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, June 28, 1966, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Mr. Daane
Mr.
Mr.
Mr.
Mr.
Hickman
Irons
Maisel
Mitchell
Messrs. Treiber, Wayne, Scanlon, Francis, and Swan,
Alternate Members of the Federal Open Market
Committee
Messrs. Ellis and Galusha, Presidents of the Federal
Reserve Banks of Boston and Minneapolis,
respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Hexter, Assistant General Counsel
Mr. Brill, Economist
Messrs. Eastburn, Garvy, Green, Koch, Mann,
Partee, Solomon, Tow, and Young, Associate
Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors
Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
Messrs. Axilrod and Gramley, Associate Advisers,
Division of Research and Statistics,
Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Mr. Forrestal, Senior Atorney, Legal Division,
Board of Governors
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Mr. Kimbrel, First Vice President, Federal
Reserve Bank of Atlanta
Messrs. Willis, Ratchford, Taylor, Baughman,
Jones, and Craven, Vice Presidents of the
Federal Reserve Banks of Boston, Richmond,
Atlanta, Chicago, St. Louis, and San
Francisco, respectively
Messrs. MacLaury and Scheld, Assistant Vice
Presidents of the Federal Reserve Banks
of New York and Chicago, respectively
Mr. Nelson, Director of Research, Federal
Reserve Bank of Minneapolis
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Upon motion duly made and seconded,
and by unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on June 7, 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 June 7 through 22, 1966, and a supplemental report for June 23
through 27, 1966.
Copies of these reports have been placed in the
files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
reported that the Treasury gold stock would remain unchanged this
week following the decline of $100 million last week.
Reserve gains
by France this month appeared to be more than $100 million, so that
another purchase, at least equal to the $75 million taken in June,
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could almost certainly be counted on in July, and consequently
another drop in the gold stock at approximately the same time.
In the
London market, the price of gold moved up from $35.13 earlier in June
to $35.17-1/2 in the last few days.
Supplies coming on the market
from new production had been substantially diminished by the rebuild
ing of South Africa's gold reserves, and in the face of sustained
demand the pool had gone $64 million further into deficit in this
month alone.
That acceleration in the amount of gold supplied by the
pool was cause for real concern;
the pool began the year with a sur
plus of some $40 million and was now nearly $120 million in deficit,
so that official losses through the pool totaled approximately $160
million for the year to date.
Without doubt, Mr. MacLaury said, the pressures on sterling
during the past month had contributed to the uneasiness in the gold
market, and there were rumors last week that China might again be a
buyer, although there was no confirmation of that.
The sizable
Russian purchase of wheat from Canada announced last week led to some
hope that Russia might at last come into the market with its long
anticipated sales of gold.
As yet there had been no evidence of such
sales, however; and he understood that, contrary to initial impres
sions, the rate of Russian wheat purchases from Canada during the
next three years would be only about half that of previous years.
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Altogether, the outlook in the gold market was not encouraging, as
Mr. Coombs had been stressing at recent meetings of the Committee.
Sterling had had a very rocky time this month, Mr. MacLaury
continued.
At the beginning of the month--between June 3 and June 7-
the Bank of England had to provide some $350 million of support in
the spot and forward markets as holders of sterling first reacted to
the announcement of the $100 million U.K. reserve decline for May,
and then to the prolongation of the British maritime strike and to
the devaluation of the Indian rupee.
The actual cost to the reserves
during that four-day period was limited to about $200 million by
shifting part of the original spot losses into the forward market.
Another brief burst of selling occurred on Friday, June 10,
when the losses amounted to about $60 million, Mr. MacLaury observed.
In the following week, however, there was a sharp turnaround in the
market as those who had sold sterling short the previous week rushed
to cover their positions on the announcement of renewed international
assistance for the pound.
The Committee would recall that on Monday,
June 13, the Bank of England announced that the international credit
facilities first extended in September 1965 by seven European central
banks, Japan, Canada, and the Bank for International Settlements had
been renewed, that related facilities with the United States were
still in force, and that the Bank of France this time was participat
ing in the arrangements.
The renewal was initially reported in the
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press as a completely new package, and on the strength of those
somewhat exaggerated press stories, substantial buying of sterling
carried through most of that week.
The Bank of England was able to
recoup most of the previous week's spot losses, regaining about $220
million of the earlier $260 million loss.
Since in fact that recovery was not based on any fundamental
change in the British situation itself, and particularly in the
strike, one could not expect the buying to be long sustained, Mr.
MacLaury noted.
It was perhaps only natural that sterling should
again come under pressure last week, when another weekend had passed
with no news of a strike settlement and when the market had had more
time to assess closely the implications of the renewal of the Septem
ber arrangements.
But, on that occasion, the pressure was compounded
by an extreme squeeze for funds that developed in the Euro-dollar
market as mid-year approached;
quotations for short maturities rose
more than 1/4 per cent to 6 per cent or higher.
The pull of the
Euro-dollar market drew funds out of sterling, and on Monday, June 20,
the Bank of England had to provide some $140 million to hold the
spot rate at $2.7890.
Since much of the selling that day reflected
covered movements of funds out of sterling, forward sterling rates
strengthened sharply; for example, one-month sterling rose to a
premium for the first time since late 1963.
With U.S. Treasury bill
yields also slipping, the covered incentive on three-month bills
6/28/66
jumped from less than .40 per cent to .70 per cent per annum in favor
of London, while London's incentive on one-month bills advanced to
approximately 1-1/4 per cent per annum,
Despite the generally tight
money market conditions in this country, there was a distinct possi
bility that covered incentives of that magnitude could pull private
funds from the U.S.
To reduce the potential for such an outflow,
and at the same time to relieve exchange market pressures resulting
from the dollar squeeze and to provide support for spot sterling,
in the afternoon of June 20 the New York Bank began to engage in
market swaps--purchasing sterling spot against one-month forward sale,
thereby widening the discounts for forward delivery.
By the close of
business that day, a total of almost $50 million equivalent of swaps
had been undertaken, half for System account and half for Treasury
account.
As a result of that intervention the net incentive on one
month bills was reduced to about 0.90 per cent per annum.
The
operation had, of course, been discussed in advance with the Bank of
England and it was welcomed by them in the full knowledge that the
market would have to reabsorb the sterling purchases when the forwards
came due in July.
On Tuesday, June 20, the Bank of England again had
to provide sizable support--$55 million--to counter brief but heavy
selling just after the opening in London.
With the forwards still
narrow and the incentive in favor of London on one-month bills still
nearly one per cent, the New York Bank continued to engage in swaps
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on Tuesday and Thursday, though on a much smaller scale.
Altogether,
during the three days of such operations, a total of $67 million of
sterling was purchased on a covered basis, half for System account.
Mr. MacLaury went on to say that although the operations
indirectly helped to offset part of the pressures on U.K. reserves
arising from the technical dollar squeeze--without the adverse effects
on the U.S. balance of payments that would have accompanied interest
induced private outflows from this country--the British authorities
nevertheless were facing a pretty bleak picture on reserves this
month.
The net result of the Bank of England's very sizable inter
vention, its repayment of the $100 million credit from the U.S.
Treasury over last month-end, and the maturing of a sizable amount
of previous forward contracts left U.K. reserves down nearly $550
million.1 /
A published
loss approximately double last month's figures--i.e., about $200
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported further
comments by Mr. NacLaury on recent and prospective activities of the
Bank of England.
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million--seemed reasonable under the difficult circumstances, even
though a decline of that magnitude clearly involved a calculated risk
of speculative repercussions.
If that reasoning was accepted by the
U.K. authorities, the U.S. would have to be prepared to put up the
remaining $200 million necessary to cover the $550 reserve decline.
Half probably would be provided by the Treasury and half through a
drawing under the swap line with the Federal Reserve.
Mr. MacLaury remarked that there had been considerable
activity in other currencies during the month, with France and Italy
continuing to take in dollars as a result of payments surpluses,
Switzerland and Germany experiencing sizable repatriations of funds
in connection with tight domestic money markets and mid-year position
ing, and the Canadian dollar benefiting from the announcement of
Russian wheat purchases.
He would not go into detail on those
developments, however, because they had not involved any System
operations.
Sterling remained the real focus of concern.
In that
connection, he noted that there had been no substantive changes in
the sterling balance arrangements finally agreed upon at the last
Basle meeting from the draft agreement circulated to the Committee by
Mr. Coombs.
Mr. Daane asked about the dates on which the British would
publish figures for June on their reserves and on their trade balance.
He suspected that the first-quarter payments figures to be announced
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soon would not be good, and he was concerned about the possible effect
on the sterling market of the conjuncture of poor payments figures and
data showing large reserve losses.
Mr. MacLaury replied that the reserve figures for a month
customarily were published two business days after the end of the
month, and the June trade figures could be expected about the middle
of July.1 /
In response to another question by Mr. Daane, Mr. MacLaury
said that the British preferred not to draw on the new credit package
because they were not certain they could prove there had been a net
decline in foreign sterling balances since the end-of-February base
period specified under the formula contained in the agreement.
Although foreign balances had been run down in June, they had increased
in April and May.
Mr. Brimmer asked what reason the British would have for not
showing a June reserve loss larger than the $200 million 2/
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported further
comments by Mr. MacLaury on the British reserve situation.
2/ Part of a sentence has been deleted at this point for one of
the reasons cited in the preface. The deleted material related to the
$200 million figure under discussion.
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Mr. MacLaury responded that they would be concerned about the
risk of setting off a cycle of speculation against sterling.
A loss
of $200 million was large for a single month; in the three preceding
months the British had shown losses of about $75 million, $50 million,
and $100 million, respectively.
In reply to questions by Mr. Mitchell, Mr. MacLaury said that
'the three figures he had just mentioned reflected the actual reserve
declines the British had experienced but, of course, a $200 million
figure for June would not.
In the past the British had always
announced the fact of recourse to their U.S. credit facilities, but
had not made known the amounts involved.1/
Mr. Mitchell said that he, for one, felt the British would
achieve the results they sought faster if they reported their reserve
position accurately than if they attempted to conceal their true
position.2/
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported a comment
by Mr. Hayes regarding a recent conversation of his with an official
of the Bank of England.
2/ A sentence has been deleted at this point for one of the reasons
cited in the preface. The sentence reported a further comment by
Mr. MacLaury on the British reserve situation.
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Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
June 7 through 27, 1966, were approved,
ratified, and confirmed.
Mr. MacLaury then recommended renewal of six standby swap
arrangements that would mature soon.
They were a $50 million arrange
ment with the Bank of Sweden, having a term of 12 months, and maturing
on July 19; a $150 million arrangement with the Swiss National Bank,
having a term of 6 months, and maturing on July 20; two $150 million
arrangements with the BIS--one for System drawings in Swiss francs and
one for System drawings in other European currencies--having terms of
6 months and maturing on July 20; a $50 million arrangement with the
Austrian National Bank, having a twelve-month term, and maturing on
July 26; and a $250 million arrangement with the Bank of Japan, also
with a twelve-month term, and maturing on July 29.
Renewals of the six standby swap
arrangements, as recommended by Mr.
MacLaury, were approved unanimously.
Mr. MacLaury then noted that he had one remaining matter to
report for the information of the Committee.
At the preceding meeting
the Committee had noted without objection the renewal of the $50
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million drawing on the National Bank of Belgium that represented the
portion of the swap arrangement with that Bank that was always fully
drawn.
As in the past, the Belgians had asked that the interest rate
on the drawing be adjusted to current market levels and, with the
concurrence of the U.S. Treasury, the rate was increased from 4-3/8
per cent to 4-1/2 per cent.
The rate on the standby portion of the
arrangement remained unchanged at 4-1/4 per cent, and no use was being
made currently of either portion of the arrangement.
Chairman Martin then invited Mr. Daane to report on the
meeting of the Deputies of the Group of Ten he had recently attended.
Mr. Daane said that the Deupties meeting was held in Frankfurt,
Germany, on Wednesday through Friday of last week (June 22-24).
His
own assessment was that it represented a significant setback in the
negotiations of the Ten.
As a backdrop to the meeting there had been
increasingly serious concern abroad with the U.S. balance of payments
position, as Chairman Martin and he had reported at the previous meet
ing of the Committee.
Skepticism was growing about the real objective
of the U.S. in the negotiations, with the question raised as to
whether the U.S. was seeking some additional financing that would
enable it to avoid the monetary discipline the members of the Group
of Ten felt it should observe.
A more specific backdrop to the meeting, Mr. Daane continued,
was the discussion at an immediately preceding meeting of the Minis
ters and Governors of the European Economic Community.
In that
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discussion apparently the French Finance Minister had capitalized on
the concern about the U.S. payments balance, and had persuaded his
colleagues to adopt a considerably firmer position on three points.
The first, and most important, was that the six members of the EEC
were now solidly of the view that the decision-making process on any
new asset creation should rest with the Group of Ten, even if the
assets were created through the IMF.
Moreover, some of the Deputies
made it perfectly clear that that position had been taken at the
cabinet level.
Thus, they had definitely hardened their positions
on the matter of decision-making.
Secondly, they had firmed even
further their positions with regard to preconditions for asset crea
tion, most significantly in setting as a precondition the restoration
of equilibrium in both the U.S. and U.K. balance of payments.
They
also called for stronger rules on the adjustment process and for
strengthened multilateral surveillance.
Third, they had coalesced
around the idea of a simple unit plan.
Those apparent developments at the EEC meeting, Mr. Daane
continued, filtered through to the subsequent deliberations in
Frankfurt of the Group of Ten Deputies, where some of the previously
discussed substantive matters relating to reserve asset creation,
such as the question of a gold link, were submerged.
The discussion
focused almost entirely on the question of the decision-making
process, particularly as it related to moving into a second stage.
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The questions were:
Was there now to be a second stage?
should it be entered, and how organized?
If so, how
As a further backdrop to
what was an unsuccessful and incomplete discussion among the Ten, the
International Monetary Fund Executive Board had held extended discus
sions of a U.S. proposal for creation of an Advisory Committee of
Governors to carry on second-stage discussions.
The Fund Executive
Board had reacted negatively, and quite strongly.
It had concluded
by endorsing a proposal of the Managing Director for a compromise
involving second-stage deliberations by the Executive Board and the
Group of Ten Deputies sitting together.
There had been discussions
between Messrs. Schweitzer and Emminger and a cross-fertilization of
the ideas of the Fund and the Group of Ten.
As he understood the out
come, the proposal was for separate, parallel efforts by both the
Fund Board and the Ten, with regularly-scheduled combined meetings,
perhaps four times a year.
Those, Mr. Daane thought, were the key points at the meeting
last week.
The Deputies did consider parts of the draft of their
report itself, but such discussion was secondary to the issue of
decision-making.
A substantial degree of agreement was reached on
the language of the introduction and of the second chapter concerning
improvements in the international payments system.
Consideration of
the third chapter, dealing with elements of various proposals for
the creation of reserve assets, was postponed to the next meeting,
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and the discussion bogged down when Chapter 4, involving a vertical
analysis of the various proposals, was considered.
The current
thinking was that the substance of Chapter 4 should be included in
an appendix.
As far as the draft report was concerned, the focus
was mainly on the fifth chapter, Conclusions and Recommendations.
The French position, while basically unchanged, had hardened; they
were now willing to say very early in the concluding chapter that
they had abstained even from participating in the discussion and
drafting of all those passages of the report relating to the elements
of contingency planning.
They indicated that they would hold firmly
to their position until the U.S. achieved equilibrium in its balance
of payments.
It was possible to get agreement among the other nine
members of the Group on the desirability of contingency planning,
but the French would certainly stand strongly on their position.
The Deputies would meet in Paris on July 6 to put their
report in final form, Mr. Daane said.
The report would then be con
sidered by the Ministers and Governors of the Ten at The Hague on
July 25-26.
Mr. Daane concluded by noting that Mr. Solomon, in addition
to attending recent meetings of the Deputies, had been a member of
a four-man drafting group that had held sessions between the Paris
and Frankfurt meetings.
He thus had been extensively exposed to the
thinking of the Europeans and might have some comments.
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Mr. Solomon said he would make two points.
First, he thought
the hardening of views by the Europeans on the question of decision
making reflected what was close to a suspicion on their part that, if
a scheme for creating reserve assets through the Fund were adopted,
the U.S. would team up with the rest of the world to force creation
of new assets that would end up in their own reserves.
At the moment
they felt strongly enough on the point to insist on conditions that
would prevent that from happening.
Secondly, the present confusion
regarding alternative proposals for procedures in the second stage
also reflected the hardening of the Europeans' position and their
reluctance to move into that stage.
They would prefer procedures
that were less than clear-cut, and that in general would involve
continuing work in the area by the Group of Ten while paying some
lip service to the idea of a second stage.
Mr. Daane remarked that he subscribed fully to Mr. Solomon's
observations.
Mr. Galusha asked whether Mr. Schweitzer's recent strongly
worded criticism of the limitation of the current dialogue to the
Ten had resulted in any significant strain.
Mr. Daane replied that, as far as the U.S. view was concerned,
there would inevitably be a second stage whether or not the Ten were
willing to accept it.
While the Group had fended off the participa
tion of other countries thus far, they were aware of the need to
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bring in the rest of the world at
some point and in his view
Mr. Schweitzer's statement was overly critical of the Ten.
The
Group probably would not be able to resist for any length of time
the strong feeling in the Fund and in the countries that were not
participating, and in due course there was likely to be parallel
consideration by the Fund and the Group, and perhaps some form of
merger.
The question would then arise whether that would consti
tute a real second stage of negotiation.
Chairman Martin noted that Mr. Hayes recently had spent
some time in Europe.
He invited Mr. Hayes to report any observa
tions of interest to the Committee.
Mr. Hayes said that he had met with the Governors of a
number of European central banks, and while the discussions were
lengthy and intimate they did not involve any specific business.
He would report a few of his general conclusions.
First, one
pattern of thinking that seemed common to many countries was an
acute fear of inflation, a feeling that monetary policy was able
to do something in that regard but not everything, and a feeling
of frustration with respect to fiscal policy.
That pattern was
clearly evident, for example, at the Bundesbank and the Netherlands
Bank.
Of course, recent experience in those countries was parallel
in some respects to that of the U.S.
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Secondly, Mr. Hayes said, he fully agreed with Mr. Daane
about the growing concern and worry in Europe with respect to the
U.S. balance of payments.
That concern had not yet taken the form
of an acute distrust of the dollar but the seeds of such distrust
were being sown and were finding fertile ground.
That, in turn,
was a cause for real concern on the part of the Committee.
The
Europeans were skeptical about the will of the U.S. to do what had
to be done to bring its payments into balance.
He was not sure of
the extent to which the effects of the Vietnam hostilities were
recognized.
They probably were not fully recognized, but even to
the extent they were the matter was clouded by the lack of sympathy
in Europe with respect to U.S. objectives in Vietnam.
In his talks
with people concerned with financial matters he had not found any
widespread sympathy with the U.S. position on Vietnam nor any
particular feeling that the hostilities were an acceptable reason
for the failure of the U.S. to achieve the balance of payments
goal it had announced earlier.
Mr. Hayes thought that U.S. balance of payments developments
were beginning to affect the thinking of some of the nation's best
friends in Europe on the subject of gold and dollar holdings.
Specifically, in his discussions with Governor Carli of the Bank
of Italy he had found a greater preoccupation with the gold ratio
than ever before, which Governor Carli attributed to pressures from
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his own Parliament and from the European Economic Community.
That
did not bode well for the System's defensive efforts; the swap
arrangements provided an exchange guarantee but not a gold guarantee.
Even in
Germany, which had been a strong friend of the U.S.,
was a good deal of worry.
there
From time to time the Bundesbank had con
sidered the desirability of enlarging its swap arrangement with the
System.
However, there were divided views at the Bundesbank and in
some views the arrangement with the System was regarded with a
certain degree of suspicion in the absence of any visible trend
toward improvement in the U.S. payments balance.
As to the sterling question, Mr. Hayes said, he could not
recall a time at which there was as much profound worry as nownot only on the continent but also in the London financial community.
The maritime strike was a bitter blow at a time when it had been
thought that Britain was making a reasonable degree of progress in
recovering from the crisis.
The general feeling was that the strike
should not have occurred and no one seemed to know what could be done
about it.
Mr. Hayes remarked that the way in which the succession at
the Bank of England had been worked out was widely approved in the
London financial community.1/
1/ A sentence has been deleted at this point for one of the
reasons cited in the preface. The sentence reported a further
comment by Mr. Hayes on reactions to the succession at the Bank
of England.
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In concluding, Mr. Hayes noted that he had joined
Mr. Shepardson, and Mr. David Hayes of the Board's staff, at the
recent 150th anniversary celebration of the Bank of Norway in
Oslo.
Their reception had been a cordial one and the affair on
the whole was a pleasant experience.
Chairman Martin noted that Mr. Bopp recently had attended
the International Monetary Conference in Madrid and the Annual
Meeting of the Bank for International Settlements, and had visited
the Bundesbank, the Bank of France, and the Bank of England.
The
Chairman invited Mr. Bopp to comment.
Mr. Bopp said he had nothing new or encouraging to report
but that he was able to confirm on the basis of personal contacts
the reports that System members had been bringing to the Committee
for some time.
There was widespread agreement that inflationary pressures
existed throughout the Western World, Mr. Bopp observed.
In
Europe and particularly on the continent construction was rampant.
There was a widespread view on the continent that the United States
and the United Kingdom were primarily responsible for those devel
opments.
Mr. Holtrop, Chairman of the Bank for International
Settlements, was particularly emphatic that the inflation had been
exported from the United States to the continent.
He (Mr. Bopp)
had responded to that line of argument by saying that until just
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recently the United States had had relatively large unuilized
resources and stable prices.
In short, the U.S. had not until
recently had inflation and it was not convincing to blame a
country which did not have inflation for exporting it elsewhere.1/
There was also widespread feeling, Mr. Bopp continued,
that too much of the burden of restraining inflation was being
placed on monetary policy and that no central bank was receiving
adequate support from fiscal policy.
He had indicated that credit
conditions in the United States were significantly tighter than
was evidenced by looking merely at the discount rate.
The scarcity
of funds was reflected more in the Federal funds rate which at
times was as much as one per cent above the discount rate.
Mr. Bopp had found the greatest sympathy and understanding
of the American position in the United Kingdom which historically
had assisted other parts of the world and, therefore, appreciated
the American efforts to reconstruct Europe after the War.
Mr. Blessing had commented to Mr. Bopp that Germany now
had about 1,300,000 foreign workers, mostly from Spain and Italy
and some from Turkey and North Africa.
Recently there were seven
to eight vacancies for each unemployed person.
Mr. Blessing
1/ A sentence has been deleted at this point for one of the
reasons cited in the preface. The sentence reported a further
comment by Mr. Bopp on international discussion of the problem
of inflation.
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had indicated that he had no fear at all that tight credit would
create unemployment of German workers.1/
Chairman Martin then noted that Mr. Young recently had
participated in a mission to Vietnam to help that country deal
with its financial problems, and he asked Mr. Young to tell the
Committee about the negotiations.
Mr. Young said the mission was for the purpose of working
with the Vietnamese Government in developing a reasonable stabiliza
tion program.
The mission consisted of a team from the International
Monetary Fund going at the request of the Vietnamese Government; a
group of three persons from the White House, State Department, and
the Treasury to work on the problem from the U.S. point of view;
and finally, himself, participating in the capacity of adviser to
the Governor of the central bank.
As matters turned out, his own
role was largely that of mediator between the IMF and U.S. Govern
ment groups.
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material reported certain
further observations by Mr. Bopp on conditions in one of the countries
he had visited.
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The mission could hardly have been launched under less
promising circumstances, Mr. Young continued.
Vietnam was on the
brink of civil war, the army had been withdrawn from active combat
to deal with the internal situation, and military developments were
not going well.
There was extreme discouragement among U.S. person
nel in the field and in Washington; the Vietnamese inflation appeared
to have gotten out of hand, and there was no agreement among the
various agencies as to what kind of approach to a solution of the
problem would make sense.
The Vietnamese inflation was being propelled by rapid
monetary expansion, Mr. Young said, and was rendered more acute by
inadequate port facilities and harbor congestion, interdiction of
major highways by the Viet Cong--so that cargoes moving by truck
were either confiscated or subject to high tribute--and disorganiza
tion of agricultural production.
The rapid monetary creation
resulted partly from the deficits of the Vietnamese Government,
primarily in connection with military outlays, and partly from
expenditures by the U.S. embassy for various activities, including
military and civilian construction.
Expenditures by U.S. personnel
in Vietnamese currency, on the order of $100-$150 million a year,
added to the problem.
All told, the pace of monetary expansion
last year was about 74 per cent and the best estimate he was able
to obtain for this year was something over 100 per cent.
Prices
6/28/66
-24
were rising at an accelerating pace in Saigon, and probably even
more rapidly in the rest of the country although price indexes were
available only for the capital.
In sum, Mr. Young continued, the situation was one of
inadequate supply and extreme excess liquidity, with additional
liquidity being pumped in at a rapid rate.
At the outset the
situation appeared virtually hopeless, but the mission was able to
move forward when the Government was found to be interested in con
sidering a program for financial stability and capable of reaching
decisions on the subject.
Three alternative proposals were advanced,
of which one was a scheme for extinguishing money by financing
capital flight.
That alternative appealed to some members of the
cabinet but was rejected by Premier Ky on the ground that it was
morally wrong.
The second proposal, which involved a partial
devaluation, was the one finally accepted.
It introduced simplifi
cation of the exchange system, improvement in import tax procedures,
some fiscal measures that would add to the Government revenues but
would not cover the inflationary gap entirely, and, finally, action
to limit the expansion of private bank credit.
In addition, the
Vietnamese proposed to extinguish some liquidity by sales of gold
from their own stock.
The third alternative, which the Government
thought too difficult, would have involved a more severe devaluation,
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6/28/66
the establishment of a single rate throughout the exchange system,
and a rigorous control of the creation of money through Government
borrowing.
At one stage in the discussions, Mr. Young said, the Viet
namese appeared prepared to accept the second alternative, but the
situation was not completely clear because there was a strong
division in the cabinet and Premier Ky had not made up his mind.
He finally did so in the mission's last week.
Mr. Young was impres
sed by the fact that the Premier found time to consider the problem
in view of the many other pressing problems facing him.
In the end
it was pointed out to Premier Ky that the operation was likely to be
a painful one; that the partial devaluation proposed would increase
prices by some uncertain amount in the range from 5 to 25 per cent,
and that the additional inflationary jolt might be severe enough
to result in overthrow of the Government.
The Premier responded
that if his Government was not strong enough to carry out a program
of value to the people his cabinet should be overthrown.
Members
of the mission were quite impressed by his decision.
Mr. Young concluded by noting that the program had been
announced about a week ago and it had not had quite as drastic
effects as some had predicted.
Some prices had advanced sharply
but others only a little, so that the average increase might well
turn out to be reasonably moderate.
The mission was hopeful that
6/28/66
-26
the program would go forward as proposed.
If carried out as planned,
some further upward price adjustments would occur for about three
months.
Money creation then would be stopped for about twelve months,
with accompanying restraint on further price pressure from the mone
tary side, after which it would again resume.
If the monetary
program was reasonably successful, if port facilities were expanded
and imports increased, and if highway traffic was opened to the north,
it should prove possible to stabilize prices in Vietnam for most of
next year.
Another look at the program would then be in order.
Chairman Martin commented that Mr. Young's report was hopeful,
indicating as it did that the U.S. might not lose the war behind the
lines.
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 June 7 through 22, 1966, and
a supplemental report for June 23 through 27, 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:
The financial markets exhibited a great deal of
strength and resiliency over much of the period since the
Committee last met with a generally confident tone pre
dominating. The corporate and municipal markets handled
6/28/66
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an exceptionally large volume of new issues at high though
generally stable rates, while an unprecedented volume of
Federal agency financing was distributed at the higher
interest rates that had emerged. In the Government secu
rities market, where there was no pressure of new supply,
prices of notes and bonds rose appreciably while Treasury
bill rates moved sharply lower. By late last week, how
ever, market sentiment appeared to be again shifting.
And although the demand in the capital markets is expected
to be less in July than June, considerable uncertainty is
developing about the future course of both long- and
short-term interest rat s.
Commercial banks remained under pressure throughout
the period, with Federal funds and dealer loan rates
pushing into new high ground and with some prime banks
offering as much as 5-1/2 per cent for 30-day CD money.
The high cost of money has brought about considerable
discussion of a possible increase in the prime rate. At
the close of business last night dealers raised bankers'
acceptance rates by 1/8 per cent to 5-5/8 per cent bid on
90-day acceptances and to 5-3/4 per cent on longer
maturities. The markets are now awaiting the outcome of
the midyear interest and dividend payment period of the
thrift institutions and the implications of that outcome
for the mortgage market. Rate developments at some
savings and loan associations and mutual savings banks
just before and after the weekend have also raised
questions of a new round of rate competition among the
savings institutions. Against this background the markets
had become quite cautious and are currently in process of
assessing the implications of the Board's actions announced
late yesterday.
Developments in the market for Treasury bills led to a
further sharp rate decline, bringing quotations to the lowest
levels for the year and extending further the already wide
gap between bills and other money market instruments. Con
tributing to this unusual degree of strength were various
special demand factors, coupled with the reduction in
supply associated with the redemption of $4.5 billion June
tax anticipation bills. As a result of these developments
dealers' inventories were picked bare, with scarcities
evident throughout the whole maturity range. In fact,
total dealer positions in Treasury bills due in three-months
dropped to less than $100 million by last Friday, and the
latest outstanding 91-day issue closed last night at 4.33
6/28/66
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per cent. To be sure, a degree of caution has emerged in
recent days as market participants questioned the tenability
of current rate levels, and despite the scarcities of supply
dealers, in particular, have approached recent Treasury bill
auctions with mixed emotions. In last Thursday's auction of
new one-year bills, for example, tenders were spread over a
very wide price range, with the average issuing rate just
under 4.70 per cent and some awards at rates as high as 4.79
per cent. Market rates, particularly for long bills, tempo
rarily adjusted higher by about 10 basis points in the wake
of that auction, and a cautious atmosphere was again in
evidence yesterday as the regular weekly bill auction
approached. Average issuing rates for the three- and six
month bills were set at about 4.44 and 4.60 per cent,
respectively, with the weight of demand on the three-month
issue as banks bid to build up positions in advance of the
June 30 statement publishing date.
It is generally expected
that the available supply of bills will increase in the
period ahead as banks reverse their midyear window dressing
operations.
As far as the aggregate reserve measures are concerned,
bank credit expansion appeared to be lagging behind expecta
tions during the first part of the period, but then
accelerated in the statement week ended June 22 in the light
of loan demand related to the tax date and to the speedup of
Treasury collection of withheld income taxes from business
firms. Thus, on June 16, both the Board and the New York
Bank staff projections of average bank credit expansion in
June were only about 3-1/2 per cent. By last Thursday,
however, the projections had been raised to a 5-6 per cent
range, but were still below the 6-1/2 per cent estimate
made at the time of the last Committee meeting.
The rise in net borrowed reserves to $417 million in the
statement week ended June 22 was partly related to the stronger
than anticipated expansion in required reserves and bank credit.
However, country banks ran down their excess reserves in the
second week of their settlement period so that member bank
borrowing from the Reserve Banks actually fell. Moreover,
the sharp downward movement of Treasury bill rates and the
strong sentiment then existing in the securities markets
generally permitted a somewhat greater swing in the net bor
rowed reserve figures with little risk of signaling any change
in monetary policy. I believe it would be desirable to
condition the market to wider swings in the net borrowed
reserve figures in response to changing patterns of credit
6/28/66
-29-
expansion or reserve distribution, but given the tender state
of expectations in recent weeks there have been obvious risks
of market misinterpretations of the implication of such swings
for the discount rate or Regulation Q ceilings. I should note,
in this respect, that there is normally an unusually wide
swing in country bank excess reserve positions between the
second and third week in July.
In the past two years country
banks have built up their excess reserves to about $500 million
in the second week of July (the first week of their settlement
period), and then let them run down to $200 million or less in
the third week. We believe that this pattern is related to
unusually heavy calls by the Treasury on tax and loan account
balances at small- and medium-sized banks at that time of the
year.
In any event, assuming the pattern is repeated this
year and other things being equal, it would seem desirable to
let net borrowed reserves run lower than usual as reserves
become immobilized in excess reserves at country banks, and
then run higher as these excesses come into the reserve stream
at the end of the country bank settlement period. The market
should not find it difficult to understand this sort of vari
ation of net borrowed reserves.
Between now and the July 4 weekend the System will have
to supply around $1 billion in reserves, reflecting the cash
needs of the public over the holiday, in order to keep net
borrowed reserves near current levels.
Given the market
scarcity of Treasury bills, we have been giving a good deal
of thought at the Trading Desk to how these reserves might
be supplied. At the present moment, with at least some
improvement in the availability of Treasury bills likely,
and with the prices of Treasury coupon issues declining--in
sharp contrast to the situation a week ago--the prospect of
supplying reserves through normal channels does not appear
as difficult as it did earlier. A combination of outright
purchases of Treasury bills and other Treasury issues in the
market and from foreign accounts, repurchase agreements on
both Government securities and acceptances, and some decline
in Treasury balances at the Reserve Banks may be enough to
do the job. Given all the uncertainties, however, in face
of the large reserve need, I would like to outline to the
Committee an alternative approach which we might follow if
market scarcities of Treasury issues persist in the weeks
just ahead.
As the Committee knows, repurchase agreements against
Government securities are based on dealer financing needs
at the moment. Dealer financing needs lately have been
6/28/66
-30-
minimal because of the heavy demand for Treasury bills and
high dealer financing costs, and the repurchase agreement
has not therefore been a feasible means of reserve supply.
However, we are quite certain if dealers were told in advance
that repurchase agreements were available, they would be
able to find the necessary collateral by arranging back-to
back repurchase agreements with either banks or other holders
of Government securities who were looking for cash over a
period of expected money stringency. This approach would
not involve any change in the repurchase instrument. It
would involve a change from our usual practice of relating
repurchase agreements to dealer inventories to a use of the
dealers as a channel to those holders of Government securities
who have temporary cash needs and who would prefer not to
sell Treasury bills or other Government securities outright.
In order to give maximum flexibility to such a repurchase
agreement approach, I recommend that the Committee waive the
requirement that repurchase agreements be limited to Govern
ment securities maturing in 24 months or less for any
agreements entered into until the next meeting of the
Committee. Let me reiterate that such a departure from
normal practices may well not be needed, but in light of
recent market scarcities of Treasury bills I believe we
should do our contingency planning now.
As you know, the Treasury will end the fiscal year in
a strong cash position and will not actually need new money
until some time in August. Although no decisions have been
made, some sentiment exists for selling tax bills in July.
If this should be decided on, the announcement would probably
have to come before the middle of the month in order to get
the auction out of the way before the regular one-year bill
auction. Towards the end of July the Treasury will meet with
its ABA and IBA borrowing committees to consider the terms of
its August refunding, with an announcement likely on July 27.
Chairman Martin called for discussion of Mr. Holmes' proposal
that the Committee temporarily waive the requirement that repurchase
agreements be limited to Government securities maturing in 24 months
or less, first asking for Mr. Hackley's views.
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6/28/66
Mr. Hackley noted that the requirement in question was
contained in paragraph 1(c) of the Committee's continuing authority
directive.
If the Committee acted on the subject he would recommend
that it do so by amending the directive rather than by waiving the
requirement.
The substantive effect would be the same but in his
opinion an amendment would be the more appropriate form of action.
In response to Mr. Brimmer's question about the specific
time period in which he might use the proposed authority, Mr. Holmes
said that if used at all it would be in the period of reserve need
immediately ahead; thus, an authorization that remained in effect
until the next meeting of the Committee would be satisfactory.
The
authorization would be used only in an emergency situation, and it
was unlikely that the need for it would arise.
In his judgment,
however, there was enough uncertainty on the question to warrant
advance preparation.
Mr. Daane thought that granting the additional authority for
the period until the next meeting of the Committee would be appro
priate in light of the many uncertainties ahead, including those
related to the reactions to the Board's reserve requirement action
of yesterday.
Mr. Galusha asked what differential would be available to
the dealers in the "back-to-back" repurchase agreements in which
they would engage.
6/28/66
-32
Mr. Holmes replied that he would contemplate making the RP's
with dealers at the customary rate--the discount rate--and let market
competition set the rates at which dealers made RP's with others.
Mr. Galusha then inquired if Mr. Holmes thought there was
any possibility of criticism to the effect that the System was
offering dealers the opportunity to make windfall profits, and
Mr. Holmes said that such a possibility did exist.
Mr. Brimmer asked whether the proposed arrangements would be
restricted to nonbank dealers.
Mr. Holmes replied affirmatively, adding that there might
well be some criticism from bank dealers, who had expressed a desire
for the Deak to make RP's with them in the past.
He would not be
overly concerned with such criticism, however, because the arrange
ments would be made only if an emergency situation arose.
Presumably
banks would be among those that the nonbank dealers would get in
touch with immediately regarding their RP's, so that the funds would
be available to the bank dealers indirectly.
Mr. Brimmer then commented that he had recently attended one
of the discussions being held currently with dealers as part of the
Federal Reserve-Treasury dealer-market study.
The dealer involved in
the discussion had made the point strongly that the Desk did not
engage in a sufficiently broad go-around when it traded in coupon
issues; some dealers were left out and others appeared to have
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6/28/66
special access to the Desk.
He assumed the Manager would not exclude
any nonbank dealers in the operation now under discussion.
Mr. Holmes replied that the Desk would contact all nonbank
dealers, and would distribute the RP's among them about in proportion
to the amount of business the Desk had done with each in the past six
months, both in outright transactions and through repurchase agree
ments.
Chairman Martin noted that he thought granting the proposed
authority would be appropriate.
He suggested that the Committee
amend the continuing authority directive today and plan on rescinding
the action at its next meeting.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, paragraph
1(c) of the continuing authority directive
to the Federal Reserve Bank of New York
was amended to read as follows:
1. (c) To buy U.S. Government securities, and prime
bankers' acceptances with maturities of 6 months or less at
the time of purchase, from nonbank dealers for the account
of the Federal Reserve Bank of New York under agreements for
repurchase of such securities or acceptances in 15 calendar
days or less, at rates not less than (1) the discount rate
of the Federal Reserve Bank of New York at the time such
agreement is entered into, or (2) the average issuing rate
on the most recent issue of 3-month Treasury bills, which
ever is the lower; provided that in the event Government
securities covered by any such agreement are not repurchased
by the dealer pursuant to the agreement or a renewal thereof,
they shall be sold in the market or transferred to the System
Open Market Account; and provided further that in the event
bankers' acceptances covered by any such agreement are not
repurchased by the seller, they shall continue to be held by
the Federal Reserve Bank or shall be sold in the open market.
6/28/66
-34
Mr. Mitchell asked what level of net borrowed reserves the
Manager thought would be consistent with the increase in reserve
requirements of $400 million, assuming that the change in require
ments was a monetary policy action intended to result in tightening.
In other words, what level of net borrowed reserves would be
appropriate when the increase in requirements became effective?
Mr. Holmes replied that the answer would depend on the
Committee's own policy decision.
If the Committee chose not to
offset any part of the increase in requirements, as a matter of
mechanical calculation net borrowed reserves should be increased
by $400 million.
Mr. Maisel commented that the question appeared to be one
of timing.
He assumed that the Committee would not want the full
adjustment of $400 million to take place during the next four weeks.
Mr. Daane remarked that the Manager's reply made sense to
him; whatever change occurred in net borrowed reserves should reflect
the decision of the Committee.
There were many other factors to be
taken into account in deciding on operations, and he did not think
one could or should say that net borrowed reserves should be deepened
by any precise figure, such as $400 million.
Mr. Scanlon asked what level of net borrowed reserves the
Manager thought the Committee should call for if it was to implement
the Board's objective in raising reserve requirements as described
6/28/66
-35
in yesterday's press statement--namely, that it "would serve to
apply a moderate additional measure of restraint upon the expansion
of banks' loanable funds."
Mr. Daane said that Mr. Scanlon's question might be sharpened
if "a moderate additional measure of restraint" was defined as the
amount of further reduction in net reserve availability possible
without creating pressures that would require an increase in the
discount rate.
Mr. Holmes replied that the answer would depend on the nature
of other developments.
For example, the answer would be different
if there were a change in the prime rate at banks.
Mr. Hayes asked whether the psychological effect of the
reserve requirement increase might not in itself exert some moderate
restraint, even if there were no change in net borrowed reserves.
Mr. Holmes replied he thought that would be the case but,
again, it was necessary to wait to see how the market reacted.
Mr. Daane commented that the Board's action in fact had had
an immediate announcement effect, but that effect might or might not
taper off quickly.
Chairman Martin remarked that it was generally recognized
that time deposit funds would now cost more to the larger banks.
6/28/66
-36
Mr. Ellis commented that he found some difficulty in accepting
the notion that net borrowed reserves should be held at $400 million.
Required reserves had been increasing more or less steadily and if
that level of net borrowed reserves was maintained the Committee would
continue to supply all of the reserves demanded.
At the other extreme,
to deepen net borrowed reserves to $800 million would represent a
large change that would exert substantial pressure on the aggregates.
Mr. Swan observed that the fact remained that reserve require
ments would increase by $400 million on the effective date of the
action.
The Committee's choice was between offsetting some or all of
that increase or having the aggregates fully reflect the increased
requirements.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period June 7 through 27, 1966,
were approved, ratified, and confirmed.
The staff economic and financial report at this meeting was
in the form of a visual-auditory presentation.
(Copies of the charts
have been placed in the files of the Committee.)
The introductory portion of the review, presented by Mr. Brill,
was as follows:
This has been a rough year for forecasters; the economy
has come up with a number of surprises. The first-quarter
pace was more rapid than any of the forecasting profession
expected at the beginning of the year. And just when sights
6/28/66
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were being revised upward, the economy stumbled a bit and
produced a slower second quarter than expected.
These jerky movements in the pace of economic activity
make life interesting--and hazardous--for forecasters. At
the same time, they underscore the necessity of looking for
longer-term underlying trends, rather than at shorter-term
oscillations. Undaunted by the prospect that the economy
in the months ahead will continue to move less evenly than
forecasters' smooth lines, we have once more girded our
loins and faced up to the necessity of exploring prospective
economic and financial developments and their possible inter
actions with policy decisions. Our analysis this morning
will focus on the basic trends in activity and finance
likely to emerge over the remainder of this year and into
1967. But first we will begin with a review of developments
thus far in 1966.
Mr. Gramley then commented on economic and financial
developments through the first half of 1966, as follows:
Economic activity since mid-1965 has been stimulated
vigorously by increased defense spending. Outlays for
defense have risen $8 billion--or 16 per cent--in the past
year. The backlog of defense orders is up 26 per cent, and
production of defense equipment 27 per cent. The current
annual rate of defense spending already exceeds the amount
budgeted for fiscal 1967, and further expansion seems
clearly in prospect.
The defense build-up, occurring at a time of high
resource use, heightened pressures on capacity and
encouraged further expansion in business fixed investment.
On a GNP basis, business fixed investment has increased 13
per cent over the past year, and now accounts for more than
10-1/2 per cent of GNP. Business inventory demands also
have been strong, as firms have sought to maintain adequate
stocks to meet rapidly advancing demands.
GNP in current dollars increased between $16 and $17
billion in both the fourth and first quarters, but growth
then slackened in the second quarter of this year. The
fast pace of GNP during the winter months reflected a sharp
upsurge in consumption expenditures adding to the thrust of
rising defense and business investment outlays. In 1958
dollars, the first-quarter rise in GNP was at nearly a 6 per
cent annual rate, exceeding the large 5-1/2 per cent advance
for all of 1965.
6/28/66
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The rise in consumption slackened in the second quarter,
as auto sales fell from record first-quarter levels. Larger
tax payments retarded the growth of disposable income, and
helped to moderate consumer purchases in the period.
Responding to strong demands, nonagricultural employment
rose very rapidly from October through March. Employment
gains substantially exceeded growth in the labor force, and
the unemployment rate fell below 4 per cent this spring.
With experienced workers in short supply and labor turnover
rising, employers lengthened the workweek further, hired
younger workers, and accelerated in-plant training programs.
Employment gains moderated in the second quarter, partly
because of strikes, and cutbacks in auto production. The
total unemployment rate rose to 4 per cent in May, as teen
agers entered the labor market early for summer jobs. But
the unemployment rate for adult men fell to 2.1 per cent in
April and May--about as low as during the Korean conflict.
A tighter labor market has led to wage increases above
the guidepost in both high- and low-wage nonmanufacturing
industries, especially those engaged in local area bargain
ing. Wage gains in these industries have been about 4-1/2
per cent or more per year--considerably higher than the
increases in manufacturing. With wages rising faster than
productivity, higher labor costs, along with demand pressures,
have been reflected in rising prices for construction and
services.
In manufacturing, wage gains last year were still in
line with increased productivity, and unit labor costs
remained stable. Average hourly compensation has begun to
rise somewhat faster, however, and unit labor costs in
manufacturing have increased moderately since last fall.
With demands intensifying and labor costs firming, the
rise in prices of industrial commodities accelerated to an
annual rate of 3-1/2 per cent in the first half of this
year--up from the 1-1/2 per cent of last year. Despite
this acceleration, the total wholesale index has been
stable since February, when the earlier sharp rise in food
stuffs was reversed.
Sensitive materials have made a larger contribution to
the rise in industrial commodities this year than lastreflecting heightened demands for copper and aluminum, and
supply problems in hides and lumber.
For other, less sensitive, materials, price increases
have become more numerous, though not yet large. One reason
is that steel prices--under the influence of foreign
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-39-
competition and public pressures--have increased little.
The three-year labor contract in steel signed last September
called for wage increases about in line with the guidepost.
The price rise for producers' equipment picked up speed
early this year, as electrical equipment turned up and non
electrical machinery continued to rise. For consumer goods,
the rise in wholesale prices has remained relatively slowdespite increases for shoes and apparel, tires, cigarettes,
whiskey, and furniture. Consumer durables, apart from
furniture, generally have been stable.
The rise in consumer prices accelerated early this year,
mainly because of a further sharp increase in foods, and a
faster rise in services, especially medical care. Among
other consumer goods, prices of clothing and other nondur
ables have increased, while durables, on the average, have
been stable.
The substantial growth of GNP in the first half was
accompanied by large demands for credit. Total funds raised
over the first six months of this year, estimated at $83
billion, annual rate, were 15 per cent above the full year
1965. Federal borrowing (including sales of participation
certificates) rose appreciably. Private borrowing was 12
per cent above the rate for all of last year, with large
security flotations accounting for most of the increase.
Foreign borrowing remained below the high levels of
previous years, reflecting both the effects of the voluntary
restraint program and tightening in domestic credit markets.
Expansion of bank loans excluding mortgages continued
at the high 1965 pace, and banks added to their mortgage
holdings in volume. The increase in total bank credit
declined, however, to not far above the 1964 rate of advance.
To meet these large loan demands, banks liquidated
Federal securities, measured here to include
investments.
agency issues, declined at nearly a $7 billion annual rate.
Net acquisitions of municipals remained close to the 1965
pace.
The impact of monetary policy has moderated the growth
of money and time deposits. Growth of money and time
deposits together has receded appreciably from the unusually
high rates late last year, and recently has been running
between 7 and 8 per cent, annual rates, on a three-month
moving average basis.
The slowdown has been especially evident in time deposits,
which on average have been growing at about an 11 per cent
annual rate recently, compared with much higher rates early
6/28/66
-40-
and late last year. This slackened pace has occurred despite
marked increases in interest rates on time deposits paid by
banks.
Growth in money, on a moving average basis, also has
declined from the high rates sustained through late 1965.
Nonetheless, with the money stock increasing sharply in
April, and also in June, the effect of monetary restraint
on banks has been reflected principally in time deposits.
The effects of monetary restraint, together with
regulatory actions, have influenced greatly the inflows of
savings to nonbank intermediaries, as well as to banks.
Banks, over the first five months of this year, recorded
gains in total time and savings deposits equal to a 10 per
cent annual rate, down from 15 per cent a year earlier.
Seasonally adjusted inflows to savings and loan associations
fell sharply further, to less than a 4 per cent annual rate.
At mutual savings banks, the inflow fell to about a
2 per cent annual rate, well below accretions from the
crediting of interest to existing deposit accounts.
With deposit inflows moderated, while total funds
supplied increased, the share of the total supplied by
financial institutions declined appreciably. For banks,
the drop was to 28 per cent of the total; the share for
nonbank intermediaries also fell to 28 per cent. On the
other hand, funds supplied directly to credit markets by
the nonfinancial public--that is, by individuals, busi
nesses, and State and local governments--increased
substantially, in response to sharply higher rates of
interest on market securities.
Yields on long-term corporate new issues rose abruptly
in the first quarter when the supply of new securities was
unusually large. The market rally that developed in mid
March lost steam within a few weeks, and new issue rates
have since moved up to around the early March peaks.
In the short-term area, the bill market has been
sheltered from the full impact of rate pressures, as bill
rates have receded from earlier highs. By contrast, other
short-term rates have continued to rise. For example,
rates on finance company paper are now a full percentage
point above early December levels, and far above earlier
postwar peaks.
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6/28/66
Mr. Koch continued the presentation, focusing on prospects
for economic activity and prices over the next year.
He commented
as follows:
Looking ahead, there appears to be little prospect for
relief of pressures on resources and prices. Our current
projection anticipates a $14 billion growth in GNP in each
of the third and fourth quarters, with continuing rapid
expansion through the middle of 1967. In current dollars,
GNP in the next year is projected to increase 7.5 per cent,
nearly as much as in the previous 12 months. But with
prices increasing somewhat faster, growth in GNP in constant
dollars would be about 4.5 per cent.
Defense expenditures are a dominant factor in the
outlook. We have no official basis for projecting these
outlays, but recent statements by the Administration,
together with rising order backlogs for defense goods,
continuing high draft calls, and a military pay raise, all
point to a large further expansion. Our projection assumes
a $7.5 billion increase by mid-1967, with the largest part
of the rise coming before the end of 1966.
Continued gains in business fixed investment will also
contribute to growth in total spending. Major determinants
of investment--high profits and intensive utilization of
industrial capacity--remain expansive. Our projection calls
for an increase consistent with the 17 per cent rise for
1966 anticipated in the Commerce-SEC survey. With the pace
of business fixed investment exceeding the growth in GNP,
the share in GNP would rise still further, to over 11 per
cent by the middle of 1967.
While defense and business investment provide the
underlying strength, resumption of large gains in consumer
spending accounts for the more rapid growth of GNP after
midyear. Consumer outlays are scheduled to increase on the
average about $9 billion a quarter over the next year, even
though the saving rate is projected to rise from the low
second-quarter level. Disposable income is expected to
advance substantially, especially in the third quarter, with
faster growth in private wages and salaries, a Federal pay
increase, and a large rise in "transfer payments" arising
from Medicare and other Federal programs.
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The projected level of consumer demand would likely be
realized only if auto sales rise from the May level. Recent
consumer surveys do suggest strong underlying demand, and
early-June figures already show some recovery. We are
projecting a moderate rise in new car sales to an annual
rate of 8.5 million units for the new model year. In the
third quarter, part of the stimulating effect of higher auto
sales on GNP will be tempered by a large runoff in auto
stocks.
The weak factor in the over-all economic outlook is
residential construction. In line with recent developments,
housing starts are projected to decline to about 1.2 million
units by the fourth quarter, and to fall somewhat further
early next year. Limitations on funds for home financing is
the primary factor, and single-family starts may be reduced
somewhat more than for multi-family units.
Although sharp, the expected drop in housing starts is
not unprecedented. Declines about as steep occurred between
1955 and early 1957, and also from 1959 to 1960.
Despite the weakness in residential construction, growth
in GNP is sufficient to keep the capacity utilization rate
high. The projection calls for substantial expansion in
manufacturing capacity--on the order of 8 per cent over the
coming year. But with industrial output and sales expanding
rapidly, the utilization rate would remain close to 92 per
cent, declining only slightly in the first half of 1967.
Manpower demands would also continue very strong, with
nonfarm employment and the armed forces projected to increase
further. Unemployment is projected to decline to 3.5 per
cent, and experienced workers will continue in short supply.
The unemployment rate for adult men is not likely to rise
above the low frictional level of 2 per cent.
With profits high and gains in real earnings reduced by
rising prices, unions have been pressing for wage increases
well above the guidepost. Their demands may largely be
realized in major negotiations over the next year. Increases
in hourly compensation in manufacturing, at an annual rate of
3.6 per cent in the first half of 1966, could accelerate to
more than 4.5 per cent in the first half of 1967.
In nonmanufacturing, wage gains have already been
averaging about 4.5 per cent and could rise even faster.
Early next year, the minimum wage will be increased and
coverage will be extended substantially, especially in the
trade and service areas. With productivity gains slowing,
unit labor costs are projected to rise, putting pressure on
consumer as well as industrial prices.
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For many industrial materials and also for finished
products, higher costs and rising demands suggest an
acceleration of the price rise later this year or early in
1967. However, prices of sensitive materials, which con
tributed so much to the recent rise, are likely to increase
less rapidly. For example, upward price pressures may
moderate in markets for nonferrous metals. Lumber prices
have turned down and curtailment in residential construction
may provoke further declines. Prices of hides have soared
into a range where the elasticity of demand is high and
will inhibit further increase.
Altogether, the rise in industrial prices may remain
close to the recent annual rate of 3-1/2 per cent through
the second half, and could pick up additional speed there
after. Prices of foodstuffs probably will decline somewhat
through the balance of this year as supplies expand. Con
sequently, the index for all commodities may increase little.
Early next year, however, food prices may no longer be
declining, and the total index would then be rising again.
Prospective developments in commodity markets point to
a slowing in the rate of increase in the consumer price
index over the next six to eight months, but an acceleration
again thereafter. Food prices turned down in May, and
should be lower by early next year. Also, elimination of
heavy 1966 auto stocks may require large seasonal discounts
this summer. But by early 1967, average prices of other
goods may rise somewhat faster in response to increasing
labor and materials costs. For services, additional
increases are to be expected, as strong demands pull wage
rates up in many of these relatively low-wage industries.
Mr. Hersey continued the presentation, discussing balance of
payments developments and prospects, as follows:
In the U.S. balance of payments, the central development
in recent months has been a further shrinkage in the
merchandise export surplus, back to levels comparable with
1958. From peaks around $7 billion in 1964, the trade surplus
first fell off sharply in early 1965. This year the export
surplus has declined further, to average about a $4 billion
rate in the first five months and even less in April and May.
Easing of demand pressures in various foreign countries
in 1964 and early 1965 had its main adverse impact on our
exports during the first half of 1965. In the past 12 months
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expansionary forces abroad have heightened again. U.S.
exports rose briskly for a while, but from the second half
of 1965 to the first five months of 1966 the rise has been
at a rate of only five per cent a year. Intensified demand
pressure in the United States may have contributed to this
disturbingly poor export performance. It has certainly
been the main factor in the steep rise in imports, by 18
per cent between the second halves of 1964 and 1965 and by
16 per cent at an annual rate since then.
Imports of materials and supplies--including quota
restricted petroleum imports--rose 15 per cent further
from the second half of 1964 to the second half of last
year. Imports of final manufacturers, which have had an
average growth rate of almost 15 per cent over the past
decade, rose by nearly 30 per cent. Food imports also
rose more than usual.
Imports of materials excluding petroleum rose 17 per
cent between the second halves of 1964 and 1965. This
increase bore the same general relation to the 8 per cent
rise in U.S. industrial production of materials over the
same period as we have seen at previous times of unsustain
ably rapid expansion, as in 1955. The growth trend in use
of materials is steeper now than in the 1950's, but the
departures from trend, then as now, have been greater for
imported than for domestically produced materials. The
slower rise in these imports in early 1966 reflected the
tailing off of last year's large steel imports, and
Government stockpile sales also held imports down.
The shrinkage of the merchandise trade surplus has
been accompanied recently by other unfavorable developments
in the current account. Growth in U.S. receipts of direct
investment income has slowed, partly because oil companies
are experiencing lower prices and higher taxes in the
Middle East. The burden on the balance of payments of our
military expenditures abroad stopped shrinking last year
because of the Vietnam war. By the first quarter of 1966
these expenditures, net of military sales, had increased
to more than $2-1/2 billion, annual rate.
Consequently, the balance of goods and services"net exports" in the GNP accounts--was down to $6 billion,
annual rate, in the first quarter and is falling lower in
the second quarter. Outflows of U.S. private capital were
relatively stable in total from mid-1965 through the first
quarter.
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With these and other developments, the over-all balance
on the liquidity basis has been a deficit near $2 billion
annual rate so far this year. This deficit would have been
substantially larger but for shifts of foreign official and
international institution funds into technically nonliquid
assets. The amount of these shifts in the second quarter
has been large enough to make the deficit figure, whatever
it may turn out to be, a potentially misleading indicator of
recent trends. On the official reserves transactions basis,
the deficit has fluctuated widely, with an average rate of
$1-1/2 billion since mid-1965.
Given the outlook for expanding domestic demands, high
profits, and upward pressures on costs, few cheery signs can
be found for the balance of payments. Further reduction of
the net outflow of U.S. private capital looks unlikely. The
recent rate of about $3 billion a year--after adjustment to
exclude amounts financed by U.S. corporations' borrowings
abroad--is low, matched in recent years only briefly in 1962
when foreign demand for U.S. bank credit was small.
Direct investment outflows are likely to be at least
at the recent $2-1/2 billion rate, not counting either bor
rowings abroad or reinvestment of foreign earnings, because
U.S. corporations' plans for plant and equipment expenditures
abroad are very large and still growing.
Net U.S. purchases of foreign securities have been
sustained by Canadian new issues in this country. The net
outflow may remain near the $1 billion rate of the six months
through March.
In that recent period bank-reported claims declined, as
U.S. banks were getting net repayments of short-term credits
and were still reducing foreign liquid asset holdings of
their own or their customers. They were also reducing out
standing term loans to foreigners, under the impact of the
IET, the voluntary restraint program, and monetary tightness.
Recently, however, there have been net outflows of bank credit
in some months. With the present stance of monetary policy,
it is by no means certain that net reflows of bank-reported
claims on foreigners will continue.
With U.S. private capital outflows perhaps more
unfavorable, the projection made here of an over-all rate of
liquidity deficit later this year around $3 billion in the
absence of official window dressing assumes no further
deterioration of the goods and services balance beyond the
first half of this year. Further increases in military
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expenditures abroad may be about offset by gains from
investment income and other services. Merchandise exports
are expected to rise strongly, helped by resumption of raw
cotton exports at a reduced price. But imports seem certain
to increase rapidly, too, preventing any improvement in the
merchandise trade surplus.
The concluding part of the staff presentation, given by
Mr. Brill, was as follows:
The GNP projection presented this morning is, I
believe, a conservative estimate of the underlying strength
of economic activity.
Increases in GNP are projected at
$14 billion or more per quarter in the last half of this
year, and only slightly less thereafter. But defense
spending could easily accelerate faster than we can
presently anticipate, given recent trends in defense orders,
in draft calls, and in apparent target levels for the Armed
Forces.
Even without such a defense acceleration, the projected
rate of increase in GNP is well beyond what the economy can
produce with available resources, and still maintain stable
costs and prices. Capacity utilization rates remain high,
and the over-all unemployment rate is likely to decline
somewhat further over the balance of the year. In conse
quence, wage rate increases are projected to spread and to
accelerate. Since productivity growth would be at a slower
rate, unit labor costs are expected to rise and industrial
commodity prices are projected to increase at about a 3-1/2
per cent annual rate.
For balance of payments reasons, among others, these
demand and price pressures indicate a need for additional
restraint on spending. The projection implies an expansion
of imports continuing to exceed the longer-run trend, and
the export surplus would remain close to the recent low
level. The balance of payments deficit will be large.
Cooling off the domestic economy would provide some immedi
ate relief by moderating the rising tide of imports. More
importantly, it would reduce the likelihood of a longer-run
erosion of our competitive position in international markets.
In the absence of additional restraint on spending, we
would expect a continued high rate of credit expansion.
Funds raised in the second half of this year would match the
high rate we saw in the first half. The total for the first
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six months of 1967 would be moderated by reduced Federal
borrowing, made possible by tax receipts in excess of
accruals. But the rate of private credit expansion in
that six-month period would be fully as high as the average
for the two halves of 1966.
An immediate and across-the-broad increase in income
taxes would be the most certain--and the most generalmethod of tempering the advance of spending between now and
the end of the year. Unfortunately, present prospects are
for near-term fiscal stimulation. Our projection implies
that the Federal budget, on a national income and product
account basis, will shift to a significant deficit in the
third quarter, and remain in deficit through the remainder
of fiscal 1967.
If inflationary pressures are to be constrained, it
appears then that monetary policy would need to move
further toward restraining growth in bank deposits and
credit. Month-to-month swings in financial variables are
large, and it is hard to be certain about the target to
shoot for. But an average growth rate for money and time
deposits together of between six and seven per cent--some
what below recent rates--would, in my judgment, be a
reasonable next step in generating additional restraint on
spending.
With such a target, time deposit growth would likely
be smaller than the average for recent months--perhaps
about nine per cent. The growth of money balances
consistent with this--between 4.5 and 5 per cent--would
be a modest rate of increase in light of the underlying
strength of demands for goods and services.
Interest rates can be expected to respond briskly to
evidence of additional monetary restraint. Apart from the
Treasury bill market, financial markets are still taut.
The calendar of new long-term security offerings for July
is modest, but that for August is already large. Conse
quently, interest rates on new issues are likely to adjust
quickly to higher levels. While we have not tried to
forecast precisely how much change in interest rates might
occur, we would not be surprised to see new issue rates on
high-grade corporates approaching six per cent beforepossibly well before--the end of the year.
Rising market rates would raise questions about the
viability of the CD market. The highest rates quoted by
prime New York banks on 3- to 6-month maturities are now
at Regulation Q ceilings. Indeed, very recently rates of
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5-1/2 per cent have been paid for around one-month maturities.
Persistent upward pressure on market interest rates, with
present Regulation Q ceilings, would force larger banks into
significant portfolio adjustments if they persisted in meeting
customer loan demands.
We must also keep in mind that rising market rates might
also aggravate the problems of nonbank intermediaries. We are
on the eve of a period that might witness sizable shifts of
assets affecting financial institutions. Judgments as to the
magnitude of the problem are hazardous, and aggressive rate
increases by mutual savings banks and savings and loan associ
ations in the past few days, together with the Board's action
of yesterday, add additional unknowns to an already cloudy
situation.
Nevertheless--with more courage than confidence--we have
attempted to spell out some of the market consequences of
implementing, in open market operations, moves to additional
restraint such as the reserve requirements increase ordered
yesterday. Technical factors--including System buying over
the July 4 holiday and low dealer inventories--would probably
cushion the impact of restraint in the bill market. The bill
rate, however, would most likely begin to move back into
closer touch with money market conditions. Thus, bill rates
might be expected to rise from 10 to 20 basis points over the
next four weeks. Other short-term rates--represented here by
the yield on three-month Federal agency issues--might increase
somewhat more, perhaps from 15 to 25 basis points.
Long-term rates are likely to respond promptly to upward
pressures on short rates, with yields on long-term Governments
increasing perhaps 5 to 10 basis points over the four weeks,
and yields on other long-term instruments rising somewhat
faster.
The net borrowed reserve figure consistent with this
behavior of market rates is exceedingly difficult to specify
in the present fluid situation. There are many specific as
well as general uncertainties, including possible sharp
seasonal swings in country bank reserve flows, and the unknown
potential for borrowing by mutual savings banks in connection
with deposit drains if the System adopts the proposal to act
as a lender of last resort for this group of intermediaries.
As the roughest of guesses, we show here a band ranging from
$400 to $450 million, but perhaps a somewhat deeper marginal
reserve target might be needed over the longer run to sustain
the interest rate levels pictured here.
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In implementing a policy of additional restraint, open
market operations should smooth the transition to tauter
financial markets. Further increases in market rates of
interest should be welcomed, and indeed encouraged, but
credit market conditions cannot be allowed to tighten too
abruptly. Indeed, market conditions may need to take
precedence over marginal reserve measures as operating
targets. On the other hand, cushioning actions should not
be allowed to offset fully the move to increase required
reserves. It will be difficult to guide the ship of policy
between these two reefs.
In reply to a question by Mr. Swan, Mr. Brill said that the
staff had not attempted a projection for the Federal funds rate.
Mr. Mitchell asked what probability the staff attached to
its projection for GNP.
Mr. Brill replied that the projection described the outcome
that the staff considered most likely, given the estimates for
defense spending.
By coincidence, it was not greatly different
from some other forecasts being made in Washington currently.
There
were some differences, mainly relating to the expected distribution
of auto sales between the third and fourth quarters, but the estimates
for the fourth quarter nevertheless were quite close.
Of course, the
levels of defense expenditures assumed were critical in all of the
projections.
Mr. Mitchell then asked what implications the kind of mone
tary policy Mr. Brill recommended would have for the GNP projection.
Mr. Brill replied that in his judgment a policy of limiting
the growth in money and time deposits to a rate between 6 and 7 per
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6/28/66
cent would produce a significant slowing in GNP in the fourth
quarter--perhaps not down to a $10 billion growth rate, but in that
direction.
He recommended such a monetary policy for the longer run;
for the short run he would advise caution because of the great
uncertainties associated with flows of funds among financial institu
tions.
As a first step he would suggest not offsetting fully the
effect on nonborrowed reserves of the increase in reserve require
ments; and then, if there were no adverse reaction, pushing
cautiously further to achieve a slowdown in deposit growth.
Mr. Mitchell commented that he was disturbed by the
possibility of overly generous wage settlements if the economy was
ebullient at the beginning of 1967.
He asked whether the policy
Mr. Brill advocated was a counsel of futility, involving holding
the line as best possible, or whether it was likely to prove
corrective.
Mr. Brill replied that the recommended policy was intended
to be corrective.
At the same time, he did not think enough was
known to say that a 6 or 7 per cent growth rate in money and time
deposits would cut back the expansion in GNP to some particular
figure, such as $10 or $11 billion per quarter.
Mr. Hickman asked what level of net borrowed reserves
Mr. Brill would recommend for the short run, in view of the pressures
expected at savings and loan associations and mutual savings banks
in the next few weeks.
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Mr. Brill replied that his short-run prescription was to
keep net borrowed reserves somewhat above the $400 million level,
but to watch closely the markets' reaction and the flows at
financial institutions.
In effect, he recommended a short-run
policy of cautious probing, recognizing the uncertainties about
flows at intermediaries in the coming period, and recognizing
that later it might prove necessary to deepen net borrowed reserves
considerably further.
The Committee was tentatively scheduled to
meet again on July 26, and it could then decide whether to move
more aggressively, depending on, among other things, what new
information was available on defense spending.
Mr. Hickman commented that he would expect pressures at
the discount window to increase as net borrowed reserves deepened,
the present discount rate to become untenable, and present
Regulation Q ceilings to be out of line with market rates.
In
effect, there would be a general upward ratcheting of interest
rates.
Mr. Brill observed in response that maintaining the exist
ing Regulation Q ceilings in a period of rising rates would in
itself provide a measure of restraint.
Mr. Koch made two observations with reference to the
preceding discussion.
First, he noted that the staff projected
housing starts to fall to a rate of 1.2 million by the fourth
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quarter of 1966, and that the projection would have to be lowered if
policy was tightened further.
However, the level of 1.2 million
starts in itself was below other estimates currently being made in
Washington, and those other estimates already were giving rise to
concern.
Secondly, he confessed to being somewhat puzzled by the
discussion of the reserve requirement increase.
As he interpreted
that action, its main effects were to increase costs to large banks
and to decrease their liquidity slightly; any other tightening would
have to come through open market operations.
Mr. Hickman commented he was highly disturbed by the projec
tions for defense spending presented today, of which there had been
no inkling in the Cleveland District.
Personally, he had vacillated
on the subject of taxes but if the defense projections were correct
a tax increase was clearly needed since monetary policy could not do
the job alone.
He concluded that the System should bring as much
pressure as possible on the Administration to act on taxes.
Chairman Martin then noted that copies of a staff memorandum
addressed to the Board, entitled "Emergency credit facilities for
mutual savings banks," had been. distributed to all Reserve Bank
Presidents on June 27.
Copies of a related document prepared at the
New York Reserve Bank also had been distributed.1/
Chairman Martin
1/ Copies of the documents referred to have been placed in the files
of the Committee.
6/28/66
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invited Mr. Treiber to open the discussion of the subject of the
documents.
Mr. Treiber made the following statement:
The Board of Governors of the Federal Reserve System
and all the Reserve Banks have been furnished with copies
of a document prepared by the Federal Reserve Bank of New
York under date of June 22, 1966, entitled "Plan to Assist
Savings Banks in Meeting Extraordinary Withdrawals." Three
exhibits are attached to the plan. These papers were pre
pared in the light of intense discussions with the heads
of large savings banks and Savings Banks Trust Company,
and, also, a large member bank.
The Board of Governors has approved the making by the
Federal Reserve Bank of New York of advances to member
banks on the Collateral Trust Notes of Savings Banks Trust
Company referred to on page 3 of Exhibit B.
The plan is designed to meet an emergency situation
that may never arise. Indeed, we think that the Federal
Reserve Bank of New York is unlikely to be asked to lend
directly to a savings bank or to Savings Banks Trust
Company, or to lend indirectly to the Trust Company through
a conduit loan as described in Exhibit B. But it is
important to have the machinery in working order. We
believe that the machinery is in good order.
In working out the plan it was the view of all involved
in the negotiations that publicity should be avoided. With
drawals by depositors of savings banks could be accentuated
greatly if there were wide discussion of a fear of a run.
It seemed wise to keep the discussions to a limited group.
It seemed unwise, for example, to suggest that all, or even
the principal, savings banks have their directors adopt
resolutions authorizing their officers to borrow directly
from the Reserve Bank. It also seemed unwise to bring a
large number of savings banks into discussions of minutiae.
We think that the brunt of the demand of savings banks
for credit accommodation to pay their depositors will fall
on the commercial banks which have over $1 billion of credit
lines to the New York savings banks. Member bank access to
the discount window will continue to be subject to the usual
disciplines.
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Only in the event of vast withdrawals by savings bank
depositors would the special arrangements come into play.
We expect to be in continuing close contact with Savings
Banks Trust Company, the heads of large savings banks, and
the head of the member bank with which the Trust Company
has its principal relations. We would also be in frequent
contact with the heads of the other principal member banks
in New York.
We would be prepared to lend directly to the larger
savings banks on direct obligations of the United States.
Presumably these would be savings banks in New York City.
In the normal course of events the smaller savings banks,
and the out-of-town banks, would seek emergency accommoda
tion in the first instance from Savings Banks Trust Company.
We would be prepared to lend directly to the Trust Company
on direct obligations of the United States, but it is
questionable whether the Trust Company would have such
obligations available as collateral.
The conduit arrangement under which the Reserve Bank
would make a loan under section 10(b) of the Federal Reserve
Act to a cooperating member bank on the Trust Company's
Collateral Trust Notes would be invoked only after consulta
tion between the Trust Company, its principal member bank,
and the Reserve Bank.
We understand that savings banks hold a negligible
amount of assets that would qualify as "eligible paper"
available for discounting under the third paragraph of
section 13. We think it would not be worthwhile to try
to use such paper. We would consider it unwise in an
emergency situation to introduce the additional complicating
factors that would be involved in the use of such paper.
It must be apparent that in an emergency situation,
with a severe run on savings banks, speed is of the essence.
Judgments will have to be made quickly on the basis of facts
available at the time. We would have one of our own men in
the Trust Company to see developments at firsthand and to
help assure that administration of the Trust Company's
lending policies are in accord with the approach which has
been agreed upon in our discussions with the Trust Company.
All in all, we think we have a workable arrangement.
Each borrowing case must be administered flexibly and on
its own merits. This observation applies both to the
extension of the credit and to the arrangements for paying
it off.
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6/28/66
Mr. Daane asked whether there were any important differences
between the procedures Mr. Treiber had outlined and those suggested
in the Board's staff memorandum.
Mr. Partee said he thought the staff plan completely
accommodated the plan of the New York Bank.
The staff plan was
developed in response to the need for a more general approach than
New York's--one that could be used in other Federal Reserve Districts
and in connection with institutions other than mutual savings banks.
He then briefly summarized the staff plan, as set forth in the memo
randum.
Mr. Treiber indicated that the New York Bank was basically
in accord with the approach recommended by the Board staff.
Mr. Ellis observed that while the Reserve Bank was prepared
to adopt emergency measures to assist mutual savings banks in the
Boston District, his appraisal suggested that such measures were
not likely to be necessary.
In the past month District savings
banks had "freshened up" their credit lines with correspondent
commercial banks, which Mr. Ellis estimated at a total of about
$200 million.
The large commercial banks had reassured the savings
banks that their lines would be honored and knew that they in turn
could borrow at the Reserve Bank if necessary.
Deposit losses at
savings banks had not been of great magnitude in April.
The banks
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6/28/66
had been alerted to the possibility of losses in July and had been
preparing for it, so they were not likely to be caught short.
Mr. Ellis said he agreed with the general tone and specific
proposals of the staff memorandum.
He asked, however, whether it
might not be desirable for the Board to issue a statement to the
effect that the Federal Reserve would make funds available to mutual
savings banks if necessary, so that all such banks would be informed
and possible misunderstandings avoided.
He agreed that it would be
undesirable to suggest a sense of urgency on the matter, but at the
same time it would be useful to let all mutuals know that liquidity
would be provided as needed.
Mr. Bopp said that three of the largest savings institutions
in Philadelphia had reported no accelerated outflows of funds in June.
They did not expect much outflow in July and thought that their
liquidity positions were adequate at present.
More generally, the
Reserve Bank had heard no expressions of concern on the part of
District institutions.
He had not yet had a chance to study the
staff memorandum, but he shared the view Mr. Ellis had expressed.
Mr. Wayne said that the only mutual savings banks in the
Fifth District were located in the Baltimore area.
Those banks had
expressed no concern about anticipated losses; their concern was
with a possible slowdown in inflows against large forward commitments.
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He would concur with the staff proposals and proceed as necessary, but
he did not anticipate a problem in the District.
In subsequent discussion of Mr. Ellis' proposal it was agreed
that giving general publicity to the emergency program was likely to
create more problems than it would solve, by stimulating concern on
the part of depositors.
It was suggested that the Reserve Banks
inform savings banks in their Districts of the program directly.
In
those Districts where the number of such banks was too large for such
a course to be feasible, it was suggested that those known to be
anticipating problems should be contacted.
Mr. Brimmer said it was not clear to him whether the emergency
program was to be restricted to savings banks.
He expressed interest
in hearing the views of the Presidents on that question.
Mr. Treiber noted that the Federal Home Loan Bank System
provided a mechanism for meeting the needs of savings and loan
associations.
Moreover, he understood that a few individual savings
and loan associations had lines of credit with member banks in New
York, and he had no doubt that those banks would extend credit under
the lines in question.
In general, there did not appear to be any
need for making additional provision for savings and loan associations
in the Second District.
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Mr. Brimmer noted that the Board staff memorandum included
the following statement on page three:
"Emergency needs for credit,
if any, seem most likely to develop among mutual savings banks
although it is conceivable that sizable deposit outflows might also
be experienced by a relatively few credit unions, nonmember banks,
and savings and loan associations not having access to Federal Home
Loan Bank credit, where assistance would be indicated."
He suggested
that if it was clear that the System would not be called on as a
lender of last resort by such institutions the matter could be laid
aside.
If that was not clear, however, some decision should be
reached regarding them.
Mr. Swan concurred, and drew attention to the following
statement on page two of the staff memorandum:
"The staff believes
that the posture of the System should be to prevent to the best of
its ability any depositary-type financial institution from failing
during this period due to lack of liquidity."
With respect to
savings and loan associations, Under Secretary of the Treasury Barr
had met in San Francisco last Friday (June 24) with some commercial
bankers, and had indicated that about $5 billion was available for
the assistance of the associations, including funds recently raised
by the Home Loan Bank System, funds of the Federal Savings and Loan
Insurance Corporation, and some $2 billion that the Treasury was
prepared to deposit directly in the Home Loan Banks.
Mr. Barr
6/28/66
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thought that that sum would be adequate to deal with the situation.
If it was not, however, the System would be faced with the question
of whether it should channel credit through the commercial banks to
the savings and loan associations.
He assumed that the System would
do so if the need arose.
Mr. Irons said that that was his assumption also.
He
observed that there were some savings and loan associations in the
Eleventh District that were not affiliated with the Federal Home
Loan Bank, and as he read the staff memorandum it was contemplated
that the System would act as lender of last resort for them.
Mr. Brimmer noted that at the present point the staff memo
randum did not reflect an official System position.
After further discussion, Chairman Martin suggested that
the substance of the staff memorandum be approved by the members of
the Board and the Reserve Bank Presidents as a general statement of
System policy, and there was no disagreement.
Chairman Martin then called for the go-around of comments
and views on economic conditions and monetary policy.
Mr. Hayes
submitted the following statement for the record, after summarizing
it orally:
spite
tion,
plans
there
Business activity in May was stronger than in April, in
of a drop in automobile sales and residential construc
and some decline in steel production. Capital spending
remain strong. Government spending is rising. While
are some signs of lessening pressures on capacity, labor
6/28/66
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resources, and prices, the over-all situation is still
characterized by excess demand. Slackening of pressures
should be welcomed rather than interpreted as pointing
to a business downturn. There is no indication so far
that this has gone far enough to eliminate our concern
over inflation, much less to be interpreted as
foreshadowing a decline in business activity. The
uncertainties in Vietnam are ever present, but at this
point we do not envisage any fundamental change in the
economic outlook.
Returning from a trip which offered wide opportuni
ties to take informal soundings, I am impressed by the
new wave of skepticism as to our will to handle our
balance of payments problems. The heavier-than-expected
foreign costs of the war in Vietnam explain only to a
limited extent the disappointing developments in our
balance of payments. And even if these costs may be an
important contributing factor, they do not constitute a
valid excuse, in the eyes of foreign observers, for
inaction with respect to remedial policies. Efforts to
improve the statistical picture through a rearrangement
of maturities of our liabilities cannot hide the fact
that, instead of moving toward equilibrium, we are
backsliding. I am particularly disturbed by the deteri
oration of the trade surplus, on which so much reliance
has been placed to achieve balance.
In the last two weeks, the banking system has
handled smoothly large flows of funds and has accommodated
a large volume of tax-related borrowing. The banking
system has taken the June 15 tax date in stride, but
unexpectedly heavy borrowing developed in the following
week in connection with the forward shifting of withhold
ing tax payments. Bank liquidity positions have declined
further, and loan-deposit ratios are at record levels.
Banks are willing to pay the maximum permissible rates on
the shortest-term certificates of deposit to attract or
hold funds.
The early June credit data, which do not fully
reflect heavy tax borrowing, appear to be consistent with
the moderate slowing down of total bank credit expansion
so far this year. But credit demands remain strong, and
the pace of loan expansion is likely to quicken in July.
Financial markets have been buffeted by peace rumors
and conflicting interpretations of recent business news,
including views that a topping out of the boom may lie
6/28/66
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ahead. As a result, the stock market has been listless
and the volume of transactions moderate.
In recent weeks,
a relatively large flow of corporate and municipal
offerings, including some large issues, has been absorbed
surprisingly well. However, over the past few days a
change in sentiment has been developing, which could well
lead to further upward pressures on yields despite the
relatively light calendar immediately ahead.
The impact of the midyear interest payment date on
the savings and loan associations and mutual savings banks
is now the next hurdle to get over. While I have the
impression that some of the apprehension is exaggerated,
we must of course do everything in our power to avoid a
liquidity crisis.
I have a good deal of confidence that
the various arrangements made to cushion any undesirable
developments will prove to be fully adequate.
After an absence of five weeks, I am impressed by
two developments--first, a slackening of very strong
inflationary expectations; second, growing evidence that
our increasingly restrictive monetary policy is having
pervasive effects in all financial markets. Credit
availability and the willingness to make forward commit
ments have been reduced significantly, and credit costs
have risen. Financial intermediaries are under intensified
pressure from a reduced inflow of funds and increased
demands.
The modest slackening of inflationary expectations
in no way alters the need for further restraint through
appropriate public policies. On the contrary, the strong
basic outlook still calls, in my judgment, for an effective
assist from fiscal policy in the form of a tax rise. On
the other hand, the reduction, for the time being at least,
in the intensity of the pressures in some sectors of private
demand permits us to give full weight to the need for a
cautious monetary policy in a period when thrift institu
tions could be subject to significant deposit drains.
Depending on how the market reacts to yesterday's
announcement, we may not have much leeway to deepen net
borrowed reserves, without calling into question the current
discount rate and the related Regulation Q ceilings. Net
borrowed reserves in the range of $350-$400 million seem
appropriate, with borrowings averaging in the neighborhood
of $650-$700 million. These ranges may have to be modified
in the light of unusual liquidity pressures or of an
unexpected burgeoning of credit demands.
6/28/66
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The time may come fairly soon to consider an increase
in the discount rate, especially if the rising cost of money
to banks should trigger a prime rate increase--and I would
not rule out the possible need, under those circumstances,
for consideration of further changes in Regulation Q ceilings.
However, I believe that right now we ought to tread cautiously
in view of the sensitivity of this midyear period--even though
we will enter a period of Treasury financing by late July and
possibly sooner. Alternative A seems quite acceptable for the
second paragraph of the directive, although I would suggest
breaking up the very long sentence into two sentences.1/
With regard to the telegram 2/ requesting comments on
commercial bank promotional activities to attract savings
funds as the interest payment date approaches, we find that
in our District advertising of bank "savings bonds" and
savings certificates, while not as extensive as three months
ago, is spirited and aggressive. A few banks are engaged now
in active advertising campaigns, using advertisements,
frequently of a very large size, and offering a variety of
such instruments with characteristics designed to attract
different categories of deposits. They invariably stress the
higher interest rates offered. These banks, which include
three of the largest banks located on Long Island, have been
advertising in the New York Times, which has a national
circulation.
However, we have found only limited evidence that
commercial banks in general are stepping up their promotional
activities in an unusual degree to attract time and savings
deposits around the end of June. It is problematical whether
the recent rate increases of several New York savings banks
will tend to set off a new wave of competitive rate moves.
1/ The draft directives submitted by the staff for consideration by
the Committee are appended to these minutes as Attachment A.
2/ Under date of June 22, 1966, Mr. Sherman had sent the following
telegram to the Reserve Bank Presidents: "In connection with go
around at Open Market meeting June 28, Board members would appreciate
having Presidents include comments on question of whether commercial
banks are now increasing or are planning to increase advertising or
other promotional activities to attract time and savings deposits
around end of June. It is not intended that you make a general sur
vey but that comments be based on what you have observed or heard or
may learn from spot checks."
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Mr. Francis said that impressions received from a few spot
checks and from other contacts with bankers were that outside of
the St. Louis metropolitan area there were very few new advertising
or other promotional campaigns in the Eighth District directed
primarily to attracting time and savings deposits around the end of
June.
In the St. Louis area, where competition for savings was
especially keen, bank advertising expenditures had been accelerated
recently, but he did not expect any difficult liquidity problems in
savings and loan associations to result.
Mr. Francis reported that the St. Louis Reserve Bank had
just completed a series of meetings throughout the District with
member bankers and representative groups of businessmen.
It had
found accelerating demand for products, for materials, and for
labor.
So great were the demands that shortages were prevalent;
equipment shortages, materials shortages, and labor shortages.
demand for highway trucks exceeded supply.
The
The great demand for
copper, along with the limited supply, was creating bottlenecks.
Here, price controls were preventing an allocation of supplies to
the most useful purposes.
Copper was generally utilized for pots
and pans and spouting while inadequate amounts were available for
the production of electric motors.
As a result of the vigorous demand, Mr. Francis said,
prices of products, of materials, and of labor were being pushed
6/28/66
-64
up rapidly.
Manifold inefficiencies of production arose as dollar
demand exceeded practical efficient production.
Wages were increas
ing more than appeared, as less efficient labor was applied to
particular jobs.
The rate of inflation of prices was more than the
indexes showed, as discounts had disappeared, premiums were paid,
and less efficient mixes of resources were necessitated.
That inflation-creating excessive demand was being fostered
by rapid bank credit expansion, Mr. Francis said.
In the Eighth
District business loans of reporting member banks had been expanding
at a 25 per cent annual rate since December.
In the nation, according
to the Reserve Bank's figures, the supply of money was continuing to
increase at a rate of about 6 per cent per annum, although in light
of the inflation and higher alternative costs of holding cash, the
demand for cash balances relative to GNP was continuing to decline.
As Mr. Francis saw it, the great total demand for goods and
services, fostered by the stimulative fiscal stance and rapid monetary
expansion, was pushing up prices of goods and services and also demand
for investment funds.
The excessive demand for funds, in turn, was
pushing up interest rates and possibly was distorting the institu
tional pattern of flow of investment funds.
Mr. Francis urged a limitation on the rate of monetary
expansion.
In the absence of appropriate fiscal restraint--namely,
a large budget surplus--the necessary monetary restraint would
6/28/66
-65
probably raise interest rates.
But if total demand were adequately
restricted, demand for investment funds also would be limited, and
the basic forces pushing interest rates up would be kept in bounds.
If total demand was not limited by those or other means, and price
inflation continued, interest rates would be increasingly bid up,
as they had been in other periods of inflation.
The Committee did
not and could not keep a rein on interest rates, under present
conditions, with bank reserves, bank credit, and money expanding
more rapidly than the productive capacity of the country.
Indeed, Mr. Francis continued, while it was generally
believed that interest rates had been rising in a restrictive
manner during the past year, they had, in a very real sense, not
done so.
The cost of money to the borrower and the return to the
saver were affected by changes in the value of the dollar.
When
one adjusted market interest rates for the decline of the value of
the dollar as measured by the implicit price deflator, one found
that interest costs had not risen at all in the past year and that
the real return to the saver had not increased.
Hence, during the
year market interest rate increases had provided no restriction to
the excessive total demand either through discouraging spending or
encouraging saving.
If limitation of expansion of bank reserves, bank credit,
and money resulted in further increases in interest rates, Mr. Francis
6/28/66
-66
said, institutional dislocations such as those connected with savings
and loan associations and mutual savings banks would be augmented.
But if the choice lay between further facilitating and possibly
accelerating inflation, on the one hand, and having to face up to
some institutional problems, on the other, he thought the welfare of
the nation clearly required the latter.
As indicated in the staff
memorandum discussed earlier, the System had the means, or could
devise the means, to provide savings banks and savings and loan
associations with enough liquidity to prevent inordinate financial
dislocations while at the same time not supplying the economy with
the liquidity which would contribute to excessive total demand.
During most of the past year, Mr. Francis observed, the
Committee's directives had provided that the growth of bank reserves,
bank credit, and money should be moderate, and since April they had
called for restricting growth in those magnitudes.
Nevertheless,
bank reserves had grown at a rate of 5 per cent, bank credit 9 per
cent, and the money supply about 6 per cent.
In a period of exces
sive total demand those rates, high by all historic standards, had
not been moderate or restricted.
He believed that the Committee
should now take those words of the directive seriously and literally,
and do what was necessary at the Desk over the next few months to
make them effective.
He favored alternative B of the draft directives.
6/28/66
-67
Mr. Kimbrel reported that, although the general level of
economic activity remained high in the Sixth District, several signs
of a slowdown in the rate of expansion were being found.
Total non
farm employment had been almost stable since January, and average
weekly hours worked in manufacturing had been trending downward
since February.
Retail sales in May, according to the Reserve Bank's
estimates, dropped 3 per cent on a seasonally adjusted basis from
April, a somewhat greater decline than nationally.
In part the drop
might reflect the slower gain in District personal income that had
characterized the past few months.
uted to slower auto sales.
But a large part might be attrib
In turn, lower automobile sales had been
reflected in a 4.5 per cent decline in April from March in the volume
of new consumer instalment loans extended by District banks.
The
lower rate of credit extensions did not seem to reflect a stiffening
of standards, according to various lenders contacted.
Latest information on construction for the District,
Mr. Kimbrel continued, suggested that, although there had been no
dramatic change, total contracts had been drifting downward, and
construction employment was probably over 5 per cent lower on a
seasonally adjusted basis than in January.
Moreover, there might
be a greater decline in the future if the results of the Atlanta
Bank's regular quarterly tabulation of the dollar volume on new
and expanded manufacturing plants announced for future construction
6/28/66
-68
in the District was any indication.
Preliminary figures for the
second quarter of 1966 showed a dramatic decline from those of the
first quarter, although in interpreting the figures it was well to
remember that the first-quarter figures were unusually high.
Never
theless, the second-quarter dollar volume was considerably below
that of the same quarter of last year.
Continuing, Mr. Kimbrel reported that partial data for May
indicated that the net flow of funds to savings and loan associations
improved slightly and that some investors from outside the District
had returned to the market for FHA and VA loans.
Nevertheless, those
changes had not been great enough to affect terms or to lower rates.
Thus far, Mr. Kimbrel observed, the emergence of new
competition by commercial banks for time deposits by offering higher
rates seemed to be confined to the Miami area.
At least three of the
smaller banks there, according to advertisements, were offering
savings-type certificates at rates between 5-1/4 and 5-1/2 per cent.
Terms were very diverse, with one bank offering 5-1/4 per cent with
a six months' maturity on a minimum of $2,500 and another 5-1/2 per
cent for three years with a $1,000 minimum.
Although bank advertis
ing continued heavy elsewhere, as yet there had been no general
increase in promotional activities and in rates.
However, it was
rumored that some banks were planning to alter their promotional
activities in response to new savings and loan rate competition.
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6/28/66
Savings and loan associations in Atlanta had announced 5 per cent
rates generally associated with a minimum time and amount.
The apparently slower rate of expansion in District economic
activity had not been paralleled by a slowdown in bank credit, Mr.
Kimbrel commented.
During the first three weeks of June, according
to data from weekly reporting banks, loan growth continued.
The
bank lending practices survey just completed showed either stronger
loan demand than in March or loan demand that was unchanged from the
previously strong position.
If economic conditions in the Sixth District could be
considered typical of those throughout the nation, Mr. Kimbrel
concluded, they suggested to him that one should take any further
restrictive actions with considerable caution.
Mr. Bopp remarked that a principal problem at present was
the lack of harmony between over-all flows of money and credit and
the allocation of funds among different lenders and different
sectors of the economy.
Restraint had been felt markedly in the
housing and mortgage-lending industries; meanwhile, bank credit and
the money supply had grown more rapidly than was desirable at the
current fast pace of business.
In the Third District, Mr. Bopp said, the mortgage market
had become increasingly tight.
in the past three weeks.
FHA discounts continued to deepen
Current "prime" FHA mortgages were now
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6/28/66
discounted from 5-1/2 to 7-1/2 points; the average had been 3 points
in April and 4-1/2 in May.
from 7-1/2 to 12 points.
Lesser quality FHA's were now discounted
Those tight conditions had prompted a local
"builders' holiday"--a rally called for today aimed at protesting
market conditions.
With regard to the Board's query on commercial bank advertis
ing, Mr. Bopp reported that most of the large Philadelphia banks had
already shifted the emphasis of their copy to attracting savings.
One large bank, for example, had doubled the amount of space and time
devoted to savings, while a smaller and somewhat less aggressive
institution increased savings copy from 25 per cent to about 35 per
cent.
The others fell in that range.
The shift was not new, however;
it had been going on for at least two months.
Moreover, none of the
banks contacted planned "all out" campaigns for the end of June and
early July.
Nor had any advertising and promotion budgets been
increased significantly in recent months.
One bank, in fact, reported
that it was waiting to see what form interest ceiling legilsation
would take before changing promotion activities.
A few savings and loan associations had responded to the
increased competition by raising dividend rates, effective July 1,
Mr. Bopp continued.
At least six relatively large Philadelphia
associations raised their dividend to 4-1/2 per cent in June, and
two others raised the rate earlier.
His over-all impression, based
6/28/66
-71
on a spot check, was that savings institutions were not overly
concerned about the expected withdrawals early in July.
Some
estimated that withdrawals would run 15 to 25 per cent greater than
normal.
Certainly no liquidity crisis was forecast.
Mr. Bopp reported that during the past week Reserve Bank
personnel had spoken with senior officials of several banks regard
ing their policies in allocating credit.
Construction loans were
being rationed more than consumer loans.
Practically all of the
banks were either refusing or discouraging loans to finance mergers
and shifts of ownership, and they were avoiding loans to finance
inventory in anticipation of future needs, to purchase land for
speculative purposes, or to speculate in securities.
Turning from the problems of credit allocation to over-all
flows, Mr. Bopp was still concerned over the rapid rate of growth
of money and credit.
Just what money market conditions were needed
to slow that growth was, of course, a difficult question to answer,
especially given the action taken yesterday on reserve requirements.
He would be inclined to maintain the current policy posture for the
next four weeks unless growth in required reserves suggested a
resumption of the rapid spurt in money and credit, in which case he
would favor some further movement toward restraint.
Alternative A
of the draft directives would best serve that purpose.
6/28/66
-72Mr. Hickman said that a spot check of bankers and newspapers
in the Cleveland, Pittsburgh, and Cincinnati areas suggested that few
if any planned to increase promotional activity for savings at the
end of June.
There was no evidence of plans to change rates or other
savings terms, and little change in advertising space was anticipated.
Mr. Hickman then submitted the following statement for the
record, after summarizing it orally:
Evidence is accumulating that the pace of economic
activity is moderating. Recently, such series as housing
starts, new orders for durable goods, personal income,
employment, retail sales, and consumer prices have either
declined or increased less than the average for the first
quarter. Nevertheless, defense spending and business out
lays for capital goods are large, and aggregate demand is
pressing upon capacity. Thus, despite recent tendencies
toward moderation, the balance could be easily tilted
once again toward overheating if, say, a new surge of
defense spending were to be imposed on the economy.
Some insights into the current business situation
and outlook were provided at the regular quarterly meeting
of Fourth District business economists held at our Bank on
June 17. The highlight of the meeting was a lessening of
the extreme bullishness that had characterized the two
previous meetings. Most of the group believe that the
pace of the economy is moderating, and a majority do not
anticipate an acceleration in activity in the second half.
Most also feel that the economy has passed the crest of
inflationary danger. They were, of course, not informed
of the Board staff's projections for defense spending.
Despite the general theme of moderation, the group's
individual forecasts of industrial production were strong
for the remainder of the year, but a few of the economists
thought that the index would decline sometime during the
first half of 1967. The median projection of GNP for 1966
of $731.5 billion was somewhat less optimistic than the
"standard" forecast of $735 billion. Quarter-to-quarter
increases in the median forecast for GNP were $12 billion
-73-
6/28/66
for the second and third quarters of 1966, $10 billion
for both the fourth quarter and the first quarter of 1967,
and $8 billion for the second quarter of 1967. The group's
median forecast for auto production for 1966 was 8.6 million
cars, with total sales, including imports, projected at 9.2
million. The median forecast for steel output was 134 mil
lion ingot tons.
A few specific items reported at the meeting may be of
interest to the Committee. Reports on the nonferrous metals
industries showed distinctly less price pressures than in
earlier meetings, particularly in zinc and lead. On the
other hand, continuing supply problems were reported for
manpower generally, for equipment (especially machine tools),
and for some materials (specifically sulphuric acid and
copper).
Before the meeting, we surveyed, on a confidential
basis, the credit situation as seen by the corporations
represented by our Fourth District business economists.
The general view was that bank credit is readily available
for the large, top-quality companies but at higher prices
(including the effects of larger compensating balances).
A few companies reported active solicitation by banks
wanting to extend credit. In many cases, increased capital
spending and expansion of accounts receivable financing had
enlarged the companies' demands for credit. The expansion
of accounts receivable financing reflects the fact that
smaller and marginal companies are turning to their suppliers
for funds, when denied credit by banks.
Turning to policy, I feel there is no need for any
major shift at this time. Yet, the staff's projection of a
considerable expansion in money supply for June is disquiet
ing. Some accommodation of money and credit expansion
perhaps can be justified by the mid-month clustering of tax
and dividend payments and CD runoffs, but the tone of the
money market suggests to me, at least, that we may have been
a bit too easy. We should avoid at all cost inflationary
monetary expansion such as occurred in December and April.
Mr. Hickman added that he had come to the meeting prepared
to vote for alternative A of the draft directives, but in view of
the staff's projections for defense spending he now favored
alternative B.
However, he would prefer very moderate further
6/28/66
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restraint until the early-July period of special pressures on nonbank
financial intermediaries was passed.
Mr. Brimmer said that he had planned to comment today on
various developments in connection with the U.S. balance of payments
but because the hour was late he would turn directly to the subject
of the Committee's directive and its background instructions to the
Manager.
In light of the Board's action of yesterday he believed
the Committee should be especially careful in formulating its
instructions.
First, he thought it should be recognized that the
recent net borrowed reserve figures were slightly shallower than
those the Committee had intended to achieve; discounting the $417
million figure for the latest week, which would be revised downward
if the pattern of the past few weeks continued, net borrowed reserves
had been running somewhat less than $400 million.
Thus, room existed
for a further deepening of net borrowed reserves, although he did not
advocate deepening them to $800 million.
Secondly, Mr. Brimmer continued, the Board's action of
yesterday should be interpreted as precisely as possible.
It was
a monetary action, intended to reduce the availability of reserves,
and he hoped the Committee would not act to offset it completely.
While he thought it would be helpful to ease the market adjustment,
by no means would he fully offset the action.
It was important, he
thought, to let the market--and especially the larger banks--know
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6/28/66
that the Committee did not subscribe to a pattern of activity in
which those banks competed actively for funds to relend to their
customers.
He would assume that net borrowed reserves would be
deepened well beyond $400 million, and that while the Manager would
ease the adjustment and play by ear over the early-July period, he
would lean as far as possible in the direction of further tightness.
A figure around $350 million would constitute backsliding.
There
would be more room to maneuver if, as now seemed likely, midyear
drains from nonbank institutions would be less than anticipated
because more institutions were raising their deposit rates.
Mr. Brimmer said that he had considered expressing a
preference for alternative B for the directive, but would vote for
alternative A with a strong recommendation for the course he had
outlined.
If the Committee did not take the present opportunity
to tighten it was likely to find itself constrained by Treasury
financing activity later and thus to be less able to act.
Mr. Maisel agreed with Mr. Brimmer that the Committee had to
act to give the Desk specific instructions on what to do about reserve
creation in the space between now and the next Committee meeting.
Required reserves would increase $400 million as a result of the
Board's action of yesterday and the specific question that had to
be faced was whether or not the Committee was going to attempt to
offset that action by furnishing additional reserves to partially
6/28/66
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or completely reduce the restraining influence of the Board action.
It seemed to him that in giving those instructions the Committee
had to be concerned with what would be happening in total reserves
and nonborrowed reserves, and not in net borrowed reserves.
blue book/
The
showed a projected increase in total reserves of $160
million for the four-week reserve period ending July 20.
That
included normal growth but excluded the impact of any special loans
to thrift institutions or of the change in reserve ratios.
If one assumed that no reserves beyond the $160 million
projected were to be furnished in that period, Mr. Maisel said,
the entire effect of the Board's action in raising reserve require
ments would have to be absorbed by member banks through a slower
expansion of credit.
Total deposits and loans would not expand as
much during the period as they otherwise would.
If the Desk made
all projected reserves available in the coming week, banks could
expand deposits sharply.
However, as Government deposits fell
during the next two weeks, banks would not be able to expand private
deposits as much as the blue book projected and they would have to
cut back the amount of credit outstanding by more than normal.
1/ The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.
6/28/66
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After an examination of reserve movements, credit expansion,
and changes in the money supply since last December, Mr. Maisel
believed that if in this period there was no additional expansion of
total reserves beyond the $160 million projected, the Committee would
be closer to the proper reserve target needed to meet its general
monetary goals than it was now.
for policy:
That, therefore, should be the target
not to allow total reserves to grow by more than $160
million through the week ending July 20.
However, Mr. Maisel continued, it might be that the adjust
ment to the higher reserve requirement would have to be spread over
a somewhat longer period than the next three weeks.
If, as the
situation developed, a six-week period appeared more logical, that
would mean according to the staff projections that total reserves
in the week ending August 10 should be at about the same level as
they were in the week ending June 22.
to that extended target.
He would have no objection
If that also turned out in the course of
the period to be too rapid a halt in credit expansion, even though
it meant no cutback; the Committee might allow any additional
expansion to come only through borrowing.
That would mean as a
minimum insuring that nonborrowed reserves were no higher than now
in the week ending August 10.
To meet that goal, Mr. Maisel would allow the level of
borrowings and of net borrowed reserves to rise as sharply as
6/28/66
-78
needed to hold nonborrowed reserves level for that period.
He would
hope that an immediate start could be made in holding back on reserve
creation.
The smaller the increase in reserves in the coming week,
the smaller would be the amount that had to be absorbed over the next
month.
The added borrowings should, hopefully, cause the banks to
slow their credit expansion.
Mr. Maisel thought the Committee should not be surprised if
banks attempted to gain their additional reserve requirements in the
period through added discounting.
An expansion of reserves through
the window, offset by open market sales, should not be feared.
It
would offer the opportunity to discuss with banks the need to con
strain loans rather than adjusting through the sales of securities.
It would also provide an opportunity to make it clear that the
System intended to hold the present Q ceilings as an aid to restraint.
Pressure at the window should be allowed for a considerable period
before any consideration was given to a discount rate change.
He obviously would avoid a panic in the money market, Mr.
Maisel continued, but he would not be afraid of fairly sizable
increases in interest rates.
Almost all market interest rates, but
especially bill rates, were far below the levels which the staff
projected at the start of the year.
The present appeared to be a
rather light period for financing and therefore a favorable period
for action.
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In Mr. Maisel's judgment the Committee had been extremely
slow in meeting any logical goal for the rate of credit expansion.
Now was a proper time to adjust to a target for reserves, credit,
and monetary expansion.
The present opportunity should be seized
by aiming at finding total reserves at the present level at the end
of the next six weeks even though reserve requirements would have
gone up in the interim.
That level of reserves would mean the
Committee was then on a proper path--that being to continue to
increase reserves at the annual rate of expansion experienced between
December 1 and August 10 under the projections.
At the moment, Mr. Maisel did not feel the Committee should
look beyond cutting back beneath that rate of growth.
be all that monetary policy could do.
That might
The Committee should not look
forward to doing more than it could; but it could continue on that
path.
Further delay in getting on target would increase the danger
of continuing to tighten for too long.
If the Committee moved to
a proper growth path now, it could then hope to stay with it.
Mr. Maisel said that clearly he would support alternative B,
but with the understanding that any increase in total reserves over
the next six weeks would be a sign that they were increasing more
than expected.
As a result, such increases would show that greater
restraint was necessary and net borrowed reserves would be allowed
to rise as much as needed.
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Mr. Daane remarked that in the interest of time he would
simply say that his own appraisal of the continuing underlying
strength of the economy, of price developments, of the impending
addition of cost-push inflation--foreshadowed in the staff's chart
on unit labor costs--to the demand-pull inflation being experienced,
of the lack of cheer in the balance of payments outlook--all led
him to the desirability of somewhat greater monetary restraint.
Under the current uncertainties, it was difficult to be precise
with respect to any of the monetary variables and, therefore, he
would favor giving the Manager maximum latitude in the expectation
he would take advantage of any opportunity to bring about the
somewhat greater restraint envisaged perhaps more clearly in
alternative B.
At the same time, Mr. Daane said, he did not detect any
great difference between the language of alternative A calling for
some further gradual reduction in reserve availability "if" liquidity
pressures were not unusually strong, and that of alternative B which
similarly called for some gradual reduction in net availability
"while taking account of" any unusual liquidity pressures.
Accord
ingly, he could accept either alternative for the directive.
Mr. Mitchell favored alternative B on the grounds that the
staff review pointed distinctly to tightening and the Board's action
of yesterday also pointed in that direction.
For a guideline, he
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would suggest keeping total member bank deposits--the bank credit
proxy--from rising above its estimated June average level of $245
billion.
He would like to see the money supply come back down
after its large rise in June.
Like Mr. Maisel, he thought an
immediate start should be made in restraining reserve creation.
Mr. Mitchell favored deepening net borrowed reserves to
the $450-$550 million range before the effective date of the reserve
requirement action.
If that did not provide effective restraint and
the proviso clause of alternative B became operative, he would favor
net reserves in the $550-$600 million range.
His basic objective
was to tranquilize growth in bank credit.
Mr. Wayne reported that evidence of a slower rate of growth
in Fifth District business continued to multiply.
The Richmond
Bank's latest survey indicated that the downtrend in new construc
tion business, evident in earlier statistics, continued in June.
On balance, the survey of manufacturers showed declines in new
orders and backlogs for the first time in nearly a year and for
only the second time since January 1964.
Demand for business loans at District banks remained strong,
Mr. Wayne said.
The position of member banks in the District seemed
to have eased a little recently, however, as indicated by a consider
able reduction in borrowing at the discount window and a fairly large
swing from net purchases to net sales of Federal funds.
Nonetheless,
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some of the District's larger banks apparently planned to step up
promotional activities in the savings competition.
There was
evidence that at least a few large banks in Virginia and North
Carolina would intensify advertising of savings-type certificates
in the week of June 27.
All of those banks, however, emphasized
that the intensity of their promotional activities was geared, as
a matter of normal practice, to interest-payment dates at other
institutions and that promotional plans for the next few weeks
were quite normal.
One large bank, however, reported that it
would avoid any step-up of its efforts in that regard for fear
that it would antagonize many good savings and loan association
customers.
In the policy area, it seemed to Mr. Wayne that the
important question at the moment concerned the dimensions of the
current slowdown in the economy's rate of advance.
The green
book 1/ and the staff presentation this morning appeared to resolve
the balance between weakness and strength on the side of significant
acceleration in the rate of improvement in the coming quarter.
But
he was skeptical respecting the staff's projections, and accordingly
was reluctant to take the policy position which they seemed to imply.
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
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On the whole, he was not convinced that any significant acceleration
in the rate of expansion in the next month or two could be expected.
For the present, maintenance of the present posture appeared to him
to be the safer course.
So far as instructions to the Desk were concerned, Mr. Wayne
favored alternative A, which he interpreted as a vote for no signif
icant change in the present degree of restraint.
Mr. Clay reported that while some Tenth District commercial
banks obviously had increased their promotional efforts for time
deposits in late June, the more typical was a continuation of the
efforts of recent weeks which in itself represented an intensive
campaign for funds by most city banks.
It seemed only realistic to
assume that bankers were conscious of the July 1 savings and loan
dividend date as a potential for acquiring time deposits.
In private
conversations, a limited number of bankers had given that as a
reason for their expanded publicity drive.
With the recent increase
in savings and loan dividend rates and the accompanying promotional
drives by those organizations, bankers also had expressed some
reservations as to the volume of funds that they might acquire.
In
one District city in which a banker freely gave the savings and loan
funds as the goal of the expanded effort by the banks, the savings
and loan associations had lifted their divident rate to 5 per cent,
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the same as the banks' interest rate on savings certificates, and had
expanded their promotional efforts fully as much as had the banks.
At this juncture, Mr. Clay felt that monetary policy probably
should remain essentially unchanged, with policy actions continuing
to apply about the present degree of pressure on the commercial banks
and the financial markets.
While pressure on resources continued and
price inflation remained a problem, the economic situation appeared
to permit such an approach to policy for the present.
In view of the
uncertainties in the period ahead, particularly those arising from
possible developments associated with the flow of funds, the financial
situation called for an avoidance of further credit tightening at
this time.
Thus, Mr. Clay continued, the Committee should aim for money
market conditions and net reserve availability about in line with
the last two weeks.
It still should be the Committee's aim to apply
added restraint if bank credit expansion was much in excess of what
was expected, insofar as such action was not precluded by the flow
of funds problem and its associated developments and by the need to
avoid precipitating a discount rate action.
The Manager might
require more than the usual degree of leeway in meeting the Commit
tee's guidelines in the period ahead.
The draft policy directive
with alternative A as the second paragraph appeared satisfactory to
Mr. Clay.
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Mr. Scanlon reported that a sampling of Seventh District
opinions indicated the current trend of economic activity was
extremely vigorous despite cutbacks in autos and home building.
In the District it was generally expected also that Vietnam
would require an increasing volume of the nation's resources,
that tax rates would not be raised soon, that interest rates
would not decline significantly in the next few months, and that
the general price level would rise further, but at a moderate
pace.
Capital goods producers continued to anticipate that output
would rise well into 1967.
Mr. Scanlon commented that he had nothing significant to
add on the subject of commercial bank advertising and promotional
activities.
As to policy, Mr. Scanlon shared Mr. Daane's view that in
the period immediately ahead the Manager should have more than the
usual amount of latitude in which to operate, but he would urge
the Manager to move to a posture of greater restraint whenever he
could do so.
Mr. Seanlon favored alternative B of the draft
directives.
Mr. Galusha submitted the following statement for the
record after summarizing it orally:
My statement today will be confined to food production
developments in the Ninth District and consumer spending
patterns as they are developing in the recreation areas of
the west.
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In a survey of opinion of various leaders around the
midwest and northwest in the livestock industry, the
following points were developed. Producers are generally
continuing optimistic even though there are a number of
major drought pockets, principally along a line through
eastern Washington, eastern Oregon, central Idaho, south
western Montana, and then broadening through Wyoming and
extending southward along the eastern slopes of the
Rockies. Marketings of cows and heifers have increased
substantially, partly as a result of this, and partly as
a result of the inversion currently obtaining in the
cattle markets. Cows had been selling at $150-$160 per
head, which is $20-$25 above the price level warranted
by the fat cattle market. This market has been laid at
the door of the U.S. Department of Agriculture and the
Administration, which have been unusually confused and
contradictory. This curtailment of breeding stock may
have supply implications for next year if it continues
at present rates.
Feeders are unhappy. Current price levels have put
them into loss positions generally vis-a-vis their present
inventories. However, bumper corn prospects plus an
unusually favorable spread between present contrasting
levels for fall delivery of feeders and the February-April
futures market should cheer them up.
Financing is no
major problem yet, although the Production Credit Associa
tions generally are bracing themselves, particularly in
the drought areas.
Wholesalers are pessimistic, but the grocery chains
are doing very well in their meat operations. The major
packer visited is optimistic and although they expect fat
cattle prices to edge up perhaps $1.00 by fall, they
expect to maintain their margins.
The wheat situation is due for basic readjustments.
Criticism of the Agriculture Department's policy is
mounting. The belief was expressed by one man who is
particularly knowledgeable in the world markets that
the increase in acreage is only the first that will be
necessary if the carryover a year from now is to be
prevented from dropping below 300 million bushels.
Approximately 50 per cent of the salable Canadian crop
has been committed to the present Communist bloc contracts.
While this is less than last year, the Canadian wheat
supply is going to be very tight partly because of the
limits of handling capacity and partly because of the
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pressure felt by non-Communist markets to cover their
positions. It is expected that prices will continue to
edge up, placing increasing pressure on the Department
of Agriculture because of their unrealistic mix of
social, political, and economic policies in wheat
pricing and production. PL 480 commitments will be
switched to coarse grains if possible but both price
and acreage movements upward are thought inevitable.
The general atmosphere of foreboding here today has
no reflection in American spending habits this vacation
season. A general question of where are the American
people spending the money they are not spending on
durables can be answered, in substantial measure, by
saying that they are spending it on the road.
These
are a few statistics gathered from the principal con
cessioners in the four big western parks:
Yellowstone
reservations up 42 per cent; paid reservations up 24
per cent; and May travel reservations up 59 per cent.
There is less criticism of pricing, with fringe services
such as boat rentals and saddle horses being bought to
capacity. Yosemite reservations are up 15 per cent as
are Sequoia reservations; Grand Canyon is up only 10 per
cent, but revenue is up 15 per cent.
The variation from
Yellowstone for May is attributable in large part to
seasonal and weather factors.
Labor is tight on the professional side, and boys
are in short supply. Vietnam pressures, direct and
indirect, are blamed. Girls are now 4 to 1 in the work
force generally.
Prices are up slightly, but a significant downturn
in all food costs except canned goods has taken off the
pressure.
In response to the Board's wire, we were unable to
find any substantial number of bankers planning to
increase advertising efforts. In one instance it was
noticed that a major Twin City correspondent was attempt
ing to redress some of its earlier wrongs by publicly
advertising that the local bank be consulted if the
listener was located outside the Twin Cities.
The word had gone out quietly from the Farm Credit
Board to the Federal Intermediate Credit Banks to encourage
PCA's to follow a four point program:
(1) avoid speculative
financing, (2) avoid loans for undue expansion, (3) con
centrate on production loans, and (4) cease the aggressive
hard sell of their services.
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What does all this add up to in terms of monetary
policy?
It seems to me that, if it is not presently going
on, a quiet but directed dialogue should be started on the
consequences of a discount shift upwards before too long,
so that if it becomes necessary--as it may well be--the
Board's peers will not be caught totally unprepared. My
preference is for alternative A.
Chairman Martin then noted that he understood Mr. Brill had
some explanatory comments to make regarding the staff's projection
of defense expenditures.
Mr. Brill said that he was somewhat disturbed by the impres
sion that the Committee may have gotten from the chart presentation
that the staff was privy to advance information on defense spending
plans.
The staff had no special private information on defense
spending, and the estimates presented today were based entirely on
its own analysis.
The information that was publicly available on
orders, draft calls, and so forth suggested to the staff that defense
spending would rise in the third quarter at about the second-quarter
rate, and then begin to taper off slowly--in contrast to the abrupt
leveling off in the third quarter that was implied in the January
Budget Document.
The projections did not envisage an acceleration
in spending from recent rates of increase, but it did envisage a
higher level than did the Budget.
Mr. Swan noted that the green book indicated that California
State-chartered savings and loan associations had an increase in
share accounts in the first 17 days of June.
Some further details of
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interest were now available.
There had been a loss in regular
accounts at associations paying 4.85 per cent, a gain at those paying
5 per cent, almost no change
in six-month certificates paying 5 per
cent, and a quite substantial increase in the three-year minimum term
accounts paying 5.35 to 5.50 per cent.
He hoped those changes indi
cated that the reduced inflows reflected rate differentials and not a
loss of confidence.
If that were the case, there should be some
response to further rate increases by the associations.
As of Friday,
one or two small institutions had increased their rates on regular
accounts to 5-1/4 per cent, and he expected that increase to spread
despite the fact that at the higher rate the associations would be
subject
to restrictions on borrowing from the Home Loan Bank for
purposes of expansion.
such restrictions.
The associations were not concerned about
On the other hand, there was a great deal of
concern of other kinds, as evidenced by the fact
that the Governor of
California had called a confidential conference on June 22 to discuss
the outlook for residential construction and mortgage capital.
In
the discussion on Friday with Under Secretary Barr, to which he had
referred earlier, some of the large commercial banks
indicated they
already had some savings and loan association passbooks on hand for
collection and deposit after
the interest-crediting date.
They
indicated that they did not have large numbers of such passbooks, but
it was unusual for them to have any noticeable numbers at all.
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With respect to bank advertising, as of Friday Mr. Swan had
noted no increases in activity and no plans for increases beyond
what was normal for the beginning of any quarter.
However, how the
banks would react if the 5-1/4 per cent rate spread to many savings
and loan associations remained to be seen; it would not be surpris
ing if banks increased their advertising efforts.
Turning to policy, Mr. Swan felt that in view of the
pressures on financial intermediaries and the uncertanties in credit
markets--including the effects of the announcement of the Board's
action of yesterday--the Committee should not tighten further, at
least not in the first two weeks of July.
He did not see how the
Committee could anticipate at the moment the extent to which it
should offset the reserve requirement increase.
He would give due
regard to the qualification in alternative A; in the language of the
draft, if "liquidity pressures are not unusually strong and required
reserve increases are larger than expected," he thought firming
action would be called for.
Barring those two developments, however,
in the immediate future he would prefer to see the Committee's policy
stay about where it was now.
Mr. Irons said he could briefly summarize the economic
situation in the Eleventh District by indicating that activity was
showing a somewhat slower rate of growth at a very high level.
With
regard to the Board's inquiry on bank advertising, a spot-check had
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indicated no concerted advertising campaign among the District's
larger banks.
Some of the smaller banks in the Houston area were
advertising heavily, but that was not a recent development; it
reflected a competitive situation that had existed for some time.
Mr. Irons believed that developments in financial markets
were reflecting the bite of recent monetary policy.
He felt that
it would be well for the Committee to exercise some caution in the
period until its next meeting, and he did not favor further tight
ening on any significant scale.
He also felt that there would be
added pressure on the discount rate and certainly on the prime rate
if short-term rates continued to push up as they had over the past
few weeks, and he would not like to see that happen.
The current
relation between the discount rate and short-term market rates left
little elbowroom in which to maneuver.
He would add that the chart
presentation this morning presented one of the clearest and
strongest cases for fiscal policy action that he had seen.
Mr. Irons concluded that during the period until the next
meeting the Committee should maintain about the situation that had
prevailed over the past three weeks, with net borrowed reserves in
the $350-$400 million range.
With that thought in mind, he favored
alternative A of the draft directives.
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Mr. Ellis, in briefly summarizing New England economic
conditions, reported that manufacturing output, construction, employ
ment, the average workweek, personal income, and consumer spending
had all increased in the most recent data, generally covering April
May changes.
Individual highlights, such as the continuing strike of
11,000 workers at the General Electric plant in Lynn for higher pay
for engine testers, merely confirmed the general impression of an
economy operating at full capacity.
First District banks continued their search for funds to
meet their continuing loan demand, Mr. Ellis said.
Outstanding
negotiable CD's on June 15 were almost identical with their May 11
level and showed a 23 per cent year-to-year gain.
The remaining
segment of other time deposits posted a 91 per cent year-to-year
growth.
Past patterns revealed that most of the CD's on the books
of the smaller banks represented local funds, often from municipal
ities, rather than out-of-State funds.
Those local contacts provided
the smaller banks with assurance that they could continue to hold
their deposits against the competition of larger banks in the reserve
cities.
For that reason he did not see in the District widespread
concern by small banks as their bigger neighbors pushed CD rates
closer to the Regulation Q ceiling.
While there continued to be a steady stream of commercial
bank announcements of consumer-oriented savings plans in the District,
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Mr. Ellis continued, no advertising programs had been observed that
were designed especially to pull funds out of savings institutions
at the time of dividend payments.
Mr. Ellis confessed to an uneasy feeling that the Committee
had lost momentum during June in moving to resist the economy's
pressure to expand credit and the money supply.
The June projections
of a 15 per cent annual rate of increase in private demand deposits,
and of nearly 13 per cent in the money stock, differed so much from
the 4.5 per cent growth rate in real GNP as almost to constitute a
definition of inflationary pressures.
Mr. Ellis went on to say that the projections for the next
few weeks--prepared before the change in reserve requirementsindicated a need to inject perhaps $1 billion reserves to meet
seasonal requirements.
In a bill market already laboring under
pressures of strong demand and limited supply, it would be difficult
to supply reserves by that route without further depressing bill
rates.
Those factors counseled a substantial reliance on RP's, as
was suggested by the Manager's recommendation the Committee had
approved earlier today.
Perhaps a lagged provision of reserves
should also be relied on to lend tightness to the feel of the market.
By the middle of July, Mr. Ellis continued, much of the
present uncertainty concerning possible deposit losses by savings
banks and savings and loan associations would have been dispelled.
6/28/66
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His own intuition urged him to the view that the problem would be not
nearly as serious as advance billing indicated.
Accordingly, he
anticipated that by the time of the Committee's next meeting near the
end of July it would be possible to reappraise pressures on the dis
count window and to consider the desirability of discount rate
increases without any change in the current Regulation Q ceilings.
For the present, Mr. Ellis said, the Committee in effect had
three alternative courses suggested by the two draft directives.
He
would characterize alternative A, without the proviso clause, as
standing firm in a passive sort of way, and alternative A with the
proviso clause as active resistance if the rate of reserve growth
accelerated.
Alternative B called for a gradual tightening.
His
own preference for this particular time was alternative A with the
proviso clause.
It allowed some reaction against sharp reserve
increases if they materialized and if market conditions permitted,
and it left the initiative for further tightening with the market.
He would consider it undesirable to ask the Manager to work with a
target formulated in terms of total reserves rather than net borrowed
reserves for the four-week period.
He suggested a net borrowed
reserves target in the $400-$500 million range, and he would expect
borrowing fairly consistently to exceed $700 million.
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Mr. Hayes said that he had understood from the comments around
the table that others who had expressed a preference for alternative A
also favored including the proviso.
Chairman Martin remarked that he did not think there was much
difference among the various views on policy expressed by Committee
members today.
The majority appeared to prefer alternative A of the
drafts of the second paragraph of the directive.
nothing more was required at present.
In his own judgment
He favored giving the Manager
as much latitude as was reasonable over the coming period.
Mr. Brimmer said he would find an answer to the following
question helpful:
How much, if at all, was the Committee asking the
Manager to offset the effect of the Board's action of yesterday?
To
communicate adequately in present circumstances, he felt that some
numerical indication was needed of the operating objectives the Com
mittee had in mind.
Mr. Hayes said that, based on his experience with past changes
in reserve requirements, it would be quite surprising if the full
impact of the change in requirements was permitted to be reflected in
the level of net borrowed reserves over any short period.
An abrupt
change of such a magnitude would be extremely upsetting to the market.
It seemed obvious to him that the Desk would have to offset most of
the effect in the short run, granting that the Committee intended to
work toward a tighter position as that became feasible.
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Mr. Brimmer noted that the reserve requirement change would
be effective at reserve city banks about the middle of July and at
country banks a week later.
The Committee's next meeting was tenta
tively scheduled for four weeks from now, and he believed that over
the four-week period there should be some bite from the Board's
action.
Mr. Hayes agreed that the Board's action should be permitted
to have some effect.
However, a $400 million deepening in net bor
rowed reserves in a four-week period struck him as beyond any
reasonable expectation.
Chairman Martin said he concurred in Mr. Hayes' point, and
thought Mr. Maisel had had the same point in mind when he suggested
that the adjustment might be spread over a six-week period.
He
(Chairman Martin) favored giving the Manager full latitude, as he had
indicated earlier.
If the Committee attempted to deal with the
matter on a purely statistical basis it was likely to make difficulties
for itself.
At the same time it was clearly the Committee's intention
to let the reserve requirement change have some bite.
Mr. Mitchell commented that he thought the Committee might be
sweeping the matter under the rug and not facing up to the problem.
In his judgment the members favoring alternative A in effect favored
a sterilization of the tightening effect of the change in reserve
requirements.
He did not advocate deepening net borrowed reserves
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by the full $400 million in a four-week period, but he did advocate
letting a substantial part of the change in requirements--perhaps
half--be effective in that period.
The Manager should deepen net
borrowed reserves as rapidly as he thought was feasible over the
coming period.
Chairman Martin commented that while Mr. Mitchell's position
was a legitimate one he personally did not think that targets of
operations could be spelled out so specifically.
The period in
question was one in which thrift institutions would be under con
siderable pressure.
Along with others he hoped those pressures
would turn out to be less than had been anticipated, but the risk
of severe repercussions to firming action had to be borne in mind.
The Committee should not call for tightening credit regardless of
how things worked out; a feel of the market was required, and that
was why he favored giving considerable latitude to the Manager.
Mr. Maisel said the problem the Committee faced, as he saw
it, was that of arriving at some measure of agreement on specific
objectives.
Chairman Martin expressed doubt that the Committee could do
so under current circumstances.
Mr. Brimmer agreed that it was necessary for the Committee
to give the Desk flexibility, but it also had to give the Desk some
guidance.
He was as sensitive as anyone to the state of the
6/28/66
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financial markets, but it was necessary to recognize that the
Committee had not achieved the kind of control of the aggregate
variables it had planned.
While he did not favor abrupt action,
he thought it should be made clear to the Desk that the Committee
wanted to begin to achieve some real restraint.
Mr. Hayes commented that in his judgment the Committee faced
a new set of circumstances as a result of the increase in reserve
requirements.
At all times the Committee's judgments had to be
attuned to all relevant factors, and a $400 million increase in
reserve requirements was one such factor.
Personally, he could not
conceive of letting net borrowed reserves increase by $400 million
in a rather short period of time without cataclysmic results.
It
would take a considerable period to deepen net borrowed reserves
from $400 million to $800 million if the Committee was to avoid
precipitating a crisis.
Mr. Brimmer observed that he did not favor deepening net
borrowed reserves to $800 million by the time of the next meeting,
but he did think the figure should be deepened well beyond the $350
$400 million range.
Mr. Hayes indicated that his preference was for a target
range of $350 to $400 million, with the proviso that the target
should be deeper if there was a surge in credit demands and shallower
6/28/66
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if the severity of liquidity pressures at financial institutions
was great.
He would give the Manager a considerable degree of
latitude.
Mr. Daane said he did not detect any real difference in the
positions various members were taking; in general, they seemed to
favor some further gradual firming, if conditions permitted.
He
personally could not say at present by how much net borrowed
reserves should be deepened, but he favored movement in that direc
tion if and when the Manager thought it was feasible.
Mr. Mitchell thought that it would be appropriate to deepen
the levels of net borrowed reserves in the period from the present
to the time that the reserve requirement increase became effective,
and then to shift to shallower levels.
The objective would be to
"wedge in" the impact of the change in requirements.
Chairman Martin remarked that the problem with which the
Committee was struggling appeared to be that of avoiding incon
sistency in policy.
Mr. Maisel observed that some members felt that the
inconsistency lay in the fact that the Committee had been calling
for a tighter policy but still had allowed bank credit to rise at
a very rapid rate.
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Mr. Holmes noted that in May the bank credit proxy had
increased at only a 2-1/2 per cent annual rate.
Before the last
meeting the Board's staff projected a rise in June at about a 6-1/2
per cent annual rate.
Around mid-June their estimate, and also that
of the New York Bank, was a 3-1/2 per cent rate; and now the Board's
projection was about 5 per cent and the New York Bank's about 6 per
cent.
For July the staff projections ranged from 9 to 13 per cent,
with the increase reflecting the large rise from the middle to the
end of June that resulted from tax payments, including the speed-up
in payments of withholding taxes.
If the Committee felt that an
increase in July in the bank credit proxy on the order of 10 or 11
per cent was too great, it could call for activating the proviso
in the directive and moving toward deeper net borrowed reserves.
Chairman Martin reiterated his view that an attempt to use
statistical measures under present circumstances would lead to
difficulties.
He thought the Committee wanted the Manager to have
latitude and that it would like to move towards firming if the
opportunity presented itself.
If there was no such opportunity it
did not want the Manager to act in a way that would result in chaos
in the market.
In his judgment either alternative A or B could be
interpreted within that framework.
Mr. Maisel said he favored the course suggested by
Mr. Holmes' final remark--namely, that the Desk should operate to
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prevent the bank credit proxy from rising at a rate as rapid as 10
or 11 per cent in July, if it could do so.
A number of members concurred in Mr. Maisel's statement.
Chairman Martin then asked whether there would be any
objections to adoption of alternative A for the second paragraph of
the directive, and none was heard.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee,
to execute transactions in the System
Account in accordance with the follow
ing current economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that, while there has been some
reduction in automobile sales and residential construction,
over-all domestic economic activity is continuing to expand,
with industrial prices rising further. Mortgage market
conditions remain tight and total credit demands continue
strong.
The foreign trade surplus has declined and the
international payments deficit has increased. 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, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining about the current state of net
reserve availability and related money market conditions,
except as changes may be needed to moderate unusual liquidity
pressures at financial institutions; provided, however, that
if such liquidity pressures are not unusually strong and
required reserve increases are larger than expected, opera
tions shall be conducted with a view to attaining some further
gradual reduction in net reserve availability and firming of
money market conditions.
6/28/66
-102
It was agreed the next meeting of the Committee would be
held on Tuesday, July 26, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
June 27, 1966
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on June 28, 1966.
First paragraph
The economic and financial developments reviewed at this
meeting indicate that, while there has been some reduction in auto
mobile sales and residential construction, over-all domestic economic
activity is continuing to expand, with industrial prices rising
further. Mortgage market conditions remain tight and total credit
demands continue strong. The foreign trade surplus has declined and
the international payments deficit has increased. In this situation,
it is the Federal Open Market Committee's policy to resist inflation
ary 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.
Second paragraph
Alternative A
(preserving current firmness, with qualifications)
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted with a
view to maintaining about the current state of net reserve avail
ability and related money market conditions, except as changes may
be needed to moderate unusual liquidity pressures at financial
institutions (; provided, however, that if such liquidity pressures
are not unusually strong and required reserve increases are larger
than expected, operations shall be conducted with a view to attain
ing some further gradual reduction in net reserve availability and
firming of money market conditions).
Alternative B (firming, with degree conditioned by movement in
required reserves
To implement this policy, while taking account of any unusual
liquidity pressures at financial institutions, 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
availability and attendant firming of money market conditions, and
to attaining somewhat greater restraint if required reserve increases
are larger than expected.
Cite this document
Federal Reserve (1966, June 27). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660628
@misc{wtfs_fomc_minutes_19660628,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Jun},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660628},
note = {Retrieved via When the Fed Speaks corpus}
}