FOMC Minutes
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D. C.,
PRESENT:
on Tuesday, September 13, 1966, at 9:30 a.m.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Daane
Hickman
Irons
Maisel
Mitchell
Mr. Robertson 1/
Mr. Shepardson
Messrs. Wayne, Scanlon, and Swan, Alternate Members
of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents
of the Federal Reserve Banks of Boston,
Atlanta, and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. 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. Fauver, Assistant to the Board of Governors
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors
1/
Entered the meeting at the point indicated.
9/13/66
Mr. Reynolds, Adviser, Division of International
Finance, Board of Governors
Mr. Axilrod, Associate Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Mr. Lewis, First Vice President, Federal
Reserve Bank of St. Louis
Messrs. Eisenmenger, Ratchford, Brandt,
Baughman, Jones, and Craven, Vice Presidents
of the Federal Reserve Banks of Boston,
Richmond, Atlanta, Chicago, St. Louis,
and San Francisco, respectively
Mr. MacLaury, Assistant Vice President, Federal
Reserve Bank of New York
Mr. Meek, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the action taken by
members of the Federal Open Market Committee
on September 9, 1966, amending paragraph 2
of the authorization for System foreign
currency operations to read as follows, was
ratified:
The Federal Open Market Committee directs the Federal
Reserve Bank of New York to maintain reciprocal currency
arrangements ("swap" arrangements) for System Open Market
Account with the following foreign banks, which are among
those designated by the Board of Governors of the Federal
Reserve System under Section 214.5 of Regulation N,
Relations with Foreign Banks and Bankers, and with the
approval of the Committee to renew such arrangements on
maturity:
9/13/66
Foreign Bank
Amount of
Maximum
Arrangement
Period of
(millions of
Arrangement
dollars equivalent)
(months)
Austrian National Bank
National Bank of Belgium
Bank of Canada
Bank of England
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Netherlands Bank
Bank of Sweden
Swiss National Bank
Bank for International Settlements
(System drawings in Swiss francs)
Bank for International Settlements
(System drawings in authorized
European currencies other than
Swiss francs)
100
150
500
1,350
100
400
600
450
150
100
200
12
12
12
12
3
6
12
12
3
12
6
200
6
200
6
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 August 23 through September 7, 1966, and a supplemental
report for September 8 through 12, 1966.
Copies of these reports
have been placed in the files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
said that, on Mr. Coombs' behalf, he would first like to summarize
briefly the negotiations that preceded the public announcement today
of the $1.7 billion increase in the System's reciprocal credit facil
ities, from $2.8 billion to $4.5 billion.
(A copy of the press
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9/13/66
announcement, dated September 13, 1966, has been placed in the files
of the Committee.)
At its last meeting the Committee had authorized
Mr. Coombs to negotiate an enlargement of the network subject to the
understanding that negotiations were not to proceed until the Board
of Governors had received specific notification from the Secretary
of the Treasury that the proposed program was fully consistent with
United States international financial policy and that the timing
was appropriate.
While the Treasury had initially expressed sympathy
with the Special Manager's proposal simply to negotiate large increases
in the swap lines, subsequently the proposal was altered by grafting
on additional elements involving direct credits to the U.K. by
other central banks.
The Special Manager strongly opposed this
alteration since he was convinced that it would greatly increase
the resistance of the Europeans to the package.
Whereas the System's
partners in the swap network were prepared to go along with large
increases in the reciprocal credit lines with the Federal Reserve,
they were exceedingly reluctant to increase their direct aid to the
U.K. at this time.
Moreover, the need to negotiate an additional
$400 million of direct credits involved from the start cutting back
the size of the increases that could be negotiated in the System's
swap network, thus reducing the potential total from the $5.2 billion
originally contemplated.
In effect, the United States sacrificed
permanent protection for the dollar for the sake of a temporary three
month increase in facilities available directly to the U.K.
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As anticipated, Mr. MacLaury continued, the negotiations
were difficult in the extreme.
Although in the end the package did
prove negotiable, the Special Manager believed that the frictions
caused by the efforts to raise the $400 million in direct credits
to the U.K. cost the U.S. and international financial cooperation
more than had been gained by that temporary contribution.
to the U.S. became apparent immediately.
One "cost"
Whereas in the past all
increases in the swap lines had been considered by both parties to
be more or less permanent additions to the network, on this occasion
a number of the continental countries had specified that the increases
were to be considered only temporary.
That was notably the case
with the Netherlands and Belgium, both of which specified that the
$50 million increases in their lines were not to be considered
automatically renewable in December.
In part, that attitude simply
reflected the desire of those smaller countries to subject the
United States to closer multilateral surveillance in Working Party 3
or the Group of Ten where their voices carried greater weight than
in bilateral negotiations.
Italy and Germany also indicated that
the respective increases in their lines ($150 million each) were to
have a term of six months.
In contrast with the Netherlands and
Belgium, however, Italy and Germany seemed prepared to rely on the
less formal multilateral surveillance procedures that now took place
at the Basle meetings.
At the moment, therefore, Mr. Coombs believed
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that the increases in the swap lines with the Bank of Italy and
the German Federal Bank could be renewed at maturity without undue
difficulty.
If the Dutch and the Belgians insisted on subjecting
the $50 million increases in their lines to formal multilateral
surveillance procedures, Mr. Coombs believed the System should simply
not ask for their renewal.
That issue, of course, did not have to
be resolved at the moment.
Turning to recent developments in gold and the exchange
markets, Mr. MacLaury reported that the Treasury gold stock would
remain unchanged this week.
As things stood now, the Stabilization
Fund did not have enough gold on hand to meet anticipated sales
during the remainder of September if France converted its August
dollar gains--which amounted to $45 million prior to their $49 million
gold subscription payment to the International Monetary Fund--into
gold.
There was a chance that the U.K. might sell the U.S. additional
gold, so it was uncertain at the moment whether there would be a
drop in the stock this month.
With respect to the London gold market,
conditions had not improved noticeably since the last meeting.
Demand
remained steady with the price not far below $35.20, and Communist
China had reappeared as a buyer, although in very small amounts thus
far.
One helpful development had been the tapering off during the
past month or so of South African reserve gains, with the result
that a larger proportion of new production had been available to the
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market.
-7
Nevertheless, the gold pool had continued to lose small
amounts fairly steadily.
As arrangements stood prior to the recent
negotiations, there would have been less than $60 million still
available to the pool from the participating central banks.
At the
meeting in Basle two weeks ago, however, it was agreed to increase
the total amount of the commitments by $50 million to $320 million,
with a possible further $50 million increase available if needed,
after further consultation.
In general, it was fairly clear that
high interest rates had been an important factor in keeping private
demand for gold lower this year than last.
Any falling off of
interest rates, therefore, could be expected to lead to an increase
in demand for gold.
Mr. MacLaury commented that tight credit conditions and
high interest rates, particularly in the Euro-dollar market, had
also had a significant impact on the exchange markets.
The dollar
had shown surprising strength against most major currencies despite
the continuing U.S. payments deficit, precisely because private
foreigners had had a substantial interest incentive to hold on, for
the time being at least, to the dollars they earned.
That strength
was reflected not only in exchange rates but in foreign central
bank intervention.
For example, for the first time in a number of
years the Bank of France had actually sold dollars to support the
franc in Paris during the past few weeks.
Similar support operations
9/13/66
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by the Belgian National Bank caused it to buy $20 million from the
Federal Reserve against francs, thus enabling the System to repay
that amount of the $30 million drawings previously outstanding under
the Belgian arrangement.
On the other hand, Italian reserve gains
this summer, while smaller than anticipated, had nevertheless been
substantial; and on September 2 the System again drew $100 million
under the arrangement with the Bank of Italy to absorb part of their
recent accruals.
Although the attractiveness of foreign interest rates had
also been a factor in sterling's continued weakness, Mr. MacLaury
observed, the causes in that case, of course, went much deeper.
Despite the drastic measures announced by Prime Minister Wilson in
late July, there had been no return of confidence, and the Bank of
England had to provide further support during August.
The actual
drain on British reserves in August amounted to about $300 million.
The announced reserve decline was $53 million, with foreign credits
making up the difference, plus the refinancing of earlier month-end
credits.
The U.S. Treasury provided $400 million of the refinancing
on the basis of an overnight credit at the end of August, and the
Federal Reserve made available $100 million--$50 million under the
swap arrangement, bringing the U.K. total drawings to $300 million,
and $50 million on an overnight basis.
It was hoped that today's
announcement showing that the U.K. still had available more than
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$1 billion under its expanded facility with the System, plus
additional credits from other central banks, would help turn
market sentiment and stem the continuing erosion of recent weeks.
In any case, the announcement of the very large general increase in
Federal Reserve reciprocal credit lines should do much to insure
market confidence in the ability of monetary authorities in general
and the U.S. in particular to deal with speculative threats to
their currencies.
In concluding, Mr. MacLaury said that he would like to
call one other matter to the Committee's attention--a $75 million
drawing on August 30 by the Bank for International Settlements on
its facility with the System providing for swaps against European
currencies other than Swiss francs.
As the Committee was aware,
for some years the System had had a $25 million gold loan facility
with the BIS to permit financing of short-term dollar drains.
From
its inception the System's swap line with the BIS was less clearly
a two-way street than its other swap lines and, for that reason, he
thought it was useful to have the BIS employ the facility.
Mr. Daane said he would like to pay special tribute to the
Special Manager for the way in which he had conducted the recent
negotiations; Mr. MacLaury's account did not give the full flavor
of the difficulties Mr. Coombs had faced nor of the skill he had
exercised in negotiating the package.
In spite of his (Mr. Coombs')
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reservations as to the appropriateness of some elements of the
package, he had carried out his instructions to the letter.
Mr. Daane observed that to some extent he shared Mr. Coombs'
feeling that a Pyrrhic victory might have been won in persuading the
Europeans to extend $400 million additional direct credits to the
U.K.
One cost was that the enlargement of the System's own network
was smaller than it might otherwise have been; and a second, longer
run, cost was that the System had been brought one step closer to
more formal multilateral surveillance for the entire swap network.
At the same time, Mr. MacLaury's report might not have done full
justice to the rationale of seeking the direct credits to the U.K.
It was not simply a matter of getting $400 million more assistance
to the British; the main objective was to make the new assistance
package multilateral, rather than have the U.S. take a unilateral
action.
Mr. Brimmer agreed with Mr. Daane that the System probably
was moving in the direction of greater multilateral surveillance,
although he hoped that could be avoided.
In any case, he wondered
whether WP-3 was the best group for that purpose.
established as a purely technical forum.
WP-3 was originally
If basic questions of
international policy were to be discussed the Committee might want
to give some thought to the appropriate forum.
Mr. Daane commented that the August, 1964 report of the
Governors and Ministers of the Group of Ten, in the preparation of
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which the U.S. had participated, quite clearly assigned a multi
lateral surveillance role to WP-3, although it did so in the
expectation that the surveillance would be more informal than that
which now appeared to be developing.
Thus, in a sense that bridge
had been crossed some time ago, although not necessarily correctly.
At the same time, that report also assigned a surveillance role to
the Basle group, as was noted in the Ministers' and Governors' more
recent report, of June 1966.
Mr. Hayes noted that there had, in fact, been a substantial
amount of multilateral surveillance at Basle.
Moreover, it was the
distinct wish of a majority of Governors attending the Basle
meetings to confine surveillance to their group.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
August 23 through September 12, 1966,
were approved, ratified, and confirmed.
Mr. MacLaury then noted that a $50 million drawing by the
Bank of England on its swap line with the System would mature on
September 30, 1966.
He recommended its renewal for a further period
of three months if the Bank of England so requested.
That would be
a first renewal.
Renewal of the Bank of England's
drawing was noted without objection.
Mr. MacLaury reported that two $50 million System drawings
of Swiss francs, on the Swiss National Bank and the Bank for
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9/13/66
International Settlements, respectively, would mature on October 13,
1966.
He recommended their renewal for a further period of three
months if no opportunity arose for their repayment in the interim.
Both would be first renewals.
Renewal of the two Swiss franc
drawings was noted without objection.
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System
Open Market Account covering open market operations in U.S. Government
securities and bankers' acceptances for the period August 23 through
September 7, 1966, and a supplemental report for September 8 through
12, 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:
Since the Committee last met the capital markets have
passed through a state of near disorganization with prices
of Government, corporate, and municipal bonds declining
precipitously until August 30. On that day, following a
statement by a Treasury official that was generally
interpreted as foreshadowing a change of Administration
thinking on fiscal policy, a sharp and sustained rally
took place that brought yields on intermediate- and long
term bonds back below where they had been three weeks
ago. The hectic daily swings in prices and yields have
been spelled out in some detail in the regular written
reports to the Committee and I will not dwell on them
here.
The President's announcement of a new anti-inflationary
program, involving both fiscal and debt management policy,
at the close of business last Thursday, came at a time when
the market rally was running out of steam. In general,
9/13/66
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after some initial skepticism, there was a favorable
psychological reaction in long-term markets. This reaction
was based mainly on relief that the Government had rec
ognized the seriousness of inflationary pressures and the
pressures of agency financing on financial markets. While
the President's program was generally considered a step
in the right direction, there were many questions in the
market as to its adequacy and its eventual impact on
spending decisions, both Governmental and private. Most
market participants felt that the program was not forceful
enough to warrant any early change in Federal Reserve
policy, although many also felt that the System had again
been put squarely on the political hot seat. The Board's
statement of September 7 was generally interpreted as a
reaffirmation of the System's policy of restraint,
although there are a number of observers who will be
watching closely for any evidence of easing in System
policy.
At the moment, the long-term markets are in better
shape than they were three weeks ago. The risks of panic
have greatly diminished, although major uncertainties
remain and the market will continue to respond to devel
opments in Vietnam and elsewhere in the international
sphere. The municipal market benefited also from the
Board statement on discount window administration, which
was generally interpreted as tending to discourage bank
sales of municipals. The corporate market may again come
under pressure later, particularly if bank credit to
business borrowers is significantly curtailed, but a
better atmosphere prevails for the time being.
In contrast to the situation in long-term markets,
short-term rates remain under pressure. Banks and cor
porations both have liquidity problems which are likely
to be keenly felt over the tax and dividend dates.
Banks have a particular problem with the heavy volume
of CD maturities and we are getting close to another
interest payment period at savings institutions at a
time when market rates are higher than at the end of
June. There has been little evidence yet of any large
scale recourse to the discount window on the part of
the money center banks which have moved into deep basic
deficit--a deficit caused in part by heavy Treasury
calls on tax and loan balances. On the other hand,
the Federal funds rate moved to an effective rate of
6 per cent last Wednesday with a heavy volume of
trading at 6-1/8 per cent and, on Friday, to an
9/13/66
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effective rate of 6-1/8 per cent with a fair volume at
6-1/4 as well. As a result of pressure on the banks,
dealer loan rates have moved into the 6-3/8 - 6-5/8
per cent range with loans simply not available at
some banks.
In the Treasury bill market a heavy atmosphere
prevails and rates have penetrated into new high
ground. Dealer bill inventories are higher than they
have been in some time as the result of bank selling,
particularly of the new tax bills sold by the Treasury
in late August. Bidding in yesterday's auction was
very skittish and the average issuing rates set on
the new three- and six-month bills were about 5.45
and 5.93 per cent, respectively, up 43 and 52 basis
points from the rates set three weeks ago.
The Treasury's press conference on Saturday on
the probable course of agency financing over the test
of the calendar year implies, of course, a much higher
level of direct Treasury borrowing than had been
expected earlier this year, and this has been a major
longer-run factor contributing to yesterday's higher
Treasury bill rates. It is, of course, impossible
to pinpoint at this moment what will be added to the
Treasury's borrowing needs. Regular Treasury spending
has been running on the high side of late, and a
quantitative estimate of the new spending restraint,
and particularly the timing of it, is hard to come by.
The suspension of FNMA and Export-Import Bank sales
of participation certificates may add as much as $2
billion to direct Treasury borrowing and the limita
tion on net market borrowing by all Government agencies
to the replacement of maturing issues will add another
substantial amount.
The new financing approach should provide, over
all, a more orderly marketing of debt, but it will
still require great ingenuity on the debt management
side. At this juncture, we can only hope that agency
financing programs can be pared back, but plans to
assist the mortgage market and the reduced cash flows
of savings and loans institutions may make this hard
to accomplish. For the System, the new financing
approach will probably involve more important even
keel considerations over the rest of the year, although
not much can be said about this until a financing
schedule can be worked out.
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At the moment, of course, the Treasury is running
with a very low cash balance. Deposits at the Federal
Reserve Banks are estimated at only about $200 million
tomorrow and uncalled balances at commercial banks are
at a minimum. Our best estimates are that the Treasury
can just barely avoid borrowing directly from the
System through an adroit juggling of its commercial
bank deposits, but even a normal miss in the day-to-day
estimates could lead to an overdraft in the next few
days. Given the increase in Treasury cash needs it
is likely that the Treasury will be running with lower
than usual cash balances over the remainder of the
year and this could lead to recurring problems in
this area.
As far as open market operations are concerned,
the System has provided reserves over the past three
weeks to offset the reduction in float brought about
by the settlement of the airlines strike and the
pre-Labor Day drain of reserves. The state of near
disorganization of the Government securities market
also required attention and a large volume of Treasury
bill purchases was necessary early in the day on
Monday, August 29, in view of the nervous conditions
then prevailing in the market. With the improvement
in atmosphere on the afternoon of August 30, an effort
was made to recapture redundant reserves through the
execution of matched sale-purchase transactions which
again proved to be a very useful tool. As a result,
the net borrowed reserve figure published for the week
ending August 31, $422 million, was well within the
recent range, although it was subsequently revised sub
stantially lower. Since then money market conditions
have continued to be tight with Federal funds, dealer
loan rates, and Treasury bill rates moving higher, as
indicated earlier.
The current statement week, ending tomorrow, has
been plagued with a highly skewed intra-weekly patternwith very high net borrowed reserve figures prevailing
before the weekend, turning into substantial free reserve
figures thereafter. Much of the post-weekend ease was
expected to develop from the sharp decline in Treasury
balances at the Reserve Banks, and the market, of
course, had no way of knowing that this would occur.
As a result we went over the weekend anticipating a
relatively low average net borrowed reserve figure
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after doing a token amount of RP's on Friday in light
of the pressures on the money market, but with the
expectation that we could mop up any redundant reserves
today and tomorrow through matched sale-purchase agree
ments. The high level of borrowings at the Reserve Banks
over the weekend ($1-1/4 billion) should help lead to
easier money market conditions that would facilitate
these operations if they prove to be necessary. I should
add that Friday's RP's were made at the discount rate.
We thought it prudent not to undertake any innovation
that could lend itself to misinterpretation at the present
time.
Throughout the period since the Committee last met,
required reserves have been falling short of estimates,
and estimates of growth of the credit proxy have been
marked lower. As the blue book 1/ sets forth, August saw
a decline of about 2-1/2 per cent in the credit proxy
and the Board staff September estimates now indicate
little or no growth, compared with a 6 per cent estimate
at the time of the last meeting. Current estimates at
the New York Bank are now in the 2-4 per cent range
after making allowance for growth in foreign branch
balances.
I should note that some unusual problems had to be
faced in yesterday's hectic Treasury bill auction. Normally
our problem is to compete with other bidders to make sure
the System can roll over its maturing holdings. Yesterday,
in contrast, the problem was to redeem at least part of the
$359 million Treasury bills maturing September 15 without
leaving the auction uncovered at anything like a half-way
reasonable rate. As my supplementary report indicates, bids
were submitted for both the 3- and 6-month bills at a wide
scale of prices. The report notes that on the basis of
preliminary indications the System had apparently redeemed
$100 million. Final results indicated that the redemption
amounted to $119.6 million, which will be of at least some
help in absorbing reserves in the statement week ending
September 21.
Looking ahead for the next few weeks, estimates indicate
that we will have a substantial reserve absorption job to
1/ The report, "Money Market and Reserve Relationships,"
prepared for the Committee by the Board's staff.
9/13/66
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do in the week ending September 21 at a time of peak tax
date pressures and with the Treasury's cash position in a
precarious state. Following that week, until the Committee
next meets, we will be supplying heavy seasonal reserve
needs. Some of the potential problems of the period ahead
are spelled out in the blue book. I do not believe it
possible to spell out in advance how things will turn out,
but open market operations may very well have to be
conducted with as much flexibility as the Committee's
over-all policy position can allow.
Mr. Scanlon asked whether the Manager planned to continue
making repurchase agreements at the discount rate.
Mr. Holmes replied he would prefer not to, since the discount
rate was so far below market rates;
it would be better to make any
RP's at about the three-month bill rate.
If Friday had been anything
like a normal day he would have made RP's at 5-1/8 per cent, which
was about the average rate in the preceding weekly auction.
However,
in view of the circumstances prevailing then, he had considered it
better not to take an action that might be misinterpreted.
In response to Mr. Mitchell's question concerning the out
look for bill rates, Mr. Holmes said that much would depend on the
nature of Treasury financing activity.
for bills at present.
The market saw little demand
On the other hand, rates had now reached a
level at which some bills could be carried profitably, and that fact
might lend a little more stability to the market.
He thought the
odds were that the bill rates would be stable or would move lower,
but in view of the many imponderables that could not be expected
with assurance.
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Mr. Daane asked what consequences Mr. Holmes thought would
follow if member bank borrowings rose to a much higher level.
Mr. Holmes said that it was hard to visualize a large increase
in borrowing that did not lead to an immediate easing throughout
the whole banking system.
for open market operations.
Such a development would create problems
The situation might tend to be self
correcting, with banks repaying their borrowings as money market
conditions eased, but it was not clear that that would be the case.
In any event, he did not think there would be a large increase in
borrowings unless banks changed their attitudes toward the discount
window.
Such a change was possible, but it had not yet occurred.
Mr. Hickman asked if the Desk had talked with the large
New York banks about their ability to roll over maturing CD's
into October.
Mr. Holmes replied that the question had been discussed
quite recently with the seven largest New York City banks.
All of
them expected a run-off of CD's over this month, but only two were
actively concerned.
The others felt that the advance preparations
they had made were adequate, although new uncertainties had now
been introduced by the latest rise in bill rates.
The picture thus
was a mixed one.
In reply to a question by Mr. Wayne, Mr. Holmes said that
CD runoffs at New York banks as a group currently were at a rate
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of about $130-$200 million per week.
September 15 maturities were
about $550 million at New York banks and about $1 billion plus in
the country as a whole.
Mr. Hayes remarked that some banks recently had reported
that their CD losses had stepped up a bit.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in
Government securities and bankers'
acceptances during the period August 23
through September 12, 1966, were
approved, ratified, and confirmed.
Chairman Martin then called for the staff economic and
financial reports, supplementing the written reports that had been
distributed prior to the meeting, copies of which have been placed
in the files of the Committee.
Mr. Koch made the following statement on economic conditions:
Having been away from the office for four weeks, my
only excuse for presuming to report to you on the domestic
economic scene this morning is that there may be less
likelihood than usual that I will be misled by transitory
day-to-day developments. By necessity, I must look at the
forest rather than the trees this morning.
There is one specific new development, though, that
I will have to comment on explicitly, and that is the
fiscal program announced by the Administration last week,
even though it will take more analysis and, indeed, events
themselves to specify all of the effects of such a program
on the economy.
Needless to say, increased fiscal restraint is better
late than never and is an important step in the right
direction. But important as this current step is,
assuming implementation of both its tax and expenditure
aspects, its effects are likely to be moderate in amount
and spread out in time.
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There seem to me three main aspects of the announce
ment. First, cuts in Federal spending are likely to be
little more than, if even equal to, the increases made by
Congress in the President's requested Budget expenditures.
Second, the temporary suspension of the investment tax
credit privilege may produce marginal cutbacks in business
capital spending, possibly rather promptly for such short
lead time items as trucks, office equipment, and the like.
But its more important impact will likely be in reducing
new orders in the booming machinery and equipment
industries and possibly some concomitant effects on wage
pressures and prices in those industries. The effects of
the suspension of accelerated depreciation will no doubt be
more delayed than those of the investment tax credit.
Third and finally, the sleeper in the announcement,
and what might turn out to be its most important revelation,
is its oblique references to continuing and increased
defense spending. When I left town several weeks ago, the
most critical element in one's evaluation of economic
prospects was his view as to likely defense spending.
The sentences in the President's fiscal announcement
regarding Vietnam and defense spending have been the first
official pronouncements on the subject for some time.
They suggest that our earlier estimates on such
spending have probably been under- rather than over
estimated. As you will remember, the official Budget
document projected a leveling off of defense spending
about mid-year and in our chart show last winter we
projected increases in the third and fourth quarters of
$2-1/2 and $2 billion, respectively, expressed at annual
rates. Now we are raising our projections of each of
these quarterly increases to about $3-1/2 billion.
Other fragmentary bases for these increased
projections are the rapid increase in actual defense
spending in August, continued increases in defense orders,
and further rises in draft calls. All of this means that
even if the President's new fiscal program is adopted in
its entirety as outlined last week, the over-all Federal
contribution to economic activity will likely continue to
shift to a more stimulative position over the rest of this
year, and probably into next year unless further tax
measures are adopted.
If it were not for the war, it is now clear that the
economy is showing characteristics common to the late
phases of a business expansion. Production of business
9/13/66
-21-
equipment is now 85 per cent above its 1957-59 average
while output of consumer goods is up only 45 per cent.
Over the past year, business equipment output has
risen 18 per cent compared to 5 per cent for consumer
goods. This spring an acceleration of business inventory
accumulation was added to the boom in plant and
equipment spending.
Tight money is producing an even larger and more
abrupt drop in residential construction than was
considered likely only a few weeks ago. Other consumer
spending, though, has picked up again recently as
disposable personal incomes have risen, reflecting
continuing sharp gains in employment, larger transfer
payments, higher wages, and lower tax payments.
Prices continue to rise, although still not as
sharply as might have been expected in the current state
of economic conditions. The pace of wage advances has
quickened; witness the recent 5 per cent per year
increases for both the airline machinists and the
telephone workers.
It is probably in part because of the length and
lopsided character of the current economic cycle that
none of 20 leading economists recently replying to a
questionnaire from the New York Times called for more
monetary restraint at this time. Indeed, although all
of them agreed that Federal Reserve policy to date had
been appropriate, a minority of them felt that some
easing would now be desirable.
The current age and character of the cycle is also a
partial answer to the weak stock market, although I
suspect that this is due more to the host of uncertainties
that currently face the saver and investor. Participants
in the stock market have also been strongly affected by
rising interest rates and the developing credit squeeze.
A further word on the recent course of prices. There
has been some talk suggesting that the steam may have gone
out of the rise and that, in any case, what rise has been
taking place has been due to supply situations in
particular areas rather than to excessive aggregate
demand.
I don't agree. Food prices continue much stronger
than had been anticipated. The rise in the industrial
component of the wholesale price index has tapered off
this summer, but it is still too early to judge whether
this is the beginning of a new trend. Prices of some
sensitive materials have actually declined, but they were
the ones that had shown the spectacular increases earlier
9/13/66
-22-
and they are not particularly important in total indus
trial costs. Although the labor cost situation in
manufacturing continues to be better than it was in the
late fifties, the favorable factors of moderate long
term wage contracts and stable consumer prices have
about run their course.
In conclusion, if one could exclude the war, I
would be joining the coterie of economists I mentioned
earlier in suggesting that with the boom now so old and
lopsided we should ride out its lingering and lagging
distortions and inflationary effects. But with the war
prospects still as disturbing as they are, inflation and
even worse distortions in the structure of spending are
likely to be our problem for many months, or even quarters,
to come.
Mr. Reynolds then presented the following statement on the
balance of payments:
The two main indicators of the U.S. balance of
payments position have been pointing in opposite direc
tions since mid-year. This has not caused any serious
confusion; but it has raised some interesting analytical
questions, and has required that this Committee's
directive refer to an "underlying" deficit rather than
simply to a deficit.
On the liquidity basis of calculation there was a
continued large payments deficit in July-August, whereas
the balance measured by official reserve transactions
swung into substantial surplus. The difference resulted
primarily from the fact that a few large U.S. banks
borrowed more than $1 billion from the Euro-dollar market
through their foreign branches in the space of only two
months. Such inflows of foreign liquid funds improve
the official settlements balance but do not affect the
liquidity balance; they are regarded as financing the
liquidity deficit, rather than as reducing it.
Given these two superficially conflicting indicators,
a judgment that the over-all payments position is one of
underlying deficit rests on the expectation that the
liquidity deficit will persist while the recent heavy
inflow of foreign liquid funds will slacken.
9/13/66
-23-
Two main considerations lie behind the view that
liquid inflows will taper off. First, there is reason
to think that the scramble by U.S. banks for Euro-dollar
funds is to a large extent defensive and temporary.
This is one way in which the banks have been adjusting
to increases in reserve requirements and preparing for
the possibility of large CD runoffs in September; they
are unlikely to want to rely for long on a continuing
massive inflow of very short-term foreign money, for
which they must pay upwards of 6-1/4 per cent. Second,
even if U.S. banks do continue to bid aggressively for
foreign liquid funds, it seems unlikely that the supply of
such funds to them can long continue even at the August
rate, which was only half that of July.
Recent flows have
been affecting European exchange rates, official reserves,
and money markets in ways that will tend to reduce the
flows. Also, distrust of sterling, especially in July,
greatly stimulated or facilitated flows out of sterling
into dollars. A favorable turn in market sentiment
towards sterling, of the sort that this Committee and the
British authorities are now hoping for and working toward,
would tend to reduce or reverse that flow, as happened in
the autumn of 1965.
For all the other international transactions that
together produce the liquidity deficit, the expectation
remains, as before, for little net change in the months
ahead. The liquidity deficit was at an annual rate of
roughly $2-1/2 billion to $3 billion in July-August, or
about the same as it would have been in the second quarter
of the year if there had not been some large, once-for-all
shifting of foreign assets from "liquid" to technically
"nonliquid" categories. There may have been some further
deterioration on current account since mid-year; the July
trade figures were very disappointing, with imports up
sharply further. But there has probably been an offsetting
reduction in net outflows of U.S. capital; we know that
reflows of U.S. bank credit in July were large.
In the months ahead, I would expect the trade
deterioration to slow down. Exports of raw cotton should
have turned up sharply since August 1 when the U.S. price
was reduced. More broadly, demand in foreign markets
that are important to us is generally becoming even more
buoyant than before. And some slowing of the import
advance may result from the economic upswing that is now
gathering momentum in Japan, and in Italy and France,
9/13/66
-24-
which might make those countries less eager to sell here
even if aggregate U.S. demand remains excessive.
But while there may be only modest further dete
rioration on current account, there are also only modest
possibilities of further improvement on capital account,
even with credit conditions here continuing very tight.
So the liquidity deficit may stay in the $2-1/2
billion to $3 billion range for the rest of the year,
reduced perhaps by some debt prepayment receipts, but
increased perhaps by another waiver of year-end debt
service due from the U.K. This would bring the liquidity
deficit for the full year to something over $2 billion in
the published figures, or more than $2-1/2 billion aside
from the shifts of foreign official and international
assets from liquid to nonliquid forms.
Probably a large proportion of this year's liquidity
deficit will have been financed by inflows of private
foreign liquid funds.
In other words, the official
settlements deficit for the year will probably be small,
perhaps as small as $1 billion; it was about zero,
seasonally adjusted, in the 8 months through August. We
will probably have drawn down our gold stock during the
year by somewhat more than the $1/2 billion so far used.
We will have used up about $1/2 billion of our IMF
position, leaving only about $300 million to go before we
get into the credit tranches where the Fund would begin
to give us specific policy advice. On the other hand,
U.S. liquid liabilities to foreign official holders will
probably not have increased during the year, and may even
have been reduced somewhat.
For 1967, international visibility is even more
limited than domestic visibility. It will, of course, be
very easy to achieve a further deterioration in our
payments position. On the other hand, I think it is still
barely possible that we might achieve some improvement by
recovering some of the ground lost this year on current
account. With foreign demand buoyant and inflation abroad
widespread, improvement may in some ways be easier from a
purely economic point of view in 1967 than it was in the
early 1960's.
Everything will depend on our ability to bring
aggregate domestic demand into better balance with domestic
supply potential. Given the opportunities open to us if we
do this, and the dangers to our payments position if we do
not, I see no case for easing up on monetary restraints until
9/13/66
-25-
there is clear evidence that we are in fact well on the
road toward making that kind of domestic adjustment.
Mr. Brill made the following statement concerning financial
developments:
The staff reports already presented this morning
bring into focus most of the major constraints and
imperatives in formulating monetary policy. Mr. Holmes
has described the still-nervous state of financial
markets, which have been buffeted severely in recent
weeks and now have to assess the import of major new
fiscal and debt management programs in the midst of a
period of peak seasonal banking pressures. The recent
behavior of financial markets suggests a policy pre
scription perhaps best described as "tender loving
care."
But Mr. Koch's analysis of the prospects for
nonfinancial markets does not hold out much hope in
the short-run for relief from price pressures, even
with swift passage and implementation of the President's
fiscal program. The cumulative impact of monetary
restraint is undoubtedly spreading from housing into
other expenditure areas, and by, say, early next year,
the combination of monetary and fiscal restraints
conceivably could produce an economic "over-kill"if it weren't for the increasing prospect of
substantially higher Vietnam spending. Whatever fears
one may have as to the lagged effect of monetary
restraint on the private sectors of the economy, it
would seem dangerous to formulate policy now on the
assumption that additional fiscal restraint will be
imposed in sufficient time and magnitude to offset
further acceleration in defense spending.
Turning to the import of international flows for
policy, one might conclude that whatever improvement
(or perhaps I should say whatever slowing in deteri
oration) has occurred in our over-all international
balance has been in large measure a function of the
restraint on bank credit we have been exerting. This
restraint has reinforced our efforts at limiting direct
bank outflows of capital; it has increased the attractive
ness of U.S. financial assets to foreign investors; it
9/13/66
-26-
has encouraged U.S. businessmen to finance abroad a
larger share of their overseas investment.
Such
results of monetary restraint on our international
capital accounts have been essential in a period
when our current account has continued to deteriorate.
Given the still dismal international flow outlook as
outlined by Mr. Reynolds, one doesn't see much basis
from the international side for easing on the monetary
reins yet.
Balancing these market, domestic, and interna
tional perspectives in an over-all appraisal of
policy needs, I come to the conclusion that it is
far too soon to be actively moving away from the
System's posture of restraint, but that our efforts
to maintain restraint should be tempered. Tempering
is called for, first to avoid further jolts to
financial markets as they try to develop new trading
levels appropriate to changes in flows and in
expectations that may be engendered by the new fiscal
program and, second on the off-chance that our
appraisal of fundamental economic conditions and
prospects could be wrong, in its assessment of either
the strength of demands or of the bite that is
already resulting from policy actions to date.
In these circumstances, caution is called for.
The appropriate policy posture can probably best be
described as "passive restraint," a policy that
permits financial indicators to ease if the source of
the easing comes from the market, but which would
maintain pressure if financial indicators suggest
renewed strength significantly beyond that now forseen
for credit demands at banks or in the capital markets.
In the few minutes remaining, I would like to
spell out what this posture might mean for the banking
and financial indicators we usually follow. At the
outset we have to recognize that several factors, such
as our new discount administration program and the
Treasury's foreswearing of new agency issues and
participation certificates, render some of the usual
policy indicia difficult to interpret. For example, a
decline to a shallower net borrowed reserve figure
would not necessarily mean an easing in monetary policy.
Indeed, it could well reflect an unwanted tightening,
a failure of policy intent, if banks insist on making
the kinds of portfolio adjustments we wish they
9/13/66
-27-
wouldn't, rather than seeking accommodation at the
window at the price of disturbing customer relation
ships. Alternatively, a shallower net borrowed
reserve figure could signify reduced pressure of
credit demands on the banking system as a whole, or
that those banks continuing to meet strong customer
loan demands are finding resources outside the discount
window, either from other banks in the Federal funds
market, or from foreign branches, or elsewhere.
Conversely, a rise in the net borrowed figure that
brought more banks within the purview of discount
window administration might be welcomed as the first
step toward our objective of achieving some redistri
bution of the brunt of monetary restraint, without
intensifying the over-all degree of restraint.
The ambiguity of alternative marginal reserve
figures can be dispelled if interpreted in terms of
concomitant developments in Federal funds and other
money markets, and in light of the information becoming
available on the composition of bank credit growth. But
because a particular net borrowed reserve figure can
have such widely different analytic meanings, it is not
appropriate now as a policy target.
We'll probably come closer to our basic policy
objectives in this period by keeping our sights on
financial prices and aggregate credit figures rather
than on marginal reserve measures. In considering
aggregate targets, let me say just a word about our
September projection for the bank credit proxy and its
relationship to the draft directives 1/ submitted by
the staff. The projection for September of virtually
no growth in the proxy on a seasonally adjusted basis
assumes that, on average over the month, CD's would
run off by about $1 billion more than the $1/2 billion
reduction to be expected on seasonal grounds.
It also
assumes that Government spending will continue to rise
so fast that even with high September tax collections,
Government balances will, on average, be reduced about
$1-1/2 billion more than seasonal. While the CD run-off
1/ Appended to these minutes as Attachment A.
9/13/66
-28-
and the spending of Government balances will likely
result in a rapid rise in private demand balances,
total bank deposits--the credit proxy--would show
very little change for the month. But the shift in
deposit structure would produce a substantial rise
in reserve needs.
Whether the contraction in CD's is held to the
$1-2 billion range depends very much on what happens
to rates on alternative investments, particularly to
Treasury bill rates. The outlook is not encouraging.
Treasury financing needs are rising swiftly, and the
Board staff's latest estimates of fourth-quarter needs
are staggeringly high. As market participants begin to
realize this, and take into account that new agency and
participation certificate financing is foresworn and
direct long-term financing impossible under the 4-1/4
per cent interest rate ceiling, upward pressures on
bill rates already evident in recent weeks will increase
and CD's will become even less attractive. Yesterday's
bill auction suggests that the market is already alert
to the Treasury financing dilemma.
At what point in the rate structure, and at what
level of flows, a new balance is struck between bill
rates and CD's is anyone's guess. The two-way tug of
bank-customer relationship cannot be ignored. The
staff assumed, for the purpose of the blue book, that
a rise in the 3-month bill rate into the 5.30-5.40
per cent range would still be consistent with only a
moderate run-off in CD's, but this is sheer conjecture.
Because there is the danger of too rapid an adjustment
in short-term rates, bringing with it too rapid a
contraction in CD's, and thereby renewing upward
pressures on the long-term markets we have been hoping
to shelter, I would urge that the bill rate be given
a high priority among the money market conditions to
be maintained at around current levels, to use the
terminology of draft directive "A."
We have to recognize that operating under this
directive, in the circumstances postulated of bill
rates tending to move up sharply and CD's tending to
run off rapidly, would probably result in increased
reserve provision, taking operations of the window
and the Desk combined. But we shouldn't get too
exercised about it, particularly if a larger share
-29-
9/13/66
of the reserves than usual comes through the window.
Expansion in bank credit over the summer (May through
August) has been contained to about a 4 per cent
annual rate, less than half the 1965 rate, and August
saw an actual credit contraction. Even if an average
credit growth rate in the 4 to 6 per cent range is
about the appropriate degree of monetary restraint
to achieve, there is no need to force the expansion
in the one month of September to be held to the
nominal amounts now projected by the staff. Certainly,
a shift in the public's preference as to the form of
bank deposit it wants to hold should not be the
occasion to force another contraction in bank credit.
The price of orderly adjustments in financial markets
and bank credit may be some temporary generosity in
reserve provision.
Mr. Robertson entered the meeting during the course of
Mr. Brill's statement.
Mr. Mitchell remarked that he agreed with Mr. Brill's
analysis except for the concluding part.
It seemed to him
(Mr. Mitchell) that a process of disintermediation by banks was
underway and, accordingly, that the bank credit proxy could be
allowed to decline without much concern.
To undertake to make
bank credit grow would, in his judgment, be contrary to the policy
the Committee had been following.
He had prepared a statement on
that point which he would make later in the meeting.
Mr. Ellis noted that in the two draft directives alternative
A was labeled "No further firming, with qualifications," and
alternative B was labeled "Firming to the extent feasible, with
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9/13/66
qualification."
He questioned the accuracy of those labels.
In
particular, the qualification in A appeared to be directed toward
easing, which suggested that three alternatives were contained in
the two directives.
Mr. Brill commented that he did not read alternative A to
call for operations directed toward easing, but rather for accepting
any tendency toward ease that might develop in the market.
Accord
ingly, he did not think it could properly be called an "easing"
directive.
Alternative B called for firming at the initiative of
the System.
Mr. Hickman noted that the proviso clause of alternative A
ran both ways; it called for further firming if bank credit
expanded substantially more than seasonally expected, as well as
for easing if credit expansion was no more than seasonal.
Mr. Shepardson said he would question the formulation of
the second part of the proviso, reading "if bank credit expands
no more than seasonally expected, some easing of money market
conditions shall be sought."
He would prefer language reading
"if bank credit expands less than seasonally expected . ..
."
Mr. Brill observed that the Board staff expectation was
for substantially no change in the credit proxy in September--the
range given in the blue book was plus or minus 1 per cent, at annual
rates.
He personally felt that some increase would be more
appropriate to the needs of the economy.
9/13/66
-31Mr. Mitchell observed that an increase in bank credit was not
necessarily appropriate if the economy was being financed outside the
banking system.
At a time when banks were reducing the degree of
their intermediation, a rise in bank credit could mean a tremendous
increase in the money supply.
Under such circumstances a money supply
target would appear more appropriate.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with Mr.
Hayes, who made the following statement:
Business developments since the last meeting
indicate that the economy is still growing at a rapid
rate and is likely to continue to grow at a rate
generating inflationary pressures well into 1967.
Important elements of strength include business plant
and equipment expenditures, rising durable goods order
backlogs, and sizable additions to inventories, besides
vigorous consumer spending plans and strongly rising
government outlays. The only significant area of
weakness in the economy continues to be residential
construction, but the prospective release of resources
in this sector does not appear large enough to offset
the excessive pressures generated elsewhere in the
economy. While a few of the key price measures have
recently been moving up at a slightly slower pace
than earlier in the year, the outlook continues to be
inflationary, as cost factors become increasingly
important.
As for the balance of payments, it appears that
the July-August deficit averaged roughly $2.6 billion
at an annual rate--close to that of the second quarter,
after adjustments for special transactions. The major
adverse factors, as has been true now for some time,
are the shrinking trade surplus, reflecting a very rapid
rise in imports, and increased expenditures connected
with Vietnam. Some of the capital accounts show a
distinct improvement, due no doubt in large measure to
9/13/66
-32-
tight credit conditions in this country; and the same
conditions have caused a sharp rise in private foreign
holdings of dollars, thus bringing important temporary
relief to the dollar in foreign exchange markets and
mitigating for the time being the drain on our gold
stock.
A distinct slowing in the rate of expansion of bank
credit is noticeable in the statistics available for
August and early September. We find considerable
evidence, both in the credit figures and in the
atmosphere of the credit markets, that the System's
restrictive credit policy is at last becoming
increasingly effective. Through the first eight
months of this year the credit proxy has grown at an
annual rate of just over 6 per cent compared with 9 per
cent a year ago. Business loans apparently experienced
an actual decline in August, whereas their rate of gain
in the previous seven months had been 22 per cent. If
the August drop is confirmed by the final data, it would
be the first monthly decline in business loans since
May 1961. Recent developments in the bank credit proxy
are likewise encouraging. Our own data suggest a
September increase of about 2 to 4 per cent after
including foreign branch funds; and this would be on top
of a 2 per cent decrease in August, or a 0.4 per cent
increase including foreign balances. Money supply also
shows a growth rate of only 1.7 per cent for the first
eight months of the year.
Since our last meeting the credit and capital
markets have been marked by convulsive movements and an
atmosphere of great uncertainty. At the nadir of the
bond market about two weeks ago there is no doubt that
the financial community was experiencing growing and
genuine fear of a financial panic. This fear seemed to
stem mainly from the conviction that credit demands
would remain very strong (with corporate and government
needs for funds unabated), that fiscal policy was making
no contribution toward a dampening of the economy, that
the agency financing program was actively stimulating
higher interest rates, and that the Federal Reserve
System was determined to push its restrictive policy
ruthlessly. Under these circumstances, I believe that
our System statement had a useful calming effect,
while at the same time properly underlining our concern
over the rapid growth--at least until very recently--of
9/13/66
-33-
bank credit. But of greater benefit to the markets
was the news that at long last the Administration was
favorable to some degree of fiscal restraint and a
more restrained policy with respect to agency
financing. I am not convinced that the near-term
impact of the proposed fiscal measures will be sufficient
or that the specific tax and depreciation measures are
either the most efficacious in reducing excessive demand
or helpful to the economy in the long run. While there
is of course ground for encouragement in the move in the
direction of a more restrictive fiscal policy, we must
probably accept the likelihood of continued doubts and
uncertainty in the money and capital markets. The stock
market's sharp decline has in itself greatly exacerbated
this uncertain atmosphere. We can be thankful, however,
that overexpansion of stock credit does not seem to be
a valid concern at this time.
In considering policy for the next three weeks, I
think we should give considerable weight not only to this
general unease in the financial markets but also to the
unusual short-term pressures over the next few weeks
expected to stem from run-offs of certificates of deposit
combined with seasonal tax and dividend requirements and
the forthcoming interest payment period for savings
institutions. On the international side we must
recognize that sterling is still viewed with suspicion,
though we can legitimately hope for a real turn-around
in sentiment if the current program for strengthening
international credit arrangements catches the imagination
of market participants all over the world. All of these
current uncertainties, together with the rather strong
evidence we now have of a slowdown in credit growth,
lead me to feel that we should not press for a more
It would also seem
restrictive policy at this time.
poor timing to tighten further in the face of the
I would think that the
Government's fiscal proposals.
Manager should be instructed to try to maintain about the
present level of restraint as measured mainly by money
market conditions, with ample leeway to adapt his
operations to market and credit developments. I would
think that the net borrowed reserve level should be of
subordinate significance.
As for the discount rate, I believe the System
missed a good opportunity in mid-July for a moderate
increase that would have brought the rate closer to
9/13/66
-34-
market realities. In the meantime market rates have
risen further, but at the present time, the same
factors that argue strongly against any open market
policy tightening also argue with equal force against
a discount rate rise. I certainly would like to sit
back for a little while and observe how effectively
the new Administration program is in dampening
inflationary expectations. I reach this conclusion
even though the period during which we shall be free
from even-keel restraints will not last many weeks
longer. I would still hope that we could move on the
rate before too long.
Turning to the directive, I prefer the first
paragraph of alternative B to that of A because I
think it is too soon to abandon our posture of
resisting inflationary pressures and strengthening
efforts to restore payments equilibrium. I would be
willing to substitute the words "continuing to re
strain" for the word "restricting" in the last
sentence. For the second paragraph I would propose a
new and simplified wording which is probably closer
to alternative A than to B but which makes clear our
intention to maintain both firm and orderly conditions,
with a suitable proviso for unusual liquidity pressures
or significant deviations of bank credit from current
expectations.
Specifically, I would propose the following
second paragraph:
To implement this policy, System open
market operations until the next meeting of
the Committee shall be conducted with a view
to maintaining firm but orderly conditions
in the money market; provided, however, that
operations shall be modified in the light of
unusual liquidity pressures or of any
apparently significant deviations of bank
credit from current expectations.
Mr. Ellis remarked that having reported at the Committee's
last meeting that residential contracting in New England had not
revealed the slowdown being reported by the banks, he should now
report that the data covering July revealed a 43 per cent drop below
July 1965.
All listed categories of residential buildings had a
9/13/66
-35
smaller contract volume than a year ago, although the 83 per cent
drop in apartment house contracts was outstanding.
Seasonally
adjusted manufacturing activity expanded further in July with most
of the rise occurring in the durable goods industries.
Preliminary
returns in the Boston Reserve Bank's follow-up survey of capital
spending by manufacturers in New England confirmed their spring
reports which indicated a sharp expansion of outlays.
In the days immediately following the Reserve Banks'
September 1 letter to member banks concerning business loans and
borrowing at the discount window,
Mr. Ellis said, he had held con
ferences with top managements of each of the reserve city banks in
his District.
Each gave enthusiastic endorsement to the concept of
loan curtailment, and each detailed the efforts it had been extending
to such an end.
One bank, having run up business loans by the end of
April by a total of 20 per cent, had a target of absolute contraction
of 10 per cent by year end.
None of those banks had borrowed at the
Reserve Bank in any volume for the past three weeks and all were
striving mightily to stay out of the discount window.
Each had
analyzed its certificates of deposit to "guesstimate" possible attri
tion and each had made plans to stay out of the discount window.
None
of the First District banks, large or small, had volunteered that they
were eligible or sought to be eligible for any special treatment under
the terms of the special program.
Borrowings, primarily through
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9/13/66
Federal funds or CD's, of the eight largest banks ranged in August
from a low of 94 per cent of required reserves to a high of 230 per
cent.
The comparable figure for eight New York City banks, taken
together, was 192 per cent.
Turning to monetary policy, Mr. Ellis judged that economic
events since the Committee's last meeting supported a conclusion that
the economy remained tilted toward inflation as it expanded rapidly,
with continuing pressures on available resources.
The next most
visible signs of that condition probably would appear in the labor
negotiations of the next several months.
In the fiscal arena, Mr. Ellis continued, it was now known
definitely that no tax restraint on corporate or individual spending
might be anticipated for the rest of this year, although order
backlogs for new equipment might shorten as the rate of new orders
was restrained.
In that connection, he enjoyed reading the Board
staff's analysis of the probable effects on the economy of the
Administration's proposals to suspend the investment tax credit and
accelerated depreciation.1/
In the debt management arena, the
revised program of Treasury financing should provide more confidence
to the securities market that the debt would be managed better.
1/ A memorandum on this subject by Eleanor Stockwell of
the Board's staff, dated September 11, 1966, was transmitted
by Mr. Brill to the Board of Governors and the Reserve Bank
Presidents prior to this meeting, and a copy has been placed
in the Committee's files.
9/13/66
-37
In the monetary arena, Mr. Ellis observed, he would suggest
that a one-month decline in the credit proxy and in business loans
should not lead the Committee to push the panic button and change its
policy.
That development should be viewed in a longer-run perspective,
including the preceding growth and the further expansion that was
virtually assured for September and the rest of the fall.
Personally,
he was not moved by the fact that there had been a one-month decline.
The fiscal program announced by the Administration would not restrain
inflation for the rest of the year.
Accordingly, he would suggest
that this was not the time for the System to ease its policy posture.
Mr. Ellis agreed with Mr. Brill that shallower net borrowed
reserve figures could have the meaning the latter had suggested.
But
they also could mean that the Committee had eased policy and was
providing reserves a little more freely, and the market was likely to
so interpret them.
In fact, the staff had projected a September shift
from CD's into demand deposits with such a surge as to expand demand
deposits faster than in any previous month this year.
That obviously
explained the expected acceleration in required and total reserves to
growth rates of 7 and 9 per cent, respectively, in contrast to their
August declines.
He recalled that at other recent Committee meetings
there had been discussion of the question of how much of the increase
in reserve requirements made by the Board should be supplied through
open market operations, but he noted that there had been no discussion
of that question around the table thus far this morning.
9/13/66
-38
Presumably, Mr. Ellis said, borrowings would have to average
in excess of $800 million--perhaps near $900 million--if net borrowed
reserves of $500 million were to be achieved.
At such a level of
borrowing even the largest banks probably would be having recourse to
the discount window, and that would enable further conversations about
the trend of lending.
Mr. Ellis noted that Mr. Koch had referred to three parts of
the President's recent message.
But there was a fourth part also;
namely, the President's request that the Federal Reserve work with the
commercial banks to help hold down, or lower, interest rates coupled
with action by the Congress authorizing the Federal agencies to
regulate savings rates.
That made it inappropriate at this time for
the System to take the long overdue action of bringing the discount
rate into line with related market rates.
It would seem feasible,
however, to maintain a target of $500 million for net borrowed
reserves, hoping that data revisions subsequent to termination of
operations would begin to be on the plus as well as the minus side.
And, with confidence somewhat restored in the securities market, it
should be feasible to attend more to reserve objectives rather than
market objectives.
Rather than backing away from reserve objectives,
the Committee should cling to them as much as possible in September.
9/13/66
-39
Mr. Ellis thought that alternative A of the draft directives
contained an unfortunate change of wording at the close of paragraph 1.
It spoke of "accommodating moderate growth in the reserve base" when
staff projections suggested September growth in total reserves would
tie for second place in monthly growth rates this year.
The second
paragraph called for easing in monetary policy if credit expansion
was strictly seasonal or fell short of the seasonal pattern, no matter
how shaky might be the ability to construct up-to-date seasonal adjust
ment factors.
Alternative B kept faith with the System's promise to
use monetary policy to restrain inflationary credit expansion, and
would be his preference.
However, he disagreed with the label put on
it; he did not think it was a policy of "firming to the extent
feasible," because the Committee could firm much more than suggested
by the language of the draft.
credit expansion accelerated."
He would describe it as "firming if
The second paragraph called for
"supplying the minimum amount of reserves consistent with the
maintenance of orderly money market conditions."
That surely should
be the Committee's objective; it would not want to supply more
reserves than those required to maintain an orderly market.
He liked
Mr. Brill's phrases, "tempered restraint," and "with tender loving
care," and he thought they described alternative B.
Mr. Irons commented that most areas of the Eleventh District
economy had advanced over the summer but probably by a bit less than
-40
9/13/66
nationally.
Employment changes in most categories had been of about
seasonal character, although some were above seasonal and some below.
Changes in industrial production were relatively minor in the latest
month.
The total index had shown no significant change in the last
few months relative to a year ago, continuing to run at a level 9 per
cent higher.
Retail trade, as measured by department store sales,
rose about 4 per cent during the past four weeks and also continued
to run 9 per cent above 1965.
Agricultural conditions were highly
favorable; farm prices were up 8 per cent over the past eight months,
with most of the increase in cattle prices.
Rains had been excellent
and grazing lands were in the best condition in some time.
In the financial area, Mr. Irons said, loans at District banks
were down in July and August, with most of the decrease occurring in
nonbank financial loans and "other" loans.
loans had advanced slightly.
Commercial and industrial
Deposits were down sharply, largely
because of a decline in Government deposits.
Negotiable CD's were
down about $10 million, and it was expected that two, or possibly
three, of the largest banks would be interested in special assistance
at the discount window.
Other banks did not appear overly concerned
at present about CD runoffs.
Average borrowing at the Reserve Bank
was up a bit in the latest period, to $42 million from $32 million in
the preceding period.
Banks continued to use the Federal funds
market most of the time to make their adjustments, although on any one
-41
9/13/66
day one or more of the large banks might find it necessary to come to
the window.
On the whole, the increase in both total loans and
commercial and industrial loans at member banks and weekly reporting
banks in the District had not been as large as nationally.
The national economic picture had been covered adequately in
the green book 1/ and in the discussion so far today, Mr. Irons said,
so he would not dwell on the subject.
His general recommendation for
policy over the next three weeks would be to maintain the current or
recent degree of restraint without attempting to bring about any
further intensification, for the several reasons indicated by
Mr. Hayes.
Mr. Irons believed that the level and movement of interest
rates and other measures of market conditions might provide a better
guide for policy now than net borrowed reserves, particularly in light
of the large revisions in the preliminary figures for the latter
recently.
Interest rates had already reached extremely high levels
and on one or two recent occasions money market conditions were
verging on disorganization.
In his judgment, further upward pressures
on interest rates and further restraint on the availability of
reserves relative to demand were not desirable.
There had been some
signs recently of a dampening tendency in bank credit expansion, and
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
-42
9/13/66
he felt that monetary policy was biting.
Banks were under pressure
to meet their loan commitments and to reduce the aggregate of their
loans outstanding.
The System should provide reserves for seasonal
loan growth and, possibly, for some nonseasonal growth through open
market operations and the discount window.
And the System should
stand ready to use the discount window to alleviate any unusual
pressures arising from CD runoffs or other deposit losses.
He would
not favor a change in the discount rate at this time and he preferred
alternative A for the directive.
Mr. Swan reported that while over-all business activity in
the Twelfth District was still strong the latest fragmentary data
certainly gave no signs of a further upward surge.
August employment
data for California and Utah--the only two States for which such data
were as yet available--reflected little change in nonagricultural
employment and a further increase in unemployment.
The California
unemployment rate had shown successive monthly increases from the low
of 4.6 per cent reached in May, and in August was 5.2 per cent.
Aero
space employment in California increased again in August, but only by
2,900 as compared with a rise of 8,400 in July.
Lumber and plywood
production continued to exceed orders and prices slipped down again in
August.
Both residential and nonresidential building contract awards
dropped sharply in July.
Total construction contracts declined only
slightly, but that was because two very large heavy construction
contracts were awarded in the month.
9/13/66
-43With respect to banking developments, Mr. Swan said, total
credit at weekly reporting banks increased in the two weeks through
August 24, but the rise was due entirely to an increase in security
holdings.
Loans were down; indeed, business loans had declined for
five consecutive weeks, and preliminary figures for the week ending
August 31 suggested another decline.
There appeared to be a little
tightening in the reserve positions of the major banks recently,
with some increase in borrowing at the Reserve Bank in the last week
of August and the first week in September, but the rise certainly
had not reached what one would call major proportions.
As to policy, Mr. Swan said his views were much the same as
those he had expressed at the preceding meeting.
phrase, "passive restraint,"
He liked Mr. Brill's
In view of the lack of increase in
bank credit and reserves in August, the market uncertainties that
still existed, and the current attempt to assess the Administration's
fiscal program, it seemed to him that the Committee should again seek
to maintain about the present money market conditions--recognizing
that, as had been indicated, the net borrowed reserve figures could
vary considerably depending upon the factors affecting them.
He
would allow the Manager considerable flexibility in day-to-day
operations, with some attention to be given to short-term interest
rates.
While movements in aggregates as well as in the marginal
reserve measures should be considered, he would leave room for a
9/13/66
-44
considerable margin in the outcome.
Despite the change in the
staff's projection of the bank credit proxy for September, he thought
that an increase on the order of 5 or 6 per cent, such as had been
anticipated three weeks ago, was still a fairly reasonable limit
before some positive action should be taken.
That conclusion led him
to favor alternative A for the directive, at least if it was inter
preted in the sense of its caption, "no further firming, with
qualification."
However, he had a question similar to one already
expressed regarding the last clause, reading "if bank credit expands
no more than seasonally expected, some easing of money market
conditions shall be sought."
He would prefer language that was
symmetrical with that in the preceding clause, such as "if bank
credit expands substantially less than seasonally expected ...
."
Mr. Swan concluded by noting that he agreed a change in the
discount rate would not be appropriate at this time.
Mr. Galusha reported that the Ninth District economy continued
to expand and about in the pattern of the national economy, and the
general outlook remained good.
agriculture.
Especially good was the outlook for
In fact, it was so good that anticipated and feared
pressures on the major banks to finance commodity dealers probably
would not develop.
Farmers, anticipating higher prices, were
apparently going to hold their crops themselves; and their cash
position was good.
The combination of cash, the shift in the U.S.
9/13/66
-45
Department of Agriculture policy, higher commodity prices, and the
generally low level of tax sophistication made him quite dubious that
any downward shift in agricultural spending for capital goods would
be caused by the Administration's fiscal program just announced.
in the lumber industry was the outlook poor.
Only
Unless residential
construction picked up, that industry would go through a decidedly
trying period.
The District's savings and loan associations appeared to have
gotten through July relatively well, Mr. Galusha said, having lost a
disproportionately small amount of share capital.
Nor had mortgage
lending and residential construction declined as much in the District
as in the nation.
The large District banks apparently were doing
better in rolling over their maturing CD's than were the money market
banks.
According to his information, New York banks were losing
about 50 per cent of their maturing CD's; Ninth District banks were
losing between 25 and 30 per cent.
All he could report about the response to the new approach to
discount administration, Mr. Galusha continued, was that he had not
heard a peep from the banks.
Possibly Ninth District banks--like
those in other Districts--were anxious to get by as best they could
on their own.
In any event, the Minneapolis Reserve Bank had not
yet had a chance to implement the System's letter.
-46-
9/13/66
Turning to the question of open market policy, Mr. Galusha
remarked that, as had already been indicated, the big news was the
President's proposal of last week.
He was greatly pleased that a
shoe had been dropped, although as an old tax man he was not thrilled
by its size or its style.
The reasoning of Miss Stockwell's
memorandum, with which he agreed wholeheartedly, must have not been
shared widely.
Apart from the public posture impact, the real effect
of the announcement would be minor.
It was apparent, therefore, at
least to him, that any monetary response to the President's proposal
was some way off--perhaps a good long way off.
At the very least the
Committee would have to be sure about what was going to happen.
Yet, Mr. Galusha continued, if easing any now would be unwise,
so would tightening further.
It was reasonably clear that the
economy was accelerating again.
Indeed, the fourth-quarter increase
in GNP might well be greater than the fourteen-odd billion dollars
the authors of the green book were presently expecting.
Then, too,
with what Congress had been appropriating for nondefense expenditures,
the forecasters' computers might soon be reading "tilt."
But what
ever the economic outlook might be, the Committee would, in his
judgment, be very poorly advised politically to go further at this
time.
And he, for one, was still a little apprehensive about the
results the Committee's new approach to monetary policy--as it
continued to evolve through this fall--was going to produce.
9/13/66
-47Mr. Galusha came out for the status quo and, more particularly,
for a net borrowed reserves total equal to the average of the past
several weeks.
Nor would he worry much about changes in interest
rates, slight or sharp, which were--in the Account Manager's judgmentproduced by changes in expectations.
expectations could be quite volatile.
Over the next few weeks
In sum, he was for alternative A
of the directives.
Mr. Scanlon reported that during August and early September
labor markets in the Seventh District continued to be extremely tight
and inflationary pressures remained dominant.
Shortages of labor,
skilled and unskilled, continued in virtually all District centers.
Help-wanted ads remained at a very high level and unemployment compen
sation claims had declined further.
Relaxation of hiring standards-
in terms of experience, education, and criminal records--had not
solved labor shortages.
Prices had continued to rise.
Early
September saw an unusually heavy flurry of price increases and it now
appeared that food prices would not decline as much in the next few
months as had been expected earlier.
Scattered reports indicated some cutbacks in capital outlays
for 1967, Mr. Scanlon continued.
In most cases those represented
completion of major programs started earlier.
On the other hand,
deliveries of capital goods had been delayed and some construction
projects had been postponed because of inability to obtain either
9/13/66
-48
reasonably firm bids or adequate financing.
Barring a change in the
general outlook, most of those projects presumably would be
reactivated next year.
Although orders for some types of capital
goods declined in July, order backlogs had increased further.
appeared to be no basis at present for calling a "turn"
There
in the
capital goods boom.
Mr. Scanlon reported that steel operating rates were rising
gradually but supplies should be adequate without pressing facilities
to the extent reported last spring.
Surveys indicated that more
steel consumers intended to reduce inventories than raise them in the
months ahead.
Auto inventories were reduced sharply in August but
remained high relative to past years, and production schedules
indicated that they would rise further during September.
Mr. Scanlon said that there was a sharp decline in the pace of
credit growth at major District banks in August, in line with the
national experience, but no indication that that was the beginning of
any extended period of easier demand for funds.
The contraseasonal
decline in loans could be attributed mainly to the further paydown of
loans to finance companies and the large volume of new capital issues,
a portion of which might have been used to retire bank loans.
Com
mercial and industrial loans in the District continued to rise, but
by somewhat less than in the same period of other recent years.
Real estate loans had been rising, but less rapidly than last year.
9/13/66
-49
Consumer loans had declined recently.
Total bank credit in the
District had risen much more since mid-year than in the same period a
year ago.
Recent rates on Federal funds of 6 per cent and over might
indicate an unwillingness by banks to submit to the discipline on
commercial and industrial loans expected to accompany use of the
discount window, Mr. Scanlon said.
However, he would expect the
current rate differentials to bring more banks to the window.
Mr. Scanlon observed that figures for August confirmed the
more moderate rate of expansion in money and credit projected at the
last meeting of the Committee.
He thought that for the present the
Committee should attempt to maintain very moderate rates of growth in
money and credit.
If that implied reduced reserve availability, he
would favor such measures short of inducing disorderly conditions in
the money and capital markets.
As to the discount rate, his views
paralleled those of Mr. Hayes.
In particular, he believed it was
essential to retain rate flexibility, both up and down.
Unless the
Committee was flexible on the up side it was restrained when easier
credit and lower rates were needed.
Mr. Scanlon favored maintaining about the present degree of
restraint for the period immediately ahead, but would give the
Manager sufficient latitude to operate should liquidity pressures
become acute.
He had some difficulty in selecting the directive that
-50
9/13/66
would accomplish that objective.
On balance, however, he would favor
alternative B, which he interpreted as Mr. Ellis had.
Mr. Clay observed that the period since the last meeting had
been one of marked financial changes.
It also had been a period of
public pronouncements concerning planned fiscal policy and debt
management changes.
Some expectational effects of those public policy
actions had been immediate in the financial markets and others might
follow.
The basic impact would take longer to work itself through the
economy and financial structure, once those programs had been worked
out and implemented.
The fiscal program relative to business capital
outlays required Congressional action for implementation, although the
retroactive feature might have some relatively prompt effect on new
orders for business equipment.
Whatever the meaning of the announced
screening of Federal outlays--and that was not clear at this time--it
had to be recognized that Federal outlays would be accelerating in the
months ahead.
Moreover, direct Treasury financing would be affected by
those expenditures as well as by the planned curtailment in agency
financing.
The basic economic situation did not appear to Mr. Clay to
have changed.
With variation among sectors, the economy still was
trying to do more than it could do in an orderly way.
Despite some
easing in sensitive materials prices, at least for the present, over
all pressure of demand on resources with upward pressure on prices
9/13/66
-51
continued.
In fact, recent developments on the wage-cost front
raised the possibility of more, rather than less, price inflation.
Apart from the economic policy issues now being debated, the
overriding consideration was the growing volume of expenditures
related to the South Vietnam war.
Despite the indications of public policy actions, Mr. Clay
remarked, the System would need to continue to formulate monetary
policy according to the economic and financial developments that
unfolded.
Any change in policy should depend on whether forth
coming evidence justified such change.
For the present, the
appropriate approach appeared to him to be a continuation of the
current policy of monetary restraint.
In view of the public
attention focused on recent economic policy statements, it was
important that the market not be misled into believing that Federal
Reserve policy had been eased.
If recent evidence of curtailment of
bank credit expansion continued in the weeks ahead, that would become
a significant factor to be taken into account in future policy
formulation.
Mr. Clay observed that the guidelines for a continuation of
the present policy of monetary restraint were not easy to delineate.
If member bank borrowing expanded substantially, an increase in net
borrowed reserves considerably above the current target would be
consistent with present policy.
Also, some increase in money market
-52
9/13/66
rates in connection with possible forthcoming money market pressures
would not be out of line with the current monetary policy posture.
The Federal Reserve discount rate continued to be inappropriate to
the present economic situation and current monetary policy.
Alternative B of the draft directives appeared to Mr. Clay
to be satisfactory.
Perhaps it should be said, however, that the
goal was the maintenance of the present degree of monetary restraint.
Alternative A seemed to carry the connotation of easing rather than
simply of no further firming.
Mr. Wayne said that responses to the Reserve Bank's latest
survey indicated a small increase of uncertainty among both
businessmen and bankers in the Fifth District.
Reports from
producers of durable goods suggested a continuing but still slight
downward shift in new orders, backlogs, and hours worked, while
returns covering nondurable goods remained mixed and showed little
or no trend.
Prices and wages in manufacturing had on balance
continued to rise.
Textile demand remained generally strong, but
soft spots in certain light cottons and blends continued to cause
concern and in the trade reports were being increasingly related
to imports, which had risen rapidly this year.
Automobile sales
remained down slightly, and there were signs of a slower pace in
construction even though contract award values had been rising since
-53
9/13/66
April and were now above last year's level.
Unemployment rates
continued at or close to historical lows and employment had con
tinued to rise.
Prices received by farmers through mid-August were
well above year-earlier levels, but prices paid reached new record
highs.
Seasonally adjusted business loans, total loans, and total
bank credit fell more in August at District banks than in the nation
as a whole.
Mr. Wayne commented that thus far banker reaction to the
discount administration policy announced in the System's letter of
September 1, 1966, had ranged from approval to resignation to the
inevitable.
There had been no adverse comments nor had any of the
banks asked for special considerations referred to in that letter.
The national economy continued to show evidence of over
spending despite a reduced pace in some areas, Mr. Wayne observed.
On balance, inflationary pressures were probably a little stronger
in August than in earlier months.
Prices continued to rise although
a few divergent trends were beginning to show.
The latest data
available on inventories indicated that they were behaving in a
manner typical of inflationary periods and in a way almost certain
to cause trouble later.
Capital outlays remained at a very high
level but there had been a few signs which indicated that the pace
might be starting to taper off.
-54
9/13/66
With respect to policy, Mr. Wayne said, the Committee had
had almost no room for maneuver even before the President made his
fiscal proposals last week.
less.
Now, it seemed to him, there was even
Obviously, an increase in the discount rate or significant
tightening in any other form would be a flagrant rebuff to that move
toward fiscal cooperation which the Committee had sought for a long
time.
On the other side, there were no valid reasons for any easing
of restraint.
The fiscal proposals were not yet law and there was
no evidence of "any easing of inflationary pressures."
To him that
suggested that the Committee should follow a very strict "even keel"
policy while Congress acted on the proposals and, unless there were
urgent reasons to the contrary, until the initial effects of the
measures could be evaluated.
He would expect the short-run effects
to be salutary, because they helped to clear the air respecting the
objectives of fiscal policy and should therefore have a settling
and strengthening effect on the bond market.
Except for those
announcement effects, the results of the proposed measures were
likely to develop slowly and uncertainly.
The initial impact would
be on corporate profits and capital investment, both of which
fluctuated widely and which might now be approaching their peaks
irrespective of the proposed tax changes.
In the meantime, Mr. Wayne thought the Committee faced a
very difficult problem in implementing monetary policy in the next
-55
9/13/66
week or two.
The large flows of funds over the tax and dividend
dates, the prospect of a sizable runoff of CD's, the banking system's
reactions to the System's policy announced on September 1, continuing
large demands on the capital market, and the volatile reactions of
the financial market as the fiscal proposals were debated and acted
upon--all of those impinging on a market already nervous and unsettled
would provide a very turbulent environment in which to carry out any
policy.
He could see no alternative but to give the Manager wide
discretion and ask him to follow as closely as possible the same policy
the Committee had been pursuing in recent weeks.
It was very likely
that the Manager would often have to give first consideration to
market conditions but, subject to that, he should attempt to maintain
about the same level of reserve availability as had prevailed in the
past month.
A directive as proposed by Mr. Hayes seemed consistent with
Mr. Wayne's idea of a desirable posture for the next three weeks and
perhaps longer.
Mr. Shepardson said he thought the economic situation had
already been clearly described today.
While there were some
conflicting indications, most of the evidence still indicated a
strong, booming pace of economic activity.
The President's program
introduced an element of uncertainty since one could not know how
-56
9/13/66
it would be implemented, and how quickly.
All of which, it seemed
to him, called for maintaining a policy position as nearly like
the present position as possible.
He did not think the Committee
should be unduly influenced by a one-month downturn in bank lending,
in the face of the preceding long-protracted uptrend.
Mr. Shepardson said that, like others, he thought the draft
directives were mislabeled.
Alternative A seemed to him definitely
to be an easing directive, and he considered inappropriate some of
the changes suggested in its first paragraph.
Alternative B more
nearly contemplated maintaining the present policy position, and
it was worded in a way that would give the Manager the necessary
degree of leeway.
The final clause, calling for seeking still
greater reliance on borrowed reserves if bank credit expanded more
than seasonally expected, seemed to him to be proper.
Basically,
over the coming period the Committee should try to maintain the
present degree of restraint without either firming or easing.
The
directive Mr. Hayes had suggested went a long way in the same
direction, and it might be preferable to the staff's alternative B.
Mr. Mitchell presented the following statement:
In the current financial environment the directive
properly emphasizes the "maintenance of orderly money
market conditions and the moderation of unusual liquidity
pressures."
9/13/66
-57-
A major reason for this concern over liquidity
pressures is that so long as interest rates on market
instruments are higher than Regulation Q ceilings there
will be a trend toward "disintermediation"--that is,
toward a run-off of negotiable CD's at banks. In
addition to our concern over liquidity pressures, we
must understand the implications for monetary policy
of such a run-off in CD's.
We start with the fact that, today, yields on
market instruments attract investors holding maturing
negotiable CD's; i.e, investors are responding to
the current pattern of interest rates by reducing
their claims on banks and increasing correspondingly
their holdings of short-term securities.
What appears to be happening is thus a reversal
of the process that occurred when Regulation Q was
raised at the beginning of 1962 and negotiable CD's
increased rapidly. Perhaps all that is necessary
for an understanding of the problem at hand is to
reverse the signs on the analytical and policy con
clusions reached four years ago. At that time, it
was concluded that a shift of the public's claims
toward bank time deposits and away from securities
and nonbank financial institutions tended to absorb
bank reserves and required offsetting open market
purchases by the System.1/
Under present conditions, holders of negotiable
CD's who do not wish to renew will probably purchase
1/ We also observed, four years ago, that the term structure
of interest rates was affected by the shifts, even if the System
accommodated them--for banks tended to acquire longer-term
obligations than the public gave up when it switched to time
deposits at banks. Such market impacts were regarded as
desirable at that time, helping to hold up bill rates and to
hold down yields and increase the availability of funds in
the municipal, mortgage, and other longer-term markets.
9/13/66
-58-
short-term agency issues, municipals, commercial and
finance company paper, and bankers' acceptances. To
the extent banks hold these types of paper, we can
cut through the intervening analysis and simply imagine
that banks redeem maturing CD's by handing over such
short-term assets, thus reducing both their assets and
liabilities.
Assuming that 100 of maturing CD's were paid in
this way, the results would be as follows:
Bank assets
-100
Time deposits
-100
No change
Money supply
Total reserves
No change
Required reserves
-
6
Excess reserves
+ 6
Public's holding of securities +100
Although bank credit and bank deposits would appear
to contract, total credit available to the economy would
not be affected nor should there by any further impact
on interest rates, in this example. All that has happened
is a reshuffling of assets between the banks and the
public with attendant effects on the distribution of
total credit availability and the shape of the yield
curve about the reverse of those that accompanied CD
In short, there will
expansion (see footnote, page 57).
have been a shift away from intermediation by the banks.
However, the situation with respect to excess
reserves is unstable; unless they are absorbed by the
System, they provide the basis for net credit and money
supply expansion.
In order to check on this short-cut reasoning, it is
useful to examine the process under the more realistic
assumption that those holding maturing CD's take the
proceeds initially in the form of demand deposits, which
they in turn use to purchase the short-term obligations
they wish to hold. I have done this and find that the
9/13/66
-59-
conclusions are unchanged once the transitional churning
is over.1/
The net result of a switch from CD's to market
instruments is, in the absence of offsetting action by
the System, to increase the over-all supply of credit and
money and to reduce average level of interest rates. So
long as individual banks in the course of reducing their
1/ Assume that 100 of CD's mature. The first step is that the
holders receive either a credit to their demand account in the
issuing bank or a check which they deposit in their own banks.
In any event, the banking system finds 100 of its deposits
shifted from time to demand status, with an immediate impact on
required reserves, in addition to churning of reserves among
banks as checks on banks that redeem CD's are deposited in
other banks.
But since the former holders of CD's intend to acquire higher
yielding assets rather than additional cash balances, we must
assume that the new demand deposits will quickly be used to
purchase short-term securities. Since the supply of such
securities much be assumed to be uninfluenced in the short run
by these developments, the securities will presumably be
purchased from existing holders, and the demand deposits pass
to the sellers of securities. At the same time, banks as a
whole find themselves under reserve pressure because time
deposits have been converted to demand deposits. Assuming
total reserves to be held constant, the banks will begin to
dispose of assets in order to adjust their reserves. As banks
sell securities, they reabsorb demand deposits, thereby reversing
the increase in both required reserves and demand deposits that
accompanied the switch from CD's to market instruments.
The switch of 100 from time to demand deposits increased
required reserves by, say, 9 (assuming the average reserve
requirement on demand deposits at the banks involved to be 15).
In order to reduce required reserves again, banks need to lower
their demand deposits by only 60, which means they must dispose
of only 60 of securities. It should be recalled that the former
holders of CD's will be in the market purchasing 100 of short
term securities. To reach complete parity with the short-cut
illustration itemized earlier, the System would now have to be
motivated to absorb 6 million reserves in order to reduce demand
deposits by 40, back to their original level; and the total of
40 securities sales by the banks and the System to accomplish
this adjustment would equilibrate the buying being done by former
CD holders.
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assets did not cause security markets to become disorderly,
the System would want to absorb the excess reserves released
by the reduction in CD's.
What is the implication of this analysis for the
aggregate measures upon which policy operates? To be
specific, assume a decline in negotiable CD's of about
$2 billion; then apart from the disturbances in security
markets arising out of adjustments by banks to the loss
of deposits, the aggregates will be affected as follows if
the System acts to absorb the $120 million in reserves that
are released as CD's decline:
-$ 2 billion
1. Bank credit (proxy)
2. Public holdings of securities + 2 billion
No change
3. Money supply
4. Total reserves
-$120 million
This decline in bank credit and total reserves would
not per se represent a tightening of policy. If the market
consequences of the changed distribution of credit avail
ability go beyond the bounds consistent with current policy,
we may want to take account of this in our operations. But
these are distinctions that it is important to recognize,
and to communicate, in order to be clear first to ourselves
and then to the many observers and critics of monetary policy.
Mr. Mitchell added that he preferred alternative B to A for the
directive.
However, he would delete the last clause of the first
paragraph, reading "by restricting the growth in the reserve base,
He thought the clause was in
bank credit, and the money supply."
appropriate at this time because, as his analysis indicated, there was
likely to be a basic inconsistency in the three measures cited.
In
the second paragraph, he would insert the words "firm and" before
"orderly money market conditions."
He did not like the proviso clause
because it was written in terms of bank credit, whereas he felt that
the focus should be on money supply.
rate target.
Others might prefer an interest
In any case, the Desk could operate properly without
the clause, and he would prefer to see it deleted.
9/13/66
-61Mr. Daane said he favored maintaining the current degree
of restraint and, to use a phrase Committee members had employed
in the past, "watchful waiting."
He would give the Manager flex
ibility to carry out the spirit of the Committee's intentions.
As to the draft directives, Mr. Daane said, he agreed that
there was a flavor of easing in alternative A that was not appropriate
at present.
He would accept the first paragraph of alternative B
with Mr. Hayes' amendment to the last clause.
Alternatively, he
would have no great objection to deleting the last clause of the
paragraph as Mr. Mitchell suggested.
For the second paragraph he
preferred Mr. Hayes' suggested language.
Mr. Maisel said he could agree with much of Mr. Mitchell's
analysis but he differed in the interpretation of the current state
of the monetary variables.
If one considered the period since
September 1965, and more particularly that since January 1966, most
such variables--with the exception of bank loans and possibly total
loans--appeared to be running considerably below a normal growth rate.
The degree of monetary restriction had been substantially greater
than might have been thought, and it would appear desirable to return
to something closer to normal growth rates.
Mr. Maisel noted that he had expressed the hope on previous
occasions that weekly net borrowed reserve figures would vary more
than they had in the past.
That goal appeared to have been attained
recently, if only as a result of large revisions in the preliminary
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figures.
He agreed with Mr. Hayes' conclusion that the net borrowed
reserve figures should be subordinated now.
Mr. Maisel thought it was important to accept Mr. Mitchell's
suggestion for deleting the reference to the reserve base, bank credit,
and the money supply from the first paragraph of the directive.
For
the second paragraph he would prefer a modified version of Mr. Hayes'
proposal.
It would be best, he thought, to avoid referring to
expectations, particularly since there was a difference between the
Board and New York Bank staff projections.
tions to be modified "in light of .
.
He would call for opera
any apparently significant
deviations of money and bank credit from a normal seasonal growth
pattern."
By "normal" for bank credit he meant a 4-6 per cent growth
rate in the credit proxy.
Mr. Brill commented that the difference between the projections
at the Board and the New York Bank did not reflect any basic disagree
ment on the outlook for bank credit.
They were mainly definitional;
the Bank's projection included the credit expansion expected as a
result of a continued pull-back of funds from foreign branches, which
was not allowed for in the Board's projection.
Mr. Hayes said he was a little puzzled by Mr. Maisel's use
of the term "normal seasonal growth pattern," which seemed to call for
no growth on a seasonally adjusted basis.
In any case, he would prefer
not to pinpoint an operating target in that manner.
9/13/66
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Mr. Maisel replied that, as he had indicated, he had a 4-6
per cent growth rate in mind as normal for bank credit.
Mr. Mitchell commented that with a reduction in bank inter
mediation underway such a growth rate in bank credit was likely to
have strong inflationary effects.
He thought it would be better to
refer to total credit than to bank credit alone.
Mr. Holmes noted that figures on total credit were available
only quarterly, in the Board's flow of funds accounts, and with a time
lag so that total credit was not a workable operational guide for the
Manager.
The go-around then resumed with remarks by Mr. Brimmer, who
noted that at its meeting just three weeks ago the Committee had no
expectaions of further assistance from fiscal policy.
Now that it
appeared that some assistance would be forthcoming, the general view
around the table was that the Administration's program was not good
enough.
Personally, he thought the Committee should keep policy
unchanged while observing developments with respect to the fiscal
package--and he would emphasize that it was a package and not simply
a collection of miscellaneous items.
It was not possible to foresee
the effectiveness or the timing of the elements, but there had been
some effects already, as indicated by the Manager's comments regarding
the postponement of agency issues.
As he understood the plan, the
Treasury proposed to sell a substantial volume of agency issues to
Federal trust funds and to increase sales in the market of short-term
9/13/66
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Treasury securities.
Such operations might have a significant effect
on money market conditions and would have to be taken into account in
open market operations; the Committee might find itself engaged in
some sort of an even keel operation.
In any case, the monetary im
plications of the Administration's package were serious.
Mr. Brimmer recalled that two months ago he had said publicly
that suspension of the investment tax credit might be helpful, and he
continued to think so.
At the same time, he thought the Committee
should not be overly optimistic about the package, but should wait to
see what happened.
As to Mr. Brill's suggestion of a policy of "passive
restraint," he (Mr. Brimmer) did not think the System should be passive;
there were some difficult areas--especially in connection with the new
discount administration program--that would call for active steps.
However, if Mr. Brill meant simply avoiding active further restraint
he agreed with him.
Mr. Brimmer said that he favored alternative A for the directive
with the several modifications suggested by Mr. Hayes.
Mr. Hickman commented that the economy continued to move forward
under forced draft, reflecting pressures generated mainly by business
and defense spending.
The rate of increase in consumer spending was
rising in the third quarter, after declining in the second quarter,
but would still fall short of the unusually rapid advance of the first
quarter.
Business investment outlays were exceptionally high, both
absolutely and relative to personal consumption expenditures, but the
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-65
rate of advance seemed to be moderating.
Defense spending remained
as the great unknown, with almost a complete absence of reliable
information.
Recent price developments suggested to Mr. Hickman some
moderation of inflationary pressures, although that might be temporary
and illusory.
Spot prices of raw industrials continued to decline,
and now were about 13 per cent below their mid-March peak.
The recent
behavior of meat and wheat prices suggested that food prices probably
would not move higher over the rest of the year.
An additional straw
in the wind was provided by Dun and Bradstreet's latest reading of
businessmen's expectations, which showed a small decline in the per
centage of businessmen expecting year-over-year price increases next
quarter, the first time that had happened in two years.
Mr. Hickman observed that financial markets were nervous and
uncertain, reacting in an extreme way to facts and rumors.
For that
reason alone, he would prefer not to make any change in monetary policy
for the next three weeks.
With most aggregate reserve measures lagging
anticipated rates of growth, and in some cases actually declining,
there was little doubt that the System's restrictive policy was taking
hold.
Most importantly, business loans declined during August, on a
seasonally adjusted basis, which indicated--despite some special
factors--that the excessive rate of expansion of bank lending was
moderating.
Other reasons for holding a steady course were the
President's five-point plan to combat inflation announced last Thursday
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9/13/66
and the heavy run-off of CD's anticipated in some quarters during
the next few weeks.
Although it might be academic now, Mr. Hickman said, he should
report for the record that at the Cleveland Reserve Bank directors'
meeting last week--before the President's announcement--there was con
siderable discussion about the effects of rescinding the investment
tax credit, and the pressures that a rescission might generate on the
demand for bank credit.
The general conclusion was that elimination
of the tax credit would have negligible short-run effects, and that
its long-run effects would be highly questionable.
Mr. Hickman had a slight preference for alternative A of the
staff draft directives, with the second paragraph as revised by Mr. Hayes.
The words "current conditions in the money market" in the staff's draft
troubled him in view of the sharp run-up in bill rates now underway.
However, the exact wording of the directive was not too significant to
him.
As he had indicated, he favored "no change."
Mr. Bopp said that as he balanced various considerations bear
ing on policy for the next three weeks he found the weight falling on
the side of no change.
That conclusion rested on three points, no one
of which alone was very persuasive, but which in combination suggested
that the best course--for the present, at least--was not to tighten
further through open market policy.
First, Mr. Bopp was not impressed with the likelihood that the
President's new program would be very effective in relieving the burden
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9/13/66
on monetary policy.
The tax measures would not have much effect for
many months, and it remained to be seen what would be done on the
expenditure side.
Yet the fiscal program should help to some extent
in restraining demand; and, although it would be unwise to try to lower
interest rates, as the President suggested, it seemed desirable--for
the time being, at least--not to take action which would raise them.
Second, it seemed to Mr. Bopp that the future effects of the
System's new discount policy were still very uncertain.
Conversations
with large Philadelphia banks suggested that vigorous efforts had already
been made to slow the growth of business loans.
Most banks expected to
hold such loans at about current levels or within the usual seasonal
rise.
The banks believed that they would be able to meet their loan
demands by issuing consumer-type CD's, borrowing Federal funds, and
selling assets--in that order.
Borrowing from the Federal Reserve
would be a last resort.
To make the new discount policy effective, Mr. Bopp continued,
open market operations would have to move aggressively to force banks
much more extensively into the discount window.
If the attitudes of
Philadelphia banks were typical, open market action might have to be
vigorous indeed.
The resulting effect on market rates could be drastic.
Announcement of the new policy was favorably received.
He would be
inclined, therefore, to move cautiously in implementing the new discount
policy and would not push open market policy so far as to force a
materially larger volume of borrowing.
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9/13/66
Third, Mr. Bopp observed, as the staff reports indicated
behavior of total bank credit and the money supply had been more
reasonable recently.
He found little comfort in that fact in view of
likely future demands for credit.
On the other hand, it was increasingly
important to be alert to the cumulative effects of restrictive policy
actions already taken.
For the time being an attitude of watchful
skepticism seemed to be the most appropriate.
Mr. Bopp observed that the directive suggested by Mr. Hayes would
accomplish the kind of no-change position he had in mind, with the
deletion in the first paragraph proposed by Mr. Mitchell.
Mr. Patterson commented that in analyzing the economy every
three or four weeks one might be reading more into figures than one
should.
But even allowing for strikes and seasonal quirks, some
indicators for the Sixth District indicated a slowing down in the
District economy's forward momentum. One such sign was the slackening
in employment gains.
Another was the decline in new car sales in July.
A third was a reduction in residential building.
Nevertheless, non
residential construction was still keeping the total contract volume
ahead of last year.
And over-all District business conditions were
undoubtedly still on the upside.
That he gathered not only from the
behavior of longer statistical trends but from the Atlanta Bank's
directors and other contacts.
The banking figures for the District showed some interesting new
developments, Mr. Patterson reported.
Starting in early August, total
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-69
loans at the large banks had declined for four straight weeks.
Business
lending had also fallen off, even though reports showed loan demand
remaining high.
That curtailment of loans confirmed statements by bankers
in recent conversations to the effect that they were eager to restrict
the pace of their lending operations.
Recent unfavorable deposit flows
were probably partly responsible for that pressure.
District banks
usually lost deposits at this time of the year, but this year they lost
50 per cent more demand deposits from mid-July to the end of August than
last year.
Furthermore, they had gained little in the way of time
deposits during the same period.
Since the banks were dependent to
some extent on an inflow of deposits from outside the District, pressures
in northern money market centers were evidently being transmitted to
the Sixth District.
Mr. Patterson remarked that District bankers, of course, were
saying the same thing indirectly when they reported that large companies
that had not borrowed from them for many years now wanted to make use of
their standing commitments.
Those conditions, and other national develop
ments, suggested to him that tightened credit conditions had begun to
take hold.
Mr. Patterson went on to observe that after having labored so long
for that to happen, one might be tempted to say:
the same."
"Let's pour on more of
But unless those trends were reversed and permissible rates on
negotiable CD's raised, he did not believe the Committee's open market
policy should become more restrictive, at least at this time.
He was
9/13/66
-70
especially worried that the short-term financial markets might not
stand too much additional strain.
He was in the dark about how to
translate that prescription into policy for the next three weeks.
However, he thought the new discount rules made guidance by net
borrowed reserve figures more difficult than ever.
Since the System
was so concerned with the trend of bank lending, he wondered if it
might not be desirable, at least experimentally, to use seasonally
adjusted bank loans as a principal guide, while taking account of
changes in bank security portfolios, member bank borrowing, and
conditions in money and securities markets.
However, the "no change"
directive was acceptable to him.
Mr. Lewis commented that various monetary indicators had
shown a marked change in direction since early summer.
Whether judged
by bank reserves, money supply, or interest rates, a significantly
different trend had apparently developed since about May or June.
From May to August, the money stock declined at a 3 per cent annual
rate after rising 6 per cent in the preceding year.
Total member
bank reserves and reserves available for private demand deposits
similarly shifted from increases to decreases.
Federal Reserve holdings
of Treasury securities and changes in reserve requirements contributed
net to effective reserves at only a 3 per cent rate compared with
8 per cent in the preceding year.
Likewise, Mr. Lewis continued, interest rates had gone up
much more rapidly since May than in the preceding year.
Yields on
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-71
long-term Government bonds had increased at a 20 per cent annual rate
since May compared with 10 per cent in the preceding year.
Yields on
commercial paper had gone up at a 39 per cent rate since May compared
with 23 per cent in the preceding year.
Such a shift of monetary indicators this past summer seemed
to Mr. Lewis to have been appropriate.
Under conditions of essentially
full use of available resources, of accelerating price increases, and
of unusually stimulative fiscal policy, it seemed to him that monetary
expansion was appropriately limited.
Looked at in another way, it
seemed likely that under the influence of high interest rates, price
inflation, and a strong propensity to invest, the demand
for money to
hold had been declining and therefore the supply of money also
appropriately declined.
Since he saw no pause in the inflation, Mr. Lewis said, and
since the fiscal situation appeared to be even more stimulative in the
last half of 1966 than in the first half, he believed the Committee
should continue in the near future about the same policy as that which
had prevailed in the last three months.
week was, of course, immensely pleasing.
The turn of fiscal policy last
He thought the Committee
needed to study very carefully what might be the magnitude and timing
of the effect.
With respect to discount rates, it had seemed to Mr. Lewis
some time back that the rates should be raised.
But, as circumstances
9/13/66
-72
had developed, that did not seem now to be of the first importance.
The System had been able to achieve a considerable monetary restriction
despite a discount rate far out of touch with the market.
During the
three summer months there was very little increase in borrowing from
the Fed in spite of the rapid rise in market interest rates.
So far as
he could see, discounting could be kept within reasonable bounds in the
course of normal administration of the window.
While he disliked the
windfall profit which accrued to those banks which borrowed from the
Reserve Bank at 4-1/2 per cent and lent at 6 per cent or more, he
believed it was sufficiently limited in amount and sufficiently dispersed
among banks that it need not for the moment weigh very heavily in the
System's considerations.
Mr. Robertson then presented the following statement:
I think this is one of those times when it is particu
larly difficult to be sure of the ideal course for monetary
policy to follow.
Inflationary pressures are persisting, as the staff
materials have underlined. Economic activity is expanding
vigorously, bolstered by strong business investment outlays
and growing Federal expenditures. Moreover, I take it that
further escalation from added Vietnam outlays has to be
considered as a possibility, even though we are still too
much in the dark about such a development as of now to base
current policy upon it.
To counter these inflationary pressures, we now have
the promise of help from a somewhat greater degree of
fiscal restraint. However, it is very hard to judge just
how much effective restraint the Administration package is
likely to provide, and how soon. To a certain extent, over
bullish expectations may have been moderated by the very
announcement of an official determination to achieve a more
restrictive fiscal posture. But the actual effects on
spending may stretch out over a number of quarters ahead.
9/13/66
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Meantime, monetary policy has also become tighter,
with lagged effects that must similarly be expected to
stretch out over the quarters ahead. In the face of strong
credit demands, we have managed to put bankers under enough
pressure to slow down the rates of growth of bank credit,
deposits, and the money supply. Our indicators of the
cost and availability of credit are also signaling new
degrees of tightness, and thanks to our new program of
discount administration, we have some extra insurance
that such tightness will prove better balanced than before.
Given what we have recently accomplished with the
reserve pressures we have brought to bear, I think it is
time to begin guarding against the possibility of substan
tially less than expected as well as greater than expected
bank credit expansion. With this view, I was glad to see
the staff draft directive A include a "two-way" proviso
clause this time, and I hope we make that a part of
whatever directive we adopt this morning.
In my view, our general objective for policy at this
juncture would be to hold about the current degree of
restraint. I think that would be our best posture as we
wait for the combination of recent public policy steps to
begin to have their effects. What money market signals
these may give us in the interim is, I judge, open to some
question. Since mid-August, net borrowed reserves and
Treasury bill rates have moved in largely opposite
directions, and I take it the staff is not at all sure
this performance will be any more consistent in the weeks
immediately ahead.
If member bank borrowings amount considerably higher
as large banks seek discount window assistance to meet their
September squeeze, I would again urge the Manager not to
engage in open market purchases simply to reduce such
borrowing, but instead to be prepared to operate so as to
keep such injection of borrowed reserves from significantly
easing money market conditions. But I do not think that
any net borrowed reserve figure or particular money market
rate can be a target for us in the present circumstances.
I would rather take the money market and reserve conditions
we have currently prevailing, and tell the Manager to
increase those pressures somewhat if bank credit expands
sharply more than seasonally expected, but also to be
prepared to ease up somewhat on such pressures if bank
credit should expand substantially less than seasonally
expected.
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I think these views are most in accord with the
language suggested in staff directive alternative A, if
the words "substantially less" are substituted for "no
more" in the second-paragraph phrase reading "if bank
credit expands no more than seasonally expected"; and
if the words "by tempering' are substituted for "while
accommodating moderate" in the last clause of the first
paragraph.
Chairman Martin remarked that, having just returned after an
absence of two months, he obviously was insufficiently informed on
recent developments to make a long statement.
While on the side-lines
during his absence he had been cheering for the System team and he
thought it had done exceedingly well.
He congratulated Messrs. Hayes
and Robertson on the quality of their leadership in a difficult period.
He was impressed today, the Chairman continued, by the high
degree of agreement on policy.
The intent of the Committee seemed
clear--there should be no overt action in either direction, and market
conditions should be kept as stable as possible.
The difficult
question was how to compose a directive that would most effectively
implement such a policy.
Personally, he could accept either of the
alternatives suggested by the staff, with or without various amend
ments that had been offered.
As was often the case, the proposed
directives were subject to different interpretations, depending on how
one read the words.
He had felt defeated over the years in the effort
to develop directives that were understandable to the public and to the
Committee and that worked.
regarding the directive.
The Chairman then invited suggestions
9/13/66
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In the ensuing discussion the Committee agreed on a first
paragraph for the directive consisting of that contained in the staff's
alternative B, with the final clause deleted.
Discussion of the second
paragraph was concerned mainly with the choice between the proposals of
Mr. Hayes and Mr. Maisel, or some modifications thereof.
Specific
questions considered were whether the proviso clause should refer to
deviations of "bank credit", "credit", or either of these in combina
tion with "money"; and whether the deviations should be considered from
"current expectations" or "normal seasonal growth."
The Committee
concluded that the proviso clause should relate to "deviations of bank
credit from current expectations", as proposed by Mr. Hayes, after
taking note that the current expectations for bank credit movements
included allowance for some prospective disintermediation.
Mr. Maisel commented that he understood the policy contemplated
by the directive would be most accurately described by the label the
staff had put on its original alternative A, namely, "No further
firming, with qualifications."
Thereupon, upon motion duly made and
seconded, and by unanimous vote, the Fed
eral Reserve Bank of New York was authorized
and directed, until otherwise directed by
the Committee, to execute transactions in
the System Account in accordance with the
following current economic policy directive:
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is
expanding vigorously, despite the substantial weakening in
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residential construction, with inflationary pressures per
sisting. Aggregate credit demands continue strong and
short-term financial markets remain under strain. The
balance of payments continues to reflect a sizable under
lying deficit. In this situation, and in light of the new
fiscal program announced by the President, 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.
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining firm but orderly conditions in
the money market; provided, however, that operations shall
be modified in the light of unusual liquidity pressures or
of any apparently significant deviations of bank credit from
current expectations.
Chairman Martin noted that Mr. Robertson had appeared on behalf
of the Board before the Senate Banking and Currency Committee this
morning regarding H.R. 14026, a bill that would, among other things,
give flexible authority to all Federal supervisory agencies to set
maximum rates on deposit-type accounts.
The Chairman invited
Mr. Robertson to comment.
Mr. Robertson observed that his testimony had been quite brief.
He had said that the Board's views had not changed from the time of his
testimony before the Committee on August 4, 1966; that the Board
endorsed the bill, except for the one-year limitation of the effec
tiveness of its provisions that had been added by amendment in the
House.
He had indicated that the Board considered that limitation unwise
(except with respect to a "sense of Congress" provision regarding a
reduction in interest rates) and that the limitation might well thwart
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the effective use of the new authority.
In response to the only
question asked of him, he had expressed the view that the bill as
written was better than nothing.
Chairman Martin then noted that a staff memorandum dated
September 1, 1966 and entitled "Contingency planning for the U.S.
Government securities and other financial markets" had been distributed
to the Committee.1/
He invited Mr. Holland to comment.
Mr. Holland said that the memorandum had been prepared by Board
staff members, in consultation with staff of the New York Reserve Bank
and the Treasury, in accordance with the Committee's instructions at
the previous meeting.
The object was to bring up to date a similar
contingency plan prepared a year ago when there also was concern about
a possible sterling crisis.
As in the earlier memorandum, the purpose
was not to resolve basic issues of policy but rather to discuss a
"holding operation" that would allow time for such policy decisions in
light of the specific circumstances prevailing, and the approach was
fairly general.
The differences from the earlier contingency plan
stemmed primarily from three main differences in underlying conditions:
dealer bond inventories now were considerably smaller than a year
earlier, credit conditions in general were considerably tighter, and
there now were likely to be problems in markets for securities other
1/ A copy of the memorandum referred to has been placed in the
Committee's files.
9/13/66
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than U.S. Government securities.
No formal action by the Committee was
required today, but the staff would take account of any comments on the
memorandum that the members might have.
No comments being heard, Chairman Martin suggested that the
staff memorandum be kept on file for possible use in case of need.
It was agreed that the next meeting of the Committee would be
held on Tuesday, October 4, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
September 12, 1966
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on September 13, 1966
Alternative A
(No further firming, with qualifications)
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is expanding
vigorously, despite the substantial weakening in residential construc
tion, with inflationary pressures persisting. Aggregate credit
demands continue strong and short-term financial markets remain under
strain. The balance of payments continues to reflect a sizable
underlying deficit. In this situation, and in light of the new
fiscal program announced by the President, it is the Federal Open
Market Committee's policy to help to counter inflationary pressures
and restore reasonable equilibrium in the country's balance of
payments, while accommodating moderate growth in the reserve base,
bank credit, and the money supply.
To implement this policy, and taking account of possible needs
to moderate unusual liquidity pressures, System open market operations
until the next meeting of the Committee shall be conducted with a view
to maintaining about the current conditions in the money market;
provided, however, that if bank credit expands substantially more
than seasonally expected, operations shall be conducted with a view
to seeking some further firming of money market conditions; and,
if bank credit expands no more than seasonally expected, some easing
of money market conditions shall be sought.
Alternative B
(Firming to extent feasible, with qualification)
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is expanding
vigorously, despite the substantial weakening in residential construc
tion, with inflationary pressures persisting. Aggregate credit demands
continue strong and short-term financial markets remain under strain.
The balance of payments continues to reflect a sizable underlying
deficit. In this situation, and in light of the new fiscal program
announced by the President, 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.
-2
To implement this policy, System open market operations until
the next meeting of the Committee shall be conducted with a view to
supplying the minimum amount of reserves consistent with the main
tenance of orderly money market conditions and the moderation of
unusual liquidity pressures; provided, however, that if bank credit
expands more rapidly than expected, operations shall be conducted
with a view to seeking still greater reliance on borrowed reserves.
Cite this document
Federal Reserve (1966, September 12). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19660913
@misc{wtfs_fomc_minutes_19660913,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Sep},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19660913},
note = {Retrieved via When the Fed Speaks corpus}
}