August 2, 1955 FOMC Minutes: Full Text
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 on Tuesday, August 2, 1955, at 10:45 a.m. PRESENT: Mr. Martin, Chairman Mr. Sproul, Vice Chairman Mr. Balderston Mr. Earhart Mr. Erickson, Alternate for Mr. Leach Mr. Fulton Mr. Irons Mr. Mills Mr. Robertson Mr. Shepardson Mr. Szymczak Messrs. Johns, Treiber, and C. S. Young, Alternate Members of the Federal Open Market Committee Messrs. Williams, Bryan, and Leedy, Presi dents of the Federal Reserve Banks of Philadelphia, Atlanta, and Kansas City, respectively Mr. Riefler, Secretary Mr. Thurston, Assistant Secretary Mr. Vest, General Counsel Mr. Solomon, Assistant General Counsel Messrs. Daane, Hostetler, Rice, Roelse, Wheeler, and Young, Associate Economists Mr. Rouse, Manager, System Open Market Account Mr. Carpenter, Secretary, Board of Governors Mr. D. C. Miller, Chief, Government Finance Section, Division of Research and Statis tics, Board of Governors Mr. Marsh, Manager, Securities Department, Federal Reserve Bank of New York Upon motion duly made and seconded, and by unanimous vote, the minutes of the meeting of the Federal Open Market Commit tee held on July 12, 1955, were approved.
Before this meeting there had been sent to the members of the Committee a report of open market operations prepared at the Federal Reserve Bank of New York covering the period July 12 to 27, 1955, in clusive, and at this meeting there were distributed copies of a supple mentary report prepared at the Bank covering operations during the period July 28 through August 1, 1955. Copies of these reports have been placed in the files of the Federal Open Market Committee. Mr. Rouse commented briefly with regard to the effect on the money and securities markets of a statement with respect to a possible increase in the discount rate of 1/2 per cent contained in a Government securities market weekly news letter which was received by subscribers on Monday morning. He said that a similar statement was circulated to Government securities dealers on Friday in a telephone service which the writer of the news letter provides and that it had had quite a disturbing effect. Upon motion duly made and seconded, vote, the open market and by unanimous transactions during the period July 12 to 1, 1955, inclusive, were approved, August ratified, and confirmed. July 12, 1955, the Secretary of the Committee on At the meeting whether the authori and report on the question to look into was requested securities should covering Government repurchase agreements zation for Reserve Bank of or only to the Federal Federal Reserve Banks run to all
New York. A memorandum prepared by Mr. Riefler in accordance with this request under date of August 2, 1955, which had been sent to the members of the Committee, expressed the view that in practice there was little likelihood that the authority would be used by the Federal Reserve Banks other than New York. Therefore, he recommended that hereafter the Committee's authorization be only to the New York Bank and that the authorization be in the form attached to the memorandum. Mr. Riefler outlined briefly the reasons for his recommenda tion pointing out that it was understood, on the basis of the discussion at the meeting on July 12, 1955, that hereafter the Committee would con sider at each meeting the extent to which repurchase agreements were to be authorized and the rate at which such agreements would be entered into. At the conclusion of a brief discus sion, upon motion duly made and seconded, and by unanimous vote the authorization was approved as follows with the understanding agreed upon at the meeting on July 12, 1955, and suggested by Mr. Earhart at this meeting, that the authority would be used sparingly into agreements at rates below in entering the discount rate: CONDITIONS FOR REPURCHASE AGREEMENTS PRESCRIBED BY THE FEDERAL OPEN MARKET COMMITTEE As Amended, August 2, 1955 New York is hereby authorized Federal Reserve Bank of The with nonbank dealers in to enter into repurchase agreements United States Government securities subject to the following conditions
1. Such agreements (a) In no event shall be at a rate below which ever is the lower of (1) the discount rate of the Federal Reserve Bank on eligible com mercial paper, or (2) the average issuing rate on the most recent issue of three-month Treasury bills; (b) Shall be for periods of not to exceed 15 calendar days; (c) Shall cover only Government securities ma turing within 15 months; and (d) Shall be used as a means of providing the money market with sufficient Federal Reserve funds to avoid undue strain on a day-to-day basis. 2. Reports of such transactions shall be included in the weekly report of open market operations which is sent to the members of the Federal Open Market Committee. 3. In the event Government securities covered by any such agreement are not repurchased by the dealer pur suant to the agreement or a renewal thereof, the se curities thus acquired by the Federal Reserve Bank of New York shall be sold in the market or transferred to the System Open Market Account. Governor Robertson stated that notwithstanding his doubts about are well known by other members the use of repurchase agreements--which oppose the above action if, in addition of the Committee--he would not was understood that the re referred to above, it to the understanding only in necessitous cases. would be used purchase authorization Ralph Young who made substantially Martin called on Mr. Chairman on a staff memorandum which was based largely the following statement
sent to the members of the Committee under date of July 29, 1955: Expectations earlier were that some deceleration of advance in activity might become evident over the summer in conformity with average business cycle patterns. The first big item of today's report is that advance continues with no clear evidence of deceleration in the economy as a whole. The index of industrial production for July, sea sonally adjusted, is tentatively placed at better than 140, but not clearly at 141. Advances are indicated to be fairly general in durable and nondurable goods lines, as well as in minerals. A number of industries--including metals, building materials, rubber, and chemicals--now appear to be producing at near capacity. With business demands in excess of output, backlog orders have continued to rise, with steel a noteworthy area of further rise. The second big item of today's report is that a second ary upsurge of consumer buying seems to be developing. Con sumer buying of autos in July remained at record rates. Buying of appliances and other goods at department stores showed remarkable gains from last month and a year ago. While this buying wave reflects the rapid rise of personal income over recent months as well as recent wage advances in major industries, it doubtless also reflects pervasive con sumer confidence, some taking of capital gains on stock in vestment, an increased willingness to draw on widely held liquid asset accumulations, and some consumer expectations of higher prices later. Consumer instalment credit expansion has been of key importance in recent buying levels and probably in the recent upsurge. The seasonally adjusted increase in June was about 600 million dollars. The expansion of over 2.5 billion for the six months ending with June was a new record. Maintenance of auto sales in July foretells another large rise in out standings for this month. Competitive liberalization of terms no alleviation, although recent supervisory steps as yet shows in the banking sector and some industry-generated efforts in finance sector may work to temper further terms the sales relaxation in the months ahead. accumulation, which attracted much Business inventory attention in May, slackened off in June. With the pick-up in July, further inventory rise has probably consumer buying in
been moderate in recent weeks. By the end of June, the total value of business inventories had risen only 2 per cent from last autumn. Activity in construction and real estate markets has been maintained at close to record levels. With residential construction showing signs of slackening, non-residential construction awards have been up a third over a year ago in June and the first half of July. Mortgage lending on non-farm real estate has continued in record volume, although mortgage commitments on residential properties have been harder to get and mortgage yields have risen somewhat. To finance their active participation in this lending, savings and loan associations owed the Federal Home Loan Banks over a billion dollars on July 21, up 300 million for the year. Thus, the insurance companies have not been alone in lending in excess of available funds. Over the week-end, the Federal housing authorities took action to discontinue 30-year maturity and no downpayment mortgages on Federal underwritings from yesterday on. Maximum maturi ties become 25 years, with FHA required downpayments raised along the line by 2 percentage points and with VA introducing a minimum downpayment of 2 per cent. Prices of industrial materials have continued upward in recent weeks and prices of finished goods show more frequent rises, but over-all these recent increases have been offset by declines, partly seasonal, of some farm and food products. prices is now more general than at The uptrend of industrial any time during the present upswing in general business. Further information on the steel price advance shows a bigger advance than at first indicated. This increase has not yet been fully reflected in prices of finished metal products. Crop prospects continue to point to a sagging level of farm through the harvest and marketing season. prices market still features strength, with non-farm The labor showing further increases and unemployment showing employment drift. The number of or possibly a modest down little change areas showing labor surpluses fell to 31 in July industrial a year ago, and present surplus communities compared with 53 Over-all productivity gains, which include few major centers. disappeared in recent last year, have virtually were sharp thus one in which a given per months. The present phase is with about an equal per gain in output is associated centage the third big news item in man hours. This is centage gain up 6 per cent and salary payments report. With wage in this
from a year ago, recent wage settlements and negotiations now in process are expected to give important impulse to still further rise. United States imports have continued to rise while ex ports have held close to their earlier advanced levels. Abroad, further production advances characterize most im portant industrial areas, and reflecting this condition as well as U. S. prosperity, primary materials prices on world markets have firmed up further. The boom atmosphere in Britain has obliged the Government again to strengthen its measures to stem inflationary trends. In domestic financial markets, the Treasury's financing needs have now been provided for until early October. Private and local government financing demands in the capital markets, while seasonally light, are substantial enough, with forward negotiations in process, to indicate continued high levels of market financing in the months ahead. Stock prices, on the basis of very favorable second quarter earnings reports for most reporting com panies, rose to new highs late in July. Yesterday, a fairly orderly technical reaction occurred. Stock market credit to customers and brokers would appear to have shown little change on balance over July. During July at city banks, bank credit showed a large increase, reflecting especially acquisitions of U. S. securi ties and some further rise in loans. banking All reports confirm a continuing strong demand for bank credit. While the money supply showed little growth in May and June, there was again an increase in July. Turnover of demand deposits in leading centers outside New York in May and June was the highest in recent years. Thus, recent Federal Reserve policy has restrained the rise of quantity, but use of money has responded to general business psychology and activity. Continuing pressures of demand for credit and smaller growth of supply were reflected in July in resumed advance level of market yields, particularly for Gov in the general ernments and municipals but also for private short-term market paper and to a less marked extent for long-term corporates, especially new issues. Yesterday, reflecting reserve situation as well as market a tight credit and bank of early Federal Reserve discount action, this expectations movement of yields was further extended. upward
Mr. Miller, commenting on the member bank reserve situation, stated that recent and projected reserve changes, as shown on a sheet distributed during this meeting, present a pattern of increasing tight ness for the coming two weeks, with free reserves for the week ending August 10 expected to average around a negative $100 million. He also stated that the situation had tightened up during the last few days largely because of an increase in Treasury balances to more than $600 million, with the result that the Treasury was considering cancelling one of its calls. He noted that, after the next two weeks, a somewhat easier pattern was expected because of the mid-month increase in float so that during that period there may be a small positive reserve posi tion, but that thereafter a pattern of increasing tightness was expected resulting from an outflow of currency over Labor Day followed by some easing as currency flows back and float expands during mid-September. At the end of the month free reserves were expected to drop to a These projections, he said, were similar to negative $230 million. of the Federal Reserve Bank of New York as shown in the supplementary those next two weeks the New except that after the report referred to above The difference between a much tighter position. York projection showed on the movement of the different estimates grew out of the estimates larger declines in Board's estimates showed the fact that the float and required reserves.
Chairman Martin initiated the discussion of credit policy with a statement substantially as follows: I want to say that differences of opinion in the Sys tem are a good thing as long as we resolve those differ ences in a friendly spirit and handle them properly. That is a sign of a strong and vigorous System and is nothing to be alarmed about. My experience with differences is that when they are put on the table and people assume responsi bility for the decisions made, the differences are not as large as they seem when they first arise. Since the meeting of the Committee on July 12 a number of things have happened which I want to report to the members of the Committee. First, I want to read from the excellent statement by Mr. Sproul at the last meeting of the Committee. I think the meetings of the Federal Open Market Committee are the place where we should discuss all aspects of System monetary and credit policy and we are very much indebted to Mr. Sproul for the manner in which he prepares for these meetings and the fine way in which he brings his thinking to bear on our problems. We have some very important decisions to make. The times when critical decisions have to be made are relatively few and, while I may exaggerate, I am inclined to think that the decisions we have to make today are criti cal ones. The comment in Mr. Sproul's statement which I want to read is as follows: "I see nothing in the immediate situation which demands that we embarrass the Treasury in its management of the public debt by further re strictive credit moves during its July-August fi nancings. We are not at a point where the dan gers of inflationary developments clearly out weigh all other considerations. The danger sig nals of inventory accumulation outrunning sales expansion, upward price movements, production, and employment bottlenecks, and excessive material increases in bank credit and the money supply have not yet flashed red." This statement opens up a number of points. Now in my opin discount rate at the Federal have been better if the ion it would prior to the recent Treasury Reserve Banks had been increased rather than afterward. However, financing financing operations
presents a difficult problem for the Treasury as well as for us. What I have just said is hindsight. I don't want any one to think I am criticizing small points. At the same time, there have been unfortunate developments in the market. I want to put the whole sequence of developments out on the table. A lot of comments have been made and a lot of gossip has gone around. Whether the market is upset or credit is tight is all part of the same picture: (1) On July 20, Paul Heffernan had a story in the New York Times about credit policy. I received inquiries during the subsequent week whether the story was authoritative and where it came from. I refused comment. (2) On July 21 we had a difficult market situation to deal with because the Treasury financing was still under way and the market was jittery. Mr. Riefler came to me that morning with an indication that our projections might be going awry and that we would have another period of a tightening market during a period of Treasury financing. Not wanting to "butt in" on the management of the System account, I called Mr. Sproul at the New York Bank. Mr. Tiebout, General Counsel of the Federal Reserve Bank of New York, was taking I talked with him about keeping the Mr. Sproul's calls and reserve position on an even keel while the financing was in with Mr. Rouse who was in Buffalo progress. After consulting Mr. Tiebout called me back Mr. Sproul, and with the desk, with the Bank could get bills, that purchases and reported that that he thought it would be wise to handle were being made, and was handled well and the situa the problem in this way. It tion worked out satisfactorily. of 100 representatives morning I addressed (3) Friday and was very careful to exchange firms in New York stock policy. At the end of to Federal Reserve avoid any reference don't know why you individualarose and said:"I the meeting an the New York Bank has I understand that are so coy because increased and that re discount rate would be said that the to comment on this. only be mild." I refused straint would came out and Porter letter the Sylvia (4) On Saturday forecasts of Fed seven points as important quoted a series of the statement was did not know whether policy. I eral Reserve did not trouble me, and, while it or was not a misquotation in recent developments an important episode it is nevertheless it concerns all on the table because am putting it out and I of us.
(5) On Monday of last week Mr. Fulton called to say that his directors had been considering the discount rate, that they were disposed to make an increase and would like some guidance. I replied that now the Treasury financing was out of the way I would discuss the matter and give him what guidance I could. (6) On Tuesday the Board had a discussion of the prob lem and decided that it would be wise for me to solicit the views of the Treasury. I went to the Treasury and met with Secretary Humphrey and Mr. Burgess. At my suggestion Mr. Burns, Chairman of the Council of Economic Advisers, was also present. I laid before them the facts of the situation indicating a need for an increase in the discount rate and also the fact that the market might suffer a serious decline if the discount rate were advanced, that the Treasury might be embarrassed and that the System might be accused of wait ing until the financing was out of the way and then letting the market drop. I said the Board of Governors had been dis cussing whether it would be better to increase the discount rate in two steps or to go to 2-1/4 per cent on one step. While the Board was inclined to believe that a one-step ac tion was better, it wanted the judgment of the Treasury. I was given the unequivocal decision that the Treasury would prefer that the increase be in one step to 2-1/4 per cent. I think that at the meeting at the Treasury we covered all of the dangers inherent in such action, although presumably there was some question subsequently as to that. the Treasury representatives the (7) After meeting with Board discussed the matter further and I called Mr. Sproul what had occurred. I then called Mr. Fulton and, and told him I did not attempt to put any pressure on as he will testify, him. I simply told him what the thinking was here and said the move to 2-1/4 per cent in one step. Sub Board was disposed to July 27, the directors of the Cleveland Bank came sequently, on per cent and I understand the action in with a rate of 2-1/4 Having received that advice from the Cleveland was unanimous. telephone the other Presidents and I Bank, I felt obliged to I could reach. I made no effort talked with every President but informed them as to the thinking to put pressure on them the course that was being pursued. Thereafter, here and as to that the directors of the Federal Mr. Young telephoned to say on a rate of 2 per cent and Bank of Chicago had agreed Reserve Bank advised of action by on Monday of this week the Boston fix a rate of 2 per cent. their directors to
(8) On last Thursday Mr. Burgess called me to say that he had had a long talk with Mr. Sproul and that there was some concern whether, if the increase in the discount rate were in one step, it would be very disruptive to the market. He wanted to know whether I had weakened in my posi tion that a one-step increase was desirable. I replied that I knew the action would be disruptive to the market but that I had not weakened in my position. Mr. Burgess said he had talked with Secretary Humphrey again and assured me that they thought 2-1/4 per cent was the correct rate. At that point I went to New York with Mr. Burns to address the Con sumer Credit Conference. The next evening I received a telephone call from Mr. Riefler which I will ask him to re late to you. (9) Mr. Riefler stated that about 3:50 p.m. on last Friday afternoon Mr. Sproul called to say that he had tried to reach Chairman Martin and Vice Chairman Balderston but had been unable to do so, that a dealer had just reported that the writer of a leading Government securities market news letter had said that a responsible Federal Reserve of ficial had made the statement that classically the discount rate went down by 1/4 per cent and up by 1/2 per cent, and that action could be expected in the near future. The dealer thought that the statement had had a very disruptive effect on the market Friday afternoon. Mr. Riefler said he responded that the observation was not one he had heard before and it did not sound like an inadvertent leak. He added that about one hour later on the same Friday Mr. Burgess called to say that he had tried to reach Chairman Martin and Vice Chairman Balderston but had been unable to do so. He said that he was with Messrs. Humphrey, Blyth, and Overby of the Treasury, that they had been considering whether the rate increase should be in one step or two, and that they had changed their minds and now felt that two increases of 1/4 per cent each were probably better than a single increase of 1/2 per cent, that they realized that this was a change in position, but that they that many institutions which had subscribed for had in mind might regard it as a breach of the 3 per cent bonds recently 2-1/4 per cent so soon rate were increased to faith if the asked Mr. Riefler to get in touch with afterward. Mr. Burgess Martin and ask him to get in touch with Secretary Chairman Humphrey early on Monday morning.
(10) (Chairman Martin continuing.) I called Secretary Humphrey yesterday morning and went over the situation with him again. He agreed that he had given us the "go ahead" on a 2-1/4 per cent rate. I told him I had seen several dealers coming up from the street on Friday (including Mr. Craft) and that they said the discussion in the market was all on the point whether the increase would be 2 per cent or 2-1/. per cent. I told Secretary Humphrey that I had not changed my mind at all and still favored an increase of 1/2 per cent. He was worried about whether we had thought through fully the Treasury's responsibility to the people who had bought long-term bonds. I said I thought it was a little late to bring that point up, that while I would go back and discuss the matter with the Board, I thought the Board was disposed to go to 2-1/4 per cent for the one Bank that had acted to fix that rate. After discussing the matter with the Board, I talked to Messrs. Humphrey and Burns again. As of the moment, Mr. Humphrey is not happy about the picture but is relying on our judgment. He has some question whether we should go first to 2 per cent and then to 2-1/4 per cent but he thinks that we should get to 2-1/4 because he believes we are in an inflationary situation. However, he is not al together happy with the prospect of a single increase to 2-1/4 per cent. That is a background statement for the discussion at this meeting. If I have made any errors in what I have said I hope someone will correct me. We have a difficult situa tion before us. We will always have differences of opinion on these matters. I would like to point out that my views would be the same if we had not had the discussions with the Treasury. I would like to go back now to Mr. Sproul's statement which I read earlier. I think personally that all the danger signals he mentions are now flashing red. Inflation is a thief in the night and if we don't act promptly and decisively we will always be behind. All of us know that it sometimes takes a long time for seeds to germinate, but when they flower, they do so with explosive force. A move such as we had in General Motors of fifteen points in one day would be disastrous if it developed over the whole price level, and once such ac tion has occurred, neither monetary policy nor anything else could effectively restore the purchasing power of the dollar without creating such distress as to preclude its usefulness.
It is true we may have a difficult situation in the Gov ernment securities market. At the same time, banks are no different from consumer credit lenders who always want "the other fellow" to restrict credit. With the heaviest de mand for credit that we have had for a long time the cost of credit must go up or the groundwork will be laid for burgeoning difficulties. We are faced with a wage cost push at a time of vir tually full employment, consumer and mortgage credit are "running out of our ears," and while the housing authorities have stiffened their terms slightly it would have been better if they had never gotten into the position of over stimulating the housing market. The new requirement of a $200 down payment on a $10,000 house is not my idea of a drastic credit move. Inventory accumulation is already under way. I don't believe in intuitive judgments, but we can not always wait for statistics. A recent revision of earlier statistics tells us that in the first quarter gross national product was up $5 billion more than we had thought earlier and I think it is now at an annual rate of $383 billion. That is quite a jump and it is utterly incomprehensible that in that situation orders to expand inventories are not increasing. People with whom I have talked tell me that the reason inventories have is because sales have been so high. Easy credit not increased when easy credit was not necessary. Plant has pushed up sales are definitely on the increase. and equipment expenditures trend will change because of a drop in the I doubt that this At the same time, I doubt that Government securities market. cause either panic or in the discount rate will the increase and catastrophe "thrown at We are having panic catastrophe. in which we have to act. we are faced with a situation us" but It seems to me money and credit have become a stimulating in the economy. There a time when it is not required force at Farm prices are declining, but are always offsetting factors. sector of the economy to go "hay I don't want the industrial get completely out of adjustment. wire" on its prices and before the end of the year, Farm prices may well be higher addition to what we now have, and if farm prices were up in general prices would be "sky high". to the Fed to be issued to the directive With reference that we change York, I would suggest Bank of New eral Reserve "to restraining infla paragraph (1) to read: clause (b) in sustainable economic the interest of developments in tionary growth."
Chairman Martin then called on the Presidents of the three Federal Reserve Banks whose directors had acted to increase the dis count rate. Mr. Fulton's comments were substantially as follows My directors met on July 14 at which time they discussed the discount rate. In view of all of the facts that had been given by Mr. Young in his economic review at the meet ing on July 12 and which were existent in the fourth Federal Reserve District, the directors were in favor of an increase in the discount rate. However, because of the Treasury's financing operation which was still in progress I counseled against any action at that time. As the minutes will show, at the meeting of the Federal Open Market Committee on July 12 I expressed the view that inflation was already present in a degree that was not readily discernible except from the "feel of the situation." Our directors discussed whether the increase in the discount rate should be in one or two steps but they were all of the opinion that an increase of 1/2 per cent was desirable in the circumstances. The directors held a special meeting last Wednesday primarily to discuss our Pittsburgh building but they dis cussed the discount rate problem also. They still felt that the rate should be increased. Several of the directors had talked with bankers and industrialists throughout the dis trict and one banker had expressed the view that if the Fed eral Reserve increased the rate by less than 1/2 per cent it would be temporizing with the situation and would ultimately regret the action. Our directors were unanimous in their decision that an increase of 1/2 per cent was desirable from of the over-all economy, including the fact the standpoint that the demand for credit was so strong that it seemed to be without limit. Last Tuesday Mr. Blyth, of the Treasury, was in Cleveland and I had a long talk with him without di what we were thinking. He said that the Treasury vulging probably would have to come into the picture for additional September rather than in October because cash financing in funds for farm price support operations and of the need for
other purposes and that this would preclude increasing the discount rae in two steps. It was his view that whatever action was taken should be in one step so that the market could adjust to it. That all served to fortify the feeling of our directors that an increase in the discount rate of 1/2 per cent in the appropriate action to take at this time. Mr. Young stated that at the meeting of his directors last Thursday at which seven directors were present (he had previously talked to the two absent directors and obtained their views) the national eco nomic situation and conditions in the Seventh Federal Reserve Ditrict were reviewed and that everything pointed in the direction of strong expansion. He had talked with two or three large automobile dealers and felt that the credit extended on new automobiles, because of the very grade in quality when compared with credit extended easy terms, was second the resulting situation was a dangerous one on used cars. He felt that to restrict credit should be taken. He added and that immediate action should be an increase of considered whether action that the directors an increase of 1/2 and that they discussed cent or 1/2 per cent 1/4 per the directors had prepared statements which they per cent first. Some of Mr. Young said, and while they agreed read at the directors' meeting, be done, no one wanted and that something should that inflation was here They then talked about an increase the rate by 1/2 per cent. to increase approve that. Mr. Young went on to say that of 1/4 per cent and voted to a meeting of the executive for authority to call he asked his directors the basis that if in the rate on a further increase committee to consider
other Federal Reserve Banks should increase their rate to 2-1/4 per cent he felt the Chicago Bank should make the same change. He also said that following the meeting two of the directors called to question whether their action should have been an increase of 1/2 per cent and that he had received a wire from one of the directors to the effect that if, after attending this meeting, he (Mr. Young) felt the rate should be 2-1/4 per cent, the director would vote for such an increase. Mr. Erickson stated that at the meeting of his directors on March 28 he recommended an increase of 1/4 per cent in the discount rate which the directors approved provided some other Federal Reserve Bank made a similar increase. The reason for this action was that the direc tors did not think that the economy of New England was as buoyant as in other districts and they wanted some other Reserve Bank to act first. In April as soon as the Federal Reserve Bank of Kansas City increased its rate the Boston directors voted an increase of 1/4 per cent. In May, Mr. Erickson said, the directors brought up the question of the unsound ness of consumer credit development and approved a letter to all banks in Federal Reserve District cautioning them about unsound consumer the First to say that the directors recently had been credit terms. He went on rate but had not done so because of anxious to increase the discount yesterday after reviewing the financing, but that at the meeting Treasury the increase should be 1/4 or 1/2 situation again and discussing whether
per cent they felt that, in view of what might happen in the Govern ment securities market if the increase of 1/2 per cent were made in one step, they would prefer to take the action in two steps and consequently voted an increase of 1/4 per cent. Their thought, Mr. Erickson said, was that after the market had adjusted to that change the rate could move up to 2-1/4 per cent if it then seemed desirable. He added that the directors also expressed the hope that through open market operations the market would be further tightened. Chairman Martin then called on Mr. Sproul who, before reading a prepared statement, made substantially the following comment: In view of the reference that has been made to getting everything "out on the table" I don't want to leave any impli cation that I have anything "under the table." I would like to refer first to the New York Times story mentioned by the Chairman, which followed a press conference I had with finan cial reporters of the New York daily newspapers. The confer ence was an ordinary press conference such as has been held at the Federal Reserve Bank of New York ever since I have been there to provide financial reporters with whatver back ground information we feel we can give them so that they will be better able to write about finacial and credit matters. The second-hand report in the news letter of what market was based on a general discussion without explicit went on certain matters. It was put or implicit statements concerning of definite statements as to what happened. With in the form on mild restraint, the reporters reference to the statement policy could be characterized and had asked how the present believe in trying to characterize a policy in said I did not been characterized at times one or two words but that it had questions about the discount of mild restraint. Any as one that I could not and would not say anything rate were answered about it. are concerned, So far as the telephone conversations views and the views and told me of his Martin called Chairman
of the Treasury and Mr. Burns. Subsequently, he called to tell me about the action of the Federal Reserve Bank of Cleveland. Mr. Rouse was away and I had fairly frequent con versations with Mr. Burgess for whom we were carrying out operations and with whom we were discussing the situation in the market. He referred to the discussions with Chairman Martin and to the fact that there was concern about the credit situation and the view that had been expressed that the rate be increased by 1/2 per cent. I asked if him ade quate consideration had been given to what that might do to the capital and Government securities markets. He said that it had been considered. I expressed the opinion that the capital market was under strain and was undergoing an adjustment and I thought that an increase in discount rates of 1/2 per cent might have a more serious effect than might be expected. He called back the next day and told me that he had talked with Secretary Humphrey and Chairman Martin and that they were still of the same opinion but thought that the matter should be thoroughly discussed at the meeting of the Committee and Mr. Burgess said he hoped Federal Open Market that I had. I said that I cer I would express any views He called again on Friday to say that Mr. Blyth tainly would. the Treasury, that there had of the Treasury had returned to and that it was discussions with the Secretary, been further to move in two steps rather thought that it might be better was going to try to get in than one and that the Secretary morning. He said he had Chairman Martin on Monday touch with that I would know that they at the Treasury had called me so irrevocably against action their faces definitely and not set was the end of my conversa instead of one. That in two steps tion with Mr. Burgess. prepared statement was as follows: Mr. Sproul's or not we have entered is no need to debate whether 1. There monetary restraint on area in which increased an economic a substantial and We have had expansion is indicated. credit during the first half of rise in bank loans contra-seasonal for bank credit during the and we face heavy demands the year that, with We have the possibility half of the year. second
increased costs pushing upward on industrial prices, the general price level may break out on the upside. We have the possibility that, in these circumstances, speculative in creases in inventories will take place. We have the fact that consumer spending (bolstered by expanding consumer credit and mortgage credit on relaxed terms) has become high and saving has become low in relation to current income. We know that prospective capital expenditures by business are slated to rise from earlier high levels. 2. The principal questions of judgment which remain are (a) Whether the weight of evidence is now indica tive of desirable growth but with speculative and credit excesses in some sectors, or whether it is in dicative of inflationary forces which have or are about to get out of hand? (b) Whether continued steady and probably increas ing pressure, as the season advances, is the best contribution which monetary policy can make to the maintenance of growth and the containment of exces sive use of credit and of speculation, or whether it is time to take action which will signal a more seri ous economic situation and more drastic measures to deal with it? also subsidiary questions 3. There are (a) As to whether the Treasury's financing needs during the remainder of the calender year are likely to hamper us in the later use of credit measures, and particularly of the discount rate, so that it might be better to act now in anticipation of pos sible later need. to whether a policy of continued and probably (b) As increasing pressure will interfere more seriously with Treaury financing than would anticipatory ac tion now followed by a period of stability, at least so far as the discount rate is concerned. the Treasury's fi questions first, 4. Taking up the subsidiary due to its need to come to nancing difficulties are fundamentally particularly for cash, in a market for refundings, and more the rising interest rates. Nothing we can do, short of period of credit policy is required by eco abandoning whatever restrictive this situation, or can keep Treasury nomic conditions can change they begin to be traded in the at par for very long after issues
market. But having said that, we have before us the recent example of the Treasury's ability successfully to raise cash and conduct an exchange offering in the face of an already tightened reserve situation and of widespread expectation of a rise in interest rates, including the discount rate. I see no need to try to anticipate now what may be the situa tion in late September, in order to be out of the way of the Treasury's September-October financing, which in any case will presumably take the form of a tax anticipation certifi cate not requiring much if any assistance from us. And, cer tainly, we can give no assurance to the Treasury, nor anyone else, that whatever action we take now will foreclose the possibility of further action later if the economic situation seems to require it. 5. Taking up the main question, I recognize the strength and the risks of the present situation, but I do not know whether it is getting out of hand. I do not know whether we have reached the limits of our productive capacity in terms of men, materials and equipment. On these matters we have opin ions rather than conclusive evidence. In such circumstances, I would deal with the situation with firmness in the light of what we can see now and immediately ahead, but I would not try to project myself too far into the future. What we can see here and now suggests (a) An open market policy which will develop condi tions tight enough to bring about a further increase in member bank borrowing and in interest rates. Inso far as free reserves are still used as a guide, they would ordinarily be on the minus side of zero, but would be less a guide than fluctuations in member they bank borrowing and in interest rates. (b) An immediate increase in the discount rate from 1-3/4 to 2 per cent. Retention of the power to use repurchase agreements, (c) within the authorized range of rates. 6. What are the risks of an increase in the discount rate to cent instead of 2 per cent, if we want to increase the 2-1/4 per pressure of credit restraint in any case? It is only a 1/4 of 1 per cent difference. Well, as I see it they are risk of giving expression to a judgment about (a) The situation which we do not yet have to a future economic make. I also see here, again, an attempt to place on much of the burden of fears about credit policy too
future economic developments - with the shadows they may cast on 1956. If the situation is as critical as some suggest, credit policy can't do the whole job, and shouldn't try to do it. It may be, for example, that fiscal policy will have to be called in, and housing policy will have to be over hauled further. Because these things won't or can't be done, doesn't mean that credit policy should try to do more than it is capable of doing effectively. (b) The risk of bringing about an erosion instead of an adjustment in the capital markets. The capi tal markets have been adjusting to what we have al ready done, and will adjust gradually further, to advantage, as the pressure of demand for credit meets a reluctant supply. Too sharp an adjustment, how ever, can arouse fears and create strains which would go beyond what we need or desire. We cannot dismiss altogether what happened in 1953, even though conditions then and now are quite different in many ways. An increase in the discount rate by 1/2 of 1 per cent, after a long period of 1/4 per cent changes, and coming when capital markets are already uncertain and beginning to sho strain, would be a risky move. I know that it is argued that the most likely outcome of a substantial increase in the discount rate now would be to relieve further un certainty and to put a floor under the market, and that even if the initial reaction proved too severe we could offset it by open market operations to correct a disorderly market. For my part, I doubt if any one knows what an increase of 1/2 of 1 per cent would do to the capital market. I think it is risk to take. Nor can we "get it over an unnecessary and put a floor under the market because this with", may well be more than a one-shot problem - we may the rate again, whatever is done now. have to raise the rate by 1/2 of 1 per cent And finally, to raise we would offset the ef with the assumption that now in rate by open market opera fect of the increase not know what we were suggest that we did tions would when we raised the not mean what we said doing or did rate in the first place. the risk of getting the (c) That is the third risk, operations out of tandem. rate and open market discount
With the smaller increase in the discount rate we shall have open market operations and the discount rate running together in harness, and the discount rate keeping more or less continuously in touch with open market rates. With the larger increase, we run greater risk of having to take counter action through open market operations, if the business and credit situation does not perform according to our projections, or if the immediate results of our ac tion are more drastic than we intended. 7. To sum up, these things I have mentioned might not happen, but we don't need to run the risk of their happening in order to have monetary policy do its share in trying to prevent in flationary developments. I think it is a time for steady pressure, not for jumpy moves. We haven't the same domestic situation and we have no balance of payments problem forcing us into immediate and dramatic action, such as has been taken by the United Kingdom and other countries where substantial in creases in discount rates have been made, and where monetary policy was probably asked to bear too great a share of the bur den of econonic stability. We can afford the better course, at this stage, of gradual moves fitted to the economic situation as it emerges. Chairman Martin then called on Mr. Bryan who read the following statement: The problem of judging appropriate monetary policy is difficult because of the unusually complex economic situation, complex, of course, not from the statistical but from the Monetary policy is also es standpoint of cyclical analysis. at this time because we have denied to our pecially difficult of the economic effects of previous selves a current knowledge as if that were not enough, the diffi monetary action, and, presence in the mar compounded by the prospective culties are a large and necessitous borrower. ket of the Treasury, that the economic situation is ebul 1. We can all agree and presses on the comfortable capacity of the economy. lient present trends in concluded that the apparent It can thus be to over-reach comfortable simply extend themselves the economy is inevitable in accordingly, an inflation capacity and that, immediate, and substantial monetary the absence of additional restraint.
I would agree that sophisticated economic arguments can be advanced to support the opinion that an extension of recent trends is likely and that, in the absence of sub stantial monetary restraint, a price-level inflation, with its accompanying distortions of the economy, is also likely. So, with regard to the economic situation, I content myself with two caveats, one in the field of business cycle rela tionships and one in the field of American economic history. We should not forget, I think, that a boom extending toward the upper reaches of comfortable capacity automatically produces powerful countervailing forces. These forces have to do with the declining profitability of marginal employ ment and the declining profitability of new real investment in the face of a stable or relatively stable level of prices for finished products. It would be pointless to pursue such considerations in detail, but it would also be unwise, I be lieve, to forget that such forces exist and that they exert a powerful braking action on an unlimited and continuous ex tension of an economic boom. We should also at least remind ourselves of American economic history. At this time, when we are fearing infla tion, we can take some comfort from the fact that the American economy in its now long history has not shown a general im portant price-level inflation except in war and as the direct aftermath and consequence of war. Our experience has been that the productive capacity of American the economy, its com petitive nature, and the countervailing forces already alluded to, have made the American economic system exceptionally dif ficult to inflate in peacetime. In making these brief comments, I do so merely in order to indicate that our inflationary problems may not be as great or as intractable as we may be inclined to fear. 2. It seems to me that we can take comfort from another factor. The monetary situation is such that general inflation is hardly going to get off the ground unless we, by decision subsequent to this time, deliberately decide that we will necessary for an inflationary price-level supply the funds movement in the economy. There exist, by and large, no free reserves in the banking system. The money supply as against last year represents a modest increase. The increase of bank ing reserves as against last year is likewise quite modest. factors should be countervailed by an excited Even if these increase in the turnover of the money supply, we have the power to dampen down the result with no untoward delay.
All this is to me quite comforting because it has a definite meaning. If the economic system endeavors to over run its comfortable capacity it will not be supplied by large, existing, and idle reserve funds. It will automat ically run against an extremely limited reserve situation, and we will be quite able to make decisions from time to time regarding the degree and extent to which we supply additional reserve funds or subtract from them. That is, we can make such decisions provided we preserve a monetary climate in which we can act of our own volition and do not create a climate in which we must act involuntarily. 3. Let me now turn to what I consider the major awkward ness in our consideration of further immediate monetary re straint. In so doing, it is necessary to recite some recent monetary history, not for the sake of history but particularly to illustrate what I regard as the grave danger of getting ourselves into precisely the same box in the future in which we now find ourselves uncomfortably confined. It will be recalled that some months ago we raised our discount rate to 1.75 per cent. We thus adopted a stated short-term rate of 1.75 per cent, which I believe could only indicate our belief that the economic system required the re straint of an increased cost for the borrowing and using of money and an increased reward for money savings. That was a correct decision, but at the time of the May financing we ap parently became a little tremulous and fearful of the effects consequent to the course we had adopted, and entered into token purchases in the open market. Thereafter, flushed with a heavy corporate and other demand for bills, the open market rate drifted down into the 1.50ies, the 1.40ies, the 1.30ies and actually reached a point more than 40 basis points below the discount rate. During nearly the whole period after th increase in the discount rate, the corresponding open market rate was permitted by us to be substantially lower than the discount rate. The net effect of this situation was to prevent the arbitrage of yields that would have made the cost of bor rowing and using money more expensive. The net effect, in to prevent the economic restraint that we short, was largely had presumably thought desirable. Only in the last few weeks, with the Treasury increasing variety of factors causing corporate bill offerings and with a and other bill purchasers to need funds, has the bill rate gotten into touch with the System's discount rate. Only in
the last few weeks, therefore, have the arbitrage effects of the previous increase in the System's discount rate begun to occur. Only in the past few weeks have we been able to see what the money market and yield curve effects of our previous action are in kind and degree; but we still do not know the degree of economic restraint that we have accomplished. We do not know that vitally important fact because of the lag in transferring money rate causes to real economic effects. We thus, it seems to me, have gotten ourselves into an embarrassing position. Our embarrassment arises from the necessity of considering further restraint at a time when we might have been currently pretty well informed regarding the restraint involved in our preceding action but are actually uninformed in major aspects because we did not quite mean what we said when we previously raised the discount rate. As I say, I do not recite all this for the sake of his tory but as a caution. We should caution ourselves, I be lieve, about getting into the same box again, and we should caution ourselves against an over-zealous action a: a time when we are not, to be sure, flying entirely blind but when the visibility is not good. 4. In the past few weeks, when the arbitrage of a pre ceding action has been allowed to come into being, we have been able to see something of the direction and extent of the money effects (not yet the consequent real economic effects) that we have produced. However, we can at least know the di rection of theeconomic effects that our actions have created. The money markets have been trying to tell us a story. That story seems to me not to have been a story read in fine print and whispered to us by innuendo. Instead, it seems to me to have been a story written in headline letters and cried out to us in a loud voice. I will not attempt to state in detail what the voice has been saying, but two major items are newsworthy. government market in nearly every sector of its a. The has been exceedingly weak, and there has maturity schedule of yields and capital values. We been a major adjustment magnitude of the yield changes that should not overlook the have occured, I believe, and should not be at all sanguine the theory that this merely represents an anticipatory about monetary restraint. An examination of discount of further months does not settle the curves over the past few yield not seem to me to support such a view. question, but it does
The existing adjustment of yields is more likely, in my opinion, to represent a normal adjustment as the short open market rate has conformed itself more nearly to the System's discount rate, and further increases in short rates are likely, I judge, to involve further upward arbitrage of yields and downward arbitrage of capital values throughout the whole range of maturity and quality schedules. b. The municipal market has been dreadfully sick. Unless we pump funds into the banking system in tremendous quantity, which I think we will not do voluntarily at near term, it would seem reasonable to suppose that that market is going to be ill for a good long time and have a slow re cuperation. There are going to be many offerings; undigested inventories of municipal securities are great; and most im portant of all, the banking system, which has for years pro vided a major market for the short end of the municipal ma turity strip, is now loaded. These developments tell us a story. They tell us that the banks of the country, almost without exception, have substantial losses in their investment portfolios not alone in governments, but in municipals and corporates. They have a substantial erosion of their capital accounts. That fact in turn tells us another story. Whereas, a few weeks ago, the banks of the country could peddle securities with, for the most part, minor losses and plus accommodate even marginal borrowings, we know that now their net security sales will generally be accompanied by losses that are not so minor and in many instances are major. Whereas, a few weeks ago, the banks were really not restrained in accommodating marginal borrowings, now the restraint has been increased. I cannot pretend to say how great the restraining ef fect on the banks will be in quantity, but I think it can safely be asserted that the effects of the past few weeks have established a new and restraining influence that was not present theretofore, and I would personally judge that that restraining influence is far more powerful than we may be inclined to imagine. Unfortunately, it will hardly show up in our statistics or in any contraction of loans for some little time in the future. The markets for both municipals and government securities to tell us that there will be a slower have also been trying revulsion in the mortgage markets but nonetheless considerable as commitments expire. For many classes of mortgage lenders, of taxes, administrative costs, and the risk in consideration
aspects of some mortgage loans, the municipal markets give a higher net yield at shorter term, with equal or greater safety, than the mortgage market. Indeed, for some mort gage lenders the government market is also attractive. We thus know that the restraint already begun in the mortgage lending field is going to be powerfully increased and aug mented by investment opportunity relationships now clearly evident, and, in a few months, as mortgage lenders run out of existing commitments, these money market and investment shifts will begin to show up in real economic effects. Other things of the sort I have noted can be cited. I will not even allude to what I diagnose as the metastasized cancers eating at the equity markets, markets still in the apparent flush of good health. What I have said, though, is enough to indicate the awkwardness of our position if we adopt large further restraint without a fairly good knowledge, which we do not have, of the economic effects we have already, though very recently, set in motion. 5. Now, if we raise the discount rate we shall be con fronted with the problem that has tripped us so badly in the past. That is, if we adopt a new and higher System rate, we will be saying, in effect, that the cost and use of money should be more expensive, and that the reward for money sav ing should be increased. We will then be confrontod with the problem of whether we mean what we say or whether we are merely making a polite observation. If we mean what we say, then we will have to permit the short open market rate to conform itself to the System discount rate, or force it to do so, and thus effect an arbitrage of interest costs along the whole maturity and quality schedule. Before we take any long step in that direction, we ought to have in mind, I think, not merely the hazard of the absence of knowledge of the economic effects acting in have thus far set in process, but we should also, that we lest we be startled by developents, have in mind the magni that can occur as a result of cer tude of the price changes this time, for if we become shifts of yields at tain upward and startled, we may respond erratically. surprised possibilities of 25 more basis Let us then consider the rate, bring the short rate in the neigh points in the short of course, contend per cent. No one would, borhood of 2 in the short market of a per cent increase that a quarter
would make an exactly corresponding increase in yields in the long market. If it did, then, the new forty-year 3's would sell in the neighborhood of 90. Still, a man would be considered reasonably conservative if he judged that a 25 basis point upward change in the short rate could easily produce a change in the longest rate in the range of 8 to 12 basis points. That puts the new forty-year 3's in the neighborhood of 95. The basis point adjustment to the short rate will be greater naturally, as we go down the maturity curve. A corresponding adjustment in the 2-1/2's of 67-72 could put them in the neighborhood of 90. Neither figure allows much, if anything, for the overrun typical of free markets. There would be further repercussions in the munic ipal and corporate markets. It seems to me, accordingly, that we should have in mind some price adjustment magnitudes in the approximate order of those I have indicated, because, once we get them in mind, we begin to understand, and only by having them in mind can we at all understand, the power and force of the financial and economic effects that we can set in train. For my part, I have little doubt that capital losses in the magnitude I suggest--losses that I deem entirely likely from even a 25 basis point increase in the short rate in the face of a large money demand--would, if they occurred suddenly and dramatically, set in motion an economic restraint of the first class. 6. The general direction of the argument that I am try ing to make is now clear. I am arguing that we are in an awkward position because the restraining capital losses in the financial markets are now considerable and can be expected to have a considerable real economic effect, but those losses have been created so recently that we are not in a position reliably to appraise their real economic effects. That situation has occurred because we have used the discount rate as an admonition, not until very recent weeks, as an effective rate in the are thus flying through heavy clouds in consider market. We ing further restraining measures The obvious danger is that we may, with further measures, developing a cumulative economic restraint find ourselves The danger that I would here em that overshoots the mark. adopt a new and higher dis however, is that we may phasize, to the financial and economic count rate, clearly indicating
worlds that an arbitrage of yields throughout the rate and maturity schedule should occur. Then, when the arbitraging process begins, we may easily find ourselves startled by the magnitude of the downward capital adjustments in the in vestment market and promptly come in with open market pur chases in order to prevent the effective open market rate from conforming to our discount rate and thus deny that we meant what we said when we raised the discount rate. In short, I am afraid that what we will do is to say that we want an arbitrage of yields and capital values in order to provide economic restraint and then, when they begin, deny the arbitrage of yields and capital values by establishing an effective open market rate substantially below the dis count rate. Such a monetary maneuver in my judgment is nearly al ways inept and has had unfortunate consequences at certain periods of the System's history. It is particularly dangerous at the present time. To my mind it has two clear dangers that we should by no means underestimate. a. One danger of importance is that, if we raise the discount rate in the face of a booming economic situation and then, in the open market, countermand the effects, we can find outselves, say in October, in the same position we are in today. That is, we will be under the necessity of a further increase in the discount rate, as we considering are now, and considering such further action without knowl edge of the effects of the previous discount if it had rate rate. We will again thus be operating been an effective lagged, real economic effets in without a knowledge of the action, and our second case will be worse volved in past conseqence of such procedure than our first. The ultimate some point we shoot well beyond the seems to me clear. At of restraint that we want. degree danger of even more important The second and perhaps b. time is that the market, taking us such a procedure at this the increase of discount rates, at our word with regard to that we intend with reasonable prompt will logically assume rate to that statement the short open market ness to conform upward adjustments of of policy. We then get substantial values. Remember of capital and downward adjustments yields overrun their mark, we of free markets to ing the tendency or incipient disorder. situation of actual can easily get a
At that point we are almost certain to be frightened and practically compelled to perform a rescue operation with sole regard to the investment markets, not the underlying economic situation. That rescue operation in the presence of a raised discount rate is almost certain to involve put ting reserves into the market in magnitudes far greater than would have been required if we had not given our dis count rate signal and far greater than the economic situa tion, either on a long-run or seasonal basis, would re motely justify. The danger, then, is precisely this: that we maneuver ourselves into a position, in a momentary ex cess of enthusiasm, in which we will have to feed the very inflation that we are intending to restrain. 7. Having emphasized the awkwardness of our position at the present time and the hazards of giving a discount rate signal, it is fair to ask how I would proceed. Well, one thing is clear, I would not at the moment increase the dis count rate to 2-1/4%. If we do so increase the rate, I take it as a practical certainty that we do not intend at all promptly to conform the short rate to it. I would judge that so large a short rate increase would produce yield and capital value arbitrage effects so great that we, our selves, would not find them tolerable as a policy result at this time and that would not, in any event, be a prac tical maneuver in the field, let us say, of political economy. So I would assume that a 2-1/4% rate would automatically mean that we would promptly establish an open market rate substantially below the discount rate. We would thus, by putting the discount rate so far above the effective open market rate, deny to ourselves the safety valve feature of the discount rate in the event adverse market developments tended to create an undesired degree of financial stringency. would thus also be likely to find ourselves, as I have We said, later on considering further action without repeatedly of knowledge that we should have. It is my judg the degree increase of the discount rate ment, then, that the maximum that we should consider is to 2%. this a time in which further However, I would consider could be approached with the least danger by doing restraint thus be inclined to: four things. I would to policy, not free our chief present guide a. Use as total reserves, but money rates, relying upon reserves, not
our knowledge that increases in those rates, particularly as they are transmitted into the long markets, will have a pervasive and powerful, though lagged, effect in the real economy. b. Preserve the present discount rate for its safety valve feature, relying on our knowledge that, as banks are pressed for reserves, they will have to come in and borrow and, in their present illiquid position, such borrowing will act as a further important restraining measure. c. To experiment with further rate increases by let ting the bill rate float above the discount rate, carefully observing the effects in the government and other fixed in come investment markets and stopping out the rate increase whenever the downturn of capital values appears to have mounting disorder or the existence of two-way markets seems seriously impaired by the withholding of investment funds in anticipation of lower prices. d. To stop out, in any event, the increase in short rates in sufficient time to provide the Treasury with sta bility for its financings. It is my judgment that proceeding in this way we could effect further powerful restraint, remain consistent in the handling of our instruments, and minimize the hazards that, to my mind, appear so great. If the economic boom is as powerful as we think it is, representing an unsustainable rate of economic expansion, and if the financial markets are able to take the restraint without erratic disorder, which would represent an unwanted degree of financial stringency, the effective short rate above the dis then, by floating to raise the discount rate as count rate, we shall be able improves and as such a move seems needed. the visibility Mr. Bryan said that he re At the end of his written statement statement might not be followed program outlined in his alized that the promptly to either 2 would increase its rate that the Atlanta Bank and following the discussion at this meeting. or 2-1/4 per cent as determined comments of Mr. Balderston then asked for the Chairman Martin rate to 2-1/4 per cent. an increase in the the first to suggest who was
Mr. Balderston's statement was substantially as follows: It seems to me that we have to face the fact that many bankers will not like a 2-1/4 per cent rate. Some stand to suffer substantial portfolio losses, perhaps significant in relation to capital. Contrary to the line of thinking that Mr. Bryan has presented, I find myself greatly disturbed by Dr. Goldenweiser's remarks about the failure of the Board to act soon enough in 1919 because of Treasury financing. Also, the drastic action of 1928 and 1929 failed to control a movement that had gotten out of hand. Mr. Young's report reinforces my concern that the inflationary forces now loose will be difficult for monetary policy alone to stem. It will take more than monetary action. It will take fiscal action, and prudent decisions by businessmen as to borrowing and by banks as to lending. Loans are on a high plateau. Indus trial production is up 14 per cent over the year, with the nondurable component up 13 per cent, and the durable goods component up 16 per cent. Capacity levels have been reached in metals, building materials, rubber and chemicals. Then there is the impact of personal incomes, which are up 6 per cent over a year ago, on retail sales. Automobile sales are up two-fifths over a year ago and the sales of major appli ances at department stores are up three-fifths. It is clear that retail sales have recently been increasing at an increas ing rate. Not only the current peak figures but increases in the rate of improvement should be taken into account. Plans of entrepreneurs to expand capacity, and the growth of consumer credit and its misuse to the point where dealers are selling terms instead of automobiles are evidences of ebullience. Increases in heay construction, consumer credit, the upsurge in retail sales, and flurries in the stock mar ket may indicate that general credit has been too easy. I feel that a greater degree of ease has existed throughout this year than the Committee contemplated. This leads me to action should be taken at once, and that a 1/2 believe that in the discount rate is indicated despite per cent increase disorderly conditions in the Gov the fact that it may create the price of inaction for the ernment security market. Since economy as a whole seems greater than the price of disturbing the bond market and bank portfolios, we should act decisively and not temporize with the situation.
Inasmuch as Mr. Williams had to leave the meeting early, Chairman Martin called on him next. He said that there had been a number of extended staff discussions of the discount rate and discus sions at two meetings of the directors of the Philadelphia Bank in which the staff participated. He added that his board of directors took a cautious attitude in respect to change in the discount rate in the present circumstances as indicated by the fact that the Phila delphia Bank had earlier this spring lagged behind other Banks in changing the discount rate; the businessmen on the board of directors were questioning the present rate of expansion and felt that the economy was coming to a period in which it could easily level out. He commented on the experience of one of his directors which indicated that there were conditions in the automobile industry which raised a question whether the present rate of production would be maintained. He went on to say that some smaller manufacturing concerns which are noted for quality work have not been making profits because of the squeeze on costs. said, which indicated that the economy is not There were other things, he to expand at its present rate. He related an experi likely to continue the department stores came to the ence at the Bank recently in which offices in bringing together the credit rating Reserve Bank and sought its the commercial banks, groups were interested including bureaus. Four small loan companies. A stores, discount houses, and large department in a number of instances indicated that had been made which survey
consumer credit had been granted beyond any relationship of the abil ity of the customer to repay in a reasonable time. The group was attempting to establish in Philadelphia and throughout the State re gional credit rating bureaus. All of these experiences, Mr. Williams said, caused the directors to be concerned, and, while there was no question that they feel some restraining action is necessary, they are fearful of the effect of a rate increase of as much as 1/2 per cent. They believe that it might be too harsh and that an increase in two steps would be better. However, he thought that there was also no question in his directors' minds but that the action taken should be a System action and that, if the decision is to increase the rate by 1/2 per cent, his directors would feel that because of the fluidity of the money market the Philadelphia Bank should go along. who also had to leave the meeting early, stated that Mr. Earhart, his directors would meet tomorrow morning, that he knew from early discus sions that the directors would be prepared to increase the rate, and the only question would be how much. The San Francisco directors that had not been asserting sufficient re felt, he said, that the System year but they had withheld any action straint in the earlier part of the of Treasury financing. Mr. rate because of the timing on the discount that some of his directors notwithstanding the fact Earhart said that, per cent, it was his own in the rate to 2-1/4 might prefer an increase
judgment that it would be preferable to increase the rate to 2 per cent for reasons which had been mentioned at this meeting. He believed it was important that open market operations conform closely to discount rate policy; that is that market rates should be closer to the discount rate than had been the case in the past. While he would like to have an increase in the discount rate when there was a substantial amount of borrowing so that the increase would have more than a psychological ef fect, the volume of discounts in the Twelfth District had been nominal up to the present time. He thought it was possible, if the market tightened as it had during the past week, that there might be more dis counting. In the circumstances his preference was to go to the 2 per cent rate. Mr. Irons had no question that there is great strength in the economy but he did not feel that the situation called for severe action. It was not a question in his mind of continuing growth but of avoiding speculative developments that would lead to unsustainable growth. He also felt that System policy should be pointing toward increasing re straint. The question of the discount rate, he said, was not one of in whether the increase should be to 2 or 2-1/4 per cent. action but rather economy and the situation in the capital markets His appraisal of the with the understanding that the short called for a 2 per cent action now bill rate) would be allowed to move term rate (i.e., the longest Treasury
up, if desirable, through the 2 per cent rate and in any event closer to the discount rate. The Committee could observe the reaction to that situation and the banks could determine rather quickly whether a second increase in the rate was justified--perhaps within a month or six weeks. Before the end of the year, if inflationary pressures develop further and persist, possibly even a third increase might be necessary. It was his view that the situation was such that the System should maintain steady and, if necessary, increasing pressure on the market and on bank reserves but should not take action that would cause a shock or a sharp down turn. He stated that the matter had been discussed at the last two meetings of the Dallas directors and that if two or three Reserve Banks increased their rate to 2-1/4 per cent, because of the fluidity of the money market, he would recommend that his Bank go to that rate notwith standing his preference for an increase to 2 per cent. Mr. Leedy did not feel as complacent about the situation as Mr. Irons. He had not felt complacent about the economy since the System changed the direction of its policy last December. Since that time, he the System had undertaken to apply a little restraint, increasingly said, too much in the way of results. After perhaps, but apparently without of the economic situation and listening to the reading Mr. Young's review if the figures are to be Mr. Leedy felt that discussion at this meeting, economic situation inflation country is in a very serious believed, the In his judgment the the credit picture is concerned. wise and so far as
increase in the discount rate in April had not created a "ripple." An increase of 1/4 per cent at this time would not create a "ripple." It was his view that the market is already discounting such a change and, therefore, it would be necessary to increase the rate more than that. He thought the time had come that the System should give an indication of its concern about the credit situation and one way that could be done would be to increase the rate by 1/2 per cent. That could not be done without some risk as to its effects on the market, but in his opinion the System could never take action that would be effective without taking some risks. He referred to Mr. Sproul's view that some monetary action was required and expressed the opinion that if an increase in the dis count rate was to be used for that purpose the increase would have to be more than the minimum increase that had been approved in the past. In economic situation nd the very real threat of in view of the over-all his view was that rather vigorous flation as presented at this meeting, was required at this time. action was no disposition in the Eighth Mr. Johns commented that there economy. However, there that exists in the to deny the strength District question the District who would people in the Eighth were sections and of an increase in and he saw no likelihood of any inflation, existence of the downtrend through but rather a continuation agricultural prices was inclined to his Bank these reservations, this year. Notwithstanding
believe that the situation calls for continuously increasing pressure without any dramatic or theatrical move. The discount rate problem, he said, was discussed thoroughly at the meeting of his directors on July 14, particularly because of the custom of his board to eliminate its August meeting. It was understood, he said, that in all probability before another meeting was held an increase in the discount rate would be given serious consideration and the executive committee was authorized to take whatever action was necessary. On the basis of the information obtained from Chairman Martin over the telephone, Mr. Johns had requested a meeting of his executive committee on Friday morning of last week at which time the committee recognized the need for continuing pressure but the opinion that it would be a mistake at this time to increase was of to 2-1/4 per cent in one step although it would be glad the discount rate of the Open Market Committee to vote for a 2 per cent after this meeting Johns agreed that the last increase in the discount rate had rate. Mr. concurred in the view that had been expressed had little effect but he just now beginning to see the effects of that by others that the System is was possible with the present and he felt that greater pressure increase, other Banks was to go to 2-1/4 if the disposition of the rate. However, at the St. Louis Bank. would fix that rate per cent his directors fundamental responsibility for supplying Turning to the System's volume of reserves market and the from the withdrawing reserves and
necessary to sustain the economy without inflationary tendencies and how this may be related to an increase in the discount rate, Mr. Mills referred to the fact that the System was faced at the moment with a tight money market--a market that has been made tight by System actionsand a situation in which the System has indicated by a declared policy and by inference that additional reserves would be added during the approaching season in amounts, in the discretion of the System, which would sustain a high level economy. He also said that the System is now at a crossroads where there is a really tight market and an economy that needs tightening and a signal of danger in the form of an increase in the discount rate which was a psychological signal rather than an action that would produce a further tightening. It appeared to him that the Committee should determine at this meeting what the mechanism would be to complement an increase in the discount rate in a manner that would re affirm the System's previously declared intention and at the same time indicate beyond any question that in the judgment of the System the economy should be restrained. He pointed out that within the last week $108 million had been put into the market in the form of repurchase agreements which was withdrawn when the agreements expired yesterday, that the forecast was that there would be deficiencies in reserves in weeks, and that the Committee should the present week and in succeeding look rather closely at the total supply of reserves, and the possibility
that excess reserves at country banks have not become available to the central money market through the medium of Federal funds. The tenor of his thinking was that the Committee should give serious consideration, as a means of reaffirming its intention and at the same time relieving pressure on the money market, to at least replacing the reserves that had been withdrawn through the expiration this week of repurchase agreements. He felt that that would relieve the position of dealers and enable them to pick up their purchases of this week's offering of Treasury bills. At the same time, he said, it would allow the New York money market banks a little leeway to purchase bills and thereby take some pressure off the market but only that pressure that could be reaffirmed through natural factors over a short space of time if desirable to do so. He suggested that if simultaneously with an announcement of an increase of the dis count rate, which in his judgment should be 2-1/4 per cent, the System could reaffirm its intention to provide additional reserves, it would be making a declaration of combined policy to the investment and financial community which would be unmistakable and would allay any fear of a steadily drifting downward of prices in the securities markets. His of reserves that had been lost to the opinion was that the replacement market by the maturity of the repurchase agreements should be the minimum and that, for the purpose of of reserves that should be supplied amount direct purchases of bills should be the means of sup giving confidence, might dictate. reserves as judgment such additional plying
The meeting then recessed for luncheon and reconvened at 1:45 p.m. with the same attendance as at the morning session except that Messrs. Williams and Miller were not present. Chairman Martin suggested that consideration be given to the suggestion which he had made at the morning session with respect to a change in the language of the Committee's directive to the Federal Re serve Bank of New York. After a brief discussion it was agreed that the changed language should be incorporated in the new directive to be issued at this meeting. In a discussion of the suggestion made by Mr. Mills before the luncheon recess, Mr. Szymczak commented that reserves put into the market and the price of credit and the extent of the effect affect bank lending on the amount of reserves supplied. When reserves are supplied depended there is no assurance that they will stay in the New York money market will be used. He interpreted Mr. Bryan's there or for what purpose they Reserve should put reserves into statement to mean that if the Federal would be putting the discount at this point, in effect it the market down. He said he realized the short-term market rate rate up and keeping in which case it with a disorderly market System may be faced that the by purchasing securi the disorderly condition be forced to correct might certain, however, that policy. To make contrary to current credit ties decision on same time, an early at the not go in both directions we do
what is a disorderly market and on the manner in which we shall pur chase the securities and the amount of purchases considered essential, is vital lest we undo what we shall have done by an increased discount rate. He also said that any such securities should be sold as promptly as possible. He questioned the desirability of a statement to the ef fect that the discount rate would be increased but that the System was going to supply reserves to the extent necessary and he felt that such a statement would be confusing and would possibly be misconstrued. Chairman Martin asked Mr. Rouse for his views on Mr. Mills' sug gestion and in response to Mr. Rouse's request Mr. Mills stated his pro posal as follows: We are in a position in the central money markets where a case can be made that, under almost any consideration, we should immediately or very shortly supply additional reserves to the market. We believe that the economic situation suggests a higher discount rate as being in line width that situation and the changes in interest rates. We have a tacit commitment to the financial community to provide reserves in amounts suf ficient in our judgment to sustain the economy. If we raise the discount rate sharply and at the same time ignore the fact that the money market is temporarily starved for funds, and, speaking solely in terms of the money market and its relation to the structure of the market fo: Government securities, ship we may very well be giving the impression that we are engaged a policy of severe credit restraint and are reenforcing in by not supplying reserves in accord emphasis on that restraint community regards as being a com ance with what the financial mind, there is a great distinction between mitment. In my the supplying or withdrawal of reserves the discount rate and there would be any contradiction in policy and I can't see that the amount necessary to re we supply reserves in at least if by the expiration of the funds removed this week place the repurchase agreements.
Mr. Rouse expressed the opinion that the reserve situation over the next two or three weeks would not suggest any injection of reserves into the market and that the only reason for such action would be to make clear at the time the discount rate was raised that the Sys tem had not forgotten the market. Mr. Mills raised the question whether there were sufficient re serves in the money market to carry it over this week in the light of the commitment that the dealers have to pick up this week's offering of bills. He also inquired whether there were not good grounds for giving a tem porary assist to the market to give a minimum of reassurance and confi to the increase in the discount rate could be dence until the reaction securities and the and until market prices of Government ascertained and municipal bond prices could move in adjust whole range of corporate ment to the discount rate. increase in the discount rate is Mr. Rouse stated that when the prices to levels which will be a mark-down of security announced there the Committee intervene and buy think appropriate. Should the dealers would be taken a purchases were made price at which these bills, the in the short-term money mar the Committee was establishing the rate that recent weeks and discussions in the light of the He added that, in ket. of the possible that on the basis it was his judgment at this meeting,
reserve position during the next two weeks there would not be occasion to put reserves into the market. Mr. Mills asked if there had been a sufficient test in a period of investment unsettlement, and also what situation the Committee will meet when the weekly average of free reserves declines. In his opinion, that question was particularly important when measured against the total supply of excess reserves, the larger portion of which is in the country banks and does not find its way into the money market except over a period of time. Mr. Rouse referred to the reserve projections contained in the supplementary report of open market operations prepared by the Federal Reserve Bank of New York which estimated average negative free reserves for the current week of $85 million and for the week ending August 10 of $150 million. Following a discussion of the possible. level of bill rates if the discount rate is increased to 2 per cent and if it is increased to 2-1/4 per cent, Mr. Earhart stated that he was strongly of the view that open market operations and discount policy should be consistent and that the policy relating to both should be the same underlying policy. That was part of the reason why he did not want to move the discount rate up too far too fast. He thought it would not be consistent for the System psychological purposes and then keep money to use the discount rate for
rates down through open market policy. Such action, he said, would con fuse the dealers and the general public. Mr. Robertson stated that there was agreement on the part of everyone that action to tighten the market was called for and that he would suggest that the discount rate be laid aside for the moment and that open market policy to be followed during the next three weeks be de termined. It would be his suggestion, he said, that no reserves be put into the market unless the bill rate exceeded something like 2 per cent (in the event the discount rate were raised to 2 per cent) which would mean that the Federal Reserve would not put funds into the market but leave it to the member banks to go to the discount window unless the need for reserves was so great as to drive the bill rate above 2 per of a disorderly market, he said, the Committee could cent. In the event always step in. questioned whether the Committee should fix a rate Mr. Sproul open market operations should be bills which would determine whether on existing demand for credit and a He thought that with the undertaken. properly go above 2 per of 2 per cent, the bill rate might discount rate cent. that the Committee would have Mr. Robertson said he did not mean 2 per cent but rather if the rate went above reserves in the market to put a guide would be reserves and that reluctant to supply that it would be
whether the bill rate went up. An increase above 2 per cent would not necessarily mean that the System would supply reserves. In a discussion of this point, Mr. Mills stated that the Commit tee did not know what unusual situation might arise that would find the market stripped of reserves. The impact of that situation would fall on the dealers who might find it difficult and certainly expensive to posi tion themselves and carry through a market situation which the Committee would wish to foster through the dealers' efforts. If the Manager of the Account, he said, had a clear prohibition that he could not supply reserves, then the only course open would be to poll the members of the Committee to get a reversal of that prohibition with a possible loss of time in correcting a worsening situation in the market. Mr. Robertson did not feel that the Committee should prohibit operations but should supply a guide. It was his view that if the situa tion were such as to require it, the manager would arrange for repurchase agreements or the outright purchase of bills, but the 2 per cent rate would be a guide indicative of the sense of this meeting. Mr. Sproul stated that the action already taken by the Committee at this meeting gave the New York Bank authority to enter into repurchase agreements which might be the only authority it would need to meet a situation in the market during the next three weeks. It would temporary look at the reserve situation, member bank be necessary, he said, to
borrowings, and the action of money rates, and that it was the desire of the Committee as he sensed it to have increasing pressure on the market but to observe the effects of that pressure on the available supply of reserves and act accordingly. With expectations based on the projections presented at this meeting possibly nothing would need to be done in the open market within the next two or three weeks. Mr. Bryan stated that he understood that repurchase agreements might do the job and that Mr. Robertson's comments were to the effect that if the discount rate is raised it should be made an effective rate as soon as possible. Mr. Sproul added that the bill rate could go to the discount rate or where it would. commented that this point bothered him, that the last Mr. Bryan time the System had a 2 per cent rate the market rate went up to 2.41, rate is fixed at 2 per cent the market that he felt that if the discount would not seem proper to to that rate and it should be in some relation the discount rate. In to get out of touch with allow the market rate the discount rate to System should not increase words, he felt the other rate to get as far the effective open market cent and then allow 2 per by a rate of 2.41 indicated, for illustration, of line as would be out or 1.70. be made in change should if any other Martin then asked Chairman Federal Reserve to the by the Committee to be issued general directive the
Bank of New York. Mr. Rouse stated that he saw no need for any further change and that the amounts contained in the existing directive were appropriate. Thereupon, upon motion duly made and seconded, the Committee voted unanimously to direct the Federal Reserve Bank of New York until otherwise directed by the Com mittee: (1) To make such purchases, sales, or exchanges (in cluding replacement of maturing securities, and allowing maturities to run off without replacement) for the System Open Market Account in the open market or, the in case of maturing securities, by direct exchange with the Treasury, as may be necessary in the light of current and prospective economic conditions and the general credit situation of the country, with a view (a) to relating the supply of funds in the market to the needs of commerce and business, (b) to re straining inflationary developments in the interest of sus tainable economic growth, and (c) to the practical administra tion of the account; provided that the aggregate amount of securities held in the System account (including commitments for the purchase or sale of securities for the account) at the close of this date, other than special short-term certif icates of indebtedness purchased from time to time for the temporary accommodation of the Treasury, shall not be in creased or decreased by more than $750 million; (2) To purchase direct from the Treasury for the account of the Federal Reserve Bank of New York (with discretion, in cases where it seems desirable, to issue participatons to one or more Federal Reserve Banks) such amounts of special short term certificates of indebtedness as may be necessary from time to time for the temporary accommodation of the Treasury; provided that the total amount of such certificates held at any one time by the Federal Reserve Banks shall not in exceed the aggregate $500 million; from the System ac direct to the Treasury (3) To sell gold certificates such amounts of Treasury securities count for as may be necessary from time to time maturing within one year the Treasury; provided that the total for the accommodation of securities so sold shall not exceed in the ag amount of such and such sales shall be made gregate $500 million face amount, at the prices currently quoted as nearly as may be practicable in the open market.
Chairman Martin stated that he had received two letters from Congressman Patman, one inquiring about the role of short selling in the United States Government securities market and the other raising several questions about the Federal funds market. He also said that the reply to the latter inquiry was being sent to Mr. Patman today and that a draft of the reply to the other letter had been distributed by Mr. Riefler at this meeting. He also said that it would be appreciated if the Presidents would study the draft and advise Mr. Riefler of any suggested changes that they might have, so that the reply could be sent within the next day or two. It was understood that the suggested procedure would be followed and that copies of the two replies as transmitted to Mr. Patman would be sent to the Presidents of all the Federal Reserve Banks. In response to an inquiry by Mr. Bryan, Chairman Martin stated that following a meeting this afternoon of himself and Messrs. Sproul and Balderston with representatives of the Treasury, the Board would which it would take with respect to an increase in consider the action rate and would advise the Reserve Banks of the decision the discount that as soon as his executive committee learned reached. Mr. Bryan stated on an increase in the rate at the of the Board's decision it would act Atlanta Bank.
It was agreed that the next meeting of the Federal Open Market Committee should be held on August 23, 1955. Thereupon the meeting adjourned. Secretary
Also: Record of Policy Actions