November 22, 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, November 22, 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 Wayne, Scanlon, and Swan, Alternate Members Messrs. of the Federal Open Market Committee Messrs. Ellis, Patterson, and Galusha, Presidents of the Federal Reserve Banks of Boston, Atlanta, and Minneapolis, respectively Mr. Holland, Secretary Mr. Sherman, Assistant Secretary Mr. Kenyon, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Molony, Assistant Secretary Hackley, General Counsel Mr. Mr. Brill, Economist Messrs. Eastburn, Garvy, Green, Koch, Partee, Solomon, Tow, and Young, Associate Economists Manager, System Open Market Account Mr. Holmes, Manager, System Open Market Mr. Coombs, Special Account Legislative Counsel, Board of Mr. Cardon, Governors Fauver, Assistant to the Board of Governors Mr. Assistant General Counsel, Legal Mr. O'Connell, Division, Board of Governors Adviser, Division of Research and Mr. Williams, Statistics, Board of Governors
Mr. Hersey, Adviser, Division of International Finance, Board of Governors Mr. Axilrod, Associate Adviser, Division of Research and Statistics, Board of Governors Miss Eaton, General Assistant, Office of the Secretary, Board of Governors Messrs. MacDonald and Lewis, First Vice Presidents of the Federal Reserve Banks of Cleveland and St. Louis, respectively Messrs. Parthemos, Taylor, Baughman, and Jones, Vice Presidents of the Federal Reserve Banks of Richmond, Atlanta, Chicago, and St. Louis, respectively Mr. Lynn, Director of Research, Federal Reserve Bank of San Francisco Mr. Meek, Assistant Vice President, Federal Reserve Bank of New York Mr. Arena, Financial Economist, Federal Reserve Bank of Boston Mr. Kareken, Consultant, Federal Reserve Bank of Minneapolis Upon motion duly made and seconded, and by unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on November 1, 1966, were approved. At the invitation of Chairman Martin, Mr. Hackley reviewed for Committee procedures of the "Freedom some possible implications Law 89-487, enacted July 4, 1966, with of Information Act" (Public 4, 1967), noting that the terms of the an effective date of July under study. Following his remarks, Mr. Hackley Act were still responded to questions. discussion, Chairman Martin suggested that the After this continue to give consideration to the subject and that members might plan on pursuing it further at coming meetings. the Committee might
Before this meeting there had been distributed to the members of the Committee a report from the Special Manager of the System Open Market Account on foreign exchange market conditions and on Open Market Account and Treasury operations in foreign currencies for the period November 1 through 16, 1966, and a supplemental report for November 17 through 21, 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 again this week for the thirteenth consecutive week, but the uncommitted holdings of the Stabilization Fund were now down to about $32 million. No French purchases were expected this month; the Bank of France lost $37 million in October, and their holdings seemed to be down about another $30 million so far this month. Unfortunately, however, there was a new customer in the form of the Bank of Italy, which was beginning to feel domestic political pressure as a result of a decline not only in its gold ratio, but also in the absolute amount of its gold holdings. Governor Carli estimated that the decline in this year might come to roughly $60 million. Italian gold reserves regarding gold purchases of $30 million He had approached the U.S. in December to rebuild Italian gold this month and $30 million level. Unless Governor Carli changed reserves to their end-of-1965 unless the Russians made some massive gold sales during his mind, or
December, the Treasury would have to show another major reduction in the gold stock fairly soon. More generally, the prospective Italian purchase would represent in part a compensation for gold losses resulting from Italian participation in the London gold pool. If other central banks should decide to follow the Italian example, the usefulness of the pool to the United States would, of course, be correspondingly reduced. On the London gold market, Mr. Coombs continued, conditions had been fairly quiet in recent weeks, with the pool picking up million during October as a result of Egyptian sales plus about $20 newly-mined gold from South Africa. As of the a heavier flow of moment, the pool had available $32 million of the $270 million origiplus a supplementary commitment of $50 million nally committed, agreed to last September, for a total of $82 million. Yesterday and today there were heavy demands in the gold market with the price moving up to $35.18. As he had indicated at other recent meetings, the gold market was likely to prove to be the single most in his view troublesome source of problems for the dollar in the period ahead. On the exchange markets, Mr. Coombs said, sterling remained a problem. So far this month, the Bank of England had made further progress in paying off forward contracts, which had been reduced since the middle of September by nearly $1 billion. On the other had been no sustained inflow into the reserves; in fact, hand, there
as of Friday, November 18, the Bank of England was down about $40 million so far this month. The market reception of the excellent trade figures reported for October was disappointing. Yesterday and today the Bank began to execute market swaps of sterling against dollars, and through this technique should be able to show a net end of the month, but probably not enough to permit surplus at the repayment of debt now outstanding. In fact, he saw any substantial to Britain's rolling over again most of the very little alternative overnight credits of $425 million which they received at the end of overnight credits were supplied in the amount of October. Those million by the U.S. Treasury, $175 million by various foreign $200 banks, and $50 million by the System. central bit further ahead, Mr. Coombs remarked, some Looking a could arise in December as a result of possibly troublesome problems pressures on the Euro-dollar market, which might react severe knew, U.S. banks had attracted against sterling. As the Committee the Euro-dollar market and, if they tried a great deal of money from the year-end, the result might be to maintain those holdings through U.S. banks and foreign banks of a tug-of-war between the something the market for year-end window-dressing to repatriate funds from seeking a very sharp rise in the Such a tug-of-war could produce purposes. in turn exert a strong pull on liquid Euro-dollar rates, which would funds now held in sterling.
At the last meeting of the Bank for International Settlements, Mr. Coombs continued, ways and means had been considered of avoiding such a sudden vacuum in the Euro-dollar market which could pull in money from London, and most of the European central banks seemed agreeable to the U.S. suggestion of a joint effort to cushion the year-end strains. The Swiss National Bank and the Netherlands Bank, for example, would be prepared to funnel back into the Euro-dollar market via the BIS most of the money that they took in as a result of year-end window-dressing by their banks. The Bundesbank had announced a reduction in reserve requirements during December already try to restrain run-offs of Euro-dollar and the Bank of Italy would market placements by the Italian commercial banks. did not suffice, Mr. Coombs said, there If those measures that might be worth taking. As the Committee were two additional steps had a reciprocal line of credit with the BIS of knew, the System currencies other than Swiss francs in the dollars against European A short-term drawing of dollars amount of $200 million equivalent. than a week's duration for placement by the BIS of perhaps no more considerably to relieve any the Euro-dollar market might help in at no risk to the System. Secondly, sudden strains that might develop, rates should tend to pull liquid if a sharp rise in the Euro-dollar probably be reflected in a weakening funds out of London, that would rate, with the of the forward sterling and a strengthening of spot
result that the New York-London arbitrage differential on Treasury bills might move sharply in favor of London. In such circumstances, it might be worthwhile for the System to execute in the market covered purchases of sterling with the dual objective of preventing any outflows from New York while simultaneously protecting sterling against year-end pressures. Thereupon, upon motion duly made and seconded, and by unanimous vote, the System open market transactions in foreign currencies during the period November 1 through 21, 1966, were approved, ratified, and confirmed. Mr. Coombs noted that the longer-standing portions of the the National Bank of Belgium and the Nether swap arrangements with for the moment the increases that had lands Bank--setting aside in September 1966--would both mature soon. Specif been negotiated $100 million line with the National Bank of Belgium, ically, the term, would mature on December 22; and the $100 with a 12-month Bank, having a three-month term, million line with the Netherlands on December 15. He recommended renewal of the two would mature twelve and three months, respectively. standby swap lines for another Renewal of the $100 million standby swap arrangements with the National Bank and the Netherlands Bank was of Belgium approved. Under the twelve-month line of credit with the National Mr. Coombs said, it had been the established Bank of Belgium,
practice for both parties to make a $50 million drawing with a maturity of six months. That $50 million drawing, on which neither party had any disbursements outstanding at the moment, also reached the end of its term on December 22, 1966, and he recommended its renewal for another six months. Renewal of the six-month drawing on the standby swap arrangement with the National Bank of Belgium was noted without objection. As the Committee knew, Mr. Coombs said, the standby credit lines with both the National Bank of Belgium and the Netherlands Bank were increased by $50 million last September, with the proviso by both the Dutch and the Belgians that they regarded the increases as temporary, and that a prolongation should be discussed in advance on a multilateral basis at a meeting of WP-3. That question had in fact been on the agenda at a recent WP-3 meeting, but apparently time did not permit a discussion then; and no further WP-3 meeting was scheduled before the swap line increases reached their maturities around the middle of December. He had been in touch informally with the Netherlands Bank on the matter, and understood that their present was to relate the question of prolongation of the September thinking increase in the swap line to the question of whether the $400 million of short-term facilities placed at the disposal of the Bank of countries in September would be renewed when England by European
they matured after the turn of the year. In effect, the Dutch position, as he understood it, was that if the September credits to the U.K. were renewed they would be prepared to renew the additional $50 million on their swap line with the System. An extension of the September credits to the U.K. would probably be discussed at the December meeting in Basle, and as far as he could see the general attitude in Europe now might be reasonably sympa thetic. He was not sure of the reasoning underlying the position of the Netherlands Bank; perhaps their effort to avoid hardening the $50 million enlargement of the line into a permanent arrangement reflected a desire to bring it under multilateral surveillance by representatives of Governments rather than of central banks. He suspected, however, that the continental lines to the U.K. would themselves eventually take on a semi-permanent character, so the Dutch might well end up having made no more than an empty debating point. Second, and more important, he thought they were worried about the objectives of U.S. policy at the moment--specifically, about the goals with respect to reforms in the international monetary system--and were not sure how the U.S. thought the swap network would fit in. In any case, Mr. Coombs said, it had already been indicated to the Dutch on several occasions that the System would prefer not to have any reluctant partners in the network; and that, if the
Netherlands Bank should find it inconvenient to prolong the increase in the swap line, the point certainly would not be pressed. He suspected that they realized that they would attract to themselves a fair amount of unwanted publicity if it became generally known that they had withdrawn part of their credit lines to the U.S. Accordingly, he felt reasonably sure that the September increase in the credit lines with the Netherlands Bank would ultimately harden into a permanent increase. In his judgment, much the same considerations applied to the increase of $50 million in the swap line with the National Bank of Belgium. Against that background, he would like to recommend Committee approval for renewal for another three months of the $50 million increases in the two swap lines in question, if the other parties were agreeable. In reply to a question by Mr. Mitchell, Mr. Coombs said it had already been made clear to the two central banks that the System in a renewal if they wanted to incorporate conditions would not concur in the documents exchanged. Mr. Daane said he thought Mr. Coombs' approach was probably the right one and he would support it. As a sidelight, he would note that despite all the discussion at the previous WP-3 meeting of of initiating multilateral surveillance of the swap the desirability most recent meeting--presided over by network in that forum, at the time had been allowed for the planned the Netherlands delegate--no not seem to disturb anyone. Since the discussion and that fact did
next meeting was scheduled for January, it was obvious then that no discussion could be held before the September 1966 enlargements of the network came up for renewal. Renewal of the $50 million enlarge ments of the standby swap arrangements with National Bank of Belgium and the Netherlands Bank was approved. Mr. Coombs said his next recommendation related to the Committee's authorization of November 1965 to assume commitments for forward sales of lire up to $500 million equivalent. When the Committee authorized such operations there were several suggestions by Committee members that the subject should be re-examined if those commitments were still on the books after a year had passed. During the last few months, he had given a fair amount of thought to the matter and had discussed it with the Treasury, which also had outstanding commitments in forward lire, totaling $1 billion. If the Committee so desired, it could pull out of those operations right now without disturbance to the international financial markets or to the Bank of Italy; the U.S. Treasury would be prepared to take over the System's $500 million. As he had thought about the question, however, it had seemed increasingly desirable to him to make a distinction between the time element involved in such forward operations on the one hand and in the swap operations on the other. In the case of swap operations, it seemed to him absolutely essential to keep such credits short-term, preferably no more than six months.
Very fundamental questions of discipline in the entire international payments mechanism were involved; swap drawings were made by a deficit country in the expectation, or at least the hope, that it was dealing with a short-term situation which might be reversed either through natural forces or by corrective policy moves. Such swap drawings constituted the short end of the credit spectrum, with drawings upon the IMF and inter-governmental loans constituting the medium- and long-term segments of the spectrum. No central bank in the swap net work, he was sure, wanted to see the maturities of the swaps lengthened out, regardless of whether the central bank concerned was doing the borrowing or the lending. However, Mr. Coombs continued, forward operations did not represent debt of one central bank to another; rather, they were contracts with the market which had been executed in order to relieve market tensions. Large-scale forward operations such as the Bank of undertaken were essentially a means of lubricating the Italy had machinery and, in particular, insuring that international financial no serious disruptions occurred in the Euro-dollar market--which, as the Committee knew, had become a major source of financing for trade and investment. No central a wide variety of international for the Euro-dollar market, but bank had any direct responsibility would be highly dangerous for the central banks to he thought it of a free planet whose movements treat that market as something
could be disregarded. By shunting Italian commercial bank money into the Euro-dollar market through those forward lire contracts, the Bank of Italy had acted to relieve a stringency in that market in the same sense that the Federal Reserve or any other central bank would buy Treasury bills to relieve pressures in its domestic market. If that analogy had any validity, Mr. Coombs said, he was inclined to think that the Committee should not be rigid insofar as the time element in such forward operations were concerned. To him, the essential issue rather seemed to be whether the operation in question was performing a useful function; if so, it should not be abruptly terminated because it reached some arbitrary maturity date. In that connection, he might also note that none of the European central banks which had engaged in such forward operationsand that included the Germans, Swiss, Dutch, and British as well as the Italians--had applied to such forward operations the same time limits they would attach to central bank swap operations. He would, therefore, like to recommend to the Committee that the System's in forward lire be continued on the books, subject present commitments to further review in three or six months. He would hope that the progressive reduction of the Italian balance of payments surplus which had been going on this year would continue and that in the new year opportunities would arise for liquidation of a substantial
portion, if not all, of those commitments. In that connection, he might mention that he had secured the agreement of the U.S. Treasury to allow the System priority over the Treasury in liqui dating its commitments insofar as market opportunities permitted. There was, of course, no risk to the System in the forward lire operations. Mr. Daane expressed the view that the Committee should continue the present authorization for forward lire commitments and plan on reviewing those operations in three months. Mr. Mitchell noted that Mr, Coombs had suggested the possibility of some reduction in the outstanding commitments, and asked whether the latter would spell out his expectations in that regard. replied that growth in the commitments had slowed Mr. Coombs zero. The real key to the outlook for them lay in the almost to They had a heavy surplus in Italian balance of payments situation. surplus had been at hardly more 1965. This year, however, their last year's rate, and their recent disastrous floods than half balance. Secondly, the Italian might accentuate the trend toward to be highly volatile. Accord position tended in general payments to find them in heavy deficit in ingly, he would not be surprised 1967 or 1968. to a question by Mr. Hickman, Mr. Coombs said that In reply of payments could easily be large the swing in the Italian balance
enough to permit liquidating all of the forward lire commitments of the Treasury and the System. Mr. Maisel said he had no specific objections to the course Mr. Coombs recommended. However, he still felt as he had when the subject was originally discussed in November 1965; the Committee was making a major decision on an ad hoc basis. Along with the Treasury, the System was underwriting $1-1/2 billion of the $9 billion Euro dollar market. Why that particular part of the market? What should the reaction be if it were proposed to underwrite the whole market? It seemed to him that a basic study of the System's role with respect to the Euro-dollar market was needed. Mr. Coombs agreed that a staff study of the type Mr. Maisel was desirable. On the substantive question, he would mentioned repeat that no central bank had specific responsibility for coping with the problems that arose in the Euro-dollar market, and one could only hope that central banks would attempt to cooperate infor to minimize the dangers. As he had indicated, he was inclined mally such forward operations should be to think that to a large extent viewed as the international equivalent to central bank operations The record seemed to suggest that this was in domestic markets. to join with other central banks in a painless way for the System dealing with the problem of restoring liquidity to the Euro-dollar the operations of the Bank of Italy were a market. In addition,
good object lesson to other central banks on desirable international behavior under conditions of payments surpluses. Mr. Daane said that similar questions had arisen in the meetings in Paris last week. He thought a review of the System's role in the Euro-dollar market was justified. Chairman Martin noted that no objections had been raised to continuing the System's forward commitments in Italian lire at present. He suggested that the Committee plan on reviewing the matter again in three months, and that the staff proceed with a study along the lines of that Mr. Maisel had suggested. Mr. Coombs then said he would like to mention that during the past few months there had been suggestions from the National Bank of Denmark and the Bank of Norway that they would welcome an opportunity to join the Federal Reserve swap network. One reason those countries had not been included earlier was the fact had so far qualified for Article VIII status under that neither regulations. He was informed, however, that it was probable the IMF meet the Article VIII requirements early that both countries would next year. In that connection, he thought it was also worth pointing joined for the first time September both central banks out that in of England. It would be useful, in his in the credits to the Bank of the possible desirability of opinion, to have staff studies banks in the network, probably with relatively including both central
small lines of credit in each case--possibly $50 million. It would be desirable, he thought, for the Committee to reach a decision in the matter fairly soon. Chairman Martin suggested the staff prepare such studies. He added that it would be worthwhile to have corresponding studies with respect to Mexico and Venezuela, since both of those countries also were interested in joining the System swap network. Mr. Brimmer referred to the two steps that Mr. Coombs had said might be taken if further measures were needed to deal with year-end problems in the Euro-dollar market, and asked which approach Mr. Coombs thought would be most likely. The choice might have important implications for the Committee's domestic operations, since the Euro-dollar market had been an important source of funds to U.S. banks recently. Mr. Coombs replied that the decision between the two coursesas well as the timing of the operations and their scale--would depend largely on the market situation. If, however, the strains were serious it might be useful to follow both courses; the two types of together might well be more effective than either alone. operations Before this meeting there had been distributed to the members of the Committee a report from the Manager of the System Open Market open market operations in U.S. Government securities Account covering and bankers' acceptances for the period November 1 through 16, 1966,
and a supplemental report for November 17 through 21, 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 market was subjected to some moderate pressure during the period since the Committee last met. As the written reports have indicated, this was mainly a reflection of increased pressure on money center banks which, for reasons we do not fully understand, appears to have been somewhat greater than has been typical in early November in other recent years. On the day following the last meeting of the Committee the effective Federal funds rate reached 6-1/4 per cent despite the injection of nearly $1/2 billion of reserves on the day and a net borrowed reserve position for the week of about $300 million. With the credit proxy showing no signs of strength, net borrowed reserves were permitted to fall still lower in the subsequent two weeks. Nonetheless, with excess reserves at a high level at country banks, the Federal funds rate remained within a 5-1/2 to 6 per cent range. Three- and six-month Treasury bill rates moved up about 20 basis points from the relatively low 5-1/4 and 5-1/2 per cent rates prevailing at the time of the last meeting, but declined sharply last Friday and yesterday as strong demand for bills developed and the temporary stresses receded from the money market. By the close of business yesterday the key three- and six-month rates were back where they were at the time of the last meeting. In yesterday's regular weekly auction the three-month rate was set at 5.25 per cent six-month rate at 5.50 per cent. and the Dealer financing rates at New York City banks touched a new high of 6-7/8 per cent for new money before receding again prior to last weekend. Dealers were able to find out of town at lower rates, however, and were not financing to liquidate inventories which had been built under pressure up as dealers took on issues involved in the Treasury's cash refunding and increased their holdings of November longer bills. Despite the fact that prices of the new notes the Treasury had fallen below par before the offered by 15 payment date, dealers tended to view their November holdings as a good investment for the still substantial
longer pull. They were not anxious, however, to build up their holdings further and backed away from modest selling by some speculative holders. Both new issues moved above par bid in yesterday's strong bond market. As far as bill holdings are concerned, the dealers are expecting heavy seasonal buying by the System over the next few weeks. While dealers had no major financing problems over the period, the high cost of money remains a serious concern to them and has, of course, made them unwilling to hold short-term bills, thus aggravating market shortages. Perhaps the most significant development since the Committee last met has been the resurgence of demand in the capital markets. As you will recall, a considerable feeling of confidence had built up in the bond markets at the time of the last Committee meeting. There was no rush of borrowers into the market and corporate and municipal dealers had willingly increased their portfolios. Since then a steady stream of announcements of additions to the new financing calendar--headed by the A.T.&T. issue set for early January--has introduced a new note of caution and long-term interest rates have moved higher. The long markets were also affected by rumors that the Federal National Mortgage Association might come to the market with participation certificates before year-end, and by the continuing uncertainty about the likelihood of fiscal policy action. At the moment the market is rather delicately poised and much will depend on the stream of economic news and on Administration tax and spending decisions that could be forthcoming before the next meeting of the Committee. The Treasury has about completed its 1966 financing program. The November refunding is now just about out of the way, although final distribution of the new issues is by no means complete, and $1.2 billion of new money was raised in a highly successful bill strip auction last week. All that remains is an auction of $1 billion or so tax anticipation bills set for early December. Looking ahead to the rest of the year there are a number of problem areas--the buildup of demand in the capital market, the Treasury's tenuous cash position which seems likely to result in direct borrowing from the System, un certainties regarding the international flow of funds as window dressing period for European banks the year-end approaches, and the continued pressure that CD attrition has been putting on money center banks. The movement of short term interest rates is of course of crucial importance in
determining the likely CD runoff between now and the end of the year. At the current level of Treasury bill rates the banks might well be able to handle their very large CD maturities without undue problems. Given the large banks' heavy dependence on the Euro-dollar market, and the possibil ities they have of switching from that market to the Federal funds market, it could be difficult to bring the Federal funds rate much lower on a consistent basis than it has been lately without a massive injection of reserves. While a loss of Euro-dollar deposits does not necessarily mean a loss of deposits in our banking system as a whole there is apt to be considerable churning if banks with large basic deficits have to make up Euro-dollar deposit losses. Mr. Coombs has already noted the international complications of this situation. The uncertainties about the Treasury cash position and the international flow of funds make the forecasting of likely interest rate movements in the weeks ahead a highly risky proposition. The blue book 1/ notes that current estimates of a need to supply about $1 billion reserves by early December could be substantially reducedor the position could even be reversed--if direct Treasury borrowing from the System reaches substantial proportions. Open market operations will, of course, have to be adapted to meet the situation as it develops day by day, but it may be difficult to achieve pinpoint control of the reserve situation. In addition, a frustration of dealer expectations of heavy System bill purchases could lead to upward pressure on bill rates. Some offsetting demand may result from sustained private buying and foreign central bank purchases, but such demand might well be concentrated on shorter bill maturities where there are already acute market shortages. If such a situation should develop, it might be useful for the System to engage in Treasury bill swaps--selling short bills that are in demand and taking longer bills from dealer positions. I would be prepared, if the Committee agrees, to undertake such swaps over the coming weeks if unsettled market conditions in the longer bill maturities appear to warrant them and provided that the market wants shorter bills at about current rates. Returning to the likelihood that the Treasury will borrow from the System, there are some technical problems that require the Committee's attention. As you know, direct borrowing by the Treasury from the System is limited by law to $5 billion. The continuing authority directive "Money Market and Reserve Relationships," 1/ The report, for the Committee by the Board's staff. prepared
authorizes and directs the Federal Reserve Bank of New York to purchase for its account directly from the Treasury, with discretion to issue participations to other Reserve Banks, special short-term certificates of indebtedness only up to $500 million. We have been working with the Treasury to try to determine what their needs might be; current guestimates--which are far from precise--range from about to around $600 million--with the maximum need $100 million beginning in early December. While these estimates may be too high, I believe--to be on the safe side--that the Committee should increase the maximum amount of short-term certificates that may be held at any one time by the Federal Reserve Banks from $500 million to $1.0 billion. Mr. Daane said it was his impression that some of the recent pressures in money markets were due to maldistribution of reserves toward country banks. He asked whether that situation was in process of being corrected. Mr. Holmes replied that the maldistribution already had been A flow of reserves from city to country banks largely corrected. seemed to be a phenomenon characteristic of early November, although it was larger this year than in past years. Mr. Daane then asked whether the Manager expected Treasury bill rates in coming weeks to reflect the upward pressures that were usually experienced near the end of the year. replied it was particularly difficult now to say Mr. Holmes to bill rates because there were forces working in what would happen directions. As he had indicated, there would be upward pressures both were supplied by means other than the System purchases of if reserves the market expected. On the other hand, rates had declined bills days as a result of strong demands. sharply in the past few
Mr. Daane asked whether Mr. Holmes would characterize present money market conditions as somewhat easier than they had been recently, and Mr. Holmes replied affirmatively. He would anticipate that the money market would turn very easy today unless pressures developed from some unexpected source. While it was too early to say what the level of net borrowed reserves would be for the current statement week the Desk was now looking at a figure well below $200 million. Mr. Mitchell asked what level of bill rates would be required to expand their outstanding CD's to offset a reflow to permit banks Euro-dollar market in a volume of, say, $400 million. of funds to the Holmes replied that while such judgments were difficult Mr. thought the bill rate probably would have to be somewhat to make he lower than it was now. the bill rate might have to drop Mr. Brimmer asked whether that he could not be cent, and Mr. Holmes replied as low as 5 per sure. would be any rate objec asked Mr. Holmes if there Mr. Ellis market swaps of short bills for long. tives in the proposed begun to build up in longer said that pressures had Mr. Holmes recently. The expected demands from foreign central banks, term bills concentrated in the probably would be perhaps other sources, and that occurred he limited. If supplies were area where shorter-term short bills into the for the Desk to feed it would be useful thought
market and take out longer bills. There would be no particular rate objectives to the operation; the purpose would be to relieve pressures. Chairman Martin asked whether the Manager was proposing a balanced operation. Mr. Holmes replied in the affirmative. He added that if Treasury actions and perhaps also the System's foreign currency operations supplied reserves over the rest of the year there would be much less to be done through domestic open market operations than implied. That might well affect expectations and the projections in bill rate movements. That would not be produce a turnaround particularly desirable at a time of seasonal churning in the market. remarked that one aspect of the proposal he found Mr. Hickman did not have many longer-term bills avail puzzling was that dealers able for sale at present. that was the case at the moment, but Mr. Holmes agreed that such bills would be coming back to dealers as outstanding noted that matured. Such RP's would be running long-term repurchase agreements but particularly around the middle of the off all through December, in that way precisely because dealers month. They had been scheduled buying by the System in December. had expected seasonal that the one-month bill was closely Mr. Hickman then commented banks, and he did not think the with negotiable CD's of competitive in a manner that would put rates on those System would want to operate
bills under upward pressure. It would be desirable, he thought, to give the banks ample room to retain their outstanding CD's, and he would be dubious about selling too many bills in the short-term area. Mr. Holmes agreed, and indicated that he would propose to engage in the operation only if it could be carried out without too much effect on short bill rates. 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 November 1 through 21, 1966, were approved, ratified, and confirmed. Chairman Martin then called for the staff economic and financial reports, supplementing the written reports that had been distributed prior to the meeting, copies of which have been placed in the files of the Committee. Mr. Koch made the following statement on economic conditions: In my view, domestic nonfinancial developments now confirm more clearly developments discernible earlier in in suggesting an appreciable slowing the financial area the rate of expansion in total economic activity. down in annual rate of real growth in the GNP for the The average combined, for example, is now estimated past two quarters at less than 3 per cent. Moreover, the pattern of GNP seems now to be becoming one of downward adjust revisions the upward revisions typical when ments in contrast to a vigorously expanding phase. Right the economy is in weakening in housing starts and now, for example, recent suggest our current fourth-quarter GNP auto output these developments were reported, estimate, made before may prove too high.
Growth in industrial production has also slackened markedly since August, with the 0.3 per cent rise in October being due largely to a sharp spurt in auto production to a level from which it has already been cut back. Employment growth continues to be sizable, but the rise since mid-year has been less than earlier. Turning to the recent spending proclivities of the major sectors of the economy, consumer outlays have been sluggish for some months now. When one makes allowance for larger tax payments and higher prices, real consumer disposable income and spending have both only increased at around a 2 per cent annual rate thus far this year. Although earnings of factory workers are rising by more than 4 per cent, and recent wage settlements are averaging around 5 per cent a year and have resulted in higher labor costs, from the wage earners' point of view the lion's share of these wage increases has been absorbed by higher consumer prices and has not been available for purchases of additional real goods and services. One of the sharpest and earliest drops in consumer spending, of course, was that for new housing. As a result, housing starts fell to a 1.1 million annual rate level in the third quarter and then plummeted to around the 850,000 level last month. New permits for future starts declined only slightly further in October, but they were already very low. Consumer outlays on furniture and major appliances have also weakened, reflecting in part the decline in housing expenditures. Moreover, public reception of the 1967 model autos to date has not been overly enthusiastic. Only consumer spending on nondurable goods and services is continuing apace, and for both categories higher prices have been accounting for a significant part of the increase in dollar purchases. The course of future consumer spending will depend in large part on the spending decisions of business enterprises and governments which help generate additional consumer income. Turning to business spending first, it, too, now has undoubtedly passed the point of maximum rate of increase. The rate of inventory accumulation dropped substantially in September at manufacturers and outstanding stocks actually declined at wholesalers. Total retail inventories were up in September, but the rise was due entirely to an increase in auto stocks. Auto stocks rose again in October to a point sparking the production cut-back
I noted earlier. Surveys of business firms and purchasing agents suggest over-all inventory accumulation is likely to taper off further in the coming months. New orders for durable goods declined rather sharply in October following the brisk run-up the month before. New orders have shown no increase on balance since spring. Several private surveys now also suggest a sharp retardation in business spending on new plant and equipment some time in 1967. If one takes into account the level such spending is already reaching in the current quarter, real business spending on plant and equipment may already be near its peak for the current investment boom. Unfortunately, I can add little today to your know ledge about the likely course of defense spending. All I can say is that it seems to me unlikely that the increase in such spending in coming quarters will exceed on average the large $4.2 billion rise of the third quarter, partly because $0.5 billion of the third-quarter rise was due to the one-time effect of the military pay increase. Our staff guess of the increase in defense spending in the current quarter is $3.5 billion. When one assesses the likely effects of future defense spending on total economic activity, he should note that effects start when orders are placed and that the large third-quarter rise in defense spending was at a time when the increase in total activity in the economy was moderate and when inflationary pressures were becoming less obvious. It is likely to take a goodly increase in aggregate Government spending next year just to offset the smaller likely rise in spending by the private sectors of the economy. As for the significance of these demand developments for resource use and prices, the rate of utilization of manufacturing capacity no doubt dropped off a little in September and October as new capacity continued to be put in place at the earlier pace and as growth in output slowed markedly. You will have noted from the green book 1/ that revised data on capacity utilization have been developed. These data show that a high rate of utilization has prevailed in recent quarters but the level of utilization has been revised down a little for many years back. "Current Economic and Financial Conditions," 1/ The report, for the Committee by the Board's staff. prepared
The unemployment rate has remained just under 4 per cent in recent months due to the fact that a reduced labor force growth has approximately matched the reduced rise in employment. Average weekly hours of work have dropped off a little, too, but remain high. Over-all industrial prices have been little changed now for several months. A drop in sensitive prices has concealed a rise in prices of other industrial goods in the total index since May whereas earlier a sharp rise in sensitive prices had hidden the relative stability of prices of other commodities in the total. In any case, over the past year as a whole, industrial prices have risen about 2 per cent, an accomplishment that most other industrial countries would no doubt have been happy to have emulated. be some further upward pressure on over-all There will prices in the months to come if wage increases industrial the 5 per cent annual-rate area, and if the continue in decline in sensitive material prices ceases. Incidentally, the Census Bureau has recently revised its data on labor in manufacturing to show a sharper recent increase costs than had been indicated by the earlier data. But some labor cost, and price inflation may be an further wage, result of past excesses. They probably unavoidable averted without a degree of over-all restraint cannot be the economy that would produce a recession. on Three weeks ago I said that domestic financial develop to me that the time had come for a further ments suggested of monetary restraint. Today, I feel that relaxation developments suggest the same course of action. nonfinancial policy has achieved the moderation in the upward Monetary it has been seeking. Policy thrust of aggregate demand be adjusted in a timely manner lest we be should now saddled with the blame for overstaying the boom. Mr. Hickman commented that he thought Mr. Koch's presentation excellent one. He then asked about the specific statistical was an at the conclusion that both Mr. Koch had used in arriving calculation consumers had risen at an income and spending of real disposable annual rate of 2 per cent thus far this year.
Mr. Koch replied that his statement was based on the calculated percentage increases in the variables in question from the fourth quarter of 1965 to the third quarter of 1966, expressed at annual rates. Mr. Brill made the following statement concerning financial developments: In assessing the economic situation for the Committee three weeks ago, I expressed some skepticism about the validity of the softening signals financial statistics had been giving us in October. While some of the preliminary nonfinancial figures available on November 1 suggested a change occurring in the underlying economic situation, I was reluctant then to accept all of the figures at full value, or to recommend more than a shading of policy in an easing direction. But as better and later figures have come in, I've had to swallow some of my skepticism and, to use a phrase hallowed in FOMC deliberation, "resolve doubts on the side of ease." The financial figures were right in signaling a major shift in activity this fall, albeit they seem to have overstated the extent of the change. While neither industrial output nor total GNP has actually contracted, as have financial flows, the production, price, and spending developments reviewed by Mr. Koch this morning all confirm that expansion of economic activity has slowed markedly. Under the circumstances, one might have expected financial indicators in November to continue to signal slackening trends in activity. Some of the financial measures have. Bank credit has continued to contract (at least on the proxy basis), and business loan growth has proceeded at only a sluggish pace. But other financial indicators have hinted at renewed pressures. After declining in late October, member bank borrowing increased through mid-November; the Federal funds rate also bounced back, reaching, at one point, a new high; and there was bank borrowing from abroad through foreign a surge in branches. These indicators of intensified pressure on the banking system were reflected throughout most money and capital markets, with both short- and long-term rates to a quarter of a per cent. Could this be advancing by up taken as a signal of resurgence in economic activity in
November? Was the late summer-early fall lull in economic activity over? I doubt it. Nothing in the fragments we have on a current weekly basis suggests a revival in business or consumer spending such as to lead to a sharp expansion in private credit demands. Indeed, the fragments suggest further economic dampening, at best, and the behavior of financial markets in the past few days suggests that investors are coming around to this view. Frankly, I'm not satisfied with any of the explana tions as to why there was a turnaround from an easing to a tightening trend in financial figures and expectations between late October and mid-November. Analysts have attributed it variously to the build-up in the corporate calendar, the aftermath of the Treasury's November refunding, rumors of a revival of participation certificate issues, and the Administration's backing and filling on tax policy. Undoubtedly, all of these factors have contributed to uncertainty in financial markets; market participants have reacted in a predictable manner, with investors holding back a bit and borrowers pressing harder. But let's not put all of the blame--and I use the word "blame" deliberately--on recent and prospective or Administration indecision, or the Treasury financings, usual vagaries of investor sentiment. Let's recognize that the Fed has contributed importantly to market in failing to give the banking system and uncertainties, a clearer signal of the current objectives financial markets of monetary policy. Not that we're free of uncertainty we know precious little more than any banker ourselves; buyer as to what defense spending or tax policies or bond be. But we have observed that expansion in economic will and even earlier that bank credit activity was slowing, appropriate to the needs of was not expanding at a rate We've wanted to correct this, as the the economy. of the proviso clause in the directive continued inclusion would indicate. Why haven't we succeeded? I would argue that the failure stems in part from devotion by this Committee to the marginal misplaced under conditions that were bound to make reserve measure, it an inadequate indicator of tightness or ease in either market conditions or bank reserve availability. money ever, the key to banking developments is Today, more than interest rates between those on CD's and the spread in investments. With rate pressures this those on alternative a shortening in CD maturities such that about fall forcing
half the volume of large CD's outstanding at the end of October mature before year-end, with the rollback in ceiling rates on consumer CD's forcing a slowing in these inflows to banks, with use of the discount window made uncomfortable, and with bank liquidity already reduced, how could we expect bank management to loosen the leash on lending officers, or even refrain from security sales to finance loan commitments? Why should we be surprised at a build-up in the capital market calendar, when monetary restraint has already forced a wring-out of corporate liquidity, and tax payments are expected to accelerate significantly in the first half of 1967, and bank loans are difficult to obtain or renew? At least one large borrower is tapping the capital market soon to repay bank loans, and some of the other issues scheduled for coming months undoubtedly are to rebuild liquidity drawn down as a result of the unavailability of bank loans, rather than as precursors to a burst of capital spending. Results such as these were legitimate objectives of policy earlier. But there's no need to carry a good thing as far or as long as we seem to be doing. By permitting a variety of forces to press bill rates back closer to CD ceilings, by limiting the possibility of banks tapping the consumer saving stream, by keeping the borrowing of reserves unattractive through retention of the September 1 letter philosophy, and--at least until recently--by providing nonborrowed reserves niggardly, we have closed off almost all of the domestic sources of bank credit expansion. There is not much logic, then, in bemoaning the failure of credit to expand. So long as there's a price at which the public will demand credit, we can achieve bank credit expansion by moderating one or more of the constraints we ourselves have imposed. Undoubtedly, it would be advisable to wait for clarification of the fiscal situation before undertaking a major loosening of constraints. And there are balance of-payments consequences to consider, as Mr. Solomon will be discussing in a moment. But if it is the appraisal of this Committee that the current domestic situation affords the possibility of some moderate easing in bank credit availability, I would suggest that policy and its implementation be directed toward sufficient provision of reserves so as to permit market rates to sink well below CD ceilings, overriding even the seasonal rate customary in the weeks ahead. The objective pressures
would be a pattern of rate relationships such as to eliminate the drain of funds from financial intermediariessavings and loan associations as well as banks--without permitting the whole rate structure to fall so far as to induce massive resurgence in credit extensions. Our knowledge of money market and bank credit interrelationships is not as well developed as yet to permit much confidence in quantifying the level of marginal reserves that would be associated with desired developments in interest rates and in the reserve and credit aggregates. The estimates advanced in the blue book--with justifiable diffidence--suggest that one consistent complex of variables might be: net reserves fluctuating around zero, 5 per cent rates on 3-month bills, and bank credit expansion in the 2-4 per cent annual rate range. This is probably as good a guess as any, although with the very recent change in financial market sentiment, these rate and aggregate objectives might possibly be reached with a milder change in net reserves than going all the way to zero. Never borrowed theless, there are seasonal and other pressure points as Mr. Holmes has indicated, and it would seem ahead, to me important to insure that the six-month bill rate moved down along with shorter-bill rates. Given our frustrations in using marginal reserve targets recent expansion and interest rate to achieve bank credit suggest putting greater emphasis on moderation, I would the latter variables directly as guides to the System's intervention in money markets in coming weeks. that in times past suggestions had been Mr. Ellis remarked regarding appropriate fiscal policy in made at Committee meetings asked what prescription for fiscal relation to monetary policy. He have in view of his projection of a slower policy Mr. Brill would economic growth rate. be certain that economic growth Mr. Brill said he could not than at present about the to slow until he knew more would continue next year. If defense spending probable course of defense spending
continued to rise at the rate the staff had guessed for the fourth quarter--and he would not be surprised if the fourth-quarter guess turned out to be on the high side--he would still favor an increase in taxes given what was known about other trends. He would add, however, that he now was less certain than he had been three weeks ago about the desirability of a tax increase, Mr. Solomon then presented the following statement on the balance of payments: I propose to concentrate this morning on the links between monetary policy and the balance of payments, focusing on the possible repercussions on capital flows of an easing of monetary conditions in the United States. The impact of an easing here would depend importantly on what happens to monetary conditions in Europe, a subject that was discussed intensively at last week's meetings of Working Party 3 and the Economic Policy Committee of the OECD. The Committee is well aware that over the past year the deterioration of the trade balance has been more than offset by inflows of capital in response to tight credit conditions in the United States. Both the increase in imports and the inflows of capital are extraordinary and temporary--reflecting the surge of domestic spending and policy responses to it. The major forms of capital inflow have been the net repayment of U.S. bank loans by foreigners--amounting to $500 million in the first nine months of this year (partly seasonal)- and Euro-dollar borrowings by U.S. banks through their foreign branches--amounting to more than $2-1/2 billion thus far this year (part of which is also seasonal). Although these Euro-dollar borrowings are often disparaged as being "hot money" and as not affecting the balance of payments on the liquidity basis, there is no that in a real sense these flows have relieved question the U.S. balance of payments this year. Surely our balance of payments problem is mainly a problem involving official acquisition of additional dollars by Europe.
What the Euro-dollar borrowings have done is to sweep up dollars that would otherwise have gone to European central banks; to some extent these borrowings may also have diverted dollars from the U.K. Without these Euro-dollar borrowings, larger reserve gains by continental Europe would have required the United States either to draw on the IMF or sell gold, after possibly first using the swaps more actively. If indeed the reduction in the trade balance is temporary--reflecting an income surge at home rather than a deterioration in our competitive position in world markets--it is difficult to find fault with a temporary capital inflow offsetting it. The question to be faced now is: what will happen to these capital inflows if monetary policy eases in the United States? In this connection, one can visualize either a move toward monetary ease by itself or such a move as part of a shift in the policy mix, in which tax rates are increased. A shift in the mix that led to more housing expenditures and less business and consumer spending would provide a modest benefit to imports, in view of the smaller import content of housing. But, whether the mix is shifted or not, the major questions have to do with the response of capital flows to a change in monetary policy. What can be said on this matter? It should be noted that if banks (1) merely stop adding to their debt to the foreign branches--without any repaymentsthe balance on official settlements next year will tend to worsen--from this factor taken by itself--by over $2 billion. Ideally, this cessation of capital inflow would be offset by a slackening of imports, continue to increase at the while exports recent rate. The green book suggests that we should be seeing some slowdown in import this quarter. A reduction growth beginning growth from close to 20 per cent in import rate to 10 per cent would help the annual trade balance by more than $2 billion per year, other things including export expansion same. Even this ideal outcome remaining the might involve lags such that the capital account deteriorated before the trade
balance improved. Much more serious would be a failure of exports to increase at a healthy rate. But that is a problem about which monetary policy can do little aside from its efforts to maintain domestic price stability. (2) It is also reasonable to assume that U.S. banks, having developed this source of funds in Europe and being anxious to rebuild their liquidity, will not rush to reduce their Euro-dollar indebt edness. What goes up does not automatically come down. We may find that this source of funds to banks remains more important than in the past. The level of interest rates in the (3) Euro-dollar market will have an important bearing on the attitude of U.S. banks toward Euro-dollar indebtedness. It is the differential between rates here and in the Euro-dollar market that counts rather than the absolute level of rates here. From the viewpoint of our balance of payments, it is desirable that Euro-dollar rates come down short-term rates in the United States. with But it matters greatly how the Euro-dollar If they fall only rates are pushed down. U.S. banks are pouring dollars back because Euro-dollar market, our balance of into the On the other hand, if payments will suffer. rates decline because Europeans Euro-dollar are demanding fewer, or supplying more, market, U.S. banks will feel dollars to that less of an incentive to reduce their Euro dollar indebtedness. reason to think There is now some (4) interest rates may decline, that European green book indicates. Two major as the and the U.K., are experi countries, Germany slowdown in economic encing a distinct to relax its The U.K. is ready activity. as soon as it can do so monetary policy funds through interest without losing outflows. Much of the WP-3 induced capital were devoted to meetings last week and EPC
persuading the German authorities that, on the basis of their own reports regarding the outlook for the German economy--slowdown and possibly recession ahead--and the German balance of payments--rapidly increasing surplusGerman monetary policy should be eased significantly. Such an easing of monetary policy in Germany, combined with declining credit demands there, should put downward pressure on Euro-dollar rates. (5) As for bank credits to foreigners, it seems likely that these would respond to an easing of credit conditions in the United States with a lag and by small amounts. The desire of banks to rebuild liquidity and to meet the needs of domestic borrowers should make for a gradual resumption of new loan extensions and therefore for a gradual reversal of the present tendency toward net repayments. (6) Thus there are reasons to expect that an easing of monetary policy here will not lead to a symmetrical reversal of this year's capital inflows. But suppose this turns out to be wrong and that next year U.S. banks do not increase their Euro-dollar indebtedness at all. This is an extreme assumption--even in 1964 and 1965, U.S. banks borrowed net from their branches, though in much smaller amounts than this year. Such a cessation of Euro-dollar borrowing would by itself bring a deterioration of some $2-1/2 billion in the official settlements balance. Following this year's surplus of $500 million, we would have an about deficit next year of official settlements $2 billion. While this year's balance of has looked better than we had any payments to expect, next year's balance would reason than we have reason to expect. look worse the two years together, the But taking average deficit on official settlements would be $750 million--better than in 1965 year of this decade. We or any previous still have a balance of payments would
problem, but that is not surprising. We had no reason to think that the long-run balance of payments problem would solve itself. It must still be faced as a long run problem. But meanwhile, it need not freeze the present posture of monetary policy if it appears appropriate to change that policy for domestic reasons. Mr. Maisel asked whether the Euro-dollar transactions of U.S. banks were really of great significance to the U.S. balance of payments if a large part of the flows was to and from Britain. Mr. Solomon replied that the impact on the British balance of payments of the Euro-dollar funds drawn in by U.S. banks this year was a point of contention between some officials of the U.S. and the U.K. There was no question but that a large volume of funds left the U.K. this summer. He suspected, however, that that outflow reflected factors of confidence, and that the funds would if they had not come to the U.S. Thus, the have gone elsewhere absorbed by U.S. banks rather than flowing to foreign dollars were banks. More recently British reserves had been risingcentral as Mr. Coombs had indicated, not at a rapid rate--and although, might have been attracting some dollars that might U.S. banks But some dollars also were being otherwise have gone to Britain. drawn from the continent, and there was no way of assessing the Accordingly, he did not importance of the two sources. relative most of the funds were coming from think it was safe to say that Britain.
Chairman Martin then asked Mr. Solomon to report to the Committee on the recent meetings of the Economic Policy Committee and Working Party 3 which he had attended. Mr. Solomon said that in general, the attitude toward the U.S. at those meetings was gentle. There was a strong awareness of both domestic and balance of payments effects of tight monetary policy. The most conspicuous cases were Germany and the United States. Mr. Ackley reported to EPC that monetary policy had restrained demand expansion by $8-$10 billion, before multiplier effects, in 1966. A general desire was expressed to end and reverse the escalation of interest rates in major countries, but in a manner that contributed to better balance in international payments. Hence the stress on monetary Germany, where both domestic and balance of payments policy in pointed to the desirability of a relaxation of credit considerations bank representative resisted the restraint. The German central could swing world interest rates, but did suggestion that one country that a relaxation of policy was likely. indicate for economic activity and payments As for the prospects continued, it was expected that both balances in 1967, Mr. Solomon U.K. would experience slower expansion. For both Germany and the recession was possible next year. On the other hand, countries and Japan were likely to experience faster expansion. Italy, France, representative stated that the recent fall-off in the The French
French balance of payments surplus was more than a transitory development. What seemed to be happening was that French imports were accelerating with domestic expansion, while exports had fallen off as a result of the slowdown in Germany and the U.K. Thus, part of the French surplus had been absorbed by domestic expansion and part was being shifted to other countries. Also, there had apparently been some capital outflow in response to short-term rates abroad. Mr. Solomon said that WP-3 had held a frank discussion in a restricted session in which the Europeans let their hair down regarding the future of the international payments system. They reiterated a well-known continental view that European official dollar holdings should not increase in total, although the dollar holdings of individual countries could swing up and down with shifting payments balances. In fact, European dollar holdings had declined by $1-1/2 billion in the past two years. Thus, the Europeans recognized that the U.S. had been financing its deficit not as a reserve currency country but no differently from non-reserve currency countries--by using its reserve assets. The second major point in that discussion, Mr. Solomon observed, was a recognition of what was called the "collective responsibility' of the gold-holding countries to avoid destabilizing the system by converting existing dollar holdings into gold. Although the means of implementing that responsibility were not
clearly at hand, it was recognized in a constructive way. The entire discussion was clearly a condemnation of French policy and of "Rueffism." Finally, Mr. Solomon said, the discussion of swap arrange ments that had been initiated at the September meeting of WP-3 was put off until January of 1967, as Mr. Coombs had indicated. Chairman Martin then invited Mr. Daane to comment on the developments at the recent meeting of the Group of Ten Deputies. Mr. Daane said he would first add one or two observations to Mr. Solomon's report. Some of those around the table at the EPC meeting--including Mr. Ackley of the U.S. delegation--urged that the Germans consider fiscal as well as monetary policy actions in moving to relax economic constraints. Secondly, the Italians thought their balance of payments surplus this year might be on the order of $450 million, but that estimate did not allow for the impact of the recent floods. Group of Ten Deputies' meeting, held in Paris Turning to the 16, 1966, Mr. Daane said that it was concerned largely, if on November procedural questions, including the physical and not entirely, with first joint meeting with the Directors of other arrangements for the the IMF. That meeting would be held at the Fund in Washington on November 28 and 29, 1966. Formally, the meetings would be chaired Managing Director of the Fund and the Chairman of the jointly by the
Deputies, but in practice it was expected that Mr. Schweitzer would preside over the meetings held in the U.S. and Mr. Emminger would preside over the alternate meetings held elsewhere. Those attending would be the Executive Directors of the Fund and their alternates; the Deputies of the Ministers and Governors of countries participating in the General Arrangements to Borrow (two persons per country) and their alternates; the Managing Director and Deputy Managing Director of the Fund and members of the IMF staff designated by the Managing Director; and, finally, observers from Switzerland, the BIS, and the OECD. As to the agenda for the first joint meeting, Mr. Daane continued, the Deputies developed a draft which was later amended in discussions between Messrs. Schweitzer and Emminger. It was now generally agreed that the agenda should include five items, as follows: the aims and objectives of reserve creation, including the need for reserves and its relationship to adjustment policies and the supply of liquidity; the nature and form of deliberately created conditional including their financing; distribution of deliberately reserves, of new reserve assets, including condi created reserves; utilization reserve assets and for assuring the tions for the transfer of new and circumstances of of these assets; and conditions acceptance respect to each topic, one or of a contingency plan. With activation forth the views of the would take the lead in setting more Deputies they issued in August 1966. the framework of the report Deputies within
Mr. Perouse of France offered to take the lead on the first item, but it was agreed that he would be joined by Mr. Deming of the U.S. Mr. Daane went on to say that the Deputies agreed to hold a meeting of their own immediately following the joint meeting in Washington to consider their work program. One possibility discussed was that of appointing small task forces from among the Deputies, alternates, and members of the secretariat to do advance work on those problems the Deputies regarded as being within their orbit, including the problems of lessening possible strains on the international monetary system and the question of the future role of gold. Mr. Daane concluded by noting that the second joint meeting with the IMF probably would be held in London in the latter part of January 1967. 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: doubt that in recent weeks the state of There is no the economy has become more complex and subject to more than was true a few months ago. After many uncertainties months of almost uninterrupted exuberance, we now find clear signs that the pace of the expansion has become rapid. Perhaps it is only natural that this change less rise to doubts whether the uptrend can be should give at all, or whether we are close to an actual sustained recession; but on careful analysis, I find business no basis at all for such a pessimistic conclusion, at least short of a major turn-around in Vietnam developments,
of which we have no convincing evidence whatever. And, after all, a basic objective of our policy in the past year or more has been precisely to slow an excessively rapid growth in aggregate demand. Economic activity continues to expand. Given the probability that defense spending will be moving up strongly through next year, inflation--both demand-pull and cost-push--remains a serious threat. It is interesting to observe that even the more pessimistic forecasters of 1967 GNP seem to assume without question a continuing price rise on the order of 3 to 3-1/2 per cent per annum. Certainly there is no reason to accept such a rise with complacence. A good deal of stress is being placed by the pessimists on the likelihood that plant and equipment spending will rise only very moderately in 1967, after a 17 per cent increase in 1966. In our Bank we believe that, as in many recent years, the McGraw-Hill figure of 5 per cent will probably turn out to be too low. We would expect an actual increase closer to 10 per cent, even after taking full account of the dampening effects of the suspension of the tax credit and accelerated depreciation, and of the significant impact of tight money on capital spending plans. As for consumer spending, this does seem to be losing some of the extra buoyancy it had shown earlier in the year. For one thing, the rate of private saving has been lower than the long-term average in the first three quarters of this year, and it appears that a rise may now be taking place. Nevertheless, as long as personal income is increasing at a substantial pace, as it is, I believe that reasonably well-sustained consumer spending will no doubt provide a strong underpinning for the economy. our estimates of fiscal impact of the According to Federal budget, the latter is providing a sizable stimulus to the economy in the current half-year, and the stimulus will still be large in the first half of With the prospect of a Federal budget calendar 1967. deficit in the current fiscal year of about $8 billion whether figured on a cash or on an adminis or more, trative basis, I find it hard to understand, on any economic grounds, the Administration's reluctance to increase in the very near future. request a general tax easily be rescinded if economic Such an increase could should take a serious turn for the worse developments some time in the coming year.
While the wholesale price indices have been behaving quite well in the last few months, the outlook for labor costs is anything but encouraging. The 5 per cent pattern set in several recent major settlements now seems to be regarded as a probable minimum for next year's important negotiations, and much more ambitious demands seem to be in the making in many industries. I was shocked, in a recent talk with Governor Rasminsky, to learn of the extreme magnitude of recent labor demands beyond our northern border. Turning to the balance of payments, we find a disturbingly large underlying deficit temporarily ob scured by special transactions, including large placements of foreign short-term funds in longer-term time deposits and U.S. agency obligations--many of these being in the nature of "window-dressing" trans And the reduced liquidity deficit that remains actions. has been more than adequately financed by the massive through the foreign branches of inflow of Euro-dollars American banks--a flow which is bound to slacken and well be reversed in the coming months. Meanwhile may surplus, which is the major hope for ultimate the trade has been deteriorating substantially. payments equilibrium, such conditions, even though the rate of import Under with the slowdown in domestic expansion may decline the prospect of considerable cost business growth, inflation is ominous indeed. credit area, we do see further evidence that In the restrictive policies have significantly the System's the expansion of bank credit. Indeed, the actual slowed decline in bank credit, as measured by the credit proxy, even suggest that we past 3-1/2 months might in the But in view of gone too far in this direction. have of all of our seasonal adjustments, the fallibility of the altered tax payment especially in the light I think it would be unwise in effect this year, schedules the statistical showing of to lay too much stress on three or four months. In somewhat longer perspective, rate of bank credit growth the reduction in the annual first ten months of 1966 from to 5.6 per cent in the 10 per cent in 1965 seems to me a somewhere around is well to bear in mind achievement. And it gratifying the economy have not total credit flows through that as sharply as the bank figures might been reduced nearly the heavy calendar of corporate suggest. Furthermore,
bond offerings suggests that credit demands remain very high. Under all these circumstances, both domestic and international, I can see no basis for making an explicit change at this time in our basic policy of credit restraint. While there is always a risk of overstaying a policy of tightness, I believe we would face an even greater risk if we were to relax policy too much too soon, There is still no assurance that fiscal policy will be moving soon to support our efforts to contain inflationary pressures, and it would seem to me unwise to consider easing monetary policy significantly before vital fiscal decisions have been made by the Adminis tration. Since none of us has wanted to achieve an absolute cessation of bank credit expansion, I would be willing to see doubts continue to be resolved on the side of ease, if staff expectations of further declines in bank credit and related aggregate measures over the rest of the year actually materialize. Given the stresses and strains that can come to bear on financial markets between now and the year-end I believe that a great deal of flexibility will be needed in the conduct of System open market operations. The Manager will have to work in terms of the feel of the market, with due attention to the Federal funds rate, the bill rate, and dealer lending rates. Our experience of the last two weeks demonstrates pretty clearly that net borrowed reserves are a rather unreliable indicator of credit conditions, especially under present circumstances. Nevertheless, the net borrowed reserve statistics receive so much public attention that we run some danger of a misinterpretation of our policy, i.e., an impression that we have moved easier policy. Thus, I would hope to a significantly that net borrowed reserves would tend to be closer to $400 million than to $200 million, provided $300 or reserve figures turned out to that those net borrowed comfortable money market. I think be consistent with a to pay close attention to the Manager should continue measures of bank credit and liquidity. And the various happy to see some weakening of interest I would be quite cooling of demand pressures. rates attributable to further we are not likely to see a But I am fearful that of demand pressures if a tax sufficient slackening Hopefully we will know increase is not forthcoming. this by the time we next meet. more about
As far as the directive is concerned I would prefer alternative A as presented by the staff.1/ If aggregate measures prove to be as weak as the staff now projects, this would, as I interpret it, mean some modification of operations to permit somewhat more confortable conditions in the money market. The net results would probably not be far different from the thrust of alternative B, but I think it unwise to commit ourselves to an overt policy of less restraint until some decisions have been made on fiscal policy. Mr. Lewis reported that the boom had apparently lost some of its strength in the Eighth District. Spending might be slowing; the volume of check payments changed little from July to October after going up 12 per cent in the previous year; business loans at large banks had also been about unchanged since July. Real output might be expanding less rapidly in the District as many sectors had reached capacity. Payroll employment had risen at a 2 per cent rate since June after growing 4 per cent in the previous twelve months. There had been little change in nonmanufacturing employment since mid-year. Nationally, Mr. Lewis said, it could now be seen from the recent revisions of the national accounts figures that total spending on goods and services rose about 7 per cent from the first to the third quarter. By comparison, outlays had gone up at a 9.5 per cent rate from late 1964 to early 1966. He thought that that 1/ Alternative draft directives proposed by the staff for consideration by the Committee are appended to these minutes as Attachment A.
apparent slowing in the growth rate of total spending had been desirable, with the economy operating at capacity and inflationary pressures building up. The abrupt change from rapid expansion in bank reserves and money to contraction beginning last spring had probably contributed to the slower growth in total demand in recent months in spite of a stimulative budget situation. Despite that apparent slackening in the rate of growth of total demand, Mr. Lewis remarked, price increases this year had accelerated. The general price index went up at a 3.8 per cent rate from the first to the third quarter as against a 2.1 per cent rate from late 1964 to early 1966. He was fearful that the basic price trends were still strongly upward. output, which had risen at a clearly unsustainable Real cent rate from late 1964 to early 1966, had since increased 7 per rate, Mr. Lewis continued. The 3 per cent rate of at a 3 per cent less than the long-run potential gain in real output was probably during the period of acceleration of production of the economy; yet, civilian goods that might be the for defense at the expense of Furthermore, acceptance of a 3 per cent necessary growth rate. the short-run in order to bring rate might be desirable in growth strong inflationary pressures. under control the the marked change from policy, Mr. Lewis believed As to to some monetary contraction beginning rapid monetary expansion
last spring had been desirable and had probably been a significant factor in moderating total demand. Total member bank reserves and the money supply had both declined at a 2 per cent rate since last April. He thought it would be a mistake to permit such declines in bank reserves and money to continue at this time. In the past two or three months it appeared that the monetary contraction had not been the Committee's intent. Initial projections had repeatedly been that the stock of reserves and money would rise; yet, after the fact, declines had occurred. As a result of some recent weakness in loan demand, net sales of Governments were to prevent greater declines in interest rates. Monetary required a drag on both spending and credit demand, contraction acted as demand in turn tended to cause further and lessening of credit unplanned monetary contraction. the near future, Mr. Lewis suggested that the System For avoid a further decline in bank reserves take the action needed to since inflationary pressures were and money. On the other hand, any rapid expansion of those magnitudes present, he thought that rates and net borrowed reserves should also be avoided. Interest wide range of movement in properly be allowed a relatively might As to the directive, Mr. Lewis response to changing credit demand. preferred alternative B.
Mr. Patterson reported that the economic data that had become available for the Sixth District since the last meeting of the Committee confirmed the previous appraisal that the economy of the area was proceeding at a slower pace than earlier in the year. In some sectors of the District the behavior was better than nationally, but even in such cases the performance exhibited no great exuberance. Contrary to national developments, total construction contract volume continued to run slightly ahead of last year, but the volume of residential construction was now feeling the pinch of the money shortage and rates to a much greater extent, and construction employment continued to trend downward. Early November reports on automobile sales suggested that sales below last year's, and the behavior of consumer credit continued statistics reflected that development. Patterson commented that the latest loan Continuing, Mr. additional evidence of a for the Sixth District gave statistics Loans at large weekly reporting changing pattern of lending. during the final week of October and had banks declined sharply the first two weeks of November. only slight increases during shown large in November. No loan increase was fairly In most years the strength at those banks. of loan showed any expansionary major type adjusted loans in member banks seasonally At all Sixth District total loans and invest from September, and October changed little answer from bankers He found no clear-cut declined slightly. ments
as to whether or not current loan trends resulted from a deliberate tightening of lending by the banks or changes in the demand for loans stemming from changed economic conditions. Apparently some of both were occurring, from what bankers told him. Bankers reported not only more restrictive practices but also a less frantic demand for bank loans. Certainly, he concluded that, so far as his own District was concerned, the demand for bank loans was no longer accelerating, as it had been earlier this year, even though credit demands might still be high. Turning to the national scene, it seemed clear to Mr. Patterson that total credit demands were still high. It also seemed clear that there was considerable difference between condi tions now and those prevailing only a short time ago. Then credit demands were accelerating, and the nonbanking economic data helped explain the cause of that acceleration. Now credit demands were apparently not accelerating, and the economic data such as statis tics on industrial production, retail sales, employment, and prices did not provide evidence that credit demands were growing faster than productive capacity. On the other hand, the behavior of the supply figures suggested that aggregate reserve and the money had had a major influence on maintaining the high System policy level of rates, for rates were still extremely high although they might be lower than two months ago.
Under those conditions, Mr. Patterson said, a policy posture that was appropriate during the period of accelerating demands for bank credit was no longer appropriate. On the contrary, a less restrictive policy seemed to be in order. If policy were to be measured solely by net borrowed reserve figures of the past two weeks, it could be concluded that policy had indeed eased. Never theless, banks continued under extremely strong pressures, as evidenced by the continued high level of borrowing and the con straints imposed by recent trends in time deposits. He believed that the Committee should try to prevent a further drift downward in the seasonally adjusted reserve figures and the money supply. also like to have the Committee place itself in a position He would that might be quickly reversed if the same sort of conditions that prevailed a few months ago reappeared. A move toward greater ease be in the nature of a probing operation at the present time should toward a net borrowed reserve be accomplished by aiming and might figure below $200 million. evidence was growing that inflationary Mr. Bopp said One could not fail to be might be subsiding somewhat. pressures decline in total construction by these facts: the impressed of about 5 per cent volume to the extent expenditures, in physical of inventories and the slowdown in accumulation below a year ago; slower increase in ratio; the a rise in the inventory-sales in capital expenditures the small increase industrial production;
now planned for 1967; and the stability of wholesale prices in October. It appeared that the upward pull of demand on prices was weakening. But even though business expansion might be losing some of its steam, Mr. Bopp continued, upward pressures remained. The backlog of manufacturers' new orders for durables continued to grow. Both defense spending and capital expenditures were expected to rise at about current rates for the remainder of this year. Growth in personal after-tax income should provide strong support for consumer demand. Wage settlements continued to show increases well above the guideline. Thus, the cost-push effect on prices could offset any weakening in demand-pull. Financial markets also reflected mixed trends, Mr. Bopp said. One that should be watched carefully was the slow downward movement of total bank credit and the money supply. Liquidation of invest ments had exceeded loan expansion; however, total loans and business loans had been rising at a slower rate. He had been unable to determine to what extent slower loan expansion reflected more restric tive bank lending policies or weaker demand resulting from earlier anticipatory borrowing and a slower rate of inventory accumulation. Looking ahead, however, the demand for funds in the capital seemed to Mr. Bopp likely to be strong during the remainder market of the year. Perhaps some of the larger volume of offerings for reflected a spill-over from restrictive bank lending December
policies; but regardless of the reasons, the likelihood was good that private demand, possibly augmented by some agency offerings and participations, would tend to force yields higher. As he summarized those various developments, Mr. Bopp observed, the situation appeared more encouraging than alarming. The economy seemed to be moving toward a more sustainable rate of growth instead of either runaway inflation or recession. As for policy, he would favor supplying sufficient funds to meet the large anticipated demands in the capital market and CD runoffs and would put more emphasis on preventing a rise in rates and arresting the decline in nonborrowed reserves and bank credit than he would on net reserve positions. Alternative B of the draft directives, as / interpreted in the notes attached, would be appropriate.1 1/ The note to which Mr. Bopp referred read as follows: "The reference to 'somewhat easier conditions in the money market' might be interpreted to call for the money market conditions described in the second full paragraph on page 5 of the blue book. As indicated in the following paragraph on that page, these money market conditions cannot be counted on to result in an appreciable expansion of bank credit before year-end. The proviso clause is worded, however, to guard against unforeseen expansion at a 'rapid' rate. Recent Committee commentary might suggest about a 10 per cent growth rate as an upper limit." The blue book paragraph (second full paragraph on page 5) mentioned in the note read as follows: "It might well be necessary, however, to move net borrowed reserves to a shallower level than has prevailed in the past two weeks in order to keep bill rates from rising much above current levels. Under such conditions, the Federal funds rate would be likely to drop to a level averaging closer to 5 per cent, dealer financing costs should decline further, and dealers would find it more comfortable to finance their inventories--not only of bills but also of coupon These developments would also tend to moderate rate pressures issues. in long-term markets, as expectations of monetary easing took hold."
Mr. Hickman commented that there was now little doubt that the pace of economic expansion moderated in the third quarter and through October. Confirming evidence included the downward revision in GNP, the slight decline in corporate profits, the further drop in construction outlays, the reduced rate of increase of business inventories and employment, some leveling tendencies in retail sales, and four months of stability in the index of wholesale industrial prices. The theme of moderation had permeated the discussion at the November meeting of the Cleveland Reserve Bank's Board of Directors. It was then pointed out that machine tool buying seemed to have passed its peak, and that delivery schedules in that key industry were shortening. Less optimism in the auto industry was reported, and steel companies were lowering their estimates of fourth-quarter shipments. The evidence did not suggest to Mr. Hickman that a recession was approaching but, coinciding with the widely-discussed surveys of plans for new plant and equipment spending in 1967, signs of moderation could not be ignored. Moreover, the Committee should recognize that a large part of the gain in real product that had taken place in recent months had been due to defense spending, and that the behavior of the private sector had been weak. Analysis of the industrial production index, for example, suggested that the weights of those components that had been posting successive new
highs during recent months accounted for only about one-third of the total. Most of the steady risers were defense-connected. Financial developments bore out the change in the business climate, Mr. Hickman said. An informal survey last week of important Fourth District banks revealed a recent general softening in the demand for business loans. Applications for new loans were fewer, and some earlier commitments were not being taken down. Opinion was divided as to whether those commitments would be activated later this year. Before turning to policy, Mr. Hickman said, he would like to remind the Committee once again of the lack of adequate informa tion for the design of appropriate policy. Inventories were an obvious gap in the Committee's knowledge, as indicated by the fact that two-thirds of the revision in third-quarter GNP was in the inventory component. Such information as was available on defense spending was almost useless until well after the fact; a significant part of the $1.7 billion difference between the estimated and actual income budget for the third quarter was due to larger national than-anticipated defense expenditures. of past moderation and future Against the background Mr. Hickman remarked, the Committee should continue uncertainty, to shade monetary policy on the side of ease. He was increasingly behavior of the bank credit proxy, which disturbed by the recent
was expected to decline in November and December, with the latter being the fifth month in a row. A stiff price could be paid in the real sector next year if the reduced flow of funds through the financial intermediaries continued much longer. In the period immediately ahead he would again let the behavior of the credit proxy and the money supply determine policy, but would seek to obtain an annual rate of growth in the credit proxy on the order of 3 or 4 per cent, even if that meant substantially shallower net borrowed reserves. The mounting calendar of corporate and tax free bonds reduced the risk that such a tactic would touch off a speculative wave in the bond market. Hopefully, by the time of the Committee's next meeting, fiscal policy for 1967 would be revealed, and the Committee would be able to determine the future course of monetary policy more easily. Mr. Hickman favored alternative B of the staff's current economic policy directive drafts. Mr. Brimmer said there was no need for him to review again on domestic economic conditions presented by the staff the evidence in the preceding comments of members. He shared and also discussed uncertainties about the underlying strength of the the doubts and He would even go further to say that in the private economy. absence of defense and related expenditures the Committee probably on the verge of describing the outlook for the U.S. economy would be
in the manner Mr. Solomon reported the German economic outlook had been described at the recent Paris meetings: slowdown and possibly recession ahead. The Committee had gone quite far in restraining domestic activity in recent months and it should be concerned about the desirability of continuing that restraint in the months ahead. Mr. Brimmer noted that some of the discussion today related to the question of the appropriate means for formulating national economic policy. He had not been a member of the Board last fall when the discount rate was raised, but after reviewing the record he felt that that step toward restraint was a proper one. Although the problem of the appropriate mix of monetary and fiscal policy had not been resolved at that time, the System had not failed to move ahead. Now, as then, it was highly desirable to have a proper Specifically, if it was necessary to fiscal-monetary policy mix. over-all restraint, it would be maintain the existing degree of monetary policy to provide it; a tax increase dangerous to rely on not think the Committee should wait would be required. But he did before easing monetary policy at for assurance of fiscal action waited for fiscal action last just as the System had not present, It was necessary, of before moving toward restraint. December to the issue and to continue to urge course, to remain sensitive one large enough to do the job but not a tax increase--hopefully to damage the economy. so large as
Secondly, Mr. Brimmer said, he thought the Committee should remain alert to the possibility that capital market flotations were now substituting for bank credit. He was impressed by the recent cessation of growth--and decline--in bank credit. The Committee obviously had wanted to provide sufficient reserves in recent months to permit some expansion in bank credit; and, on the assumption that much of the impending increase in capital market flotations reflected substitutions for bank credit, he thought the reserve supply should be increased. Also, the attrition in CD's had gone far enough, and the Committee should be especially careful to prevent further run offs. It was not easy to say how far the Desk should go in that connection--it would be undesirable to overdo the action--but hope fully a proper course could be found. Mr. Brimmer then referred to the Manager's comment that the volume of his operations in the coming period would depend on the actions of the Treasury and the operations of the Special Manager, and that domestic open market operations might not have to supply as much in reserves as was usual at this time of the year. While he (Mr. Brimmer) was not sure of the precise mechanism that should be employed, he hoped that care would be taken to insure that the System's operations in foreign currencies did not interfere with the goals of its domestic operations.
As far as the balance of payments was concerned, Mr. Brimmer was particularly pleased to hear Mr. Solomon's conclusion that there was no necessary incompatibility in the short run between the policy requirements in that area and in the domestic economy. He hoped that it would continue to be possible to take that position, and to rely primarily on the voluntary restraint program to deal with the problem of capital outflows. In concluding, Mr. Brimmer said he would lay stress on his view that it would be inappropriate for the Committee to postpone the kind of policy change indicated as necessary by the evidence on the domestic economy until there was assurance that fiscal action would be taken. Of the two draft directives, he favored alternative B; indeed, he leaned toward a "B minus" directive--one that called for going somewhat further toward easing than did alternative B. Mr. Maisel said that in preparing for today's meeting he at previous meetings of this year, had reviewed his statements to feel like a broken record. had to admit that he was beginning and to the fact that the he had called attention At most meetings an erratic path. The failure to Committee seemed to be following wanted to be was not due to uncertainty move directly to where it Committee had not been it was because the as to its goals. Rather,
willing to specify its true goals, and the method by which it hoped to achieve them, in its directive. The Committee had failed to develop clear-cut policies and procedures to alter the factors actually under its controltotal reserves or bank credit, Mr. Maiselcontinued. It had paid too much attention to changes in money market conditions and net borrowed reserves. As a result it had introduced a major lag in policy. All during the winter and spring the Committee was moving in the wrong direction, in one opposite to that necessary to reach its agreed-upon goals of restraint. That had again been true since August but in the opposite direction. Maisel commented that the proviso clause in the direc Mr. a major step forward in attempting to reduce that lag tive was and to get the Committee on its desired path more rapidly. Unfortunately, the Committee had not really been willing to live with the proviso. Those general comments were illustrated the actions of the past six weeks. In that period particularly by be agreement that bank credit ought to stop there seemed to expand. Action, however, had not declining and probably should goal. Other constraints to policy had been consistent with that Initially they were those been followed in the Desk's operations. rate and more recently that of net borrowed of the Federal funds policy had followed paths set by the market reserves. As a result,
instead of letting the market react against a policy the Committee adopted in order to reach its goals. Mr. Brill's discussion this morning was very pertinent. It was true, Mr. Maisel remarked, that for the past three months there had been great uncertainties in the production and output situation. A rapid resolution of those uncertainties was not likely. On the other hand, it had also been clear that it was not necessary to arrive at a basic decision as to the future course of the real economy in order to stake out a logical path for monetary policy. No matter what happened to output and production, the be harmed if the Committee continued a policy creating economy would great distortions in the field of money and credit. present situation it seemed quite clear to Mr. Maisel In the sphere, through a failure to that further harm to the productive rate, could only defeat the allow credit to expand at a normal upon which index was used, the Committee's basic goals. Depending from three to six months. had failed to expand for monetary variables supply imbalances grew in the economy and related The distortions pushes on the cost side. day. That meant inflationary greater day by at a point where they were imbalances might well be Those supply effects threatened through increasing exceeding any unfavorable price relative courses actual weighing of possible In any case, an demand. situation putting the monetary because in the current was not necessary
house in balance was unlikely to raise aggregate demand above supply. As a result of the past three months' experience, when bank credit declined instead of increasing, the total was probably $6 billion or so below a desirable level. There had been a short fall in the furnishing of total reserves of somewhere between $300 and $500 million. What the Committee had to do now was avoid further delay, Mr. Maisel said. It should recognize that its lags in implementing its goals were extremely dangerous. It had to be concerned with the future costs of failing now to expand the reserve base at a normal rate. The Committee also had heard that it could get into a major Euro-dollar market problem. The Committee's directives should pick a desirable level and then instruct the Desk to of expansion in required reserves of reserves was furnished the to insure that such a level attempt The Committee should be concerned market, Mr. Maisel continued. and allow the market to amount of credit being furnished with the along with it. It seemed interest rate that went determine the months the Committee had him that for the past three clear to to control interest rates far too concerned with attempting been credit. The estimates of the amount of money and rather than rates of expansion or decline. been good in terms of reserves had
However, even though the Committee's goal was an expansion of reserves it absorbed reserves on a day-by-day basis in order to meet the market constraints. Mr. Maisel said he would support alternative B of the draft directives, but he would like to see it changed to make clear that the amount of ease called for was simply that required to achieve a normal reserve expansion of approximately 1 per cent a quarter on a seasonally adjusted basis. Sufficient reserves should be furnished for the credit proxy to grow at a rate of approximately 6 per cent. Actually, the rate could be slightly higher if deposits in other institutions continued to expand at a slower rate than the credit proxy. It should be clear that any given concept of a net borrowed figure was rejected. Although if the Committee agreed, he would like he did not feel strongly, statement of the goal. Specifically, to attempt again a more direct of alternative B to call for he would revise the second paragraph expansion in bank a view to attaining moderate operations "with delete the final clause and credit," and would reserves, money, of the staff's draft. question of a talking about the remarked that in Mr. Daane had described himself last week Walter Heller possible tax increase policy was concerned As far as monetary a "cautious hawk." as at all; but he was no hawk said, he personally today, Mr. Daane
would describe himself as a "reluctant dove," at least with respect to an overt move. The balance of payments continued to pose a major problem, and the trade balance was a crucial element in that situation. Thus, while Mr. Solomon had said today that monetary policy could do little to encourage exports except for its efforts to maintain price stability, he (Mr. Daane) regarded such efforts as an extremely important contribution which the Committee should continue to make. Nor was he confident that one could look for other than adverse effects on capital flows of an overt move toward ease. For those reasons, and with the additional uncertainty in the fiscal policy area, he concluded that the position of a reluc tant dove was the better position. that there was a significant difference Mr. Daane felt taken by the Committee as part of a change between a policy action national economic policies and a Committee in the mix of over-all He agreed with Mr. Brimmer that timing action taken independently. a somewhat different conclusion of the essence, but he reached was timing was appropriate. He would much prefer a monetary on what to an easing in interest policy posture of initial non-resistance desired, if and when fiscal subsequent validation as rates, and He was impressed by Mr. Koch's action came into view. policy in the economy, but he was of the indications of weakness review unwillingness to predict slower also impressed by Mr. Brill's
economic growth until he knew more about the Federal budget. While the projections of defense spending seemed reasonable, the Committee did not in fact know what was likely to happen in that area. He thought too much emphasis was being placed on developments in the private sector in the discussion today and too little on public sector developments. Unlike Mr. Brimmer, Mr. Daane thought there was not a close analogy between the present situation with respect to the economic policy mix and that of last December. A year ago the question was whether monetary and fiscal policies should be coordinated in a general move toward restraint. The question now was whether mon etary policy should be eased in advance of a fiscal policy move toward restraint--and against a background of existing fiscal stimulus. Operationally, Mr. Daane said, for a long time he had lectured against the use of free reserves as a guide to monetary unhappy with both the Committee's and the policy, and he had been variable. Nevertheless, he felt that market's emphasis on that simply to ignore it and to try there would be risks in deciding the current uncertain market. from that emphasis in to break away flexibility and would give the Manager full Despite this, he would in operations on be a much greater emphasis suggest that there Manager should be directed From this viewpoint the interest rates.
to maintain the current comfortable tone in the market, resolving doubts on the side of ease. As to the directive, Mr. Daane said the wording of the first-paragraph statement of the Committee's general policy con tained in alternative B was more felicitous than that in alternative A; it appropriately reflected the realities of the situation in the private economy. For the second paragraph he would also favor alternative B, but with a significant amendment. He would say "To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining the somewhat easier conditions presently prevailing in the money market, unless bank credit appears to be resuming a rapid rate of expansion." As the Manager had indicated, market conditions at the moment were easier than they had been earlier period. If those conditions were maintained in the in the recent pressures, the Committee would have face of the expected seasonal desired shading of policy without making an overt achieved the in his judgment would be undesirable. move toward easing, which he agreed with Mr. Brill's analysis today. Mr. Mitchell said concerned, he did not posture of policy was As far as the general in the discount rate signal reflected in a change think the kind of the discount rate was at at this time--even if would be appropriate a purpose--but he would it could be used for such a level at which
be willing to take a step just short of that. He felt that the Committee should be pushing hard now, up to a certain point. That view presumably aligned him with Mr. Brimmer's "B minus" and perhaps with Mr. Maisel's position. One thing that appeared to be disturbing to the Committee, Mr. Mitchell remarked, was that the banking system was not respond ing to the System's moderate blandishments toward easing. Perhaps the System had not blandished banks enough. In his judgment the banks were so concerned about their liquidity positions that a successful effort to attain renewed growth in bank credit probably would require much more drastic open market operations than most of the speakers around the table had implied. He was convinced that net borrowed reserves in the $300-$400 million range suggested not do the job, and he was not sure that a zero by Mr. Hayes would might well have to be positive. level would do it; net reserves to do what it wanted them to do, the System Having gotten banks them to change, but it was important might find it hard to get that they should do so. the relation between mon to the question of With respect said he was inclined to agree etary and fiscal policy, Mr. Mitchell But he would not like rather than with Mr. Brimmer. with Mr. Daane toward ease. He System led struggling and resisting to see the would be recognized as a policy change that would prefer making
such--not necessarily widely, but by market technicians--and that would be the probable result if net reserves became positive. The Committee itself had something to gain from recognizing the recent developments in the economy; developments which, he would remind the members, were occurring despite escalating defense expenditures. He also would remind the Committee of another fact that should not be overlooked--that net funds raised in the nonfinancial sectors dropped in the third quarter to an annual rate of $63 billion, from $84 billion in the second quarter. It was quite important, Mr. Mitchell thought, for the Committee to make a change in policy significant enough for the banks to recognize. Hopefully, they would then start rebuilding their liquidity positions even though they were experiencing an outflow of funds resulting from European window-dressing operations; and at least some small growth in bank credit and the money supply would be achieved. not undertake to present another Mr. Shepardson said he would since they had already been extensively review of economic conditions, On the matter of timing, he would note that his view was discussed. Daane and Mitchell, rather than to that similar to those of Messrs. of Mr. Brimmer. Mr. Shepardson continued, that bank credit had It was clear, not been expanding recently. Whether or not that was inadvertent,
he did not think it was the Committee's intention now to press further in the direction of restraint. But he would not consider an overt change toward ease to be appropriate at this time, in view of the large existing uncertainties--and also of the near certainty of cost-push pressures on prices, which would have both domestic and balance of payments consequences. In his view it would be better to adopt alternative A, which provided for maintaining money market conditions in their recent ranges, for the directive. By adopting A, the Committee would be accepting the slight easing that had occurred in money markets and the shallower level of net borrowed reserves that had come about. He was not disturbed by the fact that the net borrowed reserve figure had not been as deep recently as some members had suggested at previous meetings. Finally, he thought that the situation that the year-end in connection with international might develop around dealt with, and in his judgment it would flows of funds should be clause of alternative A. possible to do so under the proviso be that over-all activity in the Fifth Mr. Wayne reported it now seemed rather a high level, although continued at District considerably in the of advance had slowed that the pace definite in the latest survey or two. Reports of manufacturers past month orders, backlogs, and ship further slowdown in new indicated some goods lines. Respondents of the easing in durable ments, with most
also reported further weakness in residential construction, a reduced pace of automobile sales, and smaller gains in retail trade. Confidence among both bankers and businessmen continued considerably less buoyant than earlier in the year, although perhaps a little stronger than three weeks ago. While textilemen remained concerned over growing imports and rising labor costs, they now seemed to view the future with cautious optimism. He continued to receive reports of large cutbacks in construction spending, but the building permits series showed only a relatively small over-all decline from last year. that no purpose would be served in Mr. Wayne commented repeating analyses of the national economy that had already been a whole, signs of easing continued to heard. In the country as seem that for the present the growth appear. On balance, it would to a rate which was not con demand had been reduced of aggregate significantly to inflation. tributing Wayne concurred in both the In the matter of policy, Mr. expressed by Mr. Koch. The developments analysis and conclusion capital markets noted by Mr. Brill were not surprising; in the following an anticipated course. They did they were more or less the policy posture indicated by serve to reinforce his support of Mr. Solomon's concluding comment encouraged the Committee Mr. Koch. to give priority to the domestic situation.
There was considerable lag between cause and effect, Mr. Wayne continued. The Committee's restraint continued to be quite firm and its effects would be felt for several weeks or months into the future; and the Committee should consider whether it wanted to see the current easing trends in economic activity intensified over such a period. The reduction in bank credit had brought a substantial reduction in required reserves which, in turn, had brought into play the proviso clause of the directive. Measured by marginal reserve levels, the Committee had moved into a somewhat easier policy by that back door. Historically, October and November 1966 might mark that point in time when restrictive monetary policy once again proved its painful but salutory effec tiveness. To overstay that posture would be regrettable. Certainly the proviso clause should be retained, but he believed the time had come when the Committee should recognize positively the desirability He would favor a policy of increasing slowly the of some easing. availability of reserves, the amount of easing to depend on the required reserves. Alternative B, along with the behavior of notes, represented what he believed to be a proper explanatory course of action for the Committee to adopt today. Clay observed that recent measures of economic activity Mr. the pace of activity in some evidence of slackening in gave further national economy. It was becoming increasingly a sectors of the
mixed picture, with a widening disparity from one sector to another. The situation was further complicated by the fact that the most important source of expanding activity was military spending and that the magnitude and course of that spending remained very unclear. Some of the most striking behavior continued to be found in the financial variables, notably the decreases in bank reserves, bank credit, and the money supply. The recent record of economic activity indicated to Mr. Clay that some relaxation of monetary policy would be appropriate. The monetary data particularly underscored the need for some shift in monetary policy. Decreases such as had been taking place in bank reserves, bank credit, and the money supply were not suitable for the current economic situation and, despite the increase in net reserve availability, were not in keeping with what the Committee presumably had desired to accomplish in recent weeks. Some positive growth in bank reserves that would provide the basis for moderate growth in bank credit was rather what was desired. In of recent developments in interest rates in the consideration some relaxation in monetary policy prob money and capital markets, ably would have a salutary effect on the money and capital markets too. In view of the prevailing military program and the accom resource utilization situation in many sectors of panying tight
the economy, Mr. Clay continued, any shift in monetary policy should be less aggressive than it might be under other circumstances. That view was further underscored by the uncertainty as to the volume of military spending and as to the Government's fiscal program. As he had already indicated, Mr. Clay said, the objective was to provide reserves so that both bank reserves and bank credit could show moderate growth. What targets might be consistent with that goal was difficult to know, but tentative targets might include a Treasury bill rate ranging down toward 5 per cent, and net borrowed reserves ranging substantially below recent levels, if necessary. It should be indicated, however, that a dramatic move on the part of the Federal Reserve, with accompanying sharp movements in credit markets, was not the goal sought; rather, a more gradual approach was desired. Allowance would need to be made in conducting opera tions for any direct Treasury borrowing from the Federal Reserve. Moreover, the program would need to adjust for any tendency toward market tightness as the December tax date approached. money Alternative B of the economic policy directive drafts was satisfactory to Mr. Clay. said that in the interest of time he would Mr. Scanlon the remarks he had prepared and ask that his complete summarize record. He then briefly summarized statement be included in the the following statement:
Although there is widespread agreement in the Seventh District that the economy has entered a period of slower growth, there is an equally widespread view that general price inflation will continue into 1967. Opinion varies as to the impact of the suspension of the investment tax credit. Some marginal expenditures are being sliced from 1967 capital expenditure budgets now being formulated. But it does not appear that the effect of the suspension of the credit, in itself, will be a major factor depressing capital outlays. The chief executive of a large petroleum firm finds profitable investment opportunities outrunning availability of funds, in contrast to experience of earlier years. A steel firm's management recently reviewed all capital expenditure programs to pinpoint possible deferments. Although little was accomplished, it was noted that clear signs of the development of a business recession in 1967 would slow capital projects through the abolition of overtime, extra crews, and other costly methods dictated by urgent need. A sharp decline in orders for construction equipment has occurred in recent weeks. This is not simply a reflection of the drop in home building because heavy excavating equipment has been affected. Demand for other types of machinery and equipment remains strong and back logs continue to rise. Steel orders have slowed as steel users have been cutting inventories as delivery times have been reduced. Shipments of finished steel have not kept pace with ingot production, indicating a further reduction in the ingot production rate. Ingot production for all of 1966 is expected to be 135 million tons, compared with last year's record 131 million tons. Shipments, however, are expected to total slightly less this year than last. Production and shipments in 1967 are expected to equal this year's, despite an estimated drop in auto assemblies of about 300,000 units. There are continued complaints of the poorer quality of available labor, high turnover, and wildcat strikes. Profit margins are likely to shrink. Some manufacturers who have announced price increases recently have waited anxiously for the reaction from Washington. A farm machinery producer has encountered strong pressures from Governments in other countries, prices on its products. Canada, against increasing e.g.,
In the past three weeks, our major banks have shown a contra-seasonal reduction in business loans although some bankers have indicated that they are expecting demands for business credit to increase substantially in the weeks ahead. Meanwhile, bank acquisition of mortgages has slowed markedly, outstanding loans to finance companies have been reduced, and sizable holdings of municipal and U.S. agency securities have been liquidated. Despite over-all credit contraction, the large Chicago banks continued to show a substantial basic deficit position as both demand and time deposits declined somewhat further. However, pressures appear to be less than a month ago, and a much smaller portion of funds to cover the position was acquired at the discount window. Country bank borrowings are also significantly below the August experience both in amount and number of banks. Current financial data do not indicate a substantial reversal in the slow downward drift of aggregate monetary and credit measures, although slight increases in total reserves, money supply, and time deposits may still occur for November as a whole. It is not clear whether the recent firming of interest rates reflects monetary restraint or stronger credit demands. The same amount of non-bank credit growth may entail higher interest rates. On the other hand, the recent tendency toward stabilization of CD's may indicate a slowing or halting in the process of disintermediation. Given the increasing signs of hesitancy in the private sector, some portion of which I trust we can attribute to our own actions, I think it unwise to continue to permit reserves, money supply and bank credit to decline. I favor a policy posture designed to achieve moderate would in total bank credit and related aggregate measures. growth I support alternative B for the directive, although the 10 per cent growth rate suggested as the upper limit clause in the staff notes seems too high for the proviso a problem in this regard but I to me. I do not foresee would hope that if bank credit resumes a rapid rate of until we reach a 10 per cent rate expansion we don't wait to reverse our position. that, by all appearances, the rate of economic Mr. Galusha said Committee had, in a way, succeeded in its growth had declined so the
stabilization objective. The Committee might find, come mid-1967, that the rate of growth had declined still more--too much, in fact. His impression--based admittedly on a relatively brief experience as a member of the Committee--was that monetary policy actions had an effect not immediately but after a rather appreciable length of time. No immediate vanishing of inflation was in prospect, Mr. Galusha continued. The outlook was, however, for less infla tion than there had been. If history was any guide, price increases would continue for some time, possibly through much of 1967. But historians would have to trace the price increases of 1967 to already past changes in the unemployment rate and the level of corporate profits, not to a present and continuing excess demand. There was, then, little chance at the moment that price increases were going to accelerate, or that an inflationary psychology of major dimensions was going to be created. Even if the present unemployment rate held, from here on in would get smaller and smaller. price increases the more pressure the Mr. Galusha remarked, Undeniably, future price increases the economy, the smaller Committee put on so-called, could be checked by would be. Even cost-push inflation, demand-pull inflation, only as compared with monetary policy--but, of unemployment. Thus, to of a relatively great amount at the cost increases--which in prospect in trying to check further price persist
seemed quite modest--would be to recreate the very economic situation that was barely escaped a few years ago. And in getting back again to something like full employment, the Committee would almost inevitably produce the kind of changes, particularly in corporate profits, that were conducive of relatively large increases in money wages. What the Committee had to avoid, therefore, was a stop-go type of monetary policy, Mr. Galusha said. It was necessary to avoid moving away again from near-full employment. And in the interest, he would stress, of the country's long-run international competitive position. It was better to hold steadily to a satisfac tory unemployment rate than to attain the same rate only on average. What all that suggested to Mr. Galusha was that the Committee even now should be giving its attention to increasing the supply of was not too soon to begin thinking about bank loans. Perhaps it had been put in discount policy a few ironing out the wrinkle that which would probably require some form of concerted months ago, action to avoid inter-District unevenness. Or about money market would facilitate, not hinder, the rolling-over of conditions which Even an increase in the average maturity of CD's maturing CD's. Committee perhaps would be well-advised to might be desirable. The go to some lengths to convince banks, particularly the large ones, over-extended, and that they could get back that they were not badly
to where they wanted to be without having to persist in the stringent rationing of loans. Having said all of that, Mr. Galusha continued, he would be uneasy with any obvious move of major dimensions. Rather, he would prefer to encourage the Desk to continue a cautious groping along the cliff to easier footing--plus joint efforts to correct the aberrations in discount window administration. Mr. Swan remarked that he could summarize economic develop ments in the Twelfth District with the statement that there had changes in the last few weeks. He also would favor been no major move toward easing. In light of the general economic some moderate he thought the Committee certainly should be looking situation toward some expansion in bank credit and the money supply. In the the Manager was confronted with a need to try immediate short-run, the special stresses in the money market that were to smooth out and to prevent the current anticipated between now and mid-December, capital markets from having some backlash effects in pressures in markets. To him that implied a comfortable money market. the money to quantify objectives, it did seem that While he again hesitated per cent or somewhat less, and the the bill rate should be 5-1/4 be below 6 per cent. He did Federal funds rate certainly should that that could be accomplished with net borrowed reserves not think not be necessary to go to $300 million, but he hoped it would of
zero. In any case, he thought the net reserve figure was somewhat less important at this juncture. The policy change should be moderate, Mr. Swan continued. At the same time, he would strongly urge the adoption of alternative B; the action, even though modest, should be a positive one, and it should be explicit in the directive. As to the interpretation of the proviso clause in that alternative, he shared Mr. Scanlon's question about the appropriateness of a 10 per cent upper limit on bank credit expansion. And he questioned, as he had three weeks ago, the use of the word "sharply" in the first paragraph to describe rising defense expenditures. The description probably was correct, but definitive evidence was not available to the Committee. Mr. Swan's concluding observation related to Mr. Mitchell's comments about the difficulty of getting banks to develop a more attitude toward credit expansion. That difficulty might positive be due, in part, to strong feelings at banks about their liquidity however, the attitudes of banks were positions. In his judgment, by the System's September 1 letter to member still conditioned appropriate at the time it was While the letter had been banks. should now give serious consideration issued, he thought the System of taking steps soon to dispel its effects, at to the possibility of banks persisted. if the present attitudes least
Mr. Irons said there had been no significant new develop ments in economic conditions in the Eleventh District over the past three weeks. The District economy had been following the national pattern, with evidences of moderation in some sectors and of strength or expansion in others. On balance, the District economy was expand ing a bit, in a manner not greatly different from the national economy. About the same statement would hold in the financial area, Mr. Irons observed. Total bank loans and investments had declined in the recent period, although loans changed relatively little. Deposits were down, and the CD situation was posing difficulties for some banks. Borrowings from the Reserve Bank had not been large except for borrowings under the special program. With regard to credit policy, Mr. Irons remarked that it well for the Committee to avoid any overt action at this might be time, or any action that might appear to represent a change in policy. He did not question the signs of a slower growth rate or of lessened inflationary pressures in the economy, but he was skeptical about the desirability of moving in an abrupt or overt manner on the basis of the evidence available at this time. It had been suggested that the Committee should avoid overstaying a posture of restraint; but the Committee should also avoid over-eagerness to position on the basis of the information it now had. change its
For the directive, Mr. Irons favored either alternative A or the version of alternative B Mr. Daane had suggested, which was fairly close to A. He was not overly concerned about the specific level of net borrowed reserves, but he did not think the Committee could completely ignore net borrowed reserves at this time; market participants still gave them attention, and there was little the Committee could do about that. He favored a Treasury bill rate in the 5 - 5-1/4 per cent range, and a Federal funds rate in the area of 5-1/2 per cent. He would not be disturbed if net borrowed reserves were at $200 million or less. He thought the Manager had to be given a great deal of leeway to be guided by market develop ments, but that he should not operate in a manner that would make the market conclude the Committee had moved to a different policy posture. Mr. Irons agreed with Mr. Swan's comments about the September 1 letter, and thought the System was running the risk of inconsistency in policy by leaving the letter outstanding. Regardless of the System's intentions, many banks--in the Eleventh interpreting the letter to mean that they District at least--were to the discount window except under conditions of should not come with the September 1 degree of restraint which they associated a banks now had large built A number of the larger District letter. to borrow from some source every in deficits and found it necessary
day. That situation probably was not limited to the Eleventh District. The System probably would not make the same statements today that were considered appropriate on September 1; there appeared to be no desire now, for example, to call for a slower rate of growth in business loans. The problem now was not one of strong demands for credit and a strong desire by banks to make loans, but rather one of illiquid positions and built-in deficits at banks. But the letter remained outstanding and con tinued to affect the attitudes of banks. The conflict was not one that could be brushed aside, and a re-examination of the September 1 letter was clearly needed. Mr. Ellis said that in the interest of time he would omit he had prepared on recent developments in the New the remarks Reserve Bank had now had visits by England economy. The Boston of the District's largest insurance companies officers from four farm credit banks of the District, each wishing to and from the of borrowing should their liquidity review any special avenues Bank had initiated an informal needs worsen further. The Reserve loan trends on a insurance company policy tally of New England (1) prepayments of out So far it revealed that monthly basis. lessening their cash inflows; loans had virtually ceased, standing and early fall in the summer lending spurted abruptly (2) policy year-ago rates; (3) 1967 cash rates 10 times or more above to
flows were virtually committed so that in general they were not making new commitments for 1967 funds; and (4) October and early November had seen some slackening in the squeeze and the better condition in municipal markets had allowed them to sell off enough assets to rebuild liquidity somewhat. They now felt they might get through this year without calling on their bank lines. Of course, Mr. Ellis said, the System's most direct concern was with commercial banks. In appraising their activities since September 1--a date he thought was meaningful for the purpose--he found no substantial evidence of change in pattern in New England. As of November 9, their total loans were 10.5 per cent above a year earlier. The comparable figure on August 31 was 10.3 per cent. Business loans on November 9 showed a 17.5 per cent year-to-year with 17.2 per cent on August 31. gain, compared Boston reserve city banks, only one had a Of the four August 31 level. The other three business loan volume below its their business loans as much as--and in one case, had expanded the same periods of the past two years. substantially more than--in observation might be applied to the patterns Just about the same loans. Each of those four banks had been relying of their total the forms of negotiable CD's, Federal heavily on borrowed funds in But each had also been at the Reserve Bank. funds, or discounts of borrowed funds to quite substantially the ratio able to reduce
required reserves. It seemed that the strengthening in the municipal securities market had enabled them to use their sec ondary reserves as originally intended. Turning to monetary policy, Mr. Ellis agreed with the staff's analysis but disagreed with their prescription, and he suspected that a question of timing was involved. He would focus briefly on two points. First, there was an important difference between an inflection point--the point of maximum rate of increase in a growth trend--and a recession downturn in such series as GNP, employment, and so forth. He emphasized the difference because he thought there might well be a tendency to over-react to an inflection point. Last spring and winter the Committee was seeking to slow down an unsustainable rate of economic upsurge. The first paragraph of the green book stated that that had tran spired. An inflection point in the rate of growth, not a recession downturn in real terms, had been achieved. Current projections of acceptable growth rates were being made in the context of existing policy, not of an eased policy; the latter upward revisions in the projections. The evidences would require of pause in the financial area, such as the recent pattern of change in business loans at banks, might be interpreted in the same manner as price developments were being interpreted--namely, as reactions to earlier excesses. In that connection he would
endorse the comments that had been made today regarding the contin uing impact of the System's September 1 letter. It would be desirable to seek some graceful way of withdrawing that letter. Secondly, Mr. Ellis said, the proper policy mix to maintain growth at the desired slowed rate probably should be a somewhat tighter fiscal policy and a somewhat easier monetary policy. But his own judgment was that the political process was such that the proper policy mix could not be achieved if the Committee moved first to ease monetary policy. The Committee had been alerted via the press to the possibility, perhaps by early December, of a decision and an announcement by the President concerning the outlook for the budget, including tax considerations. Certainly the prospects for Presidential support and legislative approval of any tax increase be severely worsened if monetary policy were to be substan could tially eased in advance. That act would be taken as evidence that to a point that obviously ruled out tighter the economy had weakened an overt move toward ease in the next three fiscal policy. Thus, reduce the chances of a tax increase. weeks would substantially the essentiality for the next That suggested to Mr. Ellis move and the appearance of numbers weeks of avoiding an overt three such a move had been made. the interpretation that that would allow might decry as antedeluvian specific, while the Committee To be quite reserves as an indicator attention to net borrowed continuing analyst re-education could be little chance that of policy, there seemed
accomplished this year. To him, that meant the Committee should continue as a target of operations a net borrowed reserve figure within the $300-$400 million range and not move overtly lower to a zero-$ million range. He would agree with Mr. Hayes' descrip tion of desirable operations under that objective. Concerning the directive, Mr. Ellis said that alternative B was seriously defective in providing no directions for operations if bank credit were to resume a rapid rate of expansion. As a minimum an additional clause was necessary; following the words, "unless bank credit appears to be resuming a rapid rate of expansion," should be added--to borrow language from alternative A--a clause reading, "in which case, operations shall be conducted with a view to maintaining about the same range of money market conditions as have prevailed since the previous meeting of the Committee." To be consistent, he should observe that the alternative A proviso clause was silent as to what modification might be undertaken in the light of bank credit developments. His own view was that the clause should provide for modification toward both tightening and easing, as expressed in the relevant staff note of those attached to the draft directives.1/ He would prefer a proviso clause that 1/ The staff note to which Mr, Ellis referred read as follows: "One possible interpretation (of the proviso clause in alternative operations shall be modified toward ease if the bank A) is that proxy appears to be weaker than the fractional declines credit projected by the staff for November and December...; and modified if the proxy resumes expansion at an annual rate toward firmness in excess of that for the year to date (4.6 per cent)."
read, "provided, however, that operations shall be modified to counter sharp and sustained movements in total bank credit." Obviously, of the two draft directives he favored alternative A. Mr. Robertson asked that the statement he had prepared for today's meeting, reading as follows, be included in the record: I think it is quite clear that both the facts and the analysis before us this morning argue for some easing of monetary policy, with the chief question for debate being how much. Without doubt, a number of key measures of business activity are softening. Much of this slackening is probably the direct or indirect consequence of restrictive public policies, rather than the independent sprouting of the seeds of recession; but nontheless we need to be very careful not to let money become any tighter than necessary to do its job. as the financial side is concerned, all avail Insofar able indicators are consistent with a real and pervasive slowdown in credit expansion. Thus, as has. already been indicated, we have had no net growth in bank credit or money supply for three and six months, respectively. Interest rates, particularly in the long-term area, have moved back up near their historic peaks. This, I submit, is too tight a financial restraint to hold for very long once inflationary pressures seem to on a growing economy, have passed their peak. Yet, while some monetary easing may be called for, continues to be, as I said last time, for a my preference "tentative but gradual and progressive kind of let-up of pressures." In particular, with a new Administra monetary position on taxes promised to be close at hand--perhaps tion our next meeting--I think we should make our even before move gradually at this time so that it will not importantly upon the outcome of the reduce our options, depending supposed December tax decision. this, I would favor gradually working To accomplish reserves lower, perhaps down into a range net borrowed million, over the next three weeks, thereby around $100 build-up of seasonal pressures that countering some of the takes place during this interval. I refer ordinarily
primarily to net borrowed reserves for the reasons that I gave at some length at our last meeting. I would expect the most closely associated money market interest rates to show no increase, and perhaps even some decline in this new reserve climate; and also I would expect CD attrition to slow down--outcomes that I would regard as desirable. I know some observers feel that the degree of restraint exercised by net borrowed reserves is quite variable, and hence is a poor policy guide. But such a view mistakes the best policy role for net borrowed reserves, in my judgment. Certainly the influence of a given net borrowed reserve figure does not stay the same over time, with differences stemming from differences in loan demands, banker attitudes, liquidity positions, et cetera. Proper policy prescription calls for taking all such considerations into account in judging what level or range of net borrowed reserves might best tide us over the days ahead. It is with such an arrangement of thoughts in mind that I advocate dropping net borrowed reserves back to a range around $100 million. Some consideration for such a target might, I suppose, in as part of attention to a general "money be squeezed market conditions" target in the directive. I, myself, would prefer to recognize our concern with however, by calling for open market opera reserves more directly that would, in directive language, "attain somewhat tions and related money market easier net reserve availability conditions." this time I have no objection For the proviso clause, proviso drafted by the staff in its to the kind of one-way as a general matter I prefer the alternative B, although we have recently used. Having called two-way kind that in the first part of the second for a moderate easing a proviso that might lead the paragraph, I would not want because I think too marked to ease still further, Manager at this time. On the other easing could be bad policy an see any easing action stopped hand, I would be willing to bank credit started to expand in the unlikely event that rapidly once again. and interpretive remarks, I With these exceptions directives supplied by alternative B of the draft favor the staff. indicated in his statement, then said that, as Mr. Robertson question was how much; some easing. The only also was in favor of he
no one would want to ease so far as to damage the chances of fiscal policy action. After hearing the discussion today, he would now propose a new version of the second paragraph of alternative B, reading as follows: "To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to encouraging moderate expansion in aggregate reserves and bank credit, provided that money market conditions do not ease sharply." Such language, in his judgment, would avoid the risks of an overt move toward ease that had been noted by some members. Mr. Hayes commented that the phrase Mr. Robertson had suggested embodied aggregate variables similar to the language the Committee had recently dropped from the first paragraph of the directive. He felt that such language was not feasible as an operating instruction. Mr. Daane said he felt that the instruction Mr. Robertson would be difficult to implement, since it placed main proposed emphasis on variables that the Manager could not control precisely. Mr. Hayes noted that Mr. Daane's suggested revision to some support, and indicated that he also alternative B had received would be prepared to vote for it. said that before turning to policy he wanted Chairman Martin he thought the System had performed well during 1966, to note that The performance had not been perfect--the all things considered.
timing of actions had not necessarily been right in all respectsbut the record as a whole held up quite well. It was important to keep in mind, the Chairman continued, that monetary policy could not achieve results as precise as some people apparently desired. In retrospect, he thought that by May or June of this year monetary policy probably had done about all that could have been expected of it toward slowing down excessive expansion of demand in the economy, short of risking disastrous developments in the money market of a kind that no member of the Committee would want to see. In his judgment the thrift industry was not set up well. Since the beginning of the year the savings of individuals and businesses had been totally inadequate to meet demands for credit but, with full employment and high plant utilization rates, any further monetary expansion earlier in the year would only have added to inflationary pressures. Later, cost-push pressures on prices began to be added to the demand-pull variety, and he doubted whether monetary policy could cope effectively with cost-push pressures. He was hopeful that the Administration would come forward with a fiscal policy program that would supplement monetary policy, but it was necessary to such fiscal action would be at least six to nine recognize that as the step toward monetary restraint taken a months late, just appeared, by hindsight, to have been late. year ago
Many recent developments in the economy were encouraging, the Chairman said. Automobile manufacturers had been prudent in reducing output rather than relying on credit and other forces to propel their industry forward. The shift of borrowers from banks to capital markets noted in the discussion today should have occurred some time ago. That such developments were occurring now was highly encouraging for the longer-run outlook. The Committee faced a fine judgment now on whether to make an overt change in policy, Chairman Martin observed. Before the meeting he had considered the draft directives suggested by the staff and had concluded that the difference between the policies called for by alternatives A and B was not great. After the go around today he was inclined toward alternative B--not because a majority seemed to favor it but because it indicated that the Committee was abreast of economic developments. Whether or not was likely to be taken should be known any fiscal policy action three or six weeks, and in the meantime the Committee in the next it was aware of a change in basic elements would be indicating that economy. He would consider the policy change as a probing of the to be reversed if events went the other way. Monetary movement, policy had to be flexible. by early summer the repeated his view that The Chairman all that it could do. Devel probably had done about Committee and some adjustments gotten ahead of the Committee, opments had
in the economy were inevitable; if expansion were not slowing now the situation would be serious. He thought the Committee should try to make a moderate change in its policy in line with the statistical analyses that had been presented although, he would add, he had grave reservations about the scientific aspects of analyses in this area. He intended no criticism of the staff; his point was that he doubted whether the Committee could reach firm conclusions solely on the basis of statistical analyses of periods as short as two or three months. Monetary policy remained as much an art as a science. The Chairman then said he did not think the Committee should attempt to attain the kind of precision implied by some comments today, including the references to a "B minus" directive. The staff's alternative B roughly reflected the policy course a majority appeared to favor. He would suggest adopting that alternative for the directive and leaving to the Manager the task of operating within its framework. He did not believe the appropriate level of net borrowed reserves could be spelled out precisely, but to him that was not of great importance. Several suggestions for amending draft had been offered but, while they might be workable, the staff's in his opinion the staff's alternative B implied everything necessary at this juncture. He would interpret it to call for a modest overt change. Mr. Hayes had made a good case against any overt change at
this time, but an equally good case could be made for a modest change. The Committee should not be overly reluctant to change policy in either direction. The objective now, he thought, should be to move in a gradual way without trying to be too precise about it. Mr. Brimmer observed that in light of the Chairman's remarks he would withdraw his suggestion that the Committee adopt a "B minus" alternative for the directive. He had used that expression to indicate the strength of his preference for the general type of policy called for in alternative B, and was prepared to vote for the staff's draft without amendment. Chairman Martin remarked that there obviously were some differences of degree in the views of members. He then suggested vote on the staff's alternative B. that the Committee Mr. Shepardson said that he would like to hear the language proposed again before the vote was taken. Mr. Daane Mr. Daane had of the second paragraph he had suggested then repeated the version "of the somewhat easier condi earlier, calling for the maintenance in the money market, unless bank credit tions presently prevailing be resuming a rapid rate of expansion." appears to objection to Mr. Daane's remarked that one Chairman Martin that the Manager had brought about proposal was that it implied to accept. Such an that the Committee was forced conditions
implication would be wrong, he thought; the Manager had been trying to carry out the Committee's instructions all along. Mr. Daane replied the market often moved independently to some degree, and it did not necessarily respond precisely to the Committee's actions. Market conditions had eased recently as a result of the ebb and flow of funds and that change was not with the Committee's previous directive. In his inconsistent judgment the language he had proposed spelled out the objective a majority of the Committee sought. He would be willing to accept alternative B if it was interpreted in a manner consistent with But he would have to vote against it if it was his own proposal. interpreted to call for a degree of ease he considered excessive, borrowed reserves and a bill rate down to 5 per such as zero net cent. Chairman Martin observed that Mr. Daane's comment reflected In his opinion a majority of views he had mentioned. the divergence rather than accepting existing moving further toward ease favored market conditions. that natural factors were Mr. Hayes agreed with Mr. Daane conditions apart from the of influencing money market capable that that, in fact, had happened Committee's operations, and that there would be Moreover, it was quite conceivable recently. conditions under directives moderate easing of some deliberate
of the type the Committee had issued recently, given the proviso clause they contained; otherwise there would have been no point in including the proviso. In the recent period there had been a tendency for the Desk to lean toward ease, in view of the behavior of the bank credit proxy. Under those circumstances he saw no reason against Committee acceptance of prevailing market condi tions. Chairman Martin commented that there also was another view on the appropriate policy course at present--that the Committee should move a little further toward ease. A number of members concurred in the Chairman's statement. Mr. Mitchell said he would be prepared to vote for either Mr. Robertson's proposed language or the staff's alternative B, although with respect to the latter he shared the view that the rate mentioned in the staff notes as an upper limit 10 per cent on bank credit expansion was too high. that a 10 per cent limit would not Mr. Maisel remarked applied to a short period and him as excessive because it strike in the bank credit proxy. followed several months of decline had no objection to Mr. Robertson's Chairman Martin said he preferred it, but he still leaned proposed language if a majority alternative B as drafted by the staff. toward
Mr. Wayne said he favored alternative B because he thought it was important for the record to indicate that the Committee had recognized at this meeting that the time had arrived for some change in policy. Mr. Daane asked whether the Committee would consider adop tion of alternative B to be an overt change in System policy. Chairman Martin replied that the answer, in his judgment, was yes, although the change would be a modest one--about as modest as an overt move could be. Mr. Shepardson said it was his understanding that adoption of alternative B would not imply that the Committee found a 10 per cent growth in bank credit acceptable, and the Chairman agreed. Thereupon, upon motion duly made and seconded, and with Messrs. Hayes and Daane dissenting, the Federal Reserve Bank of New York was authorized and directed, until otherwise directed by the Committee, to execute trans actions 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 continuing to expand, with sharply rising defense expenditures but with evidences of moderating tendencies in various sectors of the private economy. While there has been some slowing in the pace of advance of broad price measures, upward price pressures persist for many finished goods and services. Bank credit and money have shown no expansion in recent months. Long term interest rates have again risen somewhat after declining from their late summer peaks. The balance
of payments remains a serious problem. In this situa tion, it is the Federal Open Market Committee's policy to maintain money and credit conditions conducive to noninflationary economic expansion and progress toward 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 attaining somewhat easier conditions in the money market, unless bank credit appears to be resuming a rapid rate of expansion. Mr. Hayes said that he had cast a negative vote with reluc tance; he found it necessary to dissent because of the interpretation of the action as an overt change in policy. Mr. Daane concurred in Mr. Hayes' statement. Mr. Shepardson indicated that his affirmative vote was cast with reluctance. Chairman Martin then noted that the Manager had recommended an amendment to the Committee's continuing authority directive to $500 million to $1 billion the limit on holdings of increase from of indebtedness purchased directly from the short-term certificates In his judgment such action would be appropriate. Treasury. agreement with the Chairman's statement. There was general upon motion duly made Thereupon, and seconded, and by unanimous vote, paragraph 2 of the continuing authority was amended to read as follows: directive authorizes and Open Market Committee The Federal Bank of New York to purchase directs the Federal Reserve the account of the Federal from the Treasury for directly in cases where New York (with discretion, Reserve Bank of
it seems desirable, to issue participations to one or more Federal Reserve Banks) such amounts of special short-term certificates of indebtedness as may be necessary from time to time for the temporary accom modation of the Treasury; provided that the rate charged on such certificates shall be a rate 1/4 of 1 per cent below the discount rate of the Federal Reserve Bank of New York at the time of such purchases, and provided further that the total amount of such certificates held at any one time by the Federal Reserve Banks shall not exceed $1 billion. In reply to a question by Mr. Daane, Mr. Holmes said that no formal action by the Committee to amend its directives was the offsetting purchases of longer-term bills required to authorize of short-term bills that he had indicated earlier might and sales be desirable under certain circumstances. He had brought the the Committee's attention because the Desk had not matter to customarily engaged in operations of that type. that he would favor such operations Mr. Daane then observed Mr. Holmes had described eventuated. Other if the circumstances members concurred. meeting of the Committee would be It was agreed the next 1966, at 9:30 a.m. Tuesday, December 13, held on Thereupon the meeting adjourned. Secretary
CONFIDENTIAL (FR) ATTACHMENT A November 21, 1966. Drafts of Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on November 22, Alternative A The economic and financial developments reviewed at this meeting indicate that over-all domestic economic activity is con tinuing to expand, with sharply rising defense expenditures but with evidences of moderating tendencies in various sectors of the private economy. While there has been some slowing in the pace of advance of broad price measures, upward price pressures persist for many finished goods and services. Bank credit and money have shown no expansion in recent months. Long-term interest rates have again risen somewhat after declining from their late summer peaks. The balance of payments remains a serious problem. In this situation, it is the Federal Open Market Committee's policy to maintain money and credit conditions conducive to the restraint of inflationary pressures and progress toward 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 about the same range of money market conditions as have prevailed since the previous meeting of the Committee; provided, however, that operations shall be modified in the light of bank credit developments. Alternative B The economic and financial developments reviewed at this that over-all domestic economic activity is con meeting indicate rising defense expenditures but tinuing to expand, with sharply tendencies in various sectors of the with evidences of moderating private economy. While there has been some slowing in the pace of upward price pressures persist for advance of broad price measures, goods and services. Bank credit and money have shown many finished interest rates have again no expansion in recent months. Long-term declining from their late summer peaks. The risen somewhat after balance of payments remains a serious problem. In this situation, Market Committee's policy to maintain money it is the Federal Open conditions conducive to noninflationary economic and credit toward reasonable equilibrium in the country's expansion and progress 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 attaining somewhat easier conditions in the money market, unless bank credit appears to be resuming a rapid rate of expansion.
Also: Record of Policy Actions