October 4, 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, October 4, 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 Mr. Shepardson Messrs. Wayne, Scanlon, Francis, and Swan, Alternate Members of the Federal Open Market Committee Messrs. Ellis, Patterson, and Galusha, Presidents of the Federal Reserve Banks of Boston, Atlanta, and Minneapolis, respectively Mr. Holland, Secretary Mr. Sherman, Assistant Secretary Mr. Kenyon, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Hexter, Assistant General Counsel Messrs. Eastburn, Garvy, Green, Koch, Mann, Partee, Solomon, Tow, and Young, Associate Economists Mr. Holmes, Manager, System Open Market Account Special Manager, System Open Market Mr. Coombs, Account Mr. Cardon, Legislative Counsel, Board of Governors to the Board of Governors Mr. Fauver, Assistant Adviser, Division of Research Mr. Williams, and Statistics, Board of Governors Adviser, Division of International Mr. Hersey, Finance, Board of Governors Associate Adviser, Division of Mr. Axilrod, Board of Governors Research and Statistics, Assistant, Office of the Miss Eaton, General Secretary, Board of Governors
Messrs. Eisenmenger, Ratchford, Taylor, Baughman, Jones, and Craven, Vice Presidents of the Federal Reserve Banks of Boston, Richmond, Atlanta, Chicago, St. Louis, and San Francisco, respectively Mr. Geng, Manager, Securities Department, Federal Reserve Bank of New York Mr. Kareken, Consultant, Federal Reserve Bank of Minneapolis Upon motion duly made and seconded, and by unanimous vote, the minutes of the meetings of the Federal Open Market Com mittee held on August 23 and September 13, 1966, were approved. Under date of September 16, 1966, there had been distributed to the members of the Federal Open Market Committee copies of the of the System Open Market Account and of the report report of audit both made by the Board's of foreign currency transactions, of audit at the close of business May 13, 1966, Division of Examinations as Reserve Examiner under date of and submitted by the Chief Federal been placed in the of these reports have June 17, 1966. Copies files of the Committee. Upon motion duly made and seconded, vote, the audit reports and by unanimous were accepted. to the there had been distributed Before this meeting Manager of the from the Special the Committee a report members of market conditions on foreign exchange Open Market Account System Treasury operations in foreign Open Market Account and and on
currencies for the period September 13 through 28, 1966, and a supplemental report for September 29 through October 3, 1966. Copies of these reports have been placed in the files of the Committee. In comments supplementing the written reports, Mr. Coombs said that the Treasury gold stock would remain unchanged this week. The Stabilization Fund now had about $100 million of gold on hand, with prospective sales during the month of October of million. On the London gold market, buying pressure roughly $75 was consistently heavy during September and the original $270 the gold pool was further depleted by another $54 million, million in As the Committee would recall, a to no more than $12 million. million to the gold pool had been negotiated supplement of $50 another $50 million meeting, and if necessary at the September Basle well be the end of although that might probably be secured could for gold might be in the demand While some slackening the line. were over, he continued and Bank meetings now that the Fund seen single most dangerous constituted the the gold market to think that threat to the dollar. there had Mr. Coombs continued, exchange markets, On the since the in sterling in confidence a gradual improvement been on September 13. in the swap lines of the increase announcement the British were still 13 days of September During the first
running a sizable deficit which, in the absence of the increase in the swap network, would probably have reached major proportions during the second half of the month. The turn in the tide over the past two weeks had enabled the Bank of England to announce this morning a reserve increase for the month of three million pounds, while also indicating that no net recourse to central bank credit was made during the month. As the Committee would recall, the Bank of England had outstanding on August 31 $625 million of overnight money, of which $450 million was provided by the Treasury and Federal Reserve and $175 million by certain foreign central banks. The position at the end of September was somewhat improved although still vulnerable. The overnight money component had been reduced from $625 million to $375 million, comprised of $200 million from foreign central banks and $175 million from the Treasury. The remaining gap of $250 million had been covered by a $150 million drawing on the agreement negotiated in Basle last June providing for financing of reductions in the sterling balances, while another drawing of $100 million of three month money was made on the Federal Reserve. It was to be hoped that today's announcement that the reserve drain was stemmed which had been anticipated to some extent in during September, the market, would further restore market confidence. Yesterday, in more than $30 million and this morning the Bank of England took
they had already taken in an additional $50 million, so the signs were accumulating of a return of confidence. He would hope to see a string of reserve increases over the weeks to come. The other major development in exchange markets, Mr. Coombs observed, had been the gyrations of the French franc, which on several days slipped below par. The Bank of France did not seem to be making any special effort to check the rate move ments and, as far as he could tell, the recent selling pressure on the franc seemed mainly attributable to such short-term phenomena as money market pressures, an adverse tourist balance, and similar temporary developments. On the other hand, he that there might be some swing of the leads thought it possible and lags against the French franc. The French had benefited enormously over the years from the view that the French franc could not possibly be devalued, so that importers did not find to cover their dollar requirements. That situation it necessary as the markets reappraised the long-term might now be turning for the currency of a country which had increasingly prospects arrangements developed among cut itself off from the cooperative the other major industrial countries. Coombs thought was the effect Mr. Mitchell asked what Mr. of the pull-back of Euro-dollar funds on the British position foreign branches of U.S. banks. through
Mr. Coombs replied that the effect had definitely been adverse for two or three months, although he did not know the extent to which it had resulted in British reserve losses. At the same time, the pressures exerted on sterling by the opera tions of American banks had simultaneously been exerted on all major continental currencies. He would assume that the pull back of funds was an important factor in the third-quarter surplus in the official settlements balance of the U.S. It also had important implications for the U.S. gold stock. Mr. Mitchell then asked whether Mr. Coombs thought the British would experience difficulties if U.S. banks continued, for the next four or five months, to draw in funds through their branches at the recent rate. that such a development undoubtedly Mr. Coombs replied the pace of the British recovery. His own impression would slow a little too strong in some periods was that the pull had been the loss to the U.S. but if it were stopped entirely recently, than the gain to the British. would be greater share of the asked whether a significant Mr. Shepardson U.S. bank branches was coming from funds being drawn in through the continent. he thought the main pressure Mr. Coombs replied that had occurred in July and on sterling by the pull-back exerted
August, and that such pressure had lessened in September. He would be surprised if at present as much as 20 per cent of the funds were coming from the U.K.; the main pull now appeared to be from the continent. In reply to another question by Mr. Shepardson, Mr. Coombs said he did not think much of the reflow could be attributed to the issuance of certificates of deposit in London by American banks. It was his understanding that the volume of such certificates outstanding was not large. Mr. Daane asked whether much of the money being drawn in was likely to flow out again quickly if there was a change in international interest rate relationships. In other words, how "hot" were the funds being drawn in? Mr. Coombs responded that the funds seemed to be fairly hot money. In a sense, the U.S. was buying protection in the short run, and there might have to be an accounting if cir cumstances changed. On balance, however, he thought it would be inadvisable to do anything at present to change those flows quickly. It was not possible to say where the money would go if it was not drawn to New York, and as long as the pull-back was not overdone the British should get by. Mr. Brimmer remarked that he understood Mr. Solomon planned to comment on the subject in some detail in his remarks
later in the meeting. The pull-back of funds had domestic as well as international implications, and the Board had been giving the subject a good deal of consideration recently. The Committee might want to return to it after hearing Mr. Solomon's observations. Chairman Martin suggested that the members might offer any comments they had on the subject in the course of the go around. Thereupon, upon motion duly made and seconded, and by unanimous vote, the System open market trans actions in foreign currencies during the period September 13 through October 3, 1966, were approved, ratified, and confirmed. Coombs noted that the original $450 million standby Mr. with the Bank of Italy--not including the $150 swap arrangement million increase negotiated recently--would mature October 20, renewal of the swap arrangement at this 1966. He recommended He would expect that in another twelve-month period. time for the $150 million increase was when the end of the term of March, two arrangements could be combined. reached, the Renewal of the $450 million swap arrangement with the Bank of Italy for a term of twelve months was approved. noted that the $100 million standby swap with Mr. Coombs on November 10, 1966. He rec the Bank of France would mature its renewal for another three-month period. ommended
Renewal of the $100 million swap arrangement with the Bank of France for a term of three months was approved. Mr. Coombs then noted that two three-month drawings by the Bank of England under its swap line with the System would reach maturity soon--a $100 million drawing maturing October 21, 1966, and a $50 million drawing maturing October 28, 1966. He recommended renewal of both for further periods of three months if the Bank of England so requested. That would be a first renewal for the $100 million drawing, and a second renewal for the $50 million drawing. Renewal of the two drawings by the Bank of England was noted without objection. Mr. Coombs noted that four three-month drawings by the System would be reaching maturity soon. They were two drawings Netherlands Bank, of $30 million and $25 million, maturing on the 21 and November 7, 1966, respectively; a $25 million October National Bank maturing October 25, 1966; and drawing on the Swiss a $25 million drawing on the Bank for International Settlements, He recommended renewal of the also maturing October 25, 1966. periods of three months, if necessary. four drawings for further All would be first renewals. Renewal of the four drawings, as by Mr. Coombs, was noted recommended 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. Gov ernment securities and bankers' acceptances for the period September 13 through 28, 1966, and a supplemental report for September 29 through October 3, 1966. Copies of both reports have been placed in the files of the Committee. In supplementation of the written reports, Mr. Holmes commented as follows: The money and bond markets have been subjected to wide swings in expectations since the Committee last met. At the moment the cloud of excessive gloom and pessimism that hung over the financial markets has for the time being lifted and a fairly confident atmosphere prevails--at least temporarily. There are a number of factors that underlie this change in sentiment. First, there is the growing market conviction that fiscal policy measures in addition to those announced on September 8 will be forthcoming in the near future to deal with the pressures on the economyparticularly the pressures stemming from the growing cost of the Vietnamese war. Rumors and the announcement of fiscal action had already had an impact on the bond market at the time of the last Committee meeting, but the additional discussion since that time has buoyed the market significantly further. Second, international developments have generally tended to give the market heart. There has been a growing feeling that prospects for negotiation in Vietnam have improved. The lack of serious controversy at the annual meetings of the international monetary institutions, the feeling that the French seem to have isolated themselves, and the apparently better outlook for sterling have also been plus factors. Third, despite continuing price pressures, the market has interpreted recent economic developments
as on balance indicative of some relaxation of pressure on the economy. And while heavy demands in the capital markets are still anticipated, there is not the same kind of rush to get on the financing schedule that was present in August, and the Administration's program of limiting the demands of Government agencies has reduced an important source of pressure in the markets. In this atmosphere, municipal and corporate underwriters have become more confident in performing their under writing functions. Finally, the financial markets--after uncertainty had neared a crescendo over the tax date--have become somewhat less apprehensive about the severity of Federal Reserve intentions with respect to monetary policy, although there is still a great deal of confusion about the proper interpretation of current discount window policy. The tax date was passed with out the dire consequences that many had predicted. The CD runoff was large, but not as massive as had been feared, partly because a large amount of money became available as a result of a temporary investment of funds arising out of the financing of a corporate merger. As the Treasury rebuilt its tax and loan account balances, pressure on the money center banks relaxed somewhat and this contributed to a more comfortable tone in the money market. The relatively low net borrowed reserve figures published for the week ending September 21, the lower Federal funds throughout much of the period, and rate prevailing the prompt action by the System in conjunction with the FDIC and the Home Loan Bank Board on consumer CD rates, led to a feeling that the System might be paying high short-term interest rates more attention to the And this feeling was not entirely that had emerged. high net borrowed reserve figures dispelled by the week ending September 28. published for the this atmosphere will last is, as usual, How long The underlying facts of the current problematical. situation have not changed as economic and financial and the markets have probably much as expectations, yet to appear. Unless that have discounted developments expectations, there falls short of current loan demand blue book 1/ suggests, continued should be, as the as the Treasury's actual pressure on rates, particularly Reserve Relationships," prepared The report, "Money Market and 1/ by the Board's staff. for the Committee
moves to raise the cash it needs before the year-end unfold. While the near-disorderly atmosphere that prevailed in the markets in late August and the heavy pressure on short-term rates that prevailed around the tax date may not be duplicated, the markets remain susceptible to new developments and to new expectations about the future course of monetary and fiscal policy. Short-term interest rates reached new highs early in the period, with three- and six-month Treasury bills reaching records of 5.59 and 6.04 per cent, respectively, in the Treasury bill auction of September 19--a full 1/2 per cent above their end of August levels. In the changed atmosphere noted earlier, however, a strong demand for Treasury bills emerged with rates moving sharply downward again as dealers' positions were substantially reduced. By last Friday key rates were 10-20 basis points below their level at the time of the previous meeting. In yesterday's uneventful auction average issuing rates for the new three- and six-month bills were set at 5.41 and 5.67 per cent, respectively. System open market operations both were condi tioned by market developments and the shifting atmosphere during the period and, to some extent, that prevailed at least, influenced these developments. The week of 21 was particularly complicated by a jittery September tax date churning, and market Treasury bill market, a still tougher monetary policy. In addition, fears of banks exhibited a tendency to build up their country reserves more than normally during the first excess week of their statement period, thus immobilizing that were available in the banking system. reserves to the market's misapprehen In order to avoid adding modest action to absorb the System took only siveness were permitted to and net borrowed reserves reserves This approach to open market run at a low level. the market might involved a risk that operations policy, but the the System had eased conclude that fortified by the behavior of the approach was logic that time indicated that credit proxy, which at of the decline at an average in September might bank credit the following week, about 4 per cent. In annual rate of prevailed in the money comfortable conditions generally built-up country bank excess market as the previously play, and the net borrowed reserve reserves came into during this period of rose to its highest level figure
restraint. Hopefully, one result of the wide swing in net borrowed reserve figures--from $187 million to $568 million--will be to deemphasize their importance in the minds of market participants and analysts as a single indicator of monetary policy intentions. It should be noted that required reserves and the credit proxy consistently fell below expectations during the period since the Committee last met. The credit proxy for September now appears to have risen only slightly after taking account of foreign branch balances at major U.S. banks, despite a new seasonal adjustment that tends to make the September figures look stronger than the old seasonal would. I believe we should continue to be cautious about overinterpreting short-run changes in the aggregates, particularly since it appears probable that seasonal adjustment patterns may be in a period of radical change. As the blue book indicates, the Board staff is now projecting a 5-6 per cent increase in the credit proxy over the month of October, with the pattern involving substantially higher growth by the end of the month compared with the end of September. New York Reserve Bank estimates involve a somewhat slower growth on average but about the same level at the end of the month. Treasury financing operations will get underway again very shortly. An announcement of a cash offering of $3 to $3.5 billion tax anticipation bills is expected later this week, with the auction likely on October 13 and payment a week later. Toward the end of the month the Treasury will announce the terms of its November refunding, which probably will be utilized to raise new money, with the possibility of a combined some of short- and intermediate-term issues. offering asked if Mr. Holmes would elaborate on his comment Mr. Wayne about a temporary investment in CD's resulting from a corporate merger. billion had been invested Holmes said that about $1/2 Mr. with the merger of an oil in CD's in mid-September in connection that sum had been borrowed from and coal company. Roughly half of
banks and half from insurance companies. The CD's would mature in mid-October, and while the eventual disposition of the funds was uncertain presumably they would be spread around somewhere in the banking system. Mr. Mitchell asked what Mr. Holmes expected with regard to October run-offs of CD's. Mr. Holmes replied that from conversations with New York banks the picture seemed to be mixed. Some banks were optimistic about replacing a large percentage of their maturing certificates, particularly now that the level of bill rates had declined. Others expected losses of as much as one-half of their maturities. Mr. Hayes remarked that despite the concern of some banks the general feeling seemed to be better now than it had been a month ago, and Mr. Holmes agreed. Thereupon, upon motion duly made and seconded, and by unanimous vote, the open market transactions in Govern ment securities and bankers' acceptances during the period September 13 through October 3, 1966, were approved, ratified, and confirmed. Chairman Martin then noted that legislation enacted since the preceding meeting of the Committee gave the System authority operations in securities that were direct to engage in open market or were guaranteed by such agencies, obligations of U.S. agencies and that a staff memorandum concerning such operations, dated
October 3, 1966, had been distributed. (A copy of the memorandum referred to has been placed in the Committee's files.) He thought some members of the Committee might be skeptical about the desirability of undertaking outright transactions in agency issues at this time. The Committee certainly would want to give careful consideration to that question, and also to the question of authorizing repurchase agreements against agency issues. The Chairman suggested that the Committee plan on considering the subject at its next meeting, after the members had had an opportu nity to study the memorandum. No objections were raised to the Chairman's suggestion. Chairman Martin then called for the staff economic and financial reports, supplementing the written reports that had prior to the meeting, copies of which have been been distributed placed in the files of the Committee. following statement on economic Mr. Partee made the conditions: almost any economist would Every once in a while for just another couple of months' give his eye teeth what is going on. For me, figures to help clarify Economic expansion has this is such an occasion. through the summer and into proceeded at a high rate estimates indicate a $14 the fall. Our preliminary GNP for the third quarter, although billion rise in appears due to higher prices, and about half of this probable outlook is for a similarly large the most the fourth quarter of the year. At the same rise in the performance of the stock market time, however,
and other attitudinal indices seems to evidence a deterioration in business and public sentiment. This, along with more fundamental indications of economic imbalance, raises growing questions about the prospects for continuing vigorous expansion, looking even a rela tively few months further ahead. One of the major questions in my mind concerns the behavior of inventories. Clearly there has been a substantial acceleration in the pace of accumulation, with monthly additions to manufacturers' stocks increas ing from around $600 million in the early months of the year to more than $1 billion in both July and August. The latter represents an 18 per cent annual growth rate gain recently in shipments, so and contrasts with no that stock-sales ratios have increased abruptly. It is hard to believe that manufacturers generally or desired this outcome, and in fact the expansion planned has consistently exceeded that in inventories this year by Department of Commerce anticipations surveys. indicated the year-end level projected by the In order to keep to inventory accumulation would now have to latest survey, to a 6 per cent annual rate. This seems exceedingly drop but, by the same token, a continued buildup unlikely rates sooner or later would lead to well above desired in output, with consequent implications downward adjustments for income payments and consumption. of consumer demand is in The underlying strength at present. Retail sales its own right a question mark spring setback, which well from their have rebounded but the early weeks due to lower auto sales, was mainly due again to the auto September were a bit weaker, of yet to test reception has not been time market. There that September may be models, of course, so of the 1967 indicator of prospects. a poor Michigan survey reports University of The latest home goods are fully to buy cars and that consumer plans also shows a But that survey as a year ago. as strong index of consumer decline in its composite further about rising mainly apprehension attitudes, reflecting possibility of rates, and the prices, higher interest the index this the drop in In fact, a tax increase. it was preceding the just as sharp as year has been a great deal of I don't have 1957-58 recession. of such a measure. the predictive value confidence in one would that it may be significant But to the extent
expect a tendency towards a higher rate of personal saving in coming months, rather than the slightly lower one embodied in present staff projections. The rise in business capital spending, though it has been by far the strongest element in the private economy, may also have passed its point of inflection toward lower rates of gain. New orders for machinery and equipment have remained essentially unchanged for four months now and backlogs, though still climbing, have risen less rapidly since mid year. The August Commerce-SEC survey also indicated a slowing in the rate of rise in plant and equipment outlays, from 17 per cent in the first half to 11 per cent in the second half of the year. And now the probable suspension of the investment tax credit may be having some further marginal effect on capital spending plans, as desired. In any event, one very recent private survey reports that business is planning little further increase in capital outlays for 1967 compared with 1966. Most capital budgets are still quite tentative, but if for 1967 probably the 3 per cent increase indicated were realized, there would almost certainly be a downward tilt in spending as next year progressed. About near-term construction prospects there can be no doubt. Housing starts have dropped by about 500,000 units, annual rate, since early in the year, and the pattern of building permits--plus what the mortgage market--suggests little or no we know of for at least the next several months. improvement Residential construction outlays had declined by one-eighth by the third quarter, and a further about decline is almost certain for the quarter substantial non-residential construction now commencing. Private declined significantly in recent outlays also have and contract awards for commercial building months, weakened. Presumably this also reflects have noticeably though overbuilding in mainly the mortgage situation, some areas may be a factor. Against this rather impressive list of weaknessesbe weighed the probable and possible--must present, expenditures, particularly rising trend in Government cash expenditures for defense. The figures on for August suggest a further rise in defense in July and
the third quarter of well over $3 billion and perhaps as much as $4 billion on a national income basis, but we have no specific information on near-term prospects other than the general indications of continued rapid growth reported at previous Committee meetings. There are two considerations to be kept in mind regarding an expanding defense effort, however. The first is that this would not necessarily insure an expanding and ebullient economy; from mid-1951 through the next year or so there was little real growth in GNP and widespread evidence of weakness in the private sectors, despite (and in part because of) the Korean War effort. Second, spiraling defense costs would enhance the prospect that the Administration might seek a general tax increase, which of course could change the fiscal implications considerably. Such a development might well retard private sector demands enough to call for significant modifications in monetary policy. Under present circumstances, whatever reasonable dampening of aggregate demand can be accomplished is all to the good. It is evident that there are still significant inflationary pressures on both the demand and supply sides of the economy, and that resource utilization remains very near capacity levels. At the same time, it would not seem desirable to ignore devel opments in the private sector that might lead to unnecessary slack and, with any easing in the defense effort, possibly to a cumulative downward movement later on. Given the uncertainties in the outlook, and recognizing the substantial degree of restraint on spending already achieved and still in process through monetary policy, I would not like to see any further tightening now. It may not yet be time to ease off but the situation requires very careful appreciably, watching and a willingness to do so whenever important weaknesses do in fact emerge. Mr. Axilrod made the following statement concerning financial developments: Credit markets during the past two months have moved from a period of severe strain to one during
recent weeks of comparative relaxation. In this movement expectations, demand forces, and supply conditions have all interacted. As Mr. Holmes has pointed out, the decline in interest rates of recent weeks was influenced by growing market expectations that we are likely to have either a personal and corporate income tax increase or peace negotiations in Vietnam. Moreover, the emerging bits of news about economic prospects for the private sector of the economy did not seem to indicate quite as much basic economic strength as many had expected. And this impression was buttressed by the relative lack of strain in short-term markets after mid-September. But unless expectational shifts are sustained by the fundamentals of demand and supply they are likely to be short-lived. Thus, the question becomes one of whether monetary policy has become tight enough so that it is causing cutbacks in real expenditures to noninflationary levels. Or whether credit demands are becoming less for other reasons, such as the investment boom's vigorous running out of steam on its own. Monetary policy does appear to have become quite tight in recent months, even though we may disagree about what variables best symbolize this tightness. While net reserves have shown little change since June, borrowed supply actually dipped slightly during the summer, money markedly, and credit availability interest rates rose restrained at depositary institutions. was significantly the year the money supply and total And since the first of about 2.5 per cent, as compared reserves have grown by only around 5 per cent for both variables with growth rates of over all of last year. growth in such monetary aggregates, With restrained to the point where bank credit interest rates have risen back, even though some funds growth, too, has been held abroad through the Euro-dollar are being obtained from are losing CD's, net, at a market. Major lending banks $1 and $1.5 billion estimate at about between rate which we Moreover, the extent in September and October. per month up by competing success such losses can be made to which consumer-type time institutions for against other savings fully limited by the new has probably been somewhat deposits time and savings accounts. of ceiling rates on structure banks and other savings more importantly, both And, perhaps
institutions remain hard pressed to compete with interest rates available on market instruments. While the fund flows just described represent in large part shifts in the pattern of lending and not necessarily limitations on the total available for lending to final users of credit, this process of disintermediation does have its costs in terms of effects on the structure of interest rates. I would expect, for instance, that disintermediation would tend to raise long relative to short rates as banks and other financial institutions back away from long term markets, while former holders of CD's are likely to purchase mainly short-term market instruments. Just as the movement toward bank intermediation that was set in motion by the Regulation Q changes in the early 1960's was a tonic for long-term markets, so is the reverse process of disintermediation likely to place a strain on such markets, especially in the transitional period when banks, nonbank institutions, and security markets are moving to a new equilibrium relationship. But disintermediation may be more an effect than a cause in the current credit environment since, given current Regulation Q ceilings, it is basically monetary policy and credit demands that will determine the level of market interest rates, and hence the degree of disintermediation. Credit demands thus far this year have been buttressed by heavy corporate borrowing. This borrowing has been partly from banks, but has been especially heavy in the bond market as one might expect in a period when there have generally been expectations of rising interest rates. By borrowing heavily earlier this year, corporations have apparently anticipated a part of their future need. One indication is that corporate liquid assets over the first three quarters of the year have risen by an estimated $2 billion (seasonally adjusted and excluding some special transactions), despite the acceleration in tax payments, as compared with no change last year over the same period. Thus, it appears that corporate capital market financing could be somewhat less heavy in the period ahead without necessarily indicating a reduction in real expenditures. However, if the moderation of the corporate calendar in recent weeks and the less than expected September expan sion of bank loans to business continue for some time,
that would clearly tend to raise questions about the trend of the investment boom. But while there may be some lingering doubt about the continued strength of business credit demands, it appears certain that Federal Government demands in the period ahead will be large--with perhaps $8-$9 billion of gross new borrowing probably required between now and year-end. Some abatement of business borrowing demands would be welcome in such circumstances; however, if business spending does continue high and they choose to dispose of their accumulated liquid assets instead of borrowing, renewed strains in the short-term market could develop as both business and Government attempt to utilize it as a source of funds. With the supply of funds in the economy tight, with the future strength of private credit demands a bit uncertain, and with the duration of Federal Gov ernment demands also uncertain (because there may be a tax increase next year), this is probably a good time for monetary policy to hold roughly where it is for a while. But, in terms of day-to-day operations, the rein on money market conditions should probably be a fairly loose one. In this period of high uncertainty a flexible rein will enable the feedback of information from the nonfinancial world to have an influence on actual money market conditions. For instance, if money market conditions were showing a tendency to ease--as indicated by declines in the Treasury bill or Federal funds rates--this might suggest that credit demands were less than would be expected if economic expansion were continuing at its earlier pace. Accordingly, it would seem desirable not to fully offset such an easing tendency by exerting additional pressure on the net borrowed reserve position of banks. On the other hand, in the somewhat more likely event that money market conditions tend to tighten up the next four weeks in the face of the expected over increase in public and business credit demands, October at least some of this tautness might be captured then if it meant that net borrowed reserves moved deeper even the past three weeks on average. than they were during significant movement toward deeper net borrowed But a and tighter money market conditions should reserves
probably be dependent on a greater than desired expan sion in the monetary and reserve aggregates. The restrained growth in bank reserves and the money supply thus far this year--and the absolute lack of growth in bank credit during the past two monthssuggest to me that there is scope in the period ahead for added expansion in reserves, bank credit, and money. The blue book indicates the dimensions of a likely further expansion in October. Such an expansion in reserve and monetary aggregates would seem a useful means of helping the Government and the economy get over at least the first hurdles of the fall financing season, while the System awaits further clarification of basic economic and fiscal policy trends. Mr. Solomon then presented the following statement on the balance of payments: What I propose to do today is to review the impact on the U.S. balance of payments over the past year of the acceleration in total spending on the one hand and the tightening of credit conditions on the other--and to indicate some of the policy questions raised by these developments. As best we can estimate it now, the deficit on a liquidity basis in the third quarter was at an annual rate of $2 billion. For the first nine months of the year, the deficit on the liquidity basis thus comes to an annual rate of $1.6 billion, only $200 million more than last year, despite the substantial deterioration in the trade balance. On the official settlements basis, we appear to have had a surplus of about $1 billion in the third quarter, for rather special reasons to which I shall return later. In the first half of this year, the official settlement deficit was at an annual rate of less than $900 million, compared with $1.4 billion in 1965. All in all, the balance of payments accounts look better than might have been expected. I turn now to a closer look at the major components of the balance of payments. The most conspicuous effect of accelerated aggregate demand in the past year has been on U.S. imports, which
have increased much more rapidly than GNP. In July August, imports were almost 25 per cent higher than a year ago. A surge of imports is a normal response to excess demand at home. What is encouraging is that exports have also continued to increase at a healthy rate. After some hesitation in the spring months, exports picked up again this summer and in July-August were 9 per cent larger than a year earlier. Thus, most of the deterioration in the trade surplus can be attributed to the extraordinary increase in imports, which is in turn directly related to the excessive expansion of over-all spending in the U.S. economy. It is reasonable to think that a slowdown in the expansion of aggregate demand will bring with it a slackening in imports. From the viewpoint of long-run balance of payments objectives, what is most important is that the price level not rise too much. A temporary bulge of imports accompanying a temporary surge of demand is less harmful to our competitive position than a sharp run-up in prices. The other major factor contributing to a deterioration in the current account surplus over the past year is the increase in military spending abroad, which rose by $800 million (annual rate) from the first half of last year. Most of this increase was in Asian countries. While the current account of our balance of payments has worsened substantially over the past year, the capital accounts have moved the other way. The improvement on capital account shows up in four (1) increased borrowing abroad by U.S. corporations ways: abroad; (2) net repayment of to finance direct investment U.S. bank loans by foreigners; (3) borrowing of Euro dollars by foreign branches of U.S. banks for the use of (4) investment of liquid balances by home offices; and and international institutions in U.S. foreign official assets that are classified as nonliquid. me first dispose of this last item. The Committee Let the second quarter there was a shift of knows that in official dollar balances into CD's of more-than-one-year It is difficult to maturity and into agency issues. shift was a response to determine how much of this and how much to higher interest yields on "jawboning" any event, the liquidity deficit these instruments. In have been about $400 million higher in the second would quarter without these transactions.
Turning to other and less questionable capital flows, we may note the increase in borrowing abroad by U.S. corporations to finance direct investment. U.S. corpora tions issued nearly $500 million of securities abroad in the first half of this year, while foreign subsidiaries of U.S. corporations--so-called Luxembourg corporationsborrowed a similar amount. These borrowings abroad helped to reduce the outflow of dollars to finance what appears to be a strong determination of U.S. corporations to continue to expand their foreign operations. It seems reasonable to assign credit for the increased foreign borrowing to both the Commerce Department program and stringent credit conditions at home. The Committee is well aware of the substantial contribution, on the plus side of the balance of payments, of net repayments of bank loans to foreigners. Over the first eight months of this year, net repayments amounted to more than $400 million, despite some renewed net lending in the second quarter. Finally, we come to the inflow of short-term funds associated with the active bidding by foreign branches of American banks for Euro-dollars for the use of their home offices. This inflow is reflected in a large increase in "due to foreign branches" on the books of U.S. banks. It amounted to about $800 million in the first half of this year and a further $1-1/2 billion since the end of June. This massive absorption of dollars in foreign hands--or dollars that would have gone into foreign hands, including foreign official reserves--is the major explanation for the large difference between the liquidity balance and the official settlements balance thus far this year. No doubt part of the improvement in the balance on official settlements this summer is a reflection of the speculative outflow of funds from the U.K. In effect, the dollars that the U.K. drew on the Federal Reserve swap line and from other sources and paid out in support of sterling were absorbed by U.S. branches abroad instead of flowing into official reserves in Europe. From the scanty data so far available, we know that increases in reserves of continental countries have been rather small this summer, and this is consistent with the recent strength of the dollar on foreign exchange markets.
These massive short-term capital inflows are pro viding temporary relief to the balance of payments, which we cannot help but find refreshing. It is clear, however, that such short-term capital inflows do not represent a fundamental improvement in the balance of payments, and it is important not to be carried away by any pluses that appear in the accounts. One can go further and say that these inflows represent hot money that will flow out again as soon as pressure on bank reserves is relaxed. Thus we may hate ourselves in the morning in the sense that the relief we are enjoying at the moment may have to be paid for in one of two painful ways in the future: either a rapid build-up in European official dollar holdings requiring us to use the swaps, draw on the IMF, and sell gold, or a severe constraint on monetary policy when ease is called for. We can take some consolation from the fact that when a move toward monetary ease becomes appropriate, excess demand will have subsided and imports will tend to slacken. Just as the extraordinary bulge of imports is being offset by extraordinary capital inflows, the later outflow of capital will be offset by a slowdown in imports. Nevertheless, we must be prepared for the loss of these short-term funds, and, if we don't want monetary policy to be hamstrung in the future, we must be prepared to finance the outflow by drawing on the IMF and losing gold, unless we find ways to improve other components of the balance of payments in the meantime. Mr. Hickman observed that one of the first uses of any hot be by the British, in repaying their money flowing out might well and to the extent that was so it drawings on the System swap line, Mr. Solomon agreed with Mr. Hickman's would be a healthy development. observation. preceding the go-around there Chairman Martin said that on some of the developments at the recent might be brief reports
meetings of the International Monetary Fund and International Bank for Reconstruction and Development. He had attended a meeting of the Ministers and Governors of the Group of Ten on Sunday, September 25, which was chaired by Dr. Holtrop because the Finance Minister of the Netherlands was unable to be present. About two hours were spent in debating the wording of the communique that was subsequently issued. The communique reaffirmed the position the Group had taken at its meeting at The Hague in July. However, the French did not reassert the dissent they had made so vigorously at the earlier meeting, and there was some inclination to feel that that represented a slight softening of the French position. The Chairman then invited Mr. Daane to comment on the meeting of the Deputies of the Group of Ten. Mr. Daane said that the Deputies of the Group of Ten met on the afternoon of Friday, September 30. The meeting was largely procedural, and was concerned mainly with three questions: the arrangements and preparations for forthcoming joint meetings of the Deputies with the IMF directors, the arrangements and preparations for forthcoming meetings of the Deputies themselves, and the matter of electing a chairman of the Deputies. The first joint meeting probably would be held in Washington in late November or early December, although that fact was confidential at this point. The Deputies themselves would meet in Paris on November 16, 1966.
Dr. Emminger of the German Federal Bank had been persuaded to continue to serve as Chairman until sometime after the turn of the year. Mr. Daane added that there was a definite spirit of forward motion in the meeting. The willingness evident to move ahead in concert with the directors of the Fund struck him as significant, particularly in light of the feelings on that question that some of the Deputies had displayed earlier. Chairman Martin then asked Mr. Solomon to report on the meeting of Working Party 3 that had been held on September 23. Mr. Solomon said that the recent Working Party 3 meeting focused mainly on the U.S. economy and the U.S. balance of pay ments. But in the course of the routine multilateral surveillance on a presentation by Milton Gilbert of the BISdiscussion--based European representatives suggested that the Working some of the before the end of the year, conduct a thorough Party should, of the Federal Reserve swap of the recent extension discussion mainly procedural--the issue Although the discussion was network. or not such a discussion should be held at a future being whether were apparent: (1) did the meeting--two points of substance of the swap network represent a "permanent or semi extension liquidity and therefore did permanent" increase in international the Group of Ten work on international it have implications for
liquidity; and (2) was the United States planning to use the additional swap facilities to finance what was expected to be an enlarged deficit. Mr. Solomon reported that Under Secretary of the Treasury Deming defended the swap extensions and insisted that discussion of them properly belonged among the central bank Governors at Basle. He (Mr. Deming) saw no reason for a discussion before the end of the year, since the renewal dates were spread out evenly any event, it was impractical to envisage that over time. In would be talked about in WP-3 before they occurred. extensions inconclusively with a suggestion that those who The matter ended a discussion submit a note on what sort of discussion had requested they had in mind. As to the U.S. economy, Mr. Solomon continued, the U.S. presented a fairly comprehensive review of monetary delegation effects--both internal and external--over the past policy and its the Working Party was strongly aware of year. It was clear that the degree of monetary restraint that had been achieved and was restraint. The two at additional monetary not even hinting hinted at were, as might have policy steps that were additional action and some further restrictions been expected, further fiscal on direct investment.
Chairman Martin said he would make a further comment on the Bank-Fund meetings themselves, as he saw them. On the whole, they were much better than he had expected. The problem of the pound had been largely removed by the System's action in enlarging the swap network; the enlargement was viewed as postponing the problem, which was precisely what it was intended to do. There still was some concern about whether the U.S. was too complacent with respect to its balance of payments situation. The dialogue concerning new reserve assets had been advanced considerably; there was increasing awareness of the difficulty of designing a new asset that would supplement existing reserve assets without replacing them. He found that problem being discussed seriously by proponents of new reserve assets as well as by opponents. There was a disposition to think in terms of successive steps, with a first round involving an expansion of the existing activities of the IMF, and a new reserve asset coming into being subsequently simultaneously. That approach made good sense to him, rather than the approach now advocated by the and while it was not exactly U.S. it was worth consideration. concern that overshadowed others at the meeting, The one the Chairman continued, related to the price of gold and to the the next few years. It was recognized that if role of gold over France continued to buy gold automatically the gold exchange
standard would be endangered. It was one thing for the French to buy gold because they questioned the manner in which the U.S. managed its affairs and accordingly were not willing to hold dollars; but it was another thing if they were buying gold simply for the purpose of embarrassing the gold exchange standard. It was generally recognized that in the absence of new discoveries gold production would be inadequate to meet world needs, and that there was a real problem with respect to speculation in gold. It was unfortunate that at the time of the meeting a British official implied that there might be an increase in the price of gold. Mr. Wayne asked whether the Chairman would comment on the reactions to Secretary of the Treasury Fowler's hints that the U.S. might take drastic action to curtail capital outflows. Chairman Martin replied that the reaction was generally adverse, as might have been expected. However, the Secretary's remarks might have served a useful purpose in impressing people with the seriousness of the situation. Mr. Brimmer observed that on the subject of stronger U.S. controls of capital movements he had heard some favorable comment by Europeans who thought that the inflow of dollars to their countries was a source of inflation. They were hopeful that the U.S. would take steps in that area.
Mr. Galusha asked whether any pressure appeared to be building up behind proposed legislation to subsidize U.S. gold production. Chairman Martin said there was some discussion of such legislation, but he did not think it was likely to be enacted in the present session of Congress. Mr. Hayes observed that there had been a vigorous denial of the British official's remarks regarding an increase in the price of gold by the Chancellor of the Exchequer and the Governor of the Bank of England. They were disturbed and puzzled by those remarks, which were completely at variance with British policy. He (Mr. Hayes) was as pleased as Chairman Martin had been over the increasing realization that a new reserve asset, unless very carefully worked out, might constitute a threat to existing reserve assets and international liquidity. He had held that view for a With respect to the developments at the WP-3 meeting long time. clear from conversations he had reported by Mr. Solomon, it was continental central bank governors that they had had with several the wisdom of holding discussions of the swap grave doubts about in the WP-3 meetings. They preferred to keep such discus network and he also hoped that that would be the outcome. ions at Basle, In response to the Chairman's invitation to add his comments, surprising thing to him was that no great Mr. Bopp said that the
surprises came out of the Fund-Bank meetings. That perhaps was fortunate from the point of view of the U.S. 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: The economic expansion remains very strong, and the outlook continues to be one of serious inflationary pressures well into 1967. In our Bank we hold to this opinion even though we recognize that some observers are beginning to take a less sanguine view of next year's business prospects. A change in Vietnam is always a possibility, but in the meantime the current and prospective defense build-up overshadows the moderation of some recent business indicators. According to our analysis, the fiscal stimulus by the Federal Government remains very substantial during the second half of calendar 1966 and will still be appreciable in the first half of 1967. While the President's restraint program has contributed a good deal to steadier financial markets and may have helped prevent a serious breakout of inflationary expectations generally, the actual fiscal measures announced so far can hardly be expected to have more than a minor direct impact on business and Government spending, and that not until some time in We see little hope for a letup in cost and price pressures between now and mid-1967. In fact, cost-push pressures are becoming more serious, while the pressures of excess demand continue. Perhaps the absence of an inflation psychosis to date reflects in good measure the vigor and pervasiveness of credit policy, together with recognition that the Vietnam War is a major force behind the current boom and that its future impact on the Federal budget is too uncertain to make inflation a sure bet, In analyzing the current inflationary threat and in considering possible means of combatting it, I think we should guard against the danger of placing too much of the blame on excessive expenditures on plant and equip ment and excessive business lending. It seems to me that a too stimulative Federal budget is an even greater
contributory cause and that in any case the most desirable cure is not a sharp and deliberate reduction in private plant and equipment outlays. Because of the long-run contribution of such spending to increased productivity, I believe there should be at least equal emphasis on lower Government expenditures and an in crease in personal income taxes, i.e., the use of fiscal policy to cut back consumption growth. Our recent efforts to slow the pace of business lending have seemed to me essential if an appropriate slowdown in total bank credit growth was to be achieved, but in my view we should avoid overemphasizing curtailment of business loan expansion for its own sake. As for the balance of payments, the underlying deficit seems to be continuing at about the same rate as in the first half of the year, although the liquidity deficit will benefit again this quarter from special factors--in this case, debt prepayments. We doubt whether the August import decline is likely to persist. In general, the unsatisfactory trade surplus--with exports sluggish and imports at very high levelscontinues to be the major adverse factor, along with the less measurable impact of the Vietnam situation. The various programs to reduce capital outflows seem working reasonably well, but this is perhaps to be more the result of the current domestic credit situation than the effectiveness of the programs themselves. In recent weeks the System has quite appropriately endeavored to learn more about the flow of funds to major U.S. banks from their foreign branches. However, I think we should have clearly in mind the beneficial effects of this flow--temporary though they may beon the dollar in foreign exchange markets and in central bank demand for gold. For mitigating foreign these reasons, I would be very reluctant to see measures taken which would have the effect of reversing this flow, the domestic justification for such action was unless indeed. If concern is felt about the failure very strong credit series to reflect adequately these of some of our can readily be fund inflows, the statistics foreign into account, as in fact is now adjusted to take them being done both at the Board and at our Bank. Likewise of reserve requirements for these liabilities the absence does not mean that we cannot make due allowance in our determination for whatever contribution these policy may be making to a greater degree of credit foreign funds
expansion than would otherwise occur. Perhaps the best way of approaching this problem would be to make an informal suggestion to a few of the major banks involved not to press too hard on this source of funds. As usual, the interpretation of recent data on bank credit is a perplexing task. Bank credit indicators of the last few months are heavily influenced by the increased amounts and changed pattern of corporate payments to the Treasury since April, for which statistical adjustments are difficult to make. Nevertheless, there is a good deal of evidence that the growth of bank credit in September was rather slow, following a relatively weak month of August. October may well see some pickup in this rate of expansion. Serious un certainties both as to the probable amount of future CD runnoffs and as to the alternative methods by which banks may meet these drains also add to the difficulty of interpreting current and prospective credit data. As Governor Mitchell has pointed out from time to time, the change in degree of bank intermediation will suggest greater attention to total credit growth, but as a practical matter statistical measurement of total credit is impossible on a timely basis. Considerations such as these point up the difficulty of setting forth policy instructions in any very precise manner. We shall soon be confronted with the need to maintain an even keel in view of the prospective Treasury cash borrowing in the near future. This in itself would suggest maintenance of an unchanged credit policy, but I believe such a policy is warranted in any case on general economic grounds. The securities markets have been notably unstable in recent weeks; and while the bond market is currently going through a phase of euphoria, this may turn out to be another instance of an excessive swing of the pendulum, to be followed by a swing in the other direction. Also, I think we must reckon with the fact that there are widely differing public interpretations and misinterpretations of the System's policy state ment with respect to the discount window. In these circumstances, I think the Manager will need substantial leeway in order to cope with market developments, always in a context of maintaining a firm
but orderly money market. Both short-term rates and net borrowed reserve data should therefore be secondary considerations. With respect to the discount rate, I feel that while we "missed the boat" in July, developments since that time have been such that I would not recommend action now. I have in mind, of course, the rapid escalation of market rates a few weeks ago, the joint efforts of the various regulatory agencies to moderate or even roll back deposit interest rates, and the fact that the Administration has at long last recognized the need for action in the area of fiscal policy. There may of course be new dramatic develop ments in the coming weeks pointing up the need for a prompt increase in the discount rate, but in the absence of such developments I would be reluctant to see such an overt rate action. If I may digress for a moment on the subject of discount window administration, I should like to that the System would hold firmly to express the hope in the September 1 statement in the line propounded banks a so-called new or discussing with member revised discount program. It seems to me that the statement was that the window would be essence of the as in the past to meet seasonal and unusual available in accordance with Regulation A; that the needs, of borrowing at the window would be used more occasion than in the past to influence member aggressively business loans in banks in the direction of curtailing of adjustment; and that if preference to other means but also appeared to this route appeared feasible period during which the require a somewhat longer be made, the System would be willing adjustment could in such a delay. It is never easy to to acquiesce large bank, and I am sure that there trace dollars in a where it cannot be be many instances of borrowing will slowdown in business lending is clearly stated whether a of the borrowing, even though the means for liquidation an important part. What I feel this element may play I would like to see the System concerned with and what of the member banks that is a concept on the part avoid and distinct classes of there are two clear-cut window. The dangers of such borrowing at the discount borrowing "tranches" were a sharp distinction of joint meeting of the at length at the discussed
Governors and Presidents on August 23, and it was noteworthy that the September 1 statement definitely avoided any such definite classification of borrowings. Doubtless an intra-System exchange of information with respect to borrowings of a longer than usual character may be quite useful, but I would hope that discount of ficers would not encourage the member banks themselves to look upon the Reserve Banks as administering two quite separate types of discount programs. Mr. Holland has prepared a draft letter to discount officers which I think deals very effectively with this issue. It seems to me that the staff's draft directive 1/ is quite appropriate. Mr. Francis remarked that total demands for goods and services had continued to rise at a faster rate than productive capacity in recent months. As a result, the economy had suffered many inefficiencies due to the strain on its resources. The nation's trade balance was deteriorating, and prices were rising at an accelerated rate. Since May both wholesale and consumer prices had risen at over 4 per cent annual rates compared with about 3-1/2 per cent rates earlier in the year. The strong rise in total demand had been in part the result of very stimulative fiscal actions and the monetary expansion last winter and spring. Monetary developments were more restrictive from June to September, Mr. Francis noted. Member bank reserves, which had been rising at a rapid rate, declined. The money supply of the country also reversed its strong upward trend, and commercial bank credit rose at a much slower rate. Most interest rates went up much more rapidly 1/ Appended to these minutes as Attachment A.
than in the preceding year. He would submit a table for the record showing this apparent shift of trend.1/ Mr. Francis commented that the fiscal influence of the Government had continued to be very expansive, reflecting both expenditures for Vietnam and the large outlays for welfare programs. The high employment budget, which indicated considerable fiscal stimulus in the year ending last June 30, was probably even more expansive in the second half of this year. In view of the strong demand for goods and services and the accompanying upward pressure on prices, the greater propensity to invest than to save, and the stimulative stance of the Federal Government, he felt that the monetary restraint from June to September had been increased appropriate. Whenever there was a tightening in monetary actions, Mr. Francis continued, questions arose as to whether the monetary was too restrictive and as to the length of time restraint restraint In the current situation, the move toward should be exercised. had apparently been substantial, but he believed it had restraint great. For one thing, current data frequently were not been too because of later revisions, problems of seasonals, and misleading But even if it later appeared that monetary irregular movements. been halted, there were reasons to believe that there expansion had referred to is appended to these minutes as Attachment B. 1/ The table
might have been and continued to be a decline in the demand for money balances. The markedly higher interest rates which were now being experienced probably were causing some decline in the desire to hold cash balances. Also, with fiscal actions of the Government operating in such an expansionary way, the appropriate monetary growth was probably smaller than it might otherwise be. Mr. Francis concluded that the June-September trends in monetary developments were appropriate and should be continued for the near future. If demands for credit were so strong in the next few weeks as to push interest rates up, the Committee should not interfere. Mr. Patterson reported that, in the Sixth District, the of credit tightening were shown more clearly in financial effects data than in data measuring economic activity. Although the large city banks apparently expanded their business loans in September, after curtailing them in August, most business loans were made at substantially higher rates than those of three months earlier. At the large banks in Atlanta and New Orleans over 95 per cent of all business loans were made at rates of 6 per cent or higher during the first half of September, compared with 45 per cent in June. Generally firmer terms on business loans were reported with no diminution in the strength of loan demand. At the banks outside leading cities, however, loan expansion apparently was not large in September.
That the banks had been pressed for funds was suggested by the continued selling of U.S. Government securities and slowed-up purchases of municipals as well as a slower deposit growth, Mr, Patterson observed. Time and savings deposits remained un changed at District banks in September with reserve city banks having had practically no change in their total time deposits for three months. Growth of demand deposits in September recovered part of the August decline but was less than would ordinarily have been expected at this time of the year. District banks had been net purchasers of Federal funds ever since late July. Mr. Patterson noted that any analysis of economic conditions was complicated by the effects of the airline and construction strikes on the currently available statistics. Both total industry and manufacturing employment were practically nonfarm employment month. District lumber and in August from the preceding unchanged a decline, caused in part by receding furniture industries suffered expanded industrial plants Announcements of new and housing activity. and probably totaled continued in a large volume in the third quarter the $650 million total down only slightly from about $600 million, new and expanded pulp of last year. Proposed of the third quarter of the total. The textile made up a major part and paper activities with the demand for nonmilitary to be catching up industry seemed remained high. although activity fabrics,
On balance, the latest available financial and economic information suggested to Mr. Patterson a less frantic pace of expansion and a substantial bite on some sectors of the economy in the Sixth District. National data pointed to the same conclusion. Mr. Patterson observed that for some time the System had laid stress on the growing demands for credit as being primarily responsible for tight money conditions. There had been backing for that statement in the continued expansion of the reserve base and the rapid rise in bank loans and total bank credit. That position was now less easy to support. Of course, the process of disinter mediation, as Mr. Mitchell pointed out at the last meeting, might of bank credit data. However, it complicate the interpretation be concluded that System policy had become a much could at least in the recent credit tightening than it was a more important factor few months ago. The coming Treasury financing suggested to Mr. Patterson that an "even keel" would be the appropriate policy to follow during the next period. However, aside from the even keel considerations, it seemed to him--as it did at the last meeting of the Committee--that policy should not be made more restrictive. The financial markets had behaved remarkably well recently considering the many strains they had undergone. The Committee should be very cautious about adding to those strains. He would, therefore, favor a policy of no change. The draft directive was acceptable to him.
Mr. Bopp commented that during the past few weeks there had been a virtual halt in expansion of total bank credit, a significant slowdown in the rate of increase in business loans, and a marked downturn in interest rates. On the basis of those developments, it might appear that the Committee was well on the way to achieving the best of all possible worlds: a significant bite into credit flows without a rapid escalation of interest rates. Yet the period ahead might well see a swift reversal in those trends. It was quite probable that interest rates would rise under burgeoning public and private demands for credit and that business loans would increase as tax, inventory, and capital spending pressures built up. Certainly, Mr. Bopp continued, experience so far in the Third District suggested that banks were under pressure to expand business loans and that they would do all in their power to accommodate their favored customers. Indeed, one of the largest Philadelphia banksrecently coming under deposit strains--approached the Reserve Bank last week to discuss the conditions under which it might qualify for the special discount program. That bank had assumed that the principal a holding of the line on total loans. When quid pro quo expected was expected to hold down business loans, it the bank found it would be to borrow. That bank now was advertising heavily became more reluctant cent and had its loan officers on for 99 month consumer CD's at 5 per new CD's and attempting to persuade existing CD the phone soliciting
holders to renew their deposits so that it might avoid borrowing from the Reserve Bank. If other banks found it equally difficult to hold the line on business loans, it might be difficult to influence their behavior through administration of the discount window. It followed that significant upward pressures on business loans might be felt and that those pressures might be accompanied by rising interest rates as portfolio adjustments were made to permit loan expansion. It might be, Mr. Bopp said, that the rise in rates itself would retard to some extent the loan increase and inhibit further portfolio shifts. The question remained, however, to what extent the System should exert a further restraining influence, thus intensifying the upward adjustments in rates and making it more difficult for the banks to hold CD's and adjust their portfolios in order to make business loans. In Mr. Bopp's judgment the System's prime objective should be to maintain conditions favorable to the recent more moderate rates of growth in aggregate reserves and bank credit. If necessary to accomplish that objective, he would allow interest rates to firm, first in response to pressures from the market, and then--if neededas a result of additional action by the System. However, he would not impose more restraint than needed to attain that aggregate goal in order to help implement the selective policy toward business loans. In view of the apparent reluctance of banks to borrow under the
special program, such a policy might lead to hyper-tightness, including a more rapid deceleration of total bank credit than was warranted by developong business conditions, and upward pressures on interest rates which could complicate Treasury financing and lead again to conditions of near-panic in financial markets. Of course, Mr. Bopp concluded, policy over much of the next four weeks had to be directed toward an even keel. The imminent Treasury financing dictated that. In the meantime, the Committee would have a further chance to judge the strength of loan demand and to assess more fully bank response to the special discount program. Mr. Hickman commented that this year there were more uncertainties and cross-currents than usual as the annual forcasting period was entered. Bulls and bears could make equally strong cases about the economic outlook, reflecting conflicting evaluations of strategic factors in aggregate demand. Despite the Administration's announced intent to make more use of fiscal policy, the analyst was faced with a step-up in defense spending, the magnitude and duration of which were unknown and perhaps indeterminate. Thus, any forecast of economic activity much beyond a quarter ahead could easily be wide of the mark and, as a consequence, could lead to inappropriate monetary policy, fiscal policy, or both. regard to recent monetary policy, Mr. Hickman believed With deal of pressure had been put on the banking system and that a great
financial markets. Both the reserve base and the bank credit proxy declined on average in August and September, with influences to be felt later on, even though one might be unable to identify them or to quantify the time lags. Since labor productivity might decline if growth slackened, the Committee could over-play restraint and do more harm than good in its efforts to check built-in inflation, which would inevitably result from the failure to apply appropriate fiscal policy a year or so ago. While recent money market conditions had been somewhat easier than he thought he was voting for at the last meeting, Mr. Hickman said, in retrospect he preferred what actually occurred to a further now that the Committee steer a course as tightening. He recommended near the middle of the road as feasible, while attempting to achieve conditions very slightly firmer than recently. The basic money market continue to be to provide the reserves needed to achieve goal should moderate expansion in money and credit, and to promote sustainable economic growth. The Committee should not seek to roll back the price level, or strain to hold it at present levels, since some inflation was now the inevitable result of past errors and omissions. He would directive, which seemed to him to be vote for the proposed staff reasonably near his position. he would like to devote a few minutes to Mr. Hickman said expressed at the regular quarterly meeting of summarizing the views
Fourth District Business Economists held at the Cleveland Reserve Bank on September 20. The tone of the discussion was less bullish and more uncertain than in June. The median forecast of the group showed less than a 4 per cent increase in the production index for 1967, less than half this year's expected increase of more than 8 per cent. The median GNP forecast for 1967 was a gain of 6 per cent in current dollars, compared with about 8-1/2 per cent this year; in real terms, the group forecasted an increase in the range of 3 per cent to 3-1/2 per cent. The group's forecast for corporate profits was not encouraging, Mr. Hickman continued. No one expected after-tax profits in 1967 to be more than 5 per cent greater than in 1966. Nearly half predicted a smaller gain, and the rest expected either no change or a decline in aggregate profits. Views on profits were based on the assumption that corporate income taxes would not be increased in 1967, although most of the group expected an increase. There was widespread concern about the uncertain role of defense spending in the business outlook, Mr. Hickman noted. The group felt that capital spending would continue strong through midyear, with little or no short-run effects expected from the change in the tax credit and accelerated depreciation. Only one industry, paper and pulp, reported that capacity coming on stream was showing signs of becoming It was evident that the corporations represented were excessive. feeling the bite of monetary policy in varying degrees, although they
understood the System's problem and agreed with its objectives. The group was unanimous in recommending a better balance in the mix of monetary and fiscal policy. Just before the meeting, Mr. Hickman observed, the Cleveland Reserve Bank had conducted a special survey on recent financial experience of the corporations represented. About half the respond ents reported that they had borrowed external funds since June. Three-fifths of those borrowing had turned to commercial banks, one third to the capital market, and the rest to parent companies or foreign banks. Only one corporation failed to obtain accommodation from commercial banks, and that company obtained the needed money in the capital market. Almost all borrowers reported paying higher interest, and individual companies reported a number of restrictive changes in credit terms. The results of the survey corroborated the view expressed by the Bank's directors at the last board meeting that the investment tax credit would have little short-run effects, but might do serious harm in a year or so when there might be need for a stimulus. Mr. Brimmer said that he was concerned about the disposition of some people to have Working Party 3 engage in multilateral surveillance, as reported by Mr. Solomon. At the previous meeting of the Committee he had mentioned that he was disturbed by the tendency toward reviewing national economic policies in WP-3, but had been
reminded that that reflected a long-standing intent. Accordingly, he was pleased to hear Mr. Hayes say that some central bank Governors thought it was inappropriate to hold such discussions in WP-3 meetings. With respect to the activities of U.S. banks in drawing in funds through their branches abroad, Mr. Brimmer concurred in Mr. Solomon's analysis, and he shared Mr. Hayes' and Mr. Coombs' views regarding the best approach to the matter. For the time being, anything the System did with regard to those flows might best be done quietly and informally. Nevertheless, he was disturbed by the flows. When the Board began to focus on the subject in August and asked the staff to develop background information regarding them, he had been convinced that the flows served to complicate monetary management. He was still of that view. He also was concerned about the question of equity. While it was true that the System could offset the inflows through use of its general monetary instruments, the handful of banks involved would be able to obtain additional resources and thus to opt out of monetary restraint, and the System's operations would shift the burden to other banks. Thus, while he agreed that no formal action be taken at present he hoped that at a later time the System should to attain some control over those flows, through might consider steps the instrument of reserve requirements or otherwise. Unfortunately, in the market about possible System actions in there now were rumors the matter. It could only be hoped that they would die down.
Turning to the balance of payments, Mr. Brimmer said some interesting developments were occurring outside the capital account. Some recent analyses by the Administration suggested that the low point in U.S. export performance might have been passed in the third quarter; if there was even a slight moderation in growth of imports, the trade balance might now begin to improve. Over the weekend he had participated in a bankers' forum sponsored by Georgetown University which was attended by some of the people attending the Bank-Fund meetings. Along with Mr. Roosa, and Mr. Shaw of the Commerce Depart ment, he had taken part in a panel discussion on Saturday afternoon, in the course of which Mr. Roosa expressed the view that it was now time for the U.S. to take measures to reduce military spending abroad outside of Vietnam. Specifically, he urged that U.S. troop strength in Europe be reduced. Surprisingly, that proposal seemed to get a sympathetic reception. While there was a feeling on the part of some in the audience that the international situation might require maintaining present troop strength, there was a general disposition to consider the question favorably. A second point of interest, Mr. Brimmer continued, was the view of some members of the group, expressed to him privately, that the U.S. might have to face up to more explicit controls over direct investment. During the panel discussion both he and Mr. Shaw had taken the position that, while there might be some logic to extending
the interest equalization tax to direct investments, such a step would be risky and was perhaps undesirable at this time. In personal discussions a number of the bankers present took exception to that position and indicated that the action might be desirable. With respect to the domestic situation, Mr. Brimmer said he would not take issue with the analyses given today by the staff and the Committee members who had spoken thus far. He would hope, however, that the Committee would not again engage in "stop-and-go" operations in its effort to influence the rate of growth of bank credit. In one sense the sharp reactions in the market this summer reflected the difficulty the Committee had experienced in getting bank credit growth under control in the spring. If the Committee could avoid undue easing now it was less likely to be faced with a subsequent need to clamp down hard in order to restrain over-rapid growth of bank credit. the staff's draft directive with the hope that any He would accept the Manager would be in the direction of deviations on the part of more rapid growth of bank reserves. slightly evident that if it were not for a Mr. Maisel said it seemed in Vietnam expenditures over the next year sharp projected increase that the level of demand might the Committee would now be concerned Certainly many parts of the to shift to too low a level. be about in spending. At the same economy now indicated a downturn private of restricted monetary availability time, the individual costs
appeared to be growing. On the assumption that the Government deficit would be covered by a tax increase, monetary policy should not add further to that pressure. Given the lags behind action, the Committee should attempt to see that reserves and credit expanded at a normal rate. Mr. Maisel said he supported the draft directive, but would again make clear his belief that it should be interpreted as "no further firming," with the proviso meaning that conditions should be consider ably easier if required reserves continued to come in under expectations and the credit proxy expansion fell below the 5 to 6 per cent annual rate expected for October. Mr. Maisel thought the Committee should also recognize the base from which the present policy started--namely, average free reserves of minus $370 million; a three-month bill rate averaging under 5.10 per cent; and a Federal funds rate of close to 5.50 per cent. He the Committee should consider the sharp run-up in rates during thought the past period as unusual. He was not concerned with the fact that they occurred, since more randomness in movements should be welcomed and the market should be made aware of the fact that wider movements were to be expected. At the same time, however, the high rates should not be accepted as normal and as meeting the Committee's desires. The goal should be to return at least to the type of conditions prevailing before the recent run-up.
If high demand for loans did raise rates even with a normal increase in reserves and bank credit, Mr. Maisel observed, that should be allowed, but there should be no attempt to either raise rates or to hold them at present levels. If a normal expansion of reserves led to lower rates that should be accepted also. Mr. Daane said that before turning to the subject of policy he would comment on two matters that had been touched on in the pre ceding discussion. On the question of multilateral surveillance, he would simply say that from the beginning that term had meant different things to different people. The issue Mr. Brimmer referred to was, not a new one. From the outset the U.S. had taken the of course, position that it was willing to furnish its statistics to the Bank for International Settlements--indeed, it had been more willing to do so than some other countries--and to have such information as seemed the BIS and the Governors meeting in appropriate channeled through Party 3. Multilateral surveillance at WP-3, as the Basle to Working and as Under Secretary of the Treasury U.S. delegation had seen it, consisted of informal discussions of the Deming had reiterated, and policies of the various economic and monetary developments countries concerned; questions of international credit assistance, were most properly discussed at Basle. swap lines, and so forth, in the matter and had he had shared Mr. Hayes' concern From the outset procedures. But it was in avoiding formal surveillance tried to help
necessary to recognize the desire of some of the Europeans to harden the procedures--to move to a more active review of countries' policies and to go beyond the stage of lecturing individual countries to some thing approaching a formal approval of international credit arrangements and financing policies. That sentiment of the Europeans was perhaps most marked at the time the package of assistance to Italy was arranged, Mr. Daane continued. There was considerable resentment then on the part of the the question of the Italian credit package had not been Europeans that submitted to Working Party 3 for review. The U.S. view was that, if it to WP-3, no stabilization package would have had been submitted eventuated and Italy would not be in the position it was today. question of the reflow of funds through foreign branches On the banks, Mr. Daane said, he was not convinced that such reflows of U.S. would necessarily complicate the implementation of monetary policy. He account might have been taken of them would concede that insufficient it was not inevitable that they at times, but looking to the future, constraint on monetary policy. would represent a serious felt that at present it would be As to policy itself, Mr. Daane "steady in the boat." Both wisdom for the System to stay the course of had been mentioned and the existing uncertainties that the various augured for maintaining an even keel. prospective Treasury financings appropriate, except that it might be The draft directive appeared a reference to the Treasury financings. desirable to add
Mr. Mitchell said that he agreed with Mr. Partee's diagnosis of the economic situation; the private economy was showing unmistak able signs of some slippage. Recent inventory developments offered an impressive sign of weakness, even after allowing for the poor quality of the data and the uncertainty of the seasonal adjustments. The situation existing in the stock market for some time now did not augur well for future economic activity. The earlier general feeling of ebullience in the economy appeared to be completely gone. Various economic time series indicated that acceleration had ended, in some cases as much as a year ago. It was important to recognize that a great part of the economy--namely, the private sector--had not only lost much of its momentum but might be on the way down. Mr. Mitchell felt that monetary policy had been playing a significant, and appropriate, role recently. However, he did not believe that in the U.S. economy today monetary policy could be used effectively to check cost-push inflation. The most that monetary policy could do was to slow down the rate of economic expansion. He also was impressed with the lagged effects of policy actions; some of the consequences of the Committee's actions earlier in the year were now appearing. And he was impressed with the fact that banks were now taking the kinds of measures to counter demands for business loans, as well as other demands, that the System had hoped for earlier--and they were doing so without coming to the discount window at all.
Accordingly, he believed the Committee now had all the restraint that was needed and, considering lags, perhaps more than was needed. Mr. Mitchell said he would not want to see the System enter a period in which there was a real threat of a downturn without recognizing that threat. Part of the problem was that the Committee had, in a way, been hypnotized by the acceleration of defense spending. There was no doubt that defense spending had accelerated, but there also was no doubt in his mind that if the acceleration continued some further fiscal action would be taken. Thus, monetary policy would no longer be left to deal with the situation alone. All of that suggested to him that the Committee should be concerned that it did not go too far in the direction of restraint rather than not far enough. Turning to the draft directive, Mr. Mitchell said that the had with the second paragraph was that he did not only quarrel he analysis underlying the staff's expectations for the credit think the very realistic, but he could not improve on it. He would proxy was suggest some changes in the first paragraph, however, to make the with the staff views expressed orally today language more consistent and in the green book.1/ Following the phrase at the end of the first the substantial weakening in residential sentence reading "despite 1/ The report, "Recent Economic and Financial Developments," prepared for the Committee by the Board's staff.
construction," he would insert a comma and add "uncertainties in equity markets, and a sharp increase in business inventories." In the phrase of the second sentence reading "credit demands remain strong," he would insert "still" before "remain." Finally, he would amend the statement of the Committee's policy in the last sentence of the paragraph by replacing the phrase "to resist inflationary pressures" with the phrase "to moderate the rate of growth in credit use." Mr. Mitchell concluded by observing that he agreed with Mr. Hayes on the best manner at present for dealing with the pull back of funds through foreign branches of U.S. banks. However, he thought there might well be some backlash in the future as a result of those inflows. Mr. Hayes said he was not sure he understood Mr. Mitchell's suggested change in the last sentence of the directive's first paragraph. Was the term "credit use" meant as a synonym for credit expansion? Mr. Mitchell replied affirmatively, but indicated that he had had total credit, rather than bank credit, in mind. Mr. Shepardson agreed that there were some indications of lessening ebullience in economic activity. However, he felt that prospects for defense expenditures lent more strength to the economic outlook than Mr. Mitchell had suggested. All the evidence on defense
spending, limited as it was, pointed to significant further expansion, and the pressures that would involve had to be recognized. It was true that now, hopefully, there was greater prospect of fiscal action if those pressures developed; at the same time, such action was still in the future. Given the conflicts among indicators and the uncertainties in the economic situation, Mr. Shepardson said, the staff's draft directive, as written, seemed entirely appropriate to him. He would interpret the draft as calling for essentially the degree of restraint that had existed in the recent period, with allowance for unexpected deviations of the bank credit proxy from the projections. At some point it might be appropriate to take a definite easing action but at this time, with the uncertainties existing in both directions, he thought it was desirable to maintain firm money market conditions. It would be unfortunate, in his judgment, if money market conditions were permitted to ease as a result of an easing in demands; by taking up any slack that might develop the Committee would maintain some measure of control until such time as it was able to develop a better assessment of the outlook. Mr. Wayne commented that a feeling of uncertainty seemed to be more prevalent in the Fifth District even though employment remained strong and prices received and wages continued to inch upward. Rates of insured unemployment achieved, or remained near,
record lows. Textile industry respondents to the Richmond Reserve Bank's latest survey reported significant declines in new orders and backlogs and an increase in finished inventories. Reports had also been received that some textile mills had cut back to a five-day week. Major manufacturers of man-made textiles recently announced substantial price reductions for polyester blends, reportedly to bring quoted prices more nearly in line with the actual market and to counter the August reduction of cotton prices. Somewhat puzzling were reports that the Defense Department would reduce its purchases of military textiles this fiscal year perhaps by as much as 30 per cent--a move that might produce downward pressures on the prices of a products. Other manufacturers also reported sluggishness number of in the volume of new orders and some easing of backlogs. The strong continued for boxing material and containers was an demand that that shipments of finished goods would continue heavy. indication reason for it, it was pertinent to Without a clear indication of the District were up substantially in note that building permits in the since last February--the principal weakness August for the first time was in the northern part of the District. Thus far this season, almost 7 per cent above tobacco prices had averaged flue-cured year-earlier levels. Mr. Wayne continued, activity In the national economy, strong. Industrial production high and spending continued remained
had moved ahead, although at a reduced rate, despite lower automobile production. Substantial gains in personal income supported a high level of retail sales. Employment also showed moderate gains but there were occasional reports that labor was not as scarce as it was earlier. The continuing pressure on prices was evidenced by public announcements of price increases in September covering over a hundred companies and a wide range of major commodities. Defense expenditures seemed to be running well ahead of estimates while education and welfare expenditures showed a steady and fairly rapid acceleration. Despite large increases in revenue from income taxes, the deficit in the cash budget for July and August was substantially larger than in the same months for other recent years. Despite those sources of strength, however, inflation had not escalated in recent months, Mr. Wayne said. The rates at which prices and economic activity had been rising had not increased. In fact, there were indications to the contrary. Construction activity, of course, continued to decline. Manufacturers' new orders were down in August. Weakness persisted in a few prices. significantly Automobile sales remained low and there seemed to be some concern for the new models. Scattered reports and about the sales prospects indicated uneasiness about the trend of corporate profits. speculations Unit labor costs seemed to be inching up, interest costs were higher, and the suspension of the investment tax credit would gradually detract
from profits, If an increase in the income tax rate was added, the uneasiness could be converted into pessimism. A somewhat longer look at developments confirmed the tendency toward slower rates of growth, Mr. Wayne observed. In the six months ending with August, nine major measures of economic activity, including wholesale and consumer prices, showed an average increase of 1.3 per cent for the period, which was substantially lower than the of the three previous half years. In the latest increase in any the measures registered declines; in the three previous period, two of periods there had been no declines. for policy, Mr. Wayne did not believe that the scattered As to justify any easing at this of slower growth were sufficient signs caution against further although they might be adequate time, accomplished to a had probably been The slowing tightening. that pressure were restraint and if extent by monetary considerable in the absence bounce back, especially growth rates might relaxed, the middle of It was fortunate that further fiscal restraint. of trouble. The sharp passed with relatively little September had been conditions in the money reserves and the easier drop in net borrowed to pay for results a cheap price followed were perhaps market which to see the easier conditions But he would not want attained. to believe that gave the market reason If the Committee restored. much of what it had it could lose been eased significantly, policy had
worked hard to attain over recent months. It might be that the somewhat easier and more settled conditions in the money market during the last half of September were due to temporary factors and would shortly be reversed. It might be, however, that they were caused in part by actions of member banks to contain demand and to ration credit. If that should be the case, the Committee might be able to accomplish adequate restraint without quite such high interest rates or so much tension as there had been a month ago. Until it could be seen whether that was true, he would favor keeping a firm control on the availability of reserves. Mr. Wayne favored adoption of the draft directive. Mr. Clay remarked that while forthcoming economic devel opments could not be known with certainty, there appeared to be little reason to doubt that the national economy would continue under the pressure of over-stimulation, with resources tight and costs and prices rising. It might be that some sectors of economic activity would level off or decline, but the probable additions military sector suggested that aggregate demand for goods from the and services would remain in excess of the capacity for orderly production. Certainly, it appeared the better part of judgment that public policy, including monetary policy, should be formulated on that premise.
While proceeding on that premise led logically enough to the need for a policy of restraint, Mr. Clay continued, it did not indicate the particular monetary policy action to be taken at this time. Recent developments in both the commercial banks and the money and capital markets caused uncertainty on that point. Recent evidence did suggest that it would be appropriate to avoid added restraint on the commercial banks, but such short-run devel opments would not seem sufficient basis for a turnaround in policy. Perhaps the best course at this time would be a general goal of continuing the current monetary policy with a guide of "maintaining firm but orderly conditions in the money market." Higher interest rates would not be a target under such a policy, but rates would be permitted to rise if credit demands increased substantially. The draft economic policy directive appeared satisfactory to Mr. Clay. Mr. Scanlon reported that current discussions of economic prospects by Seventh District businessmen often included references to the sharp drop in housing starts, the reduced rate of auto sales, decline in the stock market, further escalation in the continued "tight money." Nevertheless, no convincing evidence Vietnam, and mustered in the District to indicate that demands were could be on the region's facilities and manpower. pressing less vigorously Labor markets had tightened further, Mr. Scanlon said, and new claims for unemployment compensation had been in recent weeks
well below the reduced level of a year earlier. He had been unable to uncover any evidence that construction workers had been idled as a result of the decline in housing starts. Such workers apparently had been absorbed in nonresidential construction or in industry. Order backlogs of producers of machinery and equipment continued to rise in August, with defense orders helping to boost the total. He saw no evidence that orders had been reduced signif icantly as a result of the proposed suspension of the investment tax credit. A large Chicago area steel producer reported that demand from all major customer groups--including the auto industryremained excellent, in contrast to some newspaper and trade journal accounts of a slower order trend. Demands for credit by businessstill appeared strong, Mr. Scanlon observed. Expansion in business loans, after slowing markedly in August, continued at a moderate pace in September at major District banks, but whatever slackening had occurred seemed mainly a reflection of the restrictive loan policies of the banks. Responses to the September 15 lending practice survey indicated that most of the large District banks felt loan demand was stronger now than three months ago, and the majority expected that demand to show at least moderate increases in the fourth quarter. Most of the respondents stressed their lack of liquidity, uncertainty about their ability to replace CD money, and anticipated strong
loan demand as the major reasons for their firmer lending practices. Reserve positions of the Chicago banks were showing some additional pressure, with purchases of Federal funds up substantially and moderately greater use of the discount window. With large prospective demands for credit both by Government and by private business through the fourth quarter, the pace of credit and monetary growth seemed likely to Mr. Scanlon to accelerate in the period ahead--again posing for policy a problem of maintaining adequate restraint within an acceptable range of interest rates. Recent data continued to show evidence of a general slowing in monetary and bank credit expansion since mid-year. It was apparent now that at least part of the recent increase in interest rates could be attributed to the cutback in the rate of growth in supply funds as a result of System actions. Given the current of loanable employment conditions, it appeared appro and prospective price and undertake to maintain very slow rates of monetary and priate to favored a policy of maintaining the credit expansion. Therefore he proviso that the Committee undertake recent posture but with the of any strengthened credit demand. to offset the effects The draft directive was satisfactory to Mr. Scanlon, about the phrase "current he continued to have concern although somewhere along the line the It seemed to him that expectations." in retrospect. Whether to define that phrase, System might have
that meant reading into the record the contents of the blue book and, if so, whether the Committee's actions were consistent with those "current expectations" he was not certain, but it did cause him some concern. Mr. Galusha reported that last week witnessed the establish ment, in the Twin Cities area, of a new pattern of share and deposit rates. Area savings and loan associations, taking advantage of the recently announced Federal Home Loan Bank Board policy, introduced six-month savings certificates which paid the ceiling rate. Also, the one large savings bank in the Ninth District raised its rates on passbook and time deposits. And last Friday the largest bank in the District announced a 5 per cent small-denomination CD rate. Almost certainly, all the other reserve city banks in the District were going to follow, so it would seem that the implementation of the new rate-ceiling legislation had had the effect of raising rates. tell the Committee, he supposed, that District bankers He need not Twin Cities were unhappy. Whether the savings and loan outside the to fare better under the new rate structure associations were going old was not something he as yet had any idea than they did under the was the real impact a reflow in their direction about. Also uncertain residential construction industry. might have on the depressed that there had been very few Mr. Galusha noted in passing cent on time deposits, so dealing banks paying more than 5 per member
with the distortions induced by a roll-back would not be a quan titatively significant problem. Mr. Galusha said that large District banks seemed to have gotten through September fairly well and, whether rightly or wrongly, did not seem to be panicky about an October run-off of CD's. Borrowing from the Reserve Bank had been moderate and very much in the pattern of the past several months. The banks continued very reluctant to borrow under the new program of discount window administration. Turning to the issue of policy, Mr. Galusha remarked that the GNP account projections contained in the green book seemed entirely reasonable to him. He certainly agreed that a highly probable increase in Federal defense purchases "dominates the economic outlook," but would add that, at the moment, relatively large increases in Federal civilian and State and local purchases also had to be expected. For a while to come, at any rate, State and local governments were going to be enjoying relatively high tax flows. Accordingly, Mr. Galusha saw no strong case for forcingor even permitting, in the face of temporarily reduced credit lower interest rates. But neither could a demands--generally to him, for forcing generally higher strong case be made, it seemed rates. Almost certainly the coming few months would witness interest
higher income tax rates--unless, of course, they witnessed a de escalation in Vietnam, a possibility that only the most extravagant optimist could expect. Even if a tax rate increase were not in the offing, there would still be reason enough for waiting. It was not known as yet what the effect of suspending the tax credit and accelerated depreciation was going to be. Then, too, embar rassing as it might be to Committee and staff members, it was not known what effect current monetary stringency was having on the demand for plant and equipment. He sensed that it was appreciable; but he could not prove or even be highly confident about that. Like Mr. Mitchell, he, too, felt an uneasiness. In soundings taken with businessmen he sensed a common concern with the civilian side But again, except for retail sales in the Twin of the economy. construction, there were no clear signs Cities and residential he was an advocate of a cautious visible to him. That was why the time until the new plant and equipment approach. And since was short, waiting would seem to be surveys would be available prudent. maintaining "firm but orderly Mr. Galusha thus favored aiming not, perhaps, for in the money market," and conditions rates but for a slightly higher last week's average of money market money market rates slight firming of He would expect a average. considerable decrease in average be consistent with a rather to
net borrowed reserves. But if events were to prove that expectation wrong, he would not back off from his rate objective. The market could easily be persuaded that a greater average net borrowed reserve figure did not mean the System had changed its mind about policy. The directive, as drafted, seemed fine to him. Mr. Swan said that more complete figures confirmed the impression he had reported three weeks ago--that in the Twelfth District in August there had been no increase in nonagricultural employment and another small rise in the unemployment rate. August housing starts were above July but still well below the levels of each of the first six months of 1966. Perhaps some encouragement for the longer-run could be found in the fact that the rental vacancy rate was down in the second quarter from a year earlier. However, that rate remained higher in the west than in other areas of the country. most significant recent development in the banking The seemed to be the very small growth, sector, Mr. Swan continued, rest of the country, in business and relative to the both absolute during the first three weekly reporting banks loans of District been only 1/3 of 1 per cent, September. The increase had weeks of at weekly reporting banks a rise of 2-1/4 per cent compared with practices in the survey of lending the District. While outside the strength of business show increases in continued to the District
loan demand, he wondered whether there were not some reporting lags in that area, as there were in others. Banks had tightened their business loan policies somewhat, but he would hesitate to ascribe the extraordinarily small increase in business loans solely to that factor. On the other side of the balance sheet, Mr. Swan remarked, the major District banks had had their share of CD losses in the past three weeks--both corporate CD's and, more particularly, time deposits of States and political subdivisions. In the three weeks ending September 21, Twelfth District weekly reporting banks lost 5 per cent of their State and local government deposits, compared with a corresponding decline of 1/3 of 1 per cent outside the District; since mid-year the decline in the District had been 17-1/2 per cent, compared with 11 per cent elsewhere. Borrowings from the Reserve Bank were still quite low. Following the recent high reached in the week ending September 7, borrowings had declined each week both absolutely and relative to the rest of the country. As the Committee knew, Mr. Swan said, the new ceiling rates on savings and loan passbook accounts were somewhat higher in California than elsewhere. The ceiling rates of 5-1/4 per cent on passbook accounts and 5 per cent on bank CD's under $100,000 were about in line with existing patterns. However, California associa tions could no longer offer 5-3/4 per cent on new bonus accounts,
in which there had been considerable growth during the past several months. As far as banks were concerned, a few smaller banks that had been offering 5-1/2 per cent on consumer-type certificates might suffer losses, but the great bulk of such deposits had been earning no more than 5 per cent. A number of banks had argued that the ceiling rate on CD's under $100,000 held by States and political subdivisions should have been left at 5-1/2 per cent rather than being reduced to 5 per cent. That was related in part to one kind of reaction that had occurred to the Board's earlier action with respect to multiple-maturity deposits; to some extent of governments had been replaced by a multiple-maturity deposits fixed maturity deposits, each of which was less than series of and substantial losses of such deposits were now feared. $100,000, As to policy, Mr. Swan said, like Mr. Mitchell he shared Mr. Partee's concern about some of the recent developments in the the probable levels of defense expenditures, private sector. Given of policy, and he would saw no basis for an easing however, he few weeks. While one at present for the next continue about as action if defense expenditures hope for additional fiscal might the future, and the action was still in to rise, such continued as to its form any particular assumptions could not make Committee him that the Committee it seemed to or intensity. Accordingly,
should continue to maintain the policy of caution, with exceptions allowed for unforeseen developments under the proviso clause of the directive. As to the wording of the directive, Mr. Swan would support the changes Mr. Mitchell proposed in the first two sentences. How ever, he would retain the phrase "to resist inflationary pressures" in the last sentence of the first paragraph, particularly in view of the statement earlier in the paragraph that inflationary pressures were persisting. But he was disturbed by the second part of the last sentence, reading "and to strengthen efforts to restore rea sonable equilibrium in the country's balance of payments." Whose efforts were to be strengthened was not clear; one might infer that it was the Committee's efforts. But that would imply additional firming, which was not consistent with the rest of the directive. Perhaps the word "continue" should be substituted for "strengthen." With respect to the second paragraph, he agreed that some reference financings should be included, but it should be to the Treasury financings were the primary factor worded to avoid implying that the in the policy decision. conditions in the Eleventh Mr. Irons reported that economic with inflationary overtones, but District had been strong recently, employment had risen a bit, they were not surging. Nonagricultural months. The District industrial as it had for the past several
production index continued at a high level and showed a year-to year gain of 9 per cent. Construction activity varied from month to month, but for the year to date it was up about 10 per cent from the same period last year. Retail sales remained strong--thus far in 1966 they were 7 per cent above 1965--but new car registrations were relatively unchanged this year from last year. Agriculture was enjoying highly favorable conditions; moisture was good and the outlook was excellent. Cash farm receipts were up appreciably from the comparable period in 1965. In the financial area, Mr. Irons continued, over the past loans at District weekly reporting banks were up about three weeks million, with two-thirds of the rise occurring in commercial $90 portfolios were reduced a bit, and industrial loans. Investment in holdings of Treasury securities. with most of the reduction were up substantially but time deposits in District banks Demand reflecting CD experience. down a little, perhaps deposits were million in the preced as against $42 averaged $77 million Borrowings interest in the had evidenced any Only one bank ing three weeks. and apart from that of discount administration, special program low. Average net District were relatively borrowings in the bank a bit higher recently funds had been running purchases of Federal market, even among use of the funds a relatively wide and there was slight as indications, although banks. There were smaller country
yet, that some intermediate-size banks would shift from the Federal funds market to the discount window for liquidity purposes if the Reserve Bank would permit them to do so. Some banks had indicated that they interpreted the special program as involving a less tight administration of the window and they almost implied that if funds were to be made available more readily they would be interested in getting some of them. Mr. Irons observed that the money and capital markets had been influenced by a variety of factors during most of September, including rumors as well as actual events, as had already been reported. The result was sharp and varying movements of rates and conditions in the market. He had been more satisfied with the conditions prevailing in the later part of the period than in the earlier part, but he noted that the markets had come through the difficult earlier time with much less of a problem than had been anticipated. On the basis of observations in his District, Mr. Irons felt that bankers were now taking a somewhat different view than they had three or six months ago of the System's program for restraining bank loans. Earlier, the situation had been one of a scramble for funds to lend. Now, while the banks were not nec essarily turning down every loan application they received, they
were clearly accepting the fact that it was necessary for them to carry out their part of the program. As to policy for the coming period, Mr. Irons recommended maintaining firm but orderly conditions in the market. Inflationary pressures continued strong despite the fact that monetary policy was biting; he recognized the forces working in the other direction but still felt that the balance was on the inflationary side. Perhaps, however, the Committee should attempt at this point to achieve a little more stability in the market than had existed at times in the past month. The Treasury would be in the market, and their operations would have rate effects; and it was not possible to say what would happen in connection with the short-term CD's that would mature in October. Mr. Irons favored continuing the policy of the past In sum, while trying to bring about more stable conditions and few weeks the market generally. Any effort to ease policy would attitudes in gains, and any effort to firm would risk losing some of the recent undesirable conditions in the financial threaten to produce other acceptable to him; in partic The directive as drafted was markets. the proper objectives. Certainly, ular, the second paragraph specified had to have a great deal of flexibil at this time the Account Manager from day to day--or even situations that could arise ity to meet the
from hour to hour, as had been clear during the recent period when he (Mr. Irons) had participated in the daily call. He would not favor any change in the discount rate at this time. Mr. Ellis said that again he had to confess that the fundamental aspects of employment, production, and income in the First District fell into a more comprehensible pattern than did the financial counterparts of those activities. Measured in real terms, seasonally adjusted employment had continued rising in the latest available data. Factory output, paced by year-to-year gains of 20 per cent in machinery industries, had recorded a 13 per cent twelve-month gain. The Reserve Bank's fall survey of capital investment plans of New England manufacturers was nearly completed, and it indicated that 1966 outlays would exceed those of last year Carry-over into next year of uncompleted by more than one-third. twice the normal 10 per cent programs would account for almost recorded in previous surveys. area, Mr. Ellis continued, like Mr. Hayes In the financial the past three weeks, business the data perplexing. In he found a plateau 17 per cent above New England leveled off on loans in investments continued to grow, year's level. Other loans and last demand deposit totals. On balance, however, as did both time and in a somewhat easier position than the large banks found themselves at least partially, borrowing earlier. As a result, contemplated
at the discount window in Boston declined by 35 per cent between August and September, at a time when borrowing in the nation rose by 4.7 per cent. In good conscience, Mr. Ellis remarked, he had also to report that that regional variation in borrowing might trace to some differences in administration of the discount window. Follow ing the September 1st letter, he had held face-to-face conferences with the District's eight largest banks, and he had discussed discounting in five area conferences including officers and directors of 41 per cent of member banks and 32 per cent of nonmember banks. Nowhere did he find any disposition to seek extended borrowing privileges as an assist in reserve adjustement during curtailment loans. But the Bank did receive queries reflecting of business the belief that Mr. Irons had mentioned, that discount administra tion had been eased. the need that Mr. Hayes had noted for avoiding Concerning windows, Mr. Ellis suggested abandoning the concept of two discount on the special discounting program. the effort to tabulate statistics was not clear to him, and he the intended use of the data First, have any significant meaning. convinced that they would was not that discount officers report on the Secondly, the requirement timing of their calls and affected both the program inevitably
what they said when they talked with borrowing banks. Those aspects of the program could have undesired consequences. Recently, Mr. Ellis said, a large life insurance company had advised the Reserve Bank that policy loan expansions in July and August each absorbed the equivalent of their present holdings of cash and short-term Governments. Their sales of stocks and bonds to meet that drain were quite painful in present markets. While they had a bank loan commitment of $25 million, they had not yet had to draw on it. They had requested an appointment with the Reserve Bank to discuss possible sources of liquidity if their pinch worsened. To date, he had learned of only one savings bank that was borrowing any significant amounts from commercial banks, and that was to forestall sale of near-maturity Governments. On the national scene, Mr. Ellis continued, probably the most notable and salutary development had been the interruption of bank credit expansion in September. While it was tempting to conclude that monetary policy was now--at long last--biting enough to slow down the credit boom, he was disinclined to suggest any change in policy based on such a short-term development. He noted the projections for October indicated a resumption of credit expan sion and run-up in reserves. The Committee should be careful to distinguish between inflection points, which it sought, and down turns into actual decline, which it did not seek.
Mr. Ellis viewed the Committee's principal problem today as one of usefully defining to the Manager a workable concept of "no overt change in policy." Unfortunately, the one week in which net borrowed reserves dropped below $200 million, in company with declining bill rates, did suggest to some bankers that policy was being eased. He agreed with Mr. Hayes that now was not the time to raise the discount rate. Unfortunately, however, the magnitude of the difference between the discount rate and rates on other reserve adjustment instruments threw into question the meaning of any given level of borrowing. In effect, the level of borrowing was a measure of how high and leakproof the System had built the dikes against borrowing by its discount administration. Mr. Ellis commented that the staff projections of October growth rates in bank credit of 5.6 per cent, in required reserves of 9.9 per cent, and in the money supply of 7 per cent, were all on net borrowed reserves averaging $450 million, although premised attained in any month in the present period such a level had not been of growth were clearly adequate if not of tight money. Such rates he would conclude a net borrowed reserve excessive. Accordingly, an entirely feasible starting point in target of $450 million was setting policy objectives for October. agreed with the staff comment in the blue book Mr. Ellis month is consistent with a tendency that "The outlook for the coming
not only for short-term markets to tighten but also for long-term rates to rise." However, he felt some inclination to challenge the usefulness of the subsequent and concluding paragraph, where it was suggested that "...a failure of (money market) rates to tend upward may mean that banks are under less loan pressure than we currently foresee..." Instead, he would anticipate that a failure of money market rates to rise would more likely result from the Committee's failure to re-establish the tightness experienced in August. He foresaw a danger, out of concern for Treasury financing, of repeating the December 1965 experience. By over concern with the levels of rates the Committee could easily lose its grip on required reserves, and find them flowing out even more rapidly than the 9.9 per cent rate that the staff projected as likely if the Committee were to be successful in achieving a net borrowed reserve figure of $450 million. As to the draft directive, Mr. Ellis said, the majority view expressed around the table was that it was appropriate, which he took to mean that it was vague enough to be acceptable. But he thought the Committee owed it to itself to determine what the language meant to it. The proviso clause began, "operations shall be modified in the light of unusual liquidity pressures..." He understood that to mean that operations should be modified toward ease in the event of severe liquidity pressures. The clause also
said that operations should be modified in light "of any appar ently significant deviations of bank credit from current expectations." Underscoring the words "apparently" and "significant," he reflected that while the phrase was vague he understood it to mean that operations should be modified toward tightness if bank credit growth exceeded expectations. He agreed with Mr. Scanlon that the reference to expectations posed a problem. He thought the Committee should attempt to define its current expectations in the course of presumably the intention of the directive wording its deliberations; on pages 4 and 5 in the blue to refer to the projections given was Swan's concern about the use of the word book. He shared Mr. "strengthen" in the last sentence of the first paragraph and sugges ted use of the word "support." then made the following statement: Mr. Robertson I have read and heard in connection Everything to argue for a policy of this meeting seems to me with waiting over the weeks ahead. very watchful signs of slowdown in credit On the one hand, the restraint make promise of more fiscal expansion and tightening of monetary to any further me disinclined hand, continued cost just now. On the other policy absence of any evidence of and price increases and the of public and private in the strong upthrust abatement toward monetary ease. make me wary of any shift spending premature in the matter I do not want to be While do want us to be prepared of easing, I most certainly time. With as much and at the right to act promptly built up within the as we have cumulative restraint that will result all the lagged effects System, and with we have to be very ahead, I think from it in the quarters tight too long, but staying too on our guard against much
we are just beginning to attain the goal we have been working toward and I am not yet convinced that the time for change has arrived. The staff expects money market conditions to tighten a little as Treasury bill financing and corporate borrowing for tax purposes come into the picture in October. Consequently, a little firming would be appropriate if bank credit and particularly business credit run as strong as expected, or stronger. But if they turn out to be appreciably weaker, then I would want the Manager to begin to moderate reserve pressures somewhat, and not to have to wait for the next meeting to obtain a Committee authorization for doing so. Hence, the "proviso" clause in the directive can prove to be particularly helpful during the next few weeks. The actions outlined are consistent with the substance of the directive as adopted at the last meeting, and I would favor adopting it again with the few language suggestions made by the staff; how ever, I would favor Governor Mitchell's suggested additions to the first two sentences of the directive. Chairman Martin observed that the views on policy of Committee members appeared to be closer together today than they had been for some time. He would make just one observation. On the basis of reading he had done since returning to the office after his absence this summer, he was of the view that if it were spending the economy might well be experiencing a not for defense little downturn right now, and he did not think defense spending an economy. That led him to the view was a very strong prop for had done about all it should be expected to that monetary policy do at present. The proper course for Government policy at this was clear; any substantial increase in defense expenditures juncture
should be covered by a tax increase. He believed that that was recognized by the Administration, and if there was a supplemental budget request of any size it would be accompanied by a proposal for fiscal policy action. The Chairman went on to say that the recent legislation relating to deposit interest rate ceilings had been handled as well as might have been expected. The legislation enacted probably was the least objectionable of the available means for solving the problems at which it was directed. The present was a difficult period, Chairman Martin continued, with dislocations and disruptions in markets. Like Mr. Robertson, he was inclined toward a policy of "watchful waiting." He thought the Committee should seek to attain as much stability as possible, particularly in view of the prospective Treasury financings. the Chairman suggested that the As to the directive, the changes in the first two sentences of the Committee accept draft recommended by Mr. Mitchell, the substitution staff's in the last "continue" for "strengthen" by Mr. Swan of proposed the inclusion of the ref first paragraph, and sentence of the in the second paragraph to forthcoming Treasury financings erence did not favor Mr. Mitchell's sugges recommended by Mr. Daane. He phrase "to resist inflationary tion that the first-paragraph
pressures" be replaced by other language. Inflationary pressures were continuing, whether they were of the demand-pull or cost push variety. He asked whether there were any objections to a directive formulated in the manner he had described. Mr. Solomon commented that citing "a sharp increase in business inventories" among the signs of weakness, as Mr. Mitchell had suggested, might mislead readers of the policy record if they were not aware that a good part of the increase was involuntary. It might be better to say "despite slower growth in final demand than in output." Mr. Mitchell said he would be willing to refer to an "involuntary" increase in inventories. Chairman Martin commented that if the phrase was likely it might be better to omit it. to be misleading that of the two signs of weakness for Mr. Partee observed references, he felt the Mitchell had proposed adding which Mr. than the uncertainties in increase was more significant inventory from the context it would be understood markets. He thought equity likely to have been inventory rise was considered that much of the of the policy record entry and, in any case, the text involuntary would make that point clear. for today's meeting undoubtedly prepared with Mr. Partee's observations. There was general agreement
Thereupon, upon motion duly made and seconded, and by unanimous vote, the Federal Reserve Bank of New York was authorized and directed, until otherwise directed by the Committee,to execute transactions in the System Account in accordance with the following current economic policy directive: The economic and financial developments reviewed at this meeting indicate that over-all domestic economic activity is expanding vigorously, despite the substantial weakening in residential construction, uncertainties in equity markets, and a sharp increase in business inventories. Inflationary pressures are persisting and aggregate credit demands still remain strong. The balance of payments continues to show a sizable liquidity 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 continue efforts to restore reasonable equilibrium in the country's balance of payments. To implement this policy, and taking account of forth coming Treasury financings, 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. meeting of the Committee would be It was agreed that the next held on Tuesday, November 1, 1966, at 9:30 a.m. Thereupon the meeting adjourned. Secretary
CONFIDENTIAL (FR) ATTACHMENT A October 3, 1966 Draft of Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on October 4, 1966 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. Inflationary pressures are persisting and aggregate credit demands remain strong. The balance of payments continues to show a sizable liquidity 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.
ATTACHMENT B SELECTED MEASURES OF MONETARY DEVELOPMENTS COMPOUNDED ANNUAL RATES OF CHANGE June 1965 June 1966 to to June 1966 September 1966 1/ Money Money Supply 5.8 % 1.4 % Demand Deposit Component 5.5 Currency Component 6.9 Time Deposits 12.8 Money Plus Time Deposits 9.0 Bank Reserves 2 / Reserves - Total + 3.9 2.1 Reserves Available for Private Demand Deposits* + 3.8 - 3.8 Federal Reserve Holdings of 2 / U.S. Government Securities* + 7.2 + 6.7 Interest Rates 4-to 6-Month Commercial Paper 25.8 + 30.6 3-Month Treasury Bills 18.4 +101.3 3-5 Year Governments 22.5 + 58.3 Long-Term Governments 11.8 + 13.6 Corporate Aaa Bonds 13.7 + 37.5 Municipal Aaa Bonds 14.3 + 39.2 25-Year FHA Mortgages 19.9 + .7a FHLB Average of Conventional First Mortgage Loans Including and Charges + 6.2 + .7a Fees figures are estimates. 1/ September to include effects of changes in reserve requirements 2/ Adjusted on time deposits. a June to August, partially estimated. * Seasonally adjusted by this Bank. Prepared by Federal Reserve Bank of St. Louis October 3, 1966
Also: Record of Policy Actions