February 8, 1966 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, D. C., on Tuesday, February 8, 1966, at 9:30 a.m.1/ PRESENT: Mr. Martin, Chairman Mr. Hayes, Vice Chairman Mr. Balderston Mr. Daane Mr. Ellis Mr. Galusha Mr. Maisel Mr. Mitchell Mr. Patterson Mr. Robertson Mr. Scanlon Mr. Shepardson Messrs. Bopp, Hickman, Clay, and Irons, Alternate Members of the Federal Open Market Committee Messrs. Wayne, Francis, and Swan, Presidents of the Federal Reserve Banks of Richmond, St. Louis, and San Francisco, respectively Mr. Young, Secretary Mr. Kenyon, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Hackley, General Counsel Messrs. Baughman, Holland, Koch, Taylor, and Willis, Associate Economists Mr. Holmes, Manager, System Open Market Account Mr. Solomon, Adviser to the Board of Governors Mr. Molony, Assistant to the Board of Governors Mr. Hersey, Adviser, Division of International Finance, Board of Governors Mr. Axilrod, Associate Adviser, Division of Research and Statistics, Board of Governors Miss Eaton, General Assistant, Office of the Secretary, Board of Governors originally planned for February 1, 1966, had been 1/ This meeting, postponed one week because of adverse weather conditions affecting travel.
Messrs. Link, Eastburn, Mann, Ratchford, Jones, Tow, Green, and Craven, Vice Presidents of the Federal Reserve Banks of New York, Philadelphia, Cleveland, Richmond, St. Louis, Kansas City, Dallas, and San Francisco, respectively Mr. MacLaury, Assistant Vice President, Federal Reserve Bank of New York Mr. Meek, Manager, Securities Department, Federal Reserve Bank of New York Mr. Kareken, Consultant, Federal Reserve Bank of Minneapolis Upon motion duly made and seconded, and by unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on January 11, 1966, were approved. Before this meeting there had been distributed to the members of the Committee a report from the Special Manager of the System Account on foreign exchange market conditions and on Open Market Market Account and Treasury operations in foreign currencies Open for the period January 11 through 26, 1966, and a supplemental through February 4, 1966. Copies of these report for January 27 placed in the files of the Committee. reports have been supplementing the written reports, Mr. MacLaury In comments stock would remain unchanged this said that the Treasury gold Fund made gold sales During January, the Stabilization week. which were more than offset by a amounting to $37 million, from the Bank of Canada, leaving purchase of $50 million in gold of $79 million. During February, an order a month-end balance
of at least $34 million from the Bank of France was expected. On the other hand, a second $50 million of gold had been acquired from Canada last week so that, on present prospects, there should not be any decline in the stock this month. Looking farther ahead, however, Mr. MacLaury continued, one could not ignore the implications for the United States gold stock of the situation in the London gold market. During 1965 a record volume of private demand for gold absorbed virtually the entire new supply coming from South African and other mines and from Russian sources, with the result that the Gold Pool ended the year with virtually no net accumulation of gold. As demand continued to run ahead of supply, the $40 million reserve in the Gold Pool at the beginning of 1966 had been exhausted and it again became necessary to reactivate the gold sale consortium. Since then the Pool had lost another $19 million net. There still was reason to believe that Russia would need to sell another $200 million or so of gold between now and April, which might provide some further breathing space. Over the longer pull, though, international political and financial tensions moderated unless the spring and summer months, there could be considerably during fairly heavy pressure upon the Gold Pool arrangements. On the exchange markets, Mr. MacLaury said, sterling had continued to show strength. From September through January, the
swing in the Bank of England's exchange position had amounted to more than $2 billion. Of that amount, $420 million had been reflected in reserve increases, $700 million in net repayments of central bank debt, and roughly $1 billion in liquidation of forward contracts. During January, the Bank of England made repayments of central bank debt totaling $325 million--$275 to the Federal Reserve and $50 million to the Bank for International Settlements--and it had about $300 million of forward contracts reaching maturity during the month. However, the gross dollar the month was very substantial, amounting to inflow during $535 million. That still left, at month-end, a net roughly drain of roughly $90 million on British reserves. MacLaury reported that there was general agreement Mr. the British and American officials involved that among most of a serious risk of damaging the recovery the British would run if they were to show a sizable reserve of confidence in sterling January. To avert that risk, several courses of decline for of England might have made a were open. First, the Bank action but that course was opposed both new drawing on the swap line; the System, on the grounds that by the Bank of England and by procedure of employing a new it would represent a leapfrogging drawing. Second, the British drawing to pay off an earlier on its portfolio of United States Government might have drawn
securities, but that alternative was flatly rejected by Chancellor Callaghan. Third, the British Government might have drawn on its $250 million line of credit with the Export-Import Bank, but that course was opposed for U.S. balance of payments reasons by the U.S. Treasury. There remained the fourth alternative of employing the joint Treasury-Federal Reserve authorization granted last September of $400 million for exchange operations to support the recovery of sterling. As it turned out, the $90 million needed to prevent a British reserve decline was provided from this source on a one-day swap over the month-end, divided equally between the Treasury and the Federal Reserve. In February, Mr. MacLaury continued, the Bank of England again started off the month with outpayments of $290 million, of which $200 million reflected repayment of the remaining debt under the $750 million swap line with the System and $90 million the one-day swap with the Treasury and Federal Reserve. repayment of of forward contracts would come due In addition, a sizable volume past February generally had been a seasonally in February. In the might well take in and the Bank of England favorable month to avoid any net reserve funds before the month-end sufficient already had taken in not quite loss. In the first few days they $100 million. If, however, a short-fall should materialize, of England and the Bank had been made with the Bank arrangements
of Italy for a triangular operation, having the dual objectives of strengthening the British reserve position and enabling the Federal Reserve to liquidate the bulk of its swap drawings on the Bank of Italy. As part of the credit package put together last September, the Bank of Italy committed itself to provide support for sterling, if needed, up to the amount of $70 million. If circumstances required, the Bank of England would draw $70 million of lire from the Bank of Italy at the end of February and sell the lire to the Federal Reserve against dollars, British reserve position by $70 million thereby strengthening the to pay off that amount of its and enabling the Federal Reserve debt to the Bank of Italy. lira the last meeting, Mr. MacLaury During the four weeks since continued to show strength against nearly observed, the dollar had Although the unwinding of year all of the continental currencies. undoubtedly had contributed to that strength, the end positions technical factors. In part, he improvement went beyond such the dollar was benefiting from the continued reversal thought, In addition, he could not help but of short sterling positions. of the improvement in the effects were being seen believe that The voluntary foreign balance of payments situation. the U.S. respect to corporations seemed to credit restraint program with of rates in both the exchange be biting harder, and the movement
markets and the Euro-dollar market indicated that there was, if not a growing scarcity of dollars, at least a cessation of excessive dollar availabilities. Even in the case of Italy, the huge dollar inflows of previous months had ended; in fact, there had been a slight net decline in dollar holdings in the first three weeks of January. And, in the case of France, the rate had been off the ceiling now for more than a month. Likewise, with the Belgian franc under some pressure, the System was able to buy from the Belgian National Bank sufficient francs to pay off the remaining $35 million equivalent debt under its standby facility with that bank. In addition, the Account Management was in the New York market more or less continuously during the period, buying marks for Treasury account to build up the balances that were used on February 1 to repay a $50 million equivalent mark-denominated bond maturing on that date. recall, Mr. MacLaury said, at a As the Committee would Mr. Hayes had mentioned that discussions were recent meeting bankers at the Bank for International taking place among central a way of dealing with the in an effort to find Settlements of sterling balances. A to sterling of possible drains threat up, based on the roughly of credits was now shaping package made available to the Bank of England $1 billion of credits participated to the The United States had last September.
extent of $400 million--$200 million each for System and Treasuryunder an authorization to purchase sterling on a covered or guaranteed basis. The other participants in the arrangement set a time limit of six months on the facilities that they provided. Present indications were that they would agree to extend their credit arrangements for a one-year period from March 15, the current expiration date, channeling any assistance that might in fact be required through the BIS on the basis of sterling swaps. U.S. participation would continue as at present, on a bilateral basis with the Bank of England. In response to questions, Mr. MacLaury said that about $2 billion of gold had come onto the London market in 1965--$1.2 billion from new production, $375 million from Russian sales, million from other sources. The off-take also was and about $500 about $2 billion, absorbing virtually the entire supply. Of the latter amount, mainland China had accounted for a relatively small part of the total--somewhat over $100 million. Final figures were not yet available on the change during 1965 in the volume of gold reserves by non-Communist countries, but he held in official increase. South Africa had thought it would show a small contributed between $200 and $300 million of gold to the market in the first half of 1965, but in September that country began to holdings, and thus far had withheld about $125 rebuild its own
million of new production from the market. With respect to Canada, there was some possibility of additional sales of gold by that country to the U.S. Thereupon, upon motion duly made and seconded, and by unanimous vote, the System open market transactions in foreign currencies during the period January 11 through February 7, 1966, were approved, ratified, and confirmed. Mr. MacLaury then reported that a System drawing on the swap arrangement with the Bank of Italy, in the amount of $100 million equivalent, would mature on February 28, and he requested the Committee's approval to renew the drawing a second time, if that should prove necessary. As he had indicated earlier, there was a possibility that transactions between the British and the Italians might permit reduction, if not full repayment, of the in the near future. drawing that he hoped the System would Mr. Shepardson remarked possible, and Mr. MacLaury replied repay the drawing as soon as of the Account Management. that that was the intention Possible renewal of the $100 million drawing on the Bank of noted without objection. Italy was to comment on devel invited Mr. Daane Chairman Martin Deputies of the Group of the recent meeting of the opments at Ten.
Mr. Daane said that the Deputies had met in Paris on January 31, February 1, and part of February 2. As he had indicated to the Committee earlier, the discussions at the previous meetings--in November and December--had involved rather frank and exploratory exchanges of views. At this meeting a long step had been taken toward the negotiating phase. The meeting consisted mainly of a searching question-and-answer review of four papers that had been put forward, including one containing a U.S. proposal. He would outline the U.S. proposal first, Mr. Daane observed, although it was not in fact the first advanced at the meeting. Under Secretary of Treasury Deming had made clear that the proposal was a serious one, arrived at carefully by the U.S. Government. It had been reviewed thoroughly at a series of meet ings--nine or ten in number--of the so-called Dillon Advisory Committee to the Treasury; and it had been given painstaking consideration by representatives of the Government agencies concerned, including the Federal Reserve. Also, it had been discussed with interested members of Congress and reviewed by the President. In essence, Mr. Daane said, the proposal called for a dual approach, with the first part involving the creation of special drawing rights for all member countries of the
International Monetary Fund, both Group of Ten countries and others. Those rights would be distinct from all existing drawing rights in the Fund. In operation they would resemble the drawing rights under the present gold tranches; unlike the latter, however, there would be no input of gold in connection with them. The other part of the dual approach would involve the creation of a new reserve unit, Mr. Daane continued. The new unit would constitute a claim on a pool of currencies paid in by a group of advanced countries. The U.S. had not taken a hard and fast position on the question of the exact composition of that group, but had suggested that a small number of countries in addition to the members of the Group of Ten might be brought in. The new units would be allocated on the basis of IMF quotas, and would carry a gold-value guarantee. Among a number of technical provisions, there would be one establishing limits on holdings by creditor countries, of perhaps 2 or 3 times the amount of units allocated to the country. Another provision U.S.--or any country that made its was intended to enable the into gold--to avoid excessive accumulation currency convertible countries against its units by selling them to other of the new the U.S. proposal called for a "set own currency. In addition, by the limited group for the aside" of new units or currencies of the rest of the world. benefit
Some figures had been advanced in connection with the U.S. proposal for the sake of illustration, Mr. Daane said. Thus, it was noted that total world reserves, consisting principally of gold and reserve currencies, were about $70 billion at present. If one reasoned that reserves should be increased at a 3 per cent annual rate, slightly over $2 billion of new reserves would be needed each year. Allowing for additions to the monetary gold stock at the recent average rate of $500-$600 million a year, it would be necessary to create about $1-1/2 billion in new reserves each year. It was suggested that that amount be divided equally between new drawing rights and new reserve units, each of which would then amount to $750 million per year. Similarly, if one started with a 4 per cent rate of reserve growth, about $1 billion each would be created annually in the form of drawing rights and new units. The first paper actually discussed at the meeting, Mr. Daane continued, was put forth by the Canadians, who made that it was not an official proposal but simply a collection clear those of the Finance Ministry. The Canadian of views--largely on the construction of a new unit, some proposal concentrated in the U.S. proposal but what similar to the one contemplated interesting differences. Of these, the most important with a few new unit to carry a rather high rate of was the provision for the
interest, set one or two percentage points below the U.S. Treasury bill rate. The U.S. proposal had not involved an interest return, although the U.S. delegation had indicated that its position on that question was neutral. The Canadians stressed the desirability of an interest return in order to make the new unit more acceptable. As to the make-up of the group of participating countries, the Canadians, like the U.S. representatives, were searching for some criteria for qualifi cation, and were thinking in terms of about 15 or 16 countries. The third paper, Mr. Daane said, was an official proposal put forward by the British. Again, there were a number of points of similarity with the U.S., as well as the Canadian, proposals, and some points of difference. One distinctive feature was a requirement that any holdings of unit in excess of the holding limit would be converted the new variant reflected the directly into gold. Another interesting the problem of conversion of sterling British concern with had alluded, and of dollar to which Mr. MacLaury balances, units be available not They proposed that the new balances. also to provide an alternative reserve assets but only to increase convert reserve currency holdings. for countries wanting to asset proposal, Mr. Daane noted, was advanced by The fourth the Group of Ten Deputies, who Mr. Emminger, the Chairman of
said that it represented his own views. It was concurred in by a number of delegations, however, and could be considered to represent a synthesis of the views of the continental Europeans excluding the French--and, it was learned later, the Belgians. The Emminger proposal called for a new reserve unit whose initial creation would require a unanimous vote, with subsequent decisions made by majority vote. The unit would be used by and allocated to only a limited group of countries, and it would be used in transfers in a one-to-one ratio with gold. The needs of countries outside the group would be met by providing for set-asides of the new unit. Mr. Daane remarked that the French made no new proposals at the meeting. They noted that they had had a proposal on the table for a year and a half, and that there was no change in their position. In sum, Mr. Daane said, the meeting pointed up both the areas of agreement and the areas of division. As to the former, provided for reserve units to be created all of the proposals responsibility of a limited group of countries. All under the were reasonably close with respect to the membership of the and all implied a search for that would receive the units, group qualifying criteria that pointed to inclusion of roughly some 16 countries. There was a fair consensus that the amounts 15 or
of the new reserve asset created should be established in terms of a growth trend, rather than decided ad hoc each year; and that the purpose was to provide for global needs rather than just those of a particular group of countries. As to the differences, Mr. Daane continued, the major one was in the attitude taken to the dual approach recommended by the U.S. The U.S. proposal was labeled by some as "quadri lateral" because it provided for drawing rights both for the group and for other countries, for distribution of the new units to the group, and for a set-aside of the units for other countries. There was much sentiment for a simpler procedure, perhaps involving a set-aside of the new units to finance drawings by the countries outside the group, and only units for the group. Mr. Daane said, related to the Other major differences, the U.S. had suggested as a means of safe holding limit that and to the gold link which the guarding against abuses, would involve. Speaking for the U.S., he Emminger proposal a number of questions regarding the gold (Mr. Daane) had raised was whether that link was intended link. His basic question on the actions of deficit to provide further discipline simply a gold link would not The second was whether such countries. of gold--both by the induce much larger holdings in effect
countries within the group, particularly those with low gold ratios at present, and by countries outside the group. Dr. Emminger answered those questions quite vigorously and effec tively. He argued, in effect, that if the new unit had a gold link and also carried an interest return, one could expect that the unit would become more desirable than gold, and that its creation therefore would be constructive rather than disruptive. Mr. Daane added that Mr. Polak spoke on behalf of the Managing Director of the IMF, mainly on two points. First, he noted that the Director was anxious that there be recognition of the reserve needs of countries beyond a limited group, a which the U.S. had been fully sympathetic all along. view to Secondly, it was the Director's view that the decision-making process should be broadened to involve more countries. Near of the meeting one of the German representatives had the close and thoughtful statement. He noted that made a provocative with the momentous decision to create the group was faced of whether it would not be money, and raised the question way--which Mr. Daane inter better to do so in the traditional preted to mean within the framework of the IMF. That position, on the fear that the other route Mr. Daane thought, was premised excessive world liquidity. would lead to
Mr. Daane concluded by noting that there would be another meeting on March 7 and 8, in which, he presumed, the group would move a little closer to negotiations. That would be followed by a longer meeting in Washington during the third week of April. He was happy to note that the U.S. delegation now included Mr. Robert Solomon of the Board's staff, in addition to the customary participants--Under Secretary of the Treasury Deming, Messrs. Willis and McGrew of the Treasury, and himself. In answer to Mr. Ellis' question as to how it was proposed to execute the provision for an interest return on the new unit, Mr. Daane said the group had not got down to the point of working out all of the mechanics on that question. would pay the interest on any credit In general, the debtor is, on assets used. That, of course, could be received--that done on either a gross or net basis. that recent news stories had Mr. Galusha commented had made far greater progress in suggested that the Deputies anticipated, and that the their discussions than had been possible. He asked whether to the problem now appeared solution that was Mr. Daane's impression. he thought such an appraisal Mr. Daane replied that measured in terms of the if the progress was was correct out areas of Deputies, to search given to the original charge
agreement. There had been forward movement at each of three recent meetings and, as he had indicated, there was clear progress toward agreement in several important areas. There also, however, were some important disagreements. In the words of one participant, used in a personal conversation at the end of the meeting, there had been both progress and retrogression. Mr. Hayes said he agreed with Mr. Daane's appraisal. It should be borne in mind, he thought, that some of the the positions of the U.S. and some other differences between were exceedingly important to the U.S. In his countries better to make progress slowly toward personal view, it was far right decision rather than to accelerate the proceedings the the sake of reaching some agreement. for indicated that he shared Mr. Hayes' view. Mr. Daane there had been distributed to the Before this meeting a report from the Manager of the members of the Committee open market operations in System Open Market Account covering bankers' acceptances for the U.S. Government securities and and a supplemental report January 11 through 26, 1966, period February 7, 1966. Copies of both for January 27 through been placed in the files of the Committee. reports have of the written reports, Mr. Holmes In supplementation commented as follows:
The Treasury refunding of outstanding February maturities, in which owners of April, May, and August maturities were given a chance to prerefund their holdings, was the dominant feature of the period since the last meeting of the Committee. The Treasury's decision to make this more than a routine operation and to offer a 5 per cent note was a bold move, designed to ease the problems of debt management later in the year. And despite some uneasy moments while the books were open, the decision turned out to be a wise one. While attrition in the February and April issues was somewhat greater than expected, public subscription of $6.5 billion to the 5 per cent notes was substantially greater than the market anticipated at the time the books closed and has reduced the May and August refunding operations to routine proportions. The Treasury announcement was initially very well received in the market, but the opening of the books on Monday, January 31, coincided with the resumption of bombing in North Vietnam and with accelerated discussion of the likelihood that monetary policy was apt to play the leading role in any effort to restrain inflationary pressures in the months ahead. In this atmosphere prices of some long-term Government bonds declined by as much as a full point during the three-day period while the books were open, and prices of rights and when-issued securities also declined, with the when-issued 5s closing the period at par bid compared with a premium of 7/64 immediately the Treasury announcement, Dealer support of following was minimal--with net positions in both the refunding $300 million--and with short positions new issues only intermediate issues rising significantly in outstanding pessimism was not shared by during the financing. Dealer for exchange, however, as holders of the issues eligible indicated. The notes appear to be in firm the results or no speculative activity and, as hands with little are no large dealer inventories overhanging noted, there prices of the new Since the books closed the market. yesterday when the 5s moved up somewhat until issues closed at par bid. last met, the period since the Committee During the in the Federal funds least as reflected money market--at at the Reserve banks--has and member bank borrowing rate comfortable, as the extreme generally been relatively eased. A small net money center banks finally pressure on
borrowed reserve figure has been maintained as System open market operations were generally directed towards maintaining an even keel surrounding the Treasury financing. A sizable proportion of the reserves provided involved repurchase agreements against rights. In contrast to the preceding period, there has been a general tendency since the last meeting of the Committee--at least until the past week--for reserve availability to exceed projections, as float stayed higher than anticipated and required reserves declined more than seasonally. Despite the absence of extreme pressures on the banking system, short-term interest rates moved irregularly higher over the period, with the three-month bill rate hitting an all-time high of 4,67 per cent in the auction on January 17, and with rates on three-month acceptances raised by dealers to 5 per cent bid on February 1. In yesterday's auction the 3- and 6-month bills were sold at average rates of about 4.65 and 4.77 per cent, respectively. Rates on long-term securities, which had been relatively stable since their initial adjustment to the discount rate change, rose by about 10-15 basis points. While the market does not seem to have been at all impressed, the investor response to the Treasury refunding may hold some interesting implications about the attrac tiveness to investors of the historically high yield intermediate- and long-term Government bonds. levels of At the same time, at least some of the larger banks, many of which have been heavily dependent on borrowed funds, are taking a hard look at their lending policies. To the extent that this process results in greater reluctance to meet loan demands, some of the pressure may be removed from the Federal funds and CD markets. But it is not so what pressures would be shifted to other markets clear and others seek to meet their growing as corporations credit needs elsewhere. In the meantime, the markets continue to be extremely sensitive to developments in Viet Nam, to price movements, and to demand pressures, both financial and real. Amidst all, there appears to be a growing feeling that monetary it policy will be forced to play the leading role in any anti-inflationary campaign. Some further tightening of monetary policy may well have already been discounted by the market and an unexpected settlement in Viet Nam could have a major impact on expectations. But the dominant mood continues to be one of anticipation of growing pressure on financial markets as the year progresses. At the moment the pressure appears to be focusing in the longer end of the market.
Mr. Swan referred to Mr. Holmes' observations that dealer participation in the refunding had been minimal and that the new securities appeared to be in firm hands. He asked what implications those facts had for the period over which an even keel policy would be required. Mr. Holmes replied that he thought an even keel clearly should be maintained until the payment date for the refunding, February 15. While it was somewhat difficult to understand yesterday's decline in price of the new securities, dealers had been seeing a continuing moderate demand for those securities. On the whole, he saw no particular problems ahead in connection with the refunding, and he did not expect the process of distribution to be lengthy. Mr. Daane asked what consequences for interest rates Mr. if net borrowed reserve figures were deepened Holmes would envisage levels. Was the rate impact likely to be minor from their recent reported, the market may already have since, as Mr. Holmes had further tightening of monetary policy? discounted some that, other things equal, a higher Mr. Holmes remarked already discounted by reserves probably was level of net borrowed by the "other was a great deal encompassed market. While there the that somewhat deeper net qualification, he doubted things equal" higher, particularly if would act to push rates borrowed reserves other upward pressures on rates diminished. some of the
Mr. Hickman asked whether the identity of the sellers accounting for yesterday's decline in the price of the new securities was known. Mr. Holmes replied that there were some indications of sales by investors, but the decline appeared to be mainly due to professional activity, reflecting the reluctance of dealers to take a long position in the securities. upon motion duly made Thereupon, and seconded, and by unanimous vote, the open market transactions in Government securities and bankers' acceptances during the period January 11 through February 7, 1966 were approved, ratified, and confirmed. Secretary's note: On February 1, 1966, the following message had been transmitted by Mr. Young to members of the Committee, by telegram to those outside of Washington: message has been received from System The following Account Manager: Treasury offering, System Account "Referring to current holds $2,232,950,000 of notes maturing February 15, 1966, Account management proposes about 47% of total outstanding. its entire holdings through subscrip that Account exchange 55%) of the 4-7/8% notes tion for $1,232,950,000 (about maturing August 15, 1967 and $1 billion (about 45%) into November 15, 1970. Principal reasons the 5% notes maturing of excessively heavy System for the proposal are avoidance Treasury issue, ample holdings holdings of any single and the relatively short maturing in one and two years, maturity of the 5% notes offered by the Treasury. "1. Assuming the public subscribes to $1,200 million 4-7/8% notes, if the System's entire holdings were exchanged into the 4-7/8% notes, it would represent 65% of the entire issue; under the proposed plan it will be 50% of the entire issue.
"2. Although it is difficult to assess at this moment how many fives there will be subscribed by the public (including prerefunding of May and August maturities) it appears unlikely that System holdings of the 5% notes would be excessive relative to public holdings. "3. After the exchange, 55% of the total System Account would mature in one year and 84% in two years." Please wire whether you would approve the Manager's proposal. Advices subsequently were received from all available members of the Committee indicating that they approved the Manager's proposal. Chairman Martin called at this point for the staff economic and financial reports, supplementing the written reports that had been distributed prior to the meeting, copies of which have been placed in the files of the Committee. Mr. Holland made the following statement on economic conditions: I would like to focus my comments on price pressures this morning, for it seems likely to me that the next round of critical choices for stabilization policy, monetary and otherwise, will turn largely on the current and prospective performance of prices. The over-all performance of our economy this past brought us very close to several of our year has domestic economic goals. Our level of output is high, and demand is broadly based and growing rapidly. Rates of resource utilization are correspondingly high, with at better than 91 per cent manufacturing output running of rated capacity and unemployment in January finally the 4 per cent milestone. But, partly for these down to our price performance this past year has very reasons, been less good than earlier. To be explicit, the index prices of industrial commodities has been of wholesale
rising at around a 1-1/2 per cent annual rate throughout this past year and a quarter, after virtually no net change (+.3 per cent) earlier in this expansion. From this point forward--absent an unlikely outbreak of peace in Viet Nam--the outlook seems to me to be for a further gradual step-up in the rate of price advance. This, in a nutshell, implies significantly more price rise this year than last, and more than has been projected by the Council of Economic Advisers and various other Administration officials. Let me tick off briefly the reasons for this con clusion. The chief cause of this difference from the Council outlook is not hard to find: we project more demand than they do. Our latest green book 1/ projections through the first quarter of 1966 unfold along a track that runs roughly $5 billion higher than the Council's projection. Besides some variation in the timing of the build-up of Federal outlays, the biggest differences lie in our stronger figures for plant and equipment expenditures and inventory additions. Even these may strike us as too low, once the full implications of the sharp upward tilt of November-December inventory statistics are taken into account. It may be that businesses are already acting in recognition of some of the market implications of these stronger demands. The surprisingly strong fourth-quarter inventory accumulation probably includes some buying to guard against longer delivery times, and also some stocking in anticipation of price advances. By January, the monthly purchasing agents' survey showed that more than three-fifths of the reporting firms were paying higher prices than a month earlier, a sharp rise from the two-fifths figure reported in December and the highest proportion in seven years. 1/ The report, "Current Economic and Financial Conditions," prepared for the Committee by the Board's staff.
Nonetheless, while price increases seem to be having a more pervasive effect, they are not yet omnipresent and the bulk of them still are not very large. This explains why the average price index for industrial commodities has not shown much acceleration to date. While a strong upward thrust has appeared in the latest over-all price indexes, it has stemmed chiefly from the further sharp rise in agricultural prices. These price increases did not attach to farm products that serve as industrial raw materials; rather, they have been confined mainly to food stuffs, chiefly meat. Such price increases are not much of a direct addition to business costs outside the food processing industry. The consequent increases of retail food prices, however, are obvious to the average wage earner, and will undoubtedly stiffen demands in this year's labor negotiations. It is true that relatively few major labor contracts are up for negotiation until after midyear, and by then food costs may well be showing some declines. Nonetheless, in the interim, a great many less noticeable wage bargains inside and outside the unionized area are likely to be influenced both by limited manpower supplies and by the higher cost of living. Business production costs are also likely to be enlarged somewhat by nonwage increases in labor cost. Elasticity of the labor supply surprised many observers last year, but growth in the labor force was mainly among inexperienced youths and women. Skilled adult male labor is scarce. Recent trends suggest employers are hiring more inexperienced workers and perhaps are beginning some hoarding of labor. This will help make a dent in the of the remaining unemployment problems--the toughest inexperienced youngsters, the disadvantaged, the minority groups--but there will probably be a price to pay over the short run in the form of slower productivity gains and higher training costs. The combination of these influences, plus the higher Social Security taxes on employers, can easily push unit labor costs in manufacturing above for most of this expansion, and the plateau maintained of cost-push to the demand-pull likely add a small measure be at work on prices as the year progresses. to do we have that the resultant price What assurance action will not develop rapidly into an old-fashioned outbreak? It is true that many individuals inflationary and businesses command the financial resources to finance a sudden price-boosting surge of spending if military or
other developments were to deliver the necessary shock to expectations. But this prospect appears less likely to me than a fairly gradual demand-pull, cost-push, price advance. The major moderating influences are persisting forces often cited to this Committee: the rapid rate of expansion of plant capacity, the trend toward longer-run pricing policies on the part of business, still strong domestic interproduct competition, and vigorous competition for certain products supplied by foreign producers. (This latter is a mixed blessing, of course, as Mr. Hersey's report on recent import trends will show.) Reinforcing these factors will be the weight of the Administration "guideposts" and the President's own potent persuasion in headline cases of threatened price advances. But, in my judgment, all these influences will not suffice to prevent the projected growth of public and private demands from provoking some increase in the rate of price rise, unless buttressed before long by a somewhat greater degree of fiscal and monetary restraint than has been observable up to now. Comments on how much further financial restraint may already be in train, and considera tions as to the desirable composition and timing of any changes in the fiscal-monetary mix, I shall leave to my colleague, Mr. Koch, to illumine. Mr. Koch made the following statement concerning financial developments: With the most appropriate posture for monetary policy over the next couple of weeks likely to be of an even keel nature, at least until the payment date of the current Treasury refunding, and with recent developments adequately covered by the staff written materials and by Mr. Holmes' remarks, I should like to spend my few minutes this morning talking mainly about some of the more basic, longer-run, financial developments that are facing us. domestic There was considerable discussion at our last meeting as to whether quantities of credit or liquid assets, or should be our main target over the coming interest rates, think it is a question of "either-or." months. I don't We have to keep both types of factors uppermost in our minds, continually watching their effects on each other, their effects on spending and investing, and the changing interactions among the real and financial variables.
Unfortunately, with our present state of knowledge, we do not know enough about the strength and the timing of financial restraint to be sure about either the volume of credit flows or the level of interest rates that would be consistent with a sustainable rate of growth of GNP given our current state of resource use. Historical evidence does suggest, however, that under conditions of high resource use and expanding demands the pace of total credit growth can be large, and some increases in interest rates can occur, and still be consistent with sustainable economic growth without inflation. The job of monetary policy is to determine the increases in both financial variables that would be consistent with such a happy state of affairs. There is evidence that the monetary restraint we have been seeking is having some effects. Both statistics and opinions obtained from the larger banks suggest that they are firming up their lending and investing practices. The weekly reporting banks have reduced their holdings of municipal and agency securities on balance in recent weeks and have made quite prompt redistribution of the new Treasury issues they acquired originally for tax and loan credit. Credit expansion at the nonweekly reporting banks, however, seems to have continued strong throughout January. Also, in the last two months longer-term interest even mortgage rates, have risen rather sharply rates, for such a short period of time. Some feel that this is the main avenue through which monetary policy affects the real economy. The impact of this recent rise in interest rates on housing starts and other longer-term investment may not be visible for some months. types of restraint is beginning to But even if monetary there are reasons for expecting a fairly rapid bite, to continue in the coming months. total credit expansion in the business area. After economic One reason lies years, as this one have gone on for several expansions tends to grow sharply and has, business investment internal funds to level off. As a result, available demands jump. Last year, for external financing financing increased 50 per example, business external in internal funds 1964. With the growth cent over
likely to be slow this year, a further large increase in external financing will be required to finance a desired volume of investment. The Federal Government will also add to, rather than subtract from, total credit demands in the coming months despite the apparently rosy look of the 1967 administrative and cash budgets. To assess the indirect as well as direct impacts of the Federal budget on financial markets, one has to translate the figures on spending and receipts in terms of their likely effects on the volume of the Federal debt held by the public and then to add such important influences as the projected speed-up of corporate taxes and the increased sale of financial assets. When one does this, the over-all demands on the financial markets stemming from Federal fiscal developments are likely to be considerably larger this year than in 1965, although it is very difficult to pinpoint the exact timing of the asset transactions. This conclusion is based on the volume of Federal spending projected in the Budget Document which, unless developments in Viet Nam improve greatly soon, will no doubt prove understated. Nondefense spending also may be underestimated. Thus, if the projections of GNP that are currently prevalent prove to be true, in formulating monetary policy in the months ahead we will have to expect, and I feel should consider appropriate, further fairly rapid growth in the rate of over-all credit expansion as well as some additional increase in interest rates. Credit markets are in a sensitive state these days and recent events, the resumption of bombing in Viet Nam and the such as resultant increased talk of the likelihood of inflation tighter monetary policy, have tended and the need for a to make the interest rate outlook even more bearish. One this has been to keep the 3-month near-term effect of 4.60-4.65 per cent range and to put Treasury bill rate in the further upward pressure on bond yields. I am less sure about likely future monetary expansion credit expansion, since it is not at all clear than total we still have in the existing monetary how much elasticity that is, how much the likely increase in the demand stock; transactions purposes will be offset by for balances for for money as a result of a the decrease in the demand rise in interest rates on substitutes for further likely The rate of expansion in bank credit, as contrasted money.
to total credit, will likely decline even if money supply and demand deposit growth continue substantial for, with rising market rates of interest, banks will find time and savings funds more difficult and costly to obtain. The slackened growth in bank time and savings deposits recently, despite the changes in Regulation Q in early December, may already be reflecting this fact. We are likely to have to support this course of domestic financial developments by further monetary restraint, but I would hope that the major share of any needed further restraint on the economy would come from fiscal policy. Interest rates are already historically high. If they go much higher, it may be difficult to get some of the sticky ones down when economic conditions call for lower rates. High interest rates also have significant differential effects on the various sectors of the economy, tending to limit growth-inducting investment more than consumption. In the period ahead, restraint on consumption may prove to be the more appropriate policy goal. Of course, if adequate anti-inflationary fiscal measures are not taken promptly enough, it will put an added burden on the more flexible monetary policy instrument to help keep further economic expansion on a sustainable basis. Mr. Hickman asked if there was any evidence that the Admin istration was planning to increase the degree of fiscal restraint that outlined in the report of the Council of Economic beyond Advisers. while he had no specific information Mr. Koch replied that, economists at the Council and he assumed that the on the subject, possible need for further fiscal were thinking about the Treasury restraint. statement on the balance presented the following Mr. Hersey of payments:
One of the most striking pieces of economic intel ligence to emerge in the past fortnight was the news that U.S. imports in the last three months of 1965 were even larger than in the preceding three months, with only a slight decline in steel imports. Commerce Department analysts are adjusting the Census figures down in the fourth quarter and up in the preceding quarter, to correct for statistical lags. Even so, they find a rise at a 10 per cent annual rate. In relation to GNP, fourth-quarter imports were at an almost unprecedented 3.30 per cent of total GNP expenditures. If these high and rising imports are a harbinger of what we have to expect in 1966, and if we cannot improve much on the fourth-quarter trade surplus, which was only a little over $5 billion at an annual rate, the outlook for achieving any significant reduction in our international payments deficit will be bleak indeed. Imports in the fourth quarter were 17 per cent higher than those of the final quarter of 1964. The broad features of the upsurge that was occurring last year can be seen from corrected breakdowns available for the third quarter. First, imports of manufacturesthat is, of consumer goods and capital equipmenthave been rising at an accelerated pace. The trend has been steep for many years. In the mid-1950's these goods made up one-tenth of total imports. By 1964 they were nearly one-fourth of the total, having risen at a rate of 18 per cent a year, compounded. rise has accelerated to about 25 per cent But now this per annum. Second, imports of semimanufactured and crude materials--which constitute about two-fifths of a rising trend from the mid-1950's to the total--had 1962 of only 3 per cent a year, with large fluctuations of a cyclical character around this trend. From 1962 to the present the rise has been steadily accelerating. and November, corrected as well as Data for October an annual rise in imports of materials we can, indicate the 18 per cent shown for the at least as great as third quarter. Finally, imports of petroleum (under system since 1959) have been rising very the quota terms, and the same has been true of slowly in value our imports of foods. Against this background, we must ask: is the rise going to continue in the 10-to-20 per of total imports this year? Or, can we take reassurance from cent range
the standard forecasts, which have been projecting a smaller rise--in the 5-to-10 per cent range? For example, the National Foreign Trade Council projection implies a rise to the fourth quarter of 1966 of only 5 per cent, which is less than the 7 per cent average experienced in the past decade. In the past, rapid increase in imports has tended to go with heavy inventory investment and with rapid increase in the materials and business equipment components of the industrial production index. The indications that inventory investment in the fourth quarter was large are wholly consistent with the recent import picture. Under current conditions I regard the NFTC projection as implausibly low. The problem of slowing the rise in imports now is closely linked with the problem of holding down the rate of inventory investment and damping capital outlays. As I see it, the two big economic challenges that face the country are twin problems: how to end our balance of payments deficits soon, and how to make a smooth transition to stable growth at high employment. Excessive imports threaten our success on the balance of payments front; excessive inventory investments, along with excessively accelerated fixed capital threaten the smooth passage we hope for investments, in the economic life of the country. The growing uneasiness about prices can aggravate Fears of price increases may already be both problems. motive for stocking and ordering ahead, and excessive a be giving a push to the of ordering may already bunching upward movement of domestic prices and encouraging greater importing. conditions as necessary and Can we accept these and hope to ride through them without inevitable, letdown in the domestic fear either of a subsequent in the balance of or of critical developments economy payments? domestic side of the try to deal with the I won't balance of payments, after we get question. For the first quarter the next the seasonally favorable beyond critical ones. several months may be extraordinarily bill that is at stake. It is not only the import can suck back potential domestic demand Excessive as suck in imports. Export prospects exports as well
look reasonably favorable now, but there is no guaranty that sales will increase as much as we would like. If the trade balance fails to improve in the next few months, probably the balance of payments as a whole will worsen, for the adverse balance of capital movements and Government payments is likely to be somewhat larger in coming months than it was in the fourth quarter of 1965. And if the idea gains ground among investors and businessmen that the only hope the Government has for handling the balance of payments is instituting a set of controls more permanent and less voluntary than those we have now, capital outflows may well begin to accelerate again. Eventually our problems with the dollar could begin to resemble Britain's with sterling. The Administration has held out great hopes--most recently in the President's Economic Report--that "we intend to complete the job (of moving toward payments balance) this year." The question is, how is this to be done? I would like to quote, in conclusion, what seems to me a relevant part of a paragraph in the Economic Report, in which the President states that he will look to the Federal Reserve System for help in . . . "preventing ex credit flows that could carry the pace of expansion cessive beyond prudent speed limits." Martin then called for the go-around of comments and Chairman views on economic conditions and monetary policy. Mr. Hayes, who made the following statement: began the go-around, Now that we are one month into the new year, we not only statistical evidence of a stronger economy have in December than we believed it to be at our last meeting, but also clear signs that the rapid pace of the expansion is continuing. This year we see no sign of the "winter doldrums" that used to be a normal seasonal phenomenon calendar year. Moreover, the outlook for early in the very strong. In the private sector, besides the 1966 is of vigorous consumer demand and record business stimulus on plant and equipment, accelerated inventory outlays may be becoming a significant additional accumulation factor.
Of course the Viet Nam war is a major factor affecting all prospective economic and financial developments. The rising scale of military operations has clearly contributed to the strong business outlook, has generated skepticism as to the realism of the Federal budget, and has been a major cause of continuing upward pressure on interest rates of all maturities. We must have in mind this dominant uncertainty, with its possibility for bringing unexpected changes in the economic picture in either direction. Notwithstanding the Administration's strenous efforts to produce a budget that would not add to inflationary pressures, the general atmosphere remains one of apprehen sion that excessive demands are building up. Our analysis suggests that although the budget as presented should be much less stimulative than the extraordinarily stimulative 1966 budget, it will still make a considerable expansionary contribution. All indications are that rising expenditures all along the line will increasingly press against available resources of labor and plant capacity. These pressures are likely to be especially noticeable in the area of manpower; and since the ranks of the unemployed consist, a much greater degree than a year ago, of untrained to absorption into employment could exert a workers, their strong initial drag on productivity. The changes of con tinuing stability in unit labor costs appear dim. While increase in industrial wholesale prices remained the relatively moderate in 1965, with no signs of acceleration in the over-all index, the price advances were quite pervasive and indeed increasingly so as the year went by. prices in 1966 is clearly disturbing; and The outlook for of the stock market this year, especially the performance to low-priced issues, has been just one with respect sign of growing inflationary psychology. more Fragmentary balance of payments statistics, suggesting of January, are not useful as a a deficit for the month the year as a whole, because of the outlook for measure bunching last month of large Canadian issues of the originally scheduled for placement in November and December, and royalty payments to unusually large tax besides However, recent estimates and the Middle East. Venezuela international transactions for 1966, of our prospective in Washington, are not by a Governmental committee made anticipated $900 million The benefits of an encouraging. together with a decline in our trade surplus, improvement
in direct investment, increased investment income, and the absence of large sales of British official portfolio securities, may well be fully offset by increases in military and aid expenditures, in bank credit to foreigners, and in travel expenditures. And even the hoped-for improvement in our trade surplus seems a bit optimistic in view of the prospect for continued rapid expansion in the domestic economy and accompanying cost and price pressures. In the credit area, preliminary January figures suggest that the pace of the advance of the credit and liquidity indicators has moderated since December, although the gains were still rapid. Bank loan demand remains extremely active even at the higher interest rates charged since early December. This latter impression is verified by New York bankers who foresee no let-up in loan demand. Such factors as the upward drift of rates in the corporate bond market and the prospective speed-up in corporate tax payments are providing additional stimulus to loan demands, besides the general influence of the strong business outlook. Whereas reduced bank liquidity last year was not a major deterrent to the granting of all reasonable loan requests, there is now growing evidence of efforts by the New York banks to curb loan expansion. For one thing, I am glad to note an apparent increasing reluc tance to finance transactions they consider more appropriate for the bond or equity markets, especially mergers and acquisitions. Despite some continued uneasiness, I think there are some signs that the tensions characterizing the short-term financial markets in December and part of January are gradually receding. The success of the Treasury's refunding operation should be a constructive influence. At the same time, however, the long bond markets have come under increased pressure, with no real assurance of stabilization as yet. Earlier yield in the long area had been relatively moderate, adjustments but the growing corporate calendar, the prospective large sales by Government agencies, and the already asset of insurance companies and heavily committed position investors are major factors other institutional currently affecting market sentiment. Turning to policy, I am impressed by the clear and present danger of inflation and by the fact that present fiscal policy plans do not provide any very
significant restraint. It is impossible to estimate as yet whether the combination of a very high level of credit demand and a somewhat more stringent supply will result in a moderation of the financial expansion without further restrictive steps. Restraint in the rate of credit expansion seems highly desirable for purely domestic reasons, apart from the important contribution such a move might make to our balance of payments. The nervous state of the money and capital markets during the last two months of adjustment to the higher discount rate and higher Regulation Q ceilings has made it difficult to keep reserves under sufficient pressure to encourage a slowing of credit expansion without excessive rate effects. The recent large Treasury refunding also required an especially solicitous attitude toward the state of the money and capital markets. Now that it is virtually completed, I would hope that net borrowed reserves could soon be restored to a range centering around something like $150 million, such as prevailed for sometime before last December's discount rate increase; and I would also hope that this would be consistent with other money market conditions similar to those prevailing in recent weeks. While I lean toward moving even a little further in the direction of reduced reserve availability, perhaps toward a target of $200 million or more net borrowed reserves, I think this decision might well be delayed until the next meeting, when we should have a better idea of the effects on credit expansion of our moves to date. With respect to Mr. Robertson's interesting memorandum,1/ I sympathize with his objective of more prompt counter-cyclical influence by open market opera tions, as well as with his goal of wider swings in net borrowed reserves that would have the effect of diminishing 1/ Entitled "A Free Reserve Proposal," and distributed to the Committee on January 27, 1966. A copy has been placed in the Committee's files.
the present public overemphasis on a given reserve figure. However, I wonder whether we can rely on required reserves as a valid short-run measure of the forces of credit expansion. It seems to me that we have a hard enough time interpreting credit and liquidity developments on even a monthly basis, let alone relying on an automatic reserve interpretation on a day-to-day basis. Insofar as a net borrowed reserve target is involved, I would much prefer, as a general rule, to wait three weeks or a month until the next meeting and then make a conscious judgment that the target should be higher, lower, or unchanged. The draft directive as proposed by the staff 1/ is entirely satisfactory. One possibility which the Board might wish to consider is an increase in margin requirements, in the light of the sharp rise in customer credit over the last five months, and particularly in December. Mr. Francis reported that economic activity in the Eighth District had continued to advance during the fall and early winter, the growth rate probably had not equaled the rapid national but in the District had risen since August, though increase. Employment at less than the national rate. Unemployment had declined in most major labor markets. In only two of the eight of the area's of the District was the latest seasonally metropolitan areas as much as 3 per cent. One of the areas adjusted unemployment rate where the Fort Chaffee military installa was Fort Smith, Arkansas, tion was closed. as Attachment A. Appended to these minutes 1/
McDonnell Aircraft, the region's largest employer, had received Defense Department contracts to step up production of the Phantom fighter plane, Mr. Francis said. In addition, the company was beginning to build versions of the Phantom for the British. The company planned to increase its employment between now and next fall by 4,000, to about 40,000. Other major companies in the District which had recently received contracts for military goods included Wagner Electric, General Steel Industries, Universal Match Corporation, and Olin Mathieson Chemical Corporation. Each of those companies planned to increase its employment in the near future. Also, RCA commenced construction in December on a TV receiver manufacturing plant in the Memphis area; the plant was expected ultimately to employ about 7,500. Since August, Mr. Francis continued, manufacturing output in the District had risen moderately, following a rapid expansion in late 1964 and early 1965. Spending, as indicated by the volume of bank debits, had risen at a 12 per cent annual rate in the same income, reflecting the higher level of employment period. Personal 9 per cent higher in recent activity, had been about and greater Gross farm receipts were up months than it was a year earlier. the fourth quarter 1964 to the fourth quarter 1965. 3 per cent from jumped considerably, but were partially offset Returns from livestock by reduced crop receipts. For the year 1965, income per farm was up about 5 per cent on both a gross and a net basis.
Total credit at large District'banks had risen moderately since August, Mr. Francis said. Increases in total loans, particularly on real estate and to consumers, more than offset securities. Business loans had risen less than net sales of seasonally since August, following an unusually sharp rise last spring. Both demand and time deposits had gone up. Nevertheless, banks had been pinched for funds, and borrowings--both from the Federal Reserve Bank and from others--had been at higher average levels in the past three months than at any other time in over five years. Mr. Francis observed, economic activity In summary, in the District. He based that conclusion appeared to be vigorous optimism of those with whom he both the statistics and the on data, it appeared that From a review of the national had talked. or stronger than that of the the national scene was as strong be excessive, as evidenced by District. Aggregate demand might concern about and the increased rises, labor shortages, price guideposts. not to make detailed said that he preferred Mr. Francis his first, Committee meeting. on policy at this, comments However, with most measures of the banking system--bank reserves, deposits, and moneytime deposits, demand loans, bank credit, with the current the past two months, expanding rapidly during
stimulative fiscal situation, and with the strong upward momentum in the economy, it would appear that insofar as the Committee's responsibility to the Treasury permitted some firming in monetary policy was indicated. Mr. Patterson reported that economic developments in the Sixth District continued to provide a base for strong credit demands, and the latest banking figures confirmed that conclusion. Loans at banks at leading cities in the District declined less in January this year than in 1965. District bankers were looking forward to continued loan expansion during 1966 although there were differences of opinion about its strength. A new round in the competition for time deposits might possibly be developing, Mr. Patterson said. Until recently, most bankers had adopted a "wait-and-see" attitude with respect on time deposits, and any increases in rates that to their rates were made were modest. Two weeks ago one of the large Atlanta extensive advertising campaign, offering to banks launched an for as short a time per cent on savings certificates pay 4-3/4 amounts as $25. A newly opened as 90 days and for as small 5 per cent on savings bank in New Orleans was offering nonmember $25 and over. So year in amounts of held for one certificates from the other banks or savings no reaction had been noted far, of deposit declined during Negotiable certificates institutions.
January at practically all the banks in leading Sixth District cities, the major exception being a bank that had aggressively competed on the basis of rates. For some time, Mr. Patterson observed, the Committee had been hoping that the dust would settle so that it could identify the forces that were responsible for the rate and loan behavior following the discount rate changes. That cloud of dust seemed to be very persistent. Even now, the Committee could not sort out clearly the technical, expectational, and real factors, and that seemed also to be the case for persons outside the System. more of them were commenting on the Nevertheless, more and behavior of rates and reserves. As was apparently inconsistent usual, they had been advising the System that something ought to But, contrary to most occasions, they had not told the be done. about controlling the expansion of reserves and System how to go the money supply without pushing up rates. When a dust cloud persisted for as long as this one had, tempted to just rush in to do Mr. Patterson continued, one was the best. On the other hand, if the something, and hope for dust to settle completely, it might Committee waited for the developments that could that it had permitted undesirable find not be changed after visibility had improved. There was, a policy that gently probed the possibility of adopting however,
toward the desired goal with the understanding that that course of action might have to be altered at any time. Mr. Patterson commented that during recent weeks the Committee's operations had been primarily directed toward keeping the short-term Treasury bill rate within bounds, at the same time hoping that implementing that policy would not create too large a volume of reserves. It seemed appropriate after the Treasury refunding was completed to reverse the emphasis and to carry out a probing operation aimed at getting a tighter control of reserves. He did not think that the Committee should delay that type of action until after the short-term bill rate fell below the discount rate. Possibly some tightening of member bank reserve positions would result in a further increase in the bill rate, Mr. Patterson said. However, he was not sure that that would be the case. To the extent that the present bill rate structure resulted from a of reserves and special credit demands, pressures maldistribution of the market might be reduced in the future. But on the short end remaining above the discount rate even the Treasury bill rate's for an immediate further increase in the would not inevitably call Member banks at as had sometimes been suggested. discount rate take advantage of the differential showed no disposition to present rates. Should that develop, of between the bill and the discount policy would have to be reconsidered. course, the System's
The Committee could not begin the probing operation until after the Treasury refunding program had been completed in mid February, Mr. Patterson said. After that, he would like to see System operations so conducted as to reduce the availability of reserves, by moving toward a net borrowed reserve figure of around $200 million, as suggested by Mr. Hayes. Mr. Bopp remarked that, with the President's budget message having been made public, it appeared clearer than ever to him that the economy was poised to move strongly ahead in coming months and that price pressures were likely to mount and become more pervasive. The strength of demand showed up in the trend of fixed investment, the fast pace of inventory accumulation, burgeoning new orders and unfilled orders for durable goods, and an operating rate in the manufacturing sector now within a hair's breadth of the preferred rate. Earlier, Mr. Bopp said, when the margin of unutilized resources was larger, it had seemed reasonable to him to wait for actual price increases before taking additional restrictive action. The margin of unutilized resources was much narrower now and, although industrial prices had been fairly quiet recently, set for major increases in prices. In that the stage was environment, such increases could lead to speculative inventory and other anticipatory actions, creating upward pressures building which fed on themselves.
Also, in that kind of environment uncertainties over the Federal budget became more crucial. As Mr. Bopp saw it, there were four principal areas of uncertainty, and all of them appeared to veer in an expansionary direction. First, with respect to spending: Viet Nam needs were unpredictable and spending estimates were very possibly on the conservative side. Moreover, it was uncertain whether and to what extent Congress would be successful in cutting domestic spending. Second, on timing: If, as some forecasted, the largest expansion in Government spending occurred in the second half of fiscal 1966 and early in fiscal 1967, such a "bunching up" of expenditures could prove quite stimulative even if total spending did not exceed the amount budgeted by the Third, on revenues: While a burgeoning economy might President. well generate the increased receipts envisaged by the President, tax changes probably would be passed, the and while his proposed and to what extent the tax still remained of whether question spending during the current would restrain private measures as to additional fiscal restraint: calendar year. Finally, to recommend added move very quickly if the President should Even in the event of further inflationary taxes or reduced spending to be appraised and would have pressures, those recommendations upon by Congress. acted
In short, with strong pressures from private demand and the many uncertainties in the fiscal outlook, it seemed to Mr. Bopp that action should be taken to damp current rates of flow of money and credit. However, with the Treasury refunding in progress, there was a question of whether to wait until the next meeting of the Committee before imposing additional restraint. He would be inclined to move initially to tighten reserve availability as soon after February 15 as the Manager judged was appropriate in view of the refunding. The move, however, should be a moderate and gradual one, Mr. Bopp said. It might be necessary, among other things, to relieve some pressures on commercial banks, should they have strong credit demands at the same time they were experiencing trouble replacing CDs. He would rely mainly on the discount window to relieve any excessive pressure from those and other sources. The staff's draft directive appeared appropriate to him. remarked that the impact of fiscal policy on Mr. Hickman year seemed to be even less predictable than the economy this usual. The figures for Federal spending in the national income budgets, which measured the impact of and "high-employment" budget policy on the economy, probably would be on the low side, of defense--although the situation was particularly in the area
subject to change almost on a daily basis. Despite the general uncertainty about the budget, it now appeared that fiscal policy would be stimulative, at a time when aggregate demand was pressing on the nation's capacity to produce. Under those circumstances, higher taxes than were now contemplated seemed indicated. Until such plans emerged, he thought the Committee should rely on reduced credit availability and on tighter money. Such a course of action was also indicated by current developments in the economy, Mr. Hickman said. As the staff had pointed out in the green book, GNP in the first quarter would probably increase by at least as much as in the fourth quarter of last year. Industrial production through December exceeded the most optimistic expectations. All major price indexes continued to move up, with the resurgence of farm and food prices at wholesale presaging further increases at retail. Mr. Hickman thought recent price developments were not surprising in view of the kinds of pressures now impinging upon The Cleveland Reserve Bank's informal resource utilization. survey in late January of manufacturing firms in the Fourth shortages, especially for District indicated widespread manpower metals industries, where in the machinery and fabricated firms ranging from 50 to 60 hours. In some the work week was currently on plant capacity because pressures were also developing cases,
were not coming on stream rapidly enough to offset new facilities rising order backlogs. Moreover, several important industries in the District emphasized limitations imposed by streched-out delivery dates for machinery. Many firms were already operating above preferred utilization rates and would have difficulty handling any further increase in orders. The backlog of defense orders was already large, and another surge of orders would simply intensify problems of capacity and priorities. On the financial front, Mr. Hickman continued, increases in nonborrowed reserves, money supply, and time deposits apparently had slowed to a less frenetic pace in recent weeks. Nevertheless, over-all rates of increase in those variables since the discount rate action had been excessive and inconsistent with his view of monetary policy. appropriate Because of the massive Treasury refunding, Mr. Hickman said, there was little that the Committee could do now of a constructive nature, particularly in view of the unsettled state of the bond market and the probable churning in the after-market. Nevertheless, some moderate corrective action might be possible later this month, down. In the past four weeks, the net if the bond market settled had averaged slightly above zero, and reserve position of banks about $400 million, which created bank borrowings had averaged than Mr. Hickman thought the Committee slightly easier conditions
had intended, even during a period of even keel. He hoped that it would soon be possible for the Manager to move net reserve positions back to levels prevailing before the last discount action. Once the Treasury refunding was out of the way, he would prefer a still deeper level of net borrowed reserves and correspondingly higher bank borrowings. Mr. Hickman did not agree with For reasons already indicated, the second paragraph of the staff's draft directive. It seemed to was time for the Committee now to begin to reduce credit him that it which would mean higher interest rates rather than availability, strength of loan demand. That approach stable rates, given the current would involve less tampering with the economy than would any system based on vague distinctions as to what are and of credit rationing are not productive uses of credit. thought that if the Committee examined the Economic Mr. Maisel certain assumptions as to where monetary policy Report it could derive the current situation. Monetary to aid stabilization in was expected the expansion of fixed to aid in containing policy was expected investment. In addition, and to cut back on inventory investment balance would aid in the net export as if a decrease it appeared fight against inflation. the thought the point, Mr. Maisel respect to the latter With question of whether to the give more consideration Committee should
it now had a contradiction in the directive. Could it expect mon etary policy to help in restraining inflationary pressures and at the same time aid in achieving balance in the country's international payments? If the Committee was to fight inflation, shouldn't the net export balance decrease? Could it expect the current account to carry as much foreign investment as it had in the past? Mr. Maisel agreed with the previous statements around the table that tighter fiscal policy at this time might be proper. He would doubt, however, that tighter fiscal policy would be tried policy had had its chance to decrease demand. As until monetary a result he believed that the rate of expansion of total credit had to be cut back at least to where it was in the Committee's previous policy period. Desk should put more emphasis on the rate of expansion The reserves, Mr. Maisel said. That rate of expansion of nonborrowed be reduced to prior levels, even if that caused somewhat should in Mr. Robertson's memorandum higher interest rates. The proposal the cut in the expansion of nonborrowed might be a way of achieving into effect as soon as possible. and, therefore, it should go reserves be concerned with the question the Committee also should He thought and disturbances resulted from rumors of how much of market action System was attempting to do. knowledge of what the without proper would operate better if he asked whether the market Specificially,
it knew that the Federal Reserve was willing to operate at a much higher level of borrowed reserves without resorting to another increase in the discount rate. Mr. Daane said he confessed to being a bit gloomy about the outlook after listening to, and agreeing with, the people who had spoken thus far. He noted particularly Mr. Holland's expectation of a continued price upcreep; the statement by Mr. Hersey, whose pessimism regarding the balance of payments was, he thought, well founded; and the excellent analytical case Mr. Koch had made for further fiscal restraint, about which Mr. Daane was not sanguine at this point. While he shared Mr. Koch's distaste for higher interest rates he thought that, were it not for the necessity of maintaining an even keel during the current large Treasury financing, the Committee should be trying to restore a somewhat deeper level of net borrowed reserves. He would favor such a course as soon as it was that it could be accomplished without feasible and to the extent Because he felt somewhat interest rates upward. racheting score, he would go along with a target skittish on the latter otherwise he would for net borrowed reserves; of $150 million deeper target. The inclined to accept a somewhat have been appeared appropriate to him. staff's draft directive
Mr. Daane was sympathetic with the goals of Mr. Robertson's memorandum. However, he recalled the occasion, a number of years ago, when he had tried to disabuse the Committee of the view that free reserves were an appropriate guide for policy, and had received a letter from Woodlief Thomas saying that free reserves were the only serviceable policy benchmark available to the Committee. His own views had come full circle. He shared Mr. Robertson's opinion that the free reserve figures should not be closely pinpointed, and he would like to see the market rely less on those figures as indicators of policy--as he believed it was already doing. He was skeptical, however, that the Committee could abandon free reserve figures for target purposes; and he was even more skeptical that it could use required reserves as a policy guide in the manner Mr. Robertson had suggested. While he shared all of Mr. Robertson's reservations about free reserves, he thought they still were the most useful benchmark to indicate the nature of the thinking around the table. Recently, the net borrowed reserve figures had been showing relatively wide fluctuations so, in effect, the Committee was accomplishing one of Mr. Robertson's objectives. In Mr. Daane's judgment those wider swings were appropriate; but he hoped that the Committee not try to put greater emphasis on aggregate magnitudes would and quantities in its instructions to the Desk.
Mr. Mitchell remarked that many of those speaking today, including the staff, seemed to be saying that there was something wrong with the budget submitted to Congress by the Administration. He did not think it really needed defense--and yet, perhaps, some thing should be said in its favor. In his judgment the budget represented a plan that encompassed the possibilities of both peace and war; it straddled that question, and necessarily so. What was the Committee's role when confronted with that type of budget? Mr. Mitchell thought the answer lay in the Committee's flexibility to fill in during the interim. The Committee prided itself on its flexibility but, at the same time, pinpoint the effects of its actions because it did it could not selective controls. If it were able, not have the necessary might well be trying to do something about the the Committee which in his judgment was an element not inventory situation, strength in the economy but of great weakness. of The Committee did have controls over the banking system, some pressure on which it could put Mitchell said, through Mr. interest rate effects. not without some bank reserves, although advise banks coming step could be taken immediately--to Another more quickly to repay their borrowings the discount window to The System attempted their liquidity positions. and to adjust of Regulation A, under the terms continuous borrowing to discourage
but there was no hard and fast rule as'to what "continuous borrowing" was, and banks were able to maintain an illiquid position by shifting between the window and the Federal funds market. System discount officers could be of some help in contributing to the Committee's over-all objective of restraining borrowing. As to policy, Mr. Mitchell said he agreed that at this point the Committee should not interfere with the Treasury financing. However, he favored moving toward greater firmness as soon as the Manager judged that the financing was no longer consideration; and increasing the degree of firmness an important over time if present circumstances persisted. As long as there that the country faced developments such as were was a belief associated with the Korean war, such a policy would be desirable to help reduce inflamed expectations. Mr. Shepardson commented that all of the opinions seemed to be consistent with the state expressed thus far today of the staff's draft directive that ment in the first paragraph Pressures seemed to be the economy was expanding vigorously. facet of the economy, and developments building in almost every suggested that Federal expenditures since the Budget Message in that document, implying still would be higher than estimated that efforts be made ahead. It was important greater pressures
by any available means to keep the pressures from mounting and, accordingly, there was merit in the idea of fiscal restraint to curb demand. But such restraint did not seem to be in immediate prospect. In his opinion the Committee should be exerting more restraint; it should be supporting the December discount rate increase by acting to reduce reserve availability. Recently, Mr. Shepardson said, he had been studying the possibilities of developing a better target for operations than free or net borrowed reserve targets. As everyone knew, there had been periods when the Committee had maintained negative reserve targets but had not achieved its objectives for bank credit because of rising credit demands. He had discussed the possibility of using some other measure, such as total reserves, with members of the staff, but thus far had not found a satisfactory approach. For lack of a better suggestion at this time, he recommended back toward the level of net borrowed reserves that had working rate action, and perhaps to higher prevailed before the discount Treasury financing situation but, if level. He recognized the made today on that interpreted the statements he correctly successful and the financing had been generally subject, the a relatively small new issues was digestion of the problem of an even keel would need for maintaining Moreover, the one. over the coming period. progressively less become
With those circumstances in mind, Mr. Shepardson said, he would change the second paragraph of the draft directive to read: "In light of the successful Treasury financing, System open market operations until the next meeting of the Committee shall be conducted with a view to moving toward somewhat firmer conditions in the money market." With such an instruction, he would expect the level of net borrowed reserves to be moved toward the $200 million level--not immediately, but before the next meeting of the Committee. Mr. Mitchell suggested that the Manager indicate how long he thought even keel conditions should be maintained. Mr. Holmes replied that in his opinion it certainly would be desirable to maintain an even keel through the payment date, February 15. As to the subsequent period, while he could not be certain, it appeared that even keel considerations were likely to be less important than usual at that stage of a refunding. As he had noted, the underwriters' positions in the new issues minimal and it was conceivable that they would be were rather minimal a week from now. He did see one problem with even more Mr. Shepardson's proposal for the directive, connected with the of the Treasury financing as "successful." Certainly description been successful in achieving the objective of extending it had the average maturity of the debt. From the point of view of
market developments, however, it had been somewhat less success ful; it was quite unusual to see the price of a new security move down to par at this point. Mr. Shepardson agreed that there might be some problem with the word "successful," but it was the best word he could find. He thought it definitely was desirable to start moving toward deeper net borrowed reserves; since the distribution of the new securities already was fairly well accomplished, it in his judgment, to wait three weeks before would be unfortunate, first might be to restore the earlier doing so. The objective at of $150 million net borrowed reserves. To his target level had not changed that target--the recollection the Committee the course of recent developmentshad slipped away in figures to be consistent with restoration could be considered and its indicated, however, he even keel. As he had maintaining an before the next further than that going a little favored meeting. objective might that Mr. Shepardson's Mr. Daane suggested for moving toward directive call by having the be accomplished Treasury financing soon as the current conditions "as firmer permits." language: "In the following Young then proposed Mr. the current Treasury conclusion of light of the imminent the
financing, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining in the first part of the period about the same conditions in the money market as have prevailed in recent weeks, and in the latter part of the period moving toward firmer conditions." Mr. Daane remarked he could live with that language but it seemed a little cumbersome. He would prefer a formulation along the lines of his own suggestion. In response to a question by Chairman Martin, Mr. Holmes said the intent of the members of the Committee who had spoken thus far was clear; they favored moving to firmer conditions after the Treasury financing. The economic go-around then resumed with the following statement by Mr. Robertson: The round-up of evidence suggests that a strong business advance is still under way. With demands already beginning to press hard upon our narrow remaining margin of available resources, this situation possesses all the ingredients for an outbreak of an inflationary public psychology. The latest readings on the price indexes are up somewhat, even though chiefly because of higher agricultural Other signs of a possible developing ebullient prices. attitude are exemplified by the apparent inclination of businesses to commence some hoarding of both and--in some cases--to borrow materials and labor, before interest rates rise further and lendable now funds become harder to locate. There also is the Viet Nam developments will do more possibility that to calm these inflationary expecta to aggravate than tions in the weeks and months ahead.
This is the kind of situation in which we must be alert to the signs of an inflationary outbreak and be prepared to adopt a firm counter-inflationary stand by a wise combination of fiscal and monetary policy. We have the new budget figures now, even though it is generally recognized that the visissitudes of the war effort render the figures more than ordinarily uncertain. While the analysts are still arguing over the fine points of the budget's impact, I am inclined to regard it as just a shade more stimulative than in the second half of 1965. The additional money-raising actions of the Government may be almost but not quite enough to offset the expansive effect of the step-up in Federal spending. But no matter how you shade it--either a little more stimulative or about the same--the Federal budget will do little, if anything, to help restrain any upthrust of private demands. This means that monetary policy must bear the brunt of dampening excessive demands if they actually develop. We are now in a period of "even keel" that probably has to stretch over a good part of the time between now and the next meeting of the Committee, although the relatively smaller dealer awards of the new 5's suggest that we might not have to hold very much beyond payment date. Nevertheless, I would agree that any significant further firming in our policy must wait until at least the March 1 meeting. In the interim, however, there are two operational considerations we could have in mind that might make our next policy change easier to accomplish. One is to define our current "even keel" with the same the Manager attached to the term three qualifications weeks ago, namely, that market responses to basic economic, and budgeting developments should military, only be moderated and not completely offset. The I would suggest is to permit a second adaptation greater range of movement in net borrowed somewhat lines of the memorandum I circulated reserves, along the ten days ago. I will not take the to the Committee all the arguments put forth in time to reiterate here will simply suggest that net that document, but reserves be centered on $100 million, but borrowed between $0 and $200 million as my permitted to range That would mean dropping toward memorandum suggests. reserves are larger than $200 million if required
expected, and rising toward zero if credit demands are less than expected. This would not do violence to the "even keel" principle but would give us a better basis for maneuver come the first of March. With this interpretation, I would be willing to vote in favor of the draft current directive distributed by the staff. Mr. Robertson added that he also would concur in a revision of the directive such as had been suggested, calling for firming after the payment date. He was grateful for the sympathetic comments made with respect to his memorandum, and he would simply note that he hoped further consideration would eliminate skepticism. Since the members were aware of the need to get away from fixed targets he would suggest that the staffs of the Board and the Reserve Banks be requested to give consideration to the problem; if his suggestion was not the best, the staff might be able to offer a better suggestion. Mr. Hickman commented that the Committee might want to plan on discussing Mr. Robertson's proposal in depth, perhaps at a time several months from now. Chairman Martin agreed that the staff should consider the subject and that at some time the Committee might hold a discussion not only of Mr. Robertson's paper but of any others that were prepared. It would be desirable, he thought, for other members who were so inclined to present papers to the Committee.
Mr. Wayne then reported on Fifth District business conditions, noting that they continued to follow a strong upward course. December increases in nonfarm employment and factory man-hours were even stronger in the District than in the nation as a whole. Manufacturers reported that they felt the pinch of tight labor markets in the higher costs incurred to find and train the workers needed to meet existing commitments. Furniture producers complained of the limited supply and rising cost of labor, and some were unable to promise deliveries of popular lines in less than four months. The textile industry was beset by other problems in addition to labor shortages. Leaders of the industry said they could meet Defense Department needs only by reducing production and delaying deliveries to civilian customers in some product lines. They felt, however, that the resulting upward pressure on prices could be controlled by their determination to hold the line. Textilemen were also concerned lest domestic shortages lead to increased imports, a development that would concern the Committee as well because of its implica tions for the balance of payments. national scene, Mr. Wayne continued, the long On the business expansion showed increasingly disturbing signs sustained of becoming a classical boom. Gains in business activity in December were outstandingly broad and strong and there were no signs
of slackening in January. Pervasive upward pressure on prices continued, with wholesale prices rising by 1 per cent from October to December and by 3.4 per cent for the year. Labor markets were progressively tighter, and optimal rates of capacity utilization had been passed in a number of industries. Order backlogs continued to grow steadily, with an especially large rise in December. Unfilled orders for durable goods had risen every month for two years, but they rose about as much in the last four months of 1965 as in the first eight months of the year. Business generally seemed under growing pressure to step up investment in both plant and inventories. Business expectations were increasingly buoyant and credit demands continued unusually heavy despite sharply higher interest rates. The budget presented two weeks ago had apparently made no contribution toward reducing inflationary sentiments or settling the money and capital markets. Against that background of the economy's exuberant advance, Mr. Wayne said, the growth of reserves, bank credit, and the money supply in recent weeks had not been consistent with the rationale of the policy change made in December. From 26 weekly reporting banks showed smaller December 29 to January periods of the previous two years in declines than in comparable investments, total bank credit, demand deposits, and total
reserves. The money supply apparently grew more in January than was normal for the month. He was aware that it had been necessary for the Committee to make a strong effort to provide stability and order in credit markets and that the recent rapid growth rates in money and credit had been a by-product of that effort. But if the Committee was not to negate the December action, it must now move to slow the growth of reserves, credit, and the money stock. The low level of bank borrowing in the past three weeks suggested that the Committee might have been supplying reserves somewhat more freely than might be consistent with the December rate action. Credit demands had increased greatly in the past two months, Mr. Wayne observed, and the sharp rate increases over the had not exerted any appreciable restraint on period clearly growth. In the past ten days those demands had credit and money to the long end of the capital market and, along with extended the Treasury refunding, had raised military developments and by as much as ten points. The yields on long-term Governments in part with expectational appeared to be associated heavier demand more serious problem unless that could pose a progressively factors action would be that prompt and effective it was made clear which seemed to be developing. taken to contain the boom
An unequivocal move toward a lower level of reserve availability seemed to Mr. Wayne to be necessary and also consistent with recent Administration evaluations of the situation, especially those of Secretary Fowler last week. Such a move manifestly involved risks, as a sudden turnabout in the market's assessment of the policy posture could produce serious market disorders. The increased reliance of bankers on the money market also could contribute to an over-reaction of money market rates to diminished reserve availability. Nonetheless, he was convinced that those risks would have to be assumed at some early stage if monetary policy was to make its proper contribution toward restraint. He would favor a move toward a lower level of reserve availability, and adoption of a directive which would contemplate that before the next meeting of the Committee. Mr. Clay remarked that once again the Committee was faced with a Treasury financing that tended to dominate policy considera tions for the interval between meetings. It was essential, to evaluate the economic and financial situation nevertheless, apart from Treasury financing. So far as economic activity was concerned, the statistical measurements continued their upward had been doing and what it both as to what the economy revisions and indeed as to what it probably would do. was doing now, between resource availability and Accordingly, the relationship
prices became of more crucial importance month by month. That was apparent also in the Tenth District where economic growth had been much slower than in the nation. Nevertheless, there was a growing scarcity of skilled workers in the region, with up grading and salary adjustments becoming more noticeable. As a consequence, many firms were conducting training programs for production workers, and also were endeavoring to attract workers from outlying communities and rural areas. Looking beyond the immediate interval between meetings, Mr. Clay continued, consideration would need to be given to the possible application of further monetary restraint. That view was underscored by the fact that the Federal budget appeared to carry expansionary implications for the economy, even if Federal outlays were confined to the budget projections. What should be involved in such a policy change would be difficult to perceive, would need to be made as to the rate at however. A judgment credit demands could be met which the economy's accelerating developments. In making provision without price inflationary the changing mix of demand and for the growth of the credit base, account. The problem to be taken into deposits would have time movement of interest by the marked be further complicated would actions of the monetary policy place since that had taken rates rates to of interest apparent sensitivity and the early December
further increase under current conditions, so that only limited restrictions on reserve availability might prove to be compatible with the current discount rate. As he had already indicated, Mr. Clay said, even keel considerations would need to prevail in the period ahead because of the Treasury financing. The draft economic policy directive appeared satisfactory to him. Mr. Scanlon observed that developments in January in the Seventh District provided further confirmation that the business upswing was continuing. Most District labor markets continued to tighten, backlogs of unfilled orders continued to rise, delivery schedules were lengthening, orders were being placed earlier, and reports of higher prices paid for components and raw materials were heard more frequently. Retail sales remained strong. Debits to demand deposits at District member banks were up 17 per cent from a year earlier in December, compared to a 12 per cent gain from 1964 for the year 1965 as a whole. Mr. Scanlon now saw some evidence that the domestic capital spending boom might have an adverse effect upon the balance of pay ments in 1966 while contributing to domestic inflationary pressures. Machine tool orders placed by domestic users in the fourth quarter rose sharply from the year-earlier level while foreign orders, lengthening lead times, were down substantially. discouraged by
After allowance for seasonal forces, credit demands still appeared very strong, Mr. Scanlon continued. Loan liquidation in January was relatively larger in the District than in the nation as a whole, but to a large extent that reflected pay-downsespecially by machinery and other hard goods manufacturers--on the very large borrowings over the December tax and dividend period. He had seen no indication of any diminution in the underlying strength of credit demands. Despite the seasonal reduction in loan volume, the major Chicago banks had moved to a deeper deficit position over the past month as their holdings of Governments rose and deposits declined. Like others, Mr. Scanlon said, he was pleased to receive Mr. Robertson's memorandum of January 27, since he thought it desirable that the Committee give further consideration to the form and content of its directive. He would not take time today to indicate the points on which he agreed or disagreed, but would merely state that Mr. Robertson had given the Committee something to work from, and that the Committee should pursue and not dismiss the matter. Mr. Scanlon remarked, System As to the current situation, the rising pace of business be lending support to policy appeared to undertake to moderate that the System should activity. He believed as soon after the pace of monetary expansion further the rapid
current Treasury financing as was feasible in the judgment of the Manager. He would concur in any directive that so specified. Mr. Galusha reported that the Ninth District continued to do exceedingly well economically. As noted in the green book, it was benefiting especially from higher farm prices. District cash farm income reached an all-time high in the fourth quarter of 1965; the quarterly total was up a full 10 per cent from a year ago. And of course the outlook was bright--for farmers, if not consumers. Indeed, the recent and prospective behavior of farm prices might well seriously affect the future course of money wages, as Mr. Holland had observed. There appeared to be nothing in the District's agricultural situation to suggest that prices to consumers would break at all in the next twelve months. Mr. Galusha noted that the Reserve Bank's examination reports for 1965 recently had been analyzed. Of 123 banks, 19 were eliminated because they consistently had low loan volumes loans. The remainder fell into and seldom had any criticized problem banks, numbering ten in all, two groups--the consistent the great majority. The latter and the remaining 94, comprising slightly--from 48 per cent had increased their loan ratios group per cent in 1965. Their classified both 1963 and 1964 to 50 in in 1963 to 2.5 per cent in dropped from 3.2 per cent loans had in 1965. The conclusion might be 1964 and then to 2.2 per cent
drawn that the strong loan demand in the period had enabled the banks with reasonably good management to upgrade the quality of their loan portfolios. Conversely, the problem banks had slipped slightly. Classified ratios for them rose to 7.7 per cent in 1965, from 6.8 per cent in 1963 and 4.8 per cent in 1964. Mr. Galusha said that he would omit the other comments he had prepared on District developments because they were largely reiterative of statements already made. As to open market policy, an even keel seemed to be indicated, at least for the next week and possibly beyond. He would favor holding money market conditions unchanged for the whole period until the Committee's next meeting; in his judgment it would be unwise to decide today on a change in policy that could not be put into effect until very near the time of the next meeting. Mr. Galusha added that he was unhappy about phrases like market conditions unchanged," or "maintaining about "holding money conditions in the money market," because those phrases the same appraisal that had been connoted a qualitative and quantitative hoped the day would soon continue to be illusory. He and would positive action to curb sharply come when the Committee could take As to the latter, the signs growth of credit and inflation. the of the Ninth District up in the business community were showing distressing and alarming frequency. with
Mr. Galusha concluded with an expression of gratitude to Mr. Holland for his letter of January 18, 1966, explaining the proposal he made at the preceding meeting.1/ In his judgment both proposal and that made by Mr. Robertson warranted the Mr. Holland's Committee's fullest consideration; they went to the heart of the Committee's operating procedure. Mr. Swan reported that business conditions in the Twelfth District continued to show considerable strength. Despite reports of tight labor markets, the aerospece industries reported a surprisingly large employment gain in December. They added almost 9,000 employees in that month, bringing their total increase since the low of March 1965 to 48,000. Their employment level in December was 594,000, still about 40,000 below the peak of December 1962. As elsewhere, Mr. Swan said, in the Twelfth District banks seemed to be facing a strong loan demand. They had been substantial buyers of Federal funds throughout January and early February. At weekly reporting banks savings deposits declined in January and negotiable CDs and other time deposits rose considerably less than a year ago. Still, at the moment at least, there was much less were sent to to Mr. Galusha, letter, addressed Copies of this 1/ placed in the a copy has been Committee and members of the all Committee's files.
concern than some weeks ago about the possibilities of excessive rates or destructive competition in seeking deposits of individuals through the use of savings certificates in various forms. That situation seemed to have settled down somewhat. Mr. Swan agreed with what had been said about the strength of the business and financial situation generally and about the desirability of moving toward a more restrictive credit policy. He favored slowing somewhat the rate at which reserves were being provided, and setting a somewhat deeper net borrowed reserves figure as the short-run target of operations after the payment date for the Treasury refunding. His only qualification was that the implications of the refunding for policy might have been understated somewhat in the discussion thus far. Despite the small of dealers, there was a question in his mind as to participation were held. Thus, while he how firmly some of the new securities favor moving in the direction of a somewhat tighter policy would hoped the Manager was right in thinking after the payment date, he discounted such a step. The the market might already have that to be cautious and probing, given the sensitivity move would have of the new securities thus the market and the price behavior of whether the Committee those who questioned far. He agreed with move before its next meeting. could, in fact, make a significant
For the directive Mr. Swan would accept either the staff's draft or one referring to the possibility of firming. If the Committee favored the latter, he would much rather put it in some such terms as "when conditions surrounding the Treasury financing permit" than "after the payment date," or "in the latter part of the period," because the Committee would have to rely on the Manager's judgment of the state of the market. Mr. Irons reported that Eleventh District economic condi tions were strong in all of the major areas--production, employment, unemployment, retail trade as reflected by department store figures, and so forth. Weather conditions had been good in the District recently and, generally speaking, the agricultural picture was quite favorable with respect to both production and prices. Much of what Mr. Galusha had said about the farm situation in the Ninth District applied to the Eleventh District also. On the financial side, Mr. Irons said, bank loans in all major categories had declined in the District in the first four weeks of the year. Investments rose because of gains in holdings of Governments; holdings of non-Governments were down. Demand deposits showed seasonal declines, and time deposits continued to grow. The liquidity position of banks was reflected in part for Federal funds, which on a net basis had been in their demand at about $400 million for the past two weeks. Borrowing running
from the Reserve Bank was negligible; apparently the large banks were using non-Federal Reserve facilities and the smaller banks in need of funds were borrowing from city correspondents. The situation with respect to Regulation Q had quieted down reasonably well. A number of bankers were negotiating rate increases when necessary, but they were not advertising higher rates and in general were trying to hold rates at reasonable levels. The general expectation in the District, Mr. Irons observed, was for continued over-all expansion, with capital expenditures rising further. There was an underlying concern about inflation; people found it hard to believe that the Administration could it planned domestically and in connection accomplish everything with Viet Nam. As to policy, Mr. Irons thought the point had been reached work toward a deepening of net at which the Committee should in his judgment, to reserves. It would be desirable, borrowed from the average level of under $50 move as soon as possible weeks up to the $100-$150 million range million of the last three the discount rate change. prevailing before second paragraph of the staff's Mr. Irons believed that the with a policy decision calling draft directive was inconsistent period; it would be during the coming for greater firmness about the same was to maintain only if the decision appropriate
conditions as in recent weeks. He had attempted an alternative formulation, as follows: "After settlement of the impact of the current Treasury financing, System open market operations until the next meeting of the Committee shall be conducted so as to tighten further the conditions in the money market that have prevailed in recent weeks." He held no particular brief for that specific wording, but he would not want to refer to specific dates or parts of the period; such a procedure would set an undesirable precedent. Mr. Ellis commented that in a period when the economy of New England was reflecting a general surge of rising activity, there tended to be a sameness about the glowing reports from each segment. That fact lead him to mention just two pointsthe deposit record of savings banks and the pressures on member banks in the First District. Deposit balances at regularly reporting mutual savings banks continued to grow, Mr. Ellis said, but at a slower pace. The December expansion was 0.8 per cent. Compared with a year December were 9 per cent higher, but ago, new deposits during per cent. The twelve-month net growth withdrawals were up 15 narrowed to 7 per cent from growth rates in deposit balances 2 points higher a year ago.
However, Mr. Ellis continued, savings deposits at the weekly reporting member banks showed a 17 per cent year-to-year gain, compared with 10 per cent for the U.S., and they continued to grow in the three weeks ending January 26. All other time deposits registered a 27 per cent twelve-month gain, one-tenth greater than the U.S. pattern. Those deposit inflows, coupled with a year-to-year increase in demand deposits of 6.5 per cent, helped reduce loan-deposit ratios from the regional average of 74 per cent in November and December to 72.3 per cent in January. The leading money market banks in Boston continued to lean heavily on borrowed funds in meeting their reserve positions, Through CDs, Federal funds, short-term notes, or Mr. Ellis said. Reserve, they had borrowed an average borrowings from the Federal required reserves during the past 20 of 176 per cent of their weeks, compared with 186 per cent for the eight New York City Boston banks were still holding to a money market banks. Those all their customers' requests--at least those posture of meeting of established customers. Mr. Hersey had concluded his remarks Mr. Ellis noted that Report on what the from the President's Economic with a quotation Ellis) had planned to of the System. He (Mr. President requested a fuller version of the on monetary policy with begin his remarks struck by the fact Mr. Hersey, he was quotation. On hearing same
that the statement consisted of two parts, the first of which, "meeting the credit needs of a vigorous and growing economy," reflected a point made by Mr. Koch today. The second part, relating to the prevention of "excessive credit flows that could carry the pace of expansion beyond prudent speed limits," had been cited by Mr. Hersey and reflected a point the latter had emphasized. Retrospectively, Mr. Ellis continued, while the System's rate action in December had usefully allowed more realistic rates in relation to credit demands, the Committee's action in temporarily de-emphasizing reserve targets had facilitated a sharp expansion of reserves and credit in magnitudes that certainly strained the concept of "prudent speed limits." Looking ahead, Mr. Ellis said, some of the path was marked by the economic message and the budget. From the monetary viewpoint, one of the most important decisions was to forego tax rate increases in favor of accelerating tax payments. To the extent that such acceleration would have any restraining effect on total spending, it had to influence the taxpayers, both individuals and corporations, to forego spending they would otherwise have undertaken. While might well reduce their takings by amounts roughly individuals equivalent to the accelerated payments, corporations might well seek to hold to pre-established plans by borrowing funds to replace cash positions. That alternative means of financing tax-drained
Federal outlays clearly threw additional burdens onto monetary policy. It involved an increment of borrowing in an economy that apparently was already being stimulated by a budget more stimulative this calendar year than last. In sum, fiscal restraint seemed more of a goal than a present likelihood. Clearly, Mr. Ellis observed, the need to distribute the new securities issued in the recent Treasury refunding suggested no immediate shift in monetary policy. But once the new issues had been distributed the market would be watching closely to identify the emerging posture of policy. As he listened to Mr. Holmes' report today, he got the impression that the market was waiting for the other shoe to fall. It appeared appropriate to delay no longer than absolutely necessary in recovering to at least the posture the Committee held before December, as a basis for future moves. Mr. Ellis thought that the most critical long-range facing the Committee was in deciding how much policy choice short-term targets of policyemphasis to place on alternative rates, or reserve growth. market conditions, interest money that the Committee never completely Experience suggested but it often elevated one to abandoned any one of the three; few months it had and in the past relative importance, greater rates. In the present emphasis on relatively greater placed
context, he believed interest rates should not be accepted as a principal object of policy. Changed and changing price expectationsfrom an expectation of a 2 per cent annual rate of increase to one of perhaps 2.5 or 3 per cent--coupled with foreseeable expansion in credit demands, suggested that the 1/2 point rise in short-term rates since November might not represent a completed adjustment to the new situation and outlook. However important interest rate objectives might properly become at some points in time, at present they did not serve as adequate substitutes for direct attention to the pace at which reserves were being created in relation to the economy's need for credit expansion. In his judgment, the Committee should move to restore "moderated reserve growth" as a prime target to guide the Manager's operations. In that context, Mr. Ellis found helpful the suggestions memorandum and Mr. Holland's letter in both Mr. Robertson's recent started with the objective of to Mr. Galusha. Both proposals reserves concept as a target the use of the net borrowed improving might challenge its present However much the Committee of policy. "expected demand for required capacity to determine the technical it remained true that in and deposits" on a weekly basis, reserves Manager was required to seektimes of rising demands the Account trends and money market conditions-- other constraints of rate within
to meet in full all demands in excess of such expectations for reserve expansion, in order to achieve on average a target range of net borrowed reserves. As one alternative, Mr. Ellis commented, Mr. Robertson suggested that initially, at least, the Manager not meet any such demands for required reserves when they rise at a "faster than anticipated pace." Instead, he would allow net borrowed reserves to rise to the upper limit of a target range--$200 million at present, for example. Mr. Holland's approach would be to supply decreasing proportions of the desired reserves when their growth exceeded expected rates. Both approaches would (1) rely more on borrowed reserves; (2) allow more fluctuation in net borrowed reserves; greater fluctuations in bill (3) presumably result in somewhat responses to underlying shifts of rates; and (4) provide quicker trend. His personal preference would be for the Holland alternative, apply to the whole range of reserve variationsbecause it would the amount within a preselected range--and it might not just of the Committee's target. facilitate more gradual adjustment attention from a target figure to It would avoid simply shifting a target range. obviously was not going to adopt Since the Committee today, Mr. Ellis said, he either of the suggested alternatives directed to probe toward a deeper would urge that the Manager be
level of net borrowed reserves when the market settled down from the current refunding. His own choice of target would be net borrowed reserves of $150 million, with the expectation that variations around that target would fall within plus or minus $50 million, as had been true on average during 1965. The major objective of moderating the pace of reserve growth was clearly described in the first paragraph of the directive. In the second paragraph he would avoid any effort to specify subperiods, and he favored language along the lines of that suggested by Mr. Shepardson. Mr. Balderston remarked that he was pleased by the unanimity of views on policy this morning, even though the circumstances from which it stemmed were not comforting. The economy was in a wartime boom and risking uncontrolled escalation unless restraint, both monetary and fiscal, was applied without delay. Many of the Committee members had noted that because were being built in the expectation of plant and inventories upon the pyramiding of war orders and enlarged demand based to push steadily upward. buying, prices were tending private hard against its resourcesthe economy was pressing In short, unemployment rate about the and other--with the over-all human 1957, and with the of 1956 and early same as in the expansion 2.3 per cent and of married adult men unemployed at precentage of
men at 1.8 per cent. Farm land values continued to advance; the national average rose 6.6 per cent in the year ending November 1 last. There was no substitute for real restraint that bit, especially at a time when a portion of bank credit was being used for speculative purposes and for the promotion of such activities as mergers, take-overs, and similar ventures. Reflecting current ebullience, Mr. Balderston said, January trading on the New York Stock Exchange stayed at the high level of last fall, with common stock prices rising further. The volume of daily transactions during the first three weeks of January was above the historic peak of 8.7 million shares reached in December. Since July 1965, net debit balances had risen $660 million; or 13-1/2 per cent, which about offset the decline in that form of stock market credit between the November 1963 change in margin requirements and July 1965. Not only had margin buying expanded but one could not help but suspect that credit for the buying of stocks was being obtained through bank loans mortgages. There was something reminiscent and the resetting of exuberant reception accorded the of American Founders in the situations reflected the Fund. Its focus upon special Manhattan mood of the moment. to say that two types of increased Mr. Balderston went on credit and of the underlying in the use of bank efficiency
reserves might tend to offset such braking of bank credit expansion as the System sought to apply between last spring and the December change in the discount rate. Since then, availability had not been curbed visibly, at least by the central bank. The two efficiencies were the increased turnover of demand deposits and the greater reliance on Federal funds. The turnover rates in 1965 were 12 per cent higher than in 1964 outside of New York City and 13.7 per cent higher within it. The second type of efficiency that influenced reserve utilization was resort to the Federal funds market. In addition, the use of reserves had been altered since earlier periods of bank credit restraint, such as those of 1957 and 1959, by changes in the deposit mix. Although total reserves rose last year at an annual rate of 5.2 per cent, time deposits--against which the reserves required were only 4 per cent--rose at an annual rate of 16.3 per cent. The mix of time and demand deposits had altered markedly since earlier periods when restraint was called for. That might bank credit, as reflected by total member bank explain why deposits, rose last year by 9.1 per cent and the money supply cent while the System was intending to apply restraint. by 4.8 per to Mr. Balderston that the time had come to It was clear net borrowed reserve figure substantially as soon as deepen the the current financing. He would hope that well feasible after
before the next Committee meeting the net borrowed reserve figure would rise above $150 million, with subsequent targets substantially larger. When resources were being used fully, as they were now, it was appropriate to force banks to get more of their reserves through borrowing at the Reserve Banks. He shared the view expressed so generally at this meeting that there was no time to lose; in fact, the bus might already have been missed. Chairman Martin commented that in his judgment the System had performed quite well over the past few months. The Committee should not lose sight of the fact that economic pressures had been mounting steadily. Various impediments to the free flow of funds had had to be removed, and when the System took the rate actions of December it was clear that a difficult money market operation would be involved. All it all, the System had come through that operation quite well. Now some people were beginning to say not that the actions were wrong but that they should have gone further. At present, the Chairman continued, the Committee ought to be reasonably cautious about keeping the flow of funds as The experience with the current Treasury orderly as possible. uncertainties of the current period. refunding was typical of the of last week--it appeared as if the For a time--about the middle refunding might be a failure; but it turned out to be substantially,
although not overwhelmingly, successful, despite the fact that the subscription books happened to be opened on the day the President announced the resumption of bombing of North Viet Nam. Unfortunate coincidences of that kind were likely to reoccur for some time to come, and the more orderly the Committee could make any adjustments the better it would be. As to the directive, he would have read the staff's draft as giving the Manager sufficient latitude to accomplish that objective, but perhaps the language should be made more specific. There followed a discussion of possible alternative wordings of the second paragraph of the directive, in the course of which Mr. Wayne suggested instructing the Account Management to move toward somewhat lessened reserve availability, rather than toward firmer money market conditions. Although he personally did not feel strongly about the matter, the former type of instruction to reflect the sense of today's discussion better. would seem Mr. Wayne also suggested that the move should be called for in the period "with appropriate regard for the current Treasury coming of members concurred in Mr. Wayne's financing." A number a suggestion that the reduction in proposals, and there was be described as "gradual." to be sought should reserve availability that the present was a period Chairman Martin remarked "color, tone, and feel" based largely on the in which operations
of the market would seem appropriate, although as a rule he did not particularly care for those terms. Under existing circum stances it might be difficult to achieve a gradual adjustment, but it would be desirable to make it as gradual as possible. He then asked Mr. Holmes if the Committee's intentions were clear. Mr. Holmes replied affirmatively. As he understood it, when considerations relating to the Treasury financing permitted, the Committee would like to have net borrowed reserves move back gradually to about where they were before the December discount rate action, recognizing that the market atmosphere now was somewhat different. While the objective might be difficult to reach, the desired course was clear. He added that he would interpret the references to the conclusion of the Treasury financing to take into account the aftermarket. Mr. Hickman asked whether the Manager would propose not to initiate a change until after any churning in the market had ended. Mr. Holmes replied that his course would depend on was related to the refunding, as best whether or not the churning If the churning appeared to be related as he could interpret it. he would not postpone firming action. to other developments Thereupon, upon motion duly made and seconded and by unanimous vote, the Reserve Bank of New York was Federal authorized and directed, until otherwise directed by the Committee, to execute in the System Account in transactions accordance with the following current economic policy directive:
The economic and financial developments reviewed at this meeting indicate that the domestic economy is expanding vigorously, with prices continuing to creep up and credit demands remaining strong. Our inter national payments continue in deficit. In this situation, it is the Federal Open Market Committee's policy to resist the emergence of inflationary pressures and to help restore reasonable equilibrium in the country's balance of payments, by moderating the growth in the reserve base, bank credit, and the money supply. To implement this policy, System open market operations until the next meeting of the Committee, with appropriate regard for the current Treasury financing, shall be conducted with a view toward a gradual reduction in reserve availability. Mr. Shepardson commented that over the past several months some members had felt that the Committee should be moving toward reducing the rapid rate of credit expansion. Others had felt to slow the expansion should be made until certain that no attempt had occurred. Those developments had come to pass; developments to him that the hesitancy to move earlier meant and it seemed when everyone recognized the existence of real pressures, that now, move less gradually than otherwise the Committee might have to would be that since those possible. His own hope might have been the Committee would not now were definitely apparent, pressures them. He recognized that a manner in meeting act in too gradual to be considered, but it would Treasury financing had the current a constraint for long. not constitute
Mr. Mitchell agreed, except that he noted that conditions in the money market had been disorganized during the recent period the market even yet had not settled down. and that Chairman Martin commented that it was desirable to get as smooth a flow of funds in the money markets as possible so that when an adjustment was made it would not prove disruptive. that in carrying out today's policy decision for a He hoped as much stability as it move the Desk would maintain gradual the Committee would have By the time of the next meeting could. of which it could decide whether more information on the basis a further policy change was indicated. that the next meeting of the Committee It was agreed 1, 1966, at 9:30 a.m. be held on Tuesday, March would Thereupon the meeting adjourned. Secretary
ATTACHMENT A CONFIDENTIAL (FR) February 7, 1966 Draft Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on February 8, 1966 The economic and financial developments reviewed at this meeting indicate that the domestic economy is expanding vigorously, with prices continuing to creep up and credit demands remaining strong. Our international payments continue in deficit. In this situation, it is the Federal Open Market Committee's policy to resist the emergence of inflationary pressures and to help restore reasonable equilibrium in the country's balance of payments, by moderating the growth in the reserve base, bank credit, and the money supply. In light of the current Treasury financing, System open market operations until the next meeting of the Committee with a view to maintaining about the same shall be conducted in the money market as have prevailed in recent weeks. conditions
Also: Record of Policy Actions