlier inflationary psychol
ogy had persisted.
Nevertheless, the business decline then had been
attributed to the Federal Reserve.
He thought the Committee should
bear that in mind--although he did not suggest that it should shirk
its responsibilities.
Chairman Martin said he did not know what the Administration
would do with respect to fiscal policy.
In his judgment there had
been a good deal of progress in the past six months in public under
standing of the problem of inflation; the current dialogue in the
press about policies to deal with inflation would have been impossible
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6 months ago.
Some real gains had been made, and he would repeat
that the Committee should not press too hard on monetary policy
alone.
The Chairman observed that he was agreeable to either alter
native B or alternative C for the directive.
He would be somewhat
concerned about Mr. Shepardson's proposal that the words "further
gradual" be deleted before "reduction in net reserve availability,"
because he favored a gradual approach.
He thought it was quite
important at this juncture that the Committee not move in an abrupt
way.
Mr. Shepardson said he had not intended to suggest an abrupt
move.
He had taken exception to the word "further" because he did
not think there had been a reduction in reserve availability.
He
proposed deleting the word "gradual" because, as he had noted at
previous meetings, he thought that word had been overemphasized.
Mr. Koch drew attention to the fact that in alternative C
the staff proposed to introduce the word "net" before "reserve
availability."
The phrase could then be taken to refer to net
borrowed reserves, which had been deepened over the past few months.
Mr. Shepardson remarked that he had had total reserve avail
ability in mind in stating that no reduction had occurred,
Mr. Mitchell commented that Mr. Shepardson's criticism of the
word "further" was valid if applied to the Committee's previous
5/10/66
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directive.
He agreed with Mr. Koch, however, that the word did not
pose a problem in alternative C as drafted for this meeting.
Mr. Maisel said that as he understood the sentiment of the
members today the variable with which the Committee was concerned was
total reserves.
The references to "reserve availability" in recent
directives were ambiguous, and he thought the staff had tried to
formulate alternative C in a manner that removed that ambiguity.
Mr. Daane indicated that he was not sure the Committee
intended total reserves to be used as an operational target.
Mr. Hayes said he did not think the Committee could discard
net borrowed reserves as an operational guide.
Granting that total
reserves should be used to the extent practicable, one could not be
sure that the short-run observations of that variable were meaningful.
He asked the Manager whether he thought there would be problems in
operating under the instructions contained in alternative C.
Mr. Holmes said he would note first that except for its final
clause the language of alternative C was close to that of B; he would
read both to call for some deepening of net borrowed reserves, perhaps
to around the $350 million area.
The final clause implied that if
required reserves were higher than seasonally projected the marginal
reserve figure should be deepened further by some amount--Mr. Robertson
would have them go as deep as $500 million.
Present projections indicated
a decline in required reserves over the next few weeks.
Thus, if required
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5/10/66
reserves did not decline along the projected lines, he would understand
alternative C to call for net borrowed reserves deeper than $350 million.
Mr. Daane commented that Mr. Holmes' statement illustrated the
problem he had with alternative C.
The view that a reduction in reserve
availability was called for was widely held today, but if the Committee
required the Manager to deepen net borrowed reserves below $350 million
it inevitably would cause a considerable readjustment in market rates
that could lead to a discount rate change.
He had not suggested any
particular figure as a target for operations, and he thought the
Committee had to be wary of the danger of precipitating the kind of
wholesale market adjustment that he did not think was called for at
present.
Chairman Martin then said he wished to make his position clear
with respect to a discount rate increase.
He thought that if such an
action were to be taken it should follow market developments and not be
forced by the Committee.
That was why he felt the Committee should not
press too hard in deepening the net borrowed reserve figures, and that
conditions should be allowed to tighten gradually.
Mr. Mitchell agreed with the Chairman but felt nevertheless that
the recent experience with total bank credit and the money supply was
somewhat disheartening.
If the staff projections should prove faulty
he thought the Manager should move in the direction suggested by
Mr. Robertson.
He would rather not see a discount rate increase, but
5/10/66
-99
would prefer such an increase to a repetition of the March-April
developments.
Mr. Maisel said there seemed to be a conflict today between
the members who thought that the Committee had set money market rates
as its primary goal, and those who thought that the goal had been
formulated in terms of total reserves.
Members in the two groups had
different views of the monetary policy that would be appropriate for
the next period.
The problem, as he saw it, was that in the past five
months the Committee had used money market conditions as a sub-goal,
with the result that there had been a substantial expansion in bank
credit.
Chairman Martin thought that Mr. Maisel's observation involved
an element of judgment.
He did not feel there was any difference
between his own position and Mr. Maisel's except with respect to timing
In his opinion considerations of cost and availability of money could
not be kept separate indefinitely; the question was how moves should
be timed.
Personally he did not feel that he had had a money market
sub-goal in mind, but different people measured things differently.
Mr. Hayes said he would inject a cautionary note on the subject
of the sensitivity of market conditions.
He did not believe the Com
mittee could completely ignore the effects of its actions on the market
He would remind the members that there had been occasions, even in the
past year or two, when conditions in the market had suddenly become
rather critical.
It was important that the Committee do what it could
5/10/66
-100
to prevent disorderly conditions.
Perhaps the matter was a side
issue, but the members should not lose sight of the possibility of
rapid market disruption.
To him that argued for acting gradually
rather than precipitously.
Mr. Brimmer agreed with Mr. Hayes, and said he would not
favor deleting the word "gradual" from the second paragraph of the
directive.
He had been inclined toward alternative B but would be
willing to accept alternative C provided that the word "gradual"
was retained.
He also would favor using the word "net" before
"reserve availability," and on that basis he would consider it
appropriate to retain "further" since there had been a deepening of
net borrowed reserves.
Chairman Martin said he thought alternatives B and C as
drafted by the staff were substantially the same from the standpoint
of the Manager's operations.
He wondered, however, whether the
amendment to C suggested by Mr. Shepardson would not require the
Manager to deepen net borrowed reserves below $350 million.
Mr. Holmes observed that most of those favoring alternative B
seemed to be more concerned about possible disruption in financial
market conditions, while those who favored C were more concerned
about the movements in the aggregate statistics.
That appeared to
be one significant difference between the two groups, although neither
of the draft alternatives mentioned market conditions specifically.
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Mr. Robertson remarked that no one around the table wanted
to disrupt the market; what the majority desired was a gradual but
steady reduction in the availability of reserves.
It should never
be assumed that the Committee would overlook the possibility of
disruption in market conditions.
That possibility was a reason for
the degree of latitude that would be given to the Manager in instruc
tions of the type he (Mr. Robertson) proposed.
At the same time, he
thought that the rate at which reserve availability was being reduced
should be speeded up, although it should still be gradual.
Mr. Hickman said that he would endorse Mr. Robertson's statemen
To summarize his own position briefly, he favored alternative C for the
directive, retaining the word "gradual"; he would be very much concerne
about any actions that disrupted the money market; he would want attent
paid to aggregate reserve availability as well as to net borrowed
reserves; and he would not want to see interest rates rise so high that
the discount rate would have to be increased immediately.
The Chairman commented that he thought Mr. Robertson had made
the point well--no one wanted to disrupt the market.
How to achieve
the results the Committee desired was a problem that had to be left to
the Manager.
Mr. Daane observed that he would be concerned about a deepening
of net borrowed reserves beyond the $350 million level, an area which
he thought might be a danger zone.
alternative B for the directive.
As he had indicated, he would prefe
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-102
Mr. Hayes said that he also would prefer alternative B.
If
the members considered the language calling for "some further gradual
reduction in reserve availability" to be too mild, the word "some"
might be deleted.
Mr. Shepardson commented that while a net borrowed reserve
target might be meaningful in a period of transition to a deeper
target level, to hold net borrowed reserves at any particular level
would mean meeting whatever demands for reserves arose and thus would
not necessarily imply restraint.
The Committee had been applying
some restraint recently, but the movement had been overly gradual
relative to the expansion in demands, and for that reason the Committee
had failed to accomplish its objectives.
Chairman Martin commented that no one could say with assurance
how strong the demand for reserves would be in the coming period.
Mr. Shepardson agreed.
He added, however, that he thought
the additional clause of alternative C, calling for a greater reduction
in net reserve availability if growth in required reserve did not
moderate substantially, was intended to meet that problem.
The Committee then turned to the suggestions that had been made
regarding revisions in the draft directive language submitted by the
staff.
After further discussion, it was agreed that the reference to
the Treasury financing should be retained and that Mr. Robertson's
suggested revision of the phrase relating to the balance of payments
in the last sentence of the first paragraph should be adopted.
5/10/66
-103Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the following
current economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that the domestic economy is expanding
vigorously, with industrial prices continuing to rise and
credit demands remaining strong. Our international pay
ments continue in deficit.
In this situation, it is the
Federal Open Market Committee's policy to resist inflationary
pressures and to strengthen efforts to restore reasonable
equilibrium in the country's balance of payments, by
restricting the growth in the reserve base, bank credit,
and the money supply.
To implement this policy, while taking into account
the current Treasury financing, System open market opera
tions until the next meeting of the Committee shall be
conducted with a view to attaining some further gradual
reduction in net reserve availability, and a greater
reduction if growth in required reserves does not moderate
substantially.
It was agreed that the next meeting of the Committee would be
held on Tuesday, June 7, 1966, at 9:30 a.m.
The meeting then adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
May 9, 1966
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on May 10, 1966
First paragraph
The economic and financial developments reviewed at this
meeting indicate that the domestic economy is expanding vigorously,
w: h industrial prices continuing to rise and credit demands
remaining strong. Our international payments continue in deficit.
In this situation, it is the Federal Open Market Committee's policy
to resist inflationary pressures and to help restore reasonable
equilibrium in the country's balance of payments, by restricting
the growth in the reserve base, bank credit, and the money supply.
Second paragraph
Alternative A (preserving about the current degree of firmness)
To implement this policy, while taking into account the
current Treasury financing, System open market operations until the
next meeting of the Committee shall be conducted with a view to
maintaining firm conditions in the money market and continuing to
exert pressure on bank reserve positions.
Alternative B (continued gradual firming)
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted with a
view to attaining some further gradual reduction in reserve availa
bility, while taking into account the current Treasury financing.
Alternative C (degree of firming conditioned by movement in required
reserves)
To implement this policy, while taking into account the
current Treasury financing, System open market operations until the
next meeting of the Committee shall be conducted with a view to
attaining some further gradual reduction in net reserve availa
bility, and a greater reduction if growth in required reserves
does not moderate substantially.
Cite this document
Federal Reserve (1966, May 9). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660510
@misc{wtfs_fomc_minutes_19660510,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {May},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660510},
note = {Retrieved via When the Fed Speaks corpus}
}