September 13, 1966

September 13, 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, September 13, 1966, at 9:30 a.m. PRESENT: Mr. Martin, Chairman Mr. Hayes, Vice Chairman Mr. Bopp Mr. Brimmer Mr. Clay Mr. Daane Mr. Hickman Mr. Irons Mr. Maisel Mr. Mitchell Mr. Robertson 1/ Mr. Shepardson Messrs. Wayne, Scanlon, and Swan, Alternate Members of the Federal Open Market Committee Messrs. Ellis, Patterson, and Galusha, Presidents of the Federal Reserve Banks of Boston, Atlanta, and Minneapolis, respectively Mr. Holland, Secretary Mr. Sherman, Assistant Secretary Mr. Kenyon, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Molony, Assistant Secretary Mr. Hexter, Assistant General Counsel Mr. Brill, Economist Eastburn, Garvy, Green, Koch, Mann, Messrs. Partee, Solomon, Tow, and Young, Associate Economists System Open Market Account Mr. Holmes, Manager, Assistant to the Board of Governors Mr. Fauver, Division of Research and Mr. Williams, Adviser, Board of Governors Statistics, the point indicated. the meeting at 1/ Entered

Mr. Reynolds, 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 Mr. Lewis, First Vice President, Federal Reserve Bank of St. Louis Messrs. Eisenmenger, Ratchford, Brandt, Baughman, Jones, and Craven, Vice Presidents of the Federal Reserve Banks of Boston, Richmond, Atlanta, Chicago, St. Louis, 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 action taken by members of the Federal Open Market Committee on September 9, 1966, amending paragraph 2 of the authorization for System foreign currency operations to read as follows, was ratified: Open Market Committee directs the Federal The Federal Reserve Bank of New York to maintain reciprocal currency arrangements ("swap" arrangements) for System Open Market the following foreign banks, which are among Account with by the Board of Governors of the Federal those designated under Section 214.5 of Regulation N, Reserve System and Bankers, and with the Relations with Foreign Banks to renew such arrangements on approval of the Committee maturity:

Amount of Maximum Arrangement Period of (millions of Arrangement Foreign Bank dollars equivalent) (months) Austrian National Bank National Bank of Belgium Bank of Canada Bank of England 1,350 Bank of France German Federal Bank Bank of Italy Bank of Japan Netherlands Bank Bank of Sweden Swiss National Bank Bank for International Settlements (System drawings in Swiss francs) 200 Bank for International Settlements (System drawings in authorized European currencies other than Swiss francs) Before this meeting there had been distributed to the members of the Committee a report from the Special Manager of the System Open Market Account on foreign exchange market conditions and on Open Market Account and Treasury operations in foreign currencies for the period August 23 through September 7, 1966, and a supplemental report for September 8 through 12, 1966. Copies of these reports have been placed in the files of the Committee. In comments supplementing the written reports, Mr. MacLaury he would first like to summarize said that, on Mr. Coombs' behalf, negotiations that preceded the public announcement today briefly the in the System's reciprocal credit facil of the $1.7 billion increase ities, from $2.8 billion to $4.5 billion. (A copy of the press

announcement, dated September 13, 1966, has been placed in the files of the Committee.) At its last meeting the Committee had authorized Mr. Coombs to negotiate an enlargement of the network subject to the understanding that negotiations were not to proceed until the Board of Governors had received specific notification from the Secretary of the Treasury that the proposed program was fully consistent with United States international financial policy and that the timing was appropriate. While the Treasury had initially expressed sympathy with the Special Manager's proposal simply to negotiate large increases in the swap lines, subsequently the proposal was altered by grafting on additional elements involving direct credits to the U.K. by other central banks. The Special Manager strongly opposed this alteration since he was convinced that it would greatly increase the resistance of the Europeans to the package. Whereas the System's partners in the swap network were prepared to go along with large increases in the reciprocal credit lines with the Federal Reserve, reluctant to increase their direct aid to the they were exceedingly the need to negotiate an additional U.K. at this time. Moreover, credits involved from the start cutting back $400 million of direct could be negotiated in the System's size of the increases that the from the $5.2 billion the potential total network, thus reducing swap the United States sacrificed contemplated. In effect, originally the sake of a temporary three protection for the dollar for permanent available directly to the U.K. month increase in facilities

As anticipated, Mr. MacLaury continued, the negotiations were difficult in the extreme. Although in the end the package did prove negotiable, the Special Manager believed that the frictions caused by the efforts to raise the $400 million in direct credits to the U.K. cost the U.S. and international financial cooperation more than had been gained by that temporary contribution. One "cost" to the U.S. became apparent immediately. Whereas in the past all increases in the swap lines had been considered by both parties to be more or less permanent additions to the network, on this occasion a number of the continental countries had specified that the increases were to be considered only temporary. That was notably the case with the Netherlands and Belgium, both of which specified that the $50 million increases in their lines were not to be considered automatically renewable in December. In part, that attitude simply reflected the desire of those smaller countries to subject the surveillance in Working Party 3 United States to closer multilateral of Ten where their voices carried greater weight than or the Group negotiations. Italy and Germany also indicated that in bilateral their lines ($150 million each) were to the respective increases in with the Netherlands and a term of six months. In contrast have prepared to rely on the Italy and Germany seemed Belgium, however, procedures that now took place less formal multilateral surveillance therefore, Mr. Coombs believed meetings. At the moment, at the Basle

that the increases in the swap lines with the Bank of Italy and the German Federal Bank could be renewed at maturity without undue difficulty. If the Dutch and the Belgians insisted on subjecting the $50 million increases in their lines to formal multilateral surveillance procedures, Mr. Coombs believed the System should simply not ask for their renewal. That issue, of course, did not have to be resolved at the moment. Turning to recent developments in gold and the exchange markets, Mr. MacLaury reported that the Treasury gold stock would remain unchanged this week. As things stood now, the Stabilization Fund did not have enough gold on hand to meet anticipated sales during the remainder of September if France converted its August amounted to $45 million prior to their $49 million dollar gains--which payment to the International Monetary Fund--into gold subscription gold. There was a chance that the U.K. might sell the U.S. additional uncertain at the moment whether there would be a gold, so it was drop in the stock this month. With respect to the London gold market, had not improved noticeably since the last meeting. Demand conditions the price not far below $35.20, and Communist remained steady with as a buyer, although in very small amounts thus China had reappeared the tapering off during the One helpful development had been far. gains, with the result or so of South African reserve past month of new production had been available to the that a larger proportion

market. Nevertheless, the gold pool had continued to lose small amounts fairly steadily. As arrangements stood prior to the recent negotiations, there would have been less than $60 million still available to the pool from the participating central banks. At the meeting in Basle two weeks ago, however, it was agreed to increase the total amount of the commitments by $50 million to $320 million, with a possible further $50 million increase available if needed, after further consultation. In general, it was fairly clear that high interest rates had been an important factor in keeping private demand for gold lower this year than last. Any falling off of interest rates, therefore, could be expected to lead to an increase in demand for gold. Mr. MacLaury commented that tight credit conditions and high interest rates, particularly in the Euro-dollar market, had also had a significant impact on the exchange markets. The dollar had shown surprising strength against most major currencies despite the continuing U.S. payments deficit, precisely because private foreigners had had a substantial interest incentive to hold on, for the time being at least, to the dollars they earned. That strength not only in exchange rates but in foreign central was reflected For example, for the first time in a number of bank intervention. France had actually sold dollars to support the years the Bank of the past few weeks. Similar support operations franc in Paris during

by the Belgian National Bank caused it to buy $20 million from the Federal Reserve against francs, thus enabling the System to repay that amount of the $30 million drawings previously outstanding under the Belgian arrangement. On the other hand, Italian reserve gains this summer, while smaller than anticipated, had nevertheless been substantial; and on September 2 the System again drew $100 million under the arrangement with the Bank of Italy to absorb part of their recent accruals. Although the attractiveness of foreign interest rates had also been a factor in sterling's continued weakness, Mr. MacLaury observed, the causes in that case, of course, went much deeper. Despite the drastic measures announced by Prime Minister Wilson in had been no return of confidence, and the Bank of late July, there England had to provide further support during August. The actual drain on British reserves in August amounted to about $300 million. The announced reserve decline was $53 million, with foreign credits making up the difference, plus the refinancing of earlier month-end The U.S. Treasury provided $400 million of the refinancing credits. on the basis of an overnight credit at the end of August, and the million under the made available $100 million--$50 Federal Reserve swap arrangement, bringing the U.K. total drawings to $300 million, and $50 million on an overnight basis. It was hoped that today's announcement showing that the U.K. still had available more than

$1 billion under its expanded facility with the System, plus additional credits from other central banks, would help turn market sentiment and stem the continuing erosion of recent weeks. In any case, the announcement of the very large general increase in Federal Reserve reciprocal credit lines should do much to insure market confidence in the ability of monetary authorities in general and the U.S. in particular to deal with speculative threats to their currencies. In concluding, Mr. MacLaury said that he would like to call one other matter to the Committee's attention--a $75 million drawing on August 30 by the Bank for International Settlements on with the System providing for swaps against European its facility than Swiss francs. As the Committee was aware, currencies other had had a $25 million gold loan facility for some years the System short-term dollar drains. From BIS to permit financing of with the swap line with the BIS was less clearly its inception the System's lines and, for that reason, he two-way street than its other swap a to have the BIS employ the facility. thought it was useful special tribute to the said he would like to pay Mr. Daane way in which he had conducted the recent Special Manager for the did not give the full flavor Mr. MacLaury's account negotiations; faced nor of the skill he had of the difficulties Mr. Coombs had exercised in negotiating the package. In spite of his (Mr. Coombs')

reservations as to the appropriateness of some elements of the package, he had carried out his instructions to the letter. Mr. Daane observed that to some extent he shared Mr. Coombs' feeling that a Pyrrhic victory might have been won in persuading the Europeans to extend $400 million additional direct credits to the U.K. One cost was that the enlargement of the System's own network was smaller than it might otherwise have been; and a second, longer run, cost was that the System had been brought one step closer to more formal multilateral surveillance for the entire swap network. At the same time, Mr. MacLaury's report might not have done full justice to the rationale of seeking the direct credits to the U.K. It was not simply a matter of getting $400 million more assistance to the British; the main objective was to make the new assistance rather than have the U.S. take a unilateral package multilateral, action. Mr. Brimmer agreed with Mr. Daane that the System probably was moving in the direction of greater multilateral surveillance, he hoped that could be avoided. In any case, he wondered although WP-3 was the best group for that purpose. WP-3 was originally whether forum. If basic questions of established as a purely technical discussed the Committee might want international policy were to be to the appropriate forum. to give some thought the August, 1964 report of the Mr. Daane commented that in the preparation of of the Group of Ten, Governors and Ministers

which the U.S. had participated, quite clearly assigned a multi lateral surveillance role to WP-3, although it did so in the expectation that the surveillance would be more informal than that which now appeared to be developing. Thus, in a sense that bridge had been crossed some time ago, although not necessarily correctly. At the same time, that report also assigned a surveillance role to the Basle group, as was noted in the Ministers' and Governors' more recent report, of June 1966. Mr. Hayes noted that there had, in fact, been a substantial amount of multilateral surveillance at Basle. Moreover, it was the distinct wish of a majority of Governors attending the Basle meetings to confine surveillance to their group. Thereupon, upon motion duly made and seconded, and by unanimous vote, open market transactions in the System currencies during the period foreign August 23 through September 12, 1966, were approved, ratified, and confirmed. Mr. MacLaury then noted that a $50 million drawing by the System would mature on on its swap line with the Bank of England for a further period He recommended its renewal September 30, 1966. so requested. That would be months if the Bank of England of three a first renewal. Renewal of the Bank of England's was noted without objection. drawing two $50 million System drawings Mr. MacLaury reported that Bank and the Bank for francs, on the Swiss National of Swiss

International Settlements, respectively, would mature on October 13, 1966. He recommended their renewal for a further period of three months if no opportunity arose for their repayment in the interim. Both would be first renewals. Renewal of the two Swiss franc drawings was noted without objection. Before this meeting there had been distributed to the members of the Committee a report from the Manager of the System Open Market Account covering open market operations in U.S. Government securities and bankers' acceptances for the period August 23 through September 7, 1966, and a supplemental report for September 8 through of both reports have been placed in the files of 12, 1966. Copies the Committee. In supplementation of the written reports, Mr. Holmes commented as follows: Since the Committee last met the capital markets have passed through a state of near disorganization with prices Government, corporate, and municipal bonds declining of precipitously until August 30. On that day, following a statement by a Treasury official that was generally interpreted as foreshadowing a change of Administration on fiscal policy, a sharp and sustained rally thinking that brought yields on intermediate- and long took place term bonds back below where they had been three weeks hectic daily swings in prices and yields have ago. The spelled out in some detail in the regular written been reports to the Committee and I will not dwell on them here. The President's announcement of a new anti-inflationary program, involving both fiscal and debt management policy, at the close of business last Thursday, came at a time when the market rally was running out of steam. In general,

after some initial skepticism, there was a favorable psychological reaction in long-term markets. This reaction was based mainly on relief that the Government had rec ognized the seriousness of inflationary pressures and the pressures of agency financing on financial markets. While the President's program was generally considered a step in the right direction, there were many questions in the market as to its adequacy and its eventual impact on spending decisions, both Governmental and private. Most market participants felt that the program was not forceful enough to warrant any early change in Federal Reserve policy, although many also felt that the System had again been put squarely on the political hot seat. The Board's statement of September 7 was generally interpreted as a reaffirmation of the System's policy of restraint, although there are a number of observers who will be watching closely for any evidence of easing in System policy. At the moment, the long-term markets are in better shape than they were three weeks ago. The risks of panic have greatly diminished, although major uncertainties remain and the market will continue to respond to devel opments in Vietnam and elsewhere in the international sphere. The municipal market benefited also from the Board statement on discount window administration, which was generally interpreted as tending to discourage bank sales of municipals. The corporate market may again come under pressure later, particularly if bank credit to business borrowers is significantly curtailed, but a better atmosphere prevails for the time being. In contrast to the situation in long-term markets, rates remain under pressure. Banks and cor short-term porations both have liquidity problems which are likely to be keenly felt over the tax and dividend dates. with the heavy volume Banks have a particular problem CD maturities and we are getting close to another of period at savings institutions at a interest payment rates are higher than at the end of time when market June. There has been little evidence yet of any large window on the part of scale recourse to the discount center banks which have moved into deep basic the money caused in part by heavy Treasury deficit--a deficit tax and loan balances. On the other hand, calls on moved to an effective rate of the Federal funds rate with a heavy volume of 6 per cent last Wednesday and, on Friday, to an trading at 6-1/8 per cent

effective rate of 6-1/8 per cent with a fair volume at 6-1/4 as well. As a result of pressure on the banks, dealer loan rates have moved into the 6-3/8 - 6-5/8 per cent range with loans simply not available at some banks. In the Treasury bill market a heavy atmosphere prevails and rates have penetrated into new high ground. Dealer bill inventories are higher than they have been in some time as the result of bank selling, particularly of the new tax bills sold by the Treasury in late August. Bidding in yesterday's auction was very skittish and the average issuing rates set on the new three- and six-month bills were about 5.45 and 5.93 per cent, respectively, up 43 and 52 basis points from the rates set three weeks ago. The Treasury's press conference on Saturday on the probable course of agency financing over the test of the calendar year implies, of course, a much higher level of direct Treasury borrowing than had been expected earlier this year, and this has been a major longer-run factor contributing to yesterday's higher Treasury bill rates. It is, of course, impossible to pinpoint at this moment what will be added to the Treasury's borrowing needs. Regular Treasury spending has been running on the high side of late, and a estimate of the new spending restraint, quantitative the timing of it, is hard to come by. and particularly FNMA and Export-Import Bank sales The suspension of may add as much as $2 of participation certificates billion to direct Treasury borrowing and the limita tion on net market borrowing by all Government agencies to the replacement of maturing issues will add another substantial amount. The new financing approach should provide, over more orderly marketing of debt, but it will all, a great ingenuity on the debt management still require At this juncture, we can only hope that agency side. be pared back, but plans to financing programs can market and the reduced cash flows assist the mortgage and loans institutions may make this hard of savings accomplish. For the System, the new financing to probably involve more important even approach will keel considerations over the rest of the year, although can be said about this until a financing not much schedule can be worked out.

At the moment, of course, the Treasury is running with a very low cash balance. Deposits at the Federal Reserve Banks are estimated at only about $200 million tomorrow and uncalled balances at commercial banks are at a minimum. Our best estimates are that the Treasury can just barely avoid borrowing directly from the System through an adroit juggling of its commercial bank deposits, but even a normal miss in the day-to-day estimates could lead to an overdraft in the next few days. Given the increase in Treasury cash needs it is likely that the Treasury will be running with lower than usual cash balances over the remainder of the year and this could lead to recurring problems in this area. As far as open market operations are concerned, the System has provided reserves over the past three weeks to offset the reduction in float brought about by the settlement of the airlines strike and the pre-Labor Day drain of reserves. The state of near disorganization of the Government securities market also required attention and a large volume of Treasury bill purchases was necessary early in the day on Monday, August 29, in view of the nervous conditions then prevailing in the market. With the improvement the afternoon of August 30, an effort in atmosphere on was made to recapture redundant reserves through the sale-purchase transactions which execution of matched to be a very useful tool. As a result, again proved the net borrowed reserve figure published for the week ending August 31, $422 million, was well within the it was subsequently revised sub recent range, although Since then money market conditions stantially lower. have continued to be tight with Federal funds, dealer Treasury bill rates moving higher, as loan rates, and indicated earlier. The current statement week, ending tomorrow, has skewed intra-weekly patternbeen plagued with a highly net borrowed reserve figures prevailing with very high turning into substantial free reserve before the weekend, post-weekend ease was thereafter. Much of the figures from the sharp decline in Treasury expected to develop the market, of Reserve Banks, and balances at the that this would occur. course, had no way of knowing weekend anticipating a a result we went over the As net borrowed reserve figure relatively low average

after doing a token amount of RP's on Friday in light of the pressures on the money market, but with the expectation that we could mop up any redundant reserves today and tomorrow through matched sale-purchase agree ments. The high level of borrowings at the Reserve Banks over the weekend ($1-1/4 billion) should help lead to easier money market conditions that would facilitate these operations if they prove to be necessary. I should add that Friday's RP's were made at the discount rate. We thought it prudent not to undertake any innovation that could lend itself to misinterpretation at the present time. Throughout the period since the Committee last met, required reserves have been falling short of estimates, of growth of the credit proxy have been and estimates marked lower. As the blue book 1/ sets forth, August saw a decline of about 2-1/2 per cent in the credit proxy and the Board staff September estimates now indicate little or no growth, compared with a 6 per cent estimate at the time of the last meeting. Current estimates at the New York Bank are now in the 2-4 per cent range after making allowance for growth in foreign branch balances. I should note that some unusual problems had to be faced in yesterday's hectic Treasury bill auction. Normally our problem is to compete with other bidders to make sure the System can roll over its maturing holdings. Yesterday, in contrast, the problem was to redeem at least part of the $359 million Treasury bills maturing September 15 without leaving the auction uncovered at anything like a half-way reasonable rate. As my supplementary report indicates, bids were submitted for both the 3- and 6-month bills at a wide scale of prices. The report notes that on the basis of indications the System had apparently redeemed preliminary Final results indicated that the redemption $100 million. amounted to $119.6 million, which will be of at least some reserves in the statement week ending help in absorbing September 21. Looking ahead for the next few weeks, estimates indicate that we will have a substantial reserve absorption job to Market and Reserve Relationships," 1/ The report, "Money for the Committee by the Board's staff. prepared

do in the week ending September 21 at a time of peak tax date pressures and with the Treasury's cash position in a precarious state. Following that week, until the Committee next meets, we will be supplying heavy seasonal reserve needs. Some of the potential problems of the period ahead are spelled out in the blue book. I do not believe it possible to spell out in advance how things will turn out, but open market operations may very well have to be conducted with as much flexibility as the Committee's over-all policy position can allow. Mr. Scanlon asked whether the Manager planned to continue making repurchase agreements at the discount rate. Mr. Holmes replied he would prefer not to, since the discount rate was so far below market rates; it would be better to make any RP's at about the three-month bill rate. If Friday had been anything like a normal day he would have made RP's at 5-1/8 per cent, which was about the average rate in the preceding weekly auction. However, in view of the circumstances prevailing then, he had considered it better not to take an action that might be misinterpreted. In response to Mr. Mitchell's question concerning the out bill rates, Mr. Holmes said that much would depend on the look for The market saw little demand nature of Treasury financing activity. hand, rates had now reached a for bills at present. On the other profitably, and that fact some bills could be carried level at which market. He thought the more stability to the might lend a little rates would be stable or would move lower, odds were that the bill that could not be expected view of the many imponderables but in with assurance.

Mr. Daane asked what consequences Mr. Holmes thought would follow if member bank borrowings rose to a much higher level. Mr. Holmes said that it was hard to visualize a large increase in borrowing that did not lead to an immediate easing throughout the whole banking system. Such a development would create problems for open market operations. The situation might tend to be self correcting, with banks repaying their borrowings as money market conditions eased, but it was not clear that that would be the case. In any event, he did not think there would be a large increase in borrowings unless banks changed their attitudes toward the discount window. Such a change was possible, but it had not yet occurred. Mr. Hickman asked if the Desk had talked with the large their ability to roll over maturing CD's New York banks about into October. that the question had been discussed Mr. Holmes replied largest New York City banks. All of quite recently with the seven this month, but only two were a run-off of CD's over them expected felt that the advance preparations actively concerned. The others uncertainties had now adequate, although new they had made were rates. The picture thus the latest rise in bill been introduced by was a mixed one. Wayne, Mr. Holmes said that reply to a question by Mr. In currently were at a rate New York banks as a group CD runoffs at

of about $130-$200 million per week. September 15 maturities were about $550 million at New York banks and about $1 billion plus in the country as a whole. Mr. Hayes remarked that some banks recently had reported that their CD losses had stepped up a bit. Thereupon, upon motion duly made and seconded, and by unanimous vote, the open market transactions in Government securities and bankers' acceptances during the period August 23 through September 12, 1966, were approved, ratified, and confirmed. Chairman Martin then called for the staff economic and supplementing the written reports that had been financial reports, copies of which have been placed distributed prior to the meeting, in the files of the Committee. made the following statement on economic conditions: Mr. Koch Having been away from the office for four weeks, my only excuse for presuming to report to you on the domestic economic scene this morning is that there may be less than usual that I will be misled by transitory likelihood By necessity, I must look at the day-to-day developments. rather than the trees this morning. forest new development, though, that There is one specific to comment on explicitly, and that is the I will have announced by the Administration last week, fiscal program more analysis and, indeed, events even though it will take themselves to specify all of the effects of such a program on the economy. to say, increased fiscal restraint is better Needless and is an important step in the right late than never direction. But important as this current step is, assuming implementation of both its tax and expenditure aspects, its effects are likely to be moderate in amount and spread out in time.

There seem to me three main aspects of the announce ment. First, cuts in Federal spending are likely to be little more than, if even equal to, the increases made by Congress in the President's requested Budget expenditures. Second, the temporary suspension of the investment tax credit privilege may produce marginal cutbacks in business capital spending, possibly rather promptly for such short lead time items as trucks, office equipment, and the like. But its more important impact will likely be in reducing new orders in the booming machinery and equipment industries and possibly some concomitant effects on wage pressures and prices in those industries. The effects of the suspension of accelerated depreciation will no doubt be more delayed than those of the investment tax credit. Third and finally, the sleeper in the announcement, and what might turn out to be its most important revelation, oblique references to continuing and increased is its defense spending. When I left town several weeks ago, the critical element in one's evaluation of economic most as to likely defense spending. prospects was his view in the President's fiscal announcement The sentences Vietnam and defense spending have been the first regarding the subject for some time. official pronouncements on that our earlier estimates on such They suggest been under- rather than over spending have probably estimated. As you will remember, the official Budget off of defense spending projected a leveling document our chart show last winter we about mid-year and in third and fourth quarters of projected increases in the expressed at annual $2-1/2 and $2 billion, respectively, of each of are raising our projections rates. Now we to about $3-1/2 billion. these quarterly increases bases for these increased Other fragmentary in actual defense are the rapid increase projections spending in August, continued increases in defense orders, rises in draft calls. All of this means that and further program is adopted in the President's new fiscal even if week, the over-all Federal as outlined last its entirety will likely continue to contribution to economic activity over the rest of this to a more stimulative position shift unless further tax probably into next year year, and measures are adopted. is now clear that the not for the war, it If it were common to the late economy is showing characteristics expansion. Production of business phases of a business

equipment is now 85 per cent above its 1957-59 average while output of consumer goods is up only 45 per cent. Over the past year, business equipment output has risen 18 per cent compared to 5 per cent for consumer goods. This spring an acceleration of business inventory accumulation was added to the boom in plant and equipment spending. Tight money is producing an even larger and more abrupt drop in residential construction than was considered likely only a few weeks ago. Other consumer spending, though, has picked up again recently as disposable personal incomes have risen, reflecting continuing sharp gains in employment, larger transfer payments, higher wages, and lower tax payments. Prices continue to rise, although still not as sharply as might have been expected in the current state of economic conditions. The pace of wage advances has quickened; witness the recent 5 per cent per year increases for both the airline machinists and the telephone workers. It is probably in part because of the length and of the current economic cycle that lopsided character none of 20 leading economists recently replying to a questionnaire from the New York Times called for more monetary restraint at this time. Indeed, although all that Federal Reserve policy to date had of them agreed a minority of them felt that some been appropriate, easing would now be desirable. The current age and character of the cycle is also a partial answer to the weak stock market, although I suspect that this is due more to the host of uncertainties currently face the saver and investor. Participants that market have also been strongly affected by in the stock interest rates and the developing credit squeeze. rising word on the recent course of prices. There A further that the steam may have gone has been some talk suggesting that, in any case, what rise has been out of the rise and has been due to supply situations in taking place particular areas rather than to excessive aggregate demand. I don't agree. Food prices continue much stronger than had been anticipated. The rise in the industrial component of the wholesale price index has tapered off but it is still too early to judge whether this summer, beginning of a new trend. Prices of some this is the materials have actually declined, but they were sensitive the ones that had shown the spectacular increases earlier

and they are not particularly important in total indus trial costs. Although the labor cost situation in manufacturing continues to be better than it was in the late fifties, the favorable factors of moderate long term wage contracts and stable consumer prices have about run their course. In conclusion, if one could exclude the war, I would be joining the coterie of economists I mentioned earlier in suggesting that with the boom now so old and lopsided we should ride out its lingering and lagging distortions and inflationary effects. But with the war prospects still as disturbing as they are, inflation and even worse distortions in the structure of spending are likely to be our problem for many months, or even quarters, to come. Mr. Reynolds then presented the following statement on the balance of payments: The two main indicators of the U.S. balance of payments position have been pointing in opposite direc tions since mid-year. This has not caused any serious but it has raised some interesting analytical confusion; and has required that this Committee's questions, an "underlying" deficit rather than directive refer to simply to a deficit. basis of calculation there was a On the liquidity deficit in July-August, whereas continued large payments the balance measured by official reserve transactions surplus. The difference resulted swung into substantial from the fact that a few large U.S. banks primarily $1 billion from the Euro-dollar market borrowed more than foreign branches in the space of only two through their of foreign liquid funds improve months. Such inflows settlements balance but do not affect the the official they are regarded as financing the liquidity balance; deficit, rather than as reducing it. liquidity Given these two superficially conflicting indicators, position is one of that the over-all payments a judgment rests on the expectation that the underlying deficit deficit will persist while the recent heavy liquidity liquid funds will slacken. inflow of foreign

Two main considerations lie behind the view that liquid inflows will taper off. First, there is reason to think that the scramble by U.S. banks for Euro-dollar funds is to a large extent defensive and temporary. This is one way in which the banks have been adjusting to increases in reserve requirements and preparing for the possibility of large CD runoffs in September; they are unlikely to want to rely for long on a continuing massive inflow of very short-term foreign money, for which they must pay upwards of 6-1/4 per cent. Second, even if U.S. banks do continue to bid aggressively for foreign liquid funds, it seems unlikely that the supply of such funds to them can long continue even at the August rate, which was only half that of July. Recent flows have been affecting European exchange rates, official reserves, and money markets in ways that will tend to reduce the flows. Also, distrust of sterling, especially in July, greatly stimulated or facilitated flows out of sterling into dollars. A favorable turn in market sentiment towards sterling, of the sort that this Committee and the British authorities are now hoping for and working toward, would tend to reduce or reverse that flow, as happened in the autumn of 1965. For all the other international transactions that together produce the liquidity deficit, the expectation for little net change in the months remains, as before, ahead. The liquidity deficit was at an annual rate of roughly $2-1/2 billion to $3 billion in July-August, or the same as it would have been in the second quarter about the year if there had not been some large, once-for-all of shifting of foreign assets from "liquid" to technically "nonliquid" categories. There may have been some further deterioration on current account since mid-year; the July were very disappointing, with imports up trade figures has probably been an offsetting sharply further. But there of U.S. capital; we know that reduction in net outflows bank credit in July were large. reflows of U.S. In the months ahead, I would expect the trade deterioration to slow down. Exports of raw cotton should since August 1 when the U.S. price have turned up sharply More broadly, demand in foreign markets was reduced. to us is generally becoming even more that are important And some slowing of the import buoyant than before. the economic upswing that is now advance may result from in Japan, and in Italy and France, gathering momentum

which might make those countries less eager to sell here even if aggregate U.S. demand remains excessive. But while there may be only modest further dete rioration on current account, there are also only modest possibilities of further improvement on capital account, even with credit conditions here continuing very tight. So the liquidity deficit may stay in the $2-1/2 billion to $3 billion range for the rest of the year, reduced perhaps by some debt prepayment receipts, but increased perhaps by another waiver of year-end debt service due from the U.K. This would bring the liquidity deficit for the full year to something over $2 billion in the published figures, or more than $2-1/2 billion aside from the shifts of foreign official and international assets from liquid to nonliquid forms. Probably a large proportion of this year's liquidity deficit will have been financed by inflows of private foreign liquid funds. In other words, the official settlements deficit for the year will probably be small, perhaps as small as $1 billion; it was about zero, seasonally adjusted, in the 8 months through August. We will probably have drawn down our gold stock during the year by somewhat more than the $1/2 billion so far used. We will have used up about $1/2 billion of our IMF position, leaving only about $300 million to go before we get into the credit tranches where the Fund would begin to give us specific policy advice. On the other hand, U.S. liquid liabilities to foreign official holders will probably not have increased during the year, and may even have been reduced somewhat. For 1967, international visibility is even more limited than domestic visibility. It will, of course, be very easy to achieve a further deterioration in our payments position. On the other hand, I think it is still barely possible that we might achieve some improvement by recovering some of the ground lost this year on current account. With foreign demand buoyant and inflation abroad widespread, improvement may in some ways be easier from a purely economic point of view in 1967 than it was in the early 1960's. Everything will depend on our ability to bring into better balance with domestic aggregate domestic demand supply potential. Given the opportunities open to us if we do this, and the dangers to our payments position if we do not, I see no case for easing up on monetary restraints until

there is clear evidence that we are in fact well on the road toward making that kind of domestic adjustment. Mr. Brill made the following statement concerning financial developments: The staff reports already presented this morning bring into focus most of the major constraints and imperatives in formulating monetary policy. Mr. Holmes has described the still-nervous state of financial markets, which have been buffeted severely in recent weeks and now have to assess the import of major new fiscal and debt management programs in the midst of a period of peak seasonal banking pressures. The recent behavior of financial markets suggests a policy pre scription perhaps best described as "tender loving care." But Mr. Koch's analysis of the prospects for nonfinancial markets does not hold out much hope in for relief from price pressures, even the short-run with swift passage and implementation of the President's fiscal program. The cumulative impact of monetary restraint is undoubtedly spreading from housing into and by, say, early next year, other expenditure areas, of monetary and fiscal restraints the combination conceivably could produce an economic "over-kill"- if it weren't for the increasing prospect of Vietnam spending. Whatever fears substantially higher may have as to the lagged effect of monetary one on the private sectors of the economy, it restraint to formulate policy now on the would seem dangerous fiscal restraint will be assumption that additional time and magnitude to offset imposed in sufficient further acceleration in defense spending. of international flows for Turning to the import might conclude that whatever improvement policy, one say whatever slowing in deteri (or perhaps I should in our over-all international oration) has occurred measure a function of the balance has been in large been exerting. This on bank credit we have restraint at limiting direct has reinforced our efforts restraint it has increased the attractive bank outflows of capital; investors; it financial assets to foreign ness of U.S.

has encouraged U.S. businessmen to finance abroad a larger share of their overseas investment. Such results of monetary restraint on our international capital accounts have been essential in a period when our current account has continued to deteriorate. Given the still dismal international flow outlook as outlined by Mr. Reynolds, one doesn't see much basis from the international side for easing on the monetary reins yet. Balancing these market, domestic, and interna tional perspectives in an over-all appraisal of policy needs, I come to the conclusion that it is far too soon to be actively moving away from the System's posture of restraint, but that our efforts to maintain restraint should be tempered. Tempering is called for, first to avoid further jolts to financial markets as they try to develop new trading levels appropriate to changes in flows and in expectations that may be engendered by the new fiscal program and, second on the off-chance that our appraisal of fundamental economic conditions and prospects could be wrong, in its assessment of either the strength of demands or of the bite that is resulting from policy actions to date. already circumstances, caution is called for. In these policy posture can probably best be The appropriate as "passive restraint," a policy that described indicators to ease if the source of permits financial the easing comes from the market, but which would maintain pressure if financial indicators suggest strength significantly beyond that now forseen renewed for credit demands at banks or in the capital markets. In the few minutes remaining, I would like to spell out what this posture might mean for the banking and financial indicators we usually follow. At the we have to recognize that several factors, such outset as our new discount administration program and the of new agency issues and Treasury's foreswearing render some of the usual participation certificates, difficult to interpret. For example, a policy indicia to a shallower net borrowed reserve figure decline necessarily mean an easing in monetary policy. would not Indeed, it could well reflect an unwanted tightening, of policy intent, if banks insist on making a failure of portfolio adjustments we wish they the kinds

wouldn't, rather than seeking accommodation at the window at the price of disturbing customer relation ships. Alternatively, a shallower net borrowed reserve figure could signify reduced pressure of credit demands on the banking system as a whole, or that those banks continuing to meet strong customer loan demands are finding resources outside the discount window, either from other banks in the Federal funds market, or from foreign branches, or elsewhere. Conversely, a rise in the net borrowed figure that brought more banks within the purview of discount window administration might be welcomed as the first step toward our objective of achieving some redistri bution of the brunt of monetary restraint, without intensifying the over-all degree of restraint. The ambiguity of alternative marginal reserve figures can be dispelled if interpreted in terms of concomitant developments in Federal funds and other money markets, and in light of the information becoming available on the composition of bank credit growth. But because a particular net borrowed reserve figure can have such widely different analytic meanings, it is not appropriate now as a policy target. We'll probably come closer to our basic policy objectives in this period by keeping our sights on financial prices and aggregate credit figures rather than on marginal reserve measures. In considering let me say just a word about our aggregate targets, September projection for the bank credit proxy and its relationship to the draft directives 1/ submitted by the staff. The projection for September of virtually no growth in the proxy on a seasonally adjusted basis assumes that, on average over the month, CD's would run off by about $1 billion more than the $1/2 billion reduction to be expected on seasonal grounds. It also assumes that Government spending will continue to rise so fast that even with high September tax collections, Government balances will, on average, be reduced about $1-1/2 billion more than seasonal. While the CD run-off to these minutes as Attachment A. 1/ Appended

and the spending of Government balances will likely result in a rapid rise in private demand balances, total bank deposits--the credit proxy--would show very little change for the month. But the shift in deposit structure would produce a substantial rise in reserve needs. Whether the contraction in CD's is held to the $1-2 billion range depends very much on what happens to rates on alternative investments, particularly to Treasury bill rates. The outlook is not encouraging. Treasury financing needs are rising swiftly, and the Board staff's latest estimates of fourth-quarter needs are staggeringly high. As market participants begin to realize this, and take into account that new agency and participation certificate financing is foresworn and direct long-term financing impossible under the 4-1/4 per cent interest rate ceiling, upward pressures on bill rates already evident in recent weeks will increase CD's will become even less attractive. Yesterday's and bill auction suggests that the market is already alert to the Treasury financing dilemma. At what point in the rate structure, and at what of flows, a new balance is struck between bill level guess. The two-way tug of rates and CD's is anyone's relationship cannot be ignored. The bank-customer staff assumed, for the purpose of the blue book, that in the 3-month bill rate into the 5.30-5.40 a rise be consistent with only a per cent range would still run-off in CD's, but this is sheer conjecture. moderate is the danger of too rapid an adjustment Because there rates, bringing with it too rapid a in short-term contraction in CD's, and thereby renewing upward on the long-term markets we have been hoping pressures to shelter, I would urge that the bill rate be given among the money market conditions to a high priority at around current levels, to use the be maintained terminology of draft directive "A." We have to recognize that operating under this directive, in the circumstances postulated of bill to move up sharply and CD's tending to rates tending rapidly, would probably result in increased run off provision, taking operations of the window reserve Desk combined. But we shouldn't get too and the exercised about it, particularly if a larger share

of the reserves than usual comes through the window. Expansion in bank credit over the summer (May through August) has been contained to about a 4 per cent annual rate, less than half the 1965 rate, and August saw an actual credit contraction. Even if an average credit growth rate in the 4 to 6 per cent range is about the appropriate degree of monetary restraint to achieve, there is no need to force the expansion in the one month of September to be held to the nominal amounts now projected by the staff. Certainly, a shift in the public's preference as to the form of bank deposit it wants to hold should not be the occasion to force another contraction in bank credit. The price of orderly adjustments in financial markets and bank credit may be some temporary generosity in reserve provision. Mr. Robertson entered the meeting during the course of Mr. Brill's statement. Mr. Mitchell remarked that he agreed with Mr. Brill's analysis except for the concluding part. It seemed to him that a process of disintermediation by banks was (Mr. Mitchell) accordingly, that the bank credit proxy could be underway and, much concern. To undertake to make allowed to decline without be contrary to the policy bank credit grow would, in his judgment, prepared a statement on been following. He had the Committee had make later in the meeting. point which he would that directives alternative in the two draft Ellis noted that Mr. and firming, with qualifications," labeled "No further A was the extent feasible, with labeled "Firming to alternative B was

qualification." He questioned the accuracy of those labels. In particular, the qualification in A appeared to be directed toward easing, which suggested that three alternatives were contained in the two directives. Mr. Brill commented that he did not read alternative A to call for operations directed toward easing, but rather for accepting any tendency toward ease that might develop in the market. Accord ingly, he did not think it could properly be called an "easing" directive. Alternative B called for firming at the initiative of the System. Mr. Hickman noted that the proviso clause of alternative A ran both ways; it called for further firming if bank credit expanded substantially more than seasonally expected, as well as for easing if credit expansion was no more than seasonal. Mr. Shepardson said he would question the formulation of the second part of the proviso, reading "if bank credit expands no more than seasonally expected, some easing of money market shall be sought." He would prefer language reading conditions "if bank credit expands less than seasonally expected . .. ." Mr. Brill observed that the Board staff expectation was for substantially no change in the credit proxy in September--the range given in the blue book was plus or minus 1 per cent, at annual rates. He personally felt that some increase would be more appropriate to the needs of the economy.

Mr. Mitchell observed that an increase in bank credit was not necessarily appropriate if the economy was being financed outside the banking system. At a time when banks were reducing the degree of their intermediation, a rise in bank credit could mean a tremendous increase in the money supply. Under such circumstances a money supply target would appear more appropriate. Chairman Martin then called for the go-around of comments and views on economic conditions and monetary policy, beginning with Mr. Hayes, who made the following statement: Business developments since the last meeting indicate that the economy is still growing at a rapid rate and is likely to continue to grow at a rate generating inflationary pressures well into 1967. of strength include business plant Important elements and equipment expenditures, rising durable goods order backlogs, and sizable additions to inventories, besides vigorous consumer spending plans and strongly rising government outlays. The only significant area of in the economy continues to be residential weakness but the prospective release of resources construction, does not appear large enough to offset in this sector the excessive pressures generated elsewhere in the the key price measures have economy. While a few of been moving up at a slightly slower pace recently the outlook continues to be than earlier in the year, as cost factors become increasingly inflationary, important. of payments, it appears that As for the balance roughly $2.6 billion deficit averaged the July-August that of the second quarter, annual rate--close to at an special transactions. The major after adjustments for true now for some time, factors, as has been adverse reflecting a very rapid are the shrinking trade surplus, expenditures connected imports, and increased rise in accounts show a Some of the capital with Vietnam. in large measure to due no doubt distinct improvement,

tight credit conditions in this country; and the same conditions have caused a sharp rise in private foreign holdings of dollars, thus bringing important temporary relief to the dollar in foreign exchange markets and mitigating for the time being the drain on our gold stock. A distinct slowing in the rate of expansion of bank credit is noticeable in the statistics available for August and early September. We find considerable evidence, both in the credit figures and in the atmosphere of the credit markets, that the System's restrictive credit policy is at last becoming increasingly effective. Through the first eight months of this year the credit proxy has grown at an annual rate of just over 6 per cent compared with 9 per cent a year ago. Business loans apparently experienced an actual decline in August, whereas their rate of gain in the previous seven months had been 22 per cent. If the August drop is confirmed by the final data, it would be the first monthly decline in business loans since May 1961. Recent developments in the bank credit proxy are likewise encouraging. Our own data suggest a September increase of about 2 to 4 per cent after including foreign branch funds; and this would be on top of a 2 per cent decrease in August, or a 0.4 per cent increase including foreign balances. Money supply also shows a growth rate of only 1.7 per cent for the first eight months of the year. Since our last meeting the credit and capital markets have been marked by convulsive movements and an atmosphere of great uncertainty. At the nadir of the bond market about two weeks ago there is no doubt that the financial community was experiencing growing and genuine fear of a financial panic. This fear seemed to stem mainly from the conviction that credit demands would remain very strong (with corporate and government needs for funds unabated), that fiscal policy was making no contribution toward a dampening of the economy, that the agency financing program was actively stimulating higher interest rates, and that the Federal Reserve System was determined to push its restrictive policy ruthlessly. Under these circumstances, I believe that our System statement had a useful calming effect, while at the same time properly underlining our concern over the rapid growth--at least until very recently--of

bank credit. But of greater benefit to the markets was the news that at long last the Administration was favorable to some degree of fiscal restraint and a more restrained policy with respect to agency financing. I am not convinced that the near-term impact of the proposed fiscal measures will be sufficient or that the specific tax and depreciation measures are either the most efficacious in reducing excessive demand or helpful to the economy in the long run. While there is of course ground for encouragement in the move in the direction of a more restrictive fiscal policy, we must probably accept the likelihood of continued doubts and uncertainty in the money and capital markets. The stock market's sharp decline has in itself greatly exacerbated this uncertain atmosphere. We can be thankful, however, that overexpansion of stock credit does not seem to be a valid concern at this time. In considering policy for the next three weeks, I think we should give considerable weight not only to this general unease in the financial markets but also to the unusual short-term pressures over the next few weeks expected to stem from run-offs of certificates of deposit combined with seasonal tax and dividend requirements and the forthcoming interest payment period for savings institutions. On the international side we must that sterling is still viewed with suspicion, recognize we can legitimately hope for a real turn-around though in sentiment if the current program for strengthening international credit arrangements catches the imagination over the world. All of these of market participants all together with the rather strong current uncertainties, of a slowdown in credit growth, evidence we now have we should not press for a more lead me to feel that It would also seem policy at this time. restrictive in the face of the poor timing to tighten further think that the proposals. I would Government's fiscal try to maintain about the should be instructed to Manager measured mainly by money level of restraint as present leeway to adapt his conditions, with ample market developments. I would to market and credit operations level should be of the net borrowed reserve think that subordinate significance. rate, I believe the System As for the discount in mid-July for a moderate missed a good opportunity rate closer to have brought the increase that would

market realities. In the meantime market rates have risen further, but at the present time, the same factors that argue strongly against any open market policy tightening also argue with equal force against a discount rate rise. I certainly would like to sit back for a little while and observe how effectively the new Administration program is in dampening inflationary expectations. I reach this conclusion even though the period during which we shall be free from even-keel restraints will not last many weeks longer. I would still hope that we could move on the rate before too long. Turning to the directive, I prefer the first paragraph of alternative B to that of A because I think it is too soon to abandon our posture of resisting inflationary pressures and strengthening efforts to restore payments equilibrium. I would be willing to substitute the words "continuing to re strain" for the word "restricting" in the last sentence. For the second paragraph I would propose a new and simplified wording which is probably closer to alternative A than to B but which makes clear our intention to maintain both firm and orderly conditions, with a suitable proviso for unusual liquidity pressures or significant deviations of bank credit from current expectations. Specifically, I would propose the following second paragraph: To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining firm but orderly conditions in the money market; provided, however, that operations shall be modified in the light of unusual liquidity pressures or of any apparently significant deviations of bank credit from current expectations. Mr. Ellis remarked that having reported at the Committee's residential contracting in New England had not last meeting that revealed the slowdown being reported by the banks, he should now report that the data covering July revealed a 43 per cent drop below July 1965. All listed categories of residential buildings had a

smaller contract volume than a year ago, although the 83 per cent drop in apartment house contracts was outstanding. Seasonally adjusted manufacturing activity expanded further in July with most of the rise occurring in the durable goods industries. Preliminary returns in the Boston Reserve Bank's follow-up survey of capital spending by manufacturers in New England confirmed their spring reports which indicated a sharp expansion of outlays. In the days immediately following the Reserve Banks' September 1 letter to member banks concerning business loans and borrowing at the discount window, Mr. Ellis said, he had held con ferences with top managements of each of the reserve city banks in his District. Each gave enthusiastic endorsement to the concept of loan curtailment, and each detailed the efforts it had been extending to such an end. One bank, having run up business loans by the end of April by a total of 20 per cent, had a target of absolute contraction of 10 per cent by year end. None of those banks had borrowed at the for the past three weeks and all were Reserve Bank in any volume the discount window. Each had striving mightily to stay out of to "guesstimate" possible attri analyzed its certificates of deposit to stay out of the discount window. None tion and each had made plans or small, had volunteered that they of the First District banks, large special treatment under to be eligible for any were eligible or sought Borrowings, primarily through the terms of the special program.

Federal funds or CD's, of the eight largest banks ranged in August from a low of 94 per cent of required reserves to a high of 230 per cent. The comparable figure for eight New York City banks, taken together, was 192 per cent. Turning to monetary policy, Mr. Ellis judged that economic events since the Committee's last meeting supported a conclusion that the economy remained tilted toward inflation as it expanded rapidly, with continuing pressures on available resources. The next most of that condition probably would appear in the labor visible signs negotiations of the next several months. arena, Mr. Ellis continued, it was now known In the fiscal that no tax restraint on corporate or individual spending definitely for the rest of this year, although order might be anticipated shorten as the rate of new orders backlogs for new equipment might In that connection, he enjoyed reading the Board was restrained. of the probable effects on the economy of the staff's analysis to suspend the investment tax credit and Administration's proposals In the debt management arena, the accelerated depreciation.1/ should provide more confidence program of Treasury financing revised that the debt would be managed better. to the securities market subject by Eleanor Stockwell of 1/ A memorandum on this staff, dated September 11, 1966, was transmitted the Board's of Governors and the Reserve Bank by Mr. Brill to the Board prior to this meeting, and a copy has been placed Presidents in the Committee's files.

In the monetary arena, Mr. Ellis observed, he would suggest that a one-month decline in the credit proxy and in business loans should not lead the Committee to push the panic button and change its policy. That development should be viewed in a longer-run perspective, including the preceding growth and the further expansion that was virtually assured for September and the rest of the fall. Personally, he was not moved by the fact that there had been a one-month decline. The fiscal program announced by the Administration would not restrain inflation for the rest of the year. Accordingly, he would suggest that this was not the time for the System to ease its policy posture. Mr. Ellis agreed with Mr. Brill that shallower net borrowed reserve figures could have the meaning the latter had suggested. But they also could mean that the Committee had eased policy and was providing reserves a little more freely, and the market was likely to In fact, the staff had projected a September shift so interpret them. with such a surge as to expand demand from CD's into demand deposits faster than in any previous month this year. That obviously deposits in required and total reserves to explained the expected acceleration in contrast to their 7 and 9 per cent, respectively, growth rates of recent Committee meetings He recalled that at other August declines. of how much of the increase been discussion of the question there had made by the Board should be supplied through in reserve requirements there had been no discussion but he noted that open market operations, around the table thus far this morning. of that question

Presumably, Mr. Ellis said, borrowings would have to average in excess of $800 million--perhaps near $900 million--if net borrowed reserves of $500 million were to be achieved. At such a level of borrowing even the largest banks probably would be having recourse to the discount window, and that would enable further conversations about the trend of lending. Mr. Ellis noted that Mr. Koch had referred to three parts of the President's recent message. But there was a fourth part also; namely, the President's request that the Federal Reserve work with the commercial banks to help hold down, or lower, interest rates coupled with action by the Congress authorizing the Federal agencies to regulate savings rates. That made it inappropriate at this time for the System to take the long overdue action of bringing the discount rate into line with related market rates. It would seem feasible, however, to maintain a target of $500 million for net borrowed reserves, hoping that data revisions subsequent to termination of operations would begin to be on the plus as well as the minus side. And, with confidence somewhat restored in the securities market, it should be feasible to attend more to reserve objectives rather than objectives. Rather than backing away from reserve objectives, market cling to them as much as possible in September. the Committee should

Mr. Ellis thought that alternative A of the draft directives contained an unfortunate change of wording at the close of paragraph 1. It spoke of "accommodating moderate growth in the reserve base" when staff projections suggested September growth in total reserves would tie for second place in monthly growth rates this year. The second paragraph called for easing in monetary policy if credit expansion was strictly seasonal or fell short of the seasonal pattern, no matter how shaky might be the ability to construct up-to-date seasonal adjust ment factors. Alternative B kept faith with the System's promise to use monetary policy to restrain inflationary credit expansion, and would be his preference. However, he disagreed with the label put on it; he did not think it was a policy of "firming to the extent feasible," because the Committee could firm much more than suggested by the language of the draft. He would describe it as "firming if credit expansion accelerated." The second paragraph called for "supplying the minimum amount of reserves consistent with the maintenance of orderly money market conditions." That surely should be the Committee's objective; it would not want to supply more reserves than those required to maintain an orderly market. He liked "tempered restraint," and "with tender loving Mr. Brill's phrases, described alternative B. care," and he thought they Mr. Irons commented that most areas of the Eleventh District but probably by a bit less than had advanced over the summer economy

nationally. Employment changes in most categories had been of about seasonal character, although some were above seasonal and some below. Changes in industrial production were relatively minor in the latest month. The total index had shown no significant change in the last few months relative to a year ago, continuing to run at a level 9 per cent higher. Retail trade, as measured by department store sales, rose about 4 per cent during the past four weeks and also continued to run 9 per cent above 1965. Agricultural conditions were highly favorable; farm prices were up 8 per cent over the past eight months, with most of the increase in cattle prices. Rains had been excellent and grazing lands were in the best condition in some time. In the financial area, Mr. Irons said, loans at District banks were down in July and August, with most of the decrease occurring in nonbank financial loans and "other" loans. Commercial and industrial Deposits were down sharply, largely loans had advanced slightly. a decline in Government deposits. Negotiable CD's were because of it was expected that two, or possibly down about $10 million, and be interested in special assistance three, of the largest banks would banks did not appear overly concerned at the discount window. Other borrowing at the Reserve Bank present about CD runoffs. Average at in the latest period, to $42 million from $32 million in was up a bit the preceding period. Banks continued to use the Federal funds make their adjustments, although on any one market most of the time to

day one or more of the large banks might find it necessary to come to the window. On the whole, the increase in both total loans and commercial and industrial loans at member banks and weekly reporting banks in the District had not been as large as nationally. The national economic picture had been covered adequately in the green book 1/ and in the discussion so far today, Mr. Irons said, so he would not dwell on the subject. His general recommendation for policy over the next three weeks would be to maintain the current or recent degree of restraint without attempting to bring about any further intensification, for the several reasons indicated by Mr. Hayes. Mr. Irons believed that the level and movement of interest rates and other measures of market conditions might provide a better guide for policy now than net borrowed reserves, particularly in light of the large revisions in the preliminary figures for the latter recently. Interest rates had already reached extremely high levels and on one or two recent occasions money market conditions were verging on disorganization. In his judgment, further upward pressures restraint on the availability of on interest rates and further to demand were not desirable. There had been some reserves relative in bank credit expansion, and signs recently of a dampening tendency and Financial Conditions," The report, "Current Economic 1/ for the Committee by the Board's staff. prepared

he felt that monetary policy was biting. Banks were under pressure to meet their loan commitments and to reduce the aggregate of their loans outstanding. The System should provide reserves for seasonal loan growth and, possibly, for some nonseasonal growth through open market operations and the discount window. And the System should stand ready to use the discount window to alleviate any unusual pressures arising from CD runoffs or other deposit losses. He would not favor a change in the discount rate at this time and he preferred alternative A for the directive. that while over-all business activity in Mr. Swan reported the latest fragmentary data Twelfth District was still strong the certainly gave no signs of a further upward surge. August employment and Utah--the only two States for which such data data for California available--reflected little change in nonagricultural were as yet employment and a further increase in unemployment. The California increases from the low rate had shown successive monthly unemployment was 5.2 per cent. Aero reached in May, and in August of 4.6 per cent again in August, but only by space employment in California increased July. Lumber and plywood a rise of 8,400 in 2,900 as compared with slipped down again in exceed orders and prices continued to production building contract awards residential and nonresidential August. Both contracts declined only in July. Total construction dropped sharply two very large heavy construction but that was because slightly, were awarded in the month. contracts

With respect to banking developments, Mr. Swan said, total credit at weekly reporting banks increased in the two weeks through August 24, but the rise was due entirely to an increase in security holdings. Loans were down; indeed, business loans had declined for five consecutive weeks, and preliminary figures for the week ending August 31 suggested another decline. There appeared to be a little tightening in the reserve positions of the major banks recently, with some increase in borrowing at the Reserve Bank in the last week of August and the first week in September, but the rise certainly had not reached what one would call major proportions. As to policy, Mr. Swan said his views were much the same as those he had expressed at the preceding meeting. He liked Mr. Brill's phrase, "passive restraint," In view of the lack of increase in and reserves in August, the market uncertainties that bank credit existed, and the current attempt to assess the Administration's still the Committee should again seek it seemed to him that fiscal program, the present money market conditions--recognizing to maintain about reserve figures could indicated, the net borrowed that, as had been the factors affecting them. He vary considerably depending upon flexibility in day-to-day would allow the Manager considerable be given to short-term interest with some attention to operations, as well as in the marginal While movements in aggregates rates. he would leave room for a measures should be considered, reserve

considerable margin in the outcome. Despite the change in the staff's projection of the bank credit proxy for September, he thought that an increase on the order of 5 or 6 per cent, such as had been anticipated three weeks ago, was still a fairly reasonable limit before some positive action should be taken. That conclusion led him to favor alternative A for the directive, at least if it was inter preted in the sense of its caption, "no further firming, with qualification." However, he had a question similar to one already expressed regarding the last clause, reading "if bank credit expands no more than seasonally expected, some easing of money market conditions shall be sought." He would prefer language that was symmetrical with that in the preceding clause, such as "if bank credit expands substantially less than seasonally expected ... ." Mr. Swan concluded by noting that he agreed a change in the discount rate would not be appropriate at this time. Mr. Galusha reported that the Ninth District economy continued to expand and about in the pattern of the national economy, and the general outlook remained good. Especially good was the outlook for agriculture. In fact, it was so good that anticipated and feared pressures on the major banks to finance commodity dealers probably would not develop. Farmers, anticipating higher prices, were apparently going to hold their crops themselves; and their cash position was good. The combination of cash, the shift in the U.S.

Department of Agriculture policy, higher commodity prices, and the generally low level of tax sophistication made him quite dubious that any downward shift in agricultural spending for capital goods would be caused by the Administration's fiscal program just announced. Only in the lumber industry was the outlook poor. Unless residential construction picked up, that industry would go through a decidedly trying period. The District's savings and loan associations appeared to have gotten through July relatively well, Mr. Galusha said, having lost a disproportionately small amount of share capital. Nor had mortgage lending and residential construction declined as much in the District as in the nation. The large District banks apparently were doing better in rolling over their maturing CD's than were the money market banks. According to his information, New York banks were losing about 50 per cent of their maturing CD's; Ninth District banks were losing between 25 and 30 per cent. All he could report about the response to the new approach to Mr. Galusha continued, was that he had not discount administration, a peep from the banks. Possibly Ninth District banks--like heard anxious to get by as best they could those in other Districts--were the Minneapolis Reserve Bank had not on their own. In any event, to implement the System's letter. yet had a chance

Turning to the question of open market policy, Mr. Galusha remarked that, as had already been indicated, the big news was the President's proposal of last week. He was greatly pleased that a shoe had been dropped, although as an old tax man he was not thrilled by its size or its style. The reasoning of Miss Stockwell's memorandum, with which he agreed wholeheartedly, must have not been shared widely. Apart from the public posture impact, the real effect of the announcement would be minor. It was apparent, therefore, at least to him, that any monetary response to the President's proposal was some way off--perhaps a good long way off. At the very least the Committee would have to be sure about what was going to happen. Yet, Mr. Galusha continued, if easing any now would be unwise, so would tightening further. It was reasonably clear that the economy was accelerating again. Indeed, the fourth-quarter increase in GNP might well be greater than the fourteen-odd billion dollars the authors of the green book were presently expecting. Then, too, with what Congress had been appropriating for nondefense expenditures, the forecasters' computers might soon be reading "tilt." But what be, the Committee would, in his ever the economic outlook might very poorly advised politically to go further at this judgment, be he, for one, was still a little apprehensive about the time. And new approach to monetary policy--as it results the Committee's continued to evolve through this fall--was going to produce.

Mr. Galusha came out for the status quo and, more particularly, for a net borrowed reserves total equal to the average of the past several weeks. Nor would he worry much about changes in interest rates, slight or sharp, which were--in the Account Manager's judgmentproduced by changes in expectations. Over the next few weeks expectations could be quite volatile. In sum, he was for alternative A of the directives. Mr. Scanlon reported that during August and early September labor markets in the Seventh District continued to be extremely tight and inflationary pressures remained dominant. Shortages of labor, skilled and unskilled, continued in virtually all District centers. Help-wanted ads remained at a very high level and unemployment compen sation claims had declined further. Relaxation of hiring standardsin terms of experience, education, and criminal records--had not solved labor shortages. Prices had continued to rise. Early of price increases and it now saw an unusually heavy flurry September as much in the next few food prices would not decline appeared that months as had been expected earlier. some cutbacks in capital outlays Scattered reports indicated Mr. Scanlon continued. In most cases those represented for 1967, of major programs started earlier. On the other hand, completion had been delayed and some construction deliveries of capital goods of inability to obtain either had been postponed because projects

reasonably firm bids or adequate financing. Barring a change in the general outlook, most of those projects presumably would be reactivated next year. Although orders for some types of capital goods declined in July, order backlogs had increased further. There appeared to be no basis at present for calling a "turn" in the capital goods boom. Mr. Scanlon reported that steel operating rates were rising gradually but supplies should be adequate without pressing facilities to the extent reported last spring. Surveys indicated that more steel consumers intended to reduce inventories than raise them in the months ahead. Auto inventories were reduced sharply in August but remained high relative to past years, and production schedules indicated that they would rise further during September. Mr. Scanlon said that there was a sharp decline in the pace of credit growth at major District banks in August, in line with the national experience, but no indication that that was the beginning of any extended period of easier demand for funds. The contraseasonal decline in loans could be attributed mainly to the further paydown of loans to finance companies and the large volume of new capital issues, a portion of which might have been used to retire bank loans. Com industrial loans in the District continued to rise, but mercial and less than in the same period of other recent years. by somewhat Real estate loans had been rising, but less rapidly than last year.

Consumer loans had declined recently. Total bank credit in the District had risen much more since mid-year than in the same period a year ago. Recent rates on Federal funds of 6 per cent and over might indicate an unwillingness by banks to submit to the discipline on commercial and industrial loans expected to accompany use of the discount window, Mr. Scanlon said. However, he would expect the current rate differentials to bring more banks to the window. Mr. Scanlon observed that figures for August confirmed the more moderate rate of expansion in money and credit projected at the last meeting of the Committee. He thought that for the present the Committee should attempt to maintain very moderate rates of growth in money and credit. If that implied reduced reserve availability, he would favor such measures short of inducing disorderly conditions in the money and capital markets. As to the discount rate, his views of Mr. Hayes. In particular, he believed it was paralleled those retain rate flexibility, both up and down. Unless the essential to Committee was flexible on the up side it was restrained when easier credit and lower rates were needed. Mr. Scanlon favored maintaining about the present degree of restraint for the period immediately ahead, but would give the latitude to operate should liquidity pressures Manager sufficient become acute. He had some difficulty in selecting the directive that

would accomplish that objective. On balance, however, he would favor alternative B, which he interpreted as Mr. Ellis had. Mr. Clay observed that the period since the last meeting had been one of marked financial changes. It also had been a period of public pronouncements concerning planned fiscal policy and debt management changes. Some expectational effects of those public policy actions had been immediate in the financial markets and others might follow. The basic impact would take longer to work itself through the economy and financial structure, once those programs had been worked out and implemented. The fiscal program relative to business capital outlays required Congressional action for implementation, although the retroactive feature might have some relatively prompt effect on new orders for business equipment. Whatever the meaning of the announced screening of Federal outlays--and that was not clear at this time--it had to be recognized that Federal outlays would be accelerating in the months ahead. Moreover, direct Treasury financing would be affected by those expenditures as well as by the planned curtailment in agency financing. situation did not appear to Mr. Clay to The basic economic among sectors, the economy still was have changed. With variation in an orderly way. Despite some trying to do more than it could do at least for the present, over easing in sensitive materials prices, with upward pressure on prices all pressure of demand on resources

continued. In fact, recent developments on the wage-cost front raised the possibility of more, rather than less, price inflation. Apart from the economic policy issues now being debated, the overriding consideration was the growing volume of expenditures related to the South Vietnam war. Despite the indications of public policy actions, Mr. Clay remarked, the System would need to continue to formulate monetary policy according to the economic and financial developments that unfolded. Any change in policy should depend on whether forth coming evidence justified such change. For the present, the appeared to him to be a continuation of the appropriate approach current policy of monetary restraint. In view of the public attention focused on recent economic policy statements, it was that the market not be misled into believing that Federal important If recent evidence of curtailment of Reserve policy had been eased. continued in the weeks ahead, that would become bank credit expansion be taken into account in future policy a significant factor to formulation. that the guidelines for a continuation of Mr. Clay observed were not easy to delineate. policy of monetary restraint the present an increase in net borrowing expanded substantially, If member bank the current target would be reserves considerably above borrowed increase in money market policy. Also, some consistent with present

rates in connection with possible forthcoming money market pressures would not be out of line with the current monetary policy posture. The Federal Reserve discount rate continued to be inappropriate to the present economic situation and current monetary policy. Alternative B of the draft directives appeared to Mr. Clay to be satisfactory. Perhaps it should be said, however, that the goal was the maintenance of the present degree of monetary restraint. seemed to carry the connotation of easing rather than Alternative A simply of no further firming. Mr. Wayne said that responses to the Reserve Bank's latest of uncertainty among both indicated a small increase survey Fifth District. Reports from businessmen and bankers in the producers of durable goods suggested a continuing but still slight orders, backlogs, and hours worked, while downward shift in new remained mixed and showed little returns covering nondurable goods Prices and wages in manufacturing had on balance or no trend. remained generally strong, but continued to rise. Textile demand and blends continued to cause spots in certain light cottons soft reports were being increasingly related concern and in the trade this year. Automobile sales to imports, which had risen rapidly signs of a slower pace in slightly, and there were remained down values had been rising since even though contract award construction

April and were now above last year's level. Unemployment rates continued at or close to historical lows and employment had con tinued to rise. Prices received by farmers through mid-August were well above year-earlier levels, but prices paid reached new record highs. Seasonally adjusted business loans, total loans, and total bank credit fell more in August at District banks than in the nation as a whole. Mr. Wayne commented that thus far banker reaction to the discount administration policy announced in the System's letter of September 1, 1966, had ranged from approval to resignation to the inevitable. There had been no adverse comments nor had any of the banks asked for special considerations referred to in that letter. economy continued to show evidence of over The national pace in some areas, Mr. Wayne observed. spending despite a reduced inflationary pressures were probably a little stronger On balance, Prices continued to rise although in August than in earlier months. to show. The latest data few divergent trends were beginning a that they were behaving in a available on inventories indicated periods and in a way almost certain manner typical of inflationary outlays remained at a very high to cause trouble later. Capital that the pace a few signs which indicated but there had been level be starting to taper off. might

With respect to policy, Mr. Wayne said, the Committee had had almost no room for maneuver even before the President made his fiscal proposals last week. Now, it seemed to him, there was even less. Obviously, an increase in the discount rate or significant tightening in any other form would be a flagrant rebuff to that move cooperation which the Committee had sought for a long toward fiscal time. On the other side, there were no valid reasons for any easing of restraint. The fiscal proposals were not yet law and there was no evidence of "any easing of inflationary pressures." To him that should follow a very strict "even keel" suggested that the Committee acted on the proposals and, unless there were policy while Congress to the contrary, until the initial effects of the urgent reasons could be evaluated. He would expect the short-run effects measures clear the air respecting the salutary, because they helped to to be should therefore have a settling objectives of fiscal policy and the bond market. Except for those and strengthening effect on the proposed measures were effects, the results of announcement The initial impact would to develop slowly and uncertainly. likely investment, both of which on corporate profits and capital be now be approaching their peaks fluctuated widely and which might of the proposed tax changes. irrespective thought the Committee faced a In the meantime, Mr. Wayne monetary policy in the next difficult problem in implementing very

week or two. The large flows of funds over the tax and dividend dates, the prospect of a sizable runoff of CD's, the banking system's reactions to the System's policy announced on September 1, continuing large demands on the capital market, and the volatile reactions of the financial market as the fiscal proposals were debated and acted upon--all of those impinging on a market already nervous and unsettled would provide a very turbulent environment in which to carry out any policy. He could see no alternative but to give the Manager wide discretion and ask him to follow as closely as possible the same policy the Committee had been pursuing in recent weeks. It was very likely would often have to give first consideration to that the Manager market conditions but, subject to that, he should attempt to maintain of reserve availability as had prevailed in the about the same level past month. by Mr. Hayes seemed consistent with A directive as proposed for the next three weeks and Mr. Wayne's idea of a desirable posture perhaps longer. the economic situation had Shepardson said he thought Mr. While there were some been clearly described today. already evidence still indicated a indications, most of the conflicting The President's program pace of economic activity. strong, booming could not know how since one an element of uncertainty introduced

it would be implemented, and how quickly. All of which, it seemed to him, called for maintaining a policy position as nearly like the present position as possible. He did not think the Committee should be unduly influenced by a one-month downturn in bank lending, in the face of the preceding long-protracted uptrend. Mr. Shepardson said that, like others, he thought the draft directives were mislabeled. Alternative A seemed to him definitely to be an easing directive, and he considered inappropriate some of the changes suggested in its first paragraph. Alternative B more nearly contemplated maintaining the present policy position, and it was worded in a way that would give the Manager the necessary degree of leeway. The final clause, calling for seeking still greater reliance on borrowed reserves if bank credit expanded more than seasonally expected, seemed to him to be proper. Basically, period the Committee should try to maintain the over the coming present degree of restraint without either firming or easing. The directive Mr. Hayes had suggested went a long way in the same direction, and it might be preferable to the staff's alternative B. Mr. Mitchell presented the following statement: In the current financial environment the directive the "maintenance of orderly money properly emphasizes market conditions and the moderation of unusual liquidity pressures."

A major reason for this concern over liquidity pressures is that so long as interest rates on market instruments are higher than Regulation Q ceilings there will be a trend toward "disintermediation"--that is, toward a run-off of negotiable CD's at banks. In addition to our concern over liquidity pressures, we must understand the implications for monetary policy of such a run-off in CD's. We start with the fact that, today, yields on market instruments attract investors holding maturing negotiable CD's; i.e, investors are responding to the current pattern of interest rates by reducing their claims on banks and increasing correspondingly their holdings of short-term securities. What appears to be happening is thus a reversal of the process that occurred when Regulation Q was raised at the beginning of 1962 and negotiable CD's increased rapidly. Perhaps all that is necessary for an understanding of the problem at hand is to reverse the signs on the analytical and policy con clusions reached four years ago. At that time, it was concluded that a shift of the public's claims bank time deposits and away from securities toward financial institutions tended to absorb and nonbank bank reserves and required offsetting open market purchases by the System.1/ Under present conditions, holders of negotiable who do not wish to renew will probably purchase CD's ago, that the term structure also observed, four years 1/ We shifts, even if the System was affected by the of interest rates banks tended to acquire longer-term accommodated them--for obligations than the public gave up when it switched to time deposits at banks. Such market impacts were regarded as desirable at that time, helping to hold up bill rates and to hold down yields and increase the availability of funds in the municipal, mortgage, and other longer-term markets.

short-term agency issues, municipals, commercial and finance company paper, and bankers' acceptances. To the extent banks hold these types of paper, we can cut through the intervening analysis and simply imagine that banks redeem maturing CD's by handing over such short-term assets, thus reducing both their assets and liabilities. Assuming that 100 of maturing CD's were paid in this way, the results would be as follows: Bank assets -100 Time deposits -100 Money supply No change Total reserves No change Required reserves - 6 Excess reserves + 6 Public's holding of securities +100 Although bank credit and bank deposits would appear to contract, total credit available to the economy would not be affected nor should there by any further impact on interest rates, in this example. All that has happened is a reshuffling of assets between the banks and the public with attendant effects on the distribution of total credit availability and the shape of the yield curve about the reverse of those that accompanied CD (see footnote, page 57). In short, there will expansion shift away from intermediation by the banks. have been a However, the situation with respect to excess reserves is unstable; unless they are absorbed by the provide the basis for net credit and money System, they supply expansion. check on this short-cut reasoning, it is In order to useful to examine the process under the more realistic that those holding maturing CD's take the assumption the form of demand deposits, which proceeds initially in they in turn use to purchase the short-term obligations to hold. I have done this and find that the they wish

conclusions are unchanged once the transitional churning is over.1/ The net result of a switch from CD's to market instruments is, in the absence of offsetting action by the System, to increase the over-all supply of credit and money and to reduce average level of interest rates. So long as individual banks in the course of reducing their 1/ Assume that 100 of CD's mature. The first step is that the holders receive either a credit to their demand account in the issuing bank or a check which they deposit in their own banks. In any event, the banking system finds 100 of its deposits shifted from time to demand status, with an immediate impact on required reserves, in addition to churning of reserves among banks as checks on banks that redeem CD's are deposited in other banks. But since the former holders of CD's intend to acquire higher yielding assets rather than additional cash balances, we must assume that the new demand deposits will quickly be used to purchase short-term securities. Since the supply of such securities much be assumed to be uninfluenced in the short run by these developments, the securities will presumably be purchased from existing holders, and the demand deposits pass to the sellers of securities. At the same time, banks as a whole find themselves under reserve pressure because time deposits have been converted to demand deposits. Assuming total reserves to be held constant, the banks will begin to dispose of assets in order to adjust their reserves. As banks sell securities, they reabsorb demand deposits, thereby reversing in both required reserves and demand deposits that the increase accompanied the switch from CD's to market instruments. switch of 100 from time to demand deposits increased The by, say, 9 (assuming the average reserve required reserves requirement on demand deposits at the banks involved to be 15). In order to reduce required reserves again, banks need to lower deposits by only 60, which means they must dispose their demand It should be recalled that the former of only 60 of securities. purchasing 100 of short of CD's will be in the market holders complete parity with the short-cut term securities. To reach System would now have to be itemized earlier, the illustration reserves in order to reduce demand motivated to absorb 6 million back to their original level; and the total of deposits by 40, by the banks and the System to accomplish 40 securities sales the buying being done by former this adjustment would equilibrate CD holders.

assets did not cause security markets to become disorderly, the System would want to absorb the excess reserves released by the reduction in CD's. What is the implication of this analysis for the aggregate measures upon which policy operates? To be specific, assume a decline in negotiable CD's of about $2 billion; then apart from the disturbances in security markets arising out of adjustments by banks to the loss of deposits, the aggregates will be affected as follows if the System acts to absorb the $120 million in reserves that are released as CD's decline: 1. Bank credit (proxy) -$ 2 billion 2. Public holdings of securities + 2 billion 3. Money supply No change 4. Total reserves -$120 million This decline in bank credit and total reserves would not per se represent a tightening of policy. If the market consequences of the changed distribution of credit avail ability go beyond the bounds consistent with current policy, we may want to take account of this in our operations. But these are distinctions that it is important to recognize, and to communicate, in order to be clear first to ourselves and then to the many observers and critics of monetary policy. Mr. Mitchell added that he preferred alternative B to A for the directive. However, he would delete the last clause of the first paragraph, reading "by restricting the growth in the reserve base, bank credit, and the money supply." He thought the clause was in appropriate at this time because, as his analysis indicated, there was likely to be a basic inconsistency in the three measures cited. In the second paragraph, he would insert the words "firm and" before "orderly money market conditions." He did not like the proviso clause because it was written in terms of bank credit, whereas he felt that the focus should be on money supply. Others might prefer an interest rate target. In any case, the Desk could operate properly without the clause, and he would prefer to see it deleted.

Mr. Daane said he favored maintaining the current degree of restraint and, to use a phrase Committee members had employed in the past, "watchful waiting." He would give the Manager flex ibility to carry out the spirit of the Committee's intentions. As to the draft directives, Mr. Daane said, he agreed that there was a flavor of easing in alternative A that was not appropriate at present. He would accept the first paragraph of alternative B with Mr. Hayes' amendment to the last clause. Alternatively, he would have no great objection to deleting the last clause of the paragraph as Mr. Mitchell suggested. For the second paragraph he preferred Mr. Hayes' suggested language. Mr. Maisel said he could agree with much of Mr. Mitchell's differed in the interpretation of the current state analysis but he If one considered the period since of the monetary variables. September 1965, and more particularly that since January 1966, most the exception of bank loans and possibly total such variables--with below a normal growth rate. loans--appeared to be running considerably had been substantially greater The degree of monetary restriction it would appear desirable to return than might have been thought, and to normal growth rates. to something closer expressed the hope on previous Maisel noted that he had Mr. reserve figures would vary more occasions that weekly net borrowed appeared to have been attained had in the past. That goal than they as a result of large revisions in the preliminary recently, if only

figures. He agreed with Mr. Hayes' conclusion that the net borrowed reserve figures should be subordinated now. Mr. Maisel thought it was important to accept Mr. Mitchell's suggestion for deleting the reference to the reserve base, bank credit, and the money supply from the first paragraph of the directive. For the second paragraph he would prefer a modified version of Mr. Hayes' proposal. It would be best, he thought, to avoid referring to expectations, particularly since there was a difference between the Board and New York Bank staff projections. He would call for opera tions to be modified "in light of . . any apparently significant deviations of money and bank credit from a normal seasonal growth pattern." By "normal" for bank credit he meant a 4-6 per cent growth rate in the credit proxy. Mr. Brill commented that the difference between the projections at the Board and the New York Bank did not reflect any basic disagree ment on the outlook for bank credit. They were mainly definitional; the Bank's projection included the credit expansion expected as a result of a continued pull-back of funds from foreign branches, which was not allowed for in the Board's projection. Mr. Hayes said he was a little puzzled by Mr. Maisel's use of the term "normal seasonal growth pattern," which seemed to call for no growth on a seasonally adjusted basis. In any case, he would prefer not to pinpoint an operating target in that manner.

Mr. Maisel replied that, as he had indicated, he had a 4-6 per cent growth rate in mind as normal for bank credit. Mr. Mitchell commented that with a reduction in bank inter mediation underway such a growth rate in bank credit was likely to have strong inflationary effects. He thought it would be better to refer to total credit than to bank credit alone. Mr. Holmes noted that figures on total credit were available only quarterly, in the Board's flow of funds accounts, and with a time lag so that total credit was not a workable operational guide for the Manager. The go-around then resumed with remarks by Mr. Brimmer, who noted that at its meeting just three weeks ago the Committee had no expectaions of further assistance from fiscal policy. Now that it appeared that some assistance would be forthcoming, the general view around the table was that the Administration's program was not good enough. Personally, he thought the Committee should keep policy unchanged while observing developments with respect to the fiscal package--and he would emphasize that it was a package and not simply a collection of miscellaneous items. It was not possible to foresee the effectiveness or the timing of the elements, but there had been some effects already, as indicated by the Manager's comments regarding the postponement of agency issues. As he understood the plan, the Treasury proposed to sell a substantial volume of agency issues to Federal trust funds and to increase sales in the market of short-term

Treasury securities. Such operations might have a significant effect on money market conditions and would have to be taken into account in open market operations; the Committee might find itself engaged in some sort of an even keel operation. In any case, the monetary im plications of the Administration's package were serious. Mr. Brimmer recalled that two months ago he had said publicly that suspension of the investment tax credit might be helpful, and he continued to think so. At the same time, he thought the Committee should not be overly optimistic about the package, but should wait to see what happened. As to Mr. Brill's suggestion of a policy of "passive restraint," he (Mr. Brimmer) did not think the System should be passive; there were some difficult areas--especially in connection with the new discount administration program--that would call for active steps. However, if Mr. Brill meant simply avoiding active further restraint he agreed with him. Mr. Brimmer said that he favored alternative A for the directive with the several modifications suggested by Mr. Hayes. Mr. Hickman commented that the economy continued to move forward under forced draft, reflecting pressures generated mainly by business The rate of increase in consumer spending was and defense spending. rising in the third quarter, after declining in the second quarter, but would still fall short of the unusually rapid advance of the first quarter. Business investment outlays were exceptionally high, both absolutely and relative to personal consumption expenditures, but the

rate of advance seemed to be moderating. Defense spending remained as the great unknown, with almost a complete absence of reliable information. Recent price developments suggested to Mr. Hickman some moderation of inflationary pressures, although that might be temporary and illusory. Spot prices of raw industrials continued to decline, and now were about 13 per cent below their mid-March peak. The recent behavior of meat and wheat prices suggested that food prices probably would not move higher over the rest of the year. An additional straw in the wind was provided by Dun and Bradstreet's latest reading of businessmen's expectations, which showed a small decline in the per businessmen expecting year-over-year price increases next centage of quarter, the first time that had happened in two years. observed that financial markets were nervous and Mr. Hickman uncertain, reacting in an extreme way to facts and rumors. For that not to make any change in monetary policy reason alone, he would prefer most aggregate reserve measures lagging for the next three weeks. With of growth, and in some cases actually declining, anticipated rates restrictive policy was taking there was little doubt that the System's during August, on a business loans declined hold. Most importantly, some special adjusted basis, which indicated--despite seasonally of bank lending was excessive rate of expansion factors--that the a steady course were the Other reasons for holding moderating. announced last Thursday plan to combat inflation President's five-point

and the heavy run-off of CD's anticipated in some quarters during the next few weeks. Although it might be academic now, Mr. Hickman said, he should report for the record that at the Cleveland Reserve Bank directors' meeting last week--before the President's announcement--there was con siderable discussion about the effects of rescinding the investment tax credit, and the pressures that a rescission might generate on the demand for bank credit. The general conclusion was that elimination of the tax credit would have negligible short-run effects, and that its long-run effects would be highly questionable. Mr. Hickman had a slight preference for alternative A of the staff draft directives, with the second paragraph as revised by Mr. Hayes. The words "current conditions in the money market" in the staff's draft troubled him in view of the sharp run-up in bill rates now underway. However, the exact wording of the directive was not too significant to him. As he had indicated, he favored "no change." Mr. Bopp said that as he balanced various considerations bear the next three weeks he found the weight falling on ing on policy for change. That conclusion rested on three points, no one the side of no alone was very persuasive, but which in combination suggested of which course--for the present, at least--was not to tighten that the best further through open market policy. First, Mr. Bopp was not impressed with the likelihood that the President's new program would be very effective in relieving the burden

on monetary policy. The tax measures would not have much effect for many months, and it remained to be seen what would be done on the expenditure side. Yet the fiscal program should help to some extent in restraining demand; and, although it would be unwise to try to lower interest rates, as the President suggested, it seemed desirable--for the time being, at least--not to take action which would raise them. Second, it seemed to Mr. Bopp that the future effects of the System's new discount policy were still very uncertain. Conversations with large Philadelphia banks suggested that vigorous efforts had already growth of business loans. Most banks expected to been made to slow the hold such loans at about current levels or within the usual seasonal would be able to meet their loan rise. The banks believed that they CD's, borrowing Federal funds, and demands by issuing consumer-type Borrowing from the Federal Reserve selling assets--in that order. would be a last resort. make the new discount policy effective, Mr. Bopp continued, To aggressively to force banks would have to move open market operations window. If the attitudes of extensively into the discount much more action might have to be typical, open market Philadelphia banks were rates could be drastic. resulting effect on market vigorous indeed. The received. He would be the new policy was favorably Announcement of the new discount move cautiously in implementing therefore, to inclined, policy so far as to force a and would not push open market policy volume of borrowing. materially larger

Third, Mr. Bopp observed, as the staff reports indicated behavior of total bank credit and the money supply had been more reasonable recently. He found little comfort in that fact in view of likely future demands for credit. On the other hand, it was increasingly important to be alert to the cumulative effects of restrictive policy actions already taken. For the time being an attitude of watchful skepticism seemed to be the most appropriate. Mr. Bopp observed that the directive suggested by Mr. Hayes would accomplish the kind of no-change position he had in mind, with the deletion in the first paragraph proposed by Mr. Mitchell. Mr. Patterson commented that in analyzing the economy every three or four weeks one might be reading more into figures than one should. But even allowing for strikes and seasonal quirks, some indicators for the Sixth District indicated a slowing down in the District economy's forward momentum. One such sign was the slackening in employment gains. Another was the decline in new car sales in July. A third was a reduction in residential building. Nevertheless, non was still keeping the total contract volume residential construction year. And over-all District business conditions were ahead of last on the upside. That he gathered not only from the undoubtedly still behavior of longer statistical trends but from the Atlanta Bank's directors and other contacts. The banking figures for the District showed some interesting new developments, Mr. Patterson reported. Starting in early August, total

loans at the large banks had declined for four straight weeks. Business lending had also fallen off, even though reports showed loan demand remaining high. That curtailment of loans confirmed statements by bankers in recent conversations to the effect that they were eager to restrict the pace of their lending operations. Recent unfavorable deposit flows were probably partly responsible for that pressure. District banks usually lost deposits at this time of the year, but this year they lost 50 per cent more demand deposits from mid-July to the end of August than last year. Furthermore, they had gained little in the way of time deposits during the same period. Since the banks were dependent to some extent on an inflow of deposits from outside the District, pressures in northern money market centers were evidently being transmitted to the Sixth District. that District bankers, of course, were Mr. Patterson remarked they reported that large companies the same thing indirectly when saying now wanted to make use of borrowed from them for many years that had not and other national develop commitments. Those conditions, their standing had begun to tightened credit conditions suggested to him that ments, take hold. that after having labored so long Mr. Patterson went on to observe pour on more of to say: "Let's one might be tempted for that to happen, rates on reversed and permissible those trends were same." But unless the Committee's open market he did not believe the negotiable CD's raised, this time. He was at least at become more restrictive, policy should

especially worried that the short-term financial markets might not stand too much additional strain. He was in the dark about how to translate that prescription into policy for the next three weeks. However, he thought the new discount rules made guidance by net borrowed reserve figures more difficult than ever. Since the System was so concerned with the trend of bank lending, he wondered if it might not be desirable, at least experimentally, to use seasonally adjusted bank loans as a principal guide, while taking account of changes in bank security portfolios, member bank borrowing, and conditions in money and securities markets. However, the "no change" directive was acceptable to him. that various monetary indicators had Mr. Lewis commented shown a marked change in direction since early summer. Whether judged reserves, money supply, or interest rates, a significantly by bank different trend had apparently developed since about May or June. From May to August, the money stock declined at a 3 per cent annual 6 per cent in the preceding year. Total member rate after rising bank reserves and reserves available for private demand deposits similarly shifted from increases to decreases. Federal Reserve holdings securities and changes in reserve requirements contributed of Treasury net to effective reserves at only a 3 per cent rate compared with 8 per cent in the preceding year. Likewise, Mr. Lewis continued, interest rates had gone up much more rapidly since May than in the preceding year. Yields on

long-term Government bonds had increased at a 20 per cent annual rate since May compared with 10 per cent in the preceding year. Yields on commercial paper had gone up at a 39 per cent rate since May compared with 23 per cent in the preceding year. Such a shift of monetary indicators this past summer seemed to Mr. Lewis to have been appropriate. Under conditions of essentially full use of available resources, of accelerating price increases, and of unusually stimulative fiscal policy, it seemed to him that monetary expansion was appropriately limited. Looked at in another way, it seemed likely that under the influence of high interest rates, price inflation, and a strong propensity to invest, the demand for money to hold had been declining and therefore the supply of money also declined. appropriately saw no pause in the inflation, Mr. Lewis said, and Since he to be even more stimulative in the since the fiscal situation appeared half, he believed the Committee of 1966 than in the first last half the same policy as that which continue in the near future about should of fiscal policy last last three months. The turn had prevailed in the He thought the Committee immensely pleasing. week was, of course, be the magnitude and timing very carefully what might needed to study of the effect. had seemed to Mr. Lewis to discount rates, it With respect raised. But, as circumstances the rates should be some time back that

had developed, that did not seem now to be of the first importance. The System had been able to achieve a considerable monetary restriction despite a discount rate far out of touch with the market. During the three summer months there was very little increase in borrowing from the Fed in spite of the rapid rise in market interest rates. So far as he could see, discounting could be kept within reasonable bounds in the course of normal administration of the window. While he disliked the windfall profit which accrued to those banks which borrowed from the Reserve Bank at 4-1/2 per cent and lent at 6 per cent or more, he believed it was sufficiently limited in amount and sufficiently dispersed among banks that it need not for the moment weigh very heavily in the System's considerations. Mr. Robertson then presented the following statement: I think this is one of those times when it is particu larly difficult to be sure of the ideal course for monetary policy to follow. Inflationary pressures are persisting, as the staff materials have underlined. Economic activity is expanding vigorously, bolstered by strong business investment outlays and growing Federal expenditures. Moreover, I take it that further escalation from added Vietnam outlays has to be considered as a possibility, even though we are still too much in the dark about such a development as of now to base current policy upon it. To counter these inflationary pressures, we now have help from a somewhat greater degree of the promise of fiscal restraint. However, it is very hard to judge just how much effective restraint the Administration package is likely to provide, and how soon. To a certain extent, over bullish expectations may have been moderated by the very announcement of an official determination to achieve a more fiscal posture. But the actual effects on restrictive spending may stretch out over a number of quarters ahead.

Meantime, monetary policy has also become tighter, with lagged effects that must similarly be expected to stretch out over the quarters ahead. In the face of strong credit demands, we have managed to put bankers under enough pressure to slow down the rates of growth of bank credit, deposits, and the money supply. Our indicators of the cost and availability of credit are also signaling new degrees of tightness, and thanks to our new program of discount administration, we have some extra insurance that such tightness will prove better balanced than before. Given what we have recently accomplished with the reserve pressures we have brought to bear, I think it is time to begin guarding against the possibility of substan tially less than expected as well as greater than expected bank credit expansion. With this view, I was glad to see the staff draft directive A include a "two-way" proviso clause this time, and I hope we make that a part of whatever directive we adopt this morning. In my view, our general objective for policy at this juncture would be to hold about the current degree of restraint. I think that would be our best posture as we wait for the combination of recent public policy steps to begin to have their effects. What money market signals these may give us in the interim is, I judge, open to some question. Since mid-August, net borrowed reserves and Treasury bill rates have moved in largely opposite directions, and I take it the staff is not at all sure this performance will be any more consistent in the weeks immediately ahead. If member bank borrowings amount considerably higher as large banks seek discount window assistance to meet their September squeeze, I would again urge the Manager not to engage in open market purchases simply to reduce such borrowing, but instead to be prepared to operate so as to keep such injection of borrowed reserves from significantly market conditions. But I do not think that easing money any net borrowed reserve figure or particular money market rate can be a target for us in the present circumstances. I would rather take the money market and reserve conditions we have currently prevailing, and tell the Manager to increase those pressures somewhat if bank credit expands sharply more than seasonally expected, but also to be prepared to ease up somewhat on such pressures if bank credit should expand substantially less than seasonally expected.

I think these views are most in accord with the language suggested in staff directive alternative A, if the words "substantially less" are substituted for "no more" in the second-paragraph phrase reading "if bank credit expands no more than seasonally expected"; and if the words "by tempering' are substituted for "while accommodating moderate" in the last clause of the first paragraph. Chairman Martin remarked that, having just returned after an absence of two months, he obviously was insufficiently informed on recent developments to make a long statement. While on the side-lines during his absence he had been cheering for the System team and he thought it had done exceedingly well. He congratulated Messrs. Hayes and Robertson on the quality of their leadership in a difficult period. He was impressed today, the Chairman continued, by the high degree of agreement on policy. The intent of the Committee seemed clear--there should be no overt action in either direction, and market should be kept as stable as possible. The difficult conditions question was how to compose a directive that would most effectively implement such a policy. Personally, he could accept either of the suggested by the staff, with or without various amend alternatives that had been offered. As was often the case, the proposed ments directives were subject to different interpretations, depending on how one read the words. He had felt defeated over the years in the effort directives that were understandable to the public and to the to develop Committee and that worked. The Chairman then invited suggestions regarding the directive.

In the ensuing discussion the Committee agreed on a first paragraph for the directive consisting of that contained in the staff's alternative B, with the final clause deleted. Discussion of the second paragraph was concerned mainly with the choice between the proposals of Mr. Hayes and Mr. Maisel, or some modifications thereof. Specific questions considered were whether the proviso clause should refer to deviations of "bank credit", "credit", or either of these in combina tion with "money"; and whether the deviations should be considered from "current expectations" or "normal seasonal growth." The Committee concluded that the proviso clause should relate to "deviations of bank credit from current expectations", as proposed by Mr. Hayes, after taking note that the current expectations for bank credit movements included allowance for some prospective disintermediation. Mr. Maisel commented that he understood the policy contemplated by the directive would be most accurately described by the label the staff had put on its original alternative A, namely, "No further firming, with qualifications." Thereupon, upon motion duly made and seconded, and by unanimous vote, the Fed Reserve Bank of New York was authorized eral and directed, until otherwise directed by the Committee, to execute transactions in the System Account in accordance with the economic policy directive: following current developments reviewed at this The economic and financial domestic economic activity is meeting indicate that over-all the substantial weakening in expanding vigorously, despite

residential construction, with inflationary pressures per sisting. Aggregate credit demands continue strong and short-term financial markets remain under strain. The balance of payments continues to reflect a sizable under lying deficit. In this situation, and in light of the new fiscal program announced by the President, it is the Federal Open Market Committee's policy to resist inflationary pressures and to strengthen efforts to restore reasonable equilibrium in the country's balance of payments. To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining firm but orderly conditions in the money market; provided, however, that operations shall be modified in the light of unusual liquidity pressures or of any apparently significant deviations of bank credit from current expectations. Chairman Martin noted that Mr. Robertson had appeared on behalf of the Board before the Senate Banking and Currency Committee this morning regarding H.R. 14026, a bill that would, among other things, give flexible authority to all Federal supervisory agencies to set maximum rates on deposit-type accounts. The Chairman invited Mr. Robertson to comment. Mr. Robertson observed that his testimony had been quite brief. He had said that the Board's views had not changed from the time of his on August 4, 1966; that the Board testimony before the Committee except for the one-year limitation of the effec endorsed the bill, its provisions that had been added by amendment in the tiveness of indicated that the Board considered that limitation unwise House. He had to a "sense of Congress" provision regarding a (except with respect rates) and that the limitation might well thwart reduction in interest

the effective use of the new authority. In response to the only question asked of him, he had expressed the view that the bill as written was better than nothing. Chairman Martin then noted that a staff memorandum dated September 1, 1966 and entitled "Contingency planning for the U.S. Government securities and other financial markets" had been distributed to the Committee.1/ He invited Mr. Holland to comment. Mr. Holland said that the memorandum had been prepared by Board staff members, in consultation with staff of the New York Reserve Bank and the Treasury, in accordance with the Committee's instructions at the previous meeting. The object was to bring up to date a similar prepared a year ago when there also was concern about contingency plan a possible sterling crisis. As in the earlier memorandum, the purpose but rather to discuss a not to resolve basic issues of policy was that would allow time for such policy decisions in "holding operation" prevailing, and the approach was light of the specific circumstances the earlier contingency plan general. The differences from fairly three main differences in underlying conditions: stemmed primarily from now were considerably smaller than a year dealer bond inventories were considerably tighter, and earlier, credit conditions in general for securities other to be problems in markets there now were likely has been placed in the memorandum referred to 1/ A copy of the Committee's files.

than U.S. Government securities. No formal action by the Committee was required today, but the staff would take account of any comments on the memorandum that the members might have. No comments being heard, Chairman Martin suggested that the staff memorandum be kept on file for possible use in case of need. It was agreed that the next meeting of the Committee would be held on Tuesday, October 4, 1966, at 9:30 a.m. Thereupon the meeting adjourned. Secretary

ATTACHMENT A CONFIDENTIAL (FR) September 12, 1966 Drafts of Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on September 13, 1966 Alternative A (No further firming, with qualifications) The economic and financial developments reviewed at this meeting indicate that over-all domestic economic activity is expanding vigorously, despite the substantial weakening in residential construc tion, with inflationary pressures persisting. Aggregate credit demands continue strong and short-term financial markets remain under strain. The balance of payments continues to reflect a sizable underlying deficit. In this situation, and in light of the new fiscal program announced by the President, it is the Federal Open Market Committee's policy to help to counter inflationary pressures and restore reasonable equilibrium in the country's balance of payments, while accommodating moderate growth in the reserve base, bank credit, and the money supply. To implement this policy, and taking account of possible needs to moderate unusual liquidity pressures, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining about the current conditions in the money market; provided, however, that if bank credit expands substantially more than seasonally expected, operations shall be conducted with a view to seeking some further firming of money market conditions; and, if bank credit expands no more than seasonally expected, some easing of money market conditions shall be sought. Alternative B (Firming to extent feasible, with qualification) The economic and financial developments reviewed at this that over-all domestic economic activity is expanding meeting indicate vigorously, despite the substantial weakening in residential construc inflationary pressures persisting. Aggregate credit demands tion, with and short-term financial markets remain under strain. continue strong of payments continues to reflect a sizable underlying The balance In this situation, and in light of the new fiscal program deficit. by the President, it is the Federal Open Market Committee's announced policy to resist inflationary pressures and to strengthen efforts to equilibrium in the country's balance of payments, restore reasonable in the reserve base, bank credit, and the by restricting the growth money supply.

To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to supplying the minimum amount of reserves consistent with the main tenance of orderly money market conditions and the moderation of unusual liquidity pressures; provided, however, that if bank credit expands more rapidly than expected, operations shall be conducted with a view to seeking still greater reliance on borrowed reserves.

Source

Also: Record of Policy Actions