FOMC Minutes
A meeting of the Federal Open Market Committee was held
in the offices of the Board of Governors of the Federal Reserve
System in Washington, D. C., on Tuesday, December 13,
1966, at
9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Brimmer
Clay
Daane
Hickman
Irons
Maisel
Mitchell
Robertson
Shepardson
Mr. Wayne, Alternate for Mr. Bopp
Messrs. Scanlon and Swan, Alternate Members
of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents
of the Federal Reserve Banks of Boston,
Atlanta, and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Eastburn, Green, Koch, Mann, Partee,
Solomon, Tow, and Young, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Cardon, Legislative Counsel, Board of Governors
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
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Mr. Lewis, First Vice President, Federal
Reserve Bank of St. Louis
Messrs. Eisenmenger, Link, Ratchford, Brandt,
Jones, and Craven, Vice Presidents of the
Federal Reserve Banks of Boston, New York,
Richmond, Atlanta, St. Louis, and
San Francisco, respectively
Mr. MacLaury, Assistant Vice President,
Federal Reserve Bank of New York
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Stiles, Senior Economist, Federal Reserve
Bank of Chicago
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of the
meeting of the Federal Open Market Committee
held on November 22, 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 November 22 through December 7, 1966,
and a supplemental report for December 8 through 12, 1966.
Copies
of these reports have been placed in the files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
noted that the Treasury gold stock remained unchanged this week
following a $100 million drop two weeks ago.
The Stabilization
Fund had sufficient gold on hand to take care of the second Italian
purchase of $30 million expected this month without having to show
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any further decline in the stock before the end of the year.
The
London gold market naturally reflected the ups and downs of the
Rhodesian crisis, although the fixing price remained in a rel
atively narrow range ($35.15-1/2 - 17-1/2).
Trading was
generally heavy whenever headlines concerning the Rhodesian crisis
appeared and the possibility of sanctions against South Africa
came to the fore, and on balance the gold pool lost about $12
million during the period.
That meant that there was still $25
million in the pool, not counting the $50 million supplement that
was also available.
That could go quickly, of course, if there
should be a blow-up in the discussions of the Rhodesian situation.
Events since the last meeting had demonstrated the useful
ness of the preparations made to meet year-end pressures, Mr. MacLaury
said.
Those pressures developed suddenly and with great intensity
on November 29 when one-month trading began for over-the-year-end
dates.
Euro-dollar rates for maturities of one month and over
jumped by a full percentage point--from 6-1/2 per cent to 7-1/2 per
cent--and the scramble for funds in the Euro-dollar market was
hectic.
As anticipated, the sudden demand for funds put spot
sterling under strain; and the Bank of England had to provide
nearly $50 million in spot support of the pound on that day.
Under
the circumstances, the Account Management decided to put into
operation immediately the various techniques that previously had
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been agreed upon to deal with such a situation.
The Swiss National
Bank, which up until that time had been buying dollars spot only,
announced that it would meet the temporary demand for Swiss francs
by taking in dollars on a covered basis without cost to the banks,
i.e., through flat swaps.
The dollars taken in were to be redepos
ited in the Euro-dollar market, like the dollars previously bought
outright.
That same day, November 29, the Bank for International
Settlements began placing sizable amounts of new money in the Euro
dollar market, acquiring the dollars through activation of its
swap facility with the Federal Reserve in currencies other than
Swiss francs.
Finally, in New York, the Federal Reserve began
purchasing spot sterling against forward sale for delivery after
year-end, acquiring that day a total of $28 million for System
and Treasury accounts combined.
That three-pronged attack, Mr. MacLaury said, coming as an
immediate and coordinated official response to sudden market
pressures, did much to relieve the pressures themselves, but it
was equally important psychologically as a demonstration that the
markets would not be left to fend for themselves over year-end.
Including operations prior to November 29, the Swiss National Bank
had thus far replaced in the Euro-market a total of about $200
million, partly through the BIS.
In addition, the BIS had drawn
the full $200 million under its swap arrangement with the System
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and placed those new funds in the Euro-market, as well as serving,
as it had in the past, as a channel for dollar deposits of central
banks other than the Swiss National Bank.
With Euro-market pressures
pretty well under control, and with the strain on sterling from
that source considerably alleviated, it was not necessary for the
System to extend its swap purchases of sterling beyond November 30,
by which time a total of $36 million had been acquired for the
System and the Treasury together.
Although sterling had been fairly well insulated from year
end pressures by the operations he had just mentioned, Mr. MacLaury
continued, it nevertheless felt the impact of the Rhodesian crisis.
All things considered, the markets seemed to have taken the day-to
day swings in headlines from unwarranted optimism to undue pessimism
on that issue in better stride than one might have expected.
So
far, at least, British reserves on balance had not suffered from
the shifting prospects for settlement or sanctions; the British
had recouped all of the losses they incurred when the Rhodesian
rejection of the proposed settlement was announced.
Of course, it
was impossible to tell how much better their reserves might have
looked had it not been for that problem.
But that volatile issue
remained potentially explosive and made it difficult to predict
how the month might turn out for sterling reserves.
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As the Committee knew, Mr. MacLaury said, November turned
out better for the British than appeared likely at the time of the
previous Committee meeting.
In addition to announcing a reserve
gain of $64 million they were able to liquidate about $90 million
in short-term debt, as well as to liquidate a sizable amount of
forward commitments.
It was to be hoped that December would turn
out as well, and that further repayments of short-term debt could
be made.
There were two hopeful signs.
First, at the meeting in
Basle this past weekend the package of credits of $400 million
made available to the Bank of England last September, at the time
the swap network was increased, had been extended for another
three months.
of this month.)
(Those credits had been due to expire at the end
Second, the trade figures announced today were
the most encouraging for some time.
For the first time in at least
the last three years, there was a surplus even on a crude basis;
when adjusted to a balance of payments basis the surplus was 80
million pounds.
Part of the improvement was due to the postpone
ment of imports pending removal of the surcharge on November 30.
Nevertheless, exports were up, and that was encouraging.
Mr. MacLaury then referred to two other developments, the
first of which was the recent sales of marks by the System.
During
the period the German Federal Bank took in a total of $152 million
as repatriation of bank funds came on top of a strengthening German
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balance of payments.
With marks in demand in New York the Reserve
Bank sold a total of $16.7 million equivalent in the New York
market, and in addition sold $15 million equivalent to the Federal
Bank on one day, December 7, when the latter had picked up $60
million in Frankfurt,
All of those sales were financed by drawing
down the System's mark balances.
Second, the Account had continued
to make progress in reducing the swap drawing from the Bank of
Italy.
Lira purchases of $45 million equivalent in New York
during the period had enabled that commitment to be brought down
to $25 million from the original $100 million.
Mr. MacLaury added that there had been a discussion of
multilateral surveillance, insofar as it impinged on the swap net
work, at the recent Basle meeting.
He did not know the details;
however, Mr. Coombs had reported that the discussion went well
and that he thought there would be a minimum of interference with
the swap network through multilateral surveillance in the future.
Specifically, the Netherlands and Belgium agreed to extend their
supplementary swap arrangements with the System for another three
months.
Mr. Hickman asked whether Mr. Coombs had commented on the
German attitude with respect to their tight money policy and on
the possibility of their attaining a little more balance in their
mix of monetary and fiscal policies.
He gathered that the inflow
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of dollars to Germany reflected both year-end operations and
general monetary tightness.
Mr. MacLaury replied that the Germans had been taking in
dollars fairly steadily for several months due to the sharp up
turn in their trade surplus.
Each year in the past the German
Federal Bank had taken in sizable amounts of dollars in December,
as much as $500 million.
The repatriation of dollars by German
banks was partly for year-end window-dressing purposes, but also
because the largest tax payments came due December 15.
This year,
because of changes in reserve requirements for German banks, it
was less clear that there would be a complete reversal of the in
flow after the year-end.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
November 22 through December 12, 1966,
were approved, ratified, and confirmed.
Mr. MacLaury noted that the $500 million swap agreement
with the Bank of Canada, having a term of twelve months, would
mature on December 28, 1966, and he recommended renewal.
Chairman Martin asked whether there had been any use of
that swap this year, and Mr. MacLaury replied the Bank of Canada
had drawn on it this fall for a small amount for a brief period.
Renewal of the $500 million swap
agreement with the Bank of Canada for
12 months was approved.
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Mr. MacLaury then said that the System's swap agreement
with the Swiss National Bank, and the two with the BIS, in the
amount of $200 million each, would reach the end of their six
month terms on January 20, 1967.
He recommended renewal in each
instance, adding that there was outstanding a $75 million drawing
under the Swiss franc arrangement with the BIS and $15 million
under the arrangement with the Swiss National Bank.
Renewal of the three swap agreements
for further periods of six months each was
approved.
Mr. MacLaury then reported that there were three outstand
ing drawings by the British under the swap agreement with the
Bank of England, all with terms of three months, as follows:
one
in the amount of $100 million maturing December 29, 1966; one in
the amount of $50 million maturing December 30, 1966; and one for
$100 million maturing January 20, 1967.
renewed, those would be second renewals.
If the latter two were
It was hoped that the
British would be able to make repayments on their short-term debt
this month and in January.
They had already taken in $50 million
today on market anticipations of good trade figures.
He recommended
that insofar as they were not able to make full repayment, the
drawings be renewed.
Mr. Mitchell inquired what the position would be if third
renewals should be requested, and Mr. MacLaury recalled that some
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time ago, after a second renewal, a letter was written to the
Bank of England expressing the Committee's philosophy on renewal
of swap drawings and emphasizing that they were of short-term
character.
The Bank of England made it clear that they agreed.
He did not mean to imply there should be a second letter, but the
British were well aware of the System's philosophy on the matter.
Renewal of the drawings by
the Bank of England, if requested,
was noted without objection.
Finally, Mr. MacLaury said, a System drawing on the Bank
for International Settlements in the amount of $50 million would
mature January 13, 1967.
At present the Swiss franc was not at
its ceiling, as normally might be expected at this time of the
year.
He hoped it would be even easier after the end of the year
and some progress might be made in paying down the drawing.
In
the event that the Account was unable to do so, he would recommend
that the drawing be rolled over a second time.
Renewal of the drawing, if
necessary, was noted without ob
jection.
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
November 22 through December 7, 1966, and a supplemental report
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for December 8 through 12, 1966.
Copies of both reports have been
placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
The comfortable money market conditions that
have developed since the Committee last met have
generally been interpreted by the market as a sign
that the Federal Reserve has moved in the direction
of less monetary restraint. This interpretation has
been strengthened by continued discussion of a possible
tax increase and reports of somewhat less exuberant
economic growth. Despite seasonal pressures, the
change in market expectations has led to a sharp
decline in Treasury bill and other short-term rates,
and, equally important, to a ready flow of funds in
the capital market in an atmosphere of rising prices.
Three weeks ago underwriters were looking with trepida
tion at the heavy calendar of corporate and municipal
issues to be sold. By last Friday the atmosphere had
changed to the extent that market soundings by the
FNMA with respect to an early sale of participation
certificates were received with enthusiasm. Indeed,
in the market for Treasury issues prices advanced very
sharply, with gains of 1/2 to 1 full point recorded in
yesterday's ebullient trading session.
In the short-term sector of the market dealers
were aggressive bidders for Treasury bills in the
regular weekly auctions and also in the special auction
of $800 million tax anticipation bills, which completed
the Treasury's financing program for calendar 1966. By
Friday night the three-month bill was 5.11 bid and the
six-month bill 5.22 bid. The market moved decidedly
lower in rate again yesterday with the average issuing
rate on three- and six-month bills established at about
5.05 per cent and 5.13 per cent, respectively. This
represented declines of 20 and 37 basis points from
the auction held the day before the last Committee meeting.
The decline in short-term rates is, of course,
providing a major assist to the banks in limiting the
run-off of the $5.5 billion CD's maturing during December.
We have heard of some corporations that have changed their
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approach to CD's since the beginning of the month.
Given the heavy maturity schedule a substantial
decline in CD's is inevitable, but it now seems
likely that the run-off will be towards the lower
end of the $700 million - $1 billion range mentioned
in the blue book.1/
Despite the improved atmosphere in the money
and capital markets there are a number of hurdles to
be crossed before the year-end. Dealer positions in
bills are at a high level, and rate stability over the
rest of the year depends on the continued availability
of financing at reasonable rates, and on continued
investor demand for bills. While new corporate and
municipal issues have moved out quickly there have
undoubtedly been sizable dealer takedowns and some
of the buying has been at least semi-speculative in
nature. As payments are made for the new issues some
pressure may become evident. Tax date pressures are
just upon us, and there are still uncertainties about
the international flow of funds over the year-end.
The fact that the year-end falls on a weekend could
also cause a knot in the money market if banks adhere
to their traditional reluctance to show substantial
borrowings on statement dates. Thus, although the
underlying atmosphere is much improved, we can still
expect considerable churning in the money market over
the rest of the month.
As the blue book notes, the decline in market
rates and reduced marginal reserve pressure on banks
has not, as yet, been reflected in any notable impact
on bank credit expansion. December estimates at the
New York Bank show less of a decline in the bank credit
proxy than anticipated three weeks ago, and our estimates
would now be close to the Board staff estimate of within
two percentage points either side of zero. Banks'
holdings of Euro-dollar deposits have so far held up
better than some had feared, reflecting in part the
concerted efforts by European central banks and the
System to avoid extensive repercussions of December
window-dressing activity. The year-end, however, will
1/ The report, "Money Market and Reserve Relationships,"
prepared for the Committee by the Board's staff.
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probably bring certain special and temporary problems.
The relatively high cost of Euro-dollars cannot help
but influence some major banks to switch their borrow
ing to the Federal funds market at rates around 5-1/2
per cent. While bank credit has showed no signs of
real strength, banks have been aggressive bidders for
new municipal issues, and a better CD outlook could
bring about resumed expansion after the regular
seasonal pressures have passed.
Open market operations have been described in
detail in the written reports to the Committee and I
will not dwell on them here. In general, we tried to
anticipate reserve needs and to head off any tendency
for the money market to tighten, rather than offset
tightness after it had emerged. This shift of emphasis
in the conduct of operations was fully understood by
the market. Repurchase agreements proved a particularly
useful operational tool in the light of the reserve
supply stemming from the Treasury's cash position and
of seasonal uncertainties. Given the improved outlook
for Treasury bill rates, dealers felt little pressure
to cut back bill inventories, and the substantial supply
of repurchase accommodation available from the System at
the discount rate helped the performance of the bill
market over the period. The use of repurchase agreements
during this period also provided the opportunity for the
Desk to make use for the first time of the new authority
to purchase Government agency issues under such agree
ments. The System also took advantage, on occasions,
of the aggressive bidding in the weekly bill auctions
to run off a portion of maturing Treasury bills, thus
keeping what at times appeared to be a substantial future
need to absorb reserves through outright bill sales at
a minimum.
The Treasury has done a bit better in maintaining
its cash position than seemed likely three weeks ago.
As you know, there was borrowing of $169 million over
last weekend against a special certificate issued at
1/4 per cent below the discount rate. It now looks as
if no further direct borrowing will be necessary,
although the balance at Reserve Banks will be at a low
ebb through the 15th and 16th. By the 19th the Treasury
balance should begin to work its way back towards more
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12/13/66
normal levels.
All in all, the supply of reserves
through the forced decline in the Treasury balance
at Reserve Banks did not prove overly disturbing to
open market operations, and, from a broader point of
view, it was desirable for the Treasury to make use
of the special arrangement which had remained dormant
since 1958.
The debt ceiling remains a continuing though not
insurmountable problem to the Treasury, with the latest
daily Treasury statement showing debt subject to the
ceiling at $329.7 billion compared with the ceiling
of $330 billion. It seems clear that an increase in
the ceiling will have to be an early item on the new
Congressional agenda.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period November 22 through
December 12, 1966, were approved,
ratified, and confirmed.
Chairman Martin then called for the staff economic and
financial reports, supplementing the written reports that had
been distributed prior to the meeting, copies of which have been
placed in the files of the Committee.
Mr. Brill made the following statement on economic
conditions:
For several meetings now, the Committee's staff
has been stalled in coming to grips with the economic
outlook, since so much of the future course of the
economy rested on the still unknown spending plans of
business and Government. We have been alert to unfold
ing developments that have indicated, since early fall,
a marked slowing in economic expansion, but we've
hesitated to project these trends into the future as
long as the possibility existed that capital expenditures
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and defense outlays--the two most expansive forces
driving GNP this past year--might continue to provide
significant upward thrust to the economy in 1967.
Now the veil has been partially lifted, and the
staff can no longer dodge the critical policy issues
involved. First, let's review the major new items
of information in terms of their impact on the course
of the economy. Business capital spending plans, as
revealed in the latest Commerce-SEC survey, indicate
a distinct tapering off of the investment boom. It
is not only that anticipated expenditures rise so
much more slowly through mid-1967 than the pace of
these outlays this past year. Perhaps more significant
are the indications that actual spending is beginning
to fall short of earlier anticipations, a development
which in only small degree can be attributed to supply
difficulties. In the present situation, such shortfalls
must represent a distinct and significant change in the
outlook among many business planners. The intent of
monetary restraint and of the fiscal actions taken
this fall was to cool off the investment boom; these
policies seem to have succeeded, perhaps too well.
The less ebullient outlook of businessmen seems
matched by consumers. The latest Census survey of
consumer buying intentions, and recent evidence of
sluggish retail sales, suggest little thrust from con
sumer expenditures over the near- and intermediate-term
future, especially for durable goods but also for housing.
Finally, as to Government spending plans, hard
numbers are not yet available, but one can deduce from
the range of numbers leaked to the press, and from the
size of the supplemental appropriation for fiscal year
1967 the President has announced he will request, that
the rate of expansion in Government spending may also
decelerate. The green book 1/ number on Federal spending
in the first quarter of 1967 is but a guess, and we
tried to flag it as such. But it is a guess from which
not too much dissent is likely to be found among
Washington crystal-ball readers.
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
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Of course, we all recognize that military spending
requirements can depart suddenly and widely from budget
projections. Even though valiant efforts are being made
to pin down this major element in Government spending
with more precision this year, one can still legitimately
harbor reservations. But one must also credit budget
planners with enough intelligence to learn from mistakes.
If, for the moment, one is willing to accept current
private and Government spending plans at face value, one
comes up with a relatively soggy economic outlook, one in
which GNP rises at a slower rate, over the winter and
spring, than even the current moderate pace, with capacity
use drifting off, hours of work cut back and, possibly,
the unemployment rate beginning to creep up. While all
GNP projections must be regarded only as point estimates
within a probability range, it seems to me that, barring
an upward revision in defense spending, deviations around
this point are more likely to be on the down side than on
the up side. Under the circumstances postulated earlier,
for example, we may be relatively optimistic in assuming
only a moderate decline in business inventory accumulation
in the months ahead, particularly since the October figures
on inventories, sales, and business attitudes towards
inventories suggest that the recent high rate of accumula
tion was in part involuntary. One can easily visualize a
much sharper reduction in inventories than was projected
in the green book, with repercussions on output and
employment that could cumulate.
If such an over-all expenditure outlook were the only
determinant of economic policy making, the prescription
would be fairly simple--forget about tax increases and
gear up for the possible need to stimulate the economy
some time next year. At the last FOMC meeting, President
Ellis asked me whether I thought a tax increase was still
needed. After hedging and qualifying in the time-honored
fashion of staff economists, I recall admitting that I
did think a rise in taxes would be needed. I'm not sure
I can give the same answer today; if I did, it certainly
would be for different reasons.
But it's not crystal clear as to what the right
answers should be, since anticipated domestic spending
plans cannot, in themselves, provide all of the bases
for policy making. There are balance of payments, wage,
and price implications to consider. Short of an actual
recession, for example, it is likely that wage rates and
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wage costs would continue to rise over the next half
year, despite further slowing in economic activity.
The levelling off in industrial output--which started
in early summer and has extended into November, accord
ing to preliminary estimates of the production indexhas been accompanied by continued strong advances in
employment. This implies a marked drop in the rate of
productivity gain, which in turn has been reflected in
a significant rise in unit labor costs.
While producers may be willing to suffer some
further narrowing of profit margins, I suspect that the
reaction to continued rise in labor costs will be a
tendency to try to pass them on, thus keeping upward
pressure on industrial prices. Once the offset from
declining food prices ends--a development which some
analysts think is about on us already--the broad price
measures, at both wholesale and retail, will begin to
reflect more of the industrial price creep.
Many current and prospective economic symptoms,
then, are the classic ones of a cyclical peak--inventory
sales ratios rising, business investment tapering off,
consumer demand sluggish, capacity use beginning to
drift down, and wages and prices continuing to push up.
Unfortunately, the Government's freedom of maneuver in
dealing with these developing symptoms is limited by
a continued serious balance of
two major constraints:
payments problem, and the heritage of last year's fiscal
failure, i.e., a large budgetary deficit that is hobbling
the choice of appropriate fiscal and debt management
policies.
Having done their share of the job this year,
monetary policy makers have somewhat more room for
maneuver, assuming that more rigorous capital control
programs will limit our balance of payments losses to
It seems to me, in light of domestic
tolerable levels.
economic developments and prospects, that at least the
direction in which monetary policy has to move is clear;
fiscal decisions, or the lack of them, will merely
condition the extent and pace of the monetary move. In
a more tranquil economy that appears to be heading
toward less intensive resource use, monetary policy can
appropriately continue to ease, and not be diverted by
"last gasp" wage and price increases that reflect
earlier sins and don't portend an acceleration. If the
size of the prospective budget deficit forces the
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Administration to ask for higher taxes, then the
monetary easing could be prompt and substantial. If
the fiscal decision is not to ask for higher taxes, or
if the decision is postponed, then monetary easing
could be more gradual and moderate.
For it's not as though we're starting from a
position of only mild monetary restraint. Interest
rates are still historically high, and bank credit has
been contracting, on balance, for five months now.
These are far too restrictive a set of policy results
to be appropriate to the current moderate pace of
economic expansion, let alone the prospect of even more
moderation in output and incomes. I would recommend,
therefore, continuing to press ahead with the policy
initiated at the last meeting, with sufficient vigor to
achieve easier credit conditions and, through this, some
expansion in bank credit.
Mr. Daane asked, with reference to Mr. Brill's suggestion
that the rate of increase in defense spending might decelerate,
whether there was any firm basis for that expectation.
Mr. Brill
replied that it reflected the best information he could obtain from
those associated with the formulation of the budget.
The numbers
might change; they had been changing over time in recent months, but
the changes were in the direction he had indicated.
Mr. Daane then asked whether informed judgments were involved
or simply guesses, and Chairman Martin observed that what Mr. Brill
had reported reflected the most informed judgments available, which
he felt might be regarded as fairly accurate at this stage.
Mr. Brill
commented that it should be borne in mind that a military operation
was involved, rather than a civilian-type program.
Various develop
ments, such as a new anti-ballistic missile program, of course could
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cause the figures to be adjusted upward, but the responsible parties
had been pressing to get as good a set of figures as possible for
the budget, and what he had reported reflected the best current
judgments.
Mr. Brimmer noted that it should be remembered that certain
basic questions of military strategy were still open.
On the other
hand, it appeared from the press and other sources of information
that some basic decisions had been made recently on strategic ques
tions that offered a better basis for making judgments about military
spending over at least the next six months.
He understood that the
people in the Department of Commerce who worked on national income
statistics had reached the same judgment as Mr. Brill.
Mr. Brill then commented on the apparent pace of defense
spending thus far in the fourth quarter as it could be read from
the Treasury's daily statement, following which Mr. Daane inquired
about the possibility of a repetition of last year's experience--an
unanticipated upsurge in defense spending.
Chairman Martin indicated
that he felt that would be likely only if major new decisions were
made that would change the whole picture.
Mr. Hickman commented that he assumed there was likely to
be enough feed-back of information in the event of such decisions
to enable the Committee to alter policy.
In his judgment the
situation probably would be unlike that of last year when the
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12/13/66
Committee simply did not know the facts and continued a relatively
easy monetary policy too long.
If the Committee became aware that
the pace of military spending was about to accelerate sharply, it
could shift policy.
Mr. Daane said that he doubted whether anyone in Washington
today could say what size the anti-ballistic missile program might
assume.
Mr. Partee made the following statement concerning financial
developments:
Despite the moderate easing in money market conditions
achieved on average over the last three weeks, the banking
aggregates have not yet shown strengthening tendencies.
In fact, the November figures on total member bank
deposits are somewhat weaker than was projected just
prior to the Committee's last meeting. All of the short
fall is accounted for by a significantly weaker private
demand deposit performance than had been expected, and
this, along with an indicated decline in demand deposits
in the current week, has led us to lower our sights for
December. Little or no increase in the credit proxy
this month now seems likely.
November marked the fourth consecutive month in which
actual deposit expansion fell appreciably below the
projections made around the beginning of the month. Even
allowing for some staff bias, which may result from a
tendency to project past trends into the future, this is
an impressive string of shortfalls. In August, member
bank deposits were projected to rise at about a 4 per
cent annual rate, but they actually fell 3-1/2 per cent;
in September the expectation was for a 3-1/2 per cent rise,
but the final result was a fractional decline; in October
a 5-1/2 per cent increase was initially projected, but
the outcome was a 3-1/2 per cent decrease; and in November
the staff started off projecting a 2 per cent decline and
then at mid-month lowered the figure to 3 per cent, but
the actual drop turned out to be 5-1/2 per cent.
12/13/66
-21-
Earlier in this period, these shortfalls were
spread among both demand and time deposits, but in
both October and November the misses were entirely
in the private demand deposit category. As a
result, the money stock has moved further downward,
on a monthly average basis, and in November was
lower than at any time since last February and down
nearly 3 per cent, annual rate, from the June peak.
The last several weeks have shown some net increase
in money stock, and we would expect a sizable rise
in the December average--in both cases reflecting
mainly outpayments from the Treasury balance--but
not by very much more than enough to offset the
November decline. Meanwhile, total bank credit,
though not quite so weak as the deposit figures in
view of increased Euro-dollar liabilities, has also
declined on balance over recent months.
I have gone into this background in some detail
in order to emphasize as strongly as possible my
feeling that something important has been going on
to affect financial relationships. We have consis
tently overestimated the amount of deposit and bank
credit expansion that would be associated with a
given set of money market conditions in recent
months. Moreover, the banking system has failed to
respond to the modest easing in conditions that has
proceeded irregularly going all the way back to
mid-October. Thus, net borrowed reserves were nearly
$200 million smaller in November than October, on
average, and the whole family of shorter-term bill
rates moved somewhat lower. Nevertheless, the
decline in member bank deposits was sharper in
November than in the earlier months. Obviously,
the relationship between money market variables and
the banking aggregates has been shifting even faster
than allowed for in the increasingly pessimistic
staff projections.
Three possible explanations for this unexpectedly
strong shift suggest themselves. First is the pos
sibility that credit demands in the private sectors
of the economy are diminishing markedly. Certainly
the bank lending figures of recent months do not
refute this possibility. Not only has business loan
expansion declined sharply, with virtually every
industrial sector showing slower growth than earlier
12/13/66
-22-
in the year, but other types of bank lending also
have tended to level off. Most of this undoubtedly
reflects supply constraints rather than reduced
demands for funds, which are now being reflected
in heavy current and prospective private flotations
in the money and capital markets. In the business
sector, particularly, further increases in capital
outlays and high rates of inventory accumulation,
combined with a leveling off--and possibly a
decline--in internal funds, should be producing
record external financing needs. Nevertheless,
it is only reasonable to assume that the slowing of
economic expansion generally over recent months is
having its financial counterpart in a less intense
demand for borrowed funds.
A second possibility is that bank credit is
being curbed as a result of the attitudes of bankers
themselves. By this I mean something more than just
that terms, lending standards, and other methods of
rationing credit have been tightened, which obviously
has occurred. It may be that the developments of
recent months--deposit losses, sharply declining
liquidity, the September 1 letter, and other Federal
Reserve restraining actions--have created so many
uncertainties that banks are not pushing so hard
to use the credit available to them. Many banks
may now be inclined to use any modest easing in
their positions to repay short-term indebtedness
to the Fed and others, rather than to make invest
ments or ease up on lending policy. And if the
banks do not push to expand loans and investments,
deposits are not created and new reserves are not
required. In this situation, even a gradually
easing net reserve target could fail to produce an
expansive policy effect, since reserves might have
to be absorbed through open market operations in
order to keep borrowings from declining as rapidly
as bankers desired.
The third possibility is that the demand for
deposits may have declined. This is clearly the
case in the time deposit field, where the 4 per cent
savings rate, the 5 per cent consumer CD rate, and
the 5-1/2 per cent negotiable CD rate remain out
of touch with the best yields on competitive instru
ments. And it also is probably a factor in the
12/13/66
-23-
sluggishness of demand balances, in view of the high
yields available on cash substitutes. But the behav
ior of deposits is also probably influenced by the
very limited availability of bank credit, one effect
of which is to force holders to live with cash
balances below desired levels. Many businesses may
be working their available funds harder than they
otherwise would, for example, simply because they
are inadequately financed. Support for this view
is provided by the exceptionally large decline in
liquidity reported by the SEC-FTC survey of corporate
manufacturers for the third quarter.
Whatever the relative weights assigned to these
three possible explanations of weakness in the banking
aggregates, the general policy prescription seems
clear. If the Committee wishes to foster a resumption
of moderate growth in bank credit, some further easing
in restraints on the banks is needed. An overt and
highly visible move would be most certain to alter
the attitudes of "reluctant" bankers. But barring
this, a continued easing in money market conditionsincluding some further reduction in short-term
rates--may accomplish the objective of bank credit
expansion more gradually. A renewed inflow of CD
funds, especially one of size, should serve to
stimulate credit growth both directly, through
increased intermediation, and indirectly, through
improvement in banker expectations.
Given the range of rates available on broadly
competitive money market instruments, as well as the
reduced pool of liquidity to be shared, I believe
that it would take a 3-month bill rate at or slightly
below 5 per cent--with enough follow-through to
bring commensurately lower rates on other money
market instruments--to re-establish a reasonable
competitiveness for 5-1/2 per cent CDs. Even so,
not much CD expansion could be expected before
January, in view of the heavy December pressures on
liquidity positions. A gradual easing in money
market rates over coming weeks would also tend to
help bank and other savings institutions hold on to
their consumer-type time and savings deposits in
the important January interest-crediting period.
And an improving money market should help to main
tain a receptive tone in the long-term bond markets,
12/13/66
-24
which continue to face a prospectively heavy financing
calendar from corporate borrowers and also probably
from the Treasury.
Mr. Daane asked the Manager when he would expect the
seasonal peak in short-term rates.
Normally it had been thought
that the peak occurred around the 16th or 18th of December, and he
wondered whether that was still applicable.
Mr. Holmes agreed that that had been the normal pattern.
Whether it would prevail this year, he did not know.
Mr. Daane then requested clarification of Mr. Partee's views
about the role of supply constraints on bank credit expansion.
Mr. Partee replied that he thought one would have to say
that supply constraints--that is, constraints on the supply of
reserves available to the banking system--had been the major factor
in limiting growth in bank credit and deposits.
But there also
had been some demand effects on both the bank credit and deposit
sides of the balance sheet.
The various influences had all been
mixed together.
Mr. Hersey then presented the following statement on the
balance of payments and related matters:
This morning I would like to comment on some
developments abroad that have a look of recession
about them, and then try to see what implications
these developments have for Federal Reserve policy
or--on a different level--for appraising the
economic situation in the United States.
12/13/66
-25Unemployment in Britain and Germany has been
rising this autumn at a pace, in each country, that
seems to have surprised the governments as well as
other observers. True, the levels of seasonally
adjusted unemployment are still very low: in
November still below 2 per cent in Britain and below
1 per cent in Germany, but these lines will be
broken through very soon if the rises continue.
The industrial production indexes are not available
for October and November; in September, industrial
activity was clearly falling in both countries.
In both countries domestic plans and orders for
business capital expenditures began to decline
gradually in real terms early in 1965, and the
declines have become faster lately. The picture
for inventory investment is similar. Residential
construction has also been falling off gradually
for some time. Monetary policy has made credit
and capital market conditions extraordinarily tight,
and this is an important key to what is happening.
At the moment the world economic situation
bears no resemblance to the 1957-58 downturn, which
involved a transition from world-wide shortages of
materials to ease of supply, on top of the unwinding
of the 1955 investment and automobile boom. Japan
and Italy now play much larger roles than in earlier
years, and both of them, as well as France, are in
the early stages of strong new domestic upswings.
On the other hand, several other European countries
and also Canada have been experiencing a leveling
off in industrial production this year.
For Britain and Germany, the present situation
somewhat resembles the pause during 1961 and 1962,
in the second half of a previous four-year cycle,
but there are more elements of outright recession now
than then. It has taken the British longer this time
to get some slack in their economy; but now that the
turn has been made some kinds of demand appear to be
shrinking with some speed. In Germany, the previous
pause involved hardly more than a slowing of rise
in industrial production; this time, after slowing
for a year and a half, German industrial production,
as seasonally adjusted by the OECD, fell 5 per cent
in three months from the high reached last spring.
12/13/66
-26-
These developments abroad may require some
rappraisal of U.S. balance of payments prospects
for coming months. The slide-off in German demand is
a bearish factor for our exports; if continental
European countries as a group now let their economies
cool off, or in some cases keep them from heating up,
more successfully than it had previously seemed they
could, that would tend to dampen our export growth
for a time. On the other hand, recession, or a pause,
in European economic expansion now might conceivably
be just the catalyst needed to cause American manufac
turers to review and reject some of their projects for
enlargement of operations in Europe.
Another whole series of questions relates to the
timing of changes in monetary policies in Britain or
continental Europe, as compared with the timing of
any movement toward lower interest rates in the United
States.
In thinking about the relevance for Federal Reserve
policy of all such questions about the U.S. balance of
payments next year, we may well come to the conclusion
that the objective of working toward long-run equilibrium
in international payments will be served best by policies
aimed wholeheartedly at the two-fold domestic objective
of sustaining growth and minimizing inflation of
prices and costs, without much concern about short-run
variations in our balance-of-payments prospects or
results, so long as the rise of domestic prices slackens.
Two main lines of argument can be advanced to support
such a conclusion at the present time.
First, even on balance-of-payments grounds, a
recession in the United States could have harmful
long-run effects if it were to tilt the whole demand-and
supply situation in the world at large toward recession.
Under present conditions, we can look for some slackening
But
of import expansion as excess demand diminishes.
the further benefits our balance of payments might get
from depression of our imports in a U.S. recession
might well be cancelled off in the longer run by
subsequent unfavorable repercussions on our exports
through a related recession abroad. In short, the
United States stands the best chance of enlarging its
exports in an expanding world economy, and the size of
our country gives us a special responsibility for helping
to maintain noninflationary growth in the world economy.
12/13/66
-27-
Second, the prestige of the dollar stands well
enough for the moment, and the Administration's
voluntary programs, plus the I.E.T. and the related
arrangements with Canada, will give us some protection
again next year. Under these conditions, the United
States will be doing all we can properly be asked
to do towards restoring order in international pay
ments if we follow policies that can be seen by
everyone to be the right ones for maintaining
noninflationary growth. If one consequence of what
we do and of what others do is a sharp rise next
year in the reserves of Germany or other Common
Market countries, so be it. It should then become
clearer to the whole world than ever that the chronic
and semichronic surplus countries must play a more
positive role than they have yet done to restore
international equilibrium.
With regard to the specific, narrow, question of
U.S. banks' borrowings from the Euro-dollar market,
it would be far better to let this money flow back
to Europe as soon as that tendency develops, rather
than try to hang on to it at a cost of keeping
interest rates higher than domestic conditions might
call for.
These few thoughts about the balance of payments
and monetary policy under current and prospective
conditions do not help judge how to stay on the
to minimize price and cost inflation on
tight-rope:
the one hand and to maintain growth on the other.
The first essential--easier said than done--is
to appraise current domestic developments accurately.
As we make our appraisals, perhaps the recent develop
One
ments abroad have some usable lessons for us.
lesson is the reminder that a slide-off in activity
can begin quite suddenly and almost unexpectedly, when
investment decisions and inventory policies are being
revised under the pressures of very tight money and
capital markets.
In conclusion, let me come back to the policy issue.
We are fortunate that our gold reserves are larger
than Britain's, and our basic payments position stronger.
We are fortunate also that our wage inflation, up to
now at least, has been less rapid than Germany's.
Thus we have some freedom of maneuver to deal, in a
cautious way, with the danger that the economy may be
-28
12/13/66
moving toward recession--while keeping on the look-out
to avoid the opposite danger of a new build-up of
inflationary pressures.
Mr. Daane asked, if the Committee followed the policy
prescription advocated by Messrs. Brill and Partee, what sort of
capital outflow might be expected, taking into account the extent
of recent borrowing by American banks from the Euro-dollar market
and the leeway available for foreign lending by U.S. banks under
the new guidelines of the voluntary foreign credit restraint
program.
Mr. Hersey said he supposed, if there was an easing of
rates here, that there would be a tendency for U.S. banks to turn
more to the Federal funds market and to repay borrowings in the
Euro-dollar market.
However, he did not feel he could make a very
good judgment on how and when that might happen.
He thought the
tightness in the Euro-dollar market was due, to a large extent, to
the American banks' demands and that if those demands lessened
Euro-dollar rates might decline.
If at the same time there was an
easing of rates in the national money markets in Europe, the Euro
dollar might come to seem less expensive, and the shift might be
neither rapid nor far-reaching.
It was difficult to predict what
might happen; the gist of what he had said in his statement was
that, given current economic conditions here and abroad, the
Committee probably should not place great emphasis on short-run
12/13/66
-29
movements in the balance of payments.
As to foreign lending by
U.S. banks, a moderate and gradual easing of domestic monetary
policy was not likely to lead to a sudden rapid rise.
Mr. Brimmer commented that this might be a good point at
which to discuss the new 1967 program of voluntary restraints to
improve the balance of payments position, which he understood was
being announced today.
In answer to a question from the Chairman, Mr. Robertson
said that the Board's new guidelines for financial institutions
had been announced this morning.
He suggested that Mr. Brimmer
might want to discuss the Commerce Department program.
Mr. Brimmer said that the Commerce program would be of
essentially the same type as in 1966.
For direct investments,
which was the critical area, the 1962-1964 period would still be
used as a base, and the two years 1966 and 1967 would be combined
for the purpose of providing a quota for the companies partic
ipating in the program.
However, the rate of investment permitted
within this quota--which for 1965-1966 was 135 per cent of the
average during the base period--would be reduced to an average of
120 per cent for 1966-1967.
That was a substantially more
restrictive program, as far as percentages were concerned, than
was anticipated a few weeks ago.
The quantitative result expected
under the program should be in the neighborhood of a $2.4 billion
12/13/66
-30
direct investment outflow.
Earlier it had been thought the figure
would be $2.8 billion, the same as 1966, so the program had been
tightened substantially in the last week or so after discussion
within the Administration.
There seemed to be some $400 or $500
million of direct outflow covered by neither the Commerce Depart
ment program nor the nonbank financial institution part of the
Federal Reserve program, and the question of how to deal with
those flows was still open.
Nevertheless, the further tightening
of the Commerce Department program would provide an additional
barrier to capital outflow, and thus was a favorable development.
Chairman Martin then suggested that Mr. Daane give the
Committee a summary report on the meeting on international monetary
reform held recently in Washington.
Mr. Daane said that the meeting, held November 28 and 29,
was interesting and significant.
It was the first of a series of
four joint meetings of the Executive Directors of the International
Monetary Fund and the Deputies of the Group of Ten.
He thought a
fair sum-up of the meeting was that given by the Chairman of the
Group of Ten Deputies, who said that the results exceeded the most
optimistic expectations.
The Chairman of the meeting, Mr. Schweitzer
of the Fund, made a similar comment.
Despite some earlierfears that
the meeting would simply elicit a Group of Ten view and a Fund
view, that was not the case.
Instead of bloc positions, the
12/13/66
-31
participants presented their individual views in a frank and
effective exchange.
As he had indicated at the last Committee meeting,
Mr. Daane continued, an agenda had been agreed on earlier, and
it served as a guide to the discussions.
The first item related
to the aims of reserve creation, including the need for reserves
and its relationship to adjustment policies and the supply of
conditional liquidity.
That discussion was sparked by Under
Secretary of the Treasury Deming.
On the basis of the work
that the Group of Ten had previously done, he made the case for
the need for reserves to provide adequate growth in liquidity.
Mr. Deming stressed secular considerations, emphasizing the
global need for reserves to be provided over a period of time.
He cited past experience in terms of annual increments in reserves
required and noted that gold and reserve currencies could not in
the future be expected to satisfy fully needs of the magnitudes
foreseen.
It was implied by Mr. Deming's comments--and clearly
recognized by the non-U.S. participants--that the U.S. was moving
away from its earlier stand in favor of a dual approach involving
a combination of drawing rights and reserve units.
Mr. Daane added that the French position, stated by
Mr. Perouse of the Finance Ministry early in the sessions and
maintained throughout, was essentially that there was no imminent
12/13/66
-32
shortage of reserves and, therefore, that it was more important to
focus on "more fundamental problems" than on reserve asset creation.
Mr. Perouse listed five such problems, which were:
The adjustment
process--in discussing which he focused on the deficits in the U.S.
balance of payments; the holding of reserve currencies, and whether
some restrictions should be placed on the holding of national cur
rencies as international reserves; the relationship between conditional
and unconditional liquidity; the role of gold, including the price of
gold; and the question of stability of international commodity prices
and the organization of international commodity markets.
Throughout
the sessions the French urged that the group should focus on those
issues rather than on the matter of reserve asset creation.
But no
other country, either in or outside the meeting, accepted that
diversionary tactic.
It was the consensus that a clear need existed
to proceed with contingency planning to provide for adequate secular
growth of international liquidity.
The second agenda item, Mr. Daane said, had to do with the
nature and form of deliberately created reserves.
The Chairman of
the Group of Ten Deputies, Dr. Emminger, tried to make a case for
an asset specifically designed for a limited group of countries,
on the basis that only a limited group held gold in their reserves
and were interested in having a gold-like reserve asset.
There
fore, he (Dr. Emminger) proposed having a gold-like asset for that
12/13/66
-33
group and a different type of asset for other countries.
The
representatives of non-Ten countries convincingly presented their
views on the need for universality in all aspects of reserve
creation.
They clearly were not interested in accepting "separate
but equal" treatment.
They received support around the table for
universality, and there was clear adherence to the view that it was
desirable, particularly with respect to the distribution of new
assets.
A major question left open here, however, was the desirabil
ity of universality in decision-making.
Distribution of deliberately created reserves was the third
topic on the agenda, Mr. Daane continued.
There was very little
disagreement with the view that there should be some form of
across-the-board distribution, according to an objective formula
such as Fund quotas.
The fourth item on the agenda concerned the utilization of
new reserve assets, including such questions as insuring acceptability
and preventing misuse, and the kinds of safeguards needed, Mr. Daane
said.
There was a fairly clear consensus that what the group was
striving for was an unconditional asset.
With respect to safeguards,
the Emminger position in favor of having a gold transfer ratio
attached to the asset was clearly rejected, not only by the U.S.
but by the non-Ten.
On the last day of the meeting Chairman Emminger
indicated that while a gold transfer ratio might be the more elegant
12/13/66
-34
way of providing a safeguard, one could not always have elegance.
Thus, there was evidence of some re-thinking on the part of the
Group of Ten--particularly by such people as Messrs. Emminger and
Ossola--on how to provide safeguards without a gold link.
The fifth topic on the agenda, Mr. Daane said, concerned
conditions and circumstances of activation of a contingency plan,
but that topic was not discussed.
The second joint meeting would
be held in London on January 24-25, 1967, and among the items on
the agenda probably would be the questions of decision-making and
of the holding and use of the reserve asset.
Mr. Daane added that the Group of Ten Deputies had a separate
session on November 30, largely procedural in nature, at which two
working sub-groups were set up looking forward to the agenda in
January.
One of those, on which he was included as a U.S.
representative, was to consider the question of reserve policies.
The other sub-group would deal primarily with the holding and use
of the reserve asset, but also with the entire range of questions
having to do with the construction of the asset.
It was not entirely
clear to him whether the sub-groups were simply to look back at
the record and pull together the relevant considerations or whether
they were to do some thinking of their own, looking forward.
Mr. Solomon, whose comments were invited by Mr. Daane at
this point, noted that after the meeting there were quite a few
-35
12/13/66
releases from Paris, not all official, commenting on some of the
same issues that were raised at the meeting by the French represent
ative.
Two questions were included that had not been discussed
specifically at the meeting.
One had to do with the price of gold,
which the French representative had passed over lightly at the
meeting.
The French seemed now to be saying through the Paris press
that, if and when there were a need for additional liquidity, thought
should be given to raising the price of gold, which had not been
changed in more than 30 years.
The second factor brought in was
that there was one major country with an interest in these mattersthe Soviet Union--that was not a member of the IMF.
He did not know
whether the introduction of those two new considerations would lead
anywhere or not.
On the gold price question, the French were trying
to be responsible by saying that any need for a price increase lay
at some point in the future, and therefore the gold market need
not become disturbed now.
At the same time, however, they were
trying to keep the issue alive.
It was clear to everyone who had
been at the meeting that the price of gold had not been on the agenda
at joint or separate meetings of the Group of Ten or the Fund, nor
would it be.
Mr. Daane added that both Dr. Emminger and Mr. Schweitzer
had stated categorically at their press conference that the price
of gold was not on the agenda for the London meeting or any other
12/13/66
-36-
meetings of their respective groups.
The French then asserted
that Messrs. Emminger and Schweitzer had no authority to make such
a statement, but the fact that they did have full authority was
subsequently confirmed.
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:
An accurate reading on the economic outlook seems
even more difficult at this time than usual because of
the abundance of uncertainties and conflicting cross
currents. For the moment, demand pressures in the
economy continue to moderate at the same time that cost
pressures appear to be mounting. Despite the further
evidence of a slower rate of expansion in the private
sectors of the economy provided in the latest surveys
of plant and equipment spending plans and of consumer
buying intentions, I am not at all convinced that
anything resembling a recession is in prospect for
next year. In fact, several elements in the current
picture suggest that the pace of the advance may
accelerate again early next year. The precipitous
housing decline should level off, the drag on produc
tion of the currently much slower rate of inventory
accumulation should diminish, and most of the
adjustment to a higher and more normal savings rate
should be completed. With every prospect for a further
large rise in defense spending in 1967--in the absence
of any definite word to the contrary from the
Administration--a strong and even excessive expansion
seems to be in the cards. Our economists see a good
likelihood that GNP growth may be of roughly the same
order of magnitude next year as in 1966. I might
add, parenthetically, that it is amazing to me how
different economists can look at the same figures and
come out with varying conclusions.
Even during the current quarter of slower GNP
growth the price situation is distinctly unsatisfactory.
Consumer prices continue to increase and overall
12/13/66
-37-
industrial wholesale prices are likely to resume their
rise. Declines in crude material prices seem to be
leveling off as prices of finished products remain
on the uptrend. I have been struck by the number of
individual wholesale price increases announced in
the last week or so. Labor costs per unit of output
have advanced sharply since July, and with growing
wage pressures and a slowdown in productivity growth,
the outlook for such costs is disturbing. As we have
all recognized, today's general business situation is
very different from the nicely balanced growth of the
early 1960's. There is no assurance that such a well
balanced growth can be re-established within the near
future. Rather, we may have to face the fact that
somewhat slower than ideal real growth may be required
if we are to avoid grossly excessive inflationary
pressures.
The balance of payments statistics for October,
showing a liquidity deficit of $770 million, underlined
the continued imbalance in our international accounts.
Following the November deficit of perhaps $300 to $400
million, a substantial surplus may be achieved in
December, but only as a result of prepayments on
military orders and other special transactions. If
so, the full year liquidity deficit may be only moderately
greater than the $1.3 billion of 1965. However, as we
look ahead the chances for avoiding a considerable
worsening of the deficit in 1967 do not seem favorable.
Some deterioration on capital account seems inevitable.
I was glad to hear Mr. Brimmer's report on the direct
investment program, but I still feel that some deterio
ration on total capital account is ahead. And military
outlays abroad will probably rise substantially. I
see no assurance that our trade surplus will improve
enough to offset these adverse factors, more particularly
if the business expansion accelerates again and if
appreciably higher labor costs become built into the
economy during the year. Finally, it goes without saying
that we are likely to incur a sizable official settle
ments deficit in contrast with near-balance for 1966.
I confess that I am still puzzled by the general
weakness of the credit and monetary statistics over the
past few months. In my judgment, the extent of their
weakness is not matched by any visible development of
the real economy. It still seems quite likely that our
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-38-
seasonal adjustments have given an exaggerated picture
of the slowdown by failing to take adequate account of
tax-related and anticipatory borrowing in the first
seven months of the year. There is no doubt that there
has been a significant slowing of bank credit growth,
but if we look at the year as a whole the rate of
slowdown is reasonable and more or less in line with
what we have been trying to achieve right along. One
question of particular interest is whether the current
slowdown in loan growth is still related primarily to
the supply restraints imposed by the banks, or whether
there is a slackening of underlying loan demand. Both
elements are doubtless present, but most New York
bank lending officers believe that their own restraint
policies are the major cause. The banks generally
view Federal Reserve policy as still restrictive, and
they are acutely aware of their liquidity problems.
Thus their conservatism in dealing with loan requests
is quite understandable. There has not yet been
sufficient time for them to react to the easing of
their marginal reserve positions in November nor to
the decline in short-term rates in recent weeks.
Clearly, some modest resumption of bank credit growth,
as compared with the apparent cessation of growth in
the last few months, now seems very much in order; and I
hope that the somewhat easier money market conditions
that now prevail will lead to that result.
It was suggested that it would be helpful for the
Reserve Bank Presidents to comment briefly at this time
on the construction and mortgage loan situation in their
Districts.1 / It was the general feeling of most of the
senior loan officers surveyed that new commitments for
1/ In a wire dated November 29, 1966, to the Presidents of
all Federal Reserve Banks, the Secretary of the Committee
stated that some members had indicated it would be helpful
to have comments at this meeting concerning the degree to
which the construction and mortgage loan situation in the
respective Districts was showing signs of change. It was
suggested that a small sample of representative bank and
nonbank lenders be asked several questions relating to current
flows of new commitments for construction and mortgage loans.
12/13/66
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such loans are at or near the low point for the year.
At best, only a moderate recovery can be expected in
the immediate future.
Savings and loan associations
were the most pessimistic of the four groups of
lenders contacted, and mutual savings banks were
probably the most optimistic. Life insurance companies
are presently willing to commit themselves for permanent
mortgage loans, but at a reduced pace and only in the
quite distant future--no earlier than late 1967. Commer
cial banks report that they have not tightened up on
construction lending to any greater degree than on
other types of business lending; nevertheless, the
cutbacks have in fact been substantial, possibly reflecting
the fact that the construction industry has many nonprime
borrowers. The commercial banks continue to grant a fair
amount of homeowner mortgage loans, but the relatively
few large banks that had actively sought to expand their
role in this field during the past few years have cut back
on their efforts in this direction.
Under all the circumstances, I think it is reasonably
clear that credit policy should remain unchanged over the
next four weeks. The underlying strength of the economy
and the unsatisfactory balance of payments position argue
effectively against any further easing of policy. On
the other hand, while I felt that we were moving a little
too overtly toward a policy of greater ease at the last
meeting, I would not advocate at this time a return to
a posture of greater firmness in view of some further
evidence of a slowdown in the rate of economic expansion,
the weakness of the credit and liquidity indicators,
and the prospect of the usual year-end churning in the
money market. As for specific instructions to the Manager,
I think we should stress maintenance of current money
market conditions, with Treasury bill rates in a 5 to
5-1/4 per cent range and a Federal funds rate of around
5-1/2 per cent or less. I would hope that net borrowed
reserves of around $200 million would be consistent with
these money market conditions. In any event, conditions
in the money market should take precedence over net
borrowed reserves, and the Manager should again be given
considerable leeway to use his judgment as to how best
to maintain stable market conditions.
12/13/66
With respect to the directive, I think that the
staff's draft alternative A is entirely satisfactory.1/
I would just like to make one further comment with
respect to our longer-term policy considerations and the
so-called policy mix. I believe a general tax increase
is still highly desirable as a sort of insurance against
finding ourselves again facing problems similar to those
of last summer if the economy should gain speed next
year. On the other hand, I believe we should not encourage
any tendency to think that a very major easing of monetary
policy might be considered as a sort of "trade off" against
a tax rise. I say this because I am convinced that our
continuing balance of payments difficulties place a rather
strong limitation on how far we can go in easing monetary
conditions for domestic purposes. Unfortunately, we
find the flexibility of monetary policy curtailed in
both directions, insofar as major swings of policy are
concerned. This is not to deny, of course, that there
is still considerable room within which to exercise an
important influence on business and credit developments.
Mr. Ellis commented that quite clearly the major propellent
driving the New England economy had been and continued to be the
stimulus to manufacturing that derived from Federal spending,
especially the defense and space programs.
A tally of published
defense contracts--which showed sharp expansion last spring--plus
application of an established lag period of six months or more,
suggested that New England manufacturers would continue under
delivery pressure for some time.
Such pressure was showing up in
employment, which registered its twelfth seasonally adjusted
1/ The two alternative draft directives proposed by the staff
for consideration by the Committee are appended to these minutes
as Attachment A.
12/13/66
-41
increase in October; in manhours of production workers, which
increased in October to a new record of plus 7.2 per cent
from October last year; and finally in personal income payments,
which showed New England exceeding the nation in year-to-year
percentage gains.
In the construction field, declines in the
residential category were just barely offset in the totals by
gains in other categories for a 3 per cent year-to-year gain in
October.
The ten-month total now measured a 20 per cent gain
over a year ago--for the U.S. it was 4 per cent.
Mr. Ellis remarked that in response to the Reserve Bank's
queries concerning present and prospective mortgage flows, both
the banks and insurance companies reported that their new commit
ments remained very low.
After a period of rebuilding their
liquidity and gaining assurance about the probable flow of deposits
and policy loans, they hoped to resume mortgage lending.
A very
few banks reported that they did have money and were still granting
mortgages, but most reported only extending commitments to long
established customers that they felt they must serve.
Mr. Ellis stressed (1) the desire of the insurance companies
to see a halt in policy loans before they resumed new commitments;
(2) the desire of the mutual savings banks to see their loan-deposit
ratios recede from the 85 per cent legal limit before they resumed
new committing; and (3) the desire of the commercial banks to
12/13/66
-42
rebuild liquidity before turning their loan officers loose.
A
year ago liquid asset ratios of New England banks matched or
exceeded the national average; today they ran 2 percentage points
below.
While such ratios had declined perhaps 2 percentage points
for the national average, they had declined 5 or 6 percentage
points for the Boston banks.
Looking ahead, Mr. Ellis said, his economic perspective
agreed more nearly with that of Mr. Hayes than what he judged
the staff to be presenting.
In deliberating the proper course of
monetary policy for the next four weeks, the Committee had two
major kinds of confirmation that it was looking for at its last
meeting.
On the one hand, it had a further confirmationof slow
down in the rate of expansion of the economy to what used to be
called "a more sustainable rate of expansion."
That was now
called "soggy," which he judged meant a qualitative evaluation of
a strong possibility of an actual turndown in the economy some
time in 1967 unless emerging trends in the private economy were
reversed.
On the other hand, the Committee had confirmation of a
large, and probably still growing, volume of Federal outlays.
As
expected, the delay in availability of information about Federal
outlays traced not to possible shortfalls but rather to how large
they should be allowed to appear to be.
He appreciated Mr. Brill's
measurement of the maneuvering room left for monetary policy.
12/13/66
-43
Failure to accompany the deficiency appropriation request with
any request for a tax increase suggested that the maneuvering
room for the Committee to lessen monetary pressures in favor of
fiscal restraint was narrower than it would be otherwise.
The
Committee's choice of policy now seemed confined to the question
how much monetary restraint remained appropriate given the
conditions of private and Government demand emerging in the
present fiscal and debt management context.
The principal effect of the Committee's policy change
to date, Mr. Ellis judged, had been to demonstrate that the
Committee was flexibly sensitive to the desirability of less
monetary restraint if the economy could accept it without resur
gence of the earlier excesses.
With the Committee's having
demonstrated that awareness, he would be prepared to see it rest
on its oars and initiate no further change in policy until the
course of fiscal policy became more clear.
Mr. Ellis suggested that the two draft directives were
not really different alternatives.
The blue book projected a
failure to expand or little change (plus or minus 2 per cent) in
the bank credit proxy for December.
Alternative A provided that
"somewhat easier conditions shall be sought if bank credit appears
to be failing to expand."
So, if the staff projections were
correct, the Manager was directed to ease further.
Alternative B
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12/13/66
without equivocation directed the Manager toward "attaining
somewhat easier conditions."
natives called for easing.
In effect, therefore, both alter
To provide language that would afford
more choice, he suggested that alternative B be left as it was
but that alternative A be converted to a "no change" directive by
substituting the word "declining" for the words "failing to
expand," with the understanding that "declining" would mean something
more than the plus or minus 2 per cent projected by the staff.
With that change his choice would be alternative A.
Mr. Irons commented, with regard to the construction and
mortgage loan situation in the Eleventh District, that 41 banks,
insurance companies, savings and loan associations, and other lenders
had been contacted.
Of the 41, 25 indicated that the flow of
commitments was at its lowest level for the year.
Seven of the
25 expected it to go still lower; 18 of the 25 felt that there
might be some signs of recovery within the next two or three months.
The remaining group was about evenly divided, with 8 taking the
position that they were at the low point of the year but anticipating
recovery and the other 8 already experiencing recovery from the low
point.
He would caution with respect to the over-all figures,
however, that the views reflected the situation of the particular
lender interviewed.
For example, the answers of the two largest
banks in the District did not jibe.
The same thing was true of the
12/13/66
-45
two largest locally-based insurance companies; and one of the two
largest mortgage bankers was optimistic while the other was
pessimistic.
Moving to District economic conditions, Mr. Irons said that
the various elements of the economy seemed to be basically strong
but not advancing with the same strength as some time ago.
Employ
ment continued to rise, inching up to record levels each month.
It was estimated that in Dallas the unemployment ratio was slightly
over 2 per cent and would go to 1.9, while Houston was already at
1.9, so there was a very tight labor market.
continued to move up.
The index of production
Construction was stronger last month and
department store sales were regarded as generally favorable, although
it was again a matter of obtaining the expressions of particular
department stores.
Agricultural conditions were quite good, but
there was a general need for rain in the area.
Cotton production
was going to be about 25 per cent below a year ago, largely because
of the new cotton program.
Livestock conditions were good, but the
lack of rain was having its effect on winter wheat in the District.
A couple of months ago, two West Texas banks asked if they could
obtain six-month discount accommodation for grazing on winter wheat,
but they had not been heard from since.
Credit demands in the
District might be affected somewhat depending on whether winter
wheat was sufficient to meet grazing requirements.
12/13/66
-46
On the financial side, Mr. Irons reported that bank loans
in the District had been drifting down a bit.
Total deposits were
down, but time and savings deposits were up slightly.
Borrowings
from the Reserve Bank had not been large; over the past four weeks
they had declined by some $10 million.
Throughout the fall period
there had rather surprisingly not been a demand for credit through
the discount window from the usual seasonal country bank borrowers.
Some small country banks had come in that had never been in before,
having been referred by their city correspondents, but generally
there had not been the usual demand from country banks.
The cautious conclusion of businessmen and bankers in the
major District cities was that there had been an easing of monetary
policy, Mr. Irons said.
period was over.
They thought the worst of the tight money
But they were still cautious and were worried
about the outcome in Vietnam and about the tax situation.
On
balance, the majority probably would favor an increase in taxes
if they were told why it was necessary.
In his opinion, the public
probably was more ready to move in that direction, if they knew
what was needed, particularly in terms of the cost of the Vietnam
involvement, than the politicians seemed to suppose.
On the national side, Mr. Irons noted that there had been
some further slackening in the growth of the economy, although
high levels of employment, output, and income were being maintained.
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12/13/66
The recent slackening in the pace of business plant and equipment
expenditures was of some significance.
The strength in that area
had been compensating for several weaker sectors such as housing,
automobiles, and heavy durables.
On the other hand, income and
employment continued to rise, there continued to be almost full
utilization of plant capacity, and a high volume of trade was
expected over the holiday period.
In summary, there was some
indication of lag in the private economy, but an offsetting trend
in the public sector, and the private sector did not appear to be
fundamentally weak.
One should not rule out the possibility of a
re-appearance of general strength.
Also, he had some doubt that
inflationary pressures had been calmed to the point of being more
or less canceled out as a problem.
There were still price pressures
in the economy, and wage pressures could be expected over the
coming months.
While bank credit had not increased in line with
the availability of reserves, it did not always follow that bank
credit would expand just from putting reserves into the market.
There are a number of factors that cause businessmen and bankers
to decide whether to borrow or lend, and they must be taken into
consideration.
Mr. Irons suggested that credit policy until the next
meeting of the Committee be directed toward maintaining about the
same money market conditions as had prevailed over the recent
12/13/66
period.
-48
He would avoid further easing, especially any overt move
in that direction.
He considered alternative A of the draft
directives as the more desirable of the two, although he was some
what concerned about the proviso clause, which specified that if
bank credit appeared to be failing to expand, somewhat easier
conditions should be sought.
He did not think the problem was as
direct and simple as that language implied, especially when a
short-term period was involved.
This was a period of great uncer
tainty in a number of ways, and one would hardly expect the direct
relationship to prevail that seemed implied by the proviso clause.
Nevertheless, he would accept alternative A.
He would expect that
within a reasonable margin of error the three-month Treasury bill
rate would be around 5.10 per cent, the six-month bill rate around
5.20 - 5.25 per cent, the Federal funds rate around 5-1/2 per cent,
and net borrowed reserves around $200 million, possibly less.
Mr. Swan reported that October saw a rather broadly based
increase in nonagricultural employment in the Twelfth District,
despite the possibility of a fractional increase in the unemployment
rate, and it appeared that that trend may have continued in
November on the basis of the total employment figure for California.
However, the projected employment gains in December and January in
the aerospace industry were quite modest, in part because of
expected shortages and delivery delays for various components,
12/13/66
-49-
including engines.
There had been a further considerable decline
in construction contract awards in October in all categories, and
in the first ten months of 1966 there had been a decline of 8 per
cent in total awards from the similar period in 1965, compared
with a gain of 7 per cent for the U.S. as a whole.
Residential
contract awards were down 26 per cent compared with a 4 per cent
increase in nonresidential awards and a 5 per cent increase in
heavy construction awards.
Twelfth District weekly reporting banks showed an increase
in total credit in the three weeks through the end of November,
Mr. Swan said, primarily because of acquisitions of Government
securities.
Business loans were up a little more than in the U.S.
as a whole, reversing the trend during the earlier part of the
year, but the increase was substantially less than for those same
weeks a year earlier.
He gained the impression from some of the
major banks that they still felt loan demand was strong.
In the
business loan area they were not supplying all the potential
borrowers, but at the same time there was some willingness to
admit that demands were somewhat less intense than a few months
ago.
In the three weeks through the end of November, Mr. Swan
continued, the principal weekly reporting banks showed a large gain
in time deposits of States and political subdivisions and a better
12/13/66
-50
picture in the behavior of large CD's than banks in the rest of
the country, although that was perhaps related to the State and
municipal deposits.
Large denomination CD's in total showed a
gain of some $66 million, although there was a loss of $2 million
in such certificates issued to individuals, partnerships, and
corporations.
In October the savings and loan institutions in
California apparently accounted for more than the total loss of
funds for all savings and loan institutions in the country as a
whole.
That was somewhat surprising, and he had no specific
explanation.
As to the survey relating to construction and mortgage
loans, Mr. Swan reported encountering much the same experience
as reported by Mr. Irons in terms of differences between the same
types of institutions in the same areas.
Over all, respondents
indicated that mortgage commitment activity was now at about its
lowest point, with some slight improvement expected over the next
several months but not necessarily the next two or three months.
Activity would still be at a rather low level even with the improve
ment anticipated.
As to the various types of institutions, with
few exceptions commercial banks and insurance companies seemed to
be still headed downward in their commitment volume.
The banks
had not reduced their lending in the same proportion as the others,
so they accounted for a smaller part of the decline thus far.
The
12/13/66
-51
savings and loans had cut back sharply in the spring and now
expected some improvement, with a few expecting to increase their
lending substantially, from the present low level, in the next
few months.
There seemed to be more differences between areas
within the District than among types of institutions.
The Los
Angeles and Salt Lake City areas saw little expectation of early
recovery; those were areas where overbuilding had been pronounced
in the past.
In the northern California area there was some
indication of improvement over the next several months.
Northwest the optimism seemed to be greatest.
In the
The decline in
Oregon had been more modest than in California.
In Seattle it
was doubtful whether there was any real decline due to the substan
tial increase in demand for housing during most of 1966.
It was pointed out by some lenders, Mr. Swan said, that
second mortgages taken by sellers had filled part of the gap.
Data on loan records that the Reserve Bank had been able to obtain
for certain areas tended to bear that out.
Recorded loans made by
lenders other than financial institutions were up about one-third,
in terms of the share of the total, from August 1965 to August 1966.
Mr. Swan said he had nothing specific to add to what had
been said about the national picture.
There were still uncertainties
in the situation, although some aspects of the over-all picture
were not as weak as the financial picture seemed to be.
He would
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12/13/66
translate that into a view that any further monetary easing should
be quite modest; he would not favor any substantial move in that
direction.
It seemed to him that the Committee would have a much
better perspective when the budget figures were available and
when it could see whether the seasonal decline in the early part
of next year was orderly.
In terms of the directive, Mr. Swan felt somewhat like
Mr. Ellis:
given the proviso clause, there was not a great choice
between the two draft directives.
That led him to favor, although
not strongly, alternative A as originally written.
If alternative
A were modified as Mr. Ellis has suggested, however, he (Mr. Swan)
would prefer alternative B.
Mr. Galusha reported that last week's survey of Ninth
District mortgage lenders yielded a rather confused outlook.
Mort
gage commitments, well below the 1965 total in May, had continued
to decline, and many of the lenders were inclined to believe that
commitments would not increase again soon.
But the situation of
the savings and loan associations appeared, when seasonally adjusted,
to have improved somewhat; and on that count one could reasonably
look for an increase in the level of mortgage commitments fairly
soon.
Also, mortgage terms appeared to have stabilized, at least
in the Twin Cities area.
12/13/66
-53
Mr. Galusha added that he had, surprisingly enough,
received a few reports of country banks being on the look again
for business loans.
The situation of District city banks, as
measured by their combined basic reserve position and combined
loan-deposit ratio, had eased of late, but not enough to send
those banks looking for loans.
According to reports, city banks
still felt themselves strapped.
From what the authors of the green book had to say,
particularly about banking developments nationally, it appeared
to Mr. Galusha that the Committee should continue the recently
initiated trend to easier monetary conditions.
With the plant
and equipment survey results in, it was possible to be more con
fident today than a couple of weeks ago about the economic outlook.
And that outlook, being bearish, called for an easing of the
position of commercial banks--an easing which, even allowing for
lags, had apparently not yet been effected.
There were still some
important fiscal decisions to be made, but that fact seemed to
provide no reason for the Committee to pause now.
The point, of
course, was that if tax rates were increased, the need would be
for a sharply easier monetary environment.
The September 1 letter was a constraint in the Ninth
District on the operation of the discount window, Mr. Galusha
said.
An obvious written withdrawal would be difficult enough to
12/13/66
-54
write in the best of circumstances, and in the context of these
perilous times might well be impossible.
But interment of the
letter in other less structured ways could be encouraged.
Mr. Galusha added that with the U.S. balance of payments
position being what it was, a reinstatement of the investment tax
credit would seem to make more sense than a sharply easier monetary
environment.
But that was looking rather far down the road.
The
balance of payments problem, however serious it might be, would
not seem to preclude some modest easing of monetary restraint now.
To be a bit more precise, he personally would have no misgivingsassuming the blue book authors were right--about a level of free
reserves close to zero or better.
Mr. Galusha commented that he shared Mr. Hayes' perplexities
but not Mr. Hayes' conclusions.
He favored draft alternative B.
He liked the way it was written and the fact that it had no proviso
clause.
Mr. Galusha suggested a need to begin looking closely at
prospects for the second and third quarters of next year.
He had
a feeling that there was in process a substantial slowing up of
domestic Federal programs, at least in the Ninth District, that
would begin to show up clearly next spring and summer.
Cutbacks
in Federal spending were particularly important in areas like the
Ninth District where so much of the economy was dependent on Federal
12/13/66
-55
programs and their absorption of labor displaced from other lines
of work such as construction.
Highway construction, for example,
had done a remarkable job of absorbing carpenters no longer engaged
in building houses.
Mr. Scanlon reported that the past several weeks had
witnessed growing uncertainty among Seventh District businessmen
and lenders with regard to economic prospects for the coming year.
Forecasts by prominent economists had emphasized that the restric
tive monetary policy of the past several months made a slowdown
in 1967 almost inevitable.
The business community was in a mood
to make downward adjustments in inventories, capital expenditures,
and new hirings.
Output cutbacks had occurred in building materials,
steel, autos, and household appliances.
Forecasts of auto output for next year had been reduced
to about 8 million units, Mr. Scanlon noted, compared to 8.6 million
in 1966,
Steel orders had been very slow in December and output
was expected to be off 5 to 10 per cent from the fourth quarter
to the first quarter.
District orders for machinery and equip
ment were at the lowest level in several months in October, with
construction machinery orders down sharply.
construction had not improved.
The outlook for
Despite all of that, little easing
had been noted in District labor markets except for those heavily
involved in output of autos.
New claims for unemployment compensation
12/13/66
-56
in October and November were well above last year in the State of
Michigan and in some Wisconsin centers, but otherwise labor short
ages persisted.
Credit developments at Seventh District banks closely
paralleled the national picture, Mr. Scanlon said.
Although the
evidence suggested that some weakening in demand for credit
probably had taken place, much of it was undoubtedly attributable
to monetary restraint and to continued restrictive loan policies
of the major banks.
Moreover, low bank liquidity might keep banks
reluctant to reverse those loan policies for some time ahead.
The
large Chicago banks continued to show quite large basic deficit
positions although they had managed to cover them with relatively
little resort to the discount window.
Some gradual attrition in
CD's had continued despite the current interest differential over
3-month bills, and there had been no net inflow of funds from
consumer-type certificates in recent weeks.
With respect to Mr. Holland's wire of November 29, Mr. Scanlon
said that inquiries had been made of 21 lenders (12 savings and loan
associations, 4 commercial banks, and 5 mortgage and life insurance
companies).
Three savings and loan respondents indicated that
the year's low in new commitment volume had passed and one bank
indicated that volume had been on the rise throughout the year.
All of the other lenders (9 savings and loan associations, 3 banks,
12/13/66
-57
and the 5 life and mortgage companies), reported commitments now
at their low points for the year, with respondents about evenly
divided between the wire's categories A and B combined (volume
projected as falling further or remaining at the present level)
and C (some recovery anticipated in next two or three months).
Several of the savings and loans reporting some improve
ment in savings inflow since October 1 indicated that they had
been holding back on new commitments and expected to continue to
do so until the reaction to the year-end dividend payout had been
felt, Mr. Scanlon added.
Signs of weakness in the demand for
mortgage loans were reported by a sizable proportion of the
respondents, who cited the sharp decline in used home sales
associated with the construction slowdown as responsible factors,
along with the persistence of a rate level (with contract rates
commonly in the 6-1/2 to 7 per cent range), fees and charges, and
credit worthiness/security requirements related more appropriately
to the exuberance of early 1966 than to currently prevailing
conditions.
No marked differences turned up among classes of
lenders or kinds of property financed (or areas) in the survey
responses, although the smallness of the sample might conceal such
differences.
As to policy, Mr. Scanlon said that while he would prefer
to see the figures reflect some moderate growth in aggregate
12/13/66
-58
monetary and credit measures, he believed that in view of the
uncertainty over tax policy and the course of military expend
itures and the year-end churning in the markets, a policy of
maintaining currently prevailing money market conditions was
appropriate for the next four weeks.
He favored alternative A
of the draft policy directives.
Mr. Clay said that information obtained from a survey of
23 financial institutions located in the six largest cities of
the Tenth District indicated that mortgage market conditions had
eased slightly since mid-summer.
In some cities, interest rates
on conventional mortgages and discounts on Government-underwritten
loans had declined slightly from the high levels prevailing last
summer.
A moderate improvement in net savings flows was reported
by a majority of the savings and loan associations queried, but
the availability of mortgage funds at commercial banks appeared
to be unchanged or moderately lower and the availability from life
insurance companies remained at previous low levels.
Mr. Clay also said that the recent improvement on the
supply side did not appear to be fully reflected in new commitment
extensions.
In part, that reflected a deficiency in demand result
ing from unsold new houses, houses on the market from defaults on
FHA and VA loans, and various special supply situations.
The
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-59
demand deficiency further reflected reported unwillingness or
inability of many buyers to borrow at present rates and terms.
Another reason why the increased availability of funds
was not fully reflected in new commitments was a cautious approach
adopted by the lenders, Mr. Clay continued.
Although savings and
loan institutions might have funds available, they were concerned
about their liquidity positions and were taking steps to reduce
their Federal Home Loan Bank borrowings.
In some cases they had
increased their extensions of loans to purchase existing homes but
were not yet willing to make commitments for new construction.
In summary, Mr. Clay said, the present flow of new commit
ments extended by savings and loan associations appeared to exceed
the low established in the preceding months, but, due in part to
deficiency in demand and to lender caution, new permanent financing
and construction had not kept pace with improved fund availability.
If the improvement in net savings flows continued, an increase in
commitments was anticipated as the market adjusted to new conditions.
At commercial banks, Mr. Clay said, the availability of
funds was unchanged or down moderately from levels in preceding
months.
That development on the supply side together with condi
tions of demand already mentioned had reduced the level of new
commitments extended by banks to the low point of the year.
Most
banks were expecting little change in their commitment extensions
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during the next few months.
The flow of new commitments extended
by life insurance companies remained at its low level of the year.
Some market participants expressed a weak expectation that life
insurance companies would increase their commitments in coming
months.
In view of recent economic developments, Mr. Clay continued,
the decision made at the last Committee meeting to reduce the degree
of monetary restraint appeared justified.
The shift in policy
brought significant response in the money markets.
While the
resulting developments in bank reserves and bank credit might have
been less than hoped for, note must be taken of the advance in
nonborrowed reserves as member banks reduced their borrowing from
the Federal Reserve Banks.
With the prevailing uncertainties concerning Government
spending and fiscal policy, Mr. Clay thought any further action
toward credit easing at the present time should be of moderate
proportions.
It would appear appropriate, however, to proceed
somewhat further in the process of relaxing the degree of monetary
restraint.
In the period ahead, targets might include a Treasury
bill rate of 5 to 5.15 per cent, an effective Federal funds rate
of 5 to 5-1/4 per cent, and net borrowed reserves ranging downward
from recent levels toward zero.
12/13/66
-61Open market operations conducted in accordance with those
goals should contribute to member bank reserve expansion, as
desired under present circumstances.
The most recent weekly data
suggested to Mr. Clay that that development might now be in
process.
Such money market conditions also should substantially
reduce or possibly remove the incentive to liquidate CD's for
interest rate differentials, although there could be no assurance
that substantial CD liquidation would not take place to obtain
funds apart from interest rate considerations.
Alternative B of the draft economic policy directives
appeared to Mr. Clay to be in line with the foregoing policy
approach.
Such a policy prescription for the period until the
next meeting, including the directive choice and the rough targets
for implementing policy, should be thought of in comparison with
the interval since the last meeting.
Mr. Wayne commented that on the basis of results obtained
from a small sample (18 lenders), it appeared that most mortgage
lenders in the Fifth District felt that the flow of new loan
commitments had reached its lowest point.
Half of the lenders saw
no recovery in sight, slightly less than half (7) felt that some
improvement might be expected in the next two or three months, and
two respondents felt that the recovery had already begun.
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In a personal contact apart from the survey, Mr. Wayne
continued, one large mortgage company reported that within the
past two weeks it had received several unsolicited calls from
financial institutions that had bought mortgages in the past.
The callers indicated clearly that they were not buying at present,
but wanted to know what offerings were available and intimated
that they might be buying before long.
The slower rate of advance that had characterized over-all
economic activity in the Fifth District for the past two or three
months had continued and perhaps deepened slightly, Mr. Wayne said.
Over half of the textile and durable goods manufacturers included
in the Reserve Bank's latest survey reported declines in new orders
and backlogs; on balance, the same trend was noted among manufac
turers of other nondurables but the proportion was somewhat less.
A larger number of respondents reported shorter work weeks and
slight reductions in prices received.
Paradoxically, in the face
of those reported declines, businessmen's expectations for improve
ment had increased.
Gains in nonagricultural employment had been
reported and the insured unemployment rate continued to be very
low.
In terms of the national economy, Mr. Wayne agreed with
the analysis presented by the staff:
the trend toward less vigorous
growth seemed to be continuing slowly but steadily.
Except for the
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slightly higher growth of payroll employment and the drop in the
rate of unemployment, the latest data suggested a progressive
easing in the private sector.
The cutback in automobile sales
and output now appeared to have spread to other consumer durable
lines and the recent survey of consumer buying intentions provided
no basis for expecting any early improvement in automobiles or
home appliances.
A significant new development was the reporting
by several large companies of the laying off of sizable numbers
of workers and a considerable reduction of overtime.
Steel and
lumber producers, other suppliers of building materials, and the
furniture industry were feeling the effects of the long decline
in residential building.
Retail sales continued to move at a
rather subdued pace and the irregular but persistent downward
trend in the growth rate of instalment credit for the past 16
months suggested a more than temporary decline in the demand for
durable goods.
The construction industry might be depressed
further by proposed reductions in Federal spending recently announced
by the President, especially the large cut in the highway program.
Nor could the builders derive much encouragement from the latest
surveys of planned capital outlays by business and consumer plans
to build homes.
While the economy would certainly receive a signif
icant stimulus from defense spending over the next six months, it
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was by no means clear that strength in the Government sector would
offset entirely the developing weakness in the private sector.
In any event, it seemed to Mr. Wayne that the recent behav
ior of aggregate reserves, bank credit, and the money supply was
not appropriate to the current business environment.
The Committee
had moved gradually toward slightly less restraint in its policy,
but the money supply and bank credit had shown no significant
response.
He felt the Committee should seek to encourage moderate
rates of growth in both; to attain that goal, he would favor contin
uing the policy of slightly less restraint.
Mr. Wayne also suggested that serious consideration be
given to an orderly withdrawal of the restrictive implications in
the September 1 letter.
There was never an ideal time for making
such a move, but the longer the wait the more difficult it would
be to abandon that position.
He was aware that such action at
this time might suggest to the market more ease than was wanted,
but he believed that the danger of an undue increase in business
loans had been reduced by the banks' recent experience with CD's,
by the easing in economic activity, and by the much slower growth
of capital outlays planned for next year.
obligation to the member banks.
Further, he saw a moral
In response to conversations
last spring and the September 1 letter, some Fifth District banks
had, in good faith, carried out an effective policy of curbing
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-65
business loans.
In return, they had asked to be advised when
the restriction ended so that they would not be at a competitive
disadvantage.
If their cooperation was to be expected in the
future, the System should keep faith with them on that matter.
Finally, he would be happy to get back to what he considered more
appropriate methods of implementing monetary policy.
Mr. Wayne said, in conclusion, that alternative B of the
draft directives was appropriate to his view of a proper policy
for the next few weeks.
Mr. Shepardson said it seemed to him that the action taken
at the last meeting of the Committee had resulted in some easing
as indicated by some of the rate movements that had occurred and
by the prospect of an upturn in the money supply, which he thought
was appropriate.
Admittedly, credit expansion still lagged in
light of the liquidity situation of the banks, but it might be
expected that the banks would try to improve their liquidity before
undertaking any significant credit expansion.
Recognizing the
somewhat lesser degree of pressure in the private economy, it
nevertheless seemed to him that there was still a great deal of
uncertainty in what the Government's fiscal program might be.
Therefore, in the weeks prior to the next meeting there was still
reason for proceeding cautiously.
He thought that in view of the
rate levels achieved, the report of the staff that some growth in
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the money supply was indicated, and the probability of a lower
net borrowed reserve figure this week, it would be appropriate
to continue for the coming period in about the status quo.
On the directive, Mr. Shepardson agreed with Mr. Ellis
that with the proviso clause included there was not much difference
between the two draft directives.
His preference was for alter
native A, either without the proviso clause or with Mr. Ellis'
suggested change.
Mr. Mitchell said he regarded today's staff analysis as a
strong warning against showing too little concern about the danger
of slipping into recession.
Several people had commented that the
performance of the economy was still good.
However, the accelera
tion of the economy had lost its momentum several months ago.
The
question now was whether the economy was decelerating, a state not
far from that of slipping into a downturn.
There was evidence in
the GNP figures, in the industrial production index, and in the
specifics given by Mr. Scanlon, for example.
keep in mind the lags in policy.
It was necessary to
Members of the Committee were
now apprehensive about the recent lag in achieving growth in the
money supply and bank credit.
He did not think the Committee
could afford any longer to take a relaxed position on that score;
it must do something sufficiently drastic to achieve the desired
growth.
Maybe, as some people suspected, growth had already begun,
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but from the information the staff had supplied he doubted that
the liquidity barrier had yet been pierced.
Until that barrier
was pierced the desired results would not be obtained.
Mr. Mitchell also expressed the view that the housing
situation was more serious than some seemed to assume.
Recovery
in that area was necessary, but the question was how to achieve
it.
One way would be to put the financial intermediaries back
in business and give them confidence that they could compete
with rates in the market.
Another way would be to make it possible
for the larger banks to warehouse some mortgages so that the insur
ance companies would come back into the market.
Mr. Mitchell said he believed that everyone at this meeting
shared a common objective, although that fact tended to be obscured
by semantics.
He was interested in what Mr. Ellis had said about
the directive, and agreed that the staff's two alternatives did not
give the Committee much choice.
However, he (Mr. Mitchell) doubted
that the staff could conscientiously offer the Committee any real
alternative to easing, considering the nature of their economic
analysis.
He recalled that at the last meeting Mr. Robertson had
suggested a directive calling for operations "with a view to encour
aging moderate expansion in aggregate reserves and bank credit,
provided that money market conditions do not ease sharply."
(Mr. Mitchell) now wished he had supported that proposal more
He
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strongly then.
He would favor a modified version of alternative B
today, calling for operations "with a view to attaining a moderate
expansion in the money supply and bank credit."
Mr. Daane commented that he wished he could share the
staff's seeming sense of certainty as to the economic outlook and
its implications for monetary policy, but he could not.
As an
economist and long-time member of the System's forecasting committee
on business developments, he recalled well an occasion at the end
of May 1950 when a former member of the staff assured that committee
that the one certainty that could be depended upon was that there
would be no intensification of the "cold war."
Only a few weeks
later the Korean conflict began.
On the substantive side, Mr. Daane said he remained skep
tical about a deceleration of defense spending.
He did not doubt
the credibility of the figures that would shortly appear in the
budget, nor would he impugn the motives of anyone involved in the
presentation of those figures.
He simply doubted that a war was
waged that way, and he would be surprised to see an actual decelera
tion.
As to the tapering off of capital spending, he thought that
reflected the situation on the financial supply side and also the
physical supply side, and that it was in the interest of sustainable
expansion.
As to the domestic outlook, he agreed with Mr. Irons
that the private sector was not fundamentally weak.
While he
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conceded the weight of evidence on the staff side, he would not
rule out a resurgence of pressures.
Similarly, Mr. Daane said, he was impressed by the thought
ful views presented by Mr. Polak of the International Monetary
Fund at the conclusion of this year's Article VIII consultation
with the U.S.
Mr. Polak had said in part that:
". . . if monetary
conditions should ease in 1967, whether because of a tax increase
and a shift in the policy mix or because of subsiding domestic
credit demands, there would be a great need to avoid redundancy
of bank reserves, bank credit, and general domestic liquidity
thoughout the system.
In contrast to the 1961-62 policy, for
example, the banks would have to be kept 'snug' enough, as domestic
loan demands subsided, to minimize the external leakage.
Even so,
we find it hard to envisage an easing of credit conditions suffi
cient to promote a revival of home building that would not at the
same time encourage banks to give up the expensive accommodation
they have obtained from the Euro-dollar market.
Also to be borne
in mind is a problem of timing, in that a deterioration in the
capital account could happen with some rapidity whereas any improve
ment in the current account during the course of 1967 is likely to
proceed gradually."
One further comment from the observations of
Mr. Polak, relating to the voluntary foreign credit restraint
program, was as follows:
"The bank program has, of course, been
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only on a stand-by basis during the past year, while the banks
have accumulated a large leeway under their credit ceilings; it
would seem to us important that the program be formulated in such
a way that the amount of net credit that the banks could extend
during 1967 would be kept small."
Carrying his divergence from the staff view to a logical
conclusion, Mr. Daane said, he found himself questioning the view
he understood to have been stated by Mr. Hersey that the Committee
could ignore the consequences on the capital account side of the
balance of payments in continuing to push for monetary ease.
He
questioned such a conclusion, particularly in the light of the
formulation of the bank portion of the voluntary restraint program
for the coming year.
He thought the Fund representative was more
nearly correct in appraising the immediacy of the outflow on the
Euro-dollar side.
On balance, Mr. Daane thought the action taken by the
Committee last time had resulted in some significant easing in the
money market, as gauged by the financial variables looked at most,
including bill rates and net borrowed reserves.
Therefore, he
would once again conclude that the better course of wisdom was to
stand steady.
To carry that out in the framework of a directive,
he would choose alternative A, but he would couch it in a "no
change" version as suggested by Mr. Ellis with slightly different
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-71
phraseology.
He would say that operations ". ..
shall be con
ducted with a view to maintaining the currently somewhat easier
money market conditions, unless bank credit appears to be
declining."
That would carry the flavor of validating what the
Committee had done, yet leave the Committee in a position of not
pushing further toward ease at this juncture.
Mr. Maisel said that he agreed fully with the staff
analysis today.
With reference to Mr. Galusha's comments about
cutbacks in domestic nondefense programs, he would add that
apparently the Secretary of Defense was cutting back a number of
the normal ongoing defense programs to make room for Vietnam
requirements.
It was not surprising to him, Mr. Maisel continued, that
the money and credit figures had not risen as the result of a
modest easing of monetary policy.
It was necessary to take into
account that the Committee was operating against record high
interest rate levels.
Bill and other interest rates were a good
half point above what might have been expected a year or even six
months ago.
The actual level of rates was clearly a more important
influence on demand than was a relative fall from extremely high
levels.
The Committee should not fool itself by what had occurred
over the last two or three months.
It had to move against condi
tions as they now prevailed with unusually high rates rather than
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against the situation as it stood several months ago when rates
were more modest.
Mr. Maisel suggested that the Committee should be more
concerned about the future than about this immediate point in
time.
It should endeavor to remove the present distortions in
the economy and achieve a normal expansion of money and credit.
Even if the Committee were not concerned about a downturn in the
private sector of the economy, it should make sure that it moved
to obtain expansion in money and credit simply to get rid of the
existing distortions, which would otherwise become worse.
Mr. Maisel thought that housing was heading into the
definite danger of an inflationary situation, given the working
of supply and demand factors in that particular industry.
If
housing starts remained at the prevailing low levels, one could
expect run-ups in rents, prices, and therefore in the cost of
living, along with a wage push resulting from the increase in the
cost of living.
In summary, Mr. Maisel felt that the Committee would have
to move more vigorously.
At the last meeting he had handed the
Secretary of the Committee a note proposing language for the
directive along the same lines as Mr. Robertson's subsequent
suggestion.
As he understood it, Mr. Mitchell was now recommending
that alternative B of the draft directives be changed to call for
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-73
operations with a view to attaining a moderate expansion in bank
reserves, money, and bank credit.
view.
He would support that point of
In other words, he would support alternative B with a change
to that effect in the last line.
Mr. Brimmer said he would like to make an additional
comment on the balance of payments.
He had worked along with
Mr. Daane on the formulation of the Government's program and had
also tried to keep in touch with balance of payments developments
generally.
From time to time he had expressed his concern about
the slow progress that was being made toward attaining a somewhat
more viable equilibrium.
As he had mentioned at the last Committee
meeting, those working on the Government program were exerting
every effort to make certain that the voluntary program was put
together in a way that would give the central bank as much
flexibility as possible in the management of domestic affairs.
They had tried to forestall the possibility that a weak balance
of payments program would make it necessary for the central bank
to carry an additional burden in domestic policy making.
While
he did not have any indication of the extent to which the voluntary
program would be workable next year, especially the Commerce Depart
ment program, he was convinced that it would be quite helpful.
pressure that had been brought to keep the direct investment out
flow to less than $2.5 billion should prove helpful.
The
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With respect to the Federal Reserve program, Mr. Brimmer
shared Mr. Daane's concern that the leeway permitted to accumulate
20 per cent of the quota each quarter was a point of danger.
At
the same time he saw no reason why the situation could not be
corrected by tightening the program further if necessary.
So he
shared Mr. Hersey's conclusion that it was not necessary to panic
at the prospect of a short-run outflow and a return of the funds
that had come in through overseas branches of U.S. banks.
The
Committee ought to shape its policy to the needs of the domestic
economy and rely on the voluntary foreign credit restraint program
to the fullest extent possible.
In view of the announcement today of the voluntary
programs for 1967, Mr. Brimmer suggested a modification in the
first paragraph of the draft directive to say that "The balance
of payments remains a serious problem and the voluntary programs
have been strengthened and extended through 1967."
He thought
it appropriate for the Committee to take note that the program
decisions had been made and that one element of uncertainty in
policy making had thereby been removed.
With respect to the domestic situation, Mr. Brimmer shared
the views advanced by the staff and many others around the table.
He, like Mr. Hayes, was impressed by the fact that different
economists sometimes reached different conclusions from the same
12/13/66
figures.
-75At the same time he was also impressed at this time by
the overwhelming proportion of economists who had come to the
same conclusion as the staff had.
With respect to policy making, Mr. Brimmer said he would
like to focus both on the period immediately ahead and on the
longer run.
It was his understanding that there might well be
some additional debt management operations, perhaps before the
end of the year, involving participation certificates.
There
were rumors to that effect in the market, with some feeling for
the possible configuration.
Those operations might exert some
upward pressure on interest rates.
If the amount to be offered
to the public was of the magnitude that had been suggested, the
Committee ought to be concerned about the possible need for some
further easing in the short run to maintain the same policy stance.
For the longer run he thought that further easing was absolutely
necessary.
It was not surprising that the banks had been sluggish
in responding to the easing of monetary policy thus far; over the
years economists had learned something about liquidity preferences.
The Committee should not overlook the need to make the banks feel
a little more liquid.
It also was necessary to provide some head
room for banks to achieve an increase in their CD's.
Mr. Brimmer went on to say that another look should be
taken at the September 1 letter, not only in terms of agreeing
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that there was no longer a need for it but in terms of taking
an overt step to rescind it.
The letter was made necessary by
conditions prevailing in the late summer and early fall, but
those conditions had passed.
It was sent out as a signal that
the System wanted some restraint on the expansion of business
loans, and he thought it desirable now to have an explicit state
ment that the letter was no longer in effect.
Mr. Wayne had made
the point that the banks felt they needed some indication of
System attitude, and he (Mr. Brimmer) hoped an appropriate letter
could be gotten out.
Mr. Hayes had mentioned the policy mix for the longer run,
Mr. Brimmer noted.
He (Mr. Brimmer) hoped that monetary policy
would play an active part in that mix.
If conditions required it,
and he thought they did, there should be a shift toward greater
ease.
Monetary policy had the advantage of being flexible.
It
should also be timely, and he thought now was the time to get on
with further easing.
Accordingly, he favored the approach of
alternative B of the draft directives, and would subscribe to
Mr. Mitchell's proposed change in its wording.
In concluding, Mr. Brimmer observed that the Manager had
executed a rather difficult maneuver under a directive that was
not abundantly clear.
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Mr. Hickman commented that the flow of business and finan
cial news in recent weeks showed clearly that the policy shift at
the Committee's last meeting was appropriate.
Nevertheless, the
latest data indicated to him that the Committee should push further
in the direction of ease.
Whether one looked backward or forward,
monthly data on the monetary variables showed a nearly uniform
series of minus signs.
The bank credit proxy, total reserves,
required reserves, and the money supply had been moving downward,
indicating that the supply of credit was declining relative to the
less intensive demands of recent months.
In that environment, it
seemed to him an inescapable conclusion that net borrowed reserves
had been too deep, and the money market too tight, to support
continued economic expansion.
He therefore recommended that the
Committee aim for a zero, or even a positive, level of net free
reserves, as needed to get back on the high road of balanced money
and credit growth.
Since economic activity in the Fourth District had a wider
amplitude of cyclical variation than that of the U.S. as a whole,
Mr. Hickman thought it might be timely to review briefly business
and financial conditions in that region.
Evidence had accumulated
that heavy industry in the Cleveland-Cincinnati-Pittsburgh triangle
was beginning to feel the impact of economic slackening.
That was
revealed clearly at the joint directors' meeting last week, where
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important cases were cited of a slowing in new orders, resulting
in reduced backlogs and less pressure on resources and capacity.
The Cleveland Bank's monthly survey of manufacturers in
the Fourth District, plus a number of regional series collected
by the research staff, also reflected the more moderate tempo of
local business activity, Mr. Hickman said.
Manufacturing activity
in major areas, as measured by industrial consumption of electric
power, had either turned downward or had slackened its growth.
Production and new orders in steel declined in November to the
lowest levels since August.
Insured unemployment in November
increased slightly in 9 out of 14 major District labor markets,
and declined in only 3 markets (in one market the decline was
caused by a strike settlement).
Department store sales seemed to
have leveled off, after an almost uninterrupted period of steady
growth since late 1962.
The decline in construction contracts
thus far this year had been more severe than in the nation.
The
seasonal expansion in bank credit at the weekly reporting banks
in November was only about one-fourth as large as in the comparable
period a year ago.
Mr. Hickman went on to say that early returns from a
confidential survey of recent and anticipated borrowing by a
sample of large midwestern business corporations showed that about
three-fourths of the respondents had unused commitments at banks,
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which most planned to draw upon next year.
Respondents indicated
that credit needs would be large in the second quarter of 1967,
but that the purpose of the borrowing would be largely to meet
taxes, rather than for asset expansion.
With reference to the recent mortgage survey, Mr. Hickman
said that the responses from 23 financial institutions were not
reassuring.
Only one-third of the lenders reported a recovery in
commitments or anticipated a pickup in the near future.
Although
a general increase in availability of funds had occurred recently,
demand for real estate and construction loans had fallen off,
partly because of the cool reception given borrowers by lenders
earlier this year.
Respondents indicated that new commitments
would be allocated largely to the residential mortgage market.
Mr. Hickman favored whatever net credit availability was
needed to produce pluses in the major monetary variables.
The
staff's alternative directive B was satisfactory to him, as it
stood or as amended by Messrs. Mitchell and Maisel.
He thought
the September 1 letter should be rescinded.
Mr. Patterson reported that while business activity in
the Sixth District was still at a high level, data that had become
available since the last Committee meeting indicated additional
signs of a slowing down.
With November auto sales in the District
off sharply from a year ago, the District was sharing in the recently
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announced auto layoffs.
Even the agricultural sector was begin
ning to lose some of its glow, now that cotton had been reduced
in output and prices for livestock and other products were lower.
In Florida, the price of oranges had dropped from $2.86 to 83
cents a box.
Residential construction volume was also turning in
a progressively deteriorating performance, although total construc
tion volume was still slightly ahead of last year and was outpacing
the national average.
That the softness in autos, construction,
and agriculture was becoming one of swelling proportions was further
suggested by the most recent reports from head office and branch
directors, who seemed to be less optimistic than in several years.
On the other hand, Mr. Patterson continued, the nine
commercial banks, five mortgage bankers, and handful of savings
and loan associations contacted on the question of mortgage lending
seemed to be slightly more cheerful than they had been over the
past several months.
Savings flows for October and November were
better than many had expected earlier, although not good enough to
improve commitments in most local lending markets.
The majority
of lenders indicated that flows of new commitments were at their
low for the year.
Most of them thought the bottom had been reached
and fairly early recovery might be in sight.
While commercial
bankers were the least optimistic, the savings and loan people did
not expect an early turn in the market without clarification of the
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new Home Loan Bank program.
A minority of mortgage bankers, on
the other hand, said that their flows of new money had already
shown some recovery; and about one-third of all respondents antic
ipated some recovery in the next two or three months.
Many
indicated that, with the exception of large commercial properties,
money had become more readily available, but that cost remained
high.
In single family residential housing, most new originations
by mortgage bankers were being sold to FNMA.
A number of mortgage
bankers were retaining one-year options to repurchase them, and
some permanent investors had indicated their willingness to absorb
or share that cost in order to insure the availability of mortgages.
Commitments for large commercial projects were being restricted
in some District markets because the permanent investors wanted
to defer takeouts for as long as two years.
Commercial banks were
unable or unwilling to carry them for that length of time.
It seemed quite clear to Mr. Patterson that the picture
of insignificant growth in bank lending had not changed in the
past several months after allowing for seasonal changes.
Loans
at the largest banks increased less this November than in comparable
past periods.
Many bankers with whom he had talked recently said
that their loan demand was still very high, but an increasing
number of them were also beginning to say that it was not as strong
as it had been, possibly because inventory growth had slowed.
The
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bankers were, however, of one mind in complaining that their
deposit growth had ceased--a fact borne out by statistics.
They
still worried about whether they would be able to satisfy the
loan demand of their good customers and in many cases were trying
to find ways to repay their indebtedness to the Reserve Bank and
to reduce their dependence on the Federal funds market.
Under
those conditions, it would probably be difficult for them to buy
municipals on a large scale, even if the Committee were to let up
further in its policy of restraint.
Sixth District banks also
would be slow to benefit from the effects of lower bill rates vis
a-vis CD rates, since even the largest ones were not too active
in the CD market and were less sensitive to changes in short-term
rates than banks in many other sections of the country.
Turning to the national scene, it seemed clear to
Mr. Patterson that with the further slowing down that had occurred,
his own position at the last meeting, and that of the Committee,
had been eminently correct.
He believed the thrust of that new
policy should be continued, the Treasury financing calendar permit
ting, although the uncertainty of fiscal policy and balance of
payments considerations demanded that the Committee not let up on
monetary restraint to an extreme degree.
On the other hand, it
must be remembered that the delayed effects of the restrictive
policy were still leaving their imprint.
Therefore, the Committee
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should not be under any illusion that slightly lower rates and a
reversal in money supply statistics would be likely to have a
significant impact on future financial flows unless it continued
to lift its policy targets.
He would like to see a return to the
moderate expansion rate in money and credit experienced in the
first half of 1966.
He was neutral as to whether the Committee
tried to accomplish that by couching its instructions in terms of
money market conditions or aggregate reserves, but he preferred
alternative B of the draft directives.
Mr. Lewis reported that most lenders surveyed in the Eighth
District indicated that new commitments for construction and mort
gage loans were at low points for the year.
recovery.
They foresaw no early
A few expected further reductions in the near future.
Savings and loan associations in St. Louis reported a net inflow
of funds approximating that of a year ago.
However, they were
making few new commitments because the Federal Home Loan Bank was
requiring payoff of borrowingsof last summer.
There were indica
tions that some insurance companies would like to pick up more
mortgages at higher interest rates but were prevented from doing
so because of lower cash inflows resulting from a marked reduction
in prepayments of old loans.
Most of the commitments made were for commercial, industrial,
and multi-dwelling units, Mr. Lewis continued.
Few funds were
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flowing into the single-unit residential market.
Several lenders
indicated a marked reduction in the number of loan applications,
but they felt that if they made known that they had funds available
for mortgages, applicants would readily come forth.
That was
particularly true for insurance companies and savings and loan
associations.
Total demand for goods and services was continuing to rise,
Mr. Lewis observed, but less vigorously than in late 1965 and
early 1966.
The contraction in bank reserves and money beginning
last spring probably had contributed to the slowing in private
demand, despite the stimulative budget situation.
The mix of fiscal
and monetary policy, although leading to a desirable slowing in the
growth of expenditures, had fostered high interest rates.
While
probably beneficial for balance of payments purposes, such rates
appeared to be causing hardship on the housing market and private
investment, and as a result might be hampering economic growth.
As to the future, it appeared to Mr. Lewis that total
public policy--fiscal and monetary--might not need to be so restric
tive in coming months as it had been since spring.
If the policy
mix should include a less stimulative budget in the future than
since mid-1965, monetary actions could be relaxed, and interest
rates would become less of a drag on economic growth.
Even if the
fiscal stance remained stimulative, a case might be made, although
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with less confidence, that some relaxation of monetary restraint
was in order.
Total demand had slowed and the Committee would not
want to overkill the inflationary pressures.
For the next month, Mr. Lewis said, he would like to see
still easier conditions in the money market with a view to obtain
ing a moderate growth in bank reserves, bank credit, and money.
He preferred alternative B for the directive.
Mr. Robertson made the following statement:
Developments that have emerged since the last
meeting of this Committee seem to me to have confirmed
the wisdom of the judgment we reached at that time to
begin a modest but overt easing of monetary policy.
Almost every statistic that has since become available
is indicative of a little more slackening in final
demand pressures. On the financial side, our slight
easing to date has brought down a few interest rates,
and improved bank liquidity positions a bit, but it
has not yet been able to halt the persisting decline
in bank credit. Meanwhile, we still await a clear
declaration of the future fiscal intentions of the
Administration. The budget figures revealed to date
support a further but slower rise in expenditures, but
no official position is yet definite regarding a tax
increase.
In these circumstances, I think our best policy
is to continue what I have been calling in previous
meetings a "tentative but gradual and progressive kind
of let-up of monetary pressures". What I would like
us to achieve, in the weeks ahead, is at least a full
offset of any tendencies for the money market to firm
under the expected seasonal pressures between now and
year-end; and thereafter enough further easing of bank
liquidity positions to encourage the gradual resumption
of orderly, moderate growth in bank credit and money.
I read the "blue book" and the staff directive
notes as saying, in effect, that there is a good chance
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of achieving these objectives by continuing virtually
unchanged our current directive to the Manager; that
is, by adopting the draft alternative B. This, I take
it, might involve net borrowed reserves around zero and
a three-month bill rate and Federal funds rate around
5 per cent before the Committee meets again.
I am prepared to accept that kind of prescription
for now, recognizing that the many end-of-year uncer
tainties make any elaborate specification of targets a
matter of guesswork. However, recent developments do
suggest to me that it was not amiss at the last meeting
to explore ways of giving more weight to the performance
of the monetary aggregates. This could be accomplished
in the directive by using the traditional form of the
proviso clause, if we continue to direct the Manager to
vary the degree of ease or tightness in the money market
according to the degree of weakness or strength in bank
credit and aggregate reserves. Thus, in that light, it
would not bother me if the three-month bill rate or the
Federal funds rate fell somewhat below 5 per cent in
the month ahead if bank credit were showing no tendency
to expand in, at least, the 2 -to-4 per cent range.
Mr. Robertson added that he still
felt that the suggestion
for the language of the directive that he had made at the last
meeting was a good one.
However, he thought there was probably
more sentiment today for alternative B as drafted by the staff.
Consequently, he would opt for alternative B, with the understand
ing that the objective was substantially the same as the objective
contemplated by the language he had suggested.
Chairman Martin remarked that he read alternativesA and
B in about the same way as Mr. Ellis:
much difference between them.
there did not seem to be too
However, he continued to feel, as
he had before today's discussion, that alternative B was preferable.
Like Mr. Galusha, he found the way it was written appealing.
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The Chairman went on to say that while he did not pretend
to know exactly what the leads and lags were, he did not think
that the Committee, in moving either toward restraint or ease,
could force the statistics in a brief period.
It seemed to him
the Committee had made the right decision at the last meeting.
He
questioned, however, whether it would be desirable now to move to
net
free reserves; it seemed preferable to move more gradually.
In his opinion the Desk had performed well over the past few weeks.
There had been a general understanding, without news releases, of
what the Committee was trying to do, and that was salutary.
With
the year end approaching, and with all the cross currents involved,
he thought the Committee would be running a real risk if any
substantial amount of net free reserves appeared.
That might be
taken to indicate that the Committee had become panic-stricken,
and the move would become self-defeating in terms of what the
Committee was trying to do.
was being changed.
There was always that risk when policy
As things stood, the Committee had started a
gradual move three weeks ago and the statistics so indicated.
The Chairman went on to say that he did not happen to be
bearish.
He thought the economy was still strong, and he was glad
that monetary policy had gotten out of the posture it was in until
recently.
The pace of the expansion in the private sector of the
economy clearly was tending to turn down as long ago as September
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and October, and it was not good for the System to be in a position
of forcing restraint in those circumstances.
Chairman Martin noted that there were probably going to
be some tests of public psychology and business sentiment when the
Government's general budgetary posture became fully understood.
The figures might be rather startling to a lot of people who had
not yet achieved the degree of sophistication necessary to accept
deficit financing with complacency.
The Government, Chairman Martin continued, had made a lot
of progress in the use of its tools of policy and its methods of
operation, but it should not force the issues unnecessarily.
Per
sonally, he hoped the President would recommend a tax increase,
partly because he thought the budgetary situation would call for
one and partly because he saw a psychological advantage and, in a
sense, a moral advantage in having people share in the cost of the
Vietnam effort in one way or another.
He thought the country ought
to follow a "pay as you go" principle for a lot of things.
Chairman Martin expressed the view that the Committee should
keep steady in the boat and not appear unduly concerned.
The damp
ening that had occurred in the excessive pace of economic growth
was much to be desired, but he did not think monetary policy should
claim the full credit.
As he saw it, inflationary tendencies had
gotten a foothold at a certain stage, and they in turn produced
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counter tendencies.
The Chairman also referred to the gold situa
tion, saying it was of more concern to him than the balance of
payments statistics per se.
Chairman Martin repeated that he liked alternative B of
the draft directives as written.
While he would not object strongly
to the changes that had been suggested, he did not think one could
expect to achieve precise results, particularly in a four-week
period.
It was perfectly normal, as had been pointed out, that
when banks became worried about their liquidity positions they would
not go out looking for loans at the first opportunity.
In fact, he
did not believe that that would be desirable under present conditions.
The September 1 letter concerned him a little, the Chairman
continued.
His personal preference, however, would be to take no
overt action and simply let the Presidents talk to people in their
respective Districts on an individual basis.
Issuance of a state
ment would attract more attention than seemed warranted and might
lead a lot of people to believe that the System was calling upon
banks to send their men out to seek business loans.
He would just
let the matter rest for the moment, although the Presidents could
talk with people who came to them with questions.
Mr. Wayne said that in the Fifth District certain banks
had in good faith exercised self-restraint.
They would like to
know when the September 1 letter was no longer in effect.
not have to say much for the word to get around.
He would
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Chairman Martin repeated that his preference would be to
talk with such parties individually rather than to issue a state
ment saying the September 1 letter was no longer in effect.
There
was no reason a Reserve Bank President could not talk to people
about general credit conditions, but the issuance of a statement
might be read by the press and others as a blanket invitation to
the banks to go out and seek business loans.
Mr. Brimmer expressed reservations about such a procedure.
The September 1 letter was a policy statement reflecting a System
wide credit control program.
objective of System policy.
It announced to the public an explicit
Therefore, it would not seem sufficient
for the President of a Reserve Bank to talk quietly to each banker
who called upon him about the matter.
In his judgment, that was
not the way System policy should be made or changed.
He appreciated
the difficulties of letter-drafting and the problem of timing, but
when a public policy matter was involved an announcement ought to
be made.
Chairman Martin said that he had some question about the
wisdom of such a move.
The letter of September 1 had been widely
misconstrued, and its public withdrawal might likewise be widely
misconstrued.
Mr. Swan remarked that he saw no difficulty in discussing
the credit situation with bankers.
However, the moment a President
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began to talk with one or two bankers in terms of the September 1
letter, that was going to become known and other banks were going
to be critical of the System for not having advised them directly.
While there were not very many banks deeply involved, some smaller
banks who perhaps had taken the matter seriously might not get
the word promptly.
He would not hesitate to discuss the general
change in credit conditions, but he would hesitate to talk about
the September 1 letter without being sure that all interested banks
would have the same message at approximately the same time.
Mr. Daane said he subscribed to the view that a formal
rescinding of the letter at this time might lead to more repercus
sions than desirable.
Mr. Hayes also agreed on the inadvisability of sending
out another letter at this time.
A considerable amount of
confusion had resulted from the issuance of the original letter,
and in retrospect he was not sure that it was an entirely wise
move.
While he recognized that the need for the letter no longer
existed, rescinding it formally might lead to the same confusion
and uncertainty that accompanied the issuance of the original letter.
More broadly speaking, he would be reluctant to see the System get
into a position of feeling that it must issue letters to the member
banks advertising its policy decisions.
He thought the System had
been on sounder ground in the past in letting its actions speak
for themselves.
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Mr. Hayes also said that by a formal withdrawal of the
September 1 letter the System could hardly fail to highlight
whatever policy change had been made.
He felt that that would
make the change more overt than a majority of the Committee
members desired.
He could appreciate that it would be useful to
get across the idea that the System was taking the attitude that
the need for the letter had faded away.
But he hoped a formal
withdrawal of the letter could be deferred until the idea gradually
got across that the letter was no longer operative.
It might be
useful for the Chairman, in answering questions from the press or
in making a speech, to include a comment that the program described
in the September 1 letter was designed to meet conditions as of
that date, that those conditions had changed in many respects, and
that the letter had outlived its usefulness.
Gradually that would
sink in, and the letter could then be rescinded formally at some
later date.
Mr. Galusha subscribed to that view.
He noted that there
were many ways in which a Reserve Bank President could communicate
ideas without having a public gathering or making a general announce
ment.
The only question he had was whether the way was now clear
to indicate, in whatever manner seemed appropriate, that a reduction
of business loans was no longer considered essential.
If that
point of view was expressed in conversation with individual bankers,
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the word would soon get around.
If the question came up, as it
had the other day from the head of one of the larger District
banks, and if the Presidents were free to handle the situation in
whatever way appeared necessary, the September letter would grad
ually die.
It could be disposed of formally at a later date.
But
the issuance of a withdrawal letter at this time could cause many
problems.
Mr. Wayne said that although he shared Mr. Brimmer's views
about the advantages of a public statement, he also recognized the
danger of creating an erroneous impression at this time.
The
question was one of responsibility to the banks that had cooperated.
The September 1 letter was essentially a System statement indicating
that under the circumstances as they prevailed at that time the
Federal Reserve thought the banks ought to display a high degree
of statesmanship.
All he would have to say in conversation was
that the banks had done a good job, and the word would get around.
Mr. Robertson commented that the System, in issuing the
September 1 letter, had deviated from the normal use of monetary
policy instruments in a manner that was unique, and the operation
had succeeded.
If the System was going to terminate the operation-
and he thought it should--the only question was how to go about it.
If it was true that another letter could be misconstrued, he would
not favor that procedure, but the approach should be uniform for
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all banks.
If the operation was to be terminated, he would let
each President do what he thought necessary, either through
conversation or written communication as he believed best, so
long as equal treatment was assured for all banks.
Mr. Maisel also spoke in favor of a uniform approach.
He
agreed that the timing could be delayed and was not concerned with
the form of statement.
He did feel, however, that the policy
should be terminated by an official and public action of the System.
Mr. Wayne then suggested that everyone think about the
problem, with a view to further discussion at the next Committee
meeting, and there was general agreement with that suggestion.
Returning to the question of the directive, Chairman Martin
suggested that the Secretary poll the Committee on alternative B
in the form drafted by the staff.
Question was raised whether the
vote should be taken instead on alternative B as it would read with
the change suggested by Messrs. Mitchell and Maisel, and upon request
the Secretary read the language reflecting that suggestion.
Mr. Clay
commented that he would prefer to have the vote taken on alternative
B as written by the staff because in his opinion there was a virtue
in continuing along the line of the policy instituted at the preced
ing meeting.
Chairman Martin observed that the problem seemed to get
into semantics to a certain degree.
As he had said many times,
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words meant different things to different people.
He happened
to prefer alternative B as written by the staff because he found
it easier to understand.
It specified operations with a view to
attaining somewhat easier conditions in the money market.
He
doubted whether bank credit would resume a rapid rate of expan
sion at this stage, but if it should the directive also made
provision for that contingency.
He again proposed voting on
alternative B as prepared by the staff.
That procedure, he felt,
should afford a fair opportunity for expression of opinion because
those members who opposed the staff draft no doubt would also
oppose the suggested revision of it.
Thereupon, upon motion duly made
and seconded, and with Messrs. Hayes,
Daane, Irons, and Shepardson dissenting,
the Federal Reserve Bank of New York was
authorized and directed, until otherwise
directed by the Committee, to execute
transactions in the System Account in
accordance with the following current
economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that over-all domestic economic
activity is continuing to expand, with rising defense
expenditures but with additional evidences of moderating
tendencies in the private economy. While there has been
some slowing in the pace of advance of most broad price
measures, upward price pressures persist for many finished
goods and services. Bank credit and money have shown no
net expansion in recent months. Although demands on bond
markets have increased, upward pressures on long-term
interest rates have moderated. The balance of payments
remains a serious problem. In this situation, it is the
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Federal Open Market Committee's policy to foster money
and credit conditions conducive to noninflationary
economic expansion and progress toward reasonable equili
brium in the country's balance of payments.
To implement this policy, System open market opera
tions until the next meeting of the Committee shall be
conducted with a view to attaining somewhat easier
conditions in the money market, unless bank credit appears
to be resuming a rapid rate of expansion.
It was agreed the next meeting of the Committee would be held
on Tuesday, January 10, 1967, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
December 12, 1966
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on December 13, 1966
FIRST PARAGRAPH
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 but with additional
evidences of moderating tendencies in the private economy. While
there has been some slowing in the pace of advance of most broad
price measures, upward price pressures persist for many finished
goods and services. Bank credit and money have shown no net expansion
in recent months. Although demands on bond markets have increased,
upward pressures on long-term interest rates have moderated. The
balance of payments remains a serious problem. In this situation, it
is the Federal Open Market Committee's policy to foster money and
credit conditions conducive to noninflationary economic expansion
and progress toward reasonable equilibrium in the country's balance
of payments.
SECOND PARAGRAPH
Alternative A
To implement this policy, and taking into account the widely
fluctuating seasonal pressures at this time of year, System open
market operations until the next meeting of the Committee shall be
conducted with a view to maintaining about the currently prevailing
money market conditions; provided, however, that somewhat easier
conditions shall be sought if bank credit appears to be failing to
expand.
Alternative B
To implement this policy, System open market operations until
the next meeting of the Committee shall be conducted with a view to
attaining somewhat easier conditions in the money market, unless bank
credit appears to be resuming a rapid rate of expansion.
Cite this document
Federal Reserve (1966, December 12). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19661213
@misc{wtfs_fomc_minutes_19661213,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1966},
month = {Dec},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19661213},
note = {Retrieved via When the Fed Speaks corpus}
}