FOMC Minutes
A meeting of the Federal Open Market Committee was held in the
offices of the Board of Governors of the Federal Reserve System in
Washington, D. C.,
PRESENT:
on Tuesday, February 7, 1967, at 9:30 a.m.
Mr.
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
Wayne, Alternate for Mr. Bopp
Messrs. Scanlon, Francis, and Swan, Alternate
Members of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents of
the Federal Reserve Banks of Boston, Atlanta, and
Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hexter, Assistant General Counsel
Mr. Brill, Economist
Messrs. Eastburn, Garvy, Green, Koch, Mann, Partee,
Solomon, Tow, and Young, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Fauver, Assistant to the Board of Governors
Messrs. Hersey and Reynolds, Advisers, Division of
International Finance, Board of Governors
Messrs. Axilrod and Gramley, Associate Advisers,
Division of Research and Statistics, Board of
Governors
2/7/67
Mr. Wernick, Assistant Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Mr. Hilkert, First Vice President, Federal
Reserve Bank of Philadelphia
Messrs. Eisenmenger, Ratchford, Brandt, Jones,
and Craven, Vice Presidents of the Federal
Reserve Banks of Boston, Richmond, Atlanta,
St. Louis, and San Francisco, respectively
Mr. Deming, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Stiles, Senior Economist, Federal Reserve
Bank of Chicago
Mr. Hocter, 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 January 10, 1967, 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
January 10 through February 1, 1967, and a supplemental report for
February 2 through 6, 1967.
Copies of these reports have been placed
in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs said
that there would be no change in the Treasury gold stock this week.
The gold balance in the Stabilization Fund would decline to less than
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$19 million by the end of the month, however, which might necessitate
a $100 million cut in the Treasury gold stock within the next two or
three weeks.
On the London market, Mr. Coombs continued, there had been a
good flow of gold from South Africa, which continued to run a moderate
payments deficit.
Speculative demand had been even stronger, however,
and the gold pool lost an additional $21 million during January.
As of
the close of business yesterday, there was $47 million left of the
supplementary $50 million contributed to the pool last September, but
an effort would be made to get agreement for an additional $50 million
if necessary.
The French Government continued to harass the market
with a succession of announcements designed to cast doubt on the
official $35.00 price.
The latest French move in that campaign,
announced on January 29, was to internationalize the hitherto domestic
French gold market.
Those new measures now permitted French residents
to buy gold on the London market and would encourage the growth of
French gold custody business for nonresidents.
European central banks
expected that the next French move would be to withdraw from the gold
pool, with some fanfare of publicity.
In general, the French seemed
to have deliberately put themselves on a collision course with U.S.
policy, and the time might not be far distant when the U.S. would have
to take fairly drastic defensive measures.
2/7/67
With respect to the exchange markets, Mr. Coombs said, the
Committee might recall that at the last meeting he had expressed
concern over the lagging recovery of sterling and the huge amount of
central bank credits still outstanding to the Bank of England; and he
had suggested that the best hope for bringing about a major turn for
the better in the sterling market would be for the Bank of England
to maintain a rate differential in its favor if the Euro-dollar
market continued to ease.
In fact, that was what they had done during
the past month, and that policy had helped bring about a major inflow
of $555 million during January.
Of that amount, $30 million had been
added to reserves and the remaining $525 million had been used to pay
off central bank debt.
The Bank of England had thereby reduced its
outstanding short-term debt to approximately $800 million at the end
of January, with further repayments in early February bringing the
total down to about $625 million today--as compared with a peak of
$1.5 billion last August.
There was some hope, he thought, that the
favorable trend of the past month would continue throug. the next two
months, which tended to be seasonally strong.
In any event he
thought there was a pretty good chance that the Bank of England would
pay off the remaining $100 million due under its swap line with the
System within the next week or so.
On the other side of the ledger, Mr. Coombs remarked, the
System Account had cleaned up all of the $35 million of guilder debt
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that had been outstanding at the time of the last meeting, and had
paid down the System's mark indebtedness from $85 million to no more
than $10 million.
He would hope to clean up the rest of the mark
debt within the next week or so, leaving only the Swiss franc debt of
$85 million.
As he mentioned at the last meeting, there was a strong
likelihood that the seasonal weakening of the Swiss franc would
permit the repayment of that debt by the end of March.
He thought it
might be useful, however, to accelerate such repayment by asking the
Treasury to issue a Swiss franc bond or to employ some of the
System's holdings of guaranteed sterling to acquire Swiss francs on
a swap basis.
That might enable the books to be closed as of the end
of the month with neither loans nor borrowings outstanding under the
$4-1/2 billion swap network.
There had been a good deal of discussion
of the swap network in the recent meetings concerning international
liquidity arrangements, and he thought it would be highly useful in
that connection for both sides of the System's ledger to be clear at
the end of February.
Somewhat over $7.5 billion had been drawn under
the swap arrangements since their inception; and, if the presently
outstanding drawings were paid off shortly, more than90 per cent of
all drawings would have been paid off within a six-month period.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
January 10 through February 6, 1967,
were approved, ratified, and confirmed.
2/7/67
Mr. Coombs then noted that the combined three-month standby
swap line with the Netherlands Bank, totaling $150 million would
mature on March 15, 1967.
As the Committee would recall, a $100
million arrangement had been on the books last September when the
$50 million enlargement was added.
He recommended renewal of both
the longer-standing arrangement and the enlargement, noting that
the Dutch still seemed inclined to keep them separate.
He would
hope that in due course the two could be consolidated into a single
agreement.
Renewal of the combined $150
million standby swap arrangement with
the Netherlands Bank was approved for
a further period of three months.
Mr. Coombs noted that there was a similar combined arrange
ment with the National Bank of Belgium for $150 million.
Of that
sum, $100 million was on a one-year basis and had been renewed for
that period in December 1966.
The enlargement of $50 million was on
a three-month basis, and would mature on March 13, 1967.
He
recommended renewal of the $50 million enlargement for a three-month
period, and for a longer term if agreeable to the Belgians.
Renewal of the $50 million
enlargement of the standby swap
arrangement with the National Bank
of Belgium was approved on the
basis recommended by Mr. Coombs.
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Finally, Mr. Coombs said,the enlargement of the swap arrange
ment with the Bank of Italy in the amount of $150 million, which had
been negotiated in September 1966 for a term of six months, would
mature on March 12, 1967.
The longer-standing portion of the Italian
arrangement, in the amount of $450 million, had been renewed for a
twelve-month period in October 1966.
The Bank of Italy apparently
would be prepared to renew the enlargement for an additional nine months,
through the end of the calendar year, and he was hopeful that they
would be willing to put it on a twelve-month basis.
He recommended
that the Committee approve a renewal of the enlargement for nine
months, with the understanding that it would be put on a twelve-month
basis if agreeable to the Italians.
Renewal of the $150 million
enlargement of the standby swap
arrangement with the Bank of Italy
was approved on the basis recom
mended by Mr. Coombs.
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 January 10 through February 1,
1967, and a supplemental report covering the period February 2 through 6,
1967.
Copies of both reports have been placed in the files of the
Committee.
2/7/67
In supplementation of the written reports, Mr. Holmes commented
as follows:
Interest rates again moved sharply lower during the
period since the Committee last met and money flows
appeared to have accelerated in all sectors of the money
and capital markets, reflecting the further easing of
System policy and a succession of new developments that
tended, on balance, to bolster market confidence. The
President's State of the Union message, calling for a tax
increase and for lower interest rates, came the evening
after the last Committee meeting and had an immediate
impact on market sentiment. Sixteen days later, when some
signs of hesitation had begun to appear in the capital
markets, the cut in the prime rate and the decline in the
British Bank rate again restored a buoyant tone to the
market--and generated a particularly enthusiastic response
to the Treasury's refinancing of $7.5 billion securities
Economic indicators becoming
maturing on February 15.
available during the period tended to confirm the
impression that there was less exuberance in the economy,
the budget message was generally well taken, and
developments in Vietnam were not such as to upset the
better market tone.
While most of the developments during the period
tended to be bullish for the markets, a note of caution
appeared from time to time, mainly stemming from reports
of a growing calendar of corporate and municipal issues
and from the realization that the country's balance of
payments deficit might well pose special problems some
time in 1967, particularly if lower interest rates in the
United States should lead to an outflow of capital. The
very extent of the decline in rates to date from last
summer's peaks made some market participants wonder whether
the adjustment might not prove to have been a bit overdone,
particularly if demands on the capital markets should
increase further.
In the short-term markets, rates on Treasury bills,
bankers' acceptances, commercial and finance company paper,
and CD's all moved significantly lower over the period
since the last Committee meeting. The three- and six-month
Treasury bill rates declined about 25 and 35 basis points
net over the period, and temporarily fell below the discount
rate before backing up a bit yesterday in the face of light
2/7/67
demand. Bidding was cautious in yesterday's regular
weekly bill auction, and average issuing rates were set
at about 4.53 and 4.52 per cent on the three- and
six-month issues, up 4 and 6 basis points, respectively,
from the rates set a week earlier.
Open market operations succeeded in maintaining a
generally comfortable tone in the money market. Bank
credit, as measured by the credit proxy, expanded more
rapidly than had been expected during the period but not,
in my judgment, so rapidly as to have required implemen
tation of the proviso clause--although the threshhold
was about reached. The System absorbed reserves over the
first three weeks of the period, but then turned around
to provide reserves over the last three days, with the
net effects of these operations about offsetting over the
period as a whole. The reserve absorptions were accom
plished mainly by redeeming some portion of maturing
Treasury bills held in the portfolio and by sales to
foreign accounts, and matched sale-purchase transactions
were made on two occasions to absorb temporary bulges in
reserve availability. Repurchase agreements were made
on four occasions to meet temporary reserve needs, but
the scale of such operations was far less than in the
preceding interval between Committee meetings.
During the statement week ended last Wednesday,
money market conditions were very easy as the result of
float created by the Chicago blizzard, with the Federal
funds rate below the discount rate much of the time.
Perhaps we should have done more than we did to prevent the
excessive ease that developed, but as we viewed the
statistics at the time, this would have required publishing
net borrowed reserves of $250 million or so on the same
day the Treasury would be announcing the results of its
refunding. We consequently decided to be content with a
net borrowed reserve position of about $50 million, with
the expectation that the market would attribute the low
funds rate and the low level of borrowings at Reserve Banks
to the special temporary situation that existed. We
thought we had succeeded in this, but a last-minute revision
of the Chicago reserve figures unexpectedly added
$192 million to the weekly averages, and we wound up with
free reserves of $154 million. I don't believe any
permanent damage was done by this lapse into easier
conditions than I believe the Committee had intended,
although there are some people in the market that may have
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read more into the published figures than was there.
Firmer conditions in the money market yesterday and over
the remainder of this week may help dispel some of this
overinterpretation.
As noted earlier, the Treasury's offering for cash
of $5.5 billion 4-3/4 per cent 15-month notes and $2
billion 4-3/4 per cent 5-year notes, both priced at a
discount, was very well received. The issues were priced
to yield 4.85 and 4.84 per cent, respectively, in line
with market rates prevailing on the day before the prime
rate changes. With the change in the market it was
readily apparent that the two new issues were underpriced
and would sell at premiums of at least 1/4 and 1/2 points,
respectively.
Against this background there was an inevitable
attraction for free riders and speculators, as well as
for regular investors in Government securities. Both
issues were heavily oversubscribed, with large public
subscribers receiving allotments of 10 per cent of their
subscriptions in the short note and only 7 per cent in
the longer note. As it turned out speculative demand,
while large, was not as excessive as some had feared, and
the allotments were about in line with market expectations.
The System exchanged its holdings of $3,294 million of
maturing issues for the 15-month note. Nonbank dealers
have made good progress in selling their awards of $297
million of the short note and $310 million of the longer.
At last night's close the new issues were bid at premiums
of 7/32 and 17/32 over the issue price to yield 4.67 and
4.71 per cent, respectively. I might note, parenthetically,
that while dealer positions continue to be large, and their
holdings of coupon issues have increased with the Treasury's
refunding, they appear to be relatively cautious about
building them up further. Their recent profit experience
has, of course, been very good. Contributing to this
caution has been the heavy municipal calendar, the large
volume of participation certificates to be marketed by
the Federal National Mortgage Association and the Export
Import Bank by mid-year, and the suspicion that the
decline in corporate bond yields may bring more financing
into that market.
Had it not been for debt limit problems, the Treasury
would most likely have announced an offering of $2-1/2
billion June tax anticipation bills before the end of this
week for payment around February 24. It now looks as if
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congressional action on the debt limit will not come
much before mid-month, and could be longer postponed
if an unexpected floor fight develops over minority
party proposals to link an increase in the debt limit
to proposals for bringing participation certificates
under the debt ceiling and for permitting the Treasury
to finance up to $6 billion outside the 4-1/4 per cent
interest rate ceiling. The latter proposal has a great
deal of merit and is acceptable to the Treasury, but it
is bound to cause lengthy debate and would be better
considered apart from the immediate need to raise the
debt limit.
As we look into the period ahead I would not antic
ipate any movement of interest rates comparable to those
experienced in recent weeks in the absence of either
further monetary policy moves towards ease or major public
pronouncements that give rise to further expectation of
lower rates or some move towards peace in Vietnam or some
very bad economic news. I think that I would agree with
the blue book1/ that some technical upward adjustments in
long-term rates are a possibility, although some further
decline in rates could also develop, particularly if
there is a general move to a 5-1/2 per cent prime rate.
The bill rate, too, could tend to stabilize somewhere
around the discount rate, although some minor movements
above and below 4-1/2 per cent would not be particularly
surprising. As far as the credit proxy and other aggregate
measures are concerned, I believe that we should be very
cautious in interpreting the available measures because
of the tenuous nature of seasonal adjustments in this
period of rapid change in financial flows.
As you know, the Board staff is projecting an increase
in the credit proxy of about 9 - 11 per cent (annual rate)
for February, or perhaps somewhat less if Euro-dollar
borrowings by banks are taken into account. Our pro
jections at the New York bank would show a slightly slower
rate of growth, centering about 8-1/2 per cent. It would,
of course, be helpful to me in interpreting whatever
directive the Committee decides on at this meeting if the
members of the Committee would indicate their views as to
whether these expectations are roughly consistent with
1/
The report, "Money Market and Reserve Relationships,"
prepared for the Committee by the Board's staff.
2/7/67
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the policy posture they favor. I should emphasize that
while the blue book anticipates only a 2 per cent rise
in the credit proxy from the end of January to the end
of February, this result is heavily conditioned by the
forced postponement of the Treasury's cash financing and,
as the blue book notes, there should be a considerably
sharper expansion in early March.
Mr. Maisel asked the Manager about the latter's attitude, given
the Committee's directive, with respect to intervention in the market
at the end of a statement week to smooth small changes.
He
(Mr. Maisel) had been somewhat surprised, for example, by the matched
sale-purchase transactions the Manager had made in the recent period,
and he wondered whether it might not have been preferable to leave the
market to itself when it was moving in the direction the Committee
desired.
Mr. Holmes said that the problem, as he saw it, concerned the
speed with which the market was moving.
Thus, on Tuesday, January 17,
when the money market was extremely easy and net borrowed reserves for
the week appeared very low, participants were tending to interpret the
market situation as indicating that the Committee wanted easier
conditions than it in fact did.
The Desk decided to make some sale
purchase transactions on that day, and those transactions introduced
a note of caution into the market which he thought was consistent with
the Committee's intent.
On the following day unexpected pressures
developed in the market after West Coast banks had suddenly terminated
their dealer lending operations.
In this situation the Desk reversed
2/7/67
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operations, supplying reserves through repurchase agreements.
In
short, on Tuesday the Desk absorbed reserves to give a signal to the
market and on Wednesday it supplied reserves.
Mr. Maisel said he questioned the philosophy that the market
had to be given day-to-day signals by the Desk.
Mr. Holmes replied that he did not hold to such a philosophy.
The Desk had remained out of the market over much of the recent
period, but there had been occasions when operations were considered
useful.
Mr. Brimmer noted that on the day to which Mr. Holmes had
referred a question had been raised on the eleven o'clock conference
call about the Committee's intent when it had authorized the use of
matched sale-purchase transactions last summer.
His feeling was that
the Committee had authorized the Manager to enter into such transactions
at his discretion, and had not intended that they should be used only
under the temporary circumstances of the time.
Since there had been
some difference of opinion on the matter among those participating in
the call he thought the question should be brought to the attention
of the Committee.
Chairman Martin said his understanding was that the Committee
had authorized matched sale-purchase transactions and had not withdrawn
the authorization.
He then asked Mr. Holland to comment.
2/7/67
-14Mr. Holland noted that the Committee had initially approved
such transactions in July 1966 during the emergency for open market
operations created by the airline strike.
Subsequently the Manager
had engaged in such transactions on several other occasions when
temporary reserve excesses arose, and had kept the Committee informed
concerning their use.
Mr. Holmes said it was his recollection that several members
had commented on the usefulness of the device.
Mr. Hickman remarked that he had participated in the eleven
o'clock call recently and had the impression that the Desk had
intervened in the market in almost a minimal way in what was a
difficult and turbulent period.
While he had had some questions
about matched sale-purchase transactions when they were originally
proposed last July, he now thought they were useful.
In any case, the
Manager had made relatively little use of them in the recent period.
Chairman Martin said it was well that Mr. Brimmer had brought
up the subject.
If there was no objection, he would propose to have
the record show that matched sales-purchase transactions were an
instrument that could be used by the Desk in the regular course of its
operations.
No objection was made to the Chairman's proposal.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in
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Government securities and bankers'
acceptances during the period
January 10 through February 6, 1967,
were approved, ratified, and con
firmed.
Chairman Martin noted that a memorandum had been distributed
under date of February 1, 1967 regarding criteria for increasing
membership in the Federal Reserve network of reciprocal currency
arrangements.
(A copy of this memorandum has been placed in the
Committee's files.)
He invited Mr. Solomon to comment.
Mr. Solomon said the memorandum had been prepared in response
to the Committee's request at the meeting on November 22, 1966, when
the question of extending the size of the swap network had been dis
cussed and the central banks of four countries in particular had been
mentioned as possible additions--Denmark, Norway, Mexico, and
Venezuela.
The memorandum attempted to consider the more general
question and to develop for Committee consideration some systematic and
objective criteria for membership in the swap network that would be
readily explainable to countries both inside and outside the network.
In response to the Chairman's request for comment, Mr. Coombs
said it seemed to him that the paper Mr. Solomon and his associates had
prepared was a very good one.
His only comment related to the
discussion of possible disadvantages of enlarging the swap network.
the basis of the System's operating experience to date, he did not
consider the risks to be serious in connection with the first three
On
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2/7/67
possible dangers noted--namely, that new members of the network
might tend to hold fewer uncovered dollars; that many countries,
impelled by prestige considerations to seek membership in the network,
might attempt to demonstrate eligibility by appearing less willing to
hold uncovered dollar balances; and that any damping of fluctuations
in new members' reserves might increase public sensitivity to such
fluctuations as did occur and thus lead to unwise policies designed to
minimize even temporary fluctuations.
ment, were not very likely.
Such developments, in his judg
As to the fourth possible development
noted--that certain present members of the network would be dismayed
by a widening of the membership--Mr. Coombs thought that might well
occur, especially on the part of the Dutch, Belgians, and French.1/
With respect to the question of timing, Mr. Coombs noted that
the Danes and the Norwegians had already indicated interest in joining
the network and he hoped that an encouraging and sympathetic response
could be given to them with a view to bringing them in by the late
spring.
There seemed to be somewhat less urgency with respect to
Mexico and Venezuela, with whom the Treasury already had swap lines of
$75 million and $50 million, respectively.
1/ Two sentences have been deleted at this point for one of the
reasons cited in the preface. The deleted material consisted of
further comments by Mr. Coombs regarding possible attitudes of
members of the swap network toward a widening of the membership.
2/7/67
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Mr. Mitchell remarked that he thought the staff memorandum was
a valuable addition to background materials; it set forth some general
principles under which the Committee could proceed, and that would be
preferable to continuing to act on an ad hoc basis.
While the
memorandum did not go deeply into political questions, it was clear
that the Committee had to protect its swap network against political
attack to the degree possible, and one of the great advantages of the
memorandum was that it laid out a factual and theoretical groundwork
for protecting and justifying the network.
However, he would want to
consider adding another criterion to those listed for considering the
inclusion of particular countries--the volume of U.S. trade with the
country.
He had discussed that matter with Mr. Solomon, who did not
wholly share his view.
But it seemed to him (Mr. Mitchell) that in
terms of international relationships the trading partners of the United
States were more important to it than countries that happened to use
dollars in transactions.
Accordingly, he would like to see the tables
accompanying the memorandum expanded to include a table showing the
U.S. trading position with each of the countries listed.
With respect to Mr. Coombs' point on timing, Mr. Mitchell
thought that it would be well to initiate conversations with all four
of the countries that had been suggested.
He was not sure that the
Venezuelans were prepared to qualify, but the swap line they had with
the Treasury did not strike him as a substitute for membership in the
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2/7/67
Federal Reserve network.
On the whole, he was highly pleased
with the staff memorandum and hoped that the Committee would give
it favorable consideration.
Mr. Wayne said he would not attempt to substitute his
judgment for those who had spoken, but he was not persuaded by
the staff memorandum that there was justification for extending
the network aside from the political considerations, and he had
some reservations about extending the network for political
reasons.
Accordingly, he would like to see more discussion of
the justification for adding countries.
Mr. Robertson indicated that his view was similar to
Mr. Wayne's.
He thought the criteria developed in the memorandum
represented a long step forward on a path the Committee should be
exploring.
However, he also thought that in a matter of this kind
the Committee should move slowly since its steps, once taken, could
not be easily retraced.
While criteria could be adopted which at
the moment seemed to eliminate certain countries, if the network
was broadened somewhat there was likely to be great pressure to
include countries that did not meet the criteria.
The Committee
should give careful consideration to the hazards involved in
broadening the network.
Mr. Daane said that while he thought the points Mr. Robertson
had made were valid, the advantages of expanding the network seemed
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2/7/67
somewhat stronger to him than stated in the memorandum.
As the
recent discussions of the whole area of monetary reform had progressed
the concept of participation had been broadened and the matter was
now viewed as a responsibility of all members of the International
Monetary Fund.
The U.S. position throughout the discussions had
been in favor of a wider rather than a narrower concept in terms of
participation, and expanding the swap network would be supportive
of this.
There also would be advantages to expanding the network
in terms of the System's operations, and he did not regard those
advantages as merely political.
Every country merited equal consider
ation in deciding whether it met the criteria established for member
ship.
He would favor moving slowly when new ground was being broken,
but he did not think this was entirely new ground.
He thought the
Committee should consider the memorandum favorably.
Mr. Hayes said he found himself of much the same view as
Mr. Daane, although he recognized the reasons for caution in expanding
the network.
The considerations advanced by Messrs. Solomon and
Coombs did not strike him as essentially political in nature.
They
were economic considerations, and there was a real logic for including
more countries on purely economic grounds.
The basis on which one
negotiated with individual countries might well differ in each
instance, and he personally did not feel qualified to say that
negotiations should proceed rapidly with one country and slowly with
2/7/67
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another; he would prefer to leave such decisions to the staff
members operating in the field from day to day.
He agreed with
Mr. Coombs' point about the Scandinavian countries; he thought
there was some advantage to having additional European countries
in the network that were not members of the Common Market.
had nothing against inclusion of Mexico and Venezuela.
He
It should
be recognized that inclusion of two Latin American countries would
raise some question in the minds of others, but there were so few
that were likely to qualify that he did not think the problem would
be serious.
He had a generally favorable view of the matter.
Mr. Brimmer said he supported the expansion of the swap
network.
He agreed that it was wise to have additional European
members, but he thought it might be particularly useful to the
United States to have western hemisphere countries in--especially
Mexico, which evidently could meet the criteria and might be willing
to join.
He wondered if the subject had been discussed with the
Treasury Department and, if so, whether they had any attitude toward
it.
Finally, while he agreed with that part of the second proposed
criterion which read, "The central bank, with its government's
approval, .
.
. should be prepared .
.
to exchange relevant informa
tion freely and frankly, without diplomatic participation and inter
vention," he hoped it would be agreeable to the Committee for the
diplomats to be kept acquainted with the negotiations.
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2/7/67
Mr. Coombs said he had held only brief discussions with the
Treasury on the subject.
It was his impression that the Treasury
would like to continue its swap arrangements with Mexico and
Venezuela, but that it would have no objection to the inclusion of
those countries in the System's network.
In general, he thought
the Treasury would support the proposal.
It was also his impression
that the proposal would be warmly welcomed by the central banks of
Mexico and Venezuela.
On the point that had been raised regarding political aspects,
Mr. Coombs continued, he felt sure that the approach that had been
made by the Governors of the Banks of Denmark and Norway had no
political overtones.
1/
Mr. Mitchell said that in his earlier reference to political
aspects he had meant to employ that term in a broad sense.
He viewed
the System's relationships with all central banks as basically banking
relationships.
But those relationships tended to shade into the
political area, and it was with that political periphery that he
thought the Committee had to be concerned.
It seemed to him that
if the network of central bank relationships was well conceived the
1/ A sentence has been deleted at this point for one of the reasons
cited in the preface. The sentence reported a comment by Mr. Coombs
regarding the attitudes of certain other central banks in recent
negotiations.
2/7/67
-22
political infringement would be minimal.
The network should have
a basis--a justification and a logic--which made it immune to political
attack.
Mr. Wayne noted that he had raised the question of justifica
tion, but he would add that he was not objecting to enlargement of
the network.
It seemed to him that the principal responsibility for
broadening international liquidity lay with the IMF and with Govern
ments, and that when the System entered into swap arrangements it
should do so with the recognition that its prime responsibility was
to protect the interests of the United States.
He would like to see
a somewhat better case made for extending the network in terms of
the nation's interests.
Mr. Daane said that the two matters to which Mr. Wayne had
referred were quite separate and distinct.
The liquidity discussions
in their present form were concentrated largely on the construction
of a new reserve asset, which presumably would take its place along
side gold and currencies in international reserves.
The swap network,
on the other hand, was designed to deal not with the basic problem
of growth in reserve assets but rather with volatile flows that might
prove upsetting to the U.S. dollar in the first instance and to the
functioning of the whole international monetary system in the second.
He thought the basic question at issue with respect to any proposed
2/7/67
-23
swap arrangement was the contribution it would make to the protection
of the dollar.
Mr. Wayne responded that he had seen no evidence to indicate
that swap arrangements should be made with Mexico or Venezuela on
the basis Mr. Daane had mentioned.
Chairman Martin said that the staff paper struck him as an
excellent contribution.
Personally, he had been leaning toward the
view that the System's network should be broadened when it was
possible to do so.
He thought the swap network was one of the distinc
tive achievements of the System, but Mr. Robertson's point that the
Committee should move slowly in broadening it was a good one.
If
Mexico and Venezuela were included there would be pressures to add
other countries.
On a matter as important as this he thought it
would be desirable for the Committee to consider today's discussion
as preliminary in nature and to withhold action pending further consid
eration.
He would not want to hamper negotiations but since there
were differences of opinion he suggested that the Committee postpone
action until its next meeting to give members time to study the issues
further.
Mr. Scanlon said that he favored enlarging the swap network,
but he questioned whether the Committee could rely on the staff
memorandum alone to provide the basis for decisions with respect to
particular countries.
The various criteria were well outlined in
-24-
2/7/67
the paper and the disadvantages and advantages of enlarging the network
were noted.
However, he thought that the basis for selecting the
particular cut-off points mentioned--in terms of reserves, foreign
trade, and so forth--was not sufficiently documented.
The Committee
had to justify those cut-off points; otherwise it would be in the
position of simply selecting points that would admit the particular
countries it wanted to include in the network.
He recognized, of
course, that an element of judgment would be involved in any cut-offs.
Mr. Solomon replied that the cut-offs noted in the memorandum
had, indeed, been deliberately selected to include the four countries
in question.
The purpose for doing so was to determine what other
countries would be eligible on criteria that included those four
countries.
Mr. Scanlon agreed that the memorandum had made that point
quite clear.
Nevertheless, he believed that further consideration of
the criteria was required if the Committee was to be able to defend
them.
Mr. Solomon said the staff could undertake to prepare papers
on each of the four individual countries for the Committee.
He did
not know whether it would be possible to complete all of the papers
before the next meeting, but as many as possible would be done by
that time.
Chairman Martin said he thought it would be useful to have as
many such papers as possible.
He repeated his suggestion that a
2/7/67
-25-
decision on expanding the network be held over in the hope that final
action could be taken at the next meeting.
There was no disagreement with the Chairman's suggestion.
The staff economic and financial report at this meeting was in
the form of a visual-auditory presentation.
(Copies of the charts
have been placed in the files of the Committee.)
The introductory portion of the review, presented by Mr. Brill,
was as follows:
Each year at about this time, the staff presents to
the Committee an analysis and critique of the GNP projec
tion underlying the Administration's budget. Some of the
problems we encounter remain the same from one year to
the next. For example, the official projection, as
published in the Economic Report, does not include sufficient
detail on the quarterly time path or on expenditure
components to permit a close assessment of the financial
implications of the model. As usual, we have supplied these
details--in close consultation with the Council--and
believe the patterns are reasonably accurate, even though
unofficial.
What is new this year is the role that monetary policy
is given in achieving the economic levels forecast by the
Administration. Although the press and business journals
have apparently done a better than usual job in describing
the official economic outlook, what hasn't been made clearas far as I know--is just how much monetary easing would be
required to keep the economy on the growth path envisaged
by the Council. This is the focus of the staff's analysis
this morning. The state of the art limits us to rather
rough approximations, but our estimates of financing needs
are probably close enough to provide a reasonable basis
for evaluating alternative long- and short-run strategies
for monetary policy.
The first step in the process is a detailed examination
of the official model to delineate critical expenditure areas
and timing patterns. Mr. Koch will begin the analysis.
2/7/67
-26Mr. Koch then commented as follows:
The economic model underlying the Administration's
budget assumes a rise in GNP of almost $50 billion over
the year ending in the fourth quarter of 1967. The
increase projected by the Council of Economic Advisers
amounts to about 6-1/2 per cent--significantly smaller
than the gain over the preceding year.
In constant dollars, or real terms, however, growth
is expected to maintain the 4 per cent rate of the past
year, with price increases accounting for a smaller part
of the rise in current dollar GNP. Average prices of
goods and services, as reflected in the deflator, are
assumed to increase about 2-1/4 per cent during the year.
The pace of activity slows decidedly in the first
half of 1967, with quarterly GNP increases averaging
$9-1/2 billion, well below the average in 1966. The
weakness, however, is relatively short-lived. After mid
year, activity is expected to accelerate briskly and by
the end of the year GNP gains would approach the very
large gains of late 1965 and early 1966. In contrast to
last year, Federal defense expenditures slow down during
1967, and expansion in private expenditures becomes the
decisive factor sustaining economic growth.
The first half slow-down results mainly from a sharp
decline in the rate of inventory buildup and a reversal of
the uptrend in stock-sales ratios. In the fourth quarter,
business inventory accumulation climbed to an annual rate
of $15.6 billion--a new postwar peak--and the stock-sales
ratio rose to the highest level since mid-1961.
A downward adjustment in inventory investment thus
seems likely, particularly in view of the slowing in
private final sales late last year, and the smaller advance
in prospect for defense spending. The decline in the rate
of inventory accumulation projected in the CEA model
continues until mid-year. The stock-sales ratio recedesbut not to the low of early 1966.
The reduced growth of GNP in the first half, though
mainly the result of the dropoff in inventory accumulation,
also reflects a slackening in Federal purchases. But the
substantial step-up projected by the CEA for private final
sales (including purchases by State and local governments)
prevents the first half from being considerably weaker. A
rapid turnaround in residential construction expenditures
2/7/67
-27-
and substantial gains in consumption provide the major
impetus for the growth in final sales.
This bullish outlook for private final sales permits
the speedy cleanup of excess inventories. Postwar
inventory adjustments generally have been sharp, and have
acted as a drag on private final sales and over-all
economic expansion for several quarters. In 1957-58, for
example, the adjustment in inventories occurred from lower
levels of accumulation, but private final sales leveled
off. In 1967, by contrast, final sales are projected to
accelerate. Even during the inventory adjustment of the
Korean War period, private final sales advanced less than
in the 1967 projection, and inventory investment turned
negative before the adjustment was completed.
In the Council's model, housing is one of the most
important sources of stimulus for expansion during 1967.
The expectation is that housing starts and residential
construction expenditures will begin to rise soon,and
accelerate after mid-year. By the fourth quarter, housing
starts are back to a 1.5 million annual rate, and expendi
tures have almost completely recovered the sharp decline
in 1966.
Consumption also rises briskly in the first half,
following a pronounced lag at the end of 1966. Gains in
the last half continue sizable, as the contractive influence
of the mid-year income tax increase is offset by higher
social security payments. Growth in consumption for the
year exceeds last year's increase. Higher spending is
concentrated in nondurable goods and services--autos and
other durables are expected to show little change.
This optimistic view of consumer spending depends,
in part, on a continued growth in disposable income about
as fast as in 1966. But consumers also spend a somewhat
larger portion of their after-tax income, and the savings
rate declines in the last half to the low rate of 4.7 per
cent.
Business fixed investment, on the other hand, would be
a relatively neutral influence in 1967. It shows only a
small further rise early in the year and then stabilizes.
This ends the remarkable 5-year expansion which raised
fixed capital outlays to the highest share of GNP in the
postwar years. Termination of the investment boom is
consistent with expectations of declining profit margins
and reduced capacity utilization. As a share of GNP,
business fixed investment would decline moderately.
2/7/67
Our staff projections of GNP in the first half,
shown in the green book 1/, are less optimistic than those
of the CEA. For inventories and Federal purchases, our
projections are close to those of the Council. But we
are not persuaded that private final sales will rebound so
vigorously that they offset much of the drop in inventory
accumulation.
Turning to major components of private final sales, we
do not look for a sudden surge in consumption. Certainly,
there is no evidence of it in recent retail sales figures
or in surveys of consumer spending plans. Nor are we as
optimistic as the Council concerning the speed of the
recovery in residential construction, where we expect
the increase to be delayed until the second half. Despite
the rapid revival in savings flows to thrift institutions,
getting a housing boom under way takes time. Finally, we
are somewhat less sanguine about business fixed investment
over the near-term. In our view, all this adds up to a
slower growth in final sales over the first half.
Even if we accept the Council's more optimistic first
half estimates, and then translate their GNP figures into
changes in physical output and capacity use, we find that
the increase in manufacturing production slows appreciably
this year. Output would not increase in the first half,
and the moderate gain after mid-year would raise the
production index only about 3 per cent for the year. With
capacity continuing to grow, the utilization rate would
fall to 87 per cent by the fourth quarter--the lowest level
since late 1964.
Unemployment, however, would remain about as low as in
1966. For while employment gains in manufacturing would be
small, substantial increases in service expenditures, State
and local government purchases, and residential construction
would generate strong demands for labor in these industries.
Labor force growth this year, moreover, is expected
to be more in line with normal trends, in constrast with
last year's extremely large increase. The decline in labor
force growth would be reflected in a smaller increase
this year in employment, since unemployment is projected
to remain relatively stable. Even though the projected
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
2/7/67
-29-
increase in the Armed Forces is less this year, the gain
in civilian employment would also be much smaller.
Mr. Wernick, turning first to the wage and price implications
of the projections, continued the presentation as follows:
Last year's sharp increase in hourly compensation
was not unexpected in the context of high over-all
demands, rising consumer prices, and a tight labor
market. Wage gains after mid-year generally followed a
5 per cent pattern. Meanwhile, productivity growth in
manufacturing slowed, and there was little further gain
in output per manhour after mid-year. Unit labor costs
then began rising faster, and in the last quarter of 1966
were 2.7 per cent higher than a year earlier.
As we interpret the labor market implications of the
Council's projection, we see little basis for expecting a
change in the trend of hourly compensation, despite some
easing in industrial employment indicated for the first
half. Lagged effects of last year's consumer price
increases, together with higher minimum wages, point to
continued gains of 5 per cent or more in hourly compensa
tion. With capacity utilization declining, while
manufacturing output grows slowly, a sharp increase in
output per manhour does not seem likely to us, so we are
projecting only a moderate rise. Consequently, unit
labor costs should advance about as rapidly as in the
latter half of 1966.
The upward movement of wholesale prices slowed late
in 1966, as the influence of improved supplies--for
foodstuffs and a number of sensitive materials--outweighed
cost pressures on industrial commodities.
In the consumer sector, prices of foods began to
decline in the fall, and the rise in the consumer price
index then slowed appreciably. But demand and cost
pressures remained strong for the broad spectrum of con
sumer services, and these prices continued to rise at a
5 per cent annual rate.
Favorable developments with respect to food prices
and materials, together with some slack in capacity use,
might continue to offset upward cost pressures on
But with
industrial prices--in the early months of 1967.
profit margins under pressure, and the pace of activity
accelerating in the second half, it seems optimistic to
2/7/67
-30-
assume that the rise in prices can be kept close to 2
per cent during 1967, if economic activity does advance
in line with the Council's projection.
As we noted earlier, the Council's model has the
economy bouncing back quickly from the inventory
adjustment of the first half. But the deficit in the
Federal budget is not the principal factor accounting
for the speed of the recovery. The quarterly pattern
for the national-income-accounts deficit projected by
the Council does suggest some fiscal stimulus during
the first half, but the deficit in this period stays
close to the fourth-quarter 1966 level. Thereafter, it
tapers off, and turns into a small surplus by early 1968.
The declining deficit after mid-year partly reflects
the slower advance of expenditures following the large
rise proposed for social security benefits in the third
quarter. Subsequently, expenditures rise more slowly
than in 1966, mainly because of the moderated expansion
in defense spending.
Receipts, meanwhile, are bolstered by continuing
growth in private incomes and scheduled tax increases.
The effect of the Administration's income tax proposal
is concentrated in the third quarter, when receipts rise
rapidly. Social security taxes also advance in January
1968.
If fiscal policy provides so little of the impetus
to the second-half acceleration in GNP growth, what, then,
accounts for the quick and vigorous recovery from the
inventory adjustment?
The Council appears to assign the strategic role to
easier monetary policy in its assessment of economic
performance in 1967. The rebound foreseen for the second
half would be unlikely unless private final sales responded
promptly and strongly to measures of monetary ease.
Business incentives to invest in fixed capital would be
weakening in the first half, but ample availability of
credit at low costs could be an important sustaining
factor. Also, consumer spending has recently been
sluggish, but here, too, the cumulative effect of last
year's credit restraint may still be taking its toll.
It is in the housing sector that dependence of the
Council's projections on monetary easing is most clearly
evident. Starts must turn up soon, retrace last year's
abrupt decline, and reach 1.5 million units by the fourth
quarter. Residential construction expenditures also
2/7/67
-31-
recover most of the 1966 decline. The implication is
clear: mortgage funds must soon become cheap and readily
available. Monetary ease sufficient to stimulate this
rapid recovery in housing would, of course, directly
affect other types of spending, such as business fixed
investment and consumer durables. And since increased
expenditures in these areas would raise incomes and
output, there would also be an induced increase in
spending, especially for consumer goods and inventories.
We conclude, therefore, that the financial
assumptions underlying the Council's GNP model imply a
return to conditions in the mortgage, and in other credit
markets, broadly similar to those prevailing, on average,
during 1965. This conclusion provides the basis for our
financial projection, which will be presented by Mr. Gramley.
Mr. Gramley commented as follows:
The financial conditions implicit in the Council's
GNP model suggest the likelihood of a rise in borrowing
relative to net investment. Last year, even though net
investment outlays rose, household and business borrowing
declined. Tight money took its toll in private credit
expansion, especially in the last half.
In 1967, net investment in the CEA model drops
abruptly, mainly because of reduced inventory accumulation.
Nevertheless, our financial projections suggest that if
the investment total were realized, borrowing would stay
close to last year's level, narrowing the gap between
investment and borrowing.
The increase in borrowing relative to spending occurs
mainly in household use of mortgage credit. Mortgage money
must be amply available to finance new construction, and
also to meet pent-up credit demands to finance existing
property transactions. The ratio of mortgage borrowing to
housing expenditures, which fell precipitously in 1966,
thus is projected to rise toward the 1964-65 peaks.
Corporate borrowing was also limited last year by
severe restrictions on the availability of bank loans,
and corporations made deep inroads into liquid asset
holdings late in the year. Some liquidity rebuilding
seems in prospect. Thus, corporations are projected to
borrow about as much in 1967 as in 1966, even though their
investment in real assets is lower and their gross retained
2/7/67
-32-
earnings higher. Borrowings would be especially large in
the first half, when the final instalment on accelerated
tax payments is made, but would tail off in the final six
months.
This half-year pattern shows up mainly in bank loans,
which are projected to rise somewhat more in the first
half than in the same period of last year. Loan growth
slows appreciably in the second half, when the stimulus
of tax borrowing is withdrawn, and inventory accumulation
is quite low. The projection also calls for another big
year for bonds and stocks, since corporations seem likely
to stretch out debt maturities this year to improve their
liquidity positions.
In sum, funds raised by private nonfinancial
borrowers during all of 1967 are projected at about last
year's average level. Credit expansion would once again
be higher in the first half, but with mortgage borrowing
rising over the year, the half-year pattern would be
less uneven than in 1966.
Total Federal borrowing, including sales of partici
pation certificates indicated in the budget, would be about
$9 billion for the calendar year, compared with $7 billion
in 1966. And perhaps it would be well to recall that the
Federal deficit often turns out to be larger than depicted
in the January budget document. Foreign borrowing, as
measured in flow of funds accounts, is projected to
increase, reflecting easier domestic credit conditions.
This total of funds raised is substantial--a bit
larger than the advanced levels of 1965 and 1966. High
rates of credit expansion would be required at banks and
other financial institutions to make this amount of funds
available on favorable terms.
To stimulate residential construction, an abundance
of funds must flow into nonbank intermediaries specializing
in housing finance. Inflows of shares and deposits to
savings banks and associations would have to be restored
to about 7 per cent--or near the 1965 pace. Marked
improvement has already occurred--in December, the net
inflow equaled the 7 per cent annual rate projected for
all of 1967. Special factors influenced December gains,
however--including larger interest credits, a high
fourth-quarter savings rate, and a return flow of money
transferred earlier to the securities markets. Maintaining
this growth rate through all of 1967 would likely require
some further widening of the yield spread between market
instruments and savings shares.
2/7/67
-33-
In the banking system, the amount of credit expansion
consistent with a significant thawing in lending policies
depends importantly on bank desires to rebuild liquidity.
The ratio of securities to total earning assets has
declined markedly in recent years, to about one-third
by the end of 1966.
Growth of total loans has been quite rapid through
out this long period of economic expansion. Last year,
loan growth fell below the extraordinary 1965 pace, but
the growth of total bank credit fell even more, and
security holdings were reduced for the first time since
1959. Moreover, bank attitudes toward liquidity were
colored by the discovery that CD's could not always be
counted on as a source of reserve adjustment.
Our projection calls for banks to rebuild liquidity
somewhat during 1967 as an accompaniment to relaxing
loan policies. The projected improvement in the ratio
of securities to earning assets is small, but--with loan
growth projected at nearly $17 billion--a $10 billion
expansion in security holdings would be needed to
accomplish it.
Total bank credit would thus have to rise by $27
billion--about a 9 per cent rate--for the full year.
Growth would be largest in the first half, in line
with the more rapid expansion of credit demands during
this period.
The accompanying deposit expansion would likely
be registered principally in bank time deposits. The
projected rate of 13 per cent is below that for 1965when interest rates on time deposits rose sharply--but
well above the rate for 1966. This year, accelerated
growth would be stimulated mainly by the decline in
market interest rates relative to those on time deposits.
Time deposit expansion has already achieved a 17 per
cent annual rate in January, but this high rate reflected
shifts of existing assets from the money market accompanying
the sharp decline in short-term market yields, and is not
expected to continue. Offering rates on CD's recently
have been cut back, and the weekly gain in CD's at
New York banks last week was moderated.
Expansive policies giving rise to rapid time deposit
growth would, of course, reduce interest rate incentives
to economize on money holdings, and money stock growth
would accelerate also. Our projection of a 4-1/2 per
cent growth rate in 1967 represents a rough judgment,
2/7/67
-34-
based on recent experience, as to how the public might
distribute its deposit increase between demand and
time deposits. With this distribution, bank reserves
would have to increase by about 7 per cent to support
the deposit expansion.
Sources of funds supplied to borrowers would be
altered appreciably by these large inflows to commercial
banks and nonbank intermediaries. The bank share would
return to 36 per cent, or close to the 1965 level, while
the share supplied by nonbank intermediaries would also
recover the ground lost in 1966. As usual, the offset
would be a marked reduction in the share supplied by the
nonfinancial public directly to credit markets through
security purchases.
This decline in the public's share, in our projection,
does not reflect the attraction of increased rates on
savings deposits pulling funds from the securities markets.
Average yields on deposits and shares are not likely to
change much this year, apart from downward adjustments
in CD rates. The reduced attractiveness of market secu
rities would thus reflect reductions in their yields.
Market interest rates already have declined abruptly
from last fall's peaks. In the long-term securities
markets, expectations have been a fundamental factor, and
a continued high rate of bank credit expansion would likely
be needed to validate the decline that has occurred.
Nevertheless, it seems probable that interest rates would
have to fall further to be consistent with the GNP model
and our financial flow projections.
As a rough judgment, rates on long-term marketable
securities--represented here by corporate new issues--might
have to fall by another 25 basis points, or more, to about
4-3/4 per cent--by mid-year or earlier. For three-month
bills the drop in rates might well be greater, since the
present yield curve is less steeply sloped than is customary
for a period of easy credit markets. A range around 4 per
cent for bills would be consistent with the long rates
projected, but the shape of the yield curve would be affected
importantly by the Treasury's debt management policies this
year.
Mr. Reynolds will continue the presentation, focusing
on the international implications of the GNP model and the
financial projection.
2/7/56
-35Mr. Reynolds then commented as follows:
The easing of domestic credit conditions that has been
described would significantly affect international capital
flows, although the IET and the voluntary restraint programs
should help insure that outflows of U.S. private capital
will not mushroom as in 1964. Net outflows into direct
investments and foreign securities may not change much. But
bank credits to foreigners could easily swing from last year's
$300 million reflow to an outflow of $1/2 billion this year,
even if European financial markets continue easing.
In total,
net outflows of U.S. private capital are likely to increase
by roughly $1 billion, mainly reflecting the swing in bank
credit.
Short-term borrowing abroad by U.S. banks through their
foreign branches would be even more strikingly affected by
domestic financial ease. Liabilities to foreign branches
tripled last year, rising by $2 billion in the second half
alone, when the U.S. financial squeeze was tightest and when
funds were being shifted out of sterling. We expect a
substantial reduction in these liabilities this year--part
of which has in fact already occurred. Mere cessation of
last year's inflow represents a change in flow of $2-1/2
billion. To the extent that liabilities to branches decline,
the change, and the resulting deterioration in the official
settlements balance, is that much greater.
For transactions in goods and services, the Council's
GNP model suggests a marked improvement this year, in con
trast to the worsening on capital account. Exports of
goods and services should continue rising despite slackened
demand from Canada, Britain, and Germany during the first
half; shipments to Japan and to nonindustrial countries will
be expanding vigorously.
The rise in imports of goods and services slackened
at the end of 1966. Total imports should decline in the
first half of this year because merchandise imports will
decline. In the second half, however, merchandise imports
and the total will be rising again.
The favorable balance on goods and services should
increase during the year; but it will be flattening out at
year-end, at a rate about $2-1/2 billion higher than in 1966
but $1 billion below the peak attained in 1964.
Merchandise imports will decline during the first half
mainly because of the effects that reduced inventory growth
These imports
will have on imports of industrial supplies.
2/7/67
should temporarily fall almost as much as they did
in 1960-61. Imports of nonfood consumer goods should
level off; much of the recent rise has reflected
adjustment by automobile companies to the 1965 agree
ment with Canada. Imports of capital goods should
also level off as domestic pressures on capacity
diminish.
Results of our projections for 1967 within the
Council's framework thus include an improvement of about
$2 billion on goods and services, and a $1 billion increase
in net outflows of U.S. private capital. There could also
be a decline of $1 billion in net inflows of foreign non
liquid capital. Investments by foreign official and
international agencies in nonliquid U.S. assets may be
more difficult to arrange this year. Also, debt prepay
ments may be smaller.
In terms of the over-all balance, these and other
minor changes add up to a probable enlargement of the
liquidity deficit this year. Of longer-term importance,
if domestic demand is advancing as swiftly by year-end as
the Council anticipates, and especially if prices and costs
rise more than it anticipates, the improvement on trade
might be relatively short-lived.
The balance on official reserve transactions would
shift from last year's small surplus to a large deficit.
For 1966 and 1967 together, the average deficit on
reserve transactions might be roughly $1-1/2 billion,
which would be about the same as in 1964 and 1965. The
ballooning of this deficit in 1967 could imply another
substantial drain on our gold reserves, depending on
which countries gain reserves.
Mr. Brill will now discuss the implications of
the projections for Federal Reserve policy.
Mr. Brill's concluding remarks were as follows:
Let me first underscore, as we often have, that
the state of the forecasting art is still primitive,
especially with respect to changes in relationships
between financial variables and GNP. Nevertheless,
our estimates strongly indicate that realization of the
Council's GNP model would call for still easier conditions
of bank credit and in credit markets than have developed
since the turn in policy last year. The strategic question
facing the Committee is whether policy actions should be
2/7/67
-37-
directed towards creating this further ease in the
months ahead, and in particular, whether continued
policy easing is appropriate at the moment.
A case can be made for pushing further at this
time. Our own projections of GNP for the first half
are, as noted earlier, less bullish than those of the
Council. But neither of us is projecting the weak
economic picture often associated with periods of
inventory adjustment. Final sales often weaken more
than is suggested here when declining inventory
investment leads to production cuts and income loss.
It is much too early to conclude that this prospect
can be ruled out. The production index was down in
January--perhaps by a full point--and retail sales
did decline. Monetary hesitation now, therefore,
still runs the risk of results that are too little
and too late.
But there also are serious risks running the
other way. It appears to us that output per manhour
will increase slowly next year. With increases in
hourly compensation of at least 5 per cent, there
could well be significant upward pressure on costs.
In the climate of rapidly expanding activity pro
jected by the Council for later this year, incentives
would be strong to pass through these cost increases
to prices.
Cost and price increases could cut short the
recovery anticipated in our trade balance, so essential
in light of the expected worsening in U.S. capital
accounts this year. De-escalation of the international
interest rate war is not a complete guarantee that
monetary policy can ignore balance of payments constraints.
Finally, the odds must be carefully weighed as to
whether fiscal policy will develop along the lines envisaged
by the Council. We adhere to our position that military
and budget officials are in a better position than central
bankers to gauge the probable trend of defense expenditures.
Nevertheless, barring an end to active hostility in Vietnam,
the official estimates are undoubtedly best regarded as
minimum estimates.
Uncertainty with regard to passage of the tax proposal,
and its implications for the deficit, also raise questions
for monetary policy. Instead of a decline in the Federal
deficit after mid-year, there would be a significant increase
if the tax proposal were not passed.
2/7/67
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Prospects for passage of the tax bill will depend
partly on the course of economic events in the first half.
In the context of the slower growth projected by the Council
during this period, Congressional approval is by no means
certain. If our own weaker first-half forecast materializes,
the chances of passage are even smaller.
Failure to pass the tax bill would, of course, change
greatly the economic outlook for the second half. With the
monetary easing stipulated earlier, omission of the 6 per
cent surcharge would mean significantly more rapid GNP
growth in the third and fourth quarters of this year and
into 1968.
On balance, then, it seems to us that there are
several critical aspects of the CEA projection with which
forecasters' judgments may differ, with consequent differences
in policy prescription. On the one hand, the projection
could be overstating the strength of the economy in the winter
and spring, and it could be overstating the vigor of the
rebound after mid-year, particularly in consumers' willingness
to spend. But on the other hand, the CEA could be overoptimis
tic about the likelihood of additional fiscal restraint, and
even with a tax increase, the projection may be underestimating
the potential for cost and price pressures emerging later in
the year and into 1968.
Weighing the risks involved, it would appear to us
that a prudent longer-run strategy for monetary policy would
be to continue to work toward ease, but to stop somewhat short
of the conditions called for in a strict interpretation of the
CEA model. We don't want to carry ease so far as to require
another severe wrench to the financial structure later in the
year if our GNP forecasts have to be modified.
With respect to shorter-term developments, the speed
of adjustment in financial conditions we've had over the
past two months is somewhat frightening to an economist who
is not yet sure of the consequences of rapid changes in the
value of the community's financial wealth. This concerned
me last March, when rates were rising so rapidly, and the
converse worries me now.
Given the longer-term strategy just noted, and weighing
shorter-term concerns, the staff's view of an appropriate
policy decision today would be to hold the line on financial
conditions until the next meeting of the Committee, while
intensifying efforts to assess the effects of recent monetary
2/7/67
-39-
easing on the real economy. As the blue book indicated,
holding the line over the next four weeks would mean
bill rates remaining in a 4.40 to 4.60 per cent range
and long-term rates hovering close to their current
levels. Marginal reserve availability would drop back
from the storm-induced peak, with net borrowed reserves
averaging close to $50 million over the period.
These market conditions would, we hope, be con
sistent with a bank credit proxy averaging about 10 per
cent higher in the month of February over the month of
January, although the rise would be much less on a
month-end to month-end basis. If deviations from the
money and credit conditions specified should begin to
emerge, I would argue that action should be prompt to
dampen tendencies of rates to move up. Any persisting
rise in yields could, at this juncture, inhibit the
trend toward liberalization in bank and thrift insti
tution lending policies before financing of a strong
spring building season is assured. But a persisting
downward pressure on yields accompanied by shortfalls
from the projected banking aggregates could be signaling
a greater-than-expected weakness in basic demands for
both credit and goods, to which the System should respond
with generous reserve provision.
Mr. Ellis said that he understood from the presentation that
the staff questioned the Council's projection that the GNP deflator
would rise by a little over 2 per cent in 1967.
He noted, however,
that the green book projected a similarly reduced rate of increase
in the deflator, and he asked Mr. Brill to comment.
In reply, Mr. Brill noted that the green book projection
related only to the first half of 1967.
He did not recall at the
moment whether there was any significant difference between the
deflators projected for the first half in the green book and in
the Council's model.
However, what the staff questioned was the
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2/7/67
likelihood that the price rise could be kept close to 2 per cent
for the full year, and in particular, in the second half.
Mr. Swan noted that among the money market conditions the
blue book suggested might be taken as representing no change from
prevailing conditions was a Federal funds rate in the range of
4-3/4 - 5 per cent.
He asked whether such a range would not be
higher than that which had actually prevailed recently.
Mr. Axilrod said that such a Federal funds rate, if anything,
probably would be a shade lower than the recent average, if one
excluded the effects of the snowstorm in the Midwest on the figures
for the February 1 statement week.
In general, the complex of condi
tions to which Mr. Swan had referred reflected those recently prevail
ing, excluding the effects of the storm.
Mr. Hickman asked whether in his concluding remarks Mr. Brill
was recommending that interest rates should be permitted to ease if,
with net borrowed reserves around $50 million, bank credit failed to
expand.
Mr. Brill said he was suggesting that an easing in interest
rates associated with a failure of bank credit to expand as expected
would indicate that the economy was weaker than projected.
Under such
circumstances he thought that rates certainly should be permitted to
decline.
2/7/67
-41Mr. Mitchell asked whether his understanding was correct that
the staff projected a decline in bank loans in the first half of 1967.
Mr. Gramley indicated that that was not the case.
For the
full year 1967 the staff projected bank loan growth to be a little
slower than in 1966, but the increase indicated was still substantial.
The reduction from 1966 growth in the projection reflected relatively
weak demand for bank credit in the second half of 1967, associated
with the relatively low levels of inventory accumulation shown in
the Council's model, plus the ending of the stimulus to corporate
borrowing from the acceleration of tax payments.
Chairman Martin remarked that the chart show was highly
illuminating and he thought it was an excellent presentation.
The
Chairman then called for the go-around of comments and views on
economic conditions and monetary policy, beginning with Mr. Hayes.
Mr. Hayes commented that he also had found the presentation
illuminating.
He then made the following statement:
We find ourselves in one of those periods when
uncertainties in the business situation are very great,
or, as we sometimes express it, when "visibility" is
unusually low. Estimates of the probable strength of
the economy range over a fairly wide spectrum. But I
think the picture becomes somewhat clearer if we make
an effort to distinguish between shorter-term and
longer-term prospects.
The short-term outlook is bound to be strongly
influenced by the fact that the fourth-quarter accumula
tion of inventories was much greater than expected and
that inventories appear excessive in relation to sales
in a number of industries. Hence the main question
2/7/67
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facing the economy in the near term concerns the speed
and extent of the needed inventory adjustment and its
repercussions on other economic developments. The
momentum of the private economy may weaken further in
the next few months. A slowdown in the expansion of
total output is likely to continue or even to become
more pronounced, and there may perhaps be some slight
rise in unemployment.
However, while we cannot exclude the possibility
of a resultant deterioration in the whole business
climate, it seems much more likely that the underlying
forces in the economy are strong enough to absorb the
inventory drag relatively smoothly. Indeed, in the
latter part of 1967 the elimination of the inventory
drag and a vigorous revival of residential construction
could lead to another excessive rise in private demand.
I might say parenthetically that GNP projections made at
the New York Reserve Bank are very close to the Council's,
and perhaps a shade stronger for the second half of the
year. Already the housing indicators are pointing
upward, so that one very large drag on the growth of
the economy over the past few quarters seems about to
be reversed. Also, the boost that enlarged social
security benefits will give to consumer spending will
be considerable--more than enough to offset the impact
of the personal income tax increase, if the latter is
enacted. According to our analysis, the fiscal 1968
budget, while less stimulative than those of 1966 and
1967, will still provide greater stimulus to the
economy than did the budget in the early sixties when
large unused resources were available. Furthermore,
the stimulus is likely to be more pronounced in the
second half of calendar 1967, when private demand may
well be expanding more strongly than in the first half.
I hasten to add that the budgetary outlook is of course
full of uncertainties, including the major question as
to Vietnam developments, the possibility of additional
outlays for anti-ballistic missiles, and obvious questions
as to Congressional disposition of the Administration's
latest spending and tax proposals.
While the current business slowdown has moderated
price pressures, unit labor costs continue to rise, and
I think we all agree that the prospects are disturbing
with respect to possible excessive wage increases in
1967. This persistent danger of inflation has particularly
2/7/67
-43-
serious implications when we are banking heavily on some
considerable improvement in the trade surplus as a major
means of reducing our international payments deficit. It
may be worth noting that, without the benefits of special
transactions, our liquidity deficit in 1966 would have
approximated $3 billion, and on the same basis the annual
rate of deficit in the fourth quarter was around $5
billion. The need for improvement in our trade surplus
is highlighted by the evidence that some outward capital
flows have already been induced by the easier domestic
credit conditions and lower interest rates of the last
few months. For example, liabilities of U.S. banks to
their foreign branches are now substantially below their
mid-December peak; and a further reflux of these funds
would not be surprising, with the probable consequence
of growing pressure on our gold stock.
The very large rise in total bank credit in January
on a seasonally adjusted basis was attributable largely
to security acquisitions and loans to security dealers;
and business loans also rose more than seasonally. Opinions
differ among bankers on the probable strength of loan
demand in the coming months, but a majority of the big
New York banks expect to see ample lending opportunities.
Bank lending policies remain cautious despite some drop
in loan-deposit ratios. There is no doubt that many
large banks looked upon the Chase reduction in the
prime rate to 5-1/2 per cent as decidedly premature. I
believe many of them would not have initiated a move at
this time even to 5-3/4 per cent, although they found
that rate an acceptable compromise. One banker expressed
to me the view that the 5-1/2 per cent prime rate was
warranted only on the assumption that the Federal Reserve
System was planning an additional major policy move in
the direction of ease.
Expectations are playing a very big role in all
credit markets for the moment; and it would seem wise
under present circumstances for the System to avoid
feeding unduly the expectation of a further easing of
credit and a further major decline in interest rates.
It would be well to let the market settle down after the
sharp changes of the last month or two. We could easily
find ourselves a little later in the year faced with the
necessity of sharp back-tracking, with all the political
repercussions that might accompany such an effort. I
recognize that monetary policy should always enjoy
2/7/67
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flexibility, but to me that does not mean excessive
preoccupation with the immediate future to the exclusion
of serious longer-run problems. Moreover, the balance
of payments must remain an important consideration for
monetary policy and cannot simply be left to be taken
care of by specific Government restrictions. It is
clear that the year ahead will be difficult in this
area in any case, without compounding the problem now
through excessive monetary ease. Finally, as I have
already indicated, we have only a rather vague view at
this time of the over-all impact of the Federal budget
on the economy in 1967.
I feel, therefore, that we would do well to hold
to a steady policy at this time and refrain from further
easing. We are achieving our objective of a revived
growth of bank credit. In fact, the January rate of
growth would be clearly excessive if maintained for
several months running. The Board staff's projection of
9 to 11 per cent for growth of the credit proxy in
February is a bit in excess of our own projection and
is at the upper end of what I would consider a desirable
range. I would suggest keeping about the present set
of money market conditions, with the Federal funds rate
generally above the discount rate--perhaps in the
4-1/2 - 5 per cent range--and a Treasury bill rate
fluctuating around the discount rate but not consist
ently below it. This might mean small net borrowed
reserves, say in the zero - $100 million area, with
borrowings of $200 to $400 million. The Manager, however,
needs ample leeway to deal with conditions as they develop.
Having in mind our balance of payments problems, I can see
a real advantage in using coupon issues to supply reserves
and bills to absorb reserves--both, of course, within the
limits of practicability.
As for the directive, the staff's draft with
alternative A for the second paragraph seems to me
excellent.1/
Mr. Ellis commented that measures of physical production and
activity in New England suggested the economy was moving sideways or
1/ Alternative draft directives submitted by the staff
for Committee consideration are appended to these minutes
as Attachment A.
2/7/67
-45
expanding slowly.
Manufacturing output in December recovered part
of the drop since its October peak, influenced in part by a recovery
in shoe production.
Gains in nonmanufacturing employment lines such
as construction were enough to offset some fallback in output of
nondefense durable goods.
Several of the District's defense
producers had order backlogs substantially above year-ago levels.
The dominant development in the financial area, Mr. Ellis
continued, had been the changed or changing posture of bank lending
officers.
Having made substantial progress in rebuilding liquidity
and finding their time deposits rising, both mutual savings banks and
commercial banks in the District were in the process of re-energizing
their loan officers.
There soon should be some direct evidence as to
whether loan demand had depth and was just waiting to be recognized
or whether loan officers would have to move aggressively to put their
funds to work.
Now that the budget message with accompanying materials and
testimoney was available, Mr. Ellis thought it was possible to quantify
to some degree the expectations and differences in expectations that
underlay Committee members' approaches to monetary policy.
In that
respect, the staff's GNP projection for the first two quarters of
1967 performed a real service.
Referring specifically to the projec
tions as they appeared in the green book table, he counted himself
as somewhat more optimistic about the rate of GNP expansion--which
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2/7/67
was set at $7 billion in each quarter.
The Boston Reserve Bank's
analysis of the inventory situation suggested that the fourth
quarter bulge traced principally to a corresponding unusual bulge
in defense orders last June.
If so, delivery against those orders
would be reflected in a sharp expansion in the defense component of
Government purchases in early 1967--thereby adding to the $7 billion
increment forecast for GNP.
The high and sustained rate of personal saving projected for
the next two quarters would set a nine-month record that had not been
matched since 1958, Mr. Ellis said.
Personally, he would expect a
lesser rate of saving and a somewhat higher rate of consumer spending.
Alternatively, it might be statistically possible to achieve such
high savings rates if residential construction were to expand--but
here the projection again was for virtually a no-change plateau for
nine months.
He was more inclined to expect that greater availability
of funds would combine with some catch-up need and result in some
expansion in residential construction by the second quarter of 1967.
In short, he anticipated that GNP growth would exceed $7 billion in
each of the first two quarters of 1967.
One of the exogenous forces Mr. Ellis expected to be at work
to accelerate GNP growth would be the stimulative effect of greater
credit availability.
The sharp expansion in total bank credit in
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-47
December and January could be expected to continue, given the present
trend of policy, if the economy remained as strong as he judged it
to be.
Changed expectations coupled with the reserves the Committee
had supplied had set in motion a decline in rates, Mr. Ellis noted.
That run-off had proceeded to the point where the discount rate was
beginning to exert a drag slowing the downward trend.
To the extent
that the Committee sought to stimulate investment, especially home
building, such a rate decline should be fostered.
The rate decline
also served to reestablish some freedom of movement for CD rates
beneath the Regulation Q ceiling.
For those reasons, and to avoid the emergence of the discount
rate as a prop holding up market rates, it seemed appropriate to
Mr. Ellis to consider the policy possibilities of a reduction in the
discount rate.
There seemed little point in providing the reserves
that supported the rate declines while simultaneously impeding those
rate declines by retaining a discount rate level of 4-1/2 per cent.
In a strategy framework, lowering the rate soon would hasten the
stimulation of residential construction, which was needed.
By the
same token it would set up another avenue of policy action next
summer if needed to restrain an economy beginning again to overheat
in the possible absence of Congressional surtax action.
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2/7/67
Mr. Ellis commented that, even with the less optimistic outlook
projected in the green book, the accompanying projection of bank credit
in February was for growth at an annual rate of 10 per cent, continuing
the rate achieved since the Committee's November 1966 policy shift.
That rate of expansion seemed entirely sufficient, in his judgment.
At the same time, he would judge it entirely possible that the recent
trend of declining rates had not run its course.
Bill rates below
4.40 per cent and Federal funds rates near the discount rate would
not surprise him in the next four weeks.
All of that inclined him
to prefer alternative A of the draft directives.
Mr. Irons reported that, despite some differences, conditions
in the Eleventh District generally were following about the same
pattern as reflected in the nation as a whole.
Industrial production
had declined slightly and there had been further declines in
construction contract awards.
Retail trade, as reflected by depart
ment store activity, was off a shade, and automobile sales continued
to run below 1966 by a margin in the area of 10 per cent.
Employment
was up more than seasonally and the advance was rather general.
On
the whole, however, the recent changes were not highly significant.
Agricultural cash receipts were up about 5 per cent from a year ago
and prices received by farmers in the past month were about 7 per
cent above a year ago.
2/7/67
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Eleventh District banks apparently were under less pressure
than banks nationally, Mr. Irons said.
the turn of the year were suspect.
However, the figures around
Loans and investments were shown
to have declined, and time deposits had increased.
District banks,
on the whole, were somewhat more liquid than they had been a few
months ago.
There had been a moderate increase in CD's, and banks
reported that the demand for loans was perhaps a little less than
late last year.
Borrowings from the Dallas Reserve Bank had been
negligible in the last few weeks; with only a few country banks and
no large city banks coming to the window, average borrowings had
been running in the neighborhood of $3 million.
As to the national situation and policy, Mr. Irons thought
that his views were generally in agreement with those of Mr. Hayes
and with those reflected in the chart show.
The ease that had
characterized the market during the past month had certainly been
accompanied by a substantial growth in the monetary aggregates
and by a sharp decline in interest rates.
The question now was
whether the Committee should undertake further easing deliberatelyand if so how much; or whether it should attempt to maintain the
existing conditions in the money market over the next month and
observe developments.
He would favor attempting to maintain the
prevailing money market conditions.
If such a course were followed
he would expect that the Federal funds rate might be in a 4-1/2 - 5 per
cent range, the Treasury bill rate around the discount rate in a
2/7/67
-50
4.40 - 4.60 per cent range, and net reserves at zero plus or minus
$50 million.
He would like to see continued growth in the monetary
aggregates, but at a rate somewhat below that of the past three or
four weeks.
One reason he would advocate maintaining the prevailing
money market conditions for the time being, Mr. Irons continued,
was the possibility that the question of a change in the discount
rate would be raised increasingly in the market, the press, and so
forth, if the Treasury bill rate should decline to the discount rate
or lower.
He would not like to see a change in the discount rate at
this time, and he thought there would be less speculation regarding
a possible change under a policy of continuing prevailing money
market conditions than would be the case if there were further
deliberate and overt easing.
He would favor alternative A of the
draft directives.
Mr. Swan reported that economic conditions were relatively
good in the Twelfth District.
Manufacturing employment increased in
December for the fourth month in a row.
A very modest gain was
recorded in the category of aerospace employment, despite the first
month-to-month decline in some time in aircraft employment itself.
The labor force increased somewhat faster than employment, however,
and the unemployment rate rose by one-tenth of a point to 5 per cent.
2/7/67
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Mr. Swan commented that there had been very little change
in total bank credit at District weekly reporting banks from the
year-end through January 25, in contrast to the considerable decline
for the country as a whole.
However, the data were not seasonally
adjusted and there might be some differences in the seasonal patterns
in the District and the rest of the country.
Business loans had been
maintained very well, and reporting banks had increased their loans
to Government securities dealers substantially.
Rather surprisingly,
the banks had been able to buy sizable amounts of Federal funds for
relending to dealers at a profit.
The recent increase in CD's
outstanding had been less rapid than elsewhere, but the earlier
losses also had been smaller.
And, as elsewhere, reductions in
CD rates were being announced by larger banks.
There had been some recent stirrings in mortgage markets,
Mr. Swan continued, with reports of interest on the part of institu
tional investors of the types that traditionally bought mortgages
from banks.
As inflows to savings and loan associations increased
there had been scattered announcements of reductions in mortgage
interest rates, and at least one association had indicated that it
would no longer pay the high rate of 5-3/4 per cent on those special
three-year certificates for which such a rate was permissible.
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2/7/67
As to policy, Mr. Swan said he was in virtually complete
agreement with Mr. Brill's recommendations.
He was impressed by
the rapidity of the decline in interest rates and by the pervasiveness
of the decline which, to some degree, extended through almost all of
the rate structure.
Given the growth rates in the aggregates
experienced in January and projected for February, he would be
satisfied to see no change in prevailing money market conditions
until the next meeting of the Committee.
He would shade the targets
a little from those given in the blue book; specifically, he favored
net reserves in a range of plus or minus $50 million around zero,
and the Federal funds rate in a range of 4-1/2 to 5 per cent, or even
4-1/4 to 5 per cent.
With that interpretation, he would accept
alternative A of the draft directives.
As far as the discount rate was concerned, Mr. Swan said,
while it might be well for the System to start thinking about possible
action at some point, he saw no reason for such an overt action at
present.
In particular, he did not have the impression that at
4-1/2 per cent the discount rate was impeding declines in other
interest rates.
Mr. Galusha remarked that the Ninth District--the home of
the bank that had initiated the recent round of reductions in the
prime rate--wore its new mantle of pace setter for the U.S. banking
community with something almost approaching complacency, inconsistent
2/7/67
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as that might be with an only slightly lower level of expectations.
The strength in the agricultural sector caused by the high level of
cash farm income had sustained country bank positions and kept support
industry activity at reasonable levels.
Mortgage rates had turned down sharply, Mr. Galusha reported,
with a demand for portfolio paper appearing after the doldrums of
the last year.
Labor leaders in the Twin Cities were pessimistic
that the renewal of construction activity would occur fast enough
to prevent more than a seasonal rise in unemployment, particularly
with the drying up of the alternative employment opportunities in the
District such as interstate highway construction.
Some encouragement
could be found in the search for new and expanded credit lines by
the major tract builders for the upcoming season.
As to open market policy, it seemed to Mr. Galusha that the
Committee was now in a position where to hold steady was a reasonable
course.
Before dosing the patient again, it would seem no more than
appropriate to allow sufficient time for this ministration to work a
little longer.
He would not attempt to amplify on the comments
already made with regard to money market and reserve objectives.
However, he could easily vote for a "no change" directive, since he
believed the Committee might have already largely succeeded in one
of its basic objectives of the past few months--namely to foster a
considerable recovery, later this year, in residential construction.
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2/7/67
On that the green book was quite reassuring.
The spreads between
market rates and deposit rate ceilings were not too much different
from what they were through a good part of 1965.
In the present
context, that would seem to be the important point.
Mr. Galusha went on to say that a logical concern--shared
apparently by some of the blue book authors--was that somewhere along
the line the Committee would get a change in expectations and, unless
it acted decisively, another increase in market rates.
Yet it was
particularly important, what with recent experiences so fresh in
mind, that market participants be continually reassured about the
financial outlook.
He would thus like to see the Committee's concern
extend across the whole range of market rates.
With respect to the comments made on the discount rate,
Mr. Galusha hoped that the inquiry into reserve requirements conducted
last summer would not be overlooked and that plans for changes in
requirements would at least be in workable form for possible use as
an alternative means for signaling further ease, if such a signal
should be considered necessary soon.
He would favor alternative A
of the draft directives.
Mr. Scanlon commented that the past several weeks had seen
the development of increased caution in the Seventh District concerning
economic prospects for 1967.
Recent evidence of a marked turn in
monetary policy, as reflected in most banking data, however, was tending
2/7/67
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to offset any tendency toward outright pessimism.
Price increases
continued to be announced for a wide variety of hard and soft goods
and there prevailed an attitude that the general price level would
rise as much in 1967 as last year, mainly because of upward cost
pressures, especially wages.
There was a growing view that corporate
profit margins were narrowing, and that capital expenditure prospects
were dampened as a result.
He heard frequent reports of financial
managers putting pressure on purchasing agents to hold down or reduce
inventory investments even in cases where inventories were not large
relative to sales.
Evidence continued to mount that the capital expenditure
boom had lost momentum, Mr. Scanlon continued.
Orders for construc
tion machinery remained at a sharply reduced level and, more recently,
new orders for various types of industrial equipment had declined
markedly.
Cancellations of orders, however, did not appear to have
been significant.
of District output.
Defense work was taking a steadily increased share
Some firms reported that slack in civilian
demand was being absorbed by military orders.
With auto sales in
January about 15 per cent below last year, and with used car prices
weak, output schedules for the first quarter were being reduced.
Overtime and extra shifts were being eliminated in many plants.
American motors had laid off more than 4,000 workers indefinitely and
an additional 13,000 would be furloughed for 10 days later this month.
Nevertheless, the job market in the District continued very strong.
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2/7/67
December and January saw pronounced strength in savings and
loan share accounts, Mr. Scanlon said.
A number of large Chicago
associations had stated that net inflows in January were the largest
on record for the month, in contrast to a very poor showing a year
earlier.
A number of associations had announced cuts of one-quarter
of a per cent in rates on new mortgages.
Others, having improved
their liquidity positions, were said to be interested in buying
mortgages in the secondary mortgage market.
As a result, prospects
for home building in the District in 1967 appeared to be improving
more rapidly than expected a month or two ago.
Credit at large Seventh District banks showed a contraseasonal
rise in January, Mr. Scanlon observed.
Much of the contraseasonal
gain in business loans at District banks was concentrated in machinery
manufacturing.
He had no reason to believe that there had been any
basic strengthening of loan demand compared with late 1966.
Large
Chicago banks continued to show a deep basic deficit position through
the January 25 week despite increases of almost $200 million in CD
money.
Offering rates on all maturities of CD's had been lowered.
Government security portfolios were increased further.
As to policy, Mr. Scanlon favored no change at this time and
would accept the figures projected in the blue book as being associated
with that position.
He favored alternative A for the directive and
would prefer to defer a change in the discount rate at this point.
2/7/67
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Mr. Clay commented that the recent record and the present
prospects of the economy justified the shift in monetary policy that
had taken place and the continuation of an expansive monetary policy
in the period ahead.
There was no particular need to detail those
developments and the factors involved, since they were already covered
in staff materials.
It could be observed, however, that a significant
change had occurred in available resources and productive capacity
relative to aggregate demand, and price pressures had lessened.
Moreover, prospects indicated a much slower rate of advance in
economic activity in the months ahead, with marked crosscurrents
among major sectors of demand.
It had to be recognized, Mr. Clay said, that the Committee was
not talking about a depressed economy.
Presumably it was talking about
policies and programs for encouraging economic growth within the limits
of reasonably full employment of manpower and other resources, along
with a goal of stable prices.
Presumably it also was talking about
relieving the uneven impact of the tight credit experience of 1966,
notably with respect to mortgage markets and real estate activity.
In endeavoring to attain those goals, Mr. Clay said, the
monetary policy moves thus far had been aggressive.
The interest rate
movements that had occurred in response to policy changes and other
factors had been dramatic.
had been pronounced.
The growth in most monetary aggregates
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2/7/67
In evaluating the situation for the period ahead, it seemed
reasonable to Mr. Clay to assume that further financial responses
would result from the policy moves already made, and time should be
allowed for those developments to unfold.
Moreover, the Committee
must recognize that the economy was influenced by war activity and
that it was still operating at a high level even though growing more
slowly than earlier.
Under those circumstances, it would seem prudent to Mr. Clay
to maintain essentially the prevailing money market conditions for
Operational targets would be a Treasury bill rate
the period ahead.
in a range of 4.40 to 4.60 per cent, a Federal funds rate of 4-3/4 to
5 per cent, and net borrowed reserves of about $50 million, as
described in the blue book.
The anticipated increase in bank credit
under such a policy, following the expansion of recent weeks, would
be satisfactory.
Accordingly, economic policy directive alternative A,
including the proviso clause, would be appropriate for the policy
desired.
Mr. Wayne reported that most measures of business activity in
the Fifth District continued to ease, and business sentiment remained
generally bearish.
Nonagricultural employment increased in December
but at a slower rate than earlier in the year, and rates of insured
unemployment rose significantly in early January in all District States.
In the Richmond Reserve Bank's latest survey all textile manufacturers
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reported lower backlogs of orders and a majority reported lower
levels of shipments and new orders and higher inventories of
finished goods.
The survey also indicated definite weakness in
the furniture and building materials industries and in some parts
of the machinery and equipment industry.
One large furniture
manufacturer reported that he was cutting back his work force
because his warehouses were filled with finished goods.
Cash
receipts from farm marketings in the District were up 3 per cent
in 1966 compared with a national gain of 9 per cent.
Net sales
of Federal funds by Fifth District banks, which were abnormally
high in December, advanced further to set a new record in January.
It seemed to Mr. Wayne that the transition of the economy
toward a slower rate of advance was continuing, but without any
significant increase in the rate of deceleration.
In view of the
large advances of late 1965 and early 1966, the relatively moderate
adjustments of recent months would seem to indicate considerable
stability in the economy.
For the near future, inventory fluctuations
were likely to be confusing and contradictory, but on balance the rate
of accumulation should decline substantially.
Similarly, he would
expect some weakening in business capital outlays, with some decline
in industrial and commercial construction, and he found no basis for
expecting any early recovery in consumer purchases of automobiles and
other durable goods.
The new minimum wage law would probably give
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-60
added impetus to the fairly rapid rise in unit labor costs already
under way, and might impede further reductions in unemployment.
On the other hand, it was reasonably clear that considerable fiscal
stimulus could be expected over the next two quarters at least.
In
addition, the substantial improvement in the availability of mortgage
funds, coupled with recent improvement in the housing statistics,
would seem to offer some promise that residential construction outlays
might turn the corner earlier in the year than he had anticipated.
Considering the steady growth of State and local government spending
and in consumer spending on services and nondurables, it seemed to
him that the immediate prospects were for a continued but moderate
expansion of aggregate demand.
In brief, he saw little evidence of
a cumulative downward movement.
In the financial area, Mr. Wayne said, the movement toward
lower interest rates abroad had considerably simplified the Committee's
task and underwrote, so to speak, its recent easing measures.
The
external problem was still acute, however, especially with respect to
gold, and that should act as a restraint on the speed with which rates
here could be reduced.
In the policy area, Mr. Wayne continued, the precipitate drop
in the whole pattern of short-term rates in recent weeks seemed quite
disproportionate to the increased reserves supplied.
Although reserves,
and particularly nonborrowed reserves, increased more than was desirable
2/7/67
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in the circumstances, much if not most of the rate decline was
caused by the market itself.
A major shift in the pattern of
expectations, induced by official statements, undoubtedly was an
important reason for the change, and might well have created
expectations which were not realistic in view of the heavy demands
likely to be made on the capital market.
Another reason for the
decline was a sharp turnaround in the funds used by Government
securities dealers.
From mid-October to mid-January those dealers
built up their holdings of Government and agency securities by more
than $3-1/2 billion to a record high level, and they increased their
direct use of commercial bank funds by almost $2-1/2 billion.
In
early January that buildup receded slightly but since then it
appeared to have returned to the former peak.
During the same
period banks were gaining large amounts of funds through increasing
sales of negotiable CD's.
In addition, business investment
expenditures had been slowing, reducing the need for bank loans.
Those developments, plus the Committee's own actions in increasing
reserve availability, set the stage for the decline in rates which
was triggered by official pronouncements, both here and abroad,
concerning the future trend of interest rates.
In Mr. Wayne's view some decline in rates was quite appropriate
and proper but the movement had gone too far too fast and had helped
to create a very vulnerable technical situation.
He would like to see
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reserve availability grow at a rate much lower than was realized
in January.
The February projections for reserves and the bank
credit proxy in the blue book were, in his view, higher than the
situation required and he would prefer to aim at lower rates.
He
did not favor a change in the discount rate at this time.
Alternative A of the draft directives appeared appropriate
to Mr. Wayne with the associated complex of money market conditions
and projections given in the blue book considered as the upper limits
of acceptable conditions.
Mr. Shepardson said that the detailed developments reviewed
by those who had spoken thus far appeared to him to argue for a
temporary cessation in the shift toward greater ease, and to indicate
that the policy described in alternative A of the draft directives
was entirely appropriate.
He agreed with Mr. Wayne that some of the
rates of increase in aggregates projected under such a policy posture
were higher than the Committee could reasonably expect to sustain.
Specifically, he had in mind the projected rate of bank credit
expansion, which he felt should be considered as an upper limit for
the time being.
Mr. Mitchell commented that today's chart show projected two
economies:
six months of underheating, followed by six of overheating.
He thought that the projection for the half-year immediately ahead had
far greater credibility than that for the second half.
The staff's
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recommendations might be said to suffer from a credibility gap; it
was a mistake to give as much credence to expectations for the last
six months of the year as to those for the first six months.
It seemed to Mr. Mitchell that the major danger in the
immediate future was of a real downturn in the economy.
Inventory
adjustments of the kind now under way frequently--in fact, usuallytriggered a downturn in over-all activity.
The psychology of consumers
had been deteriorating, as manifested by their recent spending rates.
In immediate prospect were a flattening in business fixed investment
and a decline in the index of industrial production.
The index had
not changed in the past three months and a slight decline was projected
for the next six months, which would mean nine months of no increase.
Those were matters of reasonable certainty rather than, like the
projections for the second half, of conjecture.
Accordingly, Mr. Mitchell thought that the best policy for
the Committee would be to move somewhat further in the direction of
ease than it had already.
The economy was at a point of incipient
recession and the System's posture would be stronger if it responded
to that fact.
He saw no immediate danger in a little further easing.
The Administration's budget message called for some fiscal policy
action in the second half of the year, a step the Committee had thought
desirable.
The Federal Reserve should take a courageous step toward
easing now, just as it had acted courageously in moving to firm last
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year.
He would strongly urge that the Committee adopt alternative B
for the directive.
Mr. Daane said that he subscribed to the policy prescriptions
of Messrs. Hayes, Irons, and Brill, on the basis of much the same
reasoning as theirs.
A considerable degree of easing had already
been achieved and was publicly recognized.
The balance of payments
problem was becoming increasingly serious.
Also, the Committee
technically was still in a period of even keel, although the market
performance suggested that the current financing would not be a
consideration for open market operations beyond the payment date.
In the light of all of those circumstances, Mr. Daane
continued, he thought a steady course was the right one, and he
would accept the thrust of alternative A of the draft directives.
But to indicate just how steady a course he favored, he would delete
the word "about" from the staff's draft, so that the directive would
call for maintaining "the prevailing conditions" in the money market
rather than "about the prevailing conditions."
He recognized that
one could not expect all of the relevant variables to remain in the
same relationship, but deleting "about" would indicate how steady
a course was desired.
Frankly, he did not like the proviso clause
in alternative A; the reference to "current expectations" troubled
him because one could never be sure of his expectations.
The formu
lation of the corresponding clause in alternative B was better, but
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he would prefer a directive with no proviso clause at all.
As to
the discount rate, he would not favor a change at this time; in
his judgment, such an action would be premature.
Mr. Maisel said he did not see much difference between
the two alternative directive drafts prepared for this meeting.
He would like to see a greater amplitude of fluctuation in the
Federal funds rate and other money market rates.
Market participants
should be prepared to take risks and should not be led to expect the
System to bail them out regularly.
Mr. Maisel shared Mr. Daane's view that neither version of
the proviso clause in the staff's drafts would be appropriate.
But
rather than deleting the proviso entirely, he would recommend that it
be formulated to meet the problem that was most important at present:
the vulnerability of medium- and long-term interest rates to upward
pressures.
The recent rate declines had reflected expectational factors,
and a small change in expectations could have important effects on rates
in the period ahead.
Accordingly, he would favor calling for maintenance
of current money market conditions--although allowing for more movement
in market rates--and for supplying more funds to the market if there
were a sharp run-up in medium- and long-term rates.
Specifically, he
would suggest a proviso reading, "but operations shall be modified as
necessary to attain somewhat easier conditions if expectational or
seasonal factors appear to be causing a rise in medium- and long-term
rates."
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2/7/67
Mr. Maisel thought that the Committee did not have to be
concerned about a decline in rates, since such a development would
reflect a weakening in demands for credit.
But a rise in rates would
primarily reflect a change in expectations, as well as a large need
for funds in the first half of the year related, not to economic
conditions, but to the pattern of tax payments and the desire for
increased liquidity.
With respect to the speed of the recent rate
adjustment, he had been surprised to discover on checking that it was
not as fast an adjustment as had occurred in the two preceding periods
of shifts to greater ease, and so he was not concerned about it.
Mr. Brimmer said that it would be helpful for the Committee
to keep in mind the inherent conflict between the need to provide
some additional stimulus to domestic activity on the one hand, and
the requirements of the balance of payments situation on the other.
Mr. Hayes had suggested that the Committee should buy coupon issues
when supplying reserves and sell bills when absorbing reserves.
had become known as "operation twist."
That
His own feeling was that while
operations of that type obviously had been helpful earlier in the
expansion that was now slowing down, it might be somewhat risky for
the Committee to attempt to use them again.
He was suggesting, not
that "operation twist" would not work, but that it might not be the
most appropriate instrument at present.
2/7/67
-67Like Mr. Mitchell, Mr. Brimmer was concerned about the
longer-run domestic outlook.
He did not agree that the staff's
analysis suffered from a "credibility gap"; rather, that analysis
had persuaded him that the outlook was not as strong as implied by
the projections of the Council and of the New York Bank, and that
a much reduced rate of growth in activity was in prospect.
In that
connection, the Committee should accept the role for monetary policy
implied in the Council's report--that of providing the stimulus
necessary to hold up private expenditures while inventory growth
was slackening.
He thought most Committee members shared that view
and that their differences were concerned primarily with the pace
of the shift toward ease.
In Mr. Brimmer's judgment it would be desirable for the
Committee to give particular attention to the structure of interest
rates at this time.
He was particularly concerned about the struggle
going on in the banking community with respect to the prime rate; he
had welcomed the reduction to 5-1/2 per cent by a few banks, and hoped
that they would not decide to move back up to the 5-3/4 per cent rate
established by most banks.
For the time being he would want the Desk
at least to keep market interest rates from rising.
He favored a
three-month bill rate not over 4-1/2 per cent and, if possible, the
Federal funds rate might well be kept under 5 per cent.
He could not
say what level of free or net borrowed reserves would be consistent
2/7/67
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with those rate targets and therefore would leave open the question
of the net reserve figure to be sought.
In any case, the objective
of insuring that the lower prime rate set by some banks remained in
effect might imply somewhat more liberal provision of reserves than
otherwise.
In sum, Mr. Brimmer favored moving cautiously toward a little
more ease.
Such a policy struck him as particularly important in view
of the strains that would be placed on financial markets by the large
issues of participation certificates now planned.
Alternative B was
his choice for the directive.
Mr. Hickman commented that further signs of leveling and
weakness were apparent in the latest economic indicators.
Production
was declining and the increase in consumption had slowed.
Because of
a slowdown of inventory accumulation in some industries, the production
index might decline by as much as two points in the first quarter of
1967, according to the estimates of his staff.
A reduced rate of
inventory accumulation was confirmed by the Reserve Bank's most recent
survey of Fourth District manufacturers.
Retail sales apparently
slipped further in January, following a decline in December to last
summer's level; and the outlook was for further weakness in the months
to come.
One favorable consequence was that most recent price changes
had been moderate; but the steady rise in unit labor costs had put
serious pressure on profit margins.
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In the Fourth District, Mr. Hickman continued, the rate of
insured unemployment rose slightly in January, the third successive
monthly increase.
In ten of the fourteen major labor market areas
of the District, insured unemployment, on a seasonally adjusted
basis, was higher at the end of January than in late December.
Bank
debits and manufacturing activity in most major industrial centers
of the District (as measured by industrial consumption of electric
power) had trended downward in recent months.
Nevertheless, Mr. Hickman thought the Committee should not
overreact to recent evidence of business slack.
Thus far, the
initial response to the shift in monetary policy had been largely
confined to financial markets and flows of funds among financial
intermediaries.
Responses on the real side of the economy, to the
extent they were identifiable, hopefully would occur later on.
In Mr. Hickman's view, an even-keel policy was called for
until the next meeting of the Committee, partly because of the
Treasury refunding, and partly because of the progress that had
already been made towards a less restrictive policy.
A steady
market tone for several weeks would have an additional advantage
of discouraging speculative excesses, which fortunately seemed to
have been minimal thus far.
To be specific, Mr.
Hickman said, he thought that until the
next meeting the Committee should attempt to keep bond yields about
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where they were, and the 91-day bill rate and the Federal funds rate
below the discount rate most of the time.
Net reserves were perhaps
almost too erratic in this transitional period to be useful, but the
type of rate structure he envisaged might be compatible with an
average level around zero over the next four weeks.
A general
acceptance of the 5-1/2 per cent prime rate would in his opinion be
highly desirable, since it would narrow the differential between
bank lending rates and open market rates, and thus stimulate business
borrowing, the rate of growth of bank lending, and the money supply.
Mr. Hickman would, however, not press for further monetary
ease at this juncture, partly because a further elevation in prices
of fixed-income securities might encourage speculation, with an
eventual reaction of bond prices in the opposite direction.
Also,
an even-keel policy until the next meeting would give the real side
of the economy time to respond to the current monetary and financial
environment.
He favored alternative A of the staff drafts, but would
interpret it as calling for slightly more ease than the situation
described in the blue book.
Mr. Hilkert remarked that Presidential messages appearing
since the last meeting had a distinct bearing on open market policy.
To judge by those messages, the prescription for monetary policy was
quite clear:
namely, ease.
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Deciding the course of policy was not so simple as that for
at least three reasons, Mr. Hilkert continued.
First, the outlook
for business might well follow the Council's pattern of first-half
weakness and second-half strength; but it might not.
That meant,
among other things, that the appropriateness of a tax increase in
mid-year remained to be seen.
A second reason why formulating
monetary policy was more complex than the recent messages suggested
was the balance of payments.
As he read the signs, there was little
new action planned to deal with a worsening of the payments deficit.
And a third reason was the outlook for cost-push inflation,
While
there was not much that monetary policy could do at this point to
prevent it, undue ease could aggravate it.
Consequently, policy
could not simply follow a straight path toward ease.
At times it
might have to deviate from that course, depending on relatively
near-term developments.
Mr. Hilkert reported that the Philadelphia Reserve Bank had
tried to supplement the customary indicators of such developments by
contacts with businessmen and bankers at the local level.
always a danger, of course, in limited samples.
There was
But, with that
reservation, discussions with some twenty-five businessmen in a
cross-section of industries shed some light on current policies,
particularly with respect to inventories.
He had been impressed
with the generally optimistic attitude toward inventory accumulation.
2/7/67
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True, about half the companies covered believed inventories were
above desired levels.
But adjustments in many cases already had
been made and would not require sharp cutbacks in production in
early 1967.
Accumulation in many cases had been in goods-in-process
because of bottlenecks and shortages.
The main area of involuntary
accumulation had been in industries related to automobile production.
Those findings were somewhat contrary to the tone of the
green book, Mr. Hilkert noted.
If they were at all valid for the
nation as a whole, they suggested that an inventory adjustment early
this year might be accomplished fairly smoothly and without substantial
repercussions on production and investment.
At the same time, Mr. Hilkert continued, bankers saw loan
demand remaining fairly strong.
They were not sure just how strong;
in fact, projections that the large Philadelphia banks had been
supplying to the Reserve Bank had been so erratic that little reliance
could be placed on them.
Nevertheless, bankers felt sufficiently
confident about loan demand that they had reduced their prime rates
only reluctantly and intended to grant loans at the prime rate very
selectively.
Mr. Hilkert commented that that information from businessmen
and bankers served as a reminder that the economy was still strong.
An adjustment in the rate of expansion was under way, but it might
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-73
proceed more smoothly than believed a few weeks ago.
growth of credit had been impressive.
Meanwhile,
The staff's projections
for February were encouraging, and if his reading of the inventory
situation was correct, they might even be exceeded.
The shift in
market rates had been sharp and rapid, and a slower rate of decline
would seem more appropriate to the economic situation immediately
ahead.
Even apart from even-keel considerations, therefore,
Mr. Hilkert was inclined to recommend no change.
He would hope
such a policy would maintain credit market conditions about where
they were and would continue to promote substantial growth in credit.
Alternative A of the draft directives would best accomplish that end.
Mr. Patterson said that recent developments in the Sixth
District were generally similar to those in other parts of the country
that had already been described.
Accordingly, in the interest of
time he would not make the comments on District developments that
he had prepared, but would submit them for inclusion in the record.
Those remarks were as follows:
The latest available business statistics for our
District do not make very exciting reading. They are
moving in about the same direction they have been moving
for some time. Weakness is still confined to just a few
sectors, such as lumber, textiles, and metals. Employment
and income continue on an upward course. Retail spending
2/7/67
-74-
is sluggish. In short, the District is not experiencing
a recession, but is sharing in the general moderation of
activity.
In the financial area, our region, too, is experiencing
some of the same developments emerging elsewhere. Mortgage
conditions have significantly improved. Our local mortgage
bankers tell us that national lenders have returned more
rapidly than anticipated. All in all, considerable optimism
has developed that increased availability of mortgage money
will revive housing rather quickly.
Our large commercial banks recently experienced inflows
of time deposits at one of the fastest paces we can recall.
Already, they recouped nearly all of their previous losses
in negotiable CD's.
Being slow in lowering their CD rates
helped them in this respect. In fact, our biggest bank
continues to hold its CD rate slightly above New York's
level in an attempt to draw in more time money. Our country
banks also gained significant amounts of time deposits in
December and January. All of this growth was in CD's.
Passbook savings have declined. As far as we can tell, the
bigger banks are using the new time money to repay borrowings,
replenish liquidity, and add slightly to tax-exempt portfolios.
Bank lending, on the other hand, is still anything but
exuberant in our District. Business loans, in fact, are
down much more this January than in early 1965 or 1966.
Yet we get the distinct impression that some bankers wanted
to relax lending standards before changing the prime rate.
Competitive factors, however, left them no alternative.
I infer from this that potential loan demand in our District
is still pretty high.
Although our banking fraternity may not be entirely
typical in this respect, some bankers evidently believe
that their customers will knock on doors as soon as they
see that the welcome mat is back out. More than one banker
has attributed his bank's weakness in loans to reluctance
of former customers to borrow because of previous denial.
Many of these people will undoubtedly be back for loans as
soon as the banks make it clear that they again are willing
to lend for construction, inventories, and land acquisitions.
While I recognize that some of this potential loan demand
will evaporate as inventory adjustments are speeded up,
some potential loan demand exists and with proper stimulation
should come to the surface. In the interim, it is our job to
determine to what degree we should stimulate bank lending.
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2/7/67
Mr. Patterson added that on glancing backward he found that
the Committee had succeeded in restoring confidence in financial
markets.
It
had reversed the decline in deposits and helped bring
short-term rates down sufficiently to encourage a considerable
expansion in
time deposits.
Those goals had been achieved far more
quickly than he would have imagined.
Looking ahead, there was every
reason to believe the economy was not going to return to a boom
course.
The liquidity position of many banks remained unsatisfactory,
and there were still many other lagging effects of past credit
restrictions in evidence.
All of that suggested that an increase in
reserve availability was in order unless the Treasury calendar or
foreign interest rate developments stood in the way.
In other words,
it seemed to him that, if the Committee wanted to be effective in
encouraging bank loan expansion, policy had to move toward slightly
further ease.
In line with that position, he favored a slightly
positive free reserve target and alternative B for the directive.
He believed, however, that discount rate action at present would be
premature.
Mr. Francis commented that economic activity remained strong.
The public sector had grown at an advanced rate while there had been
some slowing in the growth rates of private spending and production
in recent months.
Some of the goods produced might have been going
into involuntary inventory expansion, a potential drag on the economy
in the near future.
2/7/67
-76In view of the excessive total demands and inflationary
pressures of last summer and early fall, Mr. Francis thought the
moderation in the growth of private demand had been desirable.
The economy was still operating at virtual capacity.
Demand-pull
inflationary pressures seemed to be somewhat reduced although
cost-push elements were increasing.
Monetary restraint since early
last summer had been a major factor in the slower expansion of total
demand; fiscal actions had actually become more stimulative, according
to the presentation in the Budget and the Economic Report.
The
budget plan indicated that fiscal action would continue to be
extremely expansive over the next few months and, indeed, through
fiscal 1968.
In view of the slowing in total demand, Mr. Francis said,
the Committee had been concerned since last November that monetary
actions might become too restrictive, particularly if there was a
lag between such actions and their effect on the economy.
The
Manager of the Account had been asked to attain easier conditions
in the money market to promote a noninflationary growth in money
and credit.
The money market had eased, as evidenced by marked
declines in interest rates and an accompanying smaller average
borrowing from Reserve Banks.
The Federal Reserve had been supplying
a substantial amount of reserves to member banks through open market
operations.
Bank credit had been expanding sharply, although much of
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-77
the gain might reflect merely a reintermediation of funds that
temporarily passed through other channels.
The money supply
appeared to have risen at an annual rate of about 1/2 of 1 per
cent since November (adjusted for the quarterly patterns in that
series) compared with a 1.5 per cent rate of decline in the
previous six months.
For the next month Mr. Francis suggested that the Manager
attain a further gradual easing in money market conditions with a
view to fostering a slightly faster monetary growth.
The three-month
Treasury bill rate might fluctuate around 4.25 per cent, Federal
funds might trade at the discount rate or lower, and excess reserves
might average about $100 million more than borrowings at the Federal
Reserve.
The Committee was walking a tightrope; too rapid monetary
growth was likely to be inflationary, while no monetary expansion
was apt to lead to a rise in idle resources.
As an intermediate
target, he preferred to have the money supply rise at a 2 or 3 per
cent annual rate.
He strongly favored alternative B of the draft
directives.
Mr. Francis concluded with the observation that he would
not change the discount rate at this time.
Holding the rate at
4-1/2 per cent had not significantly deterred the rise in market
interest rates last year and he did not think it was deterring rate
declines at present.
2/7/67
-78Mr. Robertson presented the following statement:
I am very appreciative of the timing as well as the
content of the chart show we had this morning. This
strikes me as a time when it is more than ordinarily
appropriate for us to give attention to the longer-run
as well as the immediate consequences of policy alterna
tives. With the Budget, the Economic Report, and now
our own staff's projections before us, we are about as
well equipped for that task as we can reasonably hope to
be.
In a nutshell, none of these presentations move me
to call for a program of aggressive further monetary easing
at this juncture. On the contrary, they lead me to expect
that we may need to move into a gently stimulative money
and credit environment for much of the first half of this
year, with reasonable policy possibilities for the second
half ranging from moderate further monetary stimulus to
some mild turn toward restraint, depending upon a host of
intervening developments. All this is highly conjectural,
of course, and its relevance to today's decisions is
complicated by the fact that we currently seem to be
rewriting the record book on monetary lags--i.e., the
speed of response to monetary policy. Nonetheless, I
am inclined to regard the prospects for 1967 as arguing
that we should be a little careful of going too far too
fast in further monetary easing right now.
I am impressed with how much we have already set in
train in the way of relaxation of financial restraint.
Interest rates have dropped sharply, the financial system
has rebuilt a good deal of liquidity, and the rise in
money supply, time deposits, and nonbank savings instruments
suggests that the liquid asset holdings of the private sector
as a whole must also be mounting more substantially. A less
tangible but nonetheless significant influence is the sharp
recovery in values of all kinds of capital assets that must
have accompanied the recent drop in yields and climb in
bond and stock prices.
At the same time, it is worth emphasizing that these
developments do not have the look of the kind of rush for
liquidity that can accompany an economic contraction. Some
corporations and municipalities are already stepping up
their capital flotations, both to fund old debts and to
finance current and future spending. What we cannot yet
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judge with any real certainty is how many other borrowers
will respond affirmatively as the effects of relaxation
of restraint spread and the availability and cost of
credit improve for consumers, businesses, and would-be
home owners.
That process takes time, and the reports to date
suggest that it is still very much under way. I am prepared
to go slow in pushing further reserve easing actions, however,
until we can have a little more feedback of evidence as to
whether or not the relaxation to date may have been enough
to begin to bolster borrowing and spending plans over the
longer run. Otherwise, by overreacting to short-run increases
or the lack thereof, we could trap ourselves into a kind of
abrupt "stop-go-stop" monetary policy--that I would prefer
to avoid--that might damage confidence not only in financial
institutions but in the efficacy of monetary policy itself.
All things considered, I would be willing to settle
for a general policy of no further deliberate change between
now and the next meeting. I would, however, like at least
to guard against any appreciable back-up in interest rates
or money market pressures, because I would not want to risk
reversing the easier and more confident credit expectations
that have so recently emerged. Furthermore, I feel that it
would be desirable if we could move progressively back
towards a posture in which we (and I refer to the members
of the Committee) were a little less solicitous of every
money market wiggle. For practical purposes, this adds
up to an instruction to the Manager not to worry about
offsetting every temporary downward fluctuation in the
money market, but to resist any sizable upward fluctuation.
I would still expect the proviso clause to shade the
over-all cast of operations in such a way as to moderate
unexpectedly strong bank credit deviations, but I am not
going to worry about a proviso-initiated firming of condi
tions, since in that circumstance credit demand should be
proving sufficiently stronger than expected to withstand
any accompanying minor adjustment in rate expectations.
With this general policy view, I could vote for either
alternative A or B of the staff directive drafts, so long
as either was interpreted as encompassing a leaning toward
easing about like "resolving doubts on the side of ease",
and as meaning that the Committee would not be concerned
if its implementation resulted in a showing of positive
free reserves--even for successive weeks.
2/7/67
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Chairman Martin said he found himself in almost complete
agreement with Mr. Robertson's position.
After studying the question
carefully in preparation for today's meeting, he had concluded that
he could accept either alternative A or B of the draft directives.
It was clear to him that the Committee's policy should be one of ease,
but to overreact could be self-defeating in the sense that it might
result in a need to reverse policy later.
It also was clear to him
that the discount rate should not be changed for the time being.
He
would favor leaning toward ease within the framework of a continuation
of present policy.
Although the Treasury financing did not call for
a rigid even-keel posture at this juncture, it did provide some
grounds for what might be called "semi-"
even keel.
The majority of members seemed to think alternative A was the
more suitable for the directive, Chairman Martin continued.
He had
no objection to Mr. Daane's suggestion to delete the word "about"
from the staff's draft.
However, he did have some question about
Mr. Maisel's suggestion to formulate the proviso clause in terms
of movements in medium- and long-term interest rates.
He preferred
the type of proviso clause included in the staff's draft.
Mr. Daane said he thought that deleting the word "about"
would meet the problem Mr. Maisel had in mind, by indicating that
steadiness was desired in interest rates.
He would not favor
introducing the type of proviso clause Mr. Maisel had suggested.
2/7/67
-81
In response to Mr. Brimmer's remarks about "operation twist," he
(Mr. Daane) would certainly favor some shift toward operations in
coupon issues.
He saw no reason for rejecting a tool that the
Committee had found useful in the past in reconciling conflicts
in its domestic and balance of payments objectives.
Mr. Hayes said he strongly supported retention of the
staff's proviso clause, which was consistent with similar clauses
the Committee had been using all along.
It introduced a desirable
reference to an intermediate objective in terms of bank credit
developments, to supplement the more immediate objective in terms
of money market conditions.
Chairman Martin asked if other members cared to express
views with respect to the proviso clause, and several indicated
that they would prefer to retain the version in the staff's draft.
Mr. Brimmer said he would like to suggest a modification of
the language of alternative A which, if acceptable to the majority,
would permit him to join them in voting favorably.
His suggestion
was to add the words "of ease" after the word "conditions," so that
the directive would call for "maintaining the prevailing conditions
of ease in the money market."
The purpose of the change would be to
indicate that the money market conditions sought were somewhat closer
to those specified by alternative B than was indicated by the original
language of alternative A.
He thought that his suggested language was
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2/7/67
consistent with the proposals of Chairman Martin and Mr. Robertson
for "leaning toward ease"; if that view was shared by a majority of
the Committee it should be reflected more specifically in the
directive.
Chairman Martin and Messrs. Hickman, Robertson, and Wayne
indicated that they would have no objection to the language
Mr. Brimmer had proposed.
Mr. Hayes said that he preferred the staff's original
language because of the problems of defining the term "ease" in
Mr. Brimmer's formulation, but he did not feel strongly on the
matter.
Mr. Mitchell said he thought the underlying issue should
not be papered over by semantics.
The virtue of alternative B
was that it called specifically for somewhat easier conditions and
he thought that the Committee would be in a better posture if it
adopted that alternative for the directive.
Mr. Hayes commented that it had appeared to him that a
majority of the Committee favored the type of policy described in
alternative A.
Mr. Brimmer said that the language change he had suggested
was not intended to paper over the issue, but rather to call for a
policy intermediate to those of alternatives A and B--somewhat
closer to A than to B but definitely beyond A.
2/7/67
-83Mr. Maisel observed that if Mr. Brimmer's language was
interpreted as calling for "leaning toward ease" he was prepared
to vote for it.
Mr. Holmes said that he would interpret the proposed language
to mean that the Desk should try to resist any sharp rises in rates
but not declines in rates, while going along with small changes.
Mr. Daane said he would accept that statement as reflecting
the Committee's intent even if the original language of alternative A
was not modified.
Thereupon, upon motion duly made
and seconded, and with Mr. Mitchell
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 further moderation in various expansionary
forces, with continued large inventory accumulation. The
pace of advance of broad price measures has slowed, although
upward price and cost pressures persist for many goods and
services.
Interest rates have declined markedly, financial
conditions generally are considerably easier, and bank credit
expansion recently has been vigorous. While interest rates
abroad have also declined, trends in international trans
actions indicate a continuing serious balance of payments
problem. In this situation, it is the Federal Open Market
Committee's policy to foster money and credit conditions,
including bank credit growth, conducive to noninflationary
economic expansion and progress toward reasonable equilibrium
in the country's balance of payments.
2/7/67
-84
To implement this policy, and taking account of the
current Treasury financing, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining the prevailing conditions of ease
in the money market, but operations shall be modified as
necessary to moderate any apparently significant deviations
of bank credit from current expectations.
Chairman Martin then invited Mr. Daane to report on the
meetings of the Group of Ten Deputies which he had attended recently.
Mr. Daane said that the Deputies had held a meeting in London
on January 24 and then had met jointly with the Executive Directors
of the IMF on January 25 and 26.
At the Deputies' meeting Chairman
Emminger had distributed a partial text of the communique that had
been released by the Ministers and Governors of the Common Market
following their meeting at The Hague in the preceding week, which
read as follows:
"The Ministers and Governors, anxious to confirm
their solidarity on a question as important as the international
monetary problem, have decided, while pursuing the examination of
the plans discussed hitherto, to instruct their experts in the
Monetary Committee of the E.E.C. to study the improvement of the
methods of international credit without delay."
As Dr. Emminger
pointed out, that statement had been misinterpreted by the press
to mean that the French had agreed to shelve the question of an
increase in the price of gold in exchange for agreement to abandon
contingency planning for a new reserve asset in favor of working
toward improving the credit facilities of the IMF.
That was not true.
-85
2/7/67
In clarifying the matter, Mr. Daane continued, Dr. Emminger
made four points.
First, he called attention to the phrase in the
communique which read, "while pursuing the examination of the plans
discussed hitherto,"
and indicated that that phrase referred to the
work of the Group of Ten and to the joint meetings on contingency
planning, and had been inserted to make it clear there was no intent
on the part of the Common Market countries to impede or interrupt
that work.
Secondly, Dr. Emminger noted that the reference to "the
improvement of the methods of international credit" (to be studied
by the Monetary Committee of the E.E.C.) was to the new French
suggestions introduced at the Hague meeting.
He implied that the
French had nothing really concrete to offer on the subject of
international credit; and it was Mr. Daane's own impression that
they had advanced the suggestions primarily as a diversionary tactic.
Dr. Emminger's third point was that a decision as to whether the
French suggestions should be inserted into the work of the Ten or
of the joint meetings would depend on the outcome of the Monetary
Committee's studies.
The fourth point--and the one of perhaps
greatest interest to the Open Market Committee--was that there had
been an agreement at the Hague meeting that the question of the gold
price should be shelved for the time being, and the Dutch Prime
Minister was authorized to so state at the press conference following
the Hague meeting.
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2/7/67
After those remarks by Dr. Emminger, Mr. Daane continued,
the French took sharp exception to the statement that the gold price
question had been shelved.
Mr. Perouse said that the French had not
asked for an immediate increase in the price of gold, and "one
could
not put back in the drawer what one had not taken out of the drawer."
In effect, the French position was that it was appropriate to discuss
the problems of gold, including that of price.
They had, in fact,
continued to discuss the subject at the subsequent sessions.
The two most significant items on the agenda at the joint
meeting, Mr. Daane said, dealt with the conditions and circumstances
of activation of a contingency plan, and with decision-making.
Perhaps
the most significant development was the manner in which both groups
approached the question of conditions for activation.
As the Committee
would recall, a statement issued by the Ministers and Governors of the
Ten in August 1966 called for two preconditions for activation:
improvement in the balance of payments position of members--a point
directed particularly at the U.S. and the U.K.--and a better working
out of the adjustment process.
The consensus at this meeting was
that such conditions could not be defined precisely or applied in a
rigid manner.
Surprisingly, that view was expressed by, among others,
some members from Common Market countries, who pointed out that they
could conceive of the need for reserve asset creation arising even
2/7/67
-87
with a continued moderate deficit in the U.S. balance of payments.
Similarly, they viewed improvement in the adjustment process as a
continuing process, not capable of clear-cut delineations.
Thus,
there definitely had been a softening of attitudes on the precon
ditions for activation.
On the question of decision making, Mr. Daane said, a
"bicameral approach," involving a separate vote outside the Fund for
a limited group, was rejected.
Mr. Van Lennep of the Netherlands
made a strong case for a "double-majority" procedure in which a
limited group would have special voting rights within the Fund.
This approach too was criticized by representatives from outside
the Ten.
Instead, the approach taken was to lay greater stress on
consultation prior to formal decision-making.
Interestingly, there
seemed to be a general consensus that reserve creation should be
built into the IMF framework, with the scheme to be operated through
an affiliate of the Fund.
Although not all issues had been resolved,
it was becoming increasingly clear that decision-making would be
fully within the IMF or an affiliate.
As Dr. Emminger had put it
at the press conference, that was gratifying progress.
Mr. Daane added that the French had tried to have the problem
of gold placed on the agenda for the next joint meeting, to be held
in Washington in late April.
Mr. Schweitzer had firmly rejected that
2/7/67
-88
proposal, saying that the only purpose of the joint meetings was
to develop a plan for reserve asset creation, and Dr. Emminger
pointed out, in turn, that the Deputies' mandate from the Ministers
and Governors of the Ten had specifically excluded the subject of
the gold price.
Mr. Deming, Mr. Hockin of Canada, and Mr. Van Lennep
also had spoken against the French proposal.
In sum, Mr. Daane said, from the entire set of meetings one
got a clear sense of further progress with respect to contingency
planning, which was favored by all of the Europeans except the French.
The joint meeting was marked by a spirit of constructive advance
similar to that at the first such meeting in Washington last November.
One could take a generally optimistic view and say, as Dr. Emminger
had in his press conference, that while the full plan might not be
agreed upon by the time of the meetings in Rio de Janeiro this autumn,
the main elements of a plan might be agreed upon by that time.
In a concluding observation, Mr. Daane said that the other
main item on the agenda at the Group of Ten meeting--which was
carried over in part to the joint meeting--dealt with the question
of holding and use of the new asset.
A working group made a
preliminary report at the London meetings in which three approaches
were distinguished--a holding limit, a transfer ratio linking gold
to the new asset, and a creditor ratio.
There seemed to be less and
less sentiment for the second of those approaches.
2/7/67
-89Following Mr. Daane's remarks, Chairman Martin said that
he would report briefly on his visit last week to London, where
he had spoken before the Overseas Bankers Club.
He found that
people at the Bank of England were very much encouraged by the
progress Britain had made recently, on which Mr. Coombs had
reported this morning.
He had been interested to find a general
feeling in London that France's decision to internationalize its
gold market was taken deliberately in order to make it more
difficult for Britain to join the Common Market.
Some South
Africans with whom he had talked were quite convinced that the
move would have no effect on the practices of their country; they
felt that the shipping arrangements between South Africa and
London offered benefits to them that would offset the possibility
of higher prices in the Paris gold market.
The Chairman concluded
by expressing the hope that the recent gains in British reserves
would continue.
It was agreed that the next meeting of the Committee,
which would be the annual organizational meeting, would be held
on Tuesday, March 7, 1967, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
February 6, 1967
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on February 7, 1967
FIRST PARAGRAPH
The economic and financial developments reviewed at this
meeting indicate further moderation in various expansionary forces,
with continued large inventory accumulation. The pace of advance
of broad price measures has slowed, although upward price and cost
pressures persist for many goods and services. Interest rates have
declined markedly, financial conditions generally are considerably
easier, and bank credit expansion recently has been vigorous. While
interest rates abroad have also declined, trends in international
transactions indicate a continuing serious balance of payments
problem. In this situation, it is the Federal Open Market Committee's
policy to foster money and credit conditions, including bank credit
growth, 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 account of the current
Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to maintaining
about the prevailing conditions in the money market, but operations
shall be modified as necessary to moderate any apparently significant
deviations of bank credit from current expectations.
Alternative B
To implement this policy, and taking account of the current
Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to attaining
somewhat easier conditions in the money market than prevail at present,
unless bank credit appears to be expanding significantly faster than
currently anticipated.
Cite this document
Federal Reserve (1967, February 6). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19670207
@misc{wtfs_fomc_minutes_19670207,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1967},
month = {Feb},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19670207},
note = {Retrieved via When the Fed Speaks corpus}
}