January 10, 1967 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, January 10, 1967, at 9:30 a.m. PRESENT: Mr. Martin, Chairman Mr. Brimmer Mr. Clay Mr. Daane Mr. Hickman Mr. Irons Mr. Maisel Mr. Mitchell Robertson Mr. Mr. Shepardson Mr. Treiber, Alternate for Mr. Hayes Mr. Wayne, Alternate for Mr. Bopp Scanlon, Francis, and Swan, Alternate Messrs. of the Federal Open Market Committee Members Ellis, Patterson, and Galusha, Presidents Messrs. of the Federal Reserve Banks of Boston, Atlanta, and Minneapolis, respectively Mr. Holland, Secretary Mr. Sherman, Assistant Secretary Assistant Secretary Mr. Kenyon, Mr. Broida, Assistant Secretary Assistant Secretary Mr. Molony, Hackley, General Counsel Mr. Mr. Brill, Economist Messrs. Eastburn, Green, Koch, Mann, Partee, Young, Associate Economists Solomon, Tow, and Open Market Account Holmes, Manager, System Mr. System Open Market Special Manager, Mr. Coombs, Account to the Board of Governors Mr. Fauver, Assistant of Research and Adviser, Division Mr. Williams, Board of Governors Statistics, Advisers, Division Hersey and Reynolds, Messrs. Board of Governors International Finance, of
Mr. Axilrod, Associate Adviser, Division of Research and Statistics, Board of Governors Miss Eaton, General Assistant, Office of the Secretary, Board of Governors Mr. Hilkert, First Vice President, Federal Reserve Bank of Philadelphia Messrs. Eisenmenger, Link, Taylor, Baughman, Jones, Andersen, and Craven, Vice Presidents of the Federal Reserve Banks of Boston, New York, Atlanta, Chicago, St. Louis, St. Louis, and San Francisco, respectively Messrs. Meek and Monhollon, Assistant Vice Presidents of the Federal Reserve Banks of New York and Richmond, respectively Mr. Kareken, Consultant, Federal Reserve Bank of Minneapolis Chairman Martin said that at this, the first Committee meeting of the new year, it might be well once again to offer a word of caution to those in attendance in reminder that the discussions and decisions of the Committee were confidential until officially made public. Upon motion duly made and seconded, and by unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on December 13, 1966, were approved. meeting there had been distributed to the members Before this from the Special Manager of the System of the Committee a report Account on foreign exchange market conditions and on Open Market operations in foreign currencies Market Account and Treasury Open 1966, through January 4, 1967, and a for the period December 13, 5 through 9, 1967. Copies of these supplemental report for January have been placed in the files of the Committee. reports
In comments supplementing the written reports, Mr. Coombs said that the Treasury gold stock would remain unchanged this week. Holdings of the Stabilization Fund were about $50 million, and at the moment there were no sizable central bank orders in sight. On the London gold market, however, serious trouble appeared to be shaping up. During 1966 the gold pool lost $300 million, leaving resources at the end of the year of only $60 million. In addition, and this was not generally appreciated, during 1966 the U.S. sold $150 million for domestic uses. Thus, over the year the total drain into market uses from official stocks was $450 million--a very large figure and, as he had indicated at previous meetings, one that threatened to grow in future years. Toward the year-end, Mr. Coombs continued, a good deal of gold had been bought for window-dressing purposes, some of which might flow back; indeed, in the first few days of the year the gold pool picked up about $11 million. But there had been two disturbing events recently. One was the First National City Bank letter which pointed up the deterioration in the supply-demand situation for gold and concluded that all new production in 1966 had gone into private hands, with none left for official stocks. The true situation was worse than that, but the publication of the National City Bank's analysis had had a highly unsettling effect on the market, which now was beginning to realize the underlying situation. A second,
and more disturbing, development was the French campaign against the U.S., which was now directed at raising doubts about the official price of gold. Of course, the French were well aware of the nature of the supply-demand situation through their participation in the London gold pool. Their campaign moved into higher gear last weekend with the French Finance Minister, Mr. Debre, calling for multilateral consideration of the official price of gold. His statement was taken by the market as an official suggestion that the price of gold should be increased. Mr. Debre would meet with the other Common Market Finance Ministers on January 16 and if past experience was a guide the communique issued after that meeting might well stir up still further speculation. There had been very heavy buying of gold in London today, and thus far the pool had lost $9 million. That situation could get worse. There had been quite a bit of discussion of Mr. Debre's press conference at the Basle meeting this past weekend, Mr. Coombs continued, and the atmosphere was one of genuine alarm. He thought it fair to say that all of the Governors were angry with the French. It was not clear what they could do about it; it would be hard for them to break with France on financial policy because of their in the Common Market. He hoped, however, that it would relations be possible to get the cooperation of other central banks in devising some sort of contingency plan for dealing with a possible breakout
of the London gold price. As he had said many times before, he thought that was the single most serious threat facing the U.S. in the area of international finance, and it was more dangerous today than it had been earlier. On the exchange markets, Mr. Coombs reported, sterling continued to be depressed by uncertainties with respect to both short- and long-run prospects. For each of the past three months the British had managed to squeeze out some small reserve gainson the order of $40 or $50 million--but those gains were highly inadequate in relation to the volume of their debts falling due this year. They owed well over $1 billion in short-term (6 - 9 month) debt that had been on the books since last summer. In addition, they owed about $900 million to the International Monetary Fund, payment date was the end of November. Thus, they had on which the to be paid off within about ten months. Unless over $2 billion they were not going to make got a major swing in their favor they have very serious consequences failure to do so could it, and their He hoped that in such an international payments system. for the to protect itself, but much the System would be able eventuality themselves could do in the answer lay in what the British of the in the situation. significant turnaround to bring about a way of policy
There was some hope for sterling in a general easing of international credit conditions, Mr. Coombs said. The discount rate reduction by the German Federal Bank had been helpful, and it was quite possible that the Bank might cut the rate again during the next few weeks. More importantly, the Germans might reduce their reserve requirements and thus bring about some easing in their credit markets. The British took the position that their difficulties of last summer were attributable largely to general monetary tightness, and that argument undoubtedly had some merit. If they now were to recoup the losses they incurred beginning last fall they probably would have to maintain some competitive advantage in interest rates and credit availability, in order to attract some part of the funds from the U.S. and other countries flowing back into the Euro-dollar market. On balance, he thought it would be to the advantage of the U.S. to have those funds flow to Britainnot only in permitting the British to pay off their loans on time, but also because the safest place for the money to go that was being returned to the Euro-dollar market by U.S. banks was to the U.K. Regarding System swap operations, Mr. Coombs reported that at present the System owed $85 million to the Bundesbank, $35 million to the Netherlands Bank, and a total of $90 million to the Bank for International Settlements and the National Bank of Switzerland. He hoped that the debt in marks could be cleaned up in the next few
weeks; it had been incurred in connection with year-end pressures which had already moderated. Repayment of the Swiss franc debt might be delayed somewhat because the Swiss took in a large volume of dollars over the year-end both outright and in one-month swaps, and the reversal of those reserve accruals had priority over System acquisitions of francs as Switzerland moved into its seasonal deficit. There was a chance that repayment of the System drawings would not begin until near the end of February, but he hoped for some repayments in February and full liquidation by the end of March. That would mean that the System's Swiss franc borrowings would be extended beyond the 6-month period usually thought of as a limit, perhaps to 7-1/2 or 8 months, but he did not see much possibility of accelerating repayment. The Treasury might be asked to issue a franc-denominated bond to the Swiss to permit more rapid repayment, but in his judgment it would be better to save that future needs. It might prove more difficult device for possible debt. In part, the problem resulted from to clean up the guilder the Dutch had no means of increasing their money the fact that surplus or by main a balance of payments except by running supply that pulled money in from taining domestic money market conditions an important factor in monetary policy was abroad. This primitive of Dutch guilders and of Federal Reserve drawings the frequency repayment process. To repay the similarly tended to obstruct the well either for the U.S. it might be $35 million now outstanding,
to make a drawing on the IMF or for the Treasury to issue a guilder bond to the Dutch. Both possibilities were now under consideration. On the other side of the accounts, Mr. Coombs continued, the BIS still owed the System $49 million of the $200 million they had borrowed to deal with year-end window-dressing, and he thought they would be able to liquidate that remaining debt within the next The Bank of England had paid off $100 million of its week or two. drawings under the swap line with the System and he thought that in using any reserve accruals they would give priority to repaying their remaining debt. The System swap line was the most important source of credit the British had, and thus far they had been scrupu their borrowings. Unless some severe problems lous in paying off the next month or two--and that was conceivable, given arose over in the gold market--there was a reasonable chance the pressures debt to the System would be liquidated within roughly that their six months from the time it was incurred. that Mr. Coombs had said it might be Mr. Brimmer noted maintained some differential in helpful to the U.S. if Britain rates. Did that imply that the U.S. should not encourage interest the Bank of England to lower their Bank rate? that he thought the British would have Mr. Coombs replied out the precise means for taking a difficult problem in working
advantage of an easing of credit in international markets. He felt that it would be appropriate to offer a very general comment to the effect that it might be desirable for them to maintain some differential. But it probably would be undesirable to suggest any specific ways of doing so, since some delicate political questions might well be involved. Thereupon, upon motion duly made and seconded, and by unanimous vote, the System open market transactions in foreign currencies during the period December 13, 1966, through January 9, 1967, were approved, ratified, and confirmed. Mr. Coombs reported that the two swap arrangements with the German Federal Bank--the original $250 million, six-month arrangement and the $150 million, five-month arrangement negotiated on a temporary basis in September--matured on February 9, 1967. the last Basle meeting President Blessing of the Bundesbank At be prepared to renew the temporary arrange indicated that they would consolidate it with the original arrangement. Mr. Coombs ment and to recommended renewal of the combined arrangement with the German $400 million, for a period of six months. Federal Bank, totaling Renewal of the $400 million swap arrangement with the German Federal Bank for a period of six months was approved. then reported that the $100 million arrangement Mr. Coombs the Bank of France would come to the end of its three-month with
term on February 10, 1967. That arrangement was inoperative, and it was becoming somewhat anomalous in view of the French Government's attitude, but he thought there was some advantage in continuing to maintain it as a bridge to the future when the French might be somewhat more amenable to international cooperation than they were at the moment. Accordingly, he recommended renewal of the arrange ment. Renewal of the $100 million swap arrangement with the Bank of France for a period of three months was approved. Mr. Coombs noted that several drawings under the swap lines would reach maturity soon. On January 25, 1967 two Swiss franc drawings would mature--one for $25 million with the BIS and one for $15 million with the Swiss National Bank. If renewed, both would be second renewals, thus extending their terms beyond the usual six-month period. As he had indicated earlier, he hoped that the weakening of the franc in the spring months would enable seasonal the System to clean up those drawings in February and March. Mr. Shepardson expressed continuing reservations with regard to the extension of swap drawings beyond a six-month period. Chairman Martin observed that Mr. Shepardson's reservations were well taken. He thought, however, that the Committee could approve second renewals since it was still operating on an experi mental basis in this area.
Renewal of the two Swiss franc drawings was noted without objection. Finally, Mr. Coombs noted that two drawings on the Netherlands Bank would mature soon--a $10 million drawing on January 23, and a $25 million drawing on February 7, 1967. Both of those drawings also had already been renewed once, but as he had mentioned earlier the possibilities of cleaning them up either by going to the IMF or by issuing a guilder bond to the Dutch were under consideration. In his view the guilder bond might be the more satisfactory method since the flows of funds to the Netherlands resulted from their policies, and did not reflect a basic balance of payments tight credit surplus. But whatever the method used, he thought he could assure the Committee that the System's guilder debt would be repaid within a month or six weeks. Mr. Shepardson expressed reservations about second renewals of these drawings also. Renewal of the two drawings on the Netherlands Bank was noted without objection. been distributed to the members Before this meeting there had the Manager of the System Open Market of the Committee a report from in U.S. Government securities covering open market operations Account period December 13, 1966, through and bankers' acceptances for the report covering the period 4, 1967, and a supplemental January
January 5 through 9, 1967. Copies of both reports have been placed in the files of the Committee. In supplementation of the written reports, Mr. Holmes commented as follows: Since the Committee last met the capital markets have turned in a strong performance in a buoyant atmosphere, bank credit has showed renewed strength, and the money market has weathered the stresses and strains of the tax and year-end statement dates with out undue problems. In general, bank credit expansion moved ahead more rapidly and market interest rates declined further than had been anticipated at the time of the last meeting without a need to push net borrowed reserves to zero or the Federal funds rate to 5 per cent or below. And with market rates moving lower, banks were able to add to their outstanding CD's in December in contrast to the $700 million-$l billion decline anticipated a month ago. Market expectations--shaped by additional evidence of less restraint in monetary policy, by weakness in some economic indicators, and to some extent, by develop ments in Vietnam--in effect succeeded in changing the relationships among the short-run monetary variables with which we are most concerned in our day-to-day As the various written reports to the operations. Committee have indicated, much of the rise in bank credit borrowing by dealers to finance can be traced to increased inventories of securities and to in their substantial creases in bank portfolios of Government and municipal Dealer financing needs have exerted pressure securities, money market, but with the major New York City on the dealer loan rates at high levels, banks maintaining their some restraint recently on dealers' there has been their holdings. I would not now willingness to add to dealer positions as being dangerously characterize they could become a source of market over-extended, but flow of corporate and public pressure if the anticipated market and continued bank demand fail fund money to the materialize at a time when there is little seasonal to need for the System to supply reserves. as the written reports to Open market operations, were frequent and large, as the Committee have detailed,
they usually are in December, and were complicated more than usually by the tendency for reserves to fall short of expectations, by the shift in market expectations, and by year-end developments involving international money flows. Outright purchases of Government securities approached $1 billion, and very heavy use was made of repurchase agreements against Government and agency securities over the period. Over $4 billion in repurchase agreements were made, with the average daily balance amounting to $575 million. Repurchase agreements were a particularly useful tool during this period in view of the many uncertainties in the reserve picture. They enabled the System to make heavy injections of reserves in order to head off money market tightness on individual days, when it seemed likely that the operation would have to be shortly reversed. With dealer financing needs a source of recurrent pressure in the money markets, the repurchase agreement was a natural instrument for injecting reserves at the point of greatest need. A comparable volume of outright purchases and sales of securities would undoubtedly have subjected the markets to a series of unnecessary shocks and could have had unpredictable effects on interest rates during a difficult period. we learned early in the period that very sizable Moreover, sales of Treasury bills by foreign monetary authorities at the year-end in regular and special would be involved debt repayments to the United States. Although the precise amounts and the timing were not clear at that early date, it appeared advisable to conduct operations an option for the System in such a way as to leave open bills, rather than be acquire at least part of these to to sell as much as $1/2 billion or more Treasury forced very end of the year. Quite bills in the market at the nonbank Government securities dealers obviously the to sell securities to the System welcomed the opportunity under repurchase agreements made at the discount rate, consider it wise to give out a signal that but we did not in the market by could easily have been misinterpreted this particular time. raising the rate at Treasury bills declined on three- and six-month Rates interval, with some tendency 1/4 per cent over the about end of the period. In to level off at the for rates bill auction, average regular weekly Treasury yesterday's were set per cent, respectively, of 4.82 and 4.89 rates
on the three- and six-month bills. Rates on bankers' acceptances, commercial paper, and FNMA discount notes also moved lower over the period. Yields on intermediate and long-term Treasury obligations declined by 20 to 50 basis points, and by the close of the period yields in the 3- to 5-year area were 1 - 1-1/2 percentage points below their August peaks, while long-term bond yields were about back to where they were at the time of the December 1965 discount rate change. Despite the build-up of the calendar of new issues, the corporate and municipal markets have maintained a confident tone. The $250 million A.T. & T. issue, which is up for bidding this morning, was expected last night to be reoffered at about 5-3/8 - 5-1/2 per cent, compared with a 5.83 yield in the last Aaa telephone issue brought to market on December 6. The new FNMA 5, 10, and 15-year participation certificates--brought to market at a uniform 5.20 per cent--received an excellent reception. The 15-year issue rose to a premium of as much as 20/32 bid, until late yesterday when the price dropped 1/2 point reflecting market rumors of an early Export-Import Bank participation certificate announcement. The next few weeks are apt to be a testing period in the market for the pattern of interest rate relation ships and financial flows that have been emerging since monetary policy entered a phase of less restraint. It will also be a period in which the markets will be assessing the implications of the various Presidential messages for the monetary-fiscal policy mix in 1967, and will be reassessing the economic outlook as each new bit of information becomes available. As the blue book 1/ indicates, monetary expansion is expected to be vigorous in January, but there are at least the usual number of uncertainties in the picture. The Treasury will be announcing in about two weeks the terms of its February refunding, and the usual "even keel" considerations will come into play in the latter part of the interval before the Committee meets again. In response to a question by Mr. Mitchell, Mr. Holmes said that he thought that dealers' positions were not dangerously Market and Reserve Relationships," 1/ The report, "Money prepared for the Committee by the Board's staff.
overextended partly because they were not unusually large relative to other recent years; for example, dealer financing needs currently were only about 10 per cent larger than they had been two years ago. Dealers with whom the Desk had talked appeared confident of the market. They were concerned about the high level of marginal borrowing costs at New York banks, but were willing to incur some negative carry in the expectation that they would make out quite well. Their holdings of coupon issues had not expanded substantially, which was rather surprising in view of the change in expectations. Dealer financing needs had been a source of money market pressure recently, as he had noted, and they could pose a problem if the flows anticipated this month did not take place. question by Mr. Mitchell, Mr. Holmes In reply to another of System repurchase agreements with dealers said that the volume recently, but it usually was high in December. had been quite high about 12 per cent of 1966 the System had financed In December compared to 7 per cent in dealer positions in Governments, 1964. Thus, the Desk and 10 per cent in December December 1965 RP's recently than in earlier been doing a bit more through had but not markedly more. years, to Mr. Holmes' comment that it Mr. Mitchell then referred raise the rate charged on RP's in had been considered unwise to
the recent period on the ground that such a signal could be easily misconstrued in the market. He asked whether the same situation would hold in the coming period. Mr. Holmes replied that RP's were not likely to be made in large volume in the coming weeks of January, when the Desk probably would not be supplying reserves. He thought that a higher rate on RP's could be adequately explained to dealers. Mr. Brimmer asked whether debt management activity was likely to interfere with achievement of Committee objectives over the next month or two, apart from sales of participation certificates and agency issues. There had been reports to the effect that as monetary conditions eased the Treasury would tend increasingly to step into the market with the objective of achieving some lengthening of the debt. In particular, did the Manager expect that the February impose a greater burden on the market than had been refunding would anticipated? Mr. Holmes replied that it was obvious, given the 4-1/4 interest rate ceiling on new bond issues, that the Treasury per cent be offering a maturity beyond 5 years in the February would not not yet focused on the terms of the refund refunding. Thinking had not until the end of January approached. ing, and probably would It was possible that the Treasury might make a split offering,
involving a short-term security and one with a maturity in the neighborhood of 4 or 5 years, but no decision had been reached. Mr. Hickman asked whether the Committee was not relatively free of an even keel restraint, at least for the first part of the coming period, in view of the facts that the refunding involved less than $4 billion in publicly-held maturing issues and that its terms were not to be announced until near the end of January. Mr. Holmes replied that he thought the refunding would not be an especially difficult one, and accordingly that it should not constrain the Committee from changing policy today if it was inclined to do so. In reply to a question by Mr. Swan, Mr. Holmes said that the next Treasury financing after the forthcoming refunding was likely to be a cash offering for payment in the second half of February. Thereupon, upon motion duly made and seconded, and by unanimous vote, the open market transactions in Govern and bankers' acceptances ment securities during the period December 13, 1966, January 9, 1967, were approved, through ratified, and confirmed. for the staff economic and Chairman Martin then called reports that had been supplementing the written financial reports, of which have been placed prior to the meeting, copies distributed in the files of the Committee.
Mr. Koch made the following statement on economic conditions: The new information on domestic nonfinancial develop ments that has become available since our last meeting confirms the deceleration in the pace of the economic expansion. The staff now estimates an increase of only $7 billion in the GNP in the current quarter, despite the fact that the fourth-quarter 1966 increase has been raised to over $14 billion. The most disturbing aspect of recent economic developments is the sharply increased extent to which production is going into inventories. Business inventory accumulation has apparently been even greater than assumed earlier and final takings smaller. Christmas sales were generally disappointing to retailers and the rise of consumer expenditures in the fourth quarter as a whole was relatively small. To lagging sales of autos and construction materials has been added less strength in furniture, appliances, textiles, and other goods. As for prices, recent developments have been mixed, as indicated in the green book,1/ but the net result has been a slowdown in the rate of rise of the broad price indices. In the new year, prospects are for further advances, but at a slower pace. The future course of consumption and of the whole economy for that matter will depend importantly on developments in the three main areas of more or less namely, business outlays on plant exogenous spending, and equipment and on inventories and defense spending. true since consumption has been high This is particularly relative to income for several quarters. We have no additional direct information today on fixed expenditures, but the data on new orders business support the finding of the November for durable goods Commerce-SEC survey, namely, that the rise is decelerating. down in both October and November, in part New orders were defense orders. The level of new orders in due to lower lowest in a year and the backlog of November was the outstanding orders declined for the first time in three The National Association of Purchasing Agents years. "Current Economic and Financial Conditions," 1/ The report, by the Board's staff. prepared for the Committee
also states that the number of its members reporting improved new orders and higher production in December was the smallest since the 1960-61 recession. Definitive information on the Federal budget and defense spending is still not available, but the informa tion from the Daily Treasury Statement on recent months' spending confirms staff projections of a tapering off in the rate of increase of defense outlays beginning last quarter. But, despite a tapering off in the rate of defense spending and even if a tax increase is enacted, the Federal budget deficit for both this fiscal year and next is likely to be large. Of particular relevance to economic developments, though, is the fact that part of the deficit for the next few quarters at least is likely to be a passive reflection of a reduced rate of growth in tax revenues resulting from the projected slowdown in the economic expansion rather than of increased spending. We shall learn more about the fiscal picture shortly in the State of the Union and Budget messages. Since business inventory developments are a key factor in the likely course of the economy in the near let me turn back to them for a second and term future, closer look. I mentioned earlier that recent inventory accumulation had been larger than anticipated earlier. Despite better accounting controls and higher financing costs, stock-sales ratios have been on a sharp rise since early 1966, particularly in the durable goods manufacturing industries. The rise in stocks has been largest in work-in-process in the areas of consumer durable goods, defense goods, and machinery and equipment. mean for the likely future course of What does this inventories in particular and of the total economy in As for consumer durable goods, the recent rise general? in stocks has been in household durables as well as in autos. Production has already been cut back in many of in autos to approximately the 8-million-car these lines, annual rate of sales. In the defense area, the current off rather sharply in October rise in new orders dropped of defense equipment now and November, and, with output than earlier in 1966, defense rising much less rapidly work-in-process stocks may also be rising less rapidly if some production bottlenecks from now on, particularly Finally, in the area of machinery and are broken. the tapering off of the plant and equipment equipment,
investment boom should mean a pronounced deceleration in the rise of stocks in these industries in coming months, even though the order backlog in this area is still large. All this tends to confirm the staff estimate of a sharp fall-off in business inventory building in the current quarter, perhaps by $5 billion or more. Even such a drop is not likely to lower stock-sales ratios and as a result pressure for further curtailment of additions to inventories is apt to continue. A sharp decline in inventory accumulation would in and of itself create another pause in the economic expan sion similar to those we have experienced several times since World War II. This is a common economic forecast for the first half of 1967. It is shared by some Administration economists and by most of our staff. The inventory deceleration will reduce market demands and put to a test the underlying strength of business capital spending programs, that is, the extent to which such programs are supported by longer-run as contrasted with short-run market prospects. The rate of increase in business capital spending is already decelerating, and if such spending actually begins to decline we shall have a situation calling for major policy alterations. In the meantime, though, even the near-term prospects for moderately reduced economic growth call for a continuation of the gradual process of overt monetary easing on which the Committee embarked two meetings ago. made the following statement concerning financial Mr. Axilrod developments: The policy of reduced monetary restraint initiated by this Committee in the fall appears to be gradually taking hold in financial markets. This is evidenced mainly by the increased flow of time deposit funds to banks, including negotiable CD money to large banks, and also by the more comfortable position of nonbank savings institutions. It is also seen in the further declines of market interest rates, both short- and long-term, during the past several weeks. But in many ways the impact of the new policy on markets and the economy is not yet fully secure.
For one, the substantial rise in the money supply from its recent mid-November low point appears to have been in large part a short-run response to a decline in U.S. Government deposits. We have not yet had evidence that at current levels of interest rates the privately held money stock is capable of sustained moderate growthsay, at a rate much above the 2 per cent of 1966. For a second, the lending policies of banks and other financial institutions do not yet appear to have altered definitively toward less restraint. Some probing in that direction is probably in train, but our contacts with banks in recent weeks suggest that a wait-and-see attitude still predominates. And for a third, the recent interest rate declines were in part based on expectations--expectations not only that monetary policy was easing but that domestic business expansion was weakening and that fiscal policy would in one way or another not be a very massive expansionary force in the period ahead. I would not rule out the possibility that interest rates could rise, at least temporarily, over the weeks ahead. On the other hand, if expectations of business weakening prove correct, interest rate levels may turn out to be too even current high to provide the needed encouragement to economic demand. While one's view as to the likely strength of demands for goods and services is fundamental to one's appraisal of the appropriateness of current interest rate levels, of lending institutions is also a highly the condition that developed in these relevant factor. The stringency with the 40-year record market interest institutions along in a marked further erosion rates of last year resulted For commercial banks this of their liquidity positions. by the rise last year most dramatically illustrated is loans excluded) at ratios (with dealer in loan-deposit 70 per cent to 80 per City banks from around New York of such banks, savings cent. The adverse experience and life insurance companies and loan associations, of lending policies a significant relaxation suggests that restoration of on at least a partial depends in good part And for both of those their liquidity positions. in time might require proximate each other developments to prospective economic and clearer signals as to not only clearer signals from the monetary fiscal events but also some further reduction be indicated by authority as might
in interest rates--or, at a minimum, efforts to forestall any reversal of the recent interest rate declines. The need to encourage a relatively prompt relaxation of lending standards at financial institutions is based in part on the nature of the economic imbalances that at the moment appear to be developing. A principal danger to the economy, as Mr. Koch has pointed out, seems to come from a probable relatively sharp decrease in inven tory accumulation over the period ahead. While some inventory readjustment appears to be unavoidable, its speed and scope might be modified somewhat if banks were more accommodative of business loans. The inventory adjustment might also be tempered if consumer spending on goods, both durable and nondurable, could be relatively well maintained; and given the University of Michigan consumer survey evaluation that consumers are gloomy, but not outright pessimists, an easing of bank lending terms on loans directly to consumers and indirectly through finance companies might just make additional spending attractive or possible for some of the less dour consumers. Construction and home-building is, of course, the area which might be encouraged to provide most of the to any developing weakness in other economic offset sectors; and it is an area which has traditionally--and quite responsive to changes in the very recently--been financial environment. Recent monetary policy actions appear to have stopped the deterioration in mortgage and set in motion forces--such as the renewed markets, flow of savings funds to nonbank institutions--which should eventually yield an actual easing of conditions. This will depend on a continued good experience for and loan associations. But, if a prompter savings reversal of present market tightness is desired, it on further declines in long-term market will depend interest rates so as to increase the relative attrac of mortgages to other financial institutions tiveness such as banks and insurance companies. that the easing of lending terms and It would appear institutions seem to be conditions that major financial made more secure, and probably approaching could be usefully hastened, if open market operations were conducted way as to sustain continued bank reserve growth in such a temporarily rather rapid expansion. In and to risk a context, it may be desirable to attain a somewhat this
lower Federal funds rate and a lower level of member bank borrowings than has prevailed on average in recent weeks--perhaps even a level of borrowings that would bring the net reserve position of banks close to zero and the Federal funds rate to around 5 per cent. If that were done, it is possible, but by no means certain, that the resulting expansion of reserves would be fairly rapid on average. But such an expansion would be desirable during the turn-around phase of monetary policy in the degree that it permits a decline of interest rates, a restoration of bank liquidity, and some relaxation of bank lending standards ahead of, rather than merely in reaction to, a reduction in loan demands. It is, however, particularly difficult to anticipate and quantify the interrelations among aggregate reserves, marginal reserve measures, and interest rates in the period ahead--given the diversity of economic forecasts the unknown credit market reaction to and pressures and tonight's State of the Union message and the forthcoming Federal budget. It is not difficult to conceive, for upward bill rate pressures if dealers were example, of to run from their current extended bill positions. On hand, it is also not difficult to envision the other as worsening business news--which circumstances--such desirable for open market operations might even make it so as to give more direct at some stage to be conducted to the flow of funds in long-term markets encouragement purchases of intermediate- or by including significant coupon issues. The slackening of the invest longer-term appears to indicate that this winter's burst ment boom is likely to fade in the of corporate security issues a result, investor funds might be relatively spring; as to the mortgage market once it became quickly channeled on other long-term securities clear that interest rates I put forth the suggestion would be substantially reduced. coupon issues with some tentative for System purchases of kind of flexibility in as indicative of the ness, but might wish to keep in approach that monetary policy are resolved. of the current uncertainties reserve as some if any, of the alternative draft Mr. Mitchell asked which, 1 / the staff Mr. Axilrod thought was directives submitted by with the policy course he was recommending. consistent minutes as Attachment A. 1/ Appended to these
Mr. Axilrod replied that alternative B could be consistent with the course he recommended, depending on the interpretation the Committee placed on the phrase, "somewhat easier conditions in the money market." Mr. Brimmer commented that by adopting alternative B the Committee would not necessarily be implying that it wanted to go as far as Mr. Axilrod recommended, and the latter agreed. Mr. Daane referred to Mr. Axilrod's comments about possible System purchases of coupon issues, and asked whether he thought that present conditions were parallel to those in the latter part of 1961 when "operation twist" was begun. Mr. Axilrod replied that he had not had such a parallel in mind. In the 1961 period the U.S. balance of payments was an important factor in the decision to begin purchases of coupon issues. While balance of payments considerations might again be relevant he had been addressing himself to the fact that to the question, might be desirable to get a more rapid reversal of conditions it the mortgage market, and he had thought of open market operations in issues as a possible means of reducing the typically in coupon long leads and lags in that area. Mr. Wayne commented that the policy course Mr. Axilrod had to him to be more closely represented by recommended seemed directives than by alternative B. alternative C of the draft
Mr. Axilrod remarked that such a policy could be consistent with either of those alternatives, depending on what interpretations the Committee placed on their language. The problem he had seen with alternative C was that it called for "expansion in bank credit at a moderate rate," and under the course he recommended the expan sion rate in the short run probably would be quite rapid. But that alternative might be taken as consistent with his policy recommendation if the Committee interpreted the word "moderate" as applying to the longer run, and was prepared to tolerate a rapid short-run expansion as banks acted to improve their liquidity positions. Mr. Swan observed that, as he had interpreted the analysis in the blue book, a shift to somewhat greater ease might well mean more rapid bank credit expansion over the longer run but at the same time it might have little effect on the January growth rate. Mr. Axilrod said his interpretation of the blue book was that a move toward further ease at this meeting discussion expansion on average in January at an might result in bank credit higher than the 7 - 9 per cent projected under unchanged annual rate as banks seized the opportunity to capture money market conditions, but that the their liquidity positions, money and to restore CD winter would be lower. months of the rate in the following growth
Mr. Maisel asked whether the matter might not be clarified by concentrating on expected future developments rather than on what had already happened. As he understood it, much of the expan sion included in the projection of a 7 - 9 per cent growth rate on average in January reflected strength in the latter part of December, rather than expected strength in the weeks ahead. Mr. Axilrod agreed. He noted that the blue book projected a 4 - 6 per cent growth rate between the end of December and the end of January, and that it implied no strengthening in February. whether it was not also expected that Mr. Maisel asked over the period from this meeting to the next bank credit would grow at a rather low rate. said that that would be his guess. In reply, Mr. Axilrod Mr. Reynolds then presented the following statement on the of payments and related matters: balance fourth quarter of 1966, two new tendencies In the U.S. international transactions. The trade appeared in began to improve. And the capital accounts surplus to deteriorate. Both tendencies had been expected, began though perhaps not so soon. these tendencies, all of us have In anticipating that the trade im concern about the possibility felt slowly than the capital account provement might come more position would get so that the over-all deterioration, We have also felt concern worse before it got better. span of a year or more, the that even over the longer not show any significant payments position might improvement. no comfort on either score, but Recent events offer gloom. The fact that the do they add to the neither
capital account deterioration outweighed the trade improvement between the third and fourth quarters seems to have resulted so much from special and erratic influences that it tells us little that is new about future prospects. The only recent changes in capital flows that we can yet identify relate to U.S. bank credit and to U.S. liabilities to the Euro-dollar market. The renewed moderate outflow of bank credit in October-November probably did not reflect much change in the lending attitudes of U.S. banks. Instead, it seems likely to have resulted from more active foreign use of existing lines of credit, perhaps because of year-end stringencies, and some bunching of term-loan disbursements without significant change in the rate of new commitments. One would expect that large U.S. banks, as their reserve and liquidity positions ease, would begin to make foreign loans more readily at about the same time that they ease their domestic lending. But the October-November out flows seem to have come too soon to be related to any such general change. The leveling off and subsequent decline of U.S. banks' liabilities to their foreign branches since mid November is more likely to have reflected the first effects of reduced tightness in domestic financial markets and in bank positions. But year-end influences play such role in these flows that we cannot yet judge a large whether the repayments to the Euro-dollar market came mainly at U.S. initiative or instead reflected mainly attracting wanted funds. Hence year-end difficulties in recent experience provides little in this case, too, the to the magnitude of future flows. It does seem guide that given the large banks' preoccupation likely, however, positions, they will want to make with their liquidity market before giving further repayments to the Euro-dollar green light to their loan officers. the fourth-quarter capital flows These available data on in that quarter. There by no means explain what happened deterioration on other must also have been a substantial possibilities. Direct only guess at the items. One can fallen below the expected outflows, having investment quarter, may have increased in yearly average in the third a reversal in the There may well have been the fourth. which had turned unusually errors and omissions item, quarter, presumably reflecting favorable in the third by the sterling crisis capital inflows generated unrecorded
and by the extreme tightness of credit here during the summer. There could also have been some further deterioration in military and service transactions, but these transactions as a group do not often show large quarterly changes. The improvement in the trade balance from the third quarter to October-November is a good deal easier to interpret than the changes on capital account; it probably represented the beginning of a new trend that will continue through at least several calendar quarters. Merchandise imports in October-November were little higher than in the third quarter. Imports of materials, which account for about two-fifths of the total, actually declined, even though within that category steel imports remained at record highs. Imports of materials tend to fluctuate like domestic production of materials, but with wider cyclical amplitude. If GNP develops as projected in the first half of 1967, with a sharp reduction in the rate of inventory accumulation and some decline in production of materials, there is likely to be a substantial decline in imports of materials. Imports of capital equipment increased further in but they should level off soon if the October-November, domestic projections of a leveling off in business spending and an easing of capacity pressures are fulfilled. Thus, even if imports of some consumer goods continue buoyant, not expect total merchandise imports to increase I would appreciably in the months ahead. Exports, meanwhile, should continue to advance. The probably slow down from the 13 per cent annual pace will from the third quarter to October-November. rate registered in that advance, and there There were temporary elements weakening in Canadian demand for U.S. products. may be some also been weakening in Britain and Germany, but Demand has those countries have already declined and our exports to may not fall much further. With shipments still rising to most other countries, total U.S. exports ought not to fall the rate of growth in cent annual rate over the months below, say, an 8 per level, would raise the This rate, with imports ahead. $3-1/2 billion in trade surplus from about annual rate of half of 1966 to perhaps $5 billion or so the low second in the first half of 1967. outflows of capital (excluding foreign Since net a roughly offsetting amount liquid funds) may increase by
between these two half-years, the liquidity balance seems likely to remain above a $2 billion annual rate. In addition, there will probably be outflows of foreign liquid funds. So the official settlements deficit also will probably exceed a $2 billion rate, in marked contrast to the exceptional surplus registered during the half-year just ended. These guesses, as I suggested earlier, are not signifi cantly different from those of a month ago. What, if anything, do they imply for monetary policy, when taken together with domestic prospects? My answer is the same one that Mr. Hersey gave you at the last meeting. I can see no way in which monetary policy actions can improve the near-term payments outlookgloomy though it is--without jeopardizing the longer-term outlook. If for balance of payments reasons, monetary policy should seek to minimize capital outflows by denying an easing that domestic conditions seemed to require, the resultant further weakening of the domestic economy would be likely eventually to have adverse repercussions on activity abroad and hence on U.S. exports. In particular, if we should hesitate to ease as economic activity slackens, Britain would have to hesitate also, the German authorities too might move more slowly and than seems desirable. These three countries together have a decisive influence on the world economic climate. It remains essential, of course, to minimize domestic of prices and costs, since these are the inflation touchstone of the longer-run payments adjustment. But within that constraint, the objective of working toward long-run equilibrium in international payments is probably served at this time by policies aimed at the domestic best objective of sustaining growth. called for the go-around of comments Chairman Martin then economic conditions and monetary policy, beginning with and views on made the following statement: Mr. Treiber, who As we enter a new year it should be helpful to look back over the old year and see how successful we have been as a nation in attaining our broad national economic growth, (2) reasonable goals of: (1) maximum sustainable price stability, (3) maximum practicable employment, and international payments. (4) equilibrium in
We have done best on the employment goal. Indeed, there have been many shortages of skilled labor, and even of unskilled labor in a number of places. Economic growth was high in 1966 but the high rate was not sustainable. After several years of relative price stability, 1966 was marked by upward price pressures, and as the year ended, further price increases appeared in prospect. A severe balance-of-payments problem has become even more acute. The combination of strong private demand and an additional stimulus from Federal fiscal policy put heavy, indeed excessive, pressure on our resources of men and equipment. Not only did the boom bring price increases at home, but it also contributed to a deterioration of our international trade surplus. Monetary policy was left with too much of the burden of fighting inflation. Money was tighter than it had been in decades. As the year-end approached, the hectic pace of busi ness and credit expansion subsided, interest rates declined from their peaks, and there was some relaxation in the severe credit pressures of the summer. How about 1967? Some forecasters see a business slow down or recession in 1967. Housing is in a slump, the capital boom is moderating, and consumers appear more hesitant. But the question is basically whether we are in a pause, or about to take a definite and cumulative turn downward. The growth in business spending for fixed investment and for inventories will doubtless be slower the other hand, we may expect a revival in in 1967. On construction. In any analysis of the economic residential spending is a vital factor; indeed it is outlook defense factor. Although we will have to wait a week now a major or so before we see the President's budget message it i, to assume that in the coming year there wil1 reasonable in such expenditures over last be a substantial increase continued over-all investment demand and high year. With spending, a continued uptrend in consumer Government It seems to us, on balance, that spending seems likely. excessive expansion in demand is in 1967 as a whole an In this connection, I a greater danger than recession. staff's analysis concentrated on the early note that the part of the year. Although food prices have declined recently, the rise in the prices of consumer has seen a persistent and especially of services. Labor cost nonfood commodities per unit of output has been rising, and despite the relative prices during the last couple of stability of wholesale
months, a cost-price push seems likely. The demands of organized labor are likely to be high, and there are likely to be greater pressures on corporate profits. Our balance-of-payments record for 1966 is again discouraging. The deficit on a liquidity basis is likely to be well over $1-1/2 billion, compared with $1.3 billion in 1965. Had it not been for special transactions which were more than twice as great in 1966 as in 1965, the 1966 deficit would have exceeded $3 billion. Every effort should be made to improve our trade balance. A determined effort to check inflation at home is essential to keep our exports competitive and to dampen the high demand for imports. It is difficult to see an improvement in our international balance of payments in 1967. Indeed, without a large amount of special transactions, the deficit on a liquidity basis is likely to be worse, and it is hard to foresee such a large amount of special transactions. The problem of financing the deficit is likely to become more acute in 1967. On an official settlements a surplus of perhaps $1/2 billion in 1966. basis we had But this good showing depended essentially on high interest rates in the United States which provided foreign private holders of dollars with an incentive to hold on to, and to increase, their dollar holdings because of the on them. Thus Euro-dollar lending to American good return banks through their foreign branches increased by $2-1/2 billion last year and helped finance the deficit. It is that additional lending of this magnitude inconceivable could occur this year. Any substantial decline in interest rates in the United States relative to rates abroad could reversal of these flows. In any case the well bring a for our gold stock are ominous. implications advance in bank credit in December and The resumed the projections suggesting a further rise in January are of the earlier declines in encouraging. A persistence been incompatible with our goals. bank credit would have however, that the loan-deposit It is worth emphasizing, very high--much higher than they ratios of banks are still of 1966. Many bankers tell us that were at the beginning their liquidity position before they they want to improve seek a substantial expansion in loans. months the mix of monetary policy Over the coming importance. We policy will be of particular and fiscal however, for the President's budget may have to wait, of the Government's proposed expenditures message to learn
and the way in which the Administration expects them to be financed. In the meantime, it seems to us, there should be no change in credit policy. We believe that, until the next meeting of the Committee, open market operations should be conducted with a view to maintain ing about the currently prevailing conditions in the money market. Under such a policy one might expect the Federal funds rate to fluctuate above the 5 per cent level, with rates on three-month Treasury bills near their present levels. The range of net borrowed reserves could be wide, but free reserves should be avoided, because their appearance would be likely to bolster market expectations of further monetary ease; these are already strong, in part because the expectations of the System's statement of September 1 on rescinding business loans and discount administration has been widely interpreted as an overt act emphasizing a System intent to continue easing pressure on bank reserves. Since I think that the proper policy prescription I favor alternative A of the draft is "no change," prepared by the staff. I have difficulty in directives alternative C and its implications trying to comprehend of operations. It originally seemed to for the conduct me that it raised more issues than it settled, and the following Mr. Axilrod's remarks confirmed that discussion it means no change, I would prefer to use view. Even if similar to that used in the past to indicate no language think that the meaning of alternative A is change. I clear. I endorse it. in total demand for goods observed that growth Mr. Francis slowed somewhat. In view of that moderation and and services had trend in most aggregate measures of monetary of a restrictive action, the Committee at its last two meetings adopted a less in November the Manager of the restrictive course. Beginning asked to attain somewhat easier conditions in the Account had been of fostering moderate growth in money market with an objective Subsequently, lower interest rates, lower net money and credit.
borrowed reserves, and other indications of ease developed in the money market. However, it was not certain that the aggregate monetary measures had evidenced less restriction. In the last few weeks, Mr. Francis continued, commercial banks had obtained more funds and were probably lending or investing more. Both time deposits and demand deposits had gone up, and it appeared that total bank credit had expanded. However, one hesi tated to conclude at this point that expansion in those magnitudes and the evidence of ease resulted primarily from System actions or that they were having an expansionary effect on economic activity. The rise in time deposits might merely reflect the facts that, with declining market interest rates, banks were now able to compete for that the disintermediation of last fall was now being CD funds, and reversed without any net gain of funds to borrowers. deposits and bank reserves in the last The rise in demand be misleading, Mr. Francis said. Around several weeks might also of the last ten quarters, there the middle of the final month of each deposits. Hence, the current a marked increase in demand had been a problem of seasonal adjustment. might reflect in large measure rise recalled that Mr. Partee, in his review of recent Mr. Francis of the Committee, had developments at the last meeting financial easing of money market conditions banking noted that despite some from projected levels shown shortfalls aggregates had consistently
for some months. Although increases in reserves and money had been recorded since mid-December, there was no reason to believe that the problem of obtaining a moderate amount of monetary growth, which had been the desire of the Committee, had been solved. Mr. Francis noted that the staff projected a marked rise in total reserves from December to January, but those reserves were expected to be utilized in supporting Government demand deposits and time deposits, as the reversal of the disintermediation was expected to continue. Private demand deposits, according to projec tions, would decline and money would remain about unchanged. With those projections, and with the experience since last summer of shortfalls in final data from projected levels, special effort might be required in order to move toward a less restrictive course including expansion of the money supply. for total demand were as weak as the staff If the prospects Mr. Francis concluded, it behooved the monetary authority indicated, to do all it could to alter that situation. The Committee should "a gradual reduction in the degree of monetary not be satisfied with 6 of the blue book. Assuming the restraint" mentioned on page outlined on page 6 of the blue relation among variables which was Committee should aim for positive free book, he suggested the below 5 per cent, and a bill rate reserves, a Federal funds rate
about at the discount rate. It should strive for an upward trend of the money supply at about a 3 per cent rate. Mr. Francis thought that alternative B of the staff drafts, with some alteration, would fit his approach to the situation. He would alter its language to read ". . . System open market operations until the next meeting of the Committee shall be conducted with a view to attaining such conditions in the money market and such an increase in total reserves as are necessary to assure a moderate rise in the money supply. . ." Mr. Patterson remarked that most of the bankers in the Sixth District with whom he talked had told him that requests for loans from their good customers were still greater than they could satisfy and that they saw no signs of a general letdown in the pressures for credit. However, the statistics they reported told a somewhat different story. Loans at all member banks had been practically unchanged months after account was taken of seasonal influences, for three Mr. Patterson noted. In some areas of the District loans were Average interest rates on new business loans charged actually lower. by the banks in Atlanta and New Orleans were unchanged between September and December, after a 38-basis point gain between June and December and a 30-basis point gain during the spring quarter. In December Sixth District member bank borrowing was the lowest since
July 1966, and much less reliance was placed by District banks on the Federal funds market. Of the banks included in the Quarterly Survey of Bank Lending Practices, as of December 15 only a minority reported loan demand as moderately stronger. The rest reported loan demand as essentially unchanged or moderately weaker. District bankers were inclined to attribute those develop ments to their having adopted firmer lending practices, Mr. Patterson said. They inferred that any slight reduction in requests for loans banks resulted partly from the realization by potential at their that it would be fruitless to apply for a loan. Some borrowers bankers stressed their desire to get into a more liquid position. there actually was some shifting in the security portfolios Indeed, of the large banks in December, and loan-deposit ratios at all member banks had declined since September. Moreover, some restriction in their lending and investment volume had resulted from a less-than seasonal increase in demand and time deposits at the larger banks and a downtrend in deposits, on a seasonally adjusted basis, in the months in some areas of the Sixth District. Some change last three however, was suggested by the statistics for the in deposit trends, banks in late December, when time deposits rose large District slightly. On the other hand, Mr. Patterson continued, the behavior of the latest available economic indicators continued to confirm
the slowing in the District's economic activity that was reported at previous meetings. Employment apparently picked up a little toward the end of the year in contrast to the slackness during the months of mid-1966, and the unemployment rate in November fell to 3.5 per cent, the lowest since May. However, the District was sharing in the slower pace of auto sales and in the auto production cutbacks. Weakness persisted in some types of construction, and the tabulation of announcements of proposed new or expanded manufac for the fourth quarter promised a slower rate of turing plants capital expenditures in the future. thought a reasonable conclusion that could Mr. Patterson that mixed collection of information seemed to be be drawn from something like the following: There was a strong demand for loans, were being excluded because of although some potential borrowers policies. The slackening in high interest rates and bank lending a slowdown in demand, reflecting expansion resulted from both loan efforts of banks to expansion, and the a slower rate of economic many bankers were uneasy liquid positions. Since get into more to be welcoming any liquidity, they seemed about their declining no matter how small. respite, said, much the determine, Mr. Patterson So far as he could to the national scene. be reached in respect same conclusion could to be less responsive now were likely that member banks That meant
to increased availability of reserves in expanding their loans and investments than they would have been early last year. Thus, insofar as net borrowed reserves or free reserves reflected reserve availability, a net borrowed reserve figure of, say, $100 million was much less stimulative now than it would have been at this time last year or during a considerable part of 1966. That might explain why, despite the turn toward greater ease initiated several meetings ago by the Committee, the declining trend in the bank credit proxy had not been reversed until very recently. In order to be sure that the recent rise in the bank credit proxy did not prove to be temporary, therefore, Mr. Patterson favored continuing to move gently toward greater ease. Currently, reserve figure was especially suspect as a guide the net borrowed availability. But if that figure was to be used, he would to reserve favor moving toward a zero position. With that understanding, he would favor alternative C of the draft directives. for the real sector of Hilkert remarked that indicators Mr. seemed to him increasingly to be pointing to a lessening the economy Third District continued to demand pressures. Conditions in the of generally good, as they were in the nation. However, indications be in the District. Manufacturing employ of softening were appearing had been declining, as was off a little, and steel production ment contract awards and auto registrations. had construction
On the national scene, Mr. Hilkert found it difficult to discover any new sources of significant strength. Consumer demands and attitudes seemed relatively lethargic. Although there might be some point to the fact that construction could hardly go much lower, that did not stir hope for new strength. But most of all, he was disturbed--as apparently was the Board's staff--by the recent move ment of new orders, backlogs, and inventories. The latter pointed quite clearly to involuntary accumulation. To Mr. Hilkert, the resulting projection by the staff of a substantial cutback in the rate of gain in GNP during the first quarter was significant. Forecasts appearing daily in the press did not now generally support the view that a recession was ahead. But if the staff's projection for the first quarter proved correct, forecasts might soon become much more bearish. Other things being equal, facts like those argued for another move toward ease, Mr. Hilkert said. He was, of course, concerned about the increase in wages now taking place and likely to continue this year. Credit ease should not proceed so fast and so far as development. Yet, it seemed to him there was to aggravate that could do now to halt the trend, let little that monetary policy alone roll it back. sector of the economy, Mr. Hilkert noted, In the financial rapid easing in money market conditions had taken substantial and
place. As pointed out in the blue book, bank credit and the money supply now seemed to be responding. In his view, that easing had not been overdone. Information coming to the Philadelphia Reserve Bank from the larger banks in the District indicated that they were not yet anxious to seek more customers, had not changed their lend ing policies, and were concerned about their liquidity. Rescinding the September 1 letter had had relatively little effect on their attitudes. Another signal of the Federal Reserve's intent to ease, therefore, seemed to Mr. Hilkert to be called for if those attitudes were to be changed. On balance, he believed alternative B would be accomplishing the desired purposes. Although he appropriate in would think of the implementation of the directive as being accom gradually, the changes contemplated by alternative B plished somewhat should be sufficient to impress the market and banks that a further change was being made. The balance of payments implications of further ease did, him, Mr. Hilkert said. However, he looked for of course, concern improvement in the trade account as domestic expansion further credit conditions abroad might slackened. And, hopefully, easier the Committee to proceed toward easier make it possible for conditions domestically without adverse effect.
Mr. Hickman commented that recent economic news revealed further moderation in some sectors and increased weakness in others. Notable developments in December were the increase in insured unemployment (reflecting mainly the cutbacks in autos and steel), the disappointing performance of retail sales, and the further (probably involuntary) buildup in business inventories. The industrial production index, on the basis of very preliminary estimates made at his Bank, showed little, if any, increase in December. At the last quarterly meeting of Fourth District business economists in mid-December, Mr. Hickman continued, the general theme was one of increased anxiety about the economic outlook, which was reflected in a lowering of the group's forecasts--the third successive time that that had occurred. The group was con about the hazy outlook for defense spending, the tapering cerned of capital spending, the profit squeeze, the erosion of new orders and backlogs, and general imbalances among major economic sectors. Their median forecast for GNP in 1967 in current dollars was $783 billion, a year-to-year gain of 6 per cent, with moderate and diminishing quarterly increases. That implied a modest increase on the order of 3 per cent. Median forecasts in real GNP, something for industrial production showed fractional quarterly increases, annual gain in 1967 amounting only to 3 per cent. with the
Mr. Hickman noted that the Fourth District business economists expected appreciable increases in unit labor costs in manufacturing in each quarter of 1967, with the average of the medians for the year up 2.5 per cent. The group expected corporate profits after taxes to remain level in the first half and to decline in the second half, with a year-to-year decline of about 1-1/2 per cent. Only about one-fourth of the group expected that taxes would be increased in 1967, and almost all thought that a tax increase was undesirable. Since he was no longer a dues-paying member in the union of business economists, he was not allowed to vote. If he could have voted, he would have been one of those voting against a tax increase at this time, largely for domestic economic reasons, but partly also because of glimmerings of hope that tensions were easing in Vietnam. In regard to monetary policy, Mr. Hickman was pleased to note the substantial increase in both the money supply and the bank credit proxy that occurred in December. He would like to think that that reflected the economy's prompt response to the Committee's recent modest shift in policy, although the usual seasonal churning in December made it quite difficult to determine if that actually was the case. The staff's projection of no change in the money supply for January suggested to him some further eas ing was still needed.
Mr. Hickman's prescription for policy until the next meeting was to provide whatever reserves were needed to produce an increase in the money supply in the range of 3 to 6 per cent (seasonally adjusted annual rate), as well as to bring about some further modest reduction in interest rates. To achieve those objectives, he thought the Committee should not be constrained by the public's reaction to the published figures on the net reserve position of banks, and should permit positive free reserves to develop, if necessary. In view of the imminence of the Treasury refunding, he would prefer to move promptly in the direction of further ease. The recent reduction in the German bank rate from 5 to 4-1/2 per cent provided some basis for hope that a further modest reduction in interest rates in the trigger a flight of hot money from this country. He U.S. would not favored alternative B of the draft directives, and would be receptive to System purchase of intermediate- and long-term issues. Mr. Brimmer said that the direction in which the Committee should move in the next few weeks seemed reasonably clear to him. He agreed with Mr. Reynolds' conclusion that the objective of long in the balance of payments would be served best by run improvement growth, and he thought the Committee policies that sustained domestic a meshing of policy requirements fortunate in having so smooth was and the domestic economy. for the balance of payments
As he looked back at financial developments in the past few weeks, Mr. Brimmer continued, he was impressed with the strength of the markets and the magnitude of the change in expectations follow ing the Committee's shift toward less restraint. He thought it was now incumbent upon the Committee to validate the present expectations. As some observers had noted, there had been a large reaction to a relatively moderate change in open market policy and the rescission of the September 1 letter. He thought the Committee should now do to insure that the money supply and bank credit would much more expand at rates approaching those that members had suggested were desirable at recent meetings. He was impressed by the degree of in the banking system but he was not surprised by inertia existing of banks to restore their liquidity positions. it, given the desire low bank liquidity did impede the Committee's efforts Nevertheless, economy through changes in money market conditions. It to affect the was important that bank loan expansion not rest simply on increases dealers; it should also reflect rising loans to in loans to security business. particularly impressed with the Mr. Brimmer said he had been and he thought that by the course Mr. Axilrod had suggested, policy the Committee might want to give serious time of its next meeting for a more overt change. For the consideration to that proposal the uncertainties regarding the time being, however, in view of
Administration's tax and expenditure recommendations, he thought the proper course for the Committee was to proceed along the path it had been following recently. That led him to favor alternative B of the draft directives. At the same time, he would not want to have the level of interest rates taken as the sole key to the operations of the Desk. He would not be disturbed if the three-month bill rate declined to the neighborhood of 4-1/2 per cent. Nor would he be disturbed very much if net borrowed reserves approached the zero level or even if free reserves emerged. But it should not be the main objective of the Manager to produce those results; the main objective should be to achieve increases in bank credit and the money supply. In the preceding discussion, Mr. Brimmer continued, a had been implied as to whether the period with which the question concerned was the first half of 1967 Committee was most properly it was appropriate for the Committee or the whole year. He thought to insure that economic conditions in the to do all that it could to the point that the second-half first half did not deteriorate In his judgment, unless there was conditions would be much weaker. markets, the economy was not easing of terms in mortgage sufficient in the second half. likely to display strength favored alternative B Brimmer concluded, he In sum, Mr. time of the next meeting the today, and he hoped that by the
Committee would be in a better position to decide whether the course suggested by Mr. Axilroad was appropriate. Mr. Maisel agreed with the staff analysis of the current situation. It seemed to him, therefore, that the Committee had to make clear its current goal--namely, a monetary policy that over the course of this year would help in increasing, rather than decreas ing, total demand in the economy. Given that ultimate goal, Mr. Maisel said, what influence could monetary policy have? Either through increased credit avail ability or through lower interest rates, monetary policy might influence those making spending decisions to add somewhat to their expenditures. More specifically, liquidity could be rebuilt, credit availability might rise so that easier mortgage terms might aid housing and that, plus some direct impact through instalment credit, might add an incremental amount to expenditures on consumer durables. also be marginal credit users who had been forced to run There might with lower inventories than they desired and with less investment and equipment, but the impacts in those areas would probably in plant not be great. Given that basic role for monetary policy, Mr. Maisel asked, policy index could the Committee use in what sort of intermediate its action for the next two or three months? The directing Committee's main indexes could, as indicated in the alternative
draft directives, be concerned primarily with either quantities or rates. The Committee could use the total increase in the amount of credit flows, or, since it had only slight current knowledge of total credit flows, it could use as a proxy either bank credit expansion or reserves furnished by the Federal Reserve--adjusting the amount aimed at for either proxy with time, if the proxy seemed to vary from the total credit movement desired. On the other hand, obviously the Committee could also set an interest rate goal on the assumption that it would require particular changes in the interest rate to bring about the desired over-all goal for spending in the economy. It seemed to Mr. Maisel that, at the moment, the Committee would be better off if it chose as its major policy variable changes in credit and reserves, using interest rates as a subsidiary guide. In the first place, Mr. Maisel feared that by adopting interest rates or money market conditions alone, the Committee was likely to pay too much attention to most recent events. As the green book showed, in many money market areas rates still were running 100 basis points or more over November 1965. Even while others had come down sharply, a large gap still remained. At the same time, the Committee was uncertain as to whether it was the level of rates or their change that would make the critical differ ences in reaching any desired spending goal.
During a period of rapid change, Mr. Maisel also feared the Committee was too likely to be bemused by the rate of change rather than by the actual level of interest rates. That was partic ularly true since the real demand for credit during this period was uncertain and little was known as to how much it could be expected to affect spending. There might be strong pressures to accommodate some of the backlog which had been postponed from recent periods in order simply to improve liquidity without any spending impact. In addition, if a major inventory run-off actually occurred, demand for funds might fall far below normal. In either case interest rates would not be an adequate guide of the Federal Reserve's actions or influence. They would represent a mixture of special and would not mirror the total impact. supply and demand factors Mr. Maisel continued, the same argument might be Clearly, using the amount of credit as an index, but here the made against be less strong. The Committee knew that problems were likely to the economy had been through a period in which credit had expanded It should be simpler to get agreement for far less than normal. to a normal rate. When such an expansion credit expansion to return it could then be determined whether that normal was achieved, terms of related interest rates, credit expansion was sufficient in liquidity to achieve the Committee's ultimate goal. expansion, and
With respect to the draft directives, Mr. Maisel said, obviously he preferred the third alternative--C. He assumed that by "moderate" the Committee would, following the dictionary defini tion, mean avoiding extremes. Therefore, the directive should mean that the Committee was aiming at a normal or adequate movement in total deposits to achieve its goal. It seemed clear the Committee's goal should be a bank credit proxy that grew at about a 7 per cent annual rate. The blue book projection for the next four weeks showed required reserves expanding at far less than a normal rate and one not sufficient to achieve a desirable rate of expansion in total credit. Thus, to achieve the moderate expansion in bank credit called for in the directive, conditions would be needed under which required reserves would expand at a more rapid rate than that pro jected in the blue book. That should be the index for action used during the next four weeks. Reserves should be added unless or until required reserves were showing a far smaller run-off than free reserves might well be indicated in the blue book. Positive needed to achieve that aim and, as indicated by Mr. Axilrod, a lower Federal funds rate. If the Committee was getting considerably that expansion it should, as indicated in alternative C's proviso clause, be less concerned with rates. that the course of System policy in recent Mr. Daane said seemed to him to have been clearly appropriate as to direction. weeks
His position at the last two meetings had reflected reservations regarding the overtness of the change and the degree of ease the Committee sought as it moved down the road toward greater ease. Those reservations, in turn, reflected confidence in the underlying strength of the economy, his skepticism as to whether public spend ing might not exceed current estimates in a period of war, and his concern about the balance of payments. Those considerations had led him to feel more cautious than the majority regarding the aggressiveness with which the Committee should move toward ease. continued, he still felt concern about the Today, Mr. Daane of payments--he shared Mr. Treiber's views on possible balance on capital account--and he was no more assured than deterioration he had been earlier as to the course of public spending. He was however, by the increasing signs of deceleration in the impressed, thought it was necessary for the Committee private economy, and he to continue to move--and to demonstrate that it was moving--toward ease. Accordingly, he favored alternative B, in somewhat greater in which he would interpret it. He had some the moderate sense the view that later in 1967 the Committee might again sympathy with to restrain the economy, but it seemed be confronted with a need that the immediate problem was the reverse. to him Mr. Daane added that he was not so sanguine as the staff, or Mr. Brimmer, that longer-run strength in the domestic economy
and in the world economy would insure against a rather rapid deterioration in the balance of payments in 1967, whether on the liquidity basis or the official settlements basis. That was why he would interpret alternative B as calling for a gradual and moderate movement. Operationally, he thought there was some parallel between the current situation and that of early 1961 and thus he would favor some System purchases in the coupon area. Such purchases seemed desirable not only on the domestic grounds that Mr. Axilrod had mentioned but also for balance of payments reasons. He did not think the Committee could take great comfort in the 1/2 per cent reduction in the German discount rate in terms of the totality of international flows. Mr. Mitchell remarked that while several people had talked problem for monetary policy he thought the about the longer-run problem lay in the short run, because the lags in transmitting basic changes through commercial banks to the economy the effects of policy The Committee's task was to at large were rather substantial. to rebuild liquidity so that they would satisfy the banks' desire been following--and to do so on the loan policies they had reverse a bounce-back in loan growth basis, so that if there were a cautious The economic analysis presented would not get out of hand. it not be such a bounce-back. From today suggested that there would
his conversations with bankers, however, he gathered that they thought underlying loan demands remained strong, and that if they turned their loan officers loose the volume would build up fast. He did not think that the bankers were completely confident in their view, and he personally did not know the answer. But he thought that any policy the Committee adopted for the next four weeks should have an element of caution in it. As to the directive, Mr. Mitchell said, he had some sympathy with the modification Mr. Francis had proposed in alternative B, which introduced a reference to the money supply. He noted that had said that the money supply was not likely to show Mr. Axilrod sustained growth, although he (Mr. Mitchell) was not persuaded that that was the case. that the money supply projection was Mr. Axilrod commented an assumption of no change in money market conditions. based on Mr. Mitchell went on to say that while he could accept as written, he would prefer to delete the word "some alternative B "significantly faster" with "very much what," and to replace the words would read, ". . . with a view to faster," so that the paragraph in the money market, unless bank credit attaining easier conditions expanding very much faster than currently anticipated." appears to be alternative C if the final clause was deleted. He also could accept Whatever the language, however, he favored continuing the trend of
deliberate and steady easing, but with a readiness to pull back if and when the liquidity barrier was broken and bank credit growth became excessive. Mr. Shepardson said there was no need to elaborate on the reports of economic conditions that had been made. He thought the main consideration influencing the Committee's decision on monetary policy for the period until the next meeting was the contin uing uncertainty regarding fiscal policy. There had been some expansion in bank credit recently and the projections made on the assumption of no change in money market conditions--as contemplated in alternative A of the draft directives--were for further bank credit expansion on average in January at a 7 to 9 per cent annual seemed to him to be an appropriate growth rate at this rate. That time. In his judgment the Committee had to be concerned about the presently evident for balance of payments more serious implications That fact, together with the uncertainty about developments. called for the type of action contemplated fiscal policy, clearly indicated that there might under alternative A. The projections supply if that alternative was adopted. be no change in the money experience indicated that the money It seemed to him, however, that short run regardless of widely in the supply tended to fluctuate Accordingly, he felt that the the Committee's policy objectives. about the expected lack should not be overly concerned Committee
of money supply growth at the moment, as long as there was reason able growth in bank credit. Mr. Wayne reported that business activity showed more signs of slowing and that expectations were definitely less optimistic in the Fifth District. In November both nonfarm employment and man-hours in manufacturing scored gains, but more recent information was quite uniformly on the weak side. On balance, manufacturers in all categories reported for December lower levels of shipments, new orders, and backlogs, and significantly higher inventories of finished goods. The insured unemployment rate rose throughout the District but remained below the level of a year ago. It appeared that a slump in demand might have caused a postponement or cancel lation of price increases which had been expected in the furniture industry. In the country as a whole, Mr. Wayne said, a gradual slowing of economic activity was becoming increasingly apparent. He had to confess that he was impressed with the pervasive downward movement of the statistical indicators. The rise in housing starts in November was about the only increase which had been reported in Even if that should signal a bottoming out of the recent weeks. still be several months before housing became housing cycle, it would a source of strength. Sales of United States automobiles in both and foreign markets continued weak and production schedules domestic
were being cut back to trim new car inventories, which totaled well over 1.4 million units. Inventory accumulation by manufac turers accelerated in November, inventory-sales ratios continued to rise, and increases in finished stocks suggested that some of the recent accumulation might have been involuntary. Easing of materials prices and slower growth of order backlogs in recent months would probably reduce voluntary accumulation. To Mr. Wayne, those widespread signs of moderation in the pace of economic advance were hopefully the signs of adjustment toward a noninflationary rate of economic growth and not the signs Much depended on the degree of fiscal stimu of emerging recession. lation which the economy received in the weeks and months ahead. expenditures associated with the war effort and But the level of of a tax increase remained the principal uncertainties the question economic scene. While recent figures indicated a leveling on the awards and defense orders, those series off in military contract provide only a hazy indication of future expenditures. might Despite the uncertainties surrounding the degree of fiscal months, it seemed to Mr. Wayne that in view stimulation in coming weakness in the private sector and absence of increasing signs of financial variables in the second half of of growth in important continue to promote the moderate year, monetary policy should last credit, and time deposits indicated growth in the money supply, bank figures for December. He would not like to see by the preliminary
a rapid acceleration in the growth of those variables, but neither would he like to see the plus signs of December washed out by negative signs in January. Encouraged by the behavior of interest rates and marginal reserve measures and by the rescission of the September 1 letter, banks were perhaps becoming somewhat more willing lenders, a welcome response in view of recent slow growth in bank credit. While recognizing that in conducting day-to-day operations the Desk found it difficult to focus on aggregative measures, he believed the objective should be to encourage growth in required reserves and the bank credit proxy at something close to the December rate. B of the staff draft directives, as defined by Alternative Mr. Axilrod, seemed to Mr. Wayne appropriate. in recent weeks monetary policy Mr. Clay commented that financial variables goals generally had attained the implementation view of the economic information that sought by the Committee. In monetary policy goals and attainments had become available, those the prevailing economic situation. had been appropriate to morning's meeting relative that the timing of this Mr. Clay said Administration messages to follow to the President's message and other in formulating monetary policy the Committee under a handicap placed the information available for the next four weeks. Nevertheless, appeared to justify a the prospective economic situation concerning continuation of the policy currently prevailing. More specifically,
it appeared desirable that sufficient reserves be provided so that bank credit could continue to expand. That would not necessarily mean that loan volume would expand. Conversations with bankers confirmed that current loan behavior was only partially explained by lessened loan demand and limited availability of funds. Bankers were reluctant to relax their own credit restraints in a desire to improve their banks' liquidity positions. Mr. Clay thought it was by no means clear what targets should be set in endeavoring to continue the recent improvement in the financial aggregates. One could begin by accepting the projections of financial aggregates in the blue book, as developed from page 3 to the middle of page 6,1/ and the money market conditions specified 1/ This section of the blue book read in part as follows: "Bank credit expansion is likely to continue in January, but at a slower pace than indicated by the large recent week-to-week increases. The increase in the January average of outstanding bank credit over the December average may be in a 7 - 9 per cent (annual rate) range, but this includes the carry-over effect on the monthly averages of the strength in the latter part of December. From the end of December through the end of January, a growth rate in the 4 - 6 per cent range appears likely . . . . The interest rate and credit demand assumptions appear consistent with expansion of time and savings deposits at all commercial banks by about 12 per cent in January on a monthly average basis . . Money supply in January is expected to show little or no net change on average. Private demand deposits may decline somewhat, partly rise of almost $1 billion in U.S. Government because of a projected deposits. But private demand deposits are not assumed to decline by as much as Government deposits rise . . . . These deposit pro jections imply a sizable expansion in aggregate reserves in January on average--in the order of 10 - 12 per cent for nonborrowed and total reserves. For December-January together, nonborrowed reserves may show an increase around the 5 - 7 per cent range."
at the top of page 4 1/ of the blue book. If those projections of financial aggregates did not generally materialize, it should be understood that instructions to the Manager would call for a modification of the money market targets such as those suggested 2/ on page 6 of the blue book. Alternative A of the draft economic policy directive, as defined in the accompanying staff notes,3/ appeared to Mr. Clay to be appropriate for the period ahead. Mr. Scanlon commented that economic developments in the Seventh Federal Reserve District in recent weeks had presented no surprises. There were indications that excessive pressures on productive resources had eased further. Unemployment compensation 1/ This material read as follows: "These projections assume that the 3-month bill rate stays roughly within the recent 4.75 - 4.85 per cent range over the period ahead, that net borrowed reserves fluctuate around $100 million, and that Federal funds and dealer loan rates back down some what from recent high levels of around year-end." 2/ This material read as follows: "If the Committee wishes to continue a gradual reduction in the degree of monetary restraint, it might call for open market operations to achieve a set of money market conditions that might include a net borrowed reserve position averaging close to zero and Federal funds averaging near 5 per cent. This would, in all likelihood, bring the 3-month bill rate down to a 4.60 - 4.75 per cent range." 3/ The staff notes suggested using the complex of money market conditions cited in note 1/ as a description of the general kinds of conditions to be maintained if alternative A were to be adopted by the Committee.
claims in December were somewhat higher in each of the District States than in December 1965, but were still at very low levels. The increases had been particularly evident in automobile manufac turing centers. Also, the rise in help-wanted advertisements in major newspapers, while increasing somewhat further, had not maintained the spectacularly large increases of earlier months. Price increases continued to be announced in a variety of goods and services, Mr. Scanlon noted, notwithstanding the evidence of better balance in the over-all supply-demand situation. The demand for construction equipment had weakened further and major did not see an early end to that development. firms in that industry with businessmen, Mr. Scanlon said, he In conversations the possibility of their finding a greater sensitivity to detected with excessively large inventories. A number of firms themselves inventories. That had been noted had reported plans to reduce even though there had been some especially in steel-using firms, of strengthening demand for steel. But thus far, evidence recently situation had been a more balanced supply-demand the transition to excessive pessimism. and had not engendered orderly remarked, District banks the banking scene, Mr. Scanlon On credit during December. sharp increase in shared in the rather needs of securities mainly the temporary expansion reflected Loan in business and consumer companies. Increases dealers and finance
loans were relatively small compared with other recent Decembers. The recent growth in deposits which had accompanied the easier money market had made it possible for the large banks to acquire some Governments as well as to make additional money market loans, and the largest banks had shown a significant reduction in their loan ratios since early December. Some rebuilding of liquidity was to be expected, and banks as well as dealers might find many Governments and municipals attractively priced, given the expecta tion of further declines in interest rates in the period ahead. Mr. Scanlon reported that large District banks had acquired more than $150 million through net sales of negotiable CD's since mid-December, and had shown substantial gains through savings-type certificates following their recent boost in rates offered on While they had attracted some new money, large those instruments. banks in Chicago estimated that about three-fourths of the gain denomination resulted from the transfer of in CD's under $100,000 other deposits in the bank. Current rate relationships appeared to continued growth in deposits and credit. conducive while Mr. Scanlon would not be satisfied with As to policy, magnitude of the increase in bank credit and reserves pro the large jected for January if there were reason to expect it to continue, both on the plus side again. Even after he was happy to see them projected for January, total reserves would the sizable increase
still be below the levels of last September. In view of the signs of hesitancy in the private sector of the economy, he thought it desirable to continue the upward momentum in total reserves, possibly over the longer range at a somewhat slower rate than pro jected for January, but hopefully at a sustained rate. Mr. Scanlon said that his views on policy closely paralleled those of Mr. Mitchell. While he could accept alternative B of the draft directives in light of Mr. Axilrod's explanation, he favored alternative C since it provided for a wider range of fluctuation in money market conditions if that proved to be a necessary conse quence of operations directed at maintaining the desired rates of monetary aggregates. He believed that the Committee growth in either aggregate reserve measures or money market could stabilize could not stabilize both concurrently. conditions, but that it probably that the indices of economic activity Mr. Galusha reported Ninth District confirmed the District's historic lagging in the reflected a considerable momentum. role, for most of those measures indicated a developing pessimism, however. Recent personal interviews no less than in the nation, the In the Ninth District, during December, Mr. Galusha situation of banks eased appreciably of District banks increased more than said. Total deposits banks, the rise in total loans and seasonally; for weekly reporting
investments was double the usual seasonal increase. The December drop in the average loan-deposit ratio was very sharp at weekly reporting banks, and those banks ended 1966 with a lower average ratio than they had at the end of 1965. The largest Ninth District banks were able to increase the average maturity of their CD's somewhat. And, finally, he might mention that among Twin Cities bankers speculation had turned to when a reduction in the prime rate would come. In a way, Mr. Galusha observed, all that was gratifying. Banking developments, both in his District and in the nation, could be interpreted as showing that Committee policy was having the desired effect. But the Committee was perhaps some way still from getting the supply-side loan response that appeared to be needed. That suggested that pressing further--continuing the trend to lower market interest rates--would be appropriate. In that regard, it was considerable importance that the Bundesbank had been so obliging. of Possibly now the Bank of England would follow the Bundesbank's lead. For himself, then, Mr. Galusha favored a slight--and he would emphasize the word slight--further reduction in market interest at this time. He recognized, though, that there was something rates to be said for pausing now--for holding to the status quo at least briefly--although with a Treasury financing to be announced late in January, that hold could be too lengthy.
But one thing was clear, Mr. Galusha said. The Committee could not afford a return of market rates to previous, higher levels. According to the blue book, the recent welcome decline in the bill rate was in considerable measure the result of expectations. But from tonight on, and for the next few weeks, expectations could prove quite volatile. And the Committee should not, he believed, allow any change in expectations to result in higher interest rates. It could be that, to maintain the present structure of rates, the level of net borrowed reserves would have to be reduced somewhatpossibly to between zero and $100 million. Without knowing what the President was going to say tonight and in messages to come, Mr. Galusha continued, it was not easy to policy targets. But perhaps it was enough for the Committee talk of to agree that, at the very least, the Manager should be given all the latitude possible to resist fully any trend to higher interest about announced fiscal rates stemming possibly from disappointments B or C of the draft directives appeared policies. Either alternative appropriate. Mr. Galusha said he might replow an old furrow In concluding, be given to structural reform of and urge again that further thought and, more particularly, to lower requirements reserve requirements he was at least as concerned with the for small banks. At the moment
System's image in Sleepy Eye as in Zurich. Lest that appear exces sively parochial, it might have further usefulness for the System because--depending upon what the Administration decided about taxesthe Committee might want some way of dramatizing a switch to still greater monetary ease and, unfortunately, a reduction in discount rates would seem out of the question at present. Mr. Swan said that in December business loans of Twelfth District weekly reporting banks again rose considerably more than in the rest of the country, as they had in November, although the less than in the same month last year. Also increase was somewhat continuing in December was a greater than national increase in total time and savings deposits at commercial banks, as large negotiable CD's outstanding increased somewhat more than elsewhere. Some indications were appearing that the larger banks were reluctant to go beyond six months' maturity in their large CD's. Although most indicated that the matter was subject to negotiation, banks still one bank had adopted a definite policy of not going beyond six months. bank had announced a reduction in maximum rate, from 5-1/2 Also, one to 5-1/4 per cent, on long maturity CD's. There were strong indications in the latest survey, Mr. Swan that in both the District and the nation the lending continued, practices of most banks were unchanged from three months earlier. Four of the 17 reporting banks in the District indicated that loan
demands had weakened in the past three months, but none reported that they expected demands to be weaker in the first quarter of 1967. Similarly, their willingness to make loans remained essen tially unchanged. The only cases of increased willingness to lend involved two banks, which expressed that attitude with respect to consumer instalment loans. At the other extreme, eight of the 17 District banks indicated reduced willingness to make mortgage loans structures. Those findings suggested to him there on multifamily was still some question of the availability of supply to be worked out before much reaction could be expected in the lending policies Like Mr. Mitchell, he was somewhat concerned about of banks. banks' attitudes regarding the strength of underlying loan demands. As to monetary policy, Mr. Swan said, it seemed to him that gloomy cast of both the green book analysis and the the relatively discussion today suggested that the Committee perhaps should move of ease. However, he did not somewhat further in the direction was sufficiently clear to justify a marked believe that the evidence In view of the balance of payments situation, move at this juncture. market, the fact that the Adminis the still relatively tight labor economic policy views before would be announcing its current tration next meeting, and the fact that a Treasury financing, the Committee's he would prefer to see a not a major one, lay ahead, even though weeks, rather than a more change over the next two rather gradual
abrupt move that might lead to various kinds of undesired market interpretations. He would certainly like to see some increase in bank credit, and also in the money supply. He favored alternative B, but because he would interpret "somewhat easier conditions" rather conservatively, he was not sure that he advocated the same specific targets as others who also favored that alternative. He would hope to see the bill rate around 4-3/4 per cent, the Federal funds rate around 5 per cent, and marginal reserves ranging from $100 million net borrowed reserves to zero, but not becoming positive. with Mr. Brimmer that if much easier money market conditions He agreed and interest rates moved down further the Desk should not developed try to offset those changes, but that such conditions should not be He also saw no objections to operations in the actively sought. longer term area on a fairly small scale. noted that some sentiment had been expressed in Mr. Swan adopting alternative C, which called for fostering moderate favor of expansion, for the second paragraph of the directive. bank credit specified the Committee's immediate goal, and The second paragraph it should be formulated in terms of conditions in he thought that B. However, he would suggest the money market, as in alternative of accommodating bank credit a reference to the objective including practice during most of since it had been the Committee's expansion last year to refer to bank credit in the concluding "policy" sentence
of the first paragraph. The third sentence of the staff's draft of the first paragraph noted that "bank credit expansion has resumed"; the last sentence of that paragraph might be revised to say that it was the Committee's policy to foster money and credit conditions, "including bank credit expansion", conducive to noninflationary economic expansion. In a final comment on the first paragraph, Mr. Swan said he appreciated the staff's suggestion that the language of the balance of payments reference should be changed even though no change in substance was proposed, in order--as the notes attached to the draft said--to indicate that the payments balance was receiv ing the continuing attention of the Committee. But the new language the staff proposed, by referring to "trends in international trans actions", seemed to imply a more basic change in the situation than in fact there had been. Accordingly, he would suggest continuing the reference used in the previous directive. Mr. Irons reported that economic conditions were generally strong in the Eleventh District. At the same time there were the of slowing rates of growth that cross-currents and the indications were evident in the national economy. Slackening in autos, and other areas was partially offset by the generally construction, level of activity prevailing. Employment was up in virtually high
all categories, and the unemployment rate was low--about 2 per cent. There were signs that labor market pressures might have lessened somewhat, but not significantly. Production in the District also was up. On the other hand, department store sales had not been as favorable as had been hoped. Construction activ ity was a little lower than might have been expected, but the difference was not of large magnitude. Sales of automobiles had been relatively favorable; in December they were within 1 per cent of the year-ago volume. As to District financial conditions, Mr. Irons continued, there were increases in the past month in commercial and industrial loans, demand deposits, and both total time deposits and CD's. The reserve positions of District banks were somewhat less strained Banks still were borrowing through the Federal funds than earlier. market but in smaller volume. Borrowings from the Reserve Bank for window-dressing purposes normally were expected over the year-end, but this year there had been virtually no activity at the discount window in that period. The national picture had already been well described, that most indicators showed a Mr. Irons said. He recognized but here again the differences were tendency towards slower growth, to be the nature of the small. The major uncertainty continued
actions that would be taken in the public sector. Some of the answers on that subject would be obtained from the President's State of the Union message this evening, and more would be forth coming in messages to be delivered over the next few weeks. The markets seemed to have adjusted to the considerable shift toward ease that had been made by the System. It was the general feeling in his District that credit policy had become easier; the question was how much easier policy would be. Mr. Irons commented that he was disturbed by the deteriora tion in the balance of payments and the possibility of worsening in the gold situation. The problems in those areas were serious, and they probably deserved an increasing amount of thought and attention on the part of the Committee. Today, Mr. Irons said, he would favor maintaining an even keel, continuing the present conditions in the money market. The figures that a number of other members had indicated they would emerge seemed appropriate to him. He was not sure that like to see it would matter a great deal which of the three alternative directives the Committee adopted. He thought the staff had done drafting job, formulating each alternative to an excellent incorporate a concluding phrase that appropriately modified the earlier language. On balance, however, in view of various considerations--including the Treasury financing, the basic economic
situation and outlook as he saw it, the uncertainties with regard to the public sector, and the balance of payments situation--he favored alternative A. Mr. Ellis said that the New England economy, measured in real terms, appeared to have slowed its rate of advance. Manufac turing workweeks shortened slightly in November, and the man hour index declined a fraction. The index of factory output likewise leveled in November from its October peak. Manufacturers' shipments in the fourth quarter declined from the previous quarter, as they had projected, but were scheduled to rise sharply in the current quarter. Bankers continued to report strong loan demand, Mr. Ellis noted, but they were taking moves to restore liquidity before expanding lending. Liquidity ratios had risen more than seasonally and loan-deposit ratios had dropped noticeably since late November. At least one bank had cut its interest rate on large short-term business loans by 53 basis points, and the average for the large Boston banks had been a cut of 43 basis points in their lending rates between the September and December surveys. Meanwhile, they had become more selective in the rates they would pay for long-term CD money. Mr. Ellis reported having listened to some very direct language about the inequity of the revised voluntary foreign credit
restraint program. The thrust of one protest was against the 10 per cent limit on loans to developed countries since they were the countries most likely to be able to qualify for non-export related loans. The thrust of another protest was directed to the inequity of delaying access to the 109 per cent quota. Those "less cooper ative" banks who by last fall had reached their ceilings seemed free to disburse repayments without regard to the 10 per cent limit. Insofar as the banks felt they had been penalized for not having used their quotas, and insofar as they might be expected to have more lendable funds during 1967, it seemed only logical to expect them to move to and hold at their ceilings for fear of losing their quotas permanently. If that course was followed, it would naturally have a substantial negative impact on the U.S. balance of payments. He thought that was important if the Committee had any inclination to view the VFCR program as a shelter against an outflow of the it was putting into the economy. funds to monetary policy, Mr. Ellis said that the weight Turning last meeting had served of evidence emerging since the Committee's of the staff that the temperature to confirm the short-run forecasts cooling, which had been a economic climate had been slowly of the policy only six months ago. The clear objective of the Committee's shift in monetary policy commenced also revealed that the evidence
in mid-November had introduced a changed--and more optimisticoutlook for credit availability and effective market performance in the months immediately ahead. The paramount issue of policy was whether the easing trend should be accelerated or the present posture maintained. As Mr. Axilrod had noted, fundamental to one's judgment on that score was his evaluation of the underlying strength of the economy. His (Mr. Ellis') own resolution of that issue was that the economy was unlikely to experience anything more than a temporary "inventory" pause--a helpful consolidation period--if the country was committed to support a continuing war effort in Vietnam and continued expansion of other Government services at Federal, State, and local levels. He was inclined to view consumers as ready to utilize their enlarged incomes to expand spending when credit was available and uncertainties were reduced--conditions that seemed likely to prevail increasingly in the next several months, especially when the outlines of the Federal budget became clear. Mr. Ellis confessed to a considerable difficulty in persist in such an optimistic viewpoint while studying the well-presented ing analysis of the green book. By the same token, he found no difficulty in believing that the Committee had already obtained perhaps 80 per cent of the impact associated with public recognition of its change in policy. How hard should the Committee push to obtain the other 20 per cent? Should it flood the reservoir to insure leakage to the
economy? To postpone any further moves toward easing while awaiting the fiscal counterpart to the Committee's monetary actions seemed almost costless in terms of monetary effect to be achieved in the interim, and yet it would preserve a greater range of policy alter natives for selection when better information was available. In common with Mr. Mitchell he did not rule out the possibility of a bounce-back in bank lending. His premise that a "wait and see" posture would be virtually costless in a policy sense rested, Mr. Ellis observed, on the blue book evaluation of the manner in which bank credit expansion had resumed. The bank credit proxy had expanded at an annual rate of 7 per cent since the Committee's policy shift of mid-November and it was projected to expand at 7-9 per cent average rate in January without a further change in policy. Time deposit growth had resumed at an annual rate of 10.3 per cent, which was since mid-November the first half of last year--and was equal to the growth rate in the Committee used to think of as excessive. Without a rate that change, growth in time deposits was projected to further policy The staff opened its blue to 12 per cent in January. accelerate of prospective developments, absent further policy book discussion "Bank credit expansion is likely to actions, by indicating that in January, but at a slower pace than indicated by the continue
large recent week-to-week increases." From the end of December to the end of January the staff expectation was for bank credit expansion at a rate in the 4 to 6 per cent range, with net borrowed reserves averaging around recent levels. Total reserves were projected to rise at a 10 - 12 per cent annual rate on average in January. In his judgment those projections were an entirely accept able prospect and they encouraged him to specify as "targets" the underlying assumptions of a 90-day bill rate in the 4.75 - 4.85 per cent range, net borrowed reserves fluctuating around $100 million, and Federal funds and dealer loan rates somewhat below their high year-end levels. As he considered the three alternative directives, Mr. Ellis said, he had somewhat the same feeling as Mr. Irons had expressedtheir implications were rather similar. That led him to wonder why should accept any alternative other than A, which the Committee provided for modification of operations if bank credit growth deviated significantly from expectations. Adoption of either of the other alternatives would logically mean that the Committee sought expansion in bank credit at a rate in excess of 7 - 9 per cent, in reserves at a rate in excess of 10 - 12 per cent, and in time deposits at a rate in excess of 12 per cent. To seek such growth rates would seem to him to go beyond what might be called a "gradual" change. Accordingly, he favored alternative A.
Mr. Robertson then made the following statement: It is obvious that the effects of our easing of monetary policy are gradually spreading through the financial system, even though responses have been exaggerated in some markets by expectational influences, while being restrained in others by overhangs of caution, uncertainty, and institutional inertia. As yet, there have been few signs of any effects of such credit easing on actual spending decisions--they could hardly have been expected so quickly, given what we know about monetary lags. The business statistics flowing in seem to be indicating greater and greater moderation of underlying expansive forces, leaving us with a present rate of deceleration of growth that we would not want to see continued for very long. None theless, the economy still possesses significant elements of strength, to which some added buoyancy will be given as the easier credit climate begins to affect business decisions. I see no need, therefore, for aggressive further monetary easing today (particularly with the Government's fiscal program for calendar 1967 still up in the air). Furthermore, I am not sufficiently complacent about future price increases to be willing to push hard on the monetary accelerator at the first signs that the economy might slow down more than we contemplated when restrictive policies were formulated last year. I do think it is essential, however, for us to continue the gradual relaxation of monetary restraint that we launched a few weeks ago. We should be trying to create an environment in which we foster an orderly and moderate bank credit expansion, with some moderate recovery in large CD outstandings, a continued reasonable growth in consumer-type time and savings deposits (but not so vigorous as to pull funds away again from other intermediaries), and a money supply expansion savings that is neither so large nor so small as to have import change from the current flow of spending. for a significant To foster these intermediate objectives, we should seek some further easing of net reserve availability and related money market conditions in the interval between now and late January when "even keel" consider come to the fore. This means that I would like ations to see net borrowed reserves running regularly below $100 million (and perhaps occasionally positive), and
that I would dislike to see the Federal funds rate hanging up around 5-1/2 per cent or higher, or the bill rate running up appreciably and giving off confus ing signals to the market. But I want to emphasize, as I have in the past, that these money market factors should not be looked at as ends in themselves, and we should be quick to take moderating action as suggested by the "proviso" clause in the directive if our aggre gate credit objectives are not being fostered. As a practical matter, I know the Manager cannot reasonably expect to hit all the targets I have cited. Deviations in individual measures will inevitably occur, and they can even be positively helpful, so long as they are not disruptively large, because they will serve to keep both us and the market from settling into ruts. If, therefore, the Manager can manage to achieve some kind of average of the results I have been describing, I will be satisfied. With these views in mind, I would be prepared to vote for alternative B for the directive, as drafted by the staff. Chairman Martin commented that the Committee members seemed for the most part to be in agreement today. He personally was quite well satisfied with the way policy had gone since the decision to change; the Committee had been pursuing an easier, but not an easy, policy--a distinction he thought was significant--and he would want to continue on that course. Adoption of alternative B today would seem to him to be quite clearly consistent with such a policy. He rather disturbing operational problems could be thought some encountered if the Committee adopted alternative C. At its next meeting the Committee would have more information on prospective fiscal policy that could be taken into consideration, but for the time being he would propose adoption of alternative B as drafted.
The Chairman then suggested that the Committee vote on a directive consisting of the staff's draft for the first paragraph and alternative B for the second paragraph. Thereupon, upon motion duly made and seconded, and with Messrs. Irons, Shepardson, and Treiber dissenting, the Federal Reserve Bank of New York was authorized and directed, until otherwise directed by the Committee, to execute transactions in the System Account in accordance with the following current economic policy directive: The economic and financial developments reviewed at this meeting indicate further moderation in various expansionary forces and sharply increased inventory accumulation. The pace of advance of broad price measures has slowed, although upward price and cost pressures persist for many finished goods and services. Partly reflecting the recent modification of monetary policy, financial market conditions have become less taut than earlier and bank credit expansion has resumed. With respect to the balance of payments, trends in international transactions indicate a continuing serious problem. In this situation, it is the Federal Open policy to foster money and credit Market Committee's conditions conducive to noninflationary economic expansion and progress toward reasonable equilibrium in the country's balance of payments. To implement this policy, and taking account of forthcoming Treasury financing, System open market opera tions until the next meeting of the Committee shall be with a view to attaining somewhat easier conducted in the money market, unless bank credit appears conditions to be expanding significantly faster than currently anticipated.
It was agreed that the next meeting of the Committee would be held on Tuesday, February 7, 1967, at 9:30 a.m. Thereupon the meeting adjourned. Secretary
ATTACHMENT A CONFIDENTIAL (FR) January 9, 1967 Drafts of Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on January 10, FIRST PARAGRAPH The economic and financial developments reviewed at this meeting indicate further moderation in various expansionary forces and sharply increased inventory accumulation. The pace of advance of broad price measures has slowed, although upward price and cost pressures persist for many finished goods and services. Partly reflecting the recent modification of monetary policy, financial market conditions have become less taut than earlier and bank credit expansion has resumed. With respect to the balance of payments, trends in international transactions indicate a continuing serious problem. In this situation, it is the Federal Open Market Committee's policy to foster money and credit conditions conducive to noninflationary economic expansion and progress toward reasonable equilibrium in the country's balance of payments. SECOND PARAGRAPH Alternative A: To implement this policy, and taking account of forthcoming Treasury financing, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining about the currently prevailing conditions in the money market, but operations shall be modified as necessary to moderate any apparently significant deviation of bank credit from current expectations. Alternative B: To implement this policy, and taking account of forthcoming Treasury financing, 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 expanding significantly faster than currently antic ipated. Alternative C: To implement this policy, and taking account of forthcoming Treasury financing, System open market operations until the next
meeting of the Committee shall be conducted with a view to fostering expansion in bank credit at a moderate rate, but operations shall be modified as necessary to limit any sharp easing or firming of money market conditions.
Also: Record of Policy Actions