FOMC Minutes
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D. C.,
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
on Tuesday, November 1, 1966, at 9:30 a.m.
Martin, Chairman
Hayes, Vice Chairman
Bopp
Brimmer
Clay
Daane
Hickman
Irons
Maisel
Mitchell
Robertson
Shepardson
Messrs. Wayne, Scanlon, Francis, and Swan, Alternate
Members of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents of
the Federal Reserve Banks of Boston, Atlanta, and
Minneapolis, respectively
Mr. Holland, Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Eastburn, Green, Koch, 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
Messrs. Hersey and Reynolds, Advisers, 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. Forrestal, Senior Attorney, Legal Division
Board of Governors
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Messrs. Willis, Ratchford, Brandt, Baughman,
and Jones, Vice Presidents of the Federal
Reserve Banks of Boston, Richmond, Atlanta,
Chicago, and St. Louis, respectively
Messrs. Fousek and MacLaury, Assistant Vice
Presidents of the Federal Reserve Bank
of New York
Mr. Lynn, Director of Research, Federal
Reserve Bank of San Francisco
Mr. Deming, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Duprey, Economist, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of
the meeting of the Federal Open Market
Committee held on October 4, 1966, were
approved.
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of the
System Open Market Account on foreign exchange market conditions
and on Open Market Account and Treasury operations in foreign
currencies for the period October 4 through 26, 1966, and a
supplemental report for October 27 through 31, 1966.
Copies of
these reports have been placed in the files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
said that the Treasury gold stock would again remain unchanged this
week and there was a good chance of getting through November as well
without any drop in the gold stock.
That respite from previous
sales reflected in part the halt in French reserve gains during
recent months, and the widely publicized decision of the French
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authorities to forego this month their regular 30-ton purchase in
the absence of reserve gains.
During October the gold pool came
out about even on balance, with prices in the London gold market
remaining within a narrow range of $35.15-$35.165.
Since July,
South Africa had not been adding to its reserves with the result
that new production of gold had been coming from that country to
London in substantially larger amounts than earlier in the year.
On the other hand, it seemed increasingly unlikely that Russia
would have to sell gold in the foreseeable future.
There were many cross-currents in the sterling picture
in October, Mr. MacLaury commented, but the underlying trend in
the market was generally one of strength.
As the Committee would
recall, in July, at the time of extremely heavy selling of
sterling, the Bank of England had extended very substantial
support in the forward market as well as in the spot market.
A
large portion of the forward sterling purchases it had made at
that time--i.e., those with three-month maturities--fell due in
October.
Most of those contracts represented hedging of one
sort or another, and since the sellers in most cases did not
have sterling receipts coming in, they had to buy sterling to
make delivery; and, in effect, they bought it from the Bank of
England.
Thus, the Bank of England was able to pick up from
the market most of the dollars it needed to meet the heavy
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maturities, when it was not able to roll the contracts forward.
On several occasions during the month, however, the timing of
dollar purchases and commitments did not coincide and, on
balance, there probably was some net dollar drain in paying off
the sizable maturities that were not rolled over.
The Bank of England had borrowed $360 million overnight
at the end of September, Mr. MacLaury continued.
Also, because
of an increase in sterling balances in September, it was required
under the terms of the sterling balance credit arrangement to
repay $125 million of previously borrowed funds to the Bank for
International Settlements.
As a result, the Bank of England
would have needed nearly $500 million at the end of October just
to refinance previous borrowings.
Of that amount, the U.S. put
up $250 million on an overnight basis--from yesterday to todaywith $200 million from the Treasury and $50 million from the
System.
As it turned out, however, sizable dollar receipts
from the market in the last few days of the month would permit
the Bank of England to announce tomorrow that it had made a net
reduction of foreign indebtedness as well as a satisfactory gain
in its official reserves.
Thus, the U.S. credits to the Bank of
England this month-end represented only a partial refinancing
of credits previously extended to the British.
Taking into
account the net repayments of debt, the increase in reserves,
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and the substantial reduction in forward commitments, the over
all improvement in the British position in October amounted to
about $400 million.
That was an encouraging pattern.
The dollar continued to show strength during the month
against most continental currencies except the German mark,
Mr. MacLaury reported.
The Belgian franc and Italian lira held
around par, and the French franc was frequently just below par.
In each case, it appeared that the central bank concerned
supported its currency on occasion through the sales of dollars
in its market.
In the last few days the System Account had
bought about $12 million equivalent of lire in New York, $10
million of which would be used tomorrow (November 2) to reduce
the System's $100 million drawing on the Bank of Italy to $90
million.
Even greater progress had been made during the month
in reducing System drawings of Swiss francs from the Swiss
National Bank. Total repayments in Swiss francs since the
previous meeting of the Committee amounted to $45 million
equivalent, leaving $100 million still outstanding--including
the $75 million Swiss franc drawing on the BIS.
In contrast
to the currencies just mentioned, the German mark strengthened
considerably during the month and the German Federal Bank took
in about $100 million.
That mainly reflected the persistence
of very tight money conditions and the improvement in Germany's
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trade surplus that began earlier this year.
The German cabinet
resignations last week did not seem to have had any lasting impact
on the exchange market.
Finally, Mr. MacLaury said, his impression was that the
weakening tendency of the Canadian dollar during October was
attributable to the cumulative effects of the reduction in the
rate of new Canadian capital issues in the United States from
the first to the second half of the year, combined with short
term capital outflows from Canada.
Mr. Mitchell asked whether his understanding was correct
that the Bank of England's position had improved by roughly $400
million in October after all window-dressing operations were
discounted.
Mr. MacLaury replied that that understanding was
correct.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
October 4 through 31, 1966, were
approved, ratified, and confirmed.
Mr. MacLaury reported that two drawings by the Bank of
England on its swap line with the System, of $50 million each,
would mature at the end of November.
The Bank of England was
highly conscious of the desirability of paying down those
drawings, and it was possible that they would do so before the
maturity date.
He would recommend renewal of the drawings,
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however, if that should prove necessary.
One would be a first
renewal and the other a second renewal.
Possible renewal of the two
drawings by the Bank of England was
noted without objection.
Mr. MacLaury then noted that on December 2, 1966, the
System's drawing on the Bank of Italy which, as he had indicated
earlier, would be reduced tomorrow from $100 million to $90
million, would come up for a first renewal.
He hoped that
further progress would be made toward repaying the drawing, but
recommended renewal if it did not prove possible to liquidate
it in full.
Possible renewal of the drawing
on the Bank of Italy 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
October 4 through 26, 1966, and a supplemental report for
October 27 through 31, 1966.
Copies of both reports have been
placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
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The more buoyant psychology that had emerged in
financial markets prior to the last Committee meeting
has developed further over the past four weeks. The
factors underlying this improved sentiment have been
described in some detail in the written reports to the
Committee and I will not enumerate them here. Pressure
on the markets subsided markedly, interest rates moved
lower, and the corporate and municipal calendar showed
no signs of an unusual buildup. At the same time,
bank credit--as measured by the credit proxy--declined
in October in contrast to the 5-6 per cent rise
projected at the time of the last meeting. While
commercial banks were constrained by a substantial loss
in CD's over the month, the recent decline in Treasury
bill rates has tended to ease somewhat the pressure in
that area as well.
The important question that market participants
have been debating is whether the sign of reduced
pressure in financial markets represents the beginning
of a cyclical downtrend in interest rates and credit
demand or whether it has been a temporary lull, in
part an unwinding of the tensions and psychoses of
late August in the bond markets and of early September
in the short-term financial markets. Many banks and
market observers feel that loan demand remains very
strong and will soon be reasserting itself vigorously.
They ascribe the current shortfall in credit expansion
to anticipatory borrowing earlier and to some lessened
feeling of urgency to borrow now. At the same time,
with interest rates declining, borrowers in the capital
market, they argue, have tended to postpone needs but
may soon be seen again in force. This group also sees
less likelihood of a tax increase now than a few weeks
ago, and on balance is generally optimistic about the
business outlook.
The other major group would read something more
fundamental into recent indications of reduced credit
demand, and would generally argue that the tight money
and fiscal actions taken to date have already taken
the edge off business expansion, and that a tax increase
is no longer necessary. Vietnam is a complicating
factor for both schools of thought, but the latter
group would tend to view military spending as the only
major support of the domestic economy.
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The resolution of views just outlined is, of
course, identical with the issue that the Committee
faces today. For the time being market participants
would agree that the pressures on financial markets
have subsided. The question of "how long" remains.
System open market operations over the period
have, of course, been strongly affected by the
progressive shortfall of the bank credit proxy,
required reserves, and other aggregate measures from
the expectations of four weeks ago. A somewhat more
comfortable tone has been permitted to emerge in the
money market, partly reflecting the change in expecta
tions, and net borrowed reserve figures have fluctuated
widely without exciting either the press or the market.
Early in the period--in the week ending October 12,
for example--there appeared to be some tendency for the
larger banks to anticipate reserve needs at the discount
window. In that week heavy average borrowings and a
net borrowed reserve figure of about $500 million were
associated with a generally comfortable Federal funds
market. In the week ending October 19 country banks
built up their excess reserves substantially in the
first week of their settlement period, with the
result that a far lower level of net borrowed
reserves--around $300 million--was consistent with
about the same tone in the Federal funds market.
Last week, as excess reserves were put to use by
country banks, a somewhat higher level of net borrowed
reserves than the $366 million that eventuated would
have been consistent with the general money market
But, as the written
atmosphere of recent weeks.
reports spell out, after injecting about $250 million
of reserves on Monday, October 24, when the money
market was firm and net borrowed reserve estimates
for the week were around $600 million, we were faced
with unexpectedly large revisions in the figures on
Tuesday. While we absorbed reserves on Tuesday we
did not think it worthwhile to press too hard,
particularly in light of the behavior of the credit
proxy.
Looking ahead, the Board staff is projecting a
2 per cent decline in the credit proxy for November,
as the blue book 1/ indicates; the New York Reserve
1/ The report, "Money Market and Reserve Relationships,"
prepared for the Committee by the Board's staff.
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Bank projection is for a larger decline. I confess that
at the Desk we had been anticipating some resurgence
in private credit demand in November, and had also
expected the Treasury financing program to result in
the acquisition of Government securities by banks.
Thus I find the projections hard to believe. I
believe that in the circumstances, the proviso clause
of the directive 1/ may be hard to interpret. On the
basis of my understanding of the Committee's intentions
in the recent past, I would think that the proviso
clause should be interpreted as calling for tighter
money market conditions only if bank credit appeared to
be expanding again at a rapid rate in November. Perhaps
a rate in excess of the average expansion so far this
year would be required to bring the proviso into play.
On the other hand, if the staff expectations appeared
to be borne out, some further easing of money market
conditions might be called for. Any shading of money
market conditions and reserve availability from recent
patterns would of course have to take place within the
context of even keel considerations. I would find it
helpful if the Committee members would comment on their
own interpretation of the proviso clause during the
course of the go-around.
For the past several months now we have been paying
more attention to short-range aggregate measures--the
credit proxy and required reserves--in conducting day
to-day open market operations. On the whole I believe
this has worked rather well. The credit proxy, however,
could be improved if more weight were given to some of
the nondeposit liabilities of banks which have a
counterpart in bank credit although they do not affect
the proxy as it is currently calculated. I would hope
that the staff would give early consideration to the
improvement of the proxy in order to make it a still
better measure of daily average bank credit.
1/ A draft directive submitted by the staff for consideration by
the Committee is appended to these minutes as Attachment A. A set
of explanatory notes was attached to the draft in an experimental
effort to clarify the staff's reasons for proposing certain
language at particular points.
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Treasury financing will be an important market
factor over the remainder of the year. The books are
open today on the November refunding, in which the
Treasury is offering for cash $2.5 billion of 5-5/8
per cent 15-month notes and $1.6 billion of 5-3/8 per
cent 5-year notes in exchange for $4.1 billion of
maturing obligations--of which $3.2 billion are held
by the public. The offering announcement last
Thursday met with an enthusiastic response, and the
market anticipates that subscribers to both issuesand especially the longer note--will receive only small
allotments on their subscriptions. Both issues are
attractively priced (these are the highest coupons on
Governments since the early 1920s), and there seems to
be a lively interest on the part of dealers, banks,
public funds, and small investors. Some speculative
demand is apparent, but the Treasury's decision to use
a cash rather than a rights exchange minimizes the risk
by keeping the size of the longer issue under control.
The System holds $829.1 million of the maturing issue
and I would plan to exchange the full amount for the
5-5/8 per cent 15-month note,
By using a cash refunding the Treasury will avoid
attrition and can raise about $300 million in new money
with a normal 10 per cent overallotment. Cash needs for
the remainder of the year amount to about $2-1/2 billion,
which the Treasury currently plans to raise through a
strip of Treasury bills in the one-year cycle and through
an additional offering of tax anticipation bills. The
first part of this cash financing should be announced
before the November 15 payment date on the refunding,
with the second part scheduled for some time in December.
It should be noted that the decision to postpone
marketing of Federal National Mortgage Association and
Export-Import Bank participation certificates has
created problems with the debt limit as the Treasury's
own financing has been increased. The Treasury will be
pressing against the $330 billion temporary ceiling
by late this month, and December could bring additional
problems. While the Treasury probably will be able
to live under the present ceiling through the rest of
this year, especially if market conditions permit the
issuance of participation certificates, there could be
some annoying problems in operating the Treasury's cash
position in the next two months and an increase in the
debt ceiling may be required early next year.
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Mr. Swan asked whether the somewhat shallower net borrowed
reserve figures of the last two weeks were likely to recur in the
current week or whether Mr. Holmes would expect the figure to deepen
at this point.
Mr. Holmes responded that last night the Desk was
looking at a figure of $469 million for the current week.
It was
hard to predict the final figure, however, partly because one could
not say what revision would be indicated by the country-bank sample;
last week the sample had added about $100 million to reserves.
On
the whole, however, he thought the figure would not be far from
last week's, and perhaps a bit deeper.
Such a figure probably
would be consistent with a relatively constant tone in the money
market.
Mr. Mitchell remarked that like Mr. Holmes he had reserva
tions about the proviso clause in the directive, but perhaps for
different reasons; he was troubled by the language.
He noted that
the staff projected a decline in the bank credit proxy at an annual
rate of about 2 per cent in November.
If in fact the Committee
wanted to moderate the disintermediation that was taking place,
what could it achieve and what would be the implications for the
rate structure?
What should be done about attrition in CD's?
Mr. Holmes commented that many banks thought they might be
approaching the end of the road with respect to attrition in their
outstanding CD's; they felt that their position with respect to
CD's had improved, and that the outlook did not appear as
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discouraging as earlier,
Of course, the average maturity of CD's
was now quite short and the banks' positions remained vulnerable.
Mr. Mitchell observed that bill rates might have to remain
close to their present levels to avoid a considerable amount of
attrition, and rates might have to drop by 20 or 25 basis points
further to stop attrition altogether.
If there was some rise in
bill rates more CD run-offs would follow and the credit proxy might
well decline by more than now projected.
Mr. Holmes agreed that a rise in bill rates would tend to
increase CD run-offs, but he thought there was a range within which
rates might fluctuate without substantial effects.
It was hard to
say how much of a decline in bill rates would be required to bring
attrition to a halt.
In response to a question, Mr. Holland indicated that the
staff's projection of the bank credit proxy in November allowed for
a CD run-off of about $1/2 billion, with short-term rates expected
to rise a bit.
Mr. Hickman asked whether the one-month bill rate was the
most relevant for assessing CD developments, and Mr. Holmes replied
that rates on bills with maturities out to three months had to be
considered.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
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during the period October 4 through 31,
1966, were approved, ratified, and con
firmed.
Chairman Martin observed that at its preceding meeting the
Committee had agreed to consider today the subject of possible
System operations in agency issues, and he asked Mr. Holland to
comment.
Mr. Holland noted that recent legislation gave the System
authority to engage in open market operations in direct obligations
of U.S. agencies and obligations guaranteed by such agencies, and
that a staff memorandum on the subject, dated October 3, 1966, had
been distributed.
The question before the Committee today was
whether it wished to take some action at this juncture in recognition
of the new authority.
The Account Manager had indicated that he was
not prepared to recommend outright transactions in agency issues at
this time because of a number of problems, outlined in his memorandum
to the Committee of June 23, 1966, that required resolution; but
that he would consider repurchase agreements in such issues to be
a potentially useful addition to the kit of tools available for
reserve management.
Mr. Holland went on to say that in his judgment the immediate
market situation was not such as to make the matter a pressing one.
It was true, however, that dealer inventories of agency issues had
been rising, and now were approaching $1/2 billion.
On occasions
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when dealers had financing needs in connection with those holdings,
the use of RP's against agency issues might be an appropriate means
of making some necessary reserve injections; and such RP's might
also facilitate flotations of agency issues.
In the staff's opinion,
the only action required to authorize RP's in agency issues, if the
Committee so desired, was an amendment to paragraph 1(c) of the
continuing authority directive, and a draft of an amended paragraph
was incorporated in the October 3 memorandum.
In response to the Chairman's invitation to comment,
Mr. Holmes said he thought Mr. Holland's remarks had covered the
matter well.
He would add only that some dealers were now complain
ing about a shortage of agency issues.
In the present atmosphere,
which was quite different from that of June, outright transactions
were likely to distort the market--and that was an additional reason
for not engaging in such operations now.
Repurchase agreements
against agency issues would have been useful in the recent past on
occasions when there was a shortage of bills in the market and it
was necessary to supply reserves.
Mr. Mitchell observed that the agency market was likely
to be under great pressures in the spring.
He thought it would
be desirable to go beyond authorizing repurchase agreements against
agency issues now, and also to authorize outright transactions in
them.
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-16Mr. Brimmer said he favored authorizing RP's against agency
issues at this time.
In the absence of some unexpected development,
U.S. agencies probably would be in the market again in the spring,
and it would be helpful then to have had some experience with agency
RP's and to have accustomed the market to such operations.
Moreover,
he thought the Committee should take some action in response to the
enactment of enabling legislation.
Mr. Daane said he would go along, although somewhat reluc
tantly, with the proposal to authorize RP's against agency issues,
largely for the second of the two reasons Mr. Brimmer had mentioned.
He felt that the basic consideration in decisions on use of the
authority should be--in words drawn from the Manager's June
memorandum--"whether such operations would be of value in imple
menting System policy objectives."
He would not favor authorizing
outright transactions in agency issues at present.
Mr. Maisel remarked that the Committee should give a good
deal of attention to the matter of outright transactions.
He then
asked about the rates at which recent RP's against Treasury bills
had been made.
Mr. Holmes replied that all RP's recently had been made
at the discount rate.
For some time he had felt that that rate
was undesirably low, considering the levels of short-term market
rates in general.
On three different occasions he had considered
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applying a higher rate; the continuing authority directive, of
course, specified only a minimum rate.
Unfortunately, on each
such occasion, the market situation and psychology had developed
in a manner that led him to conclude that a higher RP rate would
have an undesirable impact on expectations.
Mr. Holmes added that the subject of agency issues was
being given extended consideration in the joint Treasury-Federal
Reserve study of the Government securities market now underway,
and at some later time the study group might bring forward some
expressions of opinion.
Chairman Martin said it seemed to him that it would be
desirable for the Committee to authorize RP's against agency
issues now.
He thought the Committee would want to study the
question of outright transactions further, and be prepared to
reach a decision regarding them at a later date.
Mr. Mitchell reiterated his view that the Committee should
go further now.
In his opinion authorizing outright transactions
would be consistent with the position the Board had taken at the
time the legislation was under consideration in Congress, and it
would be appropriate on other grounds also.
He did not think the
Committee would be trying to influence the prices of agency issues
in any manner other than that in which it now influenced Treasury
security prices.
The Committee put funds into some sector of the
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market to achieve monetary objectives--which might be defined in
terms of reserves, money supply, total deposits, interest rates,
or other variables.
He saw operations in agency issues as a
further means of achieving monetary objectives.
Mr. Daane commented that he had meant to indicate that
monetary objectives should be placed first even in the use of
RP's against agency issues, and on that point he felt there was
no disagreement between Mr. Mitchell and himself.
Mr. Brimmer asked when Mr. Holmes thought the current
study of the Government securities market would be completed.
Mr. Holmes said the study group had made substantial
progress recently and hoped to move further ahead in November.
He
was not able, however, to indicate a specific date for completion
of its work at this time.
Mr. Brimmer said he hoped the matter of the availability
of the study would not influence the date at which the Committee
would reach a decision on outright transactions in agency issues.
At the same time, he personally would be reluctant to go ahead
without having the study, and therefore he hoped that it could
be accelerated.
Mr. Hayes said that on the general issue he found himself
in agreement with both Messrs. Daane and Brimmer.
Authorizing
RP's against agency issues would be useful, and he thought the
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Committee should take that step; but he saw no need for the
Committee to reach a judgment on the broader question of outright
operations at this time.
He strongly agreed with Mr. Daane that
any operations in agency issues should be for monetary purposes
alone.
Mr. Robertson said that if the Committee thought authoriz
ing RP's against agency issues would facilitate their underwriting,
it should authorize such RP's, to be utilized just as RP's were
utilized elsewhere.
He would favor going that far now.
At some
point the Committee would have to face the question of authorizing
outright transactions, and it should do so in advance of the time
at which the question of actually undertaking such transactions
became pressing.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
paragraph 1(c) of the continuing
authority directive to the Federal
Reserve Bank of New York was amended
to read as follows:
(c) To buy U.S. Government securities, obligations
that are direct obligations of, or fully guaranteed as to
principal and interest by, any agency of the U.S., and
prime bankers' acceptances with maturities of 6 months or
less at the time of purchase, from nonbank dealers for the
account of the Federal Reserve Bank of New York under
agreements for repurchase of such securities, obligations,
or acceptances in 15 calendar days or less, at rates not
less than (1) the discount rate of the Federal Reserve
Bank of New York at the time such agreement is entered
into, or (2) the average issuing rate on the most recent
issue of 3-month Treasury bills, whichever is the lower;
provided that in the event Government securities or agency
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issues covered by any such agreement are not repurchased
by the dealer pursuant to the agreement or a renewal
thereof, they shall be sold in the market or transferred
to the System Open Market Account; and provided further
that in the event bankers' acceptances covered by any
such agreement are not repurchased by the seller, they
shall continue to be held by the Federal Reserve Bank or
shall be sold in the open market.
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. Brill made the following statement on economic conditions:
An economist has to take his economic information
where he can find it, and I'm not above using, as the
text of my sermon this morning, the caption on a delight
ful cartoon which appeared in The New Yorker magazine last
week. Most of you must have seen it. It's the one showing
two attache-case-carrying types stepping out of a building
On spotting that infamous symbol
marked "Federal Reserve."
of the Great Depression (a man selling apples on a street
corner), one of the two comments, "I say, don't you think
we've cooled the boom off enough?"
Certainly, a number of economic indicators suggest
some cooling off. And certainly, we don't want to wait
until there are apple-sellers on street corners before
reversing the stance of policy. But as usual, many of
the indicators now available are ambiguous, and some of
the uncertainties about the future, particularly about
defense outlays, remain. Under these circumstances, the
appropriate stance of policy is far from being crystal
clear.
Looking back over the economic performance of the
past several months, one can see many signs of a slowing
in the rate of rise in activity. But some of this has to
be attributed to supply constraints, perhaps as much as
For example, the industrial
to moderation in demands.
production index slowed considerably in the third quarter,
rising only half as fast from June to September as it had
over the spring quarter. The reduced rate of expansion
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did reflect production cutbacks in industries where demands
have eased, such as in autos and home goods.
But it also
represented the reaching of labor and plant capacity limits
in other industries, such as business and defense equipment.
Over all, our newly revised measure of capacity use in
manufacturing indicates that the utilization rate has remained
fairly steady this year, at levels as high as that reached
at the peak in 1955.
There also have been signs of a slowing in nonfarm
employment growth in recent months, over and above that
attributable to the exceptionally large withdrawals of teen
agers from employment in September in order to return to
school. Here, again, there is a mixture of supply limits
and demand weakening, with shortages of skilled workers in
some manufacturing industries requiring a lengthening of
the workweek, while in other industries--such as textiles
and construction--smaller employment growth reflects reduced
demands. Over all, the rate of increase in employment is
still pushing up against available supply, and the over-all
unemployment rate will show little change for October, with
unemployment of adult males continuing at low frictional
levels.
Many of us have been trying to read back from the
financial figures to the performance of the real economy
to demonstrate weakening. It may well be that the recent
abatement of pressures on banks and in financial markets
does reflect some softening in demands for goods and services,
not just financial supply limitations as lenders ration credit
more severely. While I would caution that the ratio of
financing to spending can be a volatile measure in the short
run, the recent moderation in business loans undoubtedly has
its counterpart in some reduction in business inventory
demand. This is not implausible after the very fast inventory
run-up in the second quarter and the continued large accumula
tion in the July-August period; inventory-sales ratios rose
in this period and some cutback in forward buying is not
unexpected.
Preliminary figures for manufacturing inventories, to
be released today, do indicate a decline in the rate of
accumulation in September. But a large share of the decline
was in the auto industry, which had also accounted for a
large share of the July-August inventory build-up. Stock
piling in machinery and defense equipment industries has
continued strong and rising throughout, and with the
substantial revision in the September figure for new defense
orders--it now shows an incredible 50 per cent rise from
11/1/66
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August to September, compared with what we thought was a
very large 26 per cent increase as originally reported--we
are likely to see a surge in materials buying and work-in
process in these industries shortly. This could well show
up in the business loan figures shortly, too. At this
stage of the game, I'm prone to regard recent financial
figures as useful but still somewhat tenuous and definitely
reversible indicators of the broader economic scene.
Let me now turn to areas where the economic readings,
while far from certain, are somewhat less ambiguous. First,
retail sales figures have not been strong recently, with
preliminary numbers showing a slight decline in sales in
September and early October. As best we can penetrate the
murky areas of seasonally adjusting auto sales at this time
of year, it doesn't appear that the new models have gotten
off to a sensational start. Since the strong rebound in
consumption expenditures in the summer months resulted in
a sharp drop in the savings rate to well below the rate of
recent years, it would not be implausible to expect
consumers now to be readjusting their spending down to
more normal relationships with income.
Second, the situation in housing, which I need not
belabor for this Committee, gives every sign of becoming
a bit worse before it becomes any better. Close to $6
billion of housing expenditures will have been cut from
GNP between the first and fourth quarter of this year, and
while we may be near a bottoming-out, as some analysts
suggest, there is no evidence in the building permits
figures or in the credit flow figures to warrant expecta
tions of any resurgence soon.
Third, it is becoming increasingly evident that the
expansion in business capital outlays is going to slow
down next year. The Edie survey of a month ago pointed in
this direction, and preliminary--and still very
confidential--information from a partial tabulation of
McGraw-Hill survey results confirm the likelihood of a
slowdown. The final survey results are now expected to
show an increase, year over year, of from 5 to 8 per cent,
compared with the obviously unsustainable 17 per cent
rise this year. And while the McGraw-Hill survey has
generally understated the rise in periods of expansion,
this year the 5 to 8 per cent forecast might be an over
statement because the survey coverage is weak in
commercial construction, an area hard hit by monetary
restraint. Interpolating a plausible quarterly pattern
for this annual increase, one might conclude that the
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pace of spending will continue to rise rapidly through
early 1967, begin to level off by midyear, and turn down
before year-end.
Fourth, since midyear the prices of a number of
sensitive or basic industrial materials have declined
sharply and the rate of increase in other industrial
commodities has slowed by half. The over-all index of
industrial commodities was nearly stable from midyear
through September, and only a moderate rise is likely to
be recorded for October. Both the over-all wholesale
price index and the consumer price index have benefited
recently from the decline in food prices.
What this all should mean for policy depends much on
one's notion of the lag in the effects of monetary policy,
and the efficacy of policy in restraining induced and
lagged cost-push. It would seem likely that, for at least
a few quarters ahead, business spending for capital equip
ment will continue to rise rapidly and their needs for
external financing to remain strong. An easing in monetary
policy at this point, therefore, might not be translated
substantially into an improvement in housing activity; in
fact, it might serve to rekindle fairly promptly spending
plans for shopping centers, office buildings, and other
areas of nonresidential construction which have been
temporarily deferred because of financing shortages, as
well as for additional plant capacity. Or easing in
financial conditions might encourage inventory
accumulation just when stock-sales ratios are beginning
to mount.
As for price trends, wage costs are rising and are
likely to maintain and possibly boost pressures on many
industrial prices in the months ahead. So long as an
exuberant pace of expansion persists, employers will
undoubtedly attempt to pass through these higher costs.
An easing of monetary policy, without concomitant tax
action, might encourage such cost pass-throughs.
Of course, arguments against premature easing have
been made at every cyclical peak, and have often left the
System in the position of accepting the blame for the
subsequent turndown. There is a lag in policy effects,
and we can't be oblivious to the long-run necessity of
anticipating cyclical swings, as well as to the short-run
dangers of acting too soon. But with the future course of
defense spending and the likelihood of additional fiscal
restraint still unresolved, and with the ambiguities noted
in the production, inventory, employment, and credit figures,
11/1/66
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the evidence isn't clear enough to me to warrant
recommending an aggressive move toward monetary ease
now, even if even-keel considerations weren't present.
However, there is enough evidence in the domestic
economy, I submit, to justify shading policy in an
easing direction.
Mr. Koch made the following statement concerning financial
developments:
Monetary policy must always be based mainly on
developments in the real economy, including those in our
relations with the rest of the world. But there is a lot
to learn today for monetary policy from the financial
indicators as they have been developing. It is hard for
me to reconcile the recent striking weakening in the
financial data with an estimated annual rate of rise of
GNP in the third quarter of 7.5 per cent in current dollars
and 4.5 per cent in real terms, and with our current pro
jection of substantial further expansion in the fourth
quarter. More weakness may be developing in the real
economy than meets the eye, and the current financial
numbers may be leading indicators of such weakness.
Look first at the recent course of bank credit as
reflected in the credit proxy. Declines have occurred in
each of the past 3 months, and a further drop is projected
for November. Earlier, the most dynamic component of bank
credit was business loans, but growth in bank lending to
business slackened markedly in August and September. Growth
in October continued to be slow, especially in view of large
cash needs stemming from the accelerated tax payments during
the month.
The developing weakness in over-all bank credit is
dramatically reflected in the persistent downward revisions
in our weekly projections of the change in the credit proxy.
These have been marked down in every one of the past 10
weeks. Our first estimate for September was +4.7 per cent,
annual rate. It finally turned out to be -0.5 per cent
after five successive weekly reductions. Our first estimate
of the likely October rate of expansion was +5.6 per cent.
Our latest figure is -2.9 per cent after another five
successive reductions. Perhaps we will be more accurate in
our first estimate of a further annual rate of decline on
the order of 2 per cent for November. Inclusion in these
bank credit proxy numbers of funds obtained from branches
11/1/66
-25-
abroad would raise them, but not materially over the last
2 months.
Disintermediation is part of the explanation for the
recent weakness in bank credit. Some of the credit that
previously had been obtained from banks has more recently
been obtained from the money and capital markets. With
bank credit growing less, more borrowers have been forced
to go to the market for funds. In the process, pressures
have developed from the marked structural changes in credit
flows that were involved. Higher interest rates forced
some borrowers out of the market. Lack of access to credit
pushed out others, such as home buyers and small and medium
size businesses. Moreover, the higher cost and restricted
availability of borrowed funds forced more spending to be
self-financed and some spending to be curtailed. Preliminary
flow-of-funds data for the third quarter suggest a decline
of about 20 per cent in the total amount of private credit
financing--to $60 billion from $75 billion in the second
quarter.
The cessation of growth in bank credit has been
accompanied by a similar movement in the narrowly defined
money supply. The money supply has been declining on
balance since spring. The rate of increase in money
defined to include time deposits continued fairly sub
stantial through August, but has dropped off drastically
since. A total liquid asset measure shows similar move
ments, with the tapering off of growth starting in the
second quarter.
How can one explain the weakness in the narrowly
defined money supply most recently at a time when interest
rates have been declining and incomes presumably have still
been rising fairly rapidly? Lagged responses are no doubt
a partial explanation. But perhaps incomes are not rising
as fast as the preliminary figures suggest, and perhaps
individuals and businesses, in order to maintain current
consumption and investment levels, are having to spend a
larger part of their current incomes as well as having to
draw down previously accumulated cash balances.
But interest rates have been declining since early
September. Isn't this development an indication that
monetary restraint is already less severe? Perhaps it is
to some extent, but it may also be reflecting some diminution
in the demand for credit.
In the business loan area, for example, our September
bank lending practices survey provides some slight evidence
of a moderation of loan demand. So does the slowing in the
11/1/66
-26-
actual rate of business loan expansion in the last 3
months, since it has not been accompanied by a buildup
in either actual or prospective security flotations by
corporations, although it has been associated with some
rise in commercial paper financing.
Even in the municipal field it is somewhat surprising
that a 40 basis point decline in yields since August has
brought to market few issues that had been postponed
earlier. Indeed, more postponements continue to be
announced. In a changing economic situation, the course
of interest rates, like the level of net borrowed reserves,
can be a poor indicator of the degree of monetary restraint
or ease.
This review of the recent course of the financial
variables suggests to me that the time has come for a
further backing off from the restraining posture of
monetary policy. Have we really been aiming at a
cessation of growth in both bank credit and the money
supply? High incomes and the drawing down of previously
accumulated liquidity may have adequately sustained spend
ing with reduced credit growth this fall, but it is
questionable how long this situation is sustainable.
Moreover, we do not want to be caught again maintaining
a set of money market variables, including net borrowed
reserves, when the combination of the existing degree of
tightness and demand factors is leading to declines in
more basic indicators of policy such as total reserves,
nonborrowed reserves, bank credit, and the money supply.
As the next step in relaxing monetary restraint, a
drop in net borrowed reserves to a range of, say, $200 to
$300 million as a short-run operating guide for open
market operations might be in order. As for timing, such
easing might proceed as soon as Treasury financing require
ments permit, and assuming market sentiment itself does
not in the meantime precipitate too abrupt and speculative
an easing in financial conditions. It is also probably
not too soon to consider a more overt move toward less
monetary restraint than can be achieved through the open
market operations instrument.
Mr. Hickman referred to Mr. Koch's statement that total
private credit financing appeared to have declined substantially in
the third quarter and asked how much of the decline occurred in the
11/1/66
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flow of bank credit relative to flows through other channels.
In
particular, was there evidence of slackening in the flows of savings
through nonbank financial intermediaries?
Mr. Koch replied that the slackening was sharper in bank
credit than in other flows taken together;
in the third quarter
banks accounted for less than 15 per cent of total private credit
flows, as compared with almost 40 per cent in the second quarter.
Flows through other intermediaries had slackened earlier, and
remained small in the third quarter.
Mr. Reynolds then presented the following statement on the
balance of payments:
Recent newspaper stories about the U.S. balance of
payments have been rather cheerful. The news that the
liquidity deficit was surprisingly small in the third
quarter, and that the official settlements balance was
in substantial surplus, has leaked out piecemeal.
Hence,
it has been written up repeatedly, and will, of course,
be written up again when the figures are officially
announced in mid-November.
Other news has also tended to allay anxiety. Observers
have been pleasantly surprised by the recent weakness of
the French franc, and they have been grimly reassured by
rising unemployment in Britain, although most of them
recognize that the real test of the sterling parity still
lies ahead.
It is always useful to be reminded that payments
positions can change. But on the question whether the
U.S. payments position has recently changed for the better
in any fundamental sense, the answer still seems pretty
clearly to be "no." Most of the recent sense of relief
stems from official window-dressing transactions, from
liquid inflows that are bound to prove temporary, and
from the fact that the situation has not worsened in
other respects as much as was earlier feared.
11/1/66
-28-
The deficit on the liquidity basis was at an annual
rate of less than $1 billion in the third quarter and
about $1-1/4 billion in the first 9 months; the latter
figure is unchanged from last year's level.
If it had
not been for debt prepayments and shifts of foreign
official funds from liquid to nominally nonliquid assetsshifts which I am inclined to regard as window-dressing--the
liquidity deficit would have been at a rate close to $2
billion in the third quarter and a little more than that
for the 9 months. Partial data for October indicate that
the liquidity deficit has continued in roughly the $2
billion range.
The official settlements balance was in very substantial
surplus in the third quarter, and for the first 9 months
there was also a surplus, at an annual rate of roughly $3/4
billion. However, a main source of this surplus was the
massive inflow of foreign liquid funds through the foreign
branches of U.S. banks. Discussion at the last meeting of
this Committee made clear that these funds are fairly hot
money, likely to flow out again when interest differentials
and confidence factors change. Even if the funds do not
flow out again soon, they seem certain to stop flowing in
at anything like the recent rate, and that change alone
will suffice to throw the official settlements balance back
into deficit.
If the inflow of funds from banks and branches abroad
had been of more normal proportions--say at the average
rate of the past few years--there would have been an
official settlements deficit at about a $1 billion annual
rate during the first 9 months of this year, little changed
from last year, instead of the actual surplus.
In
October, liquid inflows from foreign branches continued
on a reduced but still fairly large scale ($200 million
in the latest 4 weeks), and the official settlements
balance appears to have been very roughly zero; so again,
without abnormally large liquid inflows there would
probably have been a deficit at a rate of $1 billion or
more.
As the liquid inflows slacken or reverse in the
months ahead, the outlook is for a sizable deficit on
official reserve transactions, and hence for renewed
reserve losses, probably including gold drains, unless
something else gets better.
The something else that could get better might be
either capital flows (other than those special flows I
It would
have already mentioned) or merchandise trade.
11/1/66
-29-
probably be a mistake to count on any improvement in
ordinary capital transactions over the months ahead.
It seems more likely that having brought the outflow
of U.S. private capital down to its lowest level since
1959, we should now brace ourselves for the possibility
of some renewed rise in outflows.
The expansion plans of major U.S. corporations for
next year seem likely to require an increased outflow
of direct investment capital, as well as continued
borrowing abroad. Government programs will seek to
limit that increase, but they probably cannot entirely
prevent it.
U.S. commercial banks are not likely to go on
reducing their foreign loans indefinitely. Even during
the recent period of extremely tight credit, the reduc
tions have not been very large. Of the unadjusted
reduction of $550 million in bank-reported claims on
foreigners during the first 9 months of this year, more
than half was seasonal, leaving the adjusted reflow at
about $250 million.
If I am correct in believing that the outlook for
ordinary capital flows is for no further improvement, and
perhaps for some deterioration, even if domestic monetary
conditions stay pretty tight, then improvement in the
over-all payments situation will require improvement in
the merchandise trade account. So far, the trade account
has continued to deteriorate. There was an encouraging
4 per cent increase in exports from the second quarter
to the third. But merchandise imports jumped even more
sharply, by nearly 7 per cent. Hence the trade surplus
shrank further, to an annual rate of less than $3 billion.
For the first 9 months, the rate of trade surplus now
stands at $3.6 billion, compared with last year's $4.8
billion.
Even if exports go on rising briskly over the next
year, as Government analysts expect, a very marked slowing
down in imports will be needed to achieve significant
improvement in the trade balance. It seems reasonable to
expect a slowdown whenever domestic demand pressures abate.
But it is very difficult to judge what the precise relation
ship between domestic demand and imports will be at that
time. The last time there was an import boom at all
comparable to the present one was in 1950-51, and world
conditions have changed so much since then that the parallel
is not a close one.
11/1/66
-30-
It seems to me that the still unsatisfactory state
of the balance of payments, and the present lack of
evidence of any durable improvement, point towards a
cautious approach to any easing of monetary restraint at
this time. I think it would be unfortunate if we should
experience a significant increase in net capital outflows
before we can point to any improvement on the trade side.
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:
The expansion of total demand in the economy is now
less hectic than it was in the spring of 1966, but it
still appears to be proceeding at a rate in excess of the
economy's capacity. Defense expenditures are now the main
force behind the economic upswing, and the uncertainties
inherent in the Vietnam situation quite naturally becloud
the economic outlook. However, it looks as if defense
expenditures would continue to increase substantially
over the next year, though perhaps at a less feverish
pace than in the third quarter. Along with the speedup
of defense outlays, the soft spots in the civilian economy
have undoubtedly become more pronounced and new signs of a
possible easing of demand pressures have appeared, including
some evidence that inventory accumulation has reached a
point where some inventories are beginning to look excessive.
In my judgment, however, it would be a mistake to equate the
prospect of a modest slowing in the business expansion with
a likelihood of actual business recession in the foreseeable
future.
The stability of wholesale prices since July is a
reflection of the moderation of the growth of demand,
together with the rapid expansion of industrial capacity.
On the other hand, this year's advance in consumer prices
is quite disturbing, especially because of the effects on
future wage negotiations. With a rate of 5 per cent
apparently having been established as a pattern for wage
increases in coming negotiations, and with cost-of-living
escalator clauses becoming more common, we face a major
threat of a cost-price spiral, with all that that implies
both domestically and internationally.
11/1/66
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The basic balance of payments position remains
precarious. While the liquidity deficit this year may be
close to the $1.3 billion of 1965, special transactions of
various sorts are again of great importance in holding down
the total.
The official settlements deficit will doubtless
be much smaller, but only because extremely tight credit
conditions in this country since mid-year have caused such
a rapid increase in foreign private dollar holdings,
especially balances acquired by American banks from their
foreign branches. Whatever recovery in the current account
might be expected from a slackening in the hectic pace of
imports may be nullified if our competitive position is
sufficiently damaged by the expected cost-price pressures;
and we are clearly vulnerable on capital account. Easier
domestic credit conditions could well bring a reversal of
holdings of private dollar balances; and in any event we
probably cannot continue to look to this area as a major
means of financing our deficit. Under the circumstances,
I believe that a concerted effort should be under way to
attack the balance of payments deficit next year from a
The emphasis should probably be on
number of angles.
direct investments and Government expenditures, but the
banks should be expected to continue to play their part,
and some modest reduction in their ceilings might be
incorporated, if an effective over-all payments program
can be worked out.
There is no doubt that significant monetary restraint
is now being felt in all financial markets, despite the
great improvement in atmosphere since the nearly panicky
It is gratifying to note that
conditions of late August.
total bank credit increased over the first nine months of
1966 at a rate of only 6.5 per cent, thanks to a sharp
slowdown to about 3 per cent in the third quarter. Also,
the growth rate of business loans has declined recently
and the New York banks have noted a definite easing off
in business loan requests. They are uncertain, however,
to what extent loan demand is really declining and to
what extent the banks' negative attitude is discouraging
business borrowers from making as frequent loan requests
I think it is too early to say
as in the recent past.
that the banks have definitely brought business loans
under close control; but it is unequivocally clear that
business loans have shared importantly in the last few
months' reduction in the rate of loan extensions.
After
many weeks of severe run-offs in CD's at the New York
banks (over half of the total national run-off), the pace
11/1/66
-32-
slowed materially last week. The CD has recently been
a competitive market instrument only in relatively short
maturities, but there are signs that this competitive
maturity range is widening. It is encouraging to note
that savings institutions generally reported a rather
substantial inflow of funds in August and September,
and October indications are encouraging.
No doubt some of the slackening in bank credit growth
is being replaced by other credit flows. However, very
rough estimates indicate that the growth rate of total
credit outstanding may also have declined in the third
quarter, although by less than the bank credit growth
rate. A slower rate of expansion is also being registered
by all the major indicators of liquidity of the nonbank
public.
Since we are in the midst of a Treasury financing,
even-keel considerations preclude a change of credit policy
at this time. In any case, I agree with the Chairman's
comment at the last meeting that monetary policy has done
about all it can be expected to do for the present. In
view of the much slower expansion recently of most monetary
variables, I would hope that the less strained tone in the
money market might be preserved and that doubts might be
resolved on the side of ease rather than tightness. At
the same time it would seem premature to ease sharply,
in view of the continuing possibility of a resurgence of
credit demands. In trying to maintain money market
conditions about where they are, the Manager will need
ample leeway to exercise his judgment, but he may find
the Federal funds rate and CD developments the most useful
guides to market tone. If I had to pick a range for net
borrowed reserves, I would like to see it centered around
$400 million. I might add that, in my judgment, there is
still a very real need for a tax increase to offset the
continuing inflationary stimulus provided by rising defense
outlays.
Obviously it would be inappropriate to change the
discount rate under present conditions. Moreover, in view
of the cumulative evidence of a substantially slower growth
of both total bank credit and business loans, I should think
the System would do well to soft-pedal our earlier emphasis
on the need for curtailing the expansion of business lending.
As for the directive, I would agree with the staff that
it should be revised materially. While I recognize all the
problems involved in rewriting the directive around the table,
-33-
11/1/66
I feel a slightly different version would be more
satisfactory.1/
First, the first sentence of the first
paragraph ought to recognize the importance of rising
defense expenditures in over-all economic activity.
The sentence might then read ". . .over-all domestic
economic activity is continuing to expand, with rising
defense expenditures offsetting moderating tendencies
in some sectors of the private economy."
Second, I
think we ought to have a simple and general sentence
on the balance of payments, such as "The balance of
payments remains a serious problem."
Third, in order
to have some reference to the possibility of furthur
fiscal policy changes I would prefer the phrase on
fiscal policy to say "in the light of recent and
possible future fiscal policy measures."
Finally, it
seems to me that the proviso clause should not be
related to current expectations in view of the staff
estimates of further declines of bank credit in
November. In my view, System policy has been aiming
on balance for a moderate growth of bank credit and
should continue to do so.
I myself would think a bank
credit growth rate of 4 to 6 per cent might be appro
priate, and I would not be particularly disturbed if
the growth rate was temporarily a bit higher, especially
in view of the declines over the last three months.
With this in mind, I would suggest that the proviso
clause read "provided, however, that operations shall be
modified--in so far as the Treasury financing permits--in
the light of bank credit developments during the month."
The intent of this rather general statement would be amply
spelled out in the record of this meeting.
Mr. Ellis commented that because expectations affect at
titudes, which in turn affect events, perhaps it was as important
to report shifting expectations as it was to report changes in
performance.
For example, the 90 manufacturers covered in the
Boston Reserve Bank's quarterly sales survey reported that
1/ The complete text of the directive proposed by Mr. Hayes is
appended to these minutes as Attachment B.
11/1/66
-34
third-quarter sales exceeded previous-quarter levels by 3.7 per
cent when the rise expected had been only 0.9 per cent.
They
currently anticipated a 5.6 per cent decline for the fourth
quarter, a type of projection he had learned to discount substan
tially.
It had to be reckoned with, however, in appraising their
capital expenditure forecasts for 1967 which now--in final
tabulation--called for a year-to-year expansion of only 3.5 per
cent.
The year-ago survey called for an 18 per cent expansion,
which had now been converted into a 33 per cent actual gain.
Expectations were in flux also with respect to interest
rates on savings in Massachusetts, Mr. Ellis said.
During
September, only three of the 80 regularly reporting mutual savings
banks were paying as high as 5 per cent on special notice accounts.
During October, three Boston commercial banks lowered to $1,000
the minimum account balance on which they would pay 5 per cent,
and they were heavily advertising the change in the Boston press.
October data on savings flows through the mutuals were too frag
mentary to be conclusive, but there had been some official note
taken of the fact that only eight of the 179 Massachusetts mutual
savings banks were members of Federal Deposit Insurance Corporation
and subject to its rate ceilings.
The other 171, with almost 80
per cent of the deposits, looked to the Massachusetts Banking
Commissioner for rate guidance.
There was some concern that he
11/1/66
-35
(the Commissioner) might grant a ceiling of 5-1/4 per cent to
allow the State-controlled mutuals to be competitive with the
savings and loan associations' ceiling, set by the Federal Home
Loan Bank Board, of 5-1/4 per cent on special certificates.
Of
course, the FDIC member mutuals hoped such action could be
forestalled.
Meanwhile, Mr. Ellis continued, the housewives' protests
against high food costs had a possible parallel in complaints
about high mortgage rates.
The Massachusetts Consumers Council,
an official government board appointed by the Governor, had been
importuned to investigate high interest rates.
Mr. Ellis noted that one District bank had received front
page news attention last Wednesday when it announced a proposed
CD rate of 5.25 per cent on 3-9 month deposits.
As nearly as he
could establish, their easy position evaporated quickly.
It was
necessary for them to borrow from the Reserve Bank on the same
day and again over the last weekend.
Apparently the market was
not ready to back off from its 5-1/2 per cent rate on 90-day
deposits.
Mr. Ellis remarked that short-run, even-keel considerations
set the framework of monetary policy for the next three weeks.
The
decline in rates and easier market conditions of the past two weeks
11/1/66
-36
had about optimised circumstances for the Treasury in its current
financing.
Some sense of relief accompanied his recognition of the
need for a period of even keel, Mr. Ellis observed.
Three months
of no growth in total bank credit and the money supply required
some appraisal as to cause.
As usual, causes seemed to be
multiple--tightened monetary policy and lessened bank liquidity
had to be named.
But increasingly he had come to sense that
some lessened intensity of demand for credit was a cause also.
Were it not for the pervasive effect of accelerating defense
spending, the economic outlook would be substantially altered.
But Vietnam was a fact that had to be reckoned with--and that
reckoning might become more widely comprehended after the
elections on November 8.
Mr. Holmes had described the inter
pretations placed on recent financial developments by two groups
of observers, which might be labeled the "pause" and the "turn
down" groups, and he (Mr. Ellis) would place himself in the pause
group.
He expected bank credit to be stronger in November than
the staff projection indicated.
If no fiscal action on taxes
was forthcoming until some time in 1967, the evidence of impend
ing recession should be quite overwhelming before the Committee
retreated from the restraint it had been able to achieve via
monetary policy.
11/1/66
-37Meanwhile, Mr. Ellis continued, the Committee again faced
the responsibility of defining a policy of "no change" meaningfully
for the Manager.
Not the least of the difficulties was the burden
the Committee placed on the staff by not specifying its goals so
that their projections might at least be premised on stated goals
of policy.
He reminded the Committee that four weeks ago the
staff projections were based on a "no change" policy involving
net borrowed reserves of $450 million.
Today the staff had
presented the Committee with projections based on net borrowed
reserves of $416 million, the average of the past four weeks.
If pressures continued to lessen, four months hence the Committee
might find itself with net borrowed reserve levels of $100 million,
which it continued to ratify as a "no change" policy.
The thrust
of his criticism, he emphasized, was toward procedure, and not
toward the objective of adopting a no-change position.
Mr. Ellis thought the staff had done the Committee a real
service in attaching notes to the suggested directive to explain
its proposed changes in language.
The first paragraph of the
draft directive represented a substantial achievement.
With
regard to the second paragraph, however, the exclusion of the
word "firm" from the description of the money market conditions
to be sought, and the introduction of the term "generally steady,"
was likely to appear in retrospect as a definite turning point in
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-38
the direction of monetary policy.
He was inclined to fault the
staff for not providing alternative wordings of the second par
agraph that reflected the kind of clear-cut choice of policies
reflected in the remarks of Messrs. Brill and Koch this morning;
and for simply suggesting, instead, that as an easing alternative
the Committee might interpret the "generally steady conditions"
mentioned in the draft as being the somewhat easier conditions
of the last two weeks.
The proviso clause, of course, had been
devised as an escape hatch against an undesired degree of firming,
and if the Committee gave up the concept of firm money market
conditions he did not see any further need for the clause.
He
would be reluctant to see the proviso clause dropped--that might
be a step on the road carrying the Committee back to the kind of
"clause b" instruction used before December 1961--but nevertheless
he would suggest its deletion at this time in the hope that the
staff would bring forward more meaningful language at the next
meeting.
Basically, he was inclined to agree with Mr. Brill's
conclusions.
He favored no change in policy and opposed the
deletion of the concept of firm money market conditions from the
language of the directive.
Mr. Irons reported that most of the recent economic changes
in the Eleventh District had been consistent with what might have
been expected on seasonal grounds.
That was the case for employment
-39
11/1/66
and industrial production, although the latter was down slightly
more than seasonally at the moment.
Construction contract awards
continued their previous pattern of easing, and there were signs
of dampening in retail sales.
Agricultural conditions could be
described as generally good, although there were some spotty
situations.
In particular, there was considerable uncertainty
regarding probable developments for cotton, largely because of
sharp cut-backs in the Government support program.
But in terms
of general farm prices and farm cash receipts the picture was
favorable.
There were no highly significant changes in the District
financial situation, Mr. Irons said.
the latest period.
Bank loans were off during
Investments were up, largely as a result of
operations in Treasury bills, and deposits were down.
Borrowings
from the Reserve Bank did not appear to be following a normal
pattern; fewer of the smaller country banks were borrowing, and
in smaller amounts, relative to the customary situation at the
discount window.
Net purchases of Federal funds had been rather
substantial during the period and a sizable number of banks were
in and out of the funds market on a regular basis.
Mr. Irons' interpretation of the national situation was
much like the analyses that had been presented this morning.
The
economy was on a very high plateau with some evidence of stability
11/1/66
-40
in sight, and with strength showing in some sectors and dampening
tendencies in others.
The large underlying questions related to
the probable course of defense expenditures for Vietnam and the
possibility of further fiscal policy action.
Money market condi
tions had been easier in the past several weeks, with most of the
major variables actually showing declines.
In part that probably
reflected past monetary policy, but it also reflected market
reactions to a number of other factors, including the possibility
of further fiscal action, guesses as to future monetary policy,
the possibility of a real slowdown in economic activity, and a
dampening in underlying credit demands.
In his opinion, the
Committee had been meeting with some success in achieving the
restraint it had sought on expansive pressures in the economy,
but it remained to be seen how lasting that might be.
As to policy, Mr. Irons started with the presumption that
whatever decisions the Committee reached today they would be in
the framework of even keel, and that the Manager would be given
considerable leeway to be guided by the feel of the market.
Current economic trends and money market conditions seemed to
call for continuing the degree of restraint that had characterized
policy for the last few weeks.
He would not be in favor of any
action that could be termed aggressive, either toward tightening
or toward easing.
He would try to maintain generally steady
11/1/66
-41
conditions and a reasonably balanced set of market relationships.
While he did not particularly like to use numbers, he agreed
with Mr. Hayes that net borrowed reserves should be in the $400
million area.
The bill rate might be somewhere in the 5.20 - 5.40
per cent range, and the Federal funds rate around 5-1/2 per cent.
He mentioned those numbers only to indicate the broad range of
conditions he favored; the Committee could specify its objectives
simply as maintaining the degree of restraint existing in the last
three or four weeks and trying to encourage a general tone of
steadiness in money market conditions.
He preferred the way the
market had performed in recent weeks relative to the preceding
weeks, and would like to maintain about the same set of market
relationships.
He would not favor a change in the discount rate
at this time.
Mr. Irons thought the notes attached to the draft direc
tive submitted for this meeting were useful; the explanations of
the staff's thinking in preparing the draft were of value to the
Committee in its own deliberations.
As to the directive itself,
he had questioned the value of the proviso clause all along--and
he continued to have doubts about it, although he did not feel
strongly on the matter.
If the proviso was to be retained,
however, he would prefer Mr. Hayes' wording to that of the staff
draft, which referred to "current expectations" for bank credit.
11/1/66
-42
He was not certain what expectations were intended, but if they
were the staff projections for the bank credit proxy reported in
the blue book, he did not think the reference should be in the
directive.
Mr. Swan observed that the employment situation in the
Pacific Coast States improved somewhat in September.
Nonagricul
tural employment rose in all major groups except mining, and the
net advance more than offset a decline in agriculture.
The
unemployment rate dropped 0.2 per cent after rising in each of
the five preceding months; in September the rate was 4.8 per cent,
compared with the April low of 4.4 per cent.
Lumber and plywood
prices edged down in September and October, with the sharpest
reductions occurring in materials for residential construction.
In the four weeks ending October 19, total credit outstanding at
weekly reporting banks declined, with a reduction in business
loans of about the same magnitude as in the comparable period of
1965.
There continued to be very little pressure at the discount
window of the San Francisco Reserve Bank.
As to the national picture, Mr. Swan said, he would agree
with the descriptions given today of recent developments.
Of
course, the tapering off of growth rates in many areas was neither
surprising nor unwelcome, but the Committee had to recognize that
there was less pressure now not only in financial markets but
11/1/66
-43-
throughout the economy.
to ease at this point.
He, too, would not favor overt action
He would relate the even keel to be
maintained during the Treasury financing to the conditions of
the last two or three weeks, rather than to the average condi
tions in the four weeks since the preceding meeting.
It seemed
to him that the easing, if one wanted to use that term, that
had occurred in money markets was quite consistent with the
proviso clause regarding bank credit developments contained
in the last directive.
He saw no reason to be concerned about
that easing, and none for starting off from some position dif
ferent from the more recent one in defining even keel.
Mr. Swan said he had found the explanatory notes attached
to the directive to be extremely helpful.
The preparation of
such notes undoubtedly would lead to more extended comments about
the directive at meetings, but on the whole that probably would
be to the good.
With respect to the draft directive itself, it seemed to
Mr. Swan that the statement in the first sentence that "economic
activity is still expanding despite evidences of slackening in
some sectors of the private economy" would be read as implying
not a slower over-all growth rate but actual deterioration, and
he did not think that was what the Committee would intend.
Mr. Hayes' proposed reference to "moderating tendencies in some
11/1/66
-44
sectors of the private economy" would help meet the problem, but
it might be best to say that ". .
. domestic economic activity
is still expanding, although growth rates are slackening in
some sectors of the private economy
and there has been substan
tial weakening in residential construction activity."
Secondly,
while he agreed that there should be some reference to the recent
fiscal policy measures, he did not believe that it should be
included in the sentence describing the Committee's general
policy; the statement of the latter was appropriate apart from
fiscal policy actions.
He would include the reference with other
statements of fact in the third sentence, which would then read,
"Bank credit expansion has slackened, earlier strains in financial
markets have abated, and certain fiscal policy measures have
recently been enacted by the Congress."
With respect to the second paragraph, Mr. Swan said, he
also had a question about the use of the term "generally steady"
in describing the desired money market conditions, although he
was not as concerned as Mr. Ellis was about the proposed deletion
of the word "firm."
He would prefer calling for operations to be
conducted with a view to "maintaining about the same conditions
in the money market as have developed in the past two weeks."
That would make clear that the Committee did not intend to relate
even keel to the four-week averages; to him it would imply net
11/1/66
-45
borrowed reserve figures in the $350-$400 million range, or
perhaps $300-$400 million, and a level of borrowings and Federal
funds rate as in the more recent weeks.
As to the proviso clause,
he agreed with those who objected to the phrase, "any apparently
significant deviations of bank credit from current expectations,"
because--as Mr. Hayes had pointed out--current expectations were
for a decline, and the Committee certainly would not want to
encourage a decline at this point.
Mr. Hayes' suggestion, to
call for modification of operations "in the light of bank credit
developments during the month" would be satisfactory if the
Committee's specific intentions were clearly understood; but it
might be best to state those intentions directly.
Accordingly,
he would suggest saying that "operations shall be modified,
insofar as Treasury financing permits, if it appears necessary
to encourage no more than a moderate increase in bank credit."
Mr. Galusha observed that the economic situation in the
Ninth District appeared to be approximately what it was at the
beginning of October and so required no extensive summarizing.
For what it was worth, however, he would point out that District
reserve city bankers had cautioned against interpreting their
recent contra-seasonal decline in loans as indicating a marked
change in loan demand.
Not surprisingly, perhaps, they saw
that decline as having been produced by an increasing shortage
11/1/66
-46
of reserves and, even more, by an essentially fortuitous bunching
of loan repayments by borrowers with nation-wide banking connec
tions.
Mr. Galusha reported that the Minneapolis Reserve Bank's
discount lending had lately been almost exclusively to country
banks, and for the traditional reasons.
A few weeks ago one
reserve city bank had borrowed for several days to finance an
unexpectedly large corporate CD run-off, but even that bank made
it quite clear that it would do everything possible to get along
without continuing Reserve Bank help.
In that connection, recent
experience indicated that both keeping the ceiling on CD rates
unchanged and the Reserve Banks' September 1 letter to member
banks had had very decided effects on bank lending; and, happily,
the Reserve Bank had not had to get involved in member bank
decision-making.
But when he thought about what had been happening,
he had to confess that his feet got a little chilly, if not actually
cold.
While the members of the business establishment of the
Ninth District with whom he had visited in the last three weeks
had expressed views as diverse as those expressed by the staff
today, there were significantly more on the pessimistic side than
was the case 60 days ago, although still a distinct minority.
Mr. Galusha noted that the forthcoming Treasury refinancing
precluded a change in open market policy now.
But he thought the
11/1/66
-47
Committee perhaps would be well-advised, in defining "even keel,"
to look only at the numbers of the past week or two and not bother
about the slightly tighter money market conditions prevailing
earlier in October, and to maintain from now until the Committee's
next meeting the money market conditions of the very recent past.
That was what he would favor.
Mr. Galusha said he did not propose to be drawn into the
controversy regarding the language of the directive but, given a
choice between the wording of the staff draft and that proposed
by Mr. Hayes, he would prefer the latter.
He assumed that the
phrase "generally steady conditions in the money market" would
be interpreted to refer to the conditions of the last week, or
possibly the last two weeks, and not to the average conditions
since the preceding meeting.
Mr. Scanlon reported that there was scattered evidence
that pressures upon productive resources of the Seventh Federal
Reserve District had relaxed somewhat.
Fewer complaints were
heard concerning shortages of materials and components.
The
rate of steel output had declined since mid-September, and prob
ably would be reduced further.
sharply.
Residential permits had fallen
New orders for some types of machinery and equipment
had leveled off at a high rate in the past several months, and
orders for construction equipment had declined.
Orders for
11/1/66
-48
furniture and household appliances had eased.
Some general
merchandisers had been disappointed by the rate of consumer
purchases, and forecasters expected auto sales to continue below
year-ago levels.
Most economic forecasts now being prepared for
managements of businesses and banks in the District visualized
a slower rate of growth in both real and dollar terms in the
period ahead.
Despite those developments, Mr. Scanlon commented, no
easing in tight labor markets had yet been noted in District
centers.
Shortages of skilled workers and "trainable" unskilled
workers persisted.
Some firms complained of reduced profit
margins resulting from poorer quality labor, higher turnover,
and increased absenteeism.
A larger share of motor vehicles
and business equipment reached the finish line requiring addi
tional work to correct imperfections--so-called "cripples."
Most manufacturers of machinery and equipment, including
railroad equipment and heavy trucks, continued to operate at
practical capacity, Mr. Scanlon said.
Producers of farm machinery
were particularly optimistic, and had maintained production in
months of normal seasonal let-down to assure adequate supplies
to meet anticipated heavy demand.
Farm machinery was expected to
remain strong because of increased acreage allotments, higher
price supports, larger farm income, and Government plans to
11/1/66
-49
encourage food exports.
Many firms continued to report capital
expenditure programs behind schedule because of shortages of
manpower and delays in construction or in delivery of equipment.
Reserve Bank inquiries revealed no instances of major firms
reducing programs already in the planning stage for 1967.
Mr. Scanlon believed that construction of single-family
homes and smaller apartments would respond fairly promptly to
increased availability of credit and labor,
Vacancy rates were
low in most Seventh District centers.
Bank reports still indicated a basically strong demand
for credit by business firms, Mr. Scanlon continued.
Some bankers
had suggested recently that business borrowing was likely to
increase more than seasonally before the end of the year.
While
the timing of the expansion in business loans since mid-year had
deviated somewhat from the expected pattern, the relative increase
was only slightly less than the very strong rise in the same
period a year ago.
A relatively large proportion of the expansion
in recent months was attributable to borrowing by manufacturers
of durables; increases in loans to trade concerns had been well
below the usual seasonal amount.
Other types of bank lending
had slowed and, after adjustment for Treasury financing, bank
investments had dropped sharply--apparently reflecting reduced
availability of funds, not reduced demand for credit.
11/1/66
-50
After reporting a very large basic deficit in mid-October,
Mr. Scanlon said, the major Chicago banks ended the month in a
somewhat improved position, having eliminated their borrowing at
the discount window.
They had continued to lose funds through
CD run-offs, and gains through issuance of smaller certificates
appeared to have ceased.
The number of country banks accommodated
at the discount window had declined since August, but some bor
rowers had appeared for the first time in many years.
Mr. Scanlon commented that it now appeared that bank
reserves, member bank credit, and money supply all declined in
October, continuing a downward drift.
That reflected, in part,
at least, the reduced ability of banks to compete effectively for
time deposits.
slowed also.
It was likely that the growth of total credit had
While the easing of interest rates probably was,
in large part, a reaction to the sharp run-up of rates in August,
it could be reflecting also the fragmentary evidence of some
easing of pressures on capacity in some sectors of the private
economy.
However, consumer prices probably would continue to
rise at their recent rapid rate, at least through the year-end.
Mr. Scanlon observed that the Treasury financing dictated
an even keel posture in the period immediately ahead.
He found
the directive language suggested by Mr. Hayes acceptable, but
he shared Mr. Swan's views on the clause concerning fiscal policy
11/1/66
-51
measures.
With regard to the second paragraph, he believed the
Committee should undertake to achieve moderate growth of total
reserves.
Mr. Clay remarked that the most striking changes that
had taken place in the economy in recent weeks had been in the
financial variables.
While there had been declines in interest
rates in most credit markets, perhaps the most notable changes
had been in the commercial banking system, including bank credit,
bank loans, and the money supply.
Understandably, that raised
questions as to the meaning of those developments for the course
of the economy and as to the appropriate monetary policy.
The over-all level of economic activity continued to
advance at a rapid pace, Mr. Clay noted, although there were
important cross-currents in the economy.
While pressure on
resources and capacity continued in the defense and business
equipment sectors and their related industries, personal consump
tion was somewhat more relaxed and residential construction was
declining.
Aggregate labor requirements were strong enough to
place pressure generally on labor markets and, despite variability,
over-all price advances remained a matter of appropriate concern.
The future pattern of economic activity was by no means
clear, Mr. Clay remarked.
In addition to the need to observe
closely all future economic developments, particular attention
11/1/66
-52
centered on future defense expenditures and business capital
outlays.
Both the McGraw-Hill report in early November and the
Commerce-SEC report in early December should help clarify the
business capital outlays picture, and it was hoped that further
indications of future defense expenditures would become available
during that period.
In view of the current economic and financial situation,
Mr. Clay continued, it was obvious that further monetary restraint
should be avoided.
Whether to reduce monetary restraint, and if
so, to what degree, was a more difficult question.
The general
state of the economy and the resource-price situation probably did
not call for an overt move toward easing of monetary policy,
although such developments warranted careful watching.
At the same
time, bank credit developments of recent weeks did not appear to
be in keeping with an appropriate prescription for the economy.
It would seem desirable for bank credit to experience some expansion.
Perhaps the preferable course for monetary policy, under the
circumstances, would be an extension of the program carried out
since the last meeting of the Committee, whereby net reserve
availability would be adjusted in accordance with bank credit
developments.
Thus, if bank credit showed further weakness, net
reserve availability would be increased.
The forthcoming Treasury
financing operations and the need to maintain "even keel" conditions
11/1/66
-53
also would seem to argue for the avoidance of an overt change in
monetary policy.
The draft economic policy directive was satisfactory to
Mr. Clay if it was understood that the proviso clause referred to
a somewhat stronger bank credit performance in November than that
projected in the blue book.
That interpretation was in accordance
with the last paragraph of the staff notes accompanying the policy
directive draft.
Mr. Wayne said that the mixed air of pessimism evident in
recent Fifth District surveys appeared to have eased slightly,
although textile and durable goods manufacturers continued to
report weakness.
One textileman indicated a substantial cutback
in machine use and work force while a number of others reported
reductions from a six- to a five-day week in the face of declining
orders and backlogs.
Other nondurable goods manufacturers, however,
noted increased orders, employment, and prices.
Insured unemploy
ment rates had declined further and were now at record lows in all
but one Fifth District State.
Retailers had expressed some concern
about the availability of help for the Christmas rush.
The latest data on the national economy seemed to Mr. Wayne
to accentuate what he took to be a growing feeling of uncertainty
in the business community.
The leading indicators had been growing
more bearish for some time and the new business intelligence of the
11/1/66
-54
past six weeks lent some support to that trend.
To date, the large
surge in private credit demands generally expected some weeks ago
had not materialized.
Defense spending now seemed to have assumed
added importance as a mainstay of the business advance.
The
private sector appeared to be either experiencing or about to
experience some kind of readjustment to a change in the composition
of aggregate demand in favor of Government spending.
That might
account for the rather sluggish behavior of the business measures in
the latest period.
In any event, with defense outlays continuing to
rise, and with higher labor costs a possibility because of larger
wage increases, it was premature to interpret the latest data as
suggesting the imminence of a turnaround, even though inflationary
pressures had moderated somewhat for the present.
Mr. Wayne commented that in the policy area the Committee
seemed to be getting the kinds of results it had been saying were
necessary.
It might be that the squeeze on CD's had reduced the
aggressive bidding for short-term funds, or that the demand for
loans had not been as strong as expected.
Perhaps, also, as
Mr. Galusha had suggested, the banks were putting real effort into
the rationing of credit.
But, judged by results produced, the
present mix of tools and techniques appeared to be effective.
In any
event, it seemed to him that the Committee's present posture was
about right for existing circumstances and in view of the present
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11/1/66
operations of the Treasury.
Mr. Brill's caution lest the Committee
over-stay its posture of restraint was appropriate and timely.
However, until sufficient reason for a change was evident, the
Committee should be especially careful not to give any false signals
which might occasion a disturbing turnaround of expectation patterns.
Mr. Wayne said that Mr. Holmes' review this morning was
especially lucid and helpful.
His comments concerning the growing
usefulness of the credit proxy and required reserves as guides to
the Manager were encouraging and should stimulate the Committee's
continuing search for more satisfactory measures of policy action.
Mr. Wayne would concur in Mr. Holmes' suggested interpretation of
the proviso clause of the draft directive.
With that understanding,
he (Mr. Wayne) would approve the first paragraph of the draft
directive submitted by the staff.
The changes Mr. Hayes had proposed
in the second paragraph had merit, and Mr. Hayes' version of that
paragraph appeared preferable.
Mr. Wayne concluded by saying that he preferred to give the
Manager a high degree of discretion, and that was reflected in the
proviso clause.
The discussion this morning emphasized the difficulty
of writing a directive by the Committee as a whole.
The staff had
done a good job in its work on the directive, and their explanatory
comments were helpful and should be continued.
11/1/66
-56Mr. Shepardson said that the description of the economic
situation in the staff comments certainly put the problem before
the Committee into focus.
Evidence had been presented of apparent
easing in some sectors and of downturns in some economic indicators.
The rise in defense expenditures and the uncertainties about the
course of developments in Vietnam also had been stressed.
One point,
however, that he thought had been given insufficient attention was
that some clarification of the Vietnam situation might reasonably
be expected following the President's return from his Asian trip
Accordingly, the Committee might have
and the elections next week.
a much better idea at its next meeting of likely developments in the
uncertain, but highly significant, area of defense spending.
Both
for that reason and because of the need for an even keel in the
face of the Treasury financing, it seemed unwise to him to consider
any policy change at this time.
The Committee should not give any
potentially misleading signals of easing now, particularly because
of the uncertainties regarding Vietnam and the expectation of some
further clarification soon.
not a time for tightening.
On the other hand, this certainly was
He would maintain the recent situation
in the money market--and by that he meant the average conditions
over the whole period since the preceding meeting, not those that
had developed in the last week or so.
11/1/66
-57
Mr. Shepardson said he could accept the staff's draft
directive, but he thought the changes suggested by Mr. Hayes in the
first paragraph were desirable.
In the second paragraph he definitely
would call for "firm but orderly" rather than "generally steady"
market conditions.
He also would eliminate the proviso clause, which
had been introduced some months ago at a time when there was a great
deal more uncertainty in the market than existed now.
Mr. Mitchell commented that as he listened to the discussion
today he became more troubled than he usually was about the role of
monetary policy.
It seemed to him that three different issues had
been run together in the discussion thus far:
what monetary policy
could do; what monetary policy had already done, including the
effects to come that were now in the pipeline; and what it could not
do.
The most basic single thing that had been accomplished,
Mr. Mitchell continued, was to immobilize holders of existing assets
and outstanding debt.
That was most evident in the case of home
owners, but it also was evident in the case of holders of other types
of assets--particularly municipal securities, which now could be
liquidated only at large losses.
In his judgment that had been the
great contribution of monetary policy over the past few months, and
it had done much to bring about the improved climate existing today.
11/1/66
-58
The Committee's second major accomplishment, Mr. Mitchell said,
was to postpone a fair amount of actual spending, again most
conspicuously in the area of construction.
In addition, the Committee
had chilled all efforts to secure commitments of funds for the future;
the position of all financial intermediaries had changed drastically.
And the stock market decline this year, which reflected the classical
Keynesian reaction to tighter monetary policy, had had a salutory effect
on expectations even with the recent recovery.
As everyone knew,
monetary policy had lagged effects, and there were more consequences
to come from earlier actions.
As to what monetary policy could or should not do, Mr. Mitchell
continued, he did not think it could roll back wages.
It could produce
a climate in which business resistance to wage increases would reduce
the pace of the advance, but the rise in wages that had already taken
place was water over the dam and he did not think the Committee should
attempt to do anything about it.
Also, Mr. Mitchell said, the Committee should not overstay its
policy of tightness.
As he had mentioned earlier, asset holders had
been immobilized by the rapid change in interest rates; but the new
position was not one which the Committee should permit to become
hardened.
He did not think the new level of rates was compatible with
continued expansion of the economy, and in his judgment the Committee
should start pulling away from that rate level as soon as it felt it
11/1/66
-59
had accomplished its objectives.
It was important to remember that
monetary policy was a flexible tool, and that if a policy of restraint
was maintained too long it would do more harm than good.
On the whole, Mr. Mitchell observed, he did not think he
differed substantially from those who had already spoken with respect
to the appropriate policy course now.
He did disagree, however, with
much of the reasoning that had been advanced in support of that course.
Turning to the directive, Mr. Mitchell said he would contribute
only two points to the discussion of the first paragraph.
Mr. Swan
had criticized the opening sentence of the staff's draft as mistakenly
implying declines elsewhere than in construction.
tion would be consistent with the facts.
But such an implica
Secondly, he would not refer
to "possible future fiscal policy measures" as Mr. Hayes proposed, on
the grounds that it was not appropriate to try to predict what Congress
and the Administration would do.
Otherwise, he had no objection to
Mr. Hayes' version of the first paragraph.
As to the second paragraph, Mr. Mitchell said, along with
others he did not like the proviso clause in the staff's draft.
Mr. Ellis had suggested the easy solution of deleting the clause entirely,
and he (Mr. Mitchell) would rather do that than accept Mr. Hayes'
version.
The latter, he thought, involved the not unusual problem of
inconsistent instructions, since net borrowed reserves around $350 or
$400 million were not likely to be consistent with an increase in bank
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-60
credit in November.
As he read the staff reports, to achieve an
increase in bank credit it would be necessary to have much shallower
net borrowed reserves.
What was needed was a little more ease,
insofar as that was consistent with the Treasury financing, and he
would suggest a clause calling for operations to be modified "to
resist any falling off in the projected rate of money supply growth."
He proposed referring to the money supply because the credit proxy
did not strike him as a good measure to use as a standard, although
possibly it could be improved.
Using the money supply would suggest
about the same objectives and would be understood better by the
public.
Mr. Daane said he found himself very much in agreement today
with Mr. Hayes.
He thought monetary policy had been doing what it
could and should be doing, and that the Committee was achieving just
about the results it had intended--notwithstanding the protestations
to the contrary that he had heard last week at the meeting of the
American Bankers Association.
In response to Mr. Mitchell's useful
caveat about the need for flexibility in policy and for not holding
rigidly to any level of interest rates, he would submit that the
decline in yields since the end of August indicated that the
Committee's posture was not overly rigid.
Although no one at the
table was privy to any special information on the future course of
defense spending, it had been rising rapidly; his own intuition was
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that it was rising much faster than publicly recognized or admitted
and perhaps even faster than Mr. Brill had intimated.
Mr. Daane went on to say that like Mr. Hayes and Mr. Reynolds
he was concerned about the U.S. balance of payments situation.
He
did not think the Committee could take much comfort from the recent
figures on the official settlements basis of calculation.
However,
since the Administration was continuing to work on the problem with
a view to continuing and perhaps strengthening its over-all program
in the area, he thought it would be inappropriate for the Committee
to make an overt shift in policy now.
He agreed with Mr. Hayes that
the time had come to reappraise the problem in a more fundamental
way, and he hoped that a System effort to do just that could be
mounted.
Despite erroneous press reports of his position, he also
agreed with what Mr. Hayes had said today and what Chairman Martin
was reported in the press to have said in Boston yesterday, that
there continued to be a need for the tax increase that would have
been most appropriately made earlier this year.
He was still enough
of a Keynesian to believe that the U.S. should finance the Vietnam
war on a pay-as-you-go basis, so that it could be carried on to the
extent possible without inflation.
The Committee's policy decision today, Mr. Daane continued,
could only be to call for an even keel.
Within that framework,
however, and in an attempt to respond to the Manager's request for
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guidance, he would refer Mr. Holmes to the opening statement of his
own written report, which read, "System open market operations in
the period since the last meeting of the Committee sought to maintain
generally firm and steady conditions in the money market, though
with some leaning on the side of less firmness as bank credit
continued to show signs of weakness."
He hoped that, within the
framework of even keel, the Manager would continue to interpret
the directive in exactly the manner implied by that statement .
Mr. Daane said he would not simply accept but would strongly
endorse Mr. Hayes' suggestions for the directive, except that he
would retain the word "vigorously" in the statement of the first
sentence regarding the expansion in domestic economic activity,
Certainly there was nothing in the GNP projections contained in
the green book 1/ to indicate that the economy was going into a
decline.
Also, he disliked the language proposed by Mr. Hayes in
which rising defense expenditures were said to be "offsetting"
moderating tendencies elsewhere.
Accordingly, he would prefer
language in the first sentence reading ". . . over-all domestic
economic activity is continuing to expand vigorously, with sharply
rising defense expenditures and some evidence of moderating
tendencies in some sectors of the private economy."
For the
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
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second paragraph, he would prefer Mr. Hayes' version, to be
interpreted in line with the statement he had cited from Mr. Holmes'
report.
Mr. Maisel remarked that, as had been made clear, the present
was a period of great uncertainty with respect to the actual economic
outlook.
That was all the more reason for the Committee to pay
particular attention to the specific monetary variables for which it
was responsible.
When one looked at reserves--the item which the Committee
primarily influenced--one noted a lack of normal growth, Mr. Maisel
continued.
Depending upon which monetary variables were examined,
current levels were as low or lower than the levels reached in the
first quarter of the year.
It was proper to have restrained growth
in reserves during the second and part of the third quarter in order
to correct for their great acceleration in the first quarter.
However,
the period of stagnation for those variables should not continue.
He particularly felt that the Committee should not at this point
attempt to hold up interest rates if demand fell.
The attempt to
hold up rates seemed to him the thrust of several suggestions which
indicated that the Committee had to restrict growth in reserves or
even continue to have them decline rather than have interest rates fall
back to their early summer levels.
Given its lagged effects, policy
should attempt to bring about a normal growth in total reserves and
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non-borrowed reserves.
That meant that a further fall in required
reserves and the bank credit proxy for this month would not be useful.
Mr. Maisel hoped that the Manager would interpret "generally
steady conditions" to refer to somewhat easier conditions than had
developed.
He was disappointed that the proviso clause had not had
more influence on action during the last period.
He felt that a fall
at an annual rate of nearly 3 per cent, compared to an expected
increase of 5 per cent, in the bank credit proxy was a significant
deviation from expectations.
He did not feel that the action taken
was sufficient in the light of that deviation.
He recognized that
there were two weeks with somewhat lower net borrowed reserves.
Still, if one looked at most of the monetary variables, the action
of the latest three weeks for which there were data could be
considered about as restrictive as that in the corresponding three
week period before the last meeting.
Net borrowed reserves were
about the same, and total reserves and the credit proxy declined.
The major exception to that generalization was that interest
rates receded part way from their abnormal height, Mr. Maisel said.
That correction from the height reached as a result of the extreme
crisis in expectations which occurred at the end of August was to
be expected.
As he had indicated before, the Committee should
guard against allowing any changes which occurred simply from a
sharp runup based on expectations to get built into the system.
It
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must take a larger view and consider the total monetary picture, not
simply the retreat of interest rates from their temporary levels.
It should not be satisfied with a further decline in reserves and the
credit proxy.
The Desk should take the necessary action under the
proviso of today's directive to try to start those variables back
along a normal growth path.
expand.
That meant that total reserves should
He would guess that it probably meant lower net borrowed
reserves and a continuation of the return of interest rates toward the
early August levels.
Mr. Maisel said he did not favor retaining the word
"vigorously" in the first sentence of the directive, as Mr. Daane had
suggested.
He preferred the directive proposed by Mr. Hayes to the
staff draft, but he would replace the final phrase of the proviso
clause, reading "in the light of bank credit developments during the
month," with the phrase, "in order to aid in a moderate expansion in
bank credit and reserves."
Mr. Brimmer said that he had proposed to include in his
comments today a review of some implications of the recently reduced
liquidity of life insurance companies.
In the interest of time,
however, he would make only summary remarks on the subject and ask
that the comments he had prepared be included in the record.
summarized the following statement:
He then
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The tendency for gross cash flows at life
insurance companies to fall short of company
projections has created a serious liquidity squeeze
on some individual companies because of the very
large share of projected cash flows (well in excess
of 90 per cent) which had already been allocated
through advance loan commitments. The short-fall
in basic cash flows has reflected a combination of
(1) lower than estimated pre-payments on mortgages,
(2) higher than estimated policy loans, and (3)
larger than expected withdrawals of policy proceeds
left on deposit with the company. Some insurance
companies have been hit much harder by the policy
loan increase than others--with the increase in
several extreme cases pre-empting all or virtually
all of the basic cash flow.
To meet loan commitments in the face of this
unexpected squeeze on their basic cash flows, some
companies have had to reduce their cash balances,
and/or liquidate security holdings and draw on bank
credit lines. Initially, as evidence of the
liquidity squeeze developed, life companies stretched
out the ultimate payment dates on a large part of
their loan commitments. But more recently, with the
policy loan problem continuing, some companies have
ceased making any new loan commitments altogether.
Moreover, in the absence of a basic general easing
of credit conditions, there is no obvious reason to
expect these pressures on insurance companies to
abate for some time.
The persistence of this liquidity squeeze on
life companies poses several logical questions for
the Federal Reserve:
1) Is it likely that life insurance
companies (generally assumed to be
good business customers at banks)
will pre-empt a significantly larger
share of bank credit, either by
drawing on their own credit lines, or
by deferring the allocation of long
term funds to mortgage companies, thereby
necessitating an extension of construc
tion lending by banks or leading to an
increase of mortgage warehousing?
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11/1/66
2)
Is it likely that security liquidations
by life companies seeking to obtain
funds will be large enough to create
instability in bond markets?
3) Is it possible that any particular
companies, under pressure from policy
loan increases, will run through all
of their own sources of liquidity and
have to renege on their advance loan
commitments, or be bailed out by
special loan arrangements?
The Life Insurance Association has not indicated
whether any particular companies are about to run through
all of their liquidity reserves. But it seems unlikely
that the industry in general is facing any such problem.
Moreover, with long-term interest rates declining
recently, the capacity of bond markets to absorb some
portfolio liquidation has been improved.
In these circumstances, it seems to me that it is up
to the life insurance industry to demonstrate more fully
a need for special liquidity assistance, if there is one.
Without better evidence on the state of individual
companies, it is difficult to decide whether any special
use of Federal Reserve Bank credit (either directly or
indirectly) would be justified for this purpose.
At the same time, however, it should be recognized
that life insurance commitment activity has been sub
stantially curtailed, so that credit from this source is
much less readily available. Here, too, if the problem
were presently acute, corporate bond yields would
probably not be declining. But any build-up in the
corporate calendar would clearly be more difficult to
accommodate in the absence of active life company partici
pation. Also, it seems likely that the volume of life
insurance credit available for commercial and multi
family residential construction will be substantially
reduced in 1967, relative to the supply available at the
start of 1966. Finally, it seems very possible that life
insurance company demands for accommodation at banks
will increase. All of these elements in the total credit
picture, therefore, need to be kept in mind while setting
reserve policy for banks--although at this point it is
difficult to quantify their precise significance.
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Mr. Brimmer then said that he would report briefly on the
progress being made by the Cabinet committee on the balance of pay
ments in formulating a program for 1967.
The discussions were still
underway and it was not possible as yet to say what recommendations
were likely to be made to the President.
It might be helpful to the
Committee to have some of the flavor of the discussions, however,
because they bore on the relation between monetary policy and the
payments balance in the coming year.
Hopefully, Mr. Brimmer continued, the program for 1967 would
be announced within the next few weeks, perhaps around the date of
the Committee's next meeting.
The program would remain a voluntary
one, and it now seemed likely that most if not all of the elements
of the 1966 program would be retained.
Specifically, there would be
elements relating to direct investment abroad and to export promotion,
under the guidance of the Secretary of Commerce.
There was some hope
that the Federal Reserve's part of the program would be continued,
but that question was still under discussion.
One point he would like to note particularly, Mr. Brimmer re
marked, was that there was a definite hope within the Cabinet committee
that a balance of payments program could be developed that would permit
greater freedom for monetary policy decisions to be made in light
of domestic considerations.
It was almost a precondition for the
current discussions that something be done with respect to capital
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flows, so that monetary policy would not have to carry so much of the
burden of restraining such flows.
He personally doubted that the
President would approve any recommended program that did not allow
greater flexibility for monetary policy to be based on the needs of
the domestic economy.
Since balance of payments considerations had been mentioned in
connection with monetary policy this morning, Mr. Brimmer observed, he
thought that point was worth keeping in mind.
It also had some
bearing on the directive to be issued today.
Thus, in the first
paragraph he would prefer to specify the international payments
objective of the Committee's policy in terms of "progress toward"
reasonable equilibrium in the balance of payments rather than "restora
tion of" such equilibrium, as both the staff draft and Mr. Hayes'
version specified.
The Cabinet committee was actively discussing the
question of the payments target for 1967.
It was generally agreed that
no quantitative goal should be announced, as had been done for the 1966
program, but the question remained of what goal would be reasonable.
One issue was whether the goal should be defined apart from the impact
of the Vietnam war, which was estimated to have increased the annual
deficit by roughly $1 billion.
Because the matter was still under
discussion, he hoped the Open Market Committee would not imply in the
directive that it had set equilibrium as the target.
11/1/66
-70On a related point, Mr. Brimmer observed that Mr. Hayes'
comment to the effect that the recent inflow of foreign private
liquid funds was a means of financing the deficit implied that
the liquidity basis of calculation was the appropriate one.
He
did not believe the Committee should accept either that basis
or the official settlements basis as the one proper method for
calculating the balance.
The Administration's decision had been
to calculate the balance on both bases and to reach a decision
between them only after more experience had been accumulated.
The matter had been discussed by the Cabinet committee as recently
as yesterday, and it had been left open for the time being.
But,
however the balance was calculated, he shared Mr. Reynolds' sense
of urgency about the country's international payments problem and
he hoped that efforts to deal with it would continue.
With respect to other parts of the directive, Mr. Brimmer
agreed with Mr. Maisel that economic activity should not be
In the second paragraph
described as expanding "vigorously" now.
he would prefer to call for "generally steady" rather than "firm"
money market conditions.
He shared Mr. Hayes' view that expansion
in the bank credit proxy in November at an annual rate of about
6 per cent would not be disappointing.
The series of shortfalls
in bank credit growth that had been experienced recently might
well result in the Committee's feeling rather uncomfortable; the
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fact that the growth expected had not materialized was grounds for
pause.
Mr. Hayes had implied that a 4-6 per cent growth rate in
November would be acceptable, but he (Mr. Brimmer) would prefer
to have the Committee set such a rate as an explicit goal.
Mr. Hickman remarked that developments since the Committee's
last meeting provided further evidence of moderation in the private
sector of the economy and of a continued climb in defense spending.
Major economic series showing signs of slackened growth included
production of consumer goods and materials, unfilled orders for
durables, plant and equipment spending, steel output, and nonfarm
employment.
For many months, residential construction had been the
only major economic series showing an outright decline.
In the
third quarter, however, several important series joined residential
construction on the downside:
new orders for durable goods, auto
output, and sensitive industrial materials prices.
As the Chairman
had pointed out at the last meeting, "If it were not for defense
spending, the economy might well be experiencing a little downturn
right now, and . .
. defense spending is (not) a very strong prop
for an economy."
Unfortunately, Mr. Hickman said, the evidence cumulated
that wage-cost inflation had been built into the economy, due
almost entirely, in his opinion, to the failure of the Administration
to take appropriate fiscal action earlier this year.
Evidence also
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cumulated that monetary policy alone had done about all that it
could to restrain the economy, and that a further tightening could
aggravate imbalances now present in the economy.
As he mentioned at the last meeting, Mr. Hickman continued,
in an economy in which defense spending was the prime mover it was
extremely difficult to design appropriate monetary or fiscal policy
when even the roughest estimates of defense spending were withheld
from the U.S. Treasury and this Committee.
To the extent that the
System could bring influence to bear in appropriate places, it
should press to have the Defense Department release data to it on
new orders and estimated cash flows for the next two or three
quarters.
Without such information, monetary and fiscal policy
could easily be misdirected, to the great detriment of the economy.
He might add that his board of directors at last month's meeting
underscored the importance of the Committee's having information
on the flow of defense spending for a reasonable period ahead,
and urged the System to do what it could to fill the gap in its
knowledge.
Lacking reliable information on defense spending and the
economic outlook, Mr. Hickman continued, the Committee should allow
the behavior of the credit proxy and the money supply to determine
policy; that is, it should follow rather than lead.
If the credit
proxy and the money supply failed to come up to the weak November
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projections of the staff, then the Committee should allow net
borrowed reserves to ease further, perhaps to $200 million.
An
important question, it seemed to him, was whether the Committee
should attempt to redress recent shortfalls in the money supply
and bank credit.
He was afraid that that would produce a very
easy tone in the money market, and that it might lead to a sharp
shift in expectations and perhaps to bond market speculation.
He
would, therefore, not attempt to redress recent shortfalls but
would let deviations of money and the credit proxy from the staff
projections lead policy over the next three weeks.
That policy
of "no change with qualifications" also seemed appropriate in view
of the forthcoming Treasury refinancing.
For the directive he
would favor the staff draft as submitted, with the understanding
that it would be interpreted as the Manager had suggested.
Mr. Bopp observed that the course of the war in Vietnam
seemed even more unpredictable now than just a few weeks ago--if,
indeed, that was possible--and military uncertainties were super
imposed upon question marks in inventories, capital spending, and
housing.
The future of durable goods spending also had been coming
under closer scrutiny, with the drop in housing starts raising
doubts about furniture and appliance sales in the coming year.
Financial developments during the past few weeks certainly
underlined the need for caution in determining monetary policy,
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Mr. Bopp said.
With reserves, the money supply, and credit flows
all falling significantly short of earlier projections, the
Committee might do well to aim for somewhat easier money market
conditions in the next few weeks.
Certainly that would be the
appropriate course for policy if those trends persisted.
Of course, Mr. Bopp continued, it was difficult to determine
just what proportion of the weakness in credit flows stemmed from
slackening demand, reflecting a softening in business.
No doubt
some of the downturn in money and credit flows resulted from antic
ipatory borrowing earlier in the year.
supply side.
Some also came from the
Indeed, it appeared that the squeeze in CD's--while
not so severe as some had expected--had had an important bearing
on lending policies.
In the Third District, loss of large nego
tiable CD's since the August peak ran only about half the 10 per
cent rate experienced in the nation as a whole.
Yet the loss--or
more precisely, the threat of loss--helped to condition thinking
on loan policy.
Earlier he had reported that several of the large
Philadelphia banks had set themselves the goal of holding loans
virtually stable.
They had accomplished that in large measure.
Business loans in particular had remained virtually unchanged
from early August to the present.
In view of the present uncertainties on the business front
and projected decline in bank credit, Mr. Bopp felt that the recent
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modest easing in money market conditions should be continued.
was tolerable within an over-all policy of even keel.
That
However, if
flows of money and credit proved to be substantially greater than
projected, he would recommend that the Manager restore conditions
to where they were two weeks ago.
With respect to the directive, Mr. Bopp said, he could accept
any of several alternative proposals that had been made.
He thought
Mr. Swan's suggestion to move the reference to recent fiscal policy
measures to an earlier point in the first paragraph was a partic
ularly good one.
Mr. Patterson reported that over-all gains in the Sixth
District in recent months had slowed down.
off in August and in September.
Employment had leveled
Sales of 1967 automobiles were
running well behind last year's introductory pace.
And residential
building contracts would be down between 6 and 8 per cent for the
full year on the basis of present trends.
However, Mr. Patterson said, while noting those signs of
weakness he would not want to exaggerate their importance.
ment remained low.
Unemploy
Overtime work was still increasing, and personal
income--according to the latest available data--continued to expand.
On the whole, though, the District economy was showing less steam,
and nowhere was that more apparent than in financial data.
Business
loans in the first three weeks of October expanded less than a year
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ago.
Such moderation in pace followed vigorous business loan expan
sion in September and weakness in August, so there could be little
doubt that the trend in business lending had slackened.
Other
categories of lending also showed signs of easing.
In looking back, Mr. Patterson continued, it was now quite
clear that borrowing demands of late last year and much of this year
were clearly unsustainable.
The loan expansion could not continue
indefinitely in the face of progressive System tightening.
In fact,
his conversations with bankers, as well as the high level of member
bank borrowing at the discount window and in the Federal funds
market, indicated that even now many banks still felt in a tight
position.
On the other hand, the recent movement in loans could
not be attributed entirely to deposit trends and monetary policy.
The demand for loans seemed to be weaker than banks had anticipated
several months ago.
Since many of the same observations noted for the Sixth
District could be made about the national scene, Mr. Patterson said,
it was appropriate to ask whether the time had come for edging away
from the Committee's policy of restraint.
Considering the delayed
impact that monetary policy had, some easing was, indeed, a tempting
policy description.
The Committee should also keep in mind criticisms
leveled against the System in the past for being overly concerned
with price developments when economic activity was slowing down.
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Thus, a good case could be made for a policy shift, especially since
industrial commodity prices had shown little change in the third
quarter.
Having almost convinced himself of the wisdom of such a
policy change, Mr. Patterson concluded that the time was not quite
ripe for it, aside from "even keel" considerations.
With defense
spending strongly headed upward the economy was unlikely to turn
down quickly.
Wages were rising rapidly.
still in the offing.
Fiscal restraint was
Monetary restraint was making a contribution
to the balance of payments.
And he would judge that some recent
developments, especially those in financial markets, were in part
a reaction to overly dramatic changes in the immediate past and,
therefore, only in part for "real."
Hence, in the final analysis
he believed that the Committee should wait for additional evidence
of an easing in private demands before undertaking a major policy
shift.
But if the growth in business loans over the next few weeks
was as moderate as assumed in the green book, in Mr. Patterson's
opinion the Manager could afford to be fairly liberal in providing
reserves.
And if credit demands were less intense than now antic
ipated, he might even accommodate banks to the point of permitting
some rebuilding of their investments.
By and large, though,
Mr. Patterson suspected that the Manager would need to be guided
in his day-to-day transactions mainly by money market rates.
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Mr. Patterson said he favored adopting Mr. Hayes' suggestion
with respect to the second paragraph of the directive.
Mr. Francis commented that total spending on goods and
services had continued to rise faster than the ability of the economy
to produce, and upward pressures on prices were strong.
The Govern
ment's fiscal situation continued to add to the excessive demands.
Monetary developments since last spring had been restrictive,
Mr. Francis noted.
Member bank reserves had declined moderately,
growth of bank credit had slowed markedly, and the money supply had
changed little on balance.
In view of both the excessive total
demand for goods and services and the fiscal developments, the
monetary restraint had been desirable, but care now had to be taken
to avoid becoming too restrictive.
Monetary actions frequently had
their greatest impact after some time lag.
Recently, Mr. Francis said, interest rates had declined
and ease had developed in the money market.
Those developments
might indicate some decline in the private demand for loan funds
or might be only a technical reaction to earlier anticipatory
borrowing and speculative selling because of an over-estimate of
how high rates were going to rise.
In either case the net rise
in rates since last spring had probably been a good thing, helping
to bring planned private investment in line with planned saving
less net Government demand for loan funds.
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At this time, Mr. Francis remarked, the Committee could not
be sure what rate of monetary growth was appropriate, but he believed
that steps should be taken to avoid any sustained monetary contrac
tion, as well as to avoid a renewal of the rapid monetary expansion
that occurred last winter and spring.
If demands
for credit weakened
further, interest rates should be permitted to adjust lower, to the
extent permissible during a Treasury refunding.
Otherwise, bank
reserves, bank credit, and money were apt to decline and the
restraining force of monetary actions might cause a more than desired
contraction in total spending on goods and services.
On the other
hand, if demands for credit showed renewed strength, some upward
adjustment of interest rates might be necessary to avoid an undue
rise in credit and spending, causing further inflationary pressures.
In general, Mr. Francis thought that the Manager might be
instructed during the next few weeks to take care of normal seasonal
forces, but he should be permitted substantial latitude with regard
to fluctuations in measures of money market pressures.
If sharp
changes occurred in interest rates or other money market pressures,
attempts to offset them should be kept to a minimum consistent with
the needs of the Treasury.
Large demands for funds, especially when
translated into increases in required reserves, should be permitted
to tighten the money market.
Contractions in the demands for funds
and declines in required reserves should be allowed to ease the
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market rather than be used as a signal for the System to contract
reserves, credit, and money further.
Mr. Francis said he would favor Mr. Hayes' version of the
directive.
Mr. Robertson made the following statement:
As everybody around the table has acknowledged, we
are in the midst of an "even keel" period that constrains
our ability to make any overt change in monetary policy.
Sometimes this kind of constraint can be a positive
operational advantage to the Committee, because it provides
us with a freer opportunity to look ahead and plan possible
courses of action to be agreed upon when the even keel
period is over. This, it seems to me, is one of those
fortunate times.
In the great mass of evidence coming before us, we
see more than the usual signs of softening or easing of
pressures. Yet none of this evidence is so persuasive
as to make us want to ease policy aggressively at this
I believe in flexibility in monetary policy, but
moment.
I am not much attracted to a "stop-and-go" kind of system,
full speed ahead,
operating as if we had only two gears:
and full speed reverse. In circumstances like we face
currently, I believe that kind of approach could generate
substantially more harm than good.
My preference, if easing signals continue to flash
in increasing numbers, is for a tentative but gradual and
progressive kind of let-up of monetary pressures, related
closely to the kind of market and economic effects that
seem to be resulting. This would be my prescription,
unless and until a sharp change in the picture is introduced
by way of Vietnam spending, additional fiscal action, or
a marked further alteration in private spending intentions.
Having spoken in these general terms about our over
all policy focus, let me say a few words about our operating
instructions to the Manager, both retrospectively and
prospectively. It seems to me that the proviso clause has
I was glad that the Manager
thus far worked out well.
permitted a slight easing of money market conditions in
the last half of October when it became evident that
required reserves were showing substantially less strength
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than anticipated. He apparently felt that there was a
limit to the ease he could permit in money market
interest rates, and this was quite proper given the
sense of the Committee's previous discussion and given
the stress on money market conditions in the directive.
There are times when it is desirable for the
Committee to lay greater stress on money market condi
tions than on net borrowed or free reserves as an
immediate operating target. The recent period, when
liquidity crises were threatening, was clearly such a
time; perhaps the present even keel period is another.
However, I would like to suggest that the time is
approaching when we can and should move away from
primary reliance on money market conditions as an
operating guide. The trouble with too-slavish attention
to money market conditions as a target is that our
operations then tend to circumscribe short-term interest
rate movements into too narrow a band, thereby stul
tifying market performance and depriving us of an
immediate indicator of market pressures. We do not
want to see large and erratic rate movements in the
financial system, but we should want to see enough rate
movements to provide us with a barometer of changing
market demand pressures. For rates to reflect under
lying pressures, we obviously cannot have them as a
principal target.
What we can better use as an immediate target, I
think, is our old friend, net borrowed or free
reserves--or in directive language, "net reserve
For, with all its imperfections, it has
availability."
the key advantage of cushioning market pressures while
leaving market interest rates reasonably free to index
changing private demand pressures. With CD run-offs
slowing and bank reaction to the September 1 letter
settling into a pattern, some of the influencesthat
muddied the free reserve waters for a time this fall
are calming down and this reserve target is once again
becoming more dependable as a week-to-week guide. We
have learned, I think, not to rely on net borrowed
reserves alone, but to use that measure in conjunction
with aggregate reserve and bank credit movements in the
interest of fostering orderly and noninflationary
monetary expansion.
Our recent experience with the proviso clause has
been very instructive in this respect. Given the
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succession of weeks in which aggregates have fallen
short of our expectations, I should think the time has
arrived to give somewhat more weight to monetary
aggregates in our operating instructions than we have
in the past. One way to do so at this time is to state
clearly that we would like to see bank credit show at
least a little more strength than indicated in the blue
book projections. This could be done in the directive
by adopting the position outlined in the last paragraph
of the staff note attached to the draft directive.
This would mean that with money market conditions
roughly in the range of the past two weeks, bank credit
might show somewhat more strength than projected in
November. If it did not, money market conditions could
be permitted to gradually ease somewhat more; on the
other hand, if bank credit showed considerably more
strength, money market conditions could tighten
some--all within the constraint of even keel. And
next time--when we are beyond even keel--I hope our
instructions to the Manager will lay less stress on
money market conditions and more on reserve factors
as guides to operation.
With these interpretations, I would be prepared to
vote in favor of either the draft directive distributed
by the staff or that suggested by Mr. Hayes.
Mr. Robertson added that whichever version of the directive
was adopted he would favor moving up the reference to fiscal policy
measures, as Mr. Swan had suggested, or deleting it completely.
He would also agree with Mr. Brimmer that the words "progress
toward" should be substituted for "restoration of" before the phrase
"reasonable equilibrium in the country's balance of payments."
Chairman Martin observed that he could add little to the
discussion today;
the comments he had made at the previous meeting
still seemed valid.
He would simply emphasize that the next meeting
of the Committee might well be an important one.
As had been pointed
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11/1/66
out, the elections would then be over and more information might
be available with respect to possible developments in Vietnam and
the future course of defense spending.
Thus, the Committee should
be in a better position at that time to decide whether any overt
change in policy was appropriate.
The main problem today appeared to be that of reaching
agreement on a directive, the Chairman continued.
He noted that
the Secretary had prepared a new draft that attempted to take
account of various suggestions advanced in the go-around.
The Chairman then read the following draft that had been
developed by Mr. Holland:
The economic and financial developments reviewed
at this meeting indicate that over-all domestic economic
activity is continuing to expand with sharply rising
defense expenditures but some evidencesof moderating
tendencies in sectors of the private economy. While
prices of some materials have declined recently, upward
demand and cost pressures persist for many finished
goods and services. Bank credit expansion has slackened.
Earlier strains in financial markets have abated and
certain fiscal policy measures have recently been enacted
by the Congress. The balance of payments remains a
serious problem. In this situation, it is the Federal
Open Market Committee's policy to maintain money and
credit conditions conducive to the restraint of infla
tionary pressures and progress toward reasonable
equilibrium in the country's balance of payments.
To implement this policy, and taking account of
the current Treasury financing, System Open Market
operations until the next meeting of the Committee shall
be conducted with a view to maintaining generally steady
conditions in the money market.
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-84
Mr. Hayes noted that the proviso clause was deleted in the
text Mr. Holland proposed.
He would regret dropping the clause,
because that would imply more emphasis on money market conditions
as a guide to operations than he thought was intended.
Certainly,
money market conditions were not the Committee's sole concern; a
high degree of interest had been expressed around the table today
with regard to developments in other variables, and some recogni
tion in the directive of that interest would be useful.
Messrs. Robertson and Wayne concurred in Mr. Hayes'
observation.
The Chairman then suggested that if the proviso clause
was to be retained the version Mr. Maisel had proposed might be
acceptable.
Mr. Robertson commented that, while Mr. Maisel's proposed
clause was a possibility, the wording suggested by Mr. Hayes might
be preferable on the understanding that its intended interpretation
would be explained in the record.
Mr. Hickman asked whether inclusion of Mr. Hayes' proposed
proviso clause would imply that the Committee wanted not only to
offset the expected 2 per cent annual rate of decline in the bank
credit proxy in November but also to attempt to attain a growth
rate in the neighborhood of 4-6 per cent.
In his opinion, if the
staff projections were valid such a course would result in a sharp
runup in bond prices.
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-85
Mr. Holmes said that in his judgment such an implication
was not necessarily warranted.
Moreover, as he had indicated
earlier he doubted the validity of the staff projections.
He thought
they probably would prove to involve an understatement of bank credit
strength in November, perhaps as large as the overstatements of recent
months.
Mr. Mitchell noted that there also could be a sharper decline
in bank credit than projected, if disintermediation continued at a
substantial rate.
He was inclined to agree with Mr. Hickman.
Mr. Daane commented that he thought the version of the proviso
clause proposed by Mr. Hayes would give the Manager the kind of discre
tion needed.
Mr. Robertson remarked that he thought the members had agreed
that even keel considerations were dominant at this time and, accord
ingly, that the Committee had to focus on money market conditions;
but that action should be taken, insofar as feasible given the
Treasury financing, to prevent a further decline in bank credit or
an undesirably large increase.
That was what he understood both
the staff's draft and Mr. Hayes' version of the proviso clause to
imply, and that was the course he would consider proper.
A number of expressions of agreement were voiced.
Chairman Martin observed that the discussion reflected a
fact he had often noted:
particular words meant different things
11/1/66
-86
to different people.
Personally, he found Mr. Hayes' version of
the proviso clause acceptable.
He inquired of Mr. Maisel whether
the latter also would find that version acceptable, given the
interpretation that had been made, and the response was in the
affirmative.
Mr. Swan asked whether it was appropriate to state as a
fact that defense expenditures were rising sharply in view of the
uncertainty with respect to developments in that area.
In response to the Chairman's request for comment,
Mr. Brill
said he thought enough was known to justify the statement in question.
While monthly figures on defense expenditures were not available,
preliminary GNP estimates for the third quarter indicated that defense
spending was rising then at a $4 billion annual rate, and the 50 per
cent increase in new defense orders from August to September indicated
that the rapid advance was continuing.
Mr. Hayes remarked that he was prepared to vote in favor of
the directive on which the Committee appeared to be agreeing, but he
wanted to note that he would have preferred to retain the original
language of the Committee's policy statement relating to the balance
of payments, rather than revising it to read "progress toward"
reasonable equilibrium.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the Federal Reserve Bank of New York
11/1/66
-87was 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 continuing to expand with sharply rising
defense expenditures but some evidences of moderating
tendencies in sectors of the private economy. While
prices of some materials have declined recently, upward
demand and cost pressures persist for many finished
goods and services. Bank credit expansion has slackened.
Earlier strains in financial markets have abated and
certain fiscal policy measures have recently been enacted
by the Congress. The balance of payments remains a
serious problem. In this situation, it is the Federal
Open Market Committee's policy to maintain money and
credit conditions conducive to the restraint of infla
tionary pressures and progress toward reasonable
equilibrium in the country's balance of payments.
To implement this policy, and taking account of the
current Treasury financing, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining generally steady conditions
in the money market; provided, however, that operations
shall be modified, insofar as the Treasury financing
permits, in the light of bank credit developments during
the month.
It was agreed that the next meeting of the Committee would
be held on Tuesday, November 22, 1966, at 9:30 a.m.
Chairman Martin noted that a tentative schedule for meetings
of the Committee in 1967 had been distributed with the agenda for
today's meeting.
He asked whether anyone had any comments on or
changes to suggest in the schedule.
11/1/66
-88
Mr. Daane said that while the tentative schedule was
acceptable to him, he would reiterate the view he had expressed
on other occasions that the Committee might ideally meet monthly,
at dates related to the availability of monthly economic statistics,
with interim meetings called when necessary.
Chairman Martin commented that the tentative schedule called
for 14 meetings in 1967, only two more than would be held if the
Committee met monthly.
Thereupon the meeting adjourned.
Secretary.
CONFIDENTIAL (FR)
ATTACHMENT A
October 31, 1966.
Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its meeting on November 1, 1966
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is still
expanding, despite evidences of slackening in some sectors of the
private economy. While prices of some materials have declined
recently, upward demand and cost pressures persist for many finished
goods and services. Bank credit expansion has slackened and earlier
strains in financial markets have abated. The balance of payments
remains in deficit; although capital inflows increased in the third
quarter the trade surplus declined further. In this situation, and
in light of the fiscal policy measures recently enacted by Congress,
it is the Federal Open Market Committee's policy to maintain money
and credit conditions conducive to the restraint of inflationary
pressures and to the restoration of reasonable equilibrium in the
country's balance of payments.
To implement this policy, and taking account of the current
Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to maintain
ing generally steady conditions in the money market; provided,
however, that operations shall be modified, insofar as the Treasury
financing permits, to moderate any apparently significant deviations
of bank credit from current expectations.
ATTACHMENTS B
Current Economic Policy Directive Proposed by Mr. Hayes
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is contin
uing to expand, with rising defense expenditures offsetting moderating
tendencies in some sectors of the private economy. While prices of
some materials have declined recently, upward demand and cost pressures
persist for many finished goods and services.
Bank credit expansion
has slackened and earlier strains in financial markets have abated.
The balance of payments remains a serious problem. In this situation,
and in light of recent and possible future fiscal policy measures, it
is the Federal Open Market Committee's policy to maintain money and
credit conditions conducive to the restraint of inflationary pressures
and to the restoration of reasonable equilibrium in the country's
balance of payments.
To implement this policy, and taking account of the current
Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to maintain
ing generally steady conditions in the money market; provided,
however, that operations shall be modified, insofar as the Treasury
financing permits, in the light of bank credit developments during
the month.
Cite this document
Federal Reserve (1966, October 31). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19661101
@misc{wtfs_fomc_minutes_19661101,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Oct},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19661101},
note = {Retrieved via When the Fed Speaks corpus}
}