December 15, 1964 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, December 15, 1964, at 9:30 a.m. PRESENT: Mr. Martin, Chairman Mr. Balderston Mr. Hickman Mr. Mills Mr. Mitchell Mr. Robertson Mr. Shepardson Mr. Shuford Mr. Swan Mr. Wayne Mr. Treiber, Alterrate for Mr. Hayes Messrs. Ellis, Bryan, Scanlon, and Deming, Alternate Members of the Federal Open Market Committee Messrs. Bopp, Clay, and Irons, Presidents of the Federal Reserve Banks of Philadelphia, Kansas City, and Dallas, respectively Mr. Young, Secretary Mr. Sherman, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Hackley, General Counsel Messrs. Brill, Garvy, Holland, Jones, Koch, Mann, and Ratchford, Associate Economists Mr. Stone, Manager, System Open Market Account Mr. Molony, Assistant to the Board of Governors Mr. Cardon, Legislative Counsel, Board of Governors Mr. Partee, Adviser, Division of Research and Statistics, Board of Governors Mr. Reynolds, Associate Adviser, Division of International Finance, Board of Governors Mr. Axilrod, Chief, Government Finance Section, Division of Research and Statistics, Board of Governors Miss Eaton, General Assistant, Office of the Secretary, Board of Governors
Messrs. Sanford, Eastburn, Baughman, Parsons, Tow, and Green, Vice Presidents of the Federal Reserve Banks of New York, Philadelphia, Chicago, Minneapolis, Kansas City, and Dallas, respectively Messrs. Sternlight and Brandt, Assistant Vice Presidents of the Federal Reserve Banks of New York and Atlanta, respectively Mr. Eisenmenger, Director of Research, Federal Reserve Bank of Boston Upon motion duly made and seconded, and by unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on November 24, 1964, were approved. Before this meeting there had been distributed to the members of the Committee a report from the Special Manager of the System Open Market Account on foreign exchange market operations and on Open Market Account and Treasury operations in foreign currencies for the December 1 through December 9, 1964, and a supplemental report period 1964. Copies of these reports have been for December 10 through 14, placed in the files of the Committee. repocts, Mr. Sanford said that the Supplementing the written would remain uncnanged this week. published gold stock figure central banks this month would be Treasury sales of gold to foreign million, as compared with first anticipated--some $125 larger than 1 meeting. The at the Committee's December $75 million reported million last week in connection Bank, which bought $26 Swiss National of the Treasury's and System's sterling-Swiss with the liquidation
franc swaps of June 1963, purchased another $25 million yesterday (December 14) and was scheduled to purchase $25 million in January. In addition, the first of seven monthly $30 million sales of gold to Spain would occur this month. Barring off setting increases, the Stabilization Fund's gold holdings would amount to no more than $30 million by year end. Eventual disclosure of renewed U.S. gold losses, Mr. Sanford said, might reinforce the current uneasiness in various world financial markets. It might also increase further the recently stepped-up activity in the London gold market, where the fixing price had advarced from $35.1002 to $35.1216, and where the gold pool reserve was being whittled away. The gold price was reduced slightly to $35.1179 yesterday, and to $35.1138 today, to counter the market effect of a recommendation by the National Planning Association for an increase in the price of gold. to the foreign exchange market, Mr. Sanford reported Turning that the pound sterling's performance had been less than robust. The market remained extremely cautious, and the good reaction that of England's request last Tuesday (December 8) followed the Bank petered out quickly as pre-weekend selling once for credit restraint the market. Over the first two weeks of December again took hold of spot rate had drifted downward from $2.7931 to $2.7900 as a whole the or a trifle more. As a result, the Bank of England had intervened
on various occasions either to support the rate or to bid it up, in the process losing some $280 million in spot operations so far this month. In order to bolster its reserves, the Bank of England had made net drawings since December 3 of $150 million under its swap facility with the System, thus raising its System swap commitments to $325 million. During the period beginning November 30, the United Kingdom drew $1 billion from the International Monetary Fund and $155 million from other countries participating in the $3 billion assistance package. Of the total, 180 million had been used to bolster reserves and the balance to repay short-term credits. In the forward sterling market, Mr. Sanford continued, rates also had been under pressure with the discont for three-month forward sterling at one time having been slightly more than 3 per cent per annum. Here also there had been official British intervention to firm the rate and thus to avoid any possible movement of covered funds out of London. Intervention in the fcrward market in part had taker the form of swap operations, in which the Bank of England simultaneously bought forward sterling and sold spot sterling spot dollars). Some $170 million of swap transactions (acquired had been undertaken in this process, and by their very nature had served temporarily to offset reserve losses. these operations had depressed the spot rate, and conHowever, at times they also use of the alternative technique of sequently had necessitated
outright purchases of forward sterling, which had amounted to some $120 million. With sterling having just weathered a strong attack, Mr. Sanford commented, it was going to take a certain amount of time for the market to quiet down. Sterling was expected to improve after the year-end pressures had passed. The main problem was one of leads and lags, and the immediate task of those who managed the market was to hold a determined, firm line until the leads and lags began to operate in favor of the United Kingdom. He understood that, at the week-end meeting at Basle, satisfaction with the United Kingdom's short-run program had been expressed while indications of the needed longer-range policies were awaited. As to the continental currencies, Mr. Sanford reported that the intake of dollars by the central banks so far in December had been less than in November. Exchange rates: however, had remained at or near the respective ceilings. referred to Mr. Sanford's ,tatement that sterling Mr. Swan the year end, and asked whether the expected should strengthen after were of sufficient significance to cause shifts in seasonal forces Mr. Sanford replied that there would be considerable improvement. pressure on sterling until the end of the year because of the need people holding pounds for funds to be used in on the part of of overseas operations. Once those needs had been various kinds
met the seasonal pressures would evaporate. This in itself would be a matter of some consequence and would constitute an element of strength. Thereupon, upon motion duly made and seconded, and by unanimous vote, the System open market transactions in foreign currencies during the period December 1 through 14, 1964, were approved, ratified, and confirmed. Mr. Sanford recommended renewal for another 12 months of the $250 million standby swap arrangement with the Bank of Canada, which matured on December 28, Renewal of the swap arrangement with Bank of Canada for a further period of 12 months, as recommended by Mr. Sanford, was approved. Mr. Saaford then noted that two $150 million standby swap arrangements, with the Swiss National Bank and with the Bank for International Settlements, would mature on January 20, 1965. The facility with the BIS had been used tc the extent of $100 million to absorb previous dollar accumulations of the Swiss National Bank. He recommended renewal of both of these arrangements for a further period of six months. Renewal of the swap arrangement with the Swiss National Bank and the Bank for International Settlements for further periods of six months, as recommended by Mr. Sanford, was approved. Mr. Sanford then reported that two identical $10 million equivalent three-month sterling-Dutch guilder swaps with the BIS,
of which one was for System account and one for Treasury account, would mature for the first time on December 28. He did not at this time envisage the possibility of acquiring in the market the Netherlands' guilders needed to liquidate these swaps, and consequently he thought they probably would have to be renewed. Also, it was probable that another System guilder commitment, a $5 million equivalent drawing of guilders under the swap arrangement with the Bank falling due January 18, 1965, would have to be Netherlands renewed. Renewal of the System's sterlingguilder swap with the BIS, and of the drawing on the swap with the Netherlands Bank, were noted without objection. meeting there had been distributed to the members Before this a report from the Manager of the System Open Market of the Committee market operations in U.S. Government securities Account covering open Decenber 1 through December 14, and bankers' acceptances for the period placed in the files of the A copy of this report has been Committee. report, Mr. Stone commented supplementation of the written In as follows: time the Committee last met the market had At the of prices and rates in undergone an orderly adjustment the preceding week. dramatic events of the wake of the bills were in the then, rates on Treasury As I reported above the levels of midof 30 basis points neighborhood rates were up and long-term November, while intermediate basis points, respectively. around 12 and 5 by
The market was still in a highly uncertain state, however, and it seemed possible that a new round of expectational rate increases might get underway. Given the Committee's decision on that day, and given also the prospective withdrawal of $0.5 billion of reserves the next day because of the Bank of England's repayment on its swap drawing, we moved into the market in size on December 1 and 2, making heavy purchases of Treasury bills and lesser purchases of coupon issues. By the close of business on December 2, the rate on three-month Treasury bills was 3.84 per cent, down 5 basis points from the high two days earlier, while prices of Treasury bonds were up by 1/4 point or more. Furthermore, by that time the $65 million Pacific Gas and Electric issue, which investors had resisted the day before at 4.50 per cent, had been sold out; and a $40 million utility issue offered on the morning of December 2 at 4.49 per cent had also been sold out by the close of tha: day. The improvement in market atmosphere that followed the System's operations of December 1 and 2 was strongly reinforced by the statement of the President regarding bank lending rates that appeared in the press the next morning, and by the action of the First National Bank of Boston, and later of other banks, in rescinding their posted increases in the prime rate. Prices of bonds continued to move higher through much of the period as investment demand developed, and a number of issues reached price levels that equalled or even exceeded those prevailing before the British move. In the bill market, rates moved still lower after the President's statement, reaching the neighborhood of per cent as increased investment demand pressed against short supplies of many issues. With the close approach of the tax and dividend dates, however, rates turned around and moved back up. In the auction of December 7, a week ago yesterday, issuing rate for three- and six-month the average out to be 3.82 and 3.94 per cent, but bills turned bank demand having diminished in with corporate and of the dividend and tax dates, dealers the face found themselves, taking up record awards of almost bills at rates that scaled all the way $1.1 billion up to 3.87 per cent for the three-month issue and for the six-month bills. The unsold 3.97 per cent
portion of these bills would, of course, have to be paid for the following Thursday, which happened to be a heavy corporate dividend date--on which dealers would have to refinance up to $0.5 billion of securities coming back to them from corporations that had earlier acquired the securities under repurchase agreements. The market also would have to face another auction the following Monday (yesterday), and in addition would have to refinance yet another $0.5 billion or thereabouts of securities due to come back to them from corporate repurchase agreements today, the tax date. It was against this background of heavy seasonal pressures, and the prospect that those pressures would have pushed bill rates well into the 3.90's (with consequent upward movements in intermediate and long rates), that we made repurchase agreements at 3.85 per cent last Thursday. Even so, the average rate for three-month bills came out at 3.86 in yesterday's auction, with some awards being made at rates as high as 3.88 per cent. Once the current seasonal pressures have passed, investors may well regard these rate levels as quite attractive; and, as I suggested at the last meeting, the market might settle down with the three-month bill moving around in the 3.80's. It is perhaps well that the Committee de-emphasized at the last meeting, since the figures would free reserves have proved virtually uncontrollable even if we had to conduct operations in terms of that statistic. sought The figures will very likely continue to behave erratically, of reserve factors is always particularly since the estimation difficult over the four weeks that are ahead. in our written reports, Federal funds As indicated readily available at the discount rate and have been bank borrowings have been on frequently below. Member low level of borrowings is the low s:de. The relatively attributable in part, as the staff's comment on question 6 1/ to the level of the bill rate in relation to indicates, on certain questions considered 1/ The staff's prepared comments meeting are given at a later point by the Committee at this in these minutes.
the discount rate. Also important in this regard, however, is the somewhat higher level of aggregate free reserves last week, the lower level of country bank excess reserves during the past two weeks, and particularly the significant recent improvement in the basic reserve position of the New York banks. This improvement occurred in good part through a reduction in their loans to dealers as the latter liquidated a substantial part of their bill positions in the days following November 23. The New York banks generally have been sellers of Federal funds over the past two weeks instead of large buyers, as they customarily are. This of course had reduced the need for discount window accommodation both in New York and elsewhere. How long it will be before these banks move back into their usual basic deficiency position remains to be seen. But activity at the disccunt window is likely to remain relatively light until they do; and even then, for the reason the staff points to in its answer to question 6, borrowings may not move to their former levels. Treasury financing prospects for the next several weeks include the necessitous borrowing of perhaps $1 billion to $2 billion cash and the active possibility of an advance refunding operation. As matters now appear, the Treasury is likely to raise cash through the sale of additional June tax anticipation bills, probably announcing this operation just before year end--at the same time that they may announce an The sale of additional bills would advance refunding. tend to offset any downward tendency in bill rates that might result from the depletion in supply of short-term coupon issues through the advance refunding. It also appears likely that the Treasury ..ill raise some additional cash after the turn of the year by continuing to sell $2.2 billion of three- and six-month bills each week as against weekly maturities of $2.1 billion. Mr. Mills remarked that in following the operations of the Account and in interpreting market developments in the period since the Committee's previous meeting, at which he had not been present, it seemed to him that operations had been aimed largely at producing an interest rate structure that would instill confidence in the
financial community. This course had been followed despite the fact that there typically was a tightening of interest rates in December. The question in his mind was whether by interfering to prevent such a tightening this year the Committee was creating an unnatural situation that would require correction at some early date. By and large, and within reason, some tightening of interest rates and some effort to limit the reserve supply would have been preferable, in his opinion, to supplying reserves at a rate that created a surplus and that led to almost a sloppy market. In addition, as the new year began, if economic developments were as had been indicated, a more drastic reversal of operations might be required have been the case if seasonal developments had been than would allowed to produce their usual effects. Stone responded that the instructions of the Committee Mr. meeting, as he understood them, were to focus on at the previous particularly the bill rate, in the conduct of interest rates, the rate on three-month Treasury bills operation; and to keep per cent range. As he had indicated in roughly in the 3.75-3.90 shortly after that meeting the bill rate moved his statement, 3.75 per cent, but it then rose from that level in down to about pressures. Accordingly, there had been some response to seasonal reflection of seasonal forces in the market. Mills observed that bill rates would have been higher Mr. had been lower. As he read the than they were if free reserves
directive issued at the previous meeting--and this brought up the whole question of the Committee's directives--it called for accommodating moderate growth in reserves and for maintaining certain conditions of stability in the money market, but it made no direct mention of a target for bill rates such as might have come up in casual discussion around the table. Mr. Stone replied that he had operated on the understanding that it was the Committee's intent that a bill rate target should be used. With respect to the suggestion that market conditions might have been created by the unnatural Desk's operations, Mr. Stone noted that, as mentioned in his statement, he had suggested at the previous meeting that the three-month bill rate probably would settle down in the 3.80 per cent range after the period of seasonal pressures had passed Committee made no substantial change in its reserve if the posture. The bill rate was in that range now, and in his its current level was quite compat:ble with the kind judgment the Committee had been maintaining recently. of reserve posture there was nothing artificial in current On the whole, he thought money market conditions. Nor did he think conditions in the long-term market were The market was confident that artificial, Mr. Stone continued. continue to generate a substantial flow of the economy would
savings and that the demand for long-term funds in 1965 was not likely to be substantially greater than in 1964 and might possibly be smaller. The expectation for long-term interest rates was that, if anything, they were likely to go down in 1965. Recently, Mr. Stone said, the Federal funds rate frequently had been below the discount rate. This was closely related to the low level of borrowings, and both of these developments, in turn, were partly a consequence of the level of the bill rate relative to the discount rate. Also, the New York banks, which typically borrowed $400 to $600 million net every day, had a basic reserve excess and had been net sellers of Federal funds in the past two weeks. Ccmmercial banks in New York, as well as some other banks, had worked themselves into a basic reserve surplus position to accommodate the expected heavy demands for in order to be able and dividend dates. In other recent years funds over the tax :his by selling assets, beginning about two weeks they had done in advance of those dates. This year, however, they did not have to sell assets because they lost dealer loans as dealers worked down their trading positions. Dealers had sold a tremendous to the private sector recently, in addition to volume of bills their sales to the System Account. a question by Mr. Swan, Mr. Stone said this In reply to in the past few days as dealers resituation had been reversed acquired inventories in recent auctions and borrowed from the York banks in considerable volume. New
Thereupon, upon motion duly made and seconded, and by unanimous vote, the open market transactions in Government securities and bankers' acceptances during the period December 1 through 14, 1964, were approved, ratified, and confirmed. Chairman Martin then called for the staff economic and financial reports, supplementing the writter reports that had been distributed prior to the meeting, copies of which have been placed in the files of the Committee. Mr. Koch presented the following statement on economic conditions: Domestic economic activity has rebounded sharply from the effects of the work stoppages in the auto industry. The November industrial production index was almost a full point above the record September high, despite some impact of the Ford strike early in the month. The index is no doubt showing a further rise in December and is about 7 per cent above a year ago. The manufacturing workweek rose to 40.9 hours in November, due in part to heavy overtime in autos, but also reflecting some further increases in overtime in quite a few other industries, particularly in the durable goods area. Because of the temporary curtailment of activity in October, the fourthquarter increase in GNP is likely to be only about half as large as in earlier quarters this year, but chances are very good that this shortfall will be made up in the first quarter of the new year. One dramatic aspect of recent demand developments has been the step-up in inventory accumulation by manufacturers. Stocks of manufacturers rose $600 million in the third quarter, following increases that averaged only $125 million per quarter in the first half of 1964. anticipated to increase $1.2 billion in the They are fourth quarter. The greater accumulation since midyear
has been due in large part to resumption of accumulation of inventories of steel and other ma:erials, although accumulation of goods in process and finished goods has also stepped up since midyear. Manufacturers anticipate a further rise in stocks of $600 million in the first quarter of 1965. In viewing longer-run prospects for inventory accumulation, two points are relevant: first, much of the current step-up in manufacturers' inventory demands represents a hedge against a possible steel strike; and, second, businesses have now had several years of satisfactory experience in operating with relatively low stock-sales ratios and most of then still report that their present ratios are "about right." Turning to the price area, the weekly wholesale industrial price figures in November and early December suggest a continuation of the October rise, although at less than half the rate. The rise continues to be focused in the nonferrous metals area, with price changes outside this area continuing to be selective and largely offsetting in their effects on the general price indexes. Prospects are improving, moreover, that pressures will abate in some nonferrous markets. In copper, for example, world production has been recovering from last summer's strikes and current output is higher than last spring when inventories apparently were being accumulated. The gap between tin production and consumption is being filled by increased sales from the stockpile, and tin prices have dropped sharply from the very high levels reached in October. On the labor front, the decline in the over-all unemployment rate from 5,2 to 5.0 per cent from October to November cannot be considered highly significant. The rate remains in the relatively narrow range in which it has varied since late spring, as increases in employment have only matched increases in the labor force. Unit labor costs in manufacturing rose in September and October, but this movement, like those in many other statistics recently, was no doubt materially affected by the work stoppages in the auto industry. In November, unit labor costs may have returned to about their September level. Although labor unrest appears to be increasing and dock and rail strikes are threatening, concern about the spreading of wage increases continues to focus on the
steel industry. Here there are some factors suggesting a large settlement and others suggesting a more modest one. Those suggesting a large settlement include the struggle for political power within the union, the relatively large earlier auto settlement, the high current demands for steel, and the small settlements in steel in 1962 and 1963, settlements that consisted only of fringe benefits. Factors suggesting the possibility of a more moderate settlement are the changed attitudes of both management and labor in the industry regarding the likelihood of being able to pass on cost and price increases to buyers in the current competitive market environment, and the importance to the administration and the general public of a settlement near the guidepost and without a strike. Settlements in steel as well as in other industries have appeared in recent years to be strongly influenced by longer-term competitive aspects and by concern over the threat of substitution from other sources of supply, both domestic and foreign. Sales of Japanese steel in the U.S. market, for example, are still on the rise, and Japanese producers are likely to intensify rather than diminish their sales efforts here in the months ahead. Union demands in collective bargaining have emphasized increases in fringe benefits rather than in money wages, reflecting a heightened desire to protect job security and future income rather than just current income. On balance, these developments suggest a fairly generous steel settlement but one far less costly than the disruptive ones in the mid- and late-1950s. In sum, economic activity in the near-term future is likely to be brisk, as auto restocking and precautionary steel buying continue and as business capital expenditures rise furtner. The current vigorous expansion still poses the potential threat of a destabilizing thrust on the upside, but this threat may well lessen sharply with a steel settlement, unless it is a large one. declines in auto production following the Prospective current stock rebuilding and in steel production following the wage settlement could well lead to a slowdown in the expansion, although at this juncture one cannot see what new elements may have entered the picture by then. The most common current economic forecast is that 1965 will be a prosperous year, but not good enough to absorb the increase in the labor force, expected to be than in 1964, let alone reduce the present number larger
of unemplcyed unless more stimulus than is currently anticipated comes from either the private sectors of the economy or the Government. With this possible outlook in mind and recognizing the inevitable lags in the impacts of monetary policy, domestic ecoromic considerations still seen to me to call for a continuation of the existing degree of credit availability and of approximately current costs of Longer-term credit and capital. Chairman Martin noted that a memorandum dated December 7, 1964, entitled "Proposal for Obtaining Financial Statements from Nonbank Dealers in U. S. Government Securities," had been addressed to the Committee by the Steering Group of the Government Securities Market Study, of which Mr. Koch was a member. (A copy of this memorandum, together with certain attachments, has been placed in the files of the Committee. The Chairman suggested that the Committee discuss memorandum before proceeding to the report on financial this and he invited Mr. Koch to comment. developments, Koch observed that the proposal, which was summarized Mr. grew out of the 1959- the first five pages of the memorandum, in of :he Government securities market by the Treasury and 1960 study the Federal Reserve that followed the 1958 episode of speculative boom and collapse. The recommendation of that study for collection of better information on dealer positions, transactions, and financing already had been implemented. The Steering Group then had turned to a second recommendation, that more uniform balance sheet and income statements be obtained from nonbank dealers, and it
had developed the proposal for financial statements described in the memo andum. Mr. Koch described the proposal as a first and exploratory step in meeting the problem. He said the Steering Group had encountered considerable difficulty in taking even this first step; that it hoped to learn more about the problem as experience under the new program was accumulated; and that this might well result in further recommendations. The proposed financial statements would serve several objectives, Mr Koch said. First, it was hoped that iproved and more uniform financial statements would encourage sounder financial reporting and practices by dealers. Their financial reports at present generally were skeletal and disparate in nature. It was difficult to achieve uniformity in statements because of the wide differences in the scope of activities in which the various dealers engaged and because some dealer organizations were partnerships and some were corporations. Good accounting practices were particularly important in industry, Mr. Koch observed, because dealers typically this small capital and narrow equity margins. At the operated with time, the smooth and sound functioning of the Government same both to the financing operations of securities market was vital the open market operations of the Federal the Treasury and to
Reserve. Although great reliance in ensuring the financial solvency of dealers still would have to be placed on the integrity of the dealers themselves, the Steering Group felt that the development of uniform financial reports could play an important contributory role. Initially, the proposal called for annual statements, but later the statements might be requested more frequently. it might also be appropriate to institute surprise audits at some future date. A second purpose of the program was to provide better aggregate statistical information of a financial-statement type for the industry. There had been many requests for such informaticn from interested groups, including committees of Congress. Finally, some dealers have complained recently that various System operatiors and Treasury debt management techniques had been impairing the the market and their ability to earn adequate profits. functioning of on dealer capital, incomes, and expenses would Better information be useful in evaluating such complaints. Mr. Koch observed that the program proposed had been discussed with the Secretary of the Treasury, and Mr. Dillon had made two suggestions. First, he thought it would be desirable to have a letter to the dealers announcing the inauguration of the program from Chairman Martin and himself as well as one from Mr. Hayes as proposed in the memorandum. Secondly, he strongly urged that the
program be started with financial reports as of the end of the current calendar year. In response to an invitation to comment by Chairman Martin, Mr. Stone said that he fully endorsed the proposal. He observed that dealers were agreeing to supply the information requested with a certain amount of reluctance, but he would expect this reluctance to be overcome once the program was under way and the dealers could see its value. In the ensuing discussion Mr. Robertson remarked that he thought the proposal was a real step forward. Mr. Mitchell commented that while he did not disapprove of the program proposed he considered it inadequate for the purpose and regretted that it was not more responsive to the problem. Thereupon, the recommendations of the Steering Group for obtaining financial statements from nonbank Government security dealers, as set forth in the memorandum of December 7, 1964, were approved. Secretary's Note: The following letter was sent to nonbank dealers in Government securities over the signatures of Secretary Dillon and Chairman Martin on December 24, 1964: Dear Mr. The Treasury-Federal Reserve program for improving the available information on the Government securities market has now been underway for nearly five years. You will recall that in January 1960 Chairman Martin and then Secretary of the Treasury Anderson wrote you
to initiate a program for "collection of data covering transactions volume, dealer positions and borrowing, including financing under repurchase agreements, and balance sheet and income statement information." The data on transactions volume, oealer positions and dealer borrowing collected since 1960 have proved to be of real value to the Treasury and the Federal Reserve, as well as to interested students. We want to express our appreciation for your cooperation and public-spiritedness in providing these data which have proved so useful. Now the time has come to move ahead on the second stage of the information program, the collection of nonbank dealer financial reports, including both balance sheets and income statements. We expect that this additional information, to be collected on a confidential basis but with the prospect of publication in consolidated summary form after some reasonable trial period, will be of significant benefit to us in appraising developments in the Government securities market. The accompanying letter from Mr. Hayes and its attachments give the details of the projected program and our staffs will of course be available to work with you in implementing it. Chairman Martin observed that it mi;,ht be desirable to institute meetings with the dealers early next year to give them another opportunity to discuss their problems directly with System people. Mr. Partee then made the following statement concerning financial developments: Domestic financial markets appear now to have settled down in the wake of the official rate actions 23. Sensitive yields have declined in of November both short- and long-term markets, and in the latter case are back to about where they were just before the
discount rate increase. Partly this readjustment has been in response to official pronouncements, to market estimates of Federal Reserve policy, and to the failure of any prime bank rate increase to carry through. But the resilience of long-term markets also reflects basic supply-demand relationships, including particularly the absence of any significant current or prospective rise in financing volume. In shorter-term markets, despite some backing down in the past two weeks, yields remain appreciably above the November 20 level--generally 15 to 20 basis points higher. As a result, the yield curve is even flatter than before; taking bills on an investment yield basis, the Government list is essentially flat in yield from 6 months on out at about 4.10 per cent. The question is, how sustainable is such a yield curve? Under present circumstances, it seems to me that there is a good chance that long-term yields will hold where they are, or even drift lower, despite the upward adjustment we have had in short-term rates. Basic to this proposition is the expectation that aggregate long-term financing demands will not rise in the period ahead. There could well be some increase in corporate financing as capital expenditures continue upward, although no such tendency is yet evidenced by the new issue calendar, which is seasonally slack over the turn of the year. But the net expansion of mortgage debt has already fallen off somewhat this year from its late 1963 peak, and a further decline is to be expected as the drop in housing starts last spring is reflected more fully in the mortgage figures. The flow of savings available for long-term investment has continued large throughout this expansion, and most market observers expect such flows to remain high in the period ahead. The prospects for this have been enhanced by the Regulation Q action, which both improves the ability of banks to compete for time deposits and savings funds and virtually eliminates any possibility of a move toward lower rates by savings institutions generally at the turn of the year. The potential for larger savings flows, especially to banks, appears to underlie the recent marked decline in municipal yields to the lowest levels since the spring of 1963. Any developing
slack between supplies of and demands for longerterm funds, of course, could be taken up by Treasury debt-lengthening; a decision to undertake an advance refunding in January would present a near-term test of the absorptive capacity of the capital markets. The sustainability of the present flat yield curve is also enhanced by uncertainties about the course of the economy in 1965. If we are at or close to a cyclical peak in interest rates, borrowers would not want to accelerate their long-term financing needs, nor would lenders want to do much shortening of their investment portfolios. Growing investor uncertainty about the strength of economic prospects may be indicated by the recent behavior of the stock market, which has declined 3-1/2 per cent over the last three weeks. International financial uncertainties and the increase in official rates here and abroad may have triggered the decline, but a more basic factor probably is the growing awareness that corporate profits appear to be leveling out. Manufacturers' profit margins, in fact, have inched downward quarter by quarter this year on a seasonally adjusted basis, although there will be fillip to aftertax earnings with the second two-point cut in the corporate tax rate in January. This has long been discounted in the market, however, and the new indications of an essentially flat earnings performance, despite a possibile uptick stemming from nearterm inventory accumulation, may well not be bullish enough to sustain the relatively high price-earnings ratio of 19 reached in mid-November. Turning to recent credit market developments, the figures now confirm that total bank credit expansion in November was exceptionally large, both on a daily average and month-end basis. Much of the unusual size of the increase was accounted for by Treasury financings, which had the effect of boosting both Government portfolios and security loans more than seasonally toward month-end. Business lending also picked up, but only to a pace about in line with the year as a whole, and other loans, except for those to security dealers, continued to expand at the rate of recent months. In the first two weeks of December, judging from reports for New York City, business loan demands
strengthened significantly, partly due to hedging against possible prime rate action, but the rise in total credit was considerably less than in other recent years. Most of the increase in lendable funds in November resulted from a contraseasonal expansion in Treasury balances, and also from an acceleration in time and savings deposit growth. The former reflected the Treasury cash financing, unusual for November, and the latter a continued enlargement of savings inflows, related it. large part to the shortfall in new car sales in both October and November. Demand deposits rose only moderately on balance, expanding in the first half and contracting in the second, and the money supply increased $500 million, at the lower end of the $500- $800 million range of increases over the past 4 months. Very tentative indications are that there was only a moderate further rise in the first half of December. The November expansion brought the growth rate of the money supply for the year to date to 4.2 per cent, with currency up 6 per cent and demand deposits 3.8 per cent. (The last figure is slightly revised from the 3.5 per cent reported in element 3 of the trial directive.) Meanwhile, the banking system has reacted to the higher discount rate in a predictable manner. In the first two weeks of December, both exce.s reserves and borrowings declined from the averages of earlier twoweek settlement periods, with a little larger decline in the latter contributing to somewhat higher average free reserves. Banks have been pressing to utilize excess reserves, and the flow of Federal funds has been large, often at rates below 4 per cent. So long as rates on both bills and Federal funds remain well below the discount rate, banks will tend to make marginal reserve adjustments through these markets borrowings will be restricted. This, of course, and a higher free reserve figure on average means that to continue to be associated with current is likely market rates. Maintenance of these rates, in turn, depends basically on the availability of nonborrowed reserves as required to support current bank credit expansion. been an orderly, and on In summary, there has the whole balanced, adjustment to the November actions. The yield structure which official rate
has evolved seems sustainable in the current context, although the adjustments in investor attitudes and in initial allocations of funds are still provisional and tentative. Expansion in bank credit and in money appears to be continuing, and there is no evidence of any significant change in earlier trends as yet. Under the circumstances, domestic market conditions would appear to call for a policy of continuing open market operations aimed at stabilization of rates and flows. With seasonal fluctuations in funds flows so large at this time of the year, and with the balance of pressures on short-term rates about to reverse, it would seem that such policy must be couched primarily in terms of desired market conditions rather than in terms of either a specific marginal reserve target or any precise yield expectation for 3-month bills. Mr. Reynolds presented the following statement on the balance of payments: The year end is typ.Lcally a period of large seasonal and erratic movements in international transactions. This year, the difficulties of interpreting the data are compounded by uncertainties about the effects of Britain's problems, related policy actions, and the threat of a U.S. port strike. Also, we have just encountered a purely statistical puzzle: the "flash" report by large banks on their foreign liabilities in November indicates a considerably larger over-all payments deficit in that month than been suggested by weekly reports. has In the circumstances, there seems to be little point detail on the fourth-quarter outcome. in speculating in clear that the seasonally adjusted deficit will It seems it was in the third quarter, and that this be larger than explained by the bulge in new foreign result will be mainly :ssues. Whether Britain's difficulties have security temporarily been producing an improvement in our figures is hard to tell; to the extent that uncertainty about wider uneasiness about the whole sterling has generated it may have produced adverse as exchange rate structure, well as favorable capital flows. the full year will probably work The deficit for out at about $2-1/2 billion on "regular transactions" $1 billion on "official settlements"--about and perhaps smaller on either measure than in 1963. $1 billion
These guesses do not allow for the possibility that Britain may request a waiver of $138 million of yearend debt service payments to the United States. Perhaps the most striking data that have become available in the past two weeks are the merchandise trade figures for October. You will recall that a surge of exports in September was tentatively ascribed to anticipation of the port strike, which was then postponed. But now it turns out that exports did not fall back very much in October, and for SeptemberOctober combined, they were 7 per cent above the first half-year's rate and 12 per cent higher than a year earlier. Even if some of this gain reflects chance or anticipatory bunching of shipments, it seems clear that exports were rising again in the autumn, after a dip in the spring that had reflected the ending of unusually large grain shipments, a decline in exports to Japan, and some temporary leveling off in Western European demand, notably in Italy. The renewed autumn advance shows up in shipments to all areas except the U.K. Imports, meanwhile, did not change in October, and were only a little higher that last spring. Over the two years to September-October, imports rose--rather unevenly--by 12 per cent, or about as much as GNP. Exports over the same 2-year period increased by an extraordinary 28 per cent. The resulting improvement in the trade surplus has been a major element of strength in our balance of payments position. Two main forces have been at work here: an unusually favorable cyclical position abroad, and a basic improvement in the U.S. competitive position. The cyclical upswing has been unusual both in its strength and in its world-wide character. Taking the 2-year period as a whole, activity has been expanding vigorously in all industrial countries--the United States and Canada as well as Europe and Japan. As in 1955-57, the boom has lifted the earnings of nonindustrial countries as well, and after some lag they have sharply increased their imports. The European economies have generally been at full stretch in this period. Their wholesale price levels are now generally 10 to 20 per cent higher than they were in 1960, whereas ours has not changed significantly. In recent months, prices have continued to rise in Only Italy and France have succeeded in slowing Europe.
their price-cost advances, although Germany continues to hold hers to modest proportions, and most other countries feel that they are beginning to bring the advance under control. Thus, basic competitive trends have continued to move in our favor, although they may not move as rapidly in this direction from new on. Prospects for short-run demand changes are more difficult to assess. It seems most unlikely that the nonindustrial countries as a group can continue to increase their imports at recent rates. Australia, for instance, had a 50 per cent increase in imports over the past year, and is now trying to rein in; so is South Africa. Some major Latin American countries are now encountering renewed balance of payments difficulties. In Europe, the shift in British policy towards internal restraint, and the import surcharges, will have major dampening effects. Against this, there may be some acceleration of demand expansion in the months ahead in some continental European countries, notably Italy; and German business conditions continue buoyant as before. Outside Europe, Japan is apparently increasing its imports again, and Canadian demand continues to expand. On balance, I would expect further expansion in U.S. exports during 1965 at a rate that be fairly satisfactory by historical standards will but considerably less rapid than during the past two years. U.S. imports seem likely to be swollen in the next few months by strong inventory demand, notably for steel. Therefore, we should probably not expect further gains in the trade surplus early in 1965. (And the threatened dock strife will, of course, distort the monthly figures.) But some improvement in the trade surplus for the year 1965 as a whole over the year 1964 now seems more likely than it did a short time ago. And if price stability can be maintained in this country, the longer-run trade prospects are also favorable, in my view. Mr. Deming asked what the pattern of the balance of payments deficit for 1964 would be when figured on an official settlements basis. Mr. Reynolds replied that for the first three quarters of the year it had been running at an annual race of about $1 billion,
and there was no obvious reason to expect a substantial change in the fourth quarter. But any fourth-quarter estimate now could be only a guess since current figures were not collected on that basis. The weekly reports would have provided a clue to developments under ordinary circumstances, but as he had noted the November flash report by large banks, which gave no breakdown of liabilities as between official and private foreigners, appeared inconsistent with the weekly reports. Also, large shifts between foreign private and official holdings of dollars might, have been occurring because of uneasiness about the pound sterling. Accordingly, it was necessary to await the more detailed fourth-quarter figures before estideficit for that quarter on an official settlements basi.. mating the referred to Mr. Reynolds' comments on the Mr. Shepardson for U.S. exports, and asked whether allowance had been outlook decline in agricultural exports. These had made for a possible been high this year, Mr. Shepardson noted, partly because of abroad. Also, if he correctly read the indrought conditions dications; of current negotiations on Common Market farm policy, reduction in U.S. agricultural exports they implied a significant to Europe. that in assessing the outlook he had Mr. Reynolds replied in farm exports as a result of the ending assumed that the decline of further Russian purchases of of the drought abroad and the lack
grain had run its course. He had not allowed for any further drop in connection w.th policy decisions by the Common Market on the ground that the nature and effects of the decisions that would be taken were still uncertain. Mr. Mitchell commented that Mr. Reynolds' expectations for U.S. foreign trade seemed somewhat different from those implied in the staff statement made in response to question 4. Mr. Reynolds agreed that he saw some prospects for improvement that were not suggested by the staff statement. In part this reflected the fact that his own views were toward the optimistic end of the range of staff opinion. But perhaps the more important explanation was that he and other members of the staff had not fully absorbed the implications of the figures for October when the response to the question on the balance of payments was prepared. On the whole, however, his current expectations did not differ greatly from those implied by the staff statement. Chairman Martin then called for the go-around of comments and views on economic conditions and monetary policy, beginning with Mr. Treiber. He noted that, in accordance with the understanding the members had reached in the afternoon following the December 1 meeting, the Committee would adopt a new procedure in the go-around today; members were invited to address their remarks at least in questions and responses that had been part to some or all of the
prepared by the staff and distributed before this meeting. The staff materials to which the Chairman referred were as follows: (1) Production, sales, and invent.ories--Taking into account the effects of recent and threatened work stoppages, is the strength of current economic activity showing any signs of diminishing or increasing? After being dampened by work stoppages earlier in the fall, economic activity currently is receiving a temporary stimulus from strenuous efforts on the part of auto producers to bring retail inventories back to a level commensurate with the record level of sales and by apparently widespread efforts on the part of steel consumers to build up their stocks of steel in anticipation of a possible strike next May. These two influences are augmenting business inventory accumulation now and will probably continue to encourage inventory investment into early months of 1965, although strikes threatened by longshoremen and railroad workers might prove to be a disruptive factor. Aside from these temporary influences, trends in other sectors of economic activity have shown little change from earlier months. On balance, the underlying economic situation appears to be one of continuing moderate growth. As the year ends, business and consumer confidence remains at a high level, with recent surveys showing both groups anticipating rising levels of spending in the months ahead. (2) Employment--Can the economy achieve a significant further reduction in the margin of underutilized manpower in the near-term future without strong upward pressures on prices generally? The current prospect for further expansion in activity at about the same rate as in the past year does not suggest any great likelihood of a significant further reduction in the margin of unutilized resources in the near future, because resources of manpower and industrial equipment also are continuing to expand. Employment gains since May have been matched by increases in the labor force, and the unemployment rate has fluctuated in the narrow range of 4.9 to 5.3 per cent.
Significant near-term reduction in unemployment would require one or more of the following developments: (1) a more rapid expansion in employment than has been taking place recently. This could occur temporarily early next year because of the inventory buildups related to recent and threatened strikes. But in autos and steel, employment in November and December already is very high and overime work has been increased to meet what may be a temporary peak load. In construction, notwithstanding an unusual seasonal rise in November, employment appears to have leveled off. In trade and in public and private services, employment gains have been strong but steady; (2) a less than expected increase in the labor force. But expectations are likely to be realized if demands continue strong because the labor force tends to respond positively to job opportunities; (3) a decline in the rate of productivity advance. This could occur but there is no evidence as yet of any moderation in what has been a high and sustained rate of advance. Substantial further additions to plant capacity will be an important factor tending to maintain the advance in productivity. So far, the supply of labor has been adequate to meet expanding demands without any strong general upward pressure on prices. In some industries, strong demands have required considerable overtime work and active recruiting and training programs. The balance of forces affecting bargaining has been such that in some cases, notably in the auto industry, settlements have been larger than the general rate of productivity advance in the private economy. In September and labor costs per unit of output in manufacturing October, rose, but only to the level of December 1963, and a significant share of the rise is believed to reflect the work stoppages in autos. The critical question, not yet resolved, is whether the wage patterns developing in industries showing high productivity increases, such as autos, will spread to industries showing lower productivity increases. upward price pressures been (3) Price developments--Have getting stronger and more pervasive? High rates of economic activity in the United States and abroad have maintained strong upward price pressures in markets for nonferrous metals. In some cases upward pressures
have been intensified by political disturbances or strikes that have limited production. There are reasonably good prospects, however, that pressures in some of these markets will ease in the near future. Outside the nonferrous metal markets, price changes continue to be selective. Industrial commodities as a group rose only slightly further in November and early December, following the October advance. With prices of industrial materials increasing little, and with labor costs per unit of output in manufacturing no higher then a year ago, prices of finished goods have not been subject to pervasive upward cost pressures. Wholesale and retail prices of consumer goods (other than foods) have been stable all this year. Prices of producers' equipment, on the average, have been stable since spring, following a rise of 1 per cent over the preceding 6 to 8 months. A general steel price increase, of course, would seriously threaten this pattern of over-all stability. Balance of payments--Have underlying influences recently (4) been tending to strengthen or to weaken the position of the dollar internationally? Continuing uneasiness about the pound sterling is tending temporarily to strengthen the dollar in some ways and to weaken it in others. U.S. trade figures are being distorted to an unknown extent by anticipations of a possible port strike. Underneath all this churning, however, it is possible to discern some of the underlying forces that are likely to be of decisive importance over the period ahead. Basic trends in the competitive position for merchandise trade have been favorable for five years. But efforts to slow down price-cost advances in Europe are beginning to take effect. Therefore, continuation of favorable competitive trends hinges increasingly upon the continued maintenance of price stability in the United States. demand conditions may limit further improvement Changing trade surplus in the short run. The large increase in the two years resulted partly from in exports during the past Growth in U.S. exports now will favorable cyclical forces. slowed by recent U.K. policy actions, less buoyant be industrial countries (e.g., France), expansion in some other and less rapid growth in the imports of some nonindustrial U.S. imports, after increasing in countries. Meanwhile,
line with GNP for two years, may rise more briskly in coming months, especially if inventory demands are strong. Income from foreign investments remains on a strongly rising trend. But the increase in receipts will be smaller in 1965 than in 1964, mainly because tax factors shifted some dividends from 1963 to 1964. Relative credit conditions shifted adversely in 1963-64 as credit tightened in Europe and Japan and remained readily available here. While covered interest rate relationships affecting movements of liquid funds have not changed significantly, both short- and long-term rates have generally risen more abroad than here. Also, U.S. banks have been eager to expand their foreign lending. Outflows of U.S. private capital will have risen to a new high of more than $5 billion in 1964, including about $2 billion of direct investments, $1 billion of new foreign security issues, and $1-1/2 billion of total bank lending. If any large balance of payments improvement is to cccur during 1965 in a context of continuing U.S. economic expansion, most of the improvement must take place in capital flows. No early easing of credit conditions abroad can be counted upon to help. Continuing erosion of the U.S. incernational reserve position points to a need for showing significant further improvement in the payments position fairly soon, or at least for policies that would ensure ccntinuation of favorable basic trends. Questions arise, however, about the rate of improvement that is needed and feasible in the light of other objectives, and about the mix of Government policies most likely to achieve desired results. liquidity--What interpretation should (5) Money supply and be placed on recent fluctuations in the rate of expansion in bank credit and the money supply? Fluctuations in the rate of growth of total bank credit in recent months have reflected in large part the unusual pattern of Treasury financing operations. This true of the July decline and August was particularly increase in credit and the unusually large increase in A major factor in the disparate changes in November. September and October was the fact that the last-Wednesday for September was the last day of the month. reporting date This resulted in the recording of the large end-of-month in September rather than, as is more usual, credit increase
in October. Since midyear the rate of growth in bank credit has been about 8 per cent, the same as over the first half of this year. Within the aggregate of recent credit expansion, however, there has been some change in composition. Expansion in total loans since midyear has been somewhat slower than earlier this year while holdings of investmerts have increased somewhat faster. The rate of growth of business loans, on the other hand, has continued in recent months at an annual rate of close to 10 per cent, the same as earlier in the year. The seasonally adjusted money supply rose $500 million in November, at the lower end of the $500-$800 million range of monthly increases which has prevailed since July. Over this period, the annual rate of growth has been 4.6 per cent, considerably above the 2 per cent average for the first five months of this year but considerably below the 8-1/2 per cent rate of June and July. Short-run fluctuations in money supply growth such as chese do not represent a departure from earlier experienne in this series. A certain degree of lumpiness in money expansion results from short-run shifts between private and Government deposits and from attempts by the public to bring money balances into line with desired levels after temporary departures from those levels. Factors which might have contributed to such fluctuations this year would include: (1) heavy consumer buying in anticipation of a tax cut and large acquisitions of securitie by the consumer sector in the early months of this year; and (2) a restoration of previously reduced balances, together with a lag in the adjustment of expenditures and savings flows to the increase in disposable personal income stemming from the tax cut, in June and July. The growth rate in money balances since July, while somewhat more rapid than the 3.9 per cent rate for the first seven months of this year, is not out of line with the recent rapid rise in GNP, both in current and in constant dollars. The emergence of a substantial uptrend in seasonally adjusted demand deposits at city banks since spring, after a period of several years of little change, suggests that businesses as well as consumers now may be increasing their money holdings more closely in line with transactions needs. The recent decline in the rate of growth in CDs would be consistent with such a development.
(6) Money and credit markets--Are the adjustments to the discount rate increase in money and capital markets and in bank reserve positions completed, or are they continuing? It appears that the adjustments in yield relationships to the discount rate actions per se have been substantially completed, although some consequent changes in financial flows may still be in process and day-to-day rate fluctuations may continue for a time to be wider than usual. However, basic yield relationships are still subject to stress from the seasonal reversal of pressures in short-term markets after mid-December as well as from possible shifts in underlying supply-demand relations in both sho::t- and longer-term markets. Following the initial adjustments, bond yields returned to levels close to those obtaining at the time the official actions were taken. This resulted in part from market interpretations of official statements and also from continuing expectations that the flow of longterm savings to investing institutions would continue large--and perhaps be enhanced by the recent amendments to Regulation Q--while long-term credit demands would remain relatively moderate. Municipal and corporate security flotations have been well received recently, but the basic strength of the long-tern market will be further tested in January if the Treasury undertakes longer-term financing operations at that time, as it has in the past several years. Upward adjustments of short-term rates have amounted to as much as 25 basis poirts, resulting in further flattening of the yield curve in the shorter maturity range. Rates on Treasury bills have settled down somewhat below the highs reached in the initial adjustment, while rates on other short-term instruments generally have held at the levels reached in early December. Banks appear to have adapted to the new discount rate in management of their reserve positions, although current seasonal pressures tend to obscure basic trends. So long as the 3-month Treasury bill rate does not rise closer to the discount rate, the tendency which emerged in the past three weeks for banks to want to keep borrowings at somewhat lower levels is likely to persist. (7) Monetary policy--In light of these and other considerations, what policy with respect to bank reserves
and money market conditions would be appropriate for the next four weeks? Mr. Treiber commented that at past meetings the statement of the New York Bank member usually had focused on the areas of a number of these questions, and his statement today would be concerned with all of them. Mr. Treiber then made the following statement: 1. Domestic economic activity. The domestic economy continues to be basically strong despite some distortion of current statistics because of the auto strikes in October and November. Ecoromic activity may be expected to continue to increase. There are, however, uncertainties over labor-management problems including threatened strikes of railroad workers and longshoremen within the week, and possibly steel workers in the spring. Retailers are generally highly optimistic about Christmas sales, and longer-run strength in the consumer area is suggested by the October Census survey of consumer buying intentions. Business confidence is high. There is further indication of strength in capital spending. The November Commerce-SEC survey of plant and equipment spending plans indicates an upgrading for the second half of 1964, and a further advance in the first half of 1965. The new survey is consistent with the view that 1965 will see another sizeable advance in plant and equipment spending, though perhaps not as large as in 1964. While both inventory and sales figures have been distorted by the auto strike, it seems likely that there has been some basic accumulation of inventory. So far the building of steel inventory has been moderate, but a big push in steel inventory accumulation is expected in the first quarter of 1965. 2. Employment. The November decline in the unemployment rate to 5.0 per cent from 5.2 per cent in October is encouraging, even though some of the improvement is due to the unusually favorable weather
conditions which permitted more workers than usual to engage in construction and other outdoor work. The unemployment rate for married men is the lowest it has been in more than seven years. There are shortages in various types of skilled labor. The unemployment problem is most severe among the unskilled, particularly teenagers. To cope with the problem of unemployment, greater stress will have to be placed on measures to raise the general level of education, to improve and expand particular types of technical training, to induce young people to take full advantage of educational and training opportunities, and to enhance labor mobility as well as equality of access to job opportunities. While adequate credit is important to a dynamic and expanding economy and helps to provide job opportunities, merely increasing over-all demand by expanding credit will not solve the unemployment problem stemming from lack of education and training. There is great risk that pressing to increase over-all demand will push up prices generally without substantially reducing unemployment. 3. Prices. There has been no clear change in the price picture. The consumer price index continues its relatively mild upward drift. Industrial wholesale prices apear to have risen a bit more than seasonally. Specific price announcements continue to be predominantly on the up side. On the other hand, there still continue to be some announcements of price reductions. It is too early to assess the impact on the general price level of recent wage agreements. Yet it is apparent that general price tendencies are upward. 4. Balance of payments. The latest balance of payments figures indicate a large deficit--$272 million-- for November. Little can be said on the outlook for December, since many cross-currents are at work. There is the possibility of a deferment of $138 million of year-end interest and amortization payments by the British. Our deficit for 1964 is likely to be between $2 and $2-1/2 billion; this is too large. A much larger proportion of the deficit is reflected in a buildup of private balances than in other recent years. If, however, private holders of U.S. dollars become nervous, there could be a large transfer of those dollars to official bodies with the resultant potential drain on our gold supply.
The outflow of U.S. private capital in 1964 will probably exceed $5 billion; this is $1 billion more than in 1963. The outflow this year is at about the same rate that existed in the first half of 1963 before the midsummer ircrease in United States interest rates and the proposal of the interest equalization tax. A large part of the increased outflow in 1964 has occurred in the short-term area; there have been continuous increases throughout the year in short-term bank credits and holdings of U.S. dollar deposits and money market assets abroad. We cannot tell at this time to what extent the recent increase in our discount rate and in maximum permissible rates under Regulation Q may tend to reverse the previous outflows. The British situation is still very serious. Any threat to sterling as a reserve currercy is a threat to the whole international financial structure including the U.S. dollar and its role as a reserve currency. Even though the United States may have an inflow as a result of Britain's unfortunate experience, such an inflow is not a sign of fundamental U.S. strength. So long as sterling is under pressure we cannot say that the position of the dollar is really stronger internationally. 5 and 6. Credit conditions. Month to month fluctuations in total bank credit have been unusually in the last few months. There have also been erratic over the year in the rate of substantial fluctuations expansion in the money supply. In the longer run, however, growth has been continuous and substantial. Bank reserves, bank credit, and the money supply have continued to grow in 1964 at about the same substantial pace as in 1961, 1962, and 1963. Over that period has advanced almost steadily at aggregate bank credit about 8 per cent each year. The money supply has risen about 3 per cent a year on average and in the last two years at about 4 per cent a year. It is significant that other forms of liquid assets have also kept growing. The ratio of total liquid assets of the nonbank public to gross national product is now higher than at the recession trough of 1961; in previous expansions the ratio has declined as the economy expanded. As the demand for bank credit has expanded with the expansion of the economy over the last few years, the System has accommodated those demands by providing an expanding volume of reserves. The cost of the additional
reserves and short-term interest rates have risen and the tone of the money market has firmed as free reserves have declined; but the additional reserves have been provided to support the credit expansion. The banks have pressed to expand their loans. Reserves have been sufficiently available to enable them to meet the demands of their domestic customers and to seek aggressively and successfully to increase their foreign loans unconnected with exports. Savings appear to be readily available for longterm capital purposes. Two large issues of utility bonds were publicly offered at yields which were about the same as the yields on similar issues offered before the recent discount rate increase. 7. Monetary policy. Over the longer run the continuing large deficit in the U.S. balance of payments requires, and the generally strong domestic business outlook counsels, some reduction in credit availability. A reduction in availability would be helpful in restraining lending by banks to foreigners. Such a reduction would be reflected in a somewhat, slower rate of growth of bank credit. The time has not yet come, however, to take overt steps in that direction; rather the System should aim at maintaining relatively stable money market conditions in the coming weeks and at observing the effect of the higher rate structure on the growth of bank credit. The possibility of an early advance refunding by the Treasury also counsels market stability at this time. The money market has adjusted well to the recent the discount rate. But the effects of the increase in policy change have not fully worked their way through the market. The banks' needs for reserves are at a seasonal peak; normal market forces put Treasury bill rates under considerable pressure at this time. The tone of the money market would appear to be the important guide over the next four weeks; the amount most of free reserves should be subordinated. A three-month Treasury bill rate within the range of 3.75-3.90 per cent would seem appropriate. There should be maximum flexibility to respond to market developments. Mr. Treiber then referred to the draft directives that had by the staff, and indicated that lie preferred been submitted
alternative B for the second paragraph because it placed primary emphasis on money market conditions. Mr. Shuford said that he had considered the questions and responses that: had been prepared by tne staff and had made a few notes regarding them. however, since his views did not differ in basic respect; from those set forth in the staff statements he would not comment on details, but instead would offer some brief general observations. It appeared that the domestic economy was continuing to expand, Mr. Shuford said, although the autcmobile strikes were continuing to blur the analysis. Most recent statistics, such as those on employment, production, and total construction, had been Over the longer periods that perhaps were more relevant favorable. of policy formulation, most indicators of economic for purposes increasing, after allowance was made for the activity had been effects of strikes. Prices in some sensitive areas had risen but over-all indexes remained relatively stable. the It seemed to Mr. Shuford that it was still too early to make a completely satisfactory evaluation of the effect on the domestic economy of the recent increase in the discount rate and the accompanying rise in short-term market rates. These events 1/ The staff's draft directives are appended to these minutes as Attachment A.
might have some dampening effect, but the economy was strong and should not turn down or slow unduly as a result of them. Activity had been moving ahead with considerable momentum, and monetary actions had been relatively stimulative from May to November. The most recent data on rates of expansion in reserves and money seemed to Mr. Shuford to have shown some appropriate moderation from summer and early autumn rates. Since September, total reserves of member banks had risen at less than a 2 per cent annual rate. This was down significantly from the 5 per cent rate that had prevailed since November 1963. However, the contraction in the growth rate in total reserves had been about matched by a reduction in Treasury tax and loan account balances at commercial banks, freeing reserves for the support of private money supply had risen at a 4.2 per cent annual deposits. The a rate which was much lower than that of rate since September, but about double the average since 1951. last summer Mr. Shuford noted that the present turn-of-the-year period typically was characterized by considerable churning in the money market. He thought it would be advisable, in view of both the international and domestic situations, for the Committee to mark time for this period, attempting to keep money market conditions relatively stable. He agreed with Mr. Treiber's
suggestions with respect to the general approach that might be taken. Certainly, the level of free reserves should be an incidental consideration during the next few weeks. He would not favor having the Desk operate entirely on the basis of the tone and feel of the market; some statistical measure should be used as a guide to operations. In his opinion the bill rate continued to be the best guide for the time being, and the 3.75-3.90 per cent bill rate range discussed at the preceding meeting remained for the next few weeks. appropriate Mr. Bryan commented that recent statistics for the Sixth District: did not seem to reflect developments that were of particular significance for, or predictive of, national economic trends. Therefore, he would turn to the questions submitted by the staff. On a number of these questions he had little to contribute beyond the staff's analysis. For example, he would accept the staff reply to question 1, concerning production, sales, and inventories. On the second question, whether a significant further reduction in unemployment was possible without strong price pressures, there was a problem in his mind relating upward to the word "significant." He would expect that some reduction in unemployment could be achieved if the economy continued to expand, but in view of the expected large increases in the labor force he was not sure that there could be a significant reduction.
There was some limiting factor in any expansion, and in the present situation this factor might take the form of difficulty in matching the skills of available labor with those required, at wage rates that were satisfactory to the unemployed. Regarding question 3 on prices, it seemed to Mr. Bryan that there was no clear indication that the country was undergoing an inflationary development at present. However, on the average, whoesale industrial commodity prices had moved up a bit recently. Also, the upward movement continued in the consumer price index and in some of its elements. While these movements might have been matched by improvements in quality of consumer goods, there also were a considerable number of "hidden" price increases--that is, increases that were inadequately reflected in the index. Whether average retail prices of consumer goods (other than foods) actually had been stable thus seemed to him to be uncertain. On question 4, which called for an evaluation of the influences recently" on the international direction of "underlying position of the dollar, there was a problem associated with the meaning of the word "recently." Perhaps the intention was to refer to recent weeks. Over a somewhat longer period the U.S. balance of payments position had improved, and the country might be about to make great further "progress" by revising its
bookkeeping methods, which would be a commendable step. But it seemed to Mr. Bryan that the deficit was going to be huge over a perioc of years however it was calculated. The country seemed to be bleeding to death through these deficits. Mr. Bryan said he was not sure what interpretation should be placed on the recent fluctuations in the growth rates of bank credit and the money supply, referred to in question 5. He would agree that money supply growth on a year-to-year basis had been within a reasonable range. But he also felt that money supply expansion in the past four months had been greater than the country could absorb readily without setting the stage for inflationary developments, and that in the same period reserve growth by any measure had been at a rate that was not sustainable in the long run. A free market always was in process of adjustment, Mr. so his answer to question 6 would be that the adjustBryan said, ments t the discount rate increase were continuing. The real issue was whether a reasonable degree of market stability now be expected. In his judgment this would depend on whether could the rescue operation for the pound sterling proved to be successful, or whether the imbalances were so great that the operation would not succeed.
Mr. Bryan favored an essentially unchanged monetary policy. He agreed that an objective formulated in terms of bill rates was appropriate for the next four weeks and thought that the range of 3.75-3.90 per cent in the three-month bill rate that had been suggested would give the Manager ample latitude. In his opinion the Committee could not rely on any reserve figure for target purposes at present; as Mr. Stone had pointed out, it would be necessary to deal with complex patterns of developments over the coming period. Mr. Bopp observed that although the course of production, sales, and inventories at this time was clouded by the effects of the past and possible future labor difficulties, on balance the economy appeared to be continuing along a moderate growth trend, room to go before problems arose of labor and resource with more was important to look ahead, however, availability. It always at a time such as the present when the economy might especially be approaching a cyclical turning point. there was the strong ahead, Mr. Bopp continued, Looking some slackening would develop because of a possibility that a reduced rate of increase in capital decumulation of inventories, a shift to a surplus position in the and housing expenditures, and view seemed to him one of the Federal budget. This longer-run mind. He did not to bear in aspects of the economy most important
feel that price increases, thus far, posed a particularly disturbing problem for economic stability. The human and material resources were available. Much depended on industrial relations developments in the railroad and steel industries and on the attitude of the administration toward any settlements. The recent rates of expansion in money and credit appeared appropriate to the domestic business envircnmnnt. As for the balance of payments, Mr. Bopp thought the deficit was a continuing and difficult problem, but one that had to be kept in proper perspective within the context of a possibly weakening business environment. For the time being he would be inclined to sit tight and watch developments closely. Mr. Bopp said he would make no charge in the current posture of monetary policy, although he would be inclined to let short-term rates approach the lower limits of recent levels if necessary to maintain about the same growth in money and credit as had prevailed in recent months and if necessary to maintain longer-term interest rates substantially unchanged. Mr. Bopp reported that at a meeting last Thursday (December 10) of economists representing various firms and industries in the Third District, the consensus had been that the economy would continue to expand throughout 1965, although at a slower rate during the second half of the year. The median
forecast of the group was for a 3.8 per cent increase in GNP at an annual rate in current dollars from the fourth quarter of 1964 to June of 1965, and another 1.2 per cent increase from June to December. The group expected plant and equipment expenditures to be somewhat higher than McGraw-Hill's 5 per cent projected increase. Residential construction was expected to provide neither a lift nor a drag on the economy. With some living off of inventory, steel production was expected to decline from an expected 124 million ingot tons in 1964 to 115 million in 1965. Auto and truck output was expected to be 9.1 million units in 1965 compared to 9.3 million units in 1964. Mr. Bopp concluded by noting that he preferred alternative B of the staff's drafts for the second paragraph of the directive. Mr. Hickman observed that with the auto strikes finally out of the way, the domestic economy was getting back into full stride. Production and consumer takings were both moving forward. Except of dock or rail strikes, the near-term prospect for the possibility continuing expansion at high rates. all were on the side of one recent development in the Fourth There had been only District that had differed significantly from national trends, Hickman said, and that occurred in the area of construction. Mr. construction contracts in F. W. Dodge's Region Earlier this year, the Fourth Federal Reserve District) had been lagging IV (roughly
behind those in the nation, but this pattern was reversed in September and October because of a clustering of several very large building contracts in Ohio. This development was a reflection of the strength of heavy industries at this stage of the business expansion. As he had noted earlier in these meetings, Mr. Hickman continued, a disturbing factor in the current business situation was the stockpiling of steel as a hedge against a possible strike in 1965. Events were now moving into the full-fledged accumulation stage. The steel mills were running briskly, but some of their business, in effect, was being borrowed from next year. reported that at the e.d of 1964, steel Mr. Hickman have on hand an estimated 17 million tons of users would 1, barring an early settlement, steel finished steel. By May would have about 21 million tors on hand, as compared users 14 million tons. While this would with a normal range of 12 to as large as the steel inventory peak of 26-1/2 million not be phase preceding the long 1959 tons reached in the accumulation strike, it would be appreciably larger than amounts stocked in 1962 and 1963. If all other factors were equal, the cut-back of production following the settlement could be absorbed by the economy. The danger was, however, that other things might not
be equal. He referred specifically to the prospects of a smaller deficit, or possible surplus, in the Federal budget in the spring of 1965. It was at least conceivable that on these and other grounds the economy might be in for a serious adjustment around the middle of next year. In this context, Mr. Hickman remarked, an attempt at present to further stimulate aggregate demand through a stepped-up rate of expansion of money and credit would make the adjustment more difficult. No growth at all would be equally upsetting, and would be untenable politically. He thought the Committee should, therefore, continue to strive for modest, sustainable growth, on the order of 3 to 4 per cent for the money supply and of about 6 to 8 per cent for bank credit. In his judgment, except for a brief period of sloppy ease last summer the Committee had held fairly well to the appropriate course, and it should continue along the same path as best it could. Mr. Hickman said the present state of the money market, and to a lesser extent of the capital market, was stable but nervous, and it required unusually close attention to prevent its running off in either direction. He would, therefore, continue the policy adopted at the last meeting, attempting as a primary objective to hold the 91-day bill rate in a range of
3.75-3.90 per cent on the bid side, and as a secondary objective to provide average free reserves of about $50 million, plus or minus $100 million. For these reasons he preferred alternative B of the drafts for the second paragraph of the policy directive Mr. Hickman said that his reactions to the staff's questions, prepared largely before receiving the staff's answers, could be summarized as follows: (1) Although up-to-date figures were not available, the current growth rates of production, sales, and inventories appeared to him to be very high, and probably not sustainable beyond 4 or 5 months. In this connection it seemed to him that the first paragraph of the staff analysis, which described the temporary influences augmenting inventory accumulation, was quite satisfactory. The second paragraph, however, seemed to him to be inappropriate, because it tended to brush off the significance of what had already been said in the first paragraph. The opening phrase, "Aside from these temporary influences," marked the path of the brush-off. The second sentence ("On balance, the underlying econonic situation appears to be one of continuing moderate growth") then completed the brush-off. Some definite unbalancing forces obviously were at It was an artificial Mr. Hickman said. work in the economy,
device to distinguish between "underlying" factors, on the one hand, and "temporary" or "special" factors on the other, in a situation where the unbalancing forces were so deeply woven into the economy as was the case with the present steel inventory situation and with other inventories. (2) In Mr. Hickman's opinion the ecconomy could achieve a reduction in the margin of underutilized man power (or rather teen power and woman power) without upward price pressures, provided it was done largely through specific structural measures rather than entirely through additional aggregate demand. Mr. Treiber's comments on this question were nearer to his own thinking than were the staff's. area, the various diffusion indexes (3) In the price that Mr. Hickman watched had been above 50 per cent for many months, with the National Association of Purchasing Agents' diffusicn index showing an increase in November for the fifth consecutive month. (4) With reference to the balance of payments, commented that outpayments from Government programs Mr. Hickman capital flows obviously were still larger than net and private earnings on current account. Despite much discussion of the problem, no one appeared to be able to balance of payments the future held in store. foresee what
(5) As he had indicated earlier, Mr. Hickman felt recent changes in the money supply and liquidity had been appropriate and had been roughly in line with what he considered to be sustainable trends in measures of real economic activity. (6) From the impressions he had gained on the daily telephone conference call during the past two weeks, the money and capital markets appeared to be stable but nervous. (7) In light of these considerations Mr. Hickman would continue for the present to pay primary attention to market tone, with secondary emphasis on bank reserves and the money supply. Mr. Mitchell remarked that in considering the real alternatives for monetary policy today the Committee had to recognize that the System had made a trade-off between the of payments constraint and domestic needs when the balance was raised, and in effect had announced this to discount rate At the same time, the System had said in effect the world. that it was going to minister to the needs of the domestic economy by continuing to make funds available. Subsequently, these statements were reinforced by the operations of the Desk. had accepted the feasibility of the kind of trade-off The market that had been announced, and Mr. Mitchell did not think it was at present for the Committee to consider a departure realistic
from the described policy. Since the System had convinced the market that such a policy could be implemented, the only questions confronting the Committee today were how to continue to implement it, and how to avoid arousing expectations that it would not be possible to do so. Mr. Mitchell said he would accept the Manager's judgment that it would not be feasible now to follow a free reserve target. He noted that Mr. Partee had recommended an instruction in terms of desired market conditions, but he had not offered any specific language for such an instruction. Mr. Mitchell would accept a bill rate target, but would prefer a range of 3.65-3.85 per cent, to give rates a chance to flex a little in accordance with seasonal changes. All things considered, Mr. Mitchell did not think the short-run posture of monetary policy could be very different from this at the present time. However, it was necessary to recogniz, that monetary policy operated with a lag, and the Committee also should be thinking in terms of the longer run; in particular, it should be taking account of the possibility that the pace of activity might slacken in the coming year. Perhaps the most the Committee could do was to keep expectations out of unrealistic channels. Expectations on the business outlook ranged from boom to a leveling off or decline in activity, and
it was desirable to avoid prejudicing and one of these views by a prejudged monetary policy. Mr. Partee had raised a question about the sustainability of the present flat yield curve, and had concluced it was reasonable to expect from market forces that long-term rates would remain at about their present levels. The Committee ought to avoid discouraging such an expectation, based as it was on an analysis of market forces. Mr. Mitchell said that, by and large, he thought the staff's questions and answers made up a good document. He agreed in general with the analyses presented and he was especially impressed with those on financial subjects. He was unhappy, however, with the staff response to question 2, on employment. The analysis seemed to him to be quite unrealistic, and he was sympathetic with Mr. Treiber's views on this subject. He disagreed with Mr. Hickman's criticism of the reply to the first question; it seemed to him that if monetary policy created an environment conducive to rising investment, which he thought it should do, it could not prevent people from hoarding steel or from increasing their inventories of autos. As he read the paragraph Mr. Hickman had criticized, it implied that the special factors leading to accumulation of steel and autos had not spread to the rest of the economy. In his judgment such accumulation should not be choked off by monetary policy; rather, it should be accommodated, unless it became pervasive.
Mr. Hickman said that Mr. Mitchell evidently had misunderstood his comment, because he had not meant to suggest that the current inventory accumulations should be choked off. As he had indicated, he did not think that the Committee should attempt to stimulate aggregate demand further, but at the same time he would consider no growth in money and credit to be untenable. In short, he preferred to continue the present policy. His objection to the paragraph in question was that it implied that, apart from temporary factors, the prospects were for continued economic growth. In his judgment the more likely development w.s a letdown in activity after the inventory build-up had run its course. Mr. Brill commented that the staff had had a relatively short time horizon in mind when it prepared the paragraph in question. It was the staff's view that, aside from the temporary inventory accumulation, underlying fo::ces suggested continued run. The staff h. not intended to imply a growth in the short judgment that growth would continue through the balance of 1965. Swan commented that in his view the most important Mr. question with regard to the current steel and auto inventory accumulations was whether there would be some reaction on the rest of the economy when they came to an end. Mr. Mitchell agreed, and Mr. Hickman noted that such a development might well
occur at a time when the Federal budget was shifting to a surplus position, thus compounding the problem. Mr. Shepardson said that he thought the staff's responses to the questions on the whole were good, and in general he agreed with them. It was important, in his judgment, to distinguish between two possible reasons for the inventory developments that had just been discussed. If steel inventories were being accumulated as a hedge against anticipated price rises, that definitely would be something to be deplored, and the Committee should do what it could to discourage it. But as he understood the situation, larger steel stocks were desired primarily as a hedge against a possible stoppage of supply. He doubted if the Committee could do anything to stop such a the fact that it might result in a letdown development despite later unless there was a long strike in the steel industry, which would be equally unfortunate. remarked that he had some questions about Mr. Shepardson on employment, particularly in connection the staff's analysis given. He would have put more with the list of alternatives stress on the need for efforts toward structural improvement, time recognizing that monetary policy could not do at the same He also questioned the implication that much in this respect. the demand to meet be adequate force would in the labor growth
for labor. As he interpreted current reports, there were growing shortages of some types of skilled workers and some upward pressures on costs. On the subject of prices, Mr. Shepardson was under the impression from the announcements he saw in the press that increases in wholesale prices were more widespread than had been indicated. Moreover, even if wholesale prices were reasonably stable on average, the stability resulted in part from the fact that decreases in farm prices were offsetting rises in industrial prices. It was important not to be misled by a stable average of these two diverging components. On the balance of payments, Mr. Shepardson commented that the nature of the settlement by the Common Market countries could not be foreseen, but any settlement was likely to curb U.S. agricultural exports to Europe, apart from the declines to be expected from the unusually high level of exports that were resulting from droughts abroad. All indications were this year would involve changes ir the European agriculthat any agreement restrictions on imports that would be ture price structure and U.S. agricultural exports. This was a matter of adverse to particular concern in the context of the more general problem of a continuing adverse balance of payments.
On the money supply, Mr. Shepardson said, the growth rate of 4.2 per cent so far in 1964 was, if anything, a little higher than he would consider sustainable on a longer-run basis. He did not understand why so much emphasis was placed in various staff documents on the demand-deposit component of money, and so little on the currency component, which was growing rapidly. In his judgment the figures on the total money supply were the more appropriate ones to consider. In sum, Mr. Shepardson remarked, be thought there were grounds for shifting to a somewhat less expansionary position now--to a little less ease. On the other hand, he recognized that various circumstances--including seasonal pressures, uncertainties of various kinds, and the possibility of a argued for no change in policy at the Treasury financing--all he was inclined toward a policy of present time. Hence, while concluded that such a shift would not be a little less ease, he at this time. appropriate directive, Mr. Shepardson said he With respect to the time by the cataloging in the first had been disturbed for some paragraph of the factors that the Committee took into account, order to the listing and without any without any particular of the Committee's assessment of the implications characterization second sentence of the draft the of each factor for policy. The
staff had prepared for today's meeting, for example, referred to some factors that argued for less ease, some that argued for more ease, and some that might have implication in both directions. He proposed replacing this sentence with language along the following lines, in which he had tried to group and properly characterize the various considerations as he saw them: The Committee seeks to keep further monetary stimulus within moderate bounds in view of the persistence of a sizable deficit in the U.S. balance of payments, the upward drift of prices of selected industrial commodities, the current pickup in activity related to recent and threatened work stoppages, and the already sizable expansion in bank credit and money that has occurred in 1964. On the other hand, the Committee recognizes some further money and credit expansion is called for by the orderly and moderate character of the economic expansion apart from the strike influences, and by the persisting margin of underutilized resources. The Committee also takes special cognizance of the somewhat conflicting effects on the standing of the dollar that are resulting from marketuncertainties about the pound sterling. Mr. Shepardson preferred alternative B for the second paragraph of the directive, but he would omit the last clause read "while accommodating moderate expansion in aggregate which bank reserves." It seemed to him that this clause was redundant, since the first sentence of the first paragraph included the words "accommodating moderate growth in the reserve base, bank credit, and the money supply."
Mr. Robertson said he thought the staff had taken an excellent first step in pointing up the factors on which the Committee should focus most directly. The procedure might be augmented in the future by raising other questions with which the Committee should grapple, such as that of quantification. Also, he hoped that a better job could be done in the future in providing the linkages between the subjects discussed under question 5 and 6, although he recognized that this was a difficult task. Mr. Robertson said that in his statement he would comment first on the staff responses to each of the questions, and then on policy. He then made the following statement: (1) Production, sales, and inventories. I have no quarrel with what the staff wrote, but it is important, to recognize that the suggested bulge in inventory accumulation, along with other economic developments going on in such fields as housing and Federal finance, increases our exposure both to unsustainable and even inflationary increases in activity in the short run, and--equally important--to a letdown in business activity later on in the year. I doubt that monetary policy can deal with so narrowly based a distortion, but we ought to watch it carefully. (2) Employment. The staff answer is good. It emphasizes that the labor force growth will give us more workers to produce added output. It shows we should not base monetary policy on any assumption that we are about to enter an overemployment situation, with a wage-price spiral inevitable. developments. No added comment is (3) Price necessary. The staff notes that price increases are not spreading rapidly. With average prices of all materials up very little, and unit labor costs still as low as last year, there are no necessary upward cost pressures on prices of final products as yet.
But we should keep a wary eye on the developments in steel! (4) Balance of payments. The staff review is helpful in putting things in perspective. It is interesting to note that it has not been the shortterm flow of liquid funds (which were assumed to be so interest sensitive) that have bulked large in our capital outflow this year (only about $1/2 billion or so out of $5 billion capital outflow). The big factors have been our direct long-term corporate investment, securities issues exempt from the interest equalization tax, and bank lending. The latter is also exempt from IET to date, of course, and we should not forget that bank lending is doubly encouraged by current IET provisions; they (a) divert capital borrowing from the securities market to banks, and (b) encourage anticipatory bank lending activity now. The provision that would let the administration apply IET to longer term bank loans has no retroactive feature. The result is a "beat the hoarders" incentive for both the banks and the borrowers. The question of what Governmental policies to a good one. I feel it would be foolish to apply is tighten general monetary policy to reach a handful of banks, unless all else fails; and it would be likewise foolish to trigger general policy changes without first removing the specific IET incentive to bank lending by it to banks as authorized by law. applying supply and liquidity. I see no need (5) Money for further comment. Allowing for the changing influences on money and credit demand outlined by the I feel that changes in these magnitudes over staff, periods of months can give useful clues as to what policy might be--clues that are not always monetary dependable, and are only a few among a great number of measures the Committee should watch, but which are nonetheless helpful in that context. credit markets. The staff comments (6) Money and constitute a useful review. The last paragraph points up how important it will be for us to conduct open in a way that does not push up member market operations bank borrowings at this juncture. * * * the calmer atmosphere that has I am gratified by to domestic financial markets in the past two returned in part to the public admonition of weeks--thanks
President Johnson. It seems to me that we have come about as close as anyone could have hoped--in this interval--to achieving a somewhat higher level of money market rates than before the discount rate action, with a minimal effect on longer term credit availability. Judging from what we have read and heard in the staff reports, I would think continued pursuit of this same objective would be in order until the next meeting of the Committee. Business expansion appears reasonably based, apart from the steel inventory bulge for which monetary policy is no apt remedy. Our balance of payments picture has not improved as much as one might have wished, but to deal with that problem, particularly in the light of the British trouble, will take careful consideration of a number of Government policies--not just general monetary policy. Indeed, from a credit point of view, the remedial tool needed is not so much a blanket depressant as a scalpel--one that can reach particularly the dozen or so big banks that seem to be generating the bulk of the lending abroad. Certainly consideration should be given to means of neutralizing the positive incentive to such lending generated by an IET that applies to capital issues but not yet to banks. In so far as instructions to the Manager are concerned, I favor his continuing to meet all demonstrated market needs for reserves. Over the next month, seasonal pressures will be reversing and may be pushing bill rates down, and under the present circumstances I would not want the Desk to fight such a decline, if it happens, by tightening the money market. In particular, I would not want to see bank borrowings pushed back up. I think the moderate level of discounting since the last meeting has been a key element in stabilizing market conditions within a reasonable range, and I would not want to see borrowings rise for very long above the moderate levels established thus far in December. Mr. Robertson noted that alternatives A and B for the of the directive were identical except for the second paragraph
order of the clauses. He preferred A, in which the clause order was the same as in the previous directive, because a reversal of the clauses might prompt questions concerning possible subtle implications of the change. He agreed with Mr. Shepardson's remarks about the first paragraph, but would prefer to drop the second sentence completely rather than to introduce a substitute for it. This sentence would not be needed so long as, pursuant to the understanding reached after the last meeting, the directive itself was linked to the policy record entry for this meeting, and the entry included the substance of today's discussion of the issues covered by the staff's questions. Accordingly, he thought it would be appropriate to issue a directive consisting simply of the first sentence of the staff's draft and the second paragraph. Mr. Mills then made the following statement: During a period disturbed by the difficulties encountered by the United Kingdom and by the increase in the discount rates of the Federal Reserve Banks, the apparent purpose of Federal Reserve System monetary and credit policy was to attempt to instill confidence in the financial community by creating a background of relatively easy money market conditions intended to indicate that no further policy moves in the direction of credit restraint would be made. Judging by falling yields on U.S. Government and other fixed interest obligations, interest rate responses to policy intentions have been successful. The question is whether current policy has overreached the necessities of the economic situation and has resulted in easier money market conditions than are justified by immediate and prospective developments.
The possibility of massive inventory ;tockpiling, the further upward movement in the prices of strategic industrial materials, and pervasive but latent evidences of inflationary pressures suggest that a somewhat more restrictive credit policy should be resorted to than is now the case. A modest reduction in the supply of reserves and a consequent tightening in credit availability would still leave reasonable leeway for appropriate credit expansion without encouraging the commercial banking system to press unduly for a further increase in its holdings of loans and investments. A lesser degree of credit availability should have the wholesome effect of restraining the expansion of credit in a rather inflammable business atmosphere that could ignite into another bout of inflationary conditions. It is not believed that a tightening in the supoly of reserves from present levels would restrict whatever expansion in credit may be legitimately called for or weaken financial confidence in the general domestic and international economic picture because of a slightly stronger interest rate structure. Accordingly, the Committee's directive should not press for "maintaining about the same conditions in the money market that currently prevail" but, should direct the Manager of the System Open instead, to reduce the supply o: free reserves Market Account to a point resulting in money market conditions comparable to those that were ruling late in November and early in December. Mr. Mills added that he sensed from the comments of those the sentiment of the Committee was who had spoken thus far that that there should be no change in policy. He objected to such a course because he considered it a policy of drift which developments that to his mind ignored reasonably predictable should be anticipated by appropriate monetary and credit policy actions. He felt that a new start should be made toward moderately the availability of credit. He thought the Committee restricting
was evading the issue by continually describing the course it intended to take but then putting off appropriate policy actions. Mr. Wayne said that one brief observation based on the Richmond Bank's Fifth District survey seemed pertinent since it bore on policies which might affect both employment and prices. Textile and furniture manufacturers, who had been operating to practical capacity for some time, had resorted to further lengthening of the workweek to meet heavy celivery schedules extending well into 1965. There was no evidence of any move to enlarge the work force which would add jobs and thereby increase employment. Mr. Wayne then turned to the staff questions. (1) Production, sales, and inventories. With movements in these sectors mainly seasonal or related to special situations--i.e., steel and automobiles--and with no evidence of any speculative inventory buildup related to price expectations, he thought the Committe's attention should be focused elsewhere. Wayne considered the staff analysis (2) Employment. Mr. on this subject to be informative and useful. He concurred generally with Mr. Treiber's observations. For the most part, continued to be concentrated heavily in a few specific joblessness among the unskilled. He had serious doubts that age groups and anything further towards relieving that monetary policy could do
kind of unemployment without prejudicing its ability to achieve over-all domestic and international stability. It seemed to him that over the past three years the Committee had contributed about as much to the solution of this problem as possible, given the balance of factors it had to consider. (3) Price developments. Upward pr:..ce pressures still seemed to Mr. Wayne to be gentle, and while it was difficult to say whether they were stronger there were no indications that they were weaker. They seemed, however, to have become somewhat more pervasive. In general, while suggesting continued watchfulpressures did not appear to require action on the ness, price Committee's part. Mr. Wayne said he would (4) Balance of payments. on this subject until after he had considered postpone his comment the next two questions. Mr. Wayne agreed in Money supply and liquidity. (5) on this subject. He saw no clear general with the staff analysis money supply or bank credit was rising indication that either the He was somewhat concerned, however, at an unsustainable rate. in liquid assets. In the last about the continued large increase at an annual rate of months, time deposits had increased three and nonbank liquid assets at a rate of 8.0 per cent, 14.3 per cent cent annual rate on a 4-1/2 per growth was superimposed and this
of rise in the money stock. He was not at all certain what these rates signified, but he was increasingly convinced that the Committee had to try to interpret them in the light of recent structural changes in the financial system that had changed significantly the relationship of bank reserves to bank credit and the money supply. In other words, while the outcome of the recent changes in Regulation Q had not yet clearly been analyzed, in considering policy the Committee had to take account of the structural changes that had occurred. The large November increase in bank credit appeared to Mr. Wayne to be attributable chiefly to Treasury financing. Money supply growth over the same period actually was somewhat smaller than :.n other recent months. The step-up in the rate of expansion in time and savings deposits might have been due chiefly to the limited availability of automobiles over much of the month. markets. While the staff and (6) Noney and credit others had suggested that these markets had settled down, it seemed to Mr. Wayne that the adjustments to the recent rate changes here and abroad were not yet complete. With respect to bank reserve positions, he was not at all sure how they should be expected to adjust to the new rate alignmert, especially in view of the strong seasonal pressures in the current picture. In his an outstanding job of moderating the judgment the Desk had done
stresses of the adjustment in this difficult seasonal period; Mr. Stone and his staff had conformed as nearly as was humanly possible to the Committee's instructions. Seasonal swings would continue to complicate reserve and yield relationships in the period ahead and, Mr. Wayne thought had to be taken into account in evaluating how the adjustment was proceeding. Returning to the balance of payments question, Mr. Wayne noted that Mr. Sanford had emphasized the recessity of "holding the line" through the year end and into January to permit the disposition of seasonal pressures and to allow time for an orderly solution to the problem of the weakness of the pound. Mr. Reynolds' comments were somewhat encouraging with respect to the long run; nevertheless the improvement was relative only, some very bad years, and it still left the since it followed deficit. In the short run it was United States with a large absolutely essential that the international payments mechanism be preserved in workable order. That required both the pound and the dollar to remain acceptable currencies. What the had done in this area had been necessary, but it was Committee squarely the fact that the actions taken had important to face dollar except in the negative sense that not strengthened the had averted a disastrous collapse of the payments mechanism. they and maintain the payments current efforts to bolster Should the
mechanism prove unsuccessful, the dollar would be exposed to dangerous drains which would be accentuated considerably by the System's commitments of recent weeks. In the policy area, it seemed to Mr. Wayne that the Committee had two commitments or obligations which over-rode all others. The first was to do all that was feasible to facilitate a solution of the British problem and to help the United Kingdom regain a workable equilibrium. Then the Committee had to honor its commitment to make available sufficient reserves so that economic expansion in this country would not be curtailed by a lack of credit. At present, those two commitments seemed to be compatible but whether they would remain so would depend on developments. If confidence in the pound should be restored quickly and the discount on forward sterling dropped sharply, and if the British Bank rate remained at its present level, it might be necessary to raise short-term rates substantially to avert large outflows of funds. While a moderate reduction in the availability of funds would not be unduly burdensome to the domestic economy, a large reduction might well be crucial in stopping economic expansion. Regardless of international developments in the next four weeks, there would be a sharp seasonal reversal of market conditions in this country. In this to giving the Wayne could see no alternative situation Mr.
Manager somewhat more leeway than usual. He favored a continuation of the policy of placing primary emphasis on short-term rates, aiming at about the same range as was adopted two weeks ago-- 3.75-3.90 per cent. He would not consider this statement of a range of rates to establish terminal points to be defended at all costs, but rather as a general criterion that he would hope could be followed. Mr. Wayne had a slight preference .or alternative B for the second paragraph of the directive, but he did not consider the difference between A and B to be sufficiently significant to debate the matter. Mr. Treiber referred to Mr. Wayne's comment regarding the decisions of textile and furniture manufacturers to extend the workweek and asked whether the manufacturers had indicated the nature of the thinking behind those decisions. Mr. Wayne replied that the manufacturers had noted only that this was their usual practice. In general, they preferred using trained workers on an overtime basis to expanding their work forces by hiring untrained workers, on the ground that it was less costly in the long run. They were not particularly concerned with the questions of over-all employment and unemployment, and felt that if they enlarged their work forces would be faced with problems of industrial temporarily they became necessary to cut them back. relations when it
Mr. Clay remarked that the practice Mr. Wayne had described seened to be followed rather generally in manufacturing; initially, marufacturers would increase output by working overtime. If the higher levels of production were sustained, however, they might enlarge their work forces. Mr. Clay then said that there had been some indication of the preliminary response of Tenth District banks to the recent changes in Regulation Q and the discount rate. Among country banks, the evidence suggested little action on either count. In their unhappiness over the modification of Regulation Q, country banks apparently would try to avoid any change in the rates they paid on time and savings deposits. With the higher level of loan rates that were charged, it was not anticipated that the 1/2 per cent change in the discount rate would affect the terms of country banks' loans. Among city banks, Mr. Clay had noted a tendency, not yet uniform, to move to the 4 per cent ceiling on all maturities of on which they paid interest. The banks were savings deposits problems involved in calculating and glad to get rid of the explaining the interest payments under the old Regulation Q ceilings. In addition, the cost impact was materially lessened by the large proportion of savings deposits whose maturities 4 per cent rate. On time CDs, the already qualified for the
city banks were endeavoring to hold the line at 4 per cent for 6 month maturities and beyond. On nationally marketed CDs, the leadership of New York would force the issue as to what they must pay when renewals came along if they wished to retain such funds. Mr. Clay said that note cases were being reviewed at city banks with a view to increasing loan terms on a selective basis as renewals came along. On the strongest rated national companies with alternative sources of funds, however, the banks apparently had not found it feasible to change loan terms. Before commenting on the staff statement on the questions prepared for the Committee's consideration, Mr. Clay said it was in order to inquire whether the statement would be included in the minutes for this meeting. It seemed necessary to do so if members' comments as they appeared in the minutes were Committee He thought the staff statement had been well to be meaningful. a good evaluation of the economic situation. prepared and was While different people would approach the preparation of such statements in different ways, leading to coments and suggestions, conclusions appeared to him to be essentially the analysis and correct. question 1, Mr. Clay continued, was the One comment on need for recognition that present evidence suggested a more increase in business capital outlays than in 1964. moderate rate of
Mr. Clay remarked that price developments to date could not be characterized as of a kind that called for monetary restraint. While price increases from whatever cause had to be watched carefully, the greatest potential threat and the most awkward one for monetary policy was the labor contract settlements. The auto settlements were unfortunate, and the steel negotiations were of tremendous importance. It not only was important that the settlements should not be excessive, leading to higher steel prices and the spreading of such labor settlements; it also was important that the steel settlement should come early so as to avoid the destabilizing effect of an inventory boom. Mr. Clay suggested that the issue involved in the internapayments deficit was not whether some people were concerned tional about it and others were not. In fact, the staff statement on this giving background information and analysis, effecsubject, after pointed out the difficulties in the concluding paragraph. tively difficulties so well stated were uderscored by the indication The of the role of private capital outflows in the previous paragraph of direct investments, $1 billion of in 1964, including $2 billion foreign security issues, and $1-1/2 billion of bank lending. The Committee not only had the question of what monetary policy could there was the further question do in the light of domestic needs; those capital outflows could be dealt with of what part of effectively through monetary policy.
Mr. Clay believed monetary policy over the next four weeks should continue in its present general framework. It seemed that interest rates again should be the primary short-run guide, and for that purpose he suggested a 90-day Treasury bill rate range of 3.75-3.90 per cent. The staff draft of the economic policy directive appeared satisfactory to Mr. Clay and, in keeping with the statement on interest rates as the primary guide, he considered alternative B preferable for the second paragraph. Mr. Scanlon turned directly to consideration of the questions prepared by the staff. (1) Production, sales, and inventories. Mr. Scanlon remarked that although it was difficult to abstract from the effects of recent and prospective work stoppages, it appeared that the pace of business activity had continued to rise. Recent price developments suggested that the gap between performance and potential had narrowed further. Nevertheless, such factors as the buildup in steel inventories (due in part to shortages of cars), the unusually high current level of automobile railroad output, and projections of smaller increases in spending for new plant and equipment and for construction in 1965, carried the present expansion could begin to lose intimations that The Midwest, which had experienced a momentum next spring.
somewhat more vigorous expansion than the nation, probably was more exposed than the national economy to any reaction that might occur in the durables sector, especially steel and automobiles. Important producers of durable goods in the District generally reported--unofficially--that they were acquiring all the steel they could. (2) Employment. As viewed in the Seventh District, it seemed unlikely that any significant further reduction in the margin of underutilized manpower would be attainable in the near future even with additional upward pressure on the price structure, especially given prospects for sizable further labor force growth. Only one labor market in the District was reported to have a substantial labor surplus. It seemed appropriate, however, to maintain moderate pressure on usable labor supplies both to aid unemployment and to provide a market forces tending to alleviate to upgrade the quality of ecoromic setting for programs favorable workers and to increase mobility. current .nd prospective Mr. Scanlon observed that upward (3) Price developments. and apparently were still more numerous price movements continued by the official indexes. He continued to than was indicated reports of increases in the form of slimmer discounts receive The farm and construction machinery industry from list prices. was attempting to put through price increases to offset increased
costs resulting from recent wage negotiatiors. Thus far the increases were selective because markets were not strong enough to permit across-the-board increases. However, he thought it should be noted that price adjustments were not all upward. Spokesmen for some firms in the Seventh District offered reminders that price reductions were still a part of the economic landscape. (4) Balance of payments. Mr. Scanlon observed that views in the Seventh District regarding the balance of payments paralleled those given by the staff. The nation's balance of payments problem showed little indication of changing one way or the other. While there was no evidence that. the situation had been deteriorating recently, no sign of a turn for the better was apparent. Several leading Midwest industrial firms that were important exporters and overseas producers recently had projected gains in their foreign sales for 1965. Those appreciable estimates had been made subsequent to the United Kingdom's imposition of additional import taxes. There were hints that such firms had undertaken to reduce their exposure to loss from possible devaluation of foreign currencies. (5) and (6) Money supply and money and credit markets. On financial factors, Mr. Scanlon said, the recent behavior of bank credit and the money supply had been reasonably consistent with earlier experience in the second half of 1964, the course of
business, repercussions of the discount and Bank rate changes, and implementation of a monetary policy emphasizing an interestrate target. For those reasons, in his judgment no especial significance attached to the pattern of recent short-term fluctuations. The large Chicago banks were increasing rates on savings deposits under one year effective January 1, and one additional bank had issued a small amount of unsecured notes. That bank reported that unsecured notes might be used largely in lieu of repurchase agreements. Owing to the likelihood that credit market adjustments to the recent discount and Bank rate changes were continuing, it to Mr. Scanlon appropriate to adhere to a short-term appeared as a target for the four weeks ahead. A level between rate range 3.70 and 3.90 per cent seemed to be desirable, with reserves, to respond to market forces. money supply, and credit permitted Wayne, Mr. Scanlon would allow the Manager ample Like Mr. to meet any market pressures as they latitude during the period B for the second paragraph of occurred. He preferred alternative the directive. Deming said he did not agree with Mr. Mitchell's Mr. System had made a trade-off between balance observation that the It seemed obvious to of payments and domestic considerations. in long-term interest rates him that by maintaining stability
and by permitting the rise in bank credit that had occurred in November and December the Committee had continued to serve the needs of the domestic economy--and perhaps to a greater extent than they should have been served. While he did not advocate a change in policy at this time, he thought it could be argued that a slight curtailment of credit availability would be appropriate now. Mr. Deming said he had no comments to make on questions 1, 2, and 6 of the staff's list. With respect to question 3, he continued to be somewhat concerned about the accuracy of the official price indexes. Perhaps some price declines were occurring, but he could find no evidences of them in the Ninth District or elsewhere. For the past three months the survey that Bank made of firms with headquarters in the District the Minneapol.s had disclosed price increases but no reductions. Mr. Deming also continued to be concerned about the balance of payments, considered under question 4. There was some comfort, great deal, in the fact that the record would be better but not a last year. It appeared that the deficit would this year than remain large for some time. Capital outflows continued heavy, foreign lending their surplus of and even if banks should curtail to make unsound domestic loans. funds might lead them
With respect to banking developments discussed under question 5, Mr. Deming remarked that banks in the Ninth District had shown somewhat less deposit expansion in November than had occurred naticnally. Nevertheless, deposits were continuing to expand rather rapidly, and District banks were not in a particularly tight position. Their liquidity ratios showed little change over the past year. Mr. Deming thought the Committee should continue its recent policy without substantial change over the next four weeks. He preferred alternative B for the second paragraph of the directive. He thought the phrase in the first paragraph that read "the continued domestic expansion, currently receiving additional stimulus from recent and threatened work stoppages" needed some elaboration; it might be desirable to insert the words "and perhaps unsustainable" between "additional" and "stimulus." However, he agreed with Mr. Robertson that the of the first paragraph would best be omitted in second sentence its entirety. Mr. Swan commented that the Twelfth District continued to be faced with a larger decline in defense-related employment nationally, a higher rate of unemployment, and greater than construction. However, recent weakness in residential to reflect other differences of developments did not appear significance for the national economy.
Mr. Swan said that in commenting on the staff questions and answers he would avoid repeating points that already had been made. He had no disagreement with the staff analysis under question 1, relating to the general course of economic activity in the immediate future. But he agreed with those who, in looking a little further ahead, had emphasized the possibility of some reaction to the current accumulations of automobiles and steel. Given certain circumstances, these accumulations could come to an end rather abruptly, with some reaction on the rest of the economy. Perhaps they would end in the first part of next year at a time when there was continuing weakness in housing and a shift to surplus in the position of the Federal budget, and when consumers were experiencing the effects of settlements on their 1964 Federal income taxes. In light of these possibilities he thought there was some question about the course of events in 1965. On the subject of unemployment, Mr. Swan agreed with those to a large extent the problem was a structural one who felt that policy. The one qualification he and not susceptible to monetary the most rapid and sustained growth would make was that recently had been in trade, services, and State and local in employment substantial amount of the work done governments--areas in which a of labor skills--and there might be did not require a high order in such areas expansion in employment latitude for further some
as a result of expansion in aggregate demand. It had to be recognized that such labor resources were the types that were most likely to be augmented by continued expansion of the labor force; this was an area in which it was necessary to keep running in order to stay in one place. On the balance of payments, Mr. Swan thought that Mr. Reynolds' remarks about the outlook for the trade surplus simply highlighted the Committee's concern over the matter of capital outflows. In this connection, he found the available data on the amounts and directions of various types of flows to be rather inadequate and somewhat confusing. For example, there seemed to be some conflict with respect to the size of recent short-term outflows between Mr. Treiber's statement on this subject and Mr. Robertson's, which was based on the staff answer to question 4. If possible given the limitations of the basic data, he thought it would be desirable to get some further in the figures, distinguishing not only between breakdowns flows and among direct investments, new short- and long-term foreign security issues, and bank loans, but also between flows were not subject to the interest equalization tax; that were and some indications of geographical distribution. He and providing would be a difficult task, but thought that realized that this further refinement of the figures would be greatly welcomed. some
Mr. Reynolds commented that the conflict to which Mr. Swan had referred was apparent rather than real, and resulted from a different grouping of the figures. In the staff statement to which Mr. Robertson had referred, shortterm and long-term foreign lending by banks had been combined, but this total had been distinguished from flows of liquid funds; whereas Mr. Treiber, in referring to large short-term capital outflows, had included in this category short-term bank credit as well as flows of liquid funds. Mr. Swan said this was the kind of question on which the Committee needed better information, both in weighing balance of payments considerations against the needs of the the alternatives of general domestic economy and in evaluating policy and selective measures of some type for dealing monetary with the problem of the deficit. indicated that he had no quarrel with the recent Mr. Swan and the mory supply. It seemed to movements in bank reserves an excellent job recently, given him that the Desk had done and the policy decision made at the actual market developments In view of the uncertainties existing at previous meeting. the likelihood of a adjustments still in process, present, the his own mind at financing, and the uncertainties--in Treasury he thought the business outlook, the longer-run least--about
Committee should maintain much the same policy and the same money market conditions in the next four weeks as recently. He would add only that he felt the Committee should begin to relate its target range for short-term rates to expected market conditions. Given the anticipated shift in seasonal factors, he would agree with Mr. Mitchell that the range could be lowered a bit, perhaps to 3.70-3.85 per cent. With respect to the directive, Mr. Swan agreed that the phrase in the first paragraph on which Mr. Deming had commented was not entirely clear. However, instead of describing the stimulus from work stoppages as "additional and perhaps unsustainable," he would prefer to describe it as "temporary." Before today's meeting, he had concluded that he mildly favored alternative B for the second paragraph. However, his view had changed after hearing Mr. Robertson's comments on this subject. He now thought the Committee should maintain the same order of clauses if it was continuing the same policy; there was not enough justification for reversing the clauses to warrant promoting speculation as to why the clause order had been changed. Mr. Irons reported that there was little in recent Eleventh District developments that was worth comment today. He would note only that there had been increasing use of the higher
interest rates now allowed on savings deposits under Regulation Q. Enough banks had already moved up to the per cent rate on savings deposits to make it likely that other banks would soon follow. This was true not only among the larger banks but also among some of medium and smaller size. The national business situation seemed to Mr. Irons to be one of strength with no particularly unbalanced factors, although the wage, cost, and inventory situations warranted close watching. With respect to the questions submitted by the staff, Mr. Irons said that in the interest of avoiding repetition he would note only that his position was substantially the same as Mr. Treiber's. He thought the Committee should continue the policy it had followed in the past two weeks. Market developments in that period generally had been satisfactory and the Desk had done a good job of carrying out its instructions. He would continue to have the Desk place emphasis on interest rates and treat free re:;erves as a residual. He favored 3.75-3.90 per cent as a general range for the three-month bill rate and agreed that the expected market situation required giving the Account Manager a good deal of leeway. The Desk was likely to have problems in the period ahead in coping with international, seasonal, and other developments.
Mr. Irons did not have any strong preference between alternatives A and B for the second paragraph of the directive. However, he thought alternative B might be desirable because it placed somewhat more emphasis on the international aspect of the problem. Mr. Ellis commented that there had been no new developments of economic significance in the New England region during the past two weeks. The recent episode with respect to the prime rate at a Boston bank had led him to believe that in the future the prime rate might be downgraded in importance as an element of the interest rate structure. The banks at present were searching for alternative techniques for setting rates on term loans, and it was possible that there might never again be prime rate announcements. In reacting to the first question submitted by the staff, ' Mr. Ellis said, he would note the statement in the "green book - that in the Commerce-SEC survey actual third-quarter capital expenditures had been revised upward from expected outlays. This sounded much like what had happened last year. He, for one, found it difficult to reconcile the survey results with statements of concern that plant and equipment outlays might rise too little 1/ The report, "Current Economic and Financial Conditions," prepared for the Committee by the Board's staff.
in 1965. He would expect that in the longer run stable economic growth was likely to be associated with a lower rate of expansion in capital spending than had been experienced recently. The current inventory bubble raised in his mind the question of financing. The present easy availability of credit made it easy to finance that inventory accumulation, and so the Committee perhaps had to assume some responsibility for it. The discussion of employment in the staff's reply to question 2 was informative, Mr. Ellis said, but most of the analysis was directed to the matter of a possible near-term reduction in unemployment. In his judgment it would be more appropriate to aim monetary policy at the target of increasing employment and reducing unemployment in the longer run; he would not direct policy primarily to techniques for lowering unemployment in the short-run. With respect to price developments, Mr. Ellis noted that in its response to question 3 the staff said that "Industrial commodities as a group rose only slightly further in November and early December, following the October advance." Alternatively, they might have written simply that industrial commodity prices as a group rose in October, November, and early December. The construction seemed to reflect a tendency to explain staff's away the rise.
Mr. Ellis had no disagreement with what was said in the staff comments on the balance of payments under question 4. However, he thought a distinction should be made between availability and cost, and he noted that while the Committee had made some move on the cost side it could not, in his opinion, escape responsibility on the availability side for the large volume of ban. lending to foreigners. Banks had been able to make foreign loans at the recent rate because the Committee had supplied the necessary reserves. On the money supply and liquidity question, Mr. Ellis noted that the second table in the green book offered the basis for an analysis on a three-month basis. It seemed to him that there had been some shift in the last seve:al months. In the three months ending with November, total bank loans and investments as well as business loans had increased at about a 9-1/2 per cent annual rate, in both cases not very different from the growth rate for the last 12 months. But banks seemed to be reaching out in other areas; the rise in holdings of "other" securities, for example, was 15 per cent in the three-month period, compared with less than 12 per cent in the last year. As long as the Committee had a policy setting an interest-rate target and of supplying reserves at the initiative of the market, banks would continue to reach out in this way, using
the reserves that would be supplied. Total reserves had increased at a 5.1 per cent rate in the last three months, and Mr. Ellis found it hard to accept that rate as a "moderate" one, especially when it was higher than the rate that had prevailed before August. Turning to the money mar:et and the directive, Mr. Ellis noted that Mr. Partee had urged the Committee to refer to neither interest rates nor reserves, but rather to desired market conditions, in setting its policy targets for the next four weeks. Mr. Ellis said he frankly was at a loss as to how "currently prevailing conditions in the mor.ey market" might be defined. The Manager had reported that the, substantial volume of securities purchased by the Desk immediately after the previous meeting had contributed to an improvement in the effect, without a reserve target the market atmosphere. In 10 basis points then, and later Committee had put bill rates down up again. The Manager also had told rates gradually had edged that New York banks were flush with the Committee this morning the Committee would be Were those the conditions reserves. suggesting in the directive should be maintained? with the problem Mr. Mills Mr. Ellis said he sympathized had been followed since the understanding the policy that had in the directive that the language of in light of preceding meeting
had been issued then. He noted that at th.t meeting the Committee had agreed to use an interest rate target and had agreed on a specific range for the bill rate, but then had decided not to say so in the directive. This morning it had been noted that alternatives A and B for the second paragraph contained the same two instructions, and differed only in the order of the clauses. He would suggest that the two goals given in both alternatives were not consistent. He agreed with Mr. Shepardson's suggestion that if alternative B was adopted the last clause should be omitted. But he urged the Committee to consider element 4 of the trial directive as a substitute for B; to his mind it was a clear statement of the Committee's intent at present. Mr. Swan referred to Mr. Ellis' renarks on the excess reserve situation at New York banks and said that he had understood from an earlier comment of Mr. Stone's that this situation had now changed. Mr. Stone said that Mr. Swan's understanding was correct. As of yesterday, the basic reserve position of New York banks was negative and they would be making large loans to dealers today, the tax date. The banks had worked themselves into a basic position of excess reserves to be able to meet expected demands, and those demands now were converging on them.
Mr. Balderston remarked that he was quite pleased with the list of questions the staff had prepared and with the replies they had submitted to the Committee in advance of this meeting. He would make two comments. With respect to question 4, regarding the balance of payments, he thought that the $7-1/2 billion trade surplus realized in the last few months had resulted in part from the threat of a longshoremen's strike, a threat that was not yet over. The Committee could not count on so large a trade surplus in the future; the surplus was more likely to be about $6 billion than $7-1/2 billion. Mr. Balderston's second comment related to question 1. In his opinion, the adverse effects of strikes and threatened strikes were particularly serious when they occurred in the steel industry; because of the importance of steel in the economy, effects ramified widely. Last week he had heard one analyst these from 1937 to date every steel strike or strike threat observe that had had adverse effects on the whole economy. own concern continued to center on Mr. Balderston's appeared to him to be sufficiently great at liquidity, which at home and to stimulate bank present to foster some excesses abroad. Noting that short- and long-term foreign loans lending billion this year, he observed that banks of banks would be $1-1/2 foreign borrowers less willingly if liquidity would accommodate
were reduced. He emphasized that it was not only large banks that were involved; some foreign borrowers were soliciting funds from banks of varying size throughout the country. Now that the System had accommodated seasonal needs this fall and faced a return flow of some S900 million in in January, Mr. Balderston thought it was especially reserves important to keep in mind Mr. Mills' admonition to the effect that it was overly easy for the Committee to conclude at meeting after meeting that the status quo was the best policy. His own feeling two weeks ago had been that the status quo was the best solution them, to permit the dust to settle after the official rate actions and other events. But the four-week period ahead was one in which strikes threatened and in which the foreign situation was likely to continue to be turbulent. He thought the time might have come for the Committee to tighten--gradually and carefully, but nevertheless to tighten. Mr. Balderston said he was unhappy with the proposals for the directive which, he noted, were in the usual form. He certainly subscribed to Mr. Shepardson's suggestion that the should be dropped, but even with last clause of alternative B to him; he could not nor B meant very much change neither A this to do. He would the Desk what they instructed visualize just directive, as from the trial use language taken prefer to
proposed by Mr. Ellis. On the assumption that the policy record entry for this meeting would reflect the substance of today's discussion of the staff's questions, he recommended a brief directive consisting of the following language drawn from the trial directive: In the light of the economic and financial developments reviewed at this meeting, it remains the current objective of the Federal Open Market Committee to accommodate moderate further growth in bank credit and the money supply. To implement this policy, and recognizing that international uncertainties and year-end seasonal pressures require a larger than usual degree of flexibility in operations, System open market operations over the next four weeks shall be conducted with a view to accommodating seasonal changes in reserve needs and to moderating any tendency for the 3-month Treasury bill to move below 3.75 or above 3.90 per cent. In concluding, Mr. Balderston said that he subscribed in general to Mr. Ellis' comments. He thought the new approach to the go-around that had been used today was an excellent one. Chairman Martin recalled that at the preceding meeting he had agreed with a view expressed by Mr. Balderston that the Committee should never be complacent. However, recently he had reviewed the Committee's minutes for the past year and he could not help but feel a sense of satisfaction with the course of monetary policy in 1964. Not all of the Committee's goals had been achieved and perhaps each member, if acting alone, would
have done things somewhat differently. Nevertheless, in his judgment the decisions of the Committee had been good, and he thought that the members could well be pleased with them. He also was happy that it was unnecessary to question the motives of any of the people who sat around the table. All were seeking the right answers to difficult problems. He thought these answers could not be put in precise terms; if the Committee tried to get too precise it might be asking for trouble. This last meeting of the year seemed to be an appropriate occasion to make these observations, the Chairman remarked. He did not mean to imply that the System was organized perfectly, but he did think that on the whole the Committee had done well this year. Chairman Martin did not agree with Mr. Mitchell's suggestion that the Committee had made a trade-off between domestic and international objectives. He thought that recently the two had come together in terms of the policy appropriate to them, as they did periodically. In the Chairman's opinion the next four weeks would cover a period for which it was extremely difficult to assess the likely course of developments in the economy. He thought the Committee should not now move toward either greater tightness or greater ease, but it should try to maintain essentially the
same posture for policy. Perhaps the Committee might decide at its next meeting to make some overt policy change but the present seemed to him to be a good time to pause. The Committee's consensus evidently was for no change in policy at this. time, the Chairman continued, although there might be dissents from such a decision. A rather wide variety of suggestions had been made for the directive. Personally, he found the staff's draft for the first paragraph acceptable, although some modification might be made in individual phrases; and he could accept either alternative for the second paragraph. At the same time, Mr. Balderston's suggestion for a directive had considerable appeal. Mr. Hickman commented that Mr. Balderston's proposal for the first paragraph amounted essentially to omitting the explanatory material from the staff's draft, and this struck him as a good idea, Mr. Shepardson said that he was completely in accord with the proposal for omitting this explanatory statement entirely. His earlier suggestions for revision had reflected a belief that if such a statement was to be included in the directive the language proposed by the staff should be modified. commented that Mr. Balderston's suggestion Mr. Mitchell paragraph would be particularly appropriate if the for the first
substance of today's go-around was integrated with the directive in the policy record entry for this meeting. For the second paragraph, however, he would prefer to use the complete text of element 4 of the trial directive, rather than to omit the last part. Specifically, he would replace the final period in Mr. Balderston's proposed text with a semi-colon, and add this language: provided that the bill rate shall be permitted to move below or above this range to moderate any persistent tendency for bank credit to contract more than seasonally, or to moderate any sharp acceleration in short-term capital outflows in response to widening international interest rate differentials. Mr. Wayne said he had no objection to Mr. Balderston's proposed first paragraph. However, he would object to the proposed second paragraph, because it included a statement of a range for the bill rate. It seemed to him that the last meeting of the year was the worst possible time to begin using quantified instructions in the directive. Moreover, at the preceding meeting there had been fairly general agreement that the Committee should not quantify its instructions until it had discussed the question of quantification on its merits. suggested that it might be possible to make the Mr. Ellis more specific and still avoid explicit quantification instruction in the range prevailing during the past by calling for bill rates
few weeks. Mr. Wayne commented that he would prefer to have any references to the bill rate confined to the text of the policy record entry for this meeting, and not included in the directive itself. Mr. Shuford remarked that Mr. Wayne's position seemed to him to be consistent with the Committee's conclusion at the previous meeting. Mr. Robertson proposed that the first paragraph of the directive consist of the opening sentence of element 3 of the trial directive, and that the second paragraph consist of alternative B with the last clause omitted. Several members concurred in this proposal. the course of further discussion it was suggested In the first paragraph should be based on certain language that taken from element 3 of the trial directive and from the staff's draft for the regular directive. Thereupon, upon motion duly made and seconded, the Federal Reserve Bank of New York was authorized and directed, until otherwise directed by the Committee, to execute transactions in the System Account in accordance with the following current economic policy directive: In light of the economic and financial developments reviewed at this meeting, it remains the Federal Open Committee's current policy to facilitate Market of the economy by accommodating continued expansion moderate growth in the reserve base, bank credit, and
the money supply, while seeking to avoid the emergence of inflationary pressures and to strengthen the international position of the dollar. To implement this policy, and recognizing that international uncertainties and year-end seasonal pressures continue to require a larger than usual degree of flexibility in operations, System open market operations shall be conducted with a view to about the same conditions in the money maintaining market as currently prevail. Votes for this action: Messrs. Martin, Balderston, Hickman, Mitchell, Robertson, Shepardson, Shuford, Swan, Wayne, and Treiber. Vote against this action: Mr. Mills. Mr. ills said that he dissented from this action for reasons given in the statement he had made earlier in the meeting. Chairman Martin then called for an expression of views on Mr. Clay's suggestion that the question.; and responses prepared by the staff for today's meeting be incorporated in the minutes. There was general agreement with this suggestion. It also was agreed that the substance of these staff materials, and of the members' views on them as expressed in the go-around, should be included in the policy record entry. In this connection, Mr. Mitchell said it would be helpful if a draft entry was available in advance of the next meeting. Mr. Young observed that the entry for today's meeting would be more difficult to draft than usually was the case but that the staff would endeavor to comply with Mr. Mitchell's suggestion.
It was agreed that the next meeting of the Committee would be held on Tuesday, January 12, 1965, at 9:30 a.m. The Chairman proposed that Committee members plan to devote the afternoon of that day, after adjournment of the meeting, to a general discussion of the desirability of quantification in the Committee's directives. No objections were made to this proposal. Thereupon the meeting adjourned. Secretary
Attachment A CONFIDENTIAL (FR) December 14, 1964 Draft language for current economic policy directive for consideration by the Federal Open Market Committee at its meeting on December 15, 1966. First Paragraph It is the Federal Open Market Committee's current policy to facilitate continued expansion of the economy by accommodating moderate growth in the reserve base, bank credit, and the money supply, while seeking to avoid the emergence of inflationary pressures and to strengthen the international position of the dollar. This policy takes into account the effects on the dollar of market uncertainties about the pound sterling and the persistence of sizable deficit in the U.S. balance of payments: the continued domestic expansion, currently receiving additional stimulus from recent and threatened work stoppages; the persistent margin of underutilized manpower; the upward drift of selected industrial commodities; and the continued prices for expansion of bank credit and money. Second Paragraph Alternative A To implement this policy, and recognizing that international uncertainties and year-end seasonal pressures continue to require a larger than usual degree of flexibility in operations, System open market operations shall be conducted with a view to accommodating expansion in aggregate bank reserves, while maintaining moderate conditions in the money market as currently prevail. about the same
Alternative B To implement this policy, and recognizing that international uncertainties and year-end seasonal pressures continue to require a larger than usual degree of flexibility in operations, System open market operations shall be conducted with a view to maintaining about the same conditions in the money market as currently prevail, while accommodating moderate expansion in aggregate bank reserves.
Also: Record of Policy Actions