May 23, 1967

May 23, 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, May 23, 1967, at 9:30 a.m. PRESENT: Mr. Martin, Chairman Mr. Brimmer Mr. Daane Mr. Francis Mr. Maisel Mr. Mitchell Mr. Robertson Mr. Scanlon Mr. Sherrill Mr. Swan Mr. Wayne Mr. Treiber, Alternate for Mr. Hayes Messrs. Ellis, Hickman, and Galusha, Alternate Members of the Federal Open Market Committee Messrs. Bopp, Clay, and Irons, Presidents of the Reserve Banks of Philadelphia, Kansas Federal City, and Dallas, respectively Mr. Holland, Secretary Mr. Sherman, Assistant Secretary Mr. Kenyon, Assistant Secretary Mr. Broida, Assistant Secretary Mr. Hackley, General Counsel Mr. Hexter, Assistant General Counsel Mr. Brill, Economist Baughman, Hersey, Jones, Koch, Partee, Messrs. and Solomon, Associate Economists Holmes, Manager, System Open Market Account Mr. Mr. Fauver, Assistant to the Board of Governors Mr. O'Connell, Assistant General Counsel, Legal Division, Board of Governors Mr. Williams, Adviser, Division of Research and Statistics, Board of Governors Adviser, Division of International Mr. Reynolds, Finance, Board of Governors Miss Eaton, General Assistant, Office of the Secretary, Board of Governors

Mr. Kimbrel, First Vice President of the Federal Reserve Bank of Atlanta Messrs. Eisenmenger, Eastburn, Mann, Parthemos, Brandt, Tow, and Green, Vice Presidents of the Federal Reserve Banks of Boston, Philadelphia, Cleveland, Richmond, Atlanta, Kansas City, and Dallas, respectively Messrs. Fousek, MacLaury, and Olin, Assistant Vice Presidents of the Federal Reserve Banks of New York, New York, and Minneapolis, respectively Mr. Lynn, Director of Research, Federal Reserve Bank of San Francisco Mr. Geng, Manager, Securities Department, Federal Reserve Bank of New York By unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on May 2, 1967, were approved. By unanimous vote, the action taken by members of the Federal Open Market Committee on May 12, 1967, amending paragraphs 1A and 2 of the authorization for System foreign currency operations, effective May 17, 1967, to read as follows, was ratified: and sell the following foreign currencies 1A. To purchase through spot or forward trans in the form of cable transfers at home and abroad, including actions on the open market Fund established by transactions with the U.S. Stabilization of 1934, with foreign monetary 10 of the Gold Reserve Act Section Bank for International Settlements: and with the authorities, Austrian schillings Belgian francs Canadian dollars Danish kroner Pounds sterling French francs German marks Italian lire

Japanese yen Mexican pesos Netherlands guilders Norwegian kroner Swedish kronor Swiss francs 2. The Federal Open Market Committee directs the Federal Reserve Bank of New York to maintain reciprocal currency arrangements ("swap" arrangements) for System Open Market Account with the following foreign banks, which are among those designated by the Board of Governors of the Federal Reserve System under Section 214.5 of Regulation N, Relations with Foreign Banks and Bankers, and with the approval of the Committee to renew such arrangements on maturity: Amount of Maximum arrangement period of Foreign bank (millions of arrangement dollars equivalent) (months) Austrian National Bank 100 12 National Bank of Belgium 150 12 Bank of Canada 500 12 National Bank of Denmark 100 12 Bank of England 1,350 12 Bank of France 100 3 German Federal Bank 400 6 Bank of Italy 600 12 Bank of Japan 450 12 Bank of Mexico 130 12 Netherlands Bank 150 3 Bank of Norway 100 12 Bank of Sweden 100 12 Swiss National Bank 200 6 Bank for International Settlements System drawings in Swiss francs 200 6 System drawings in authorized European currencies other than Swiss francs 200 6

Before this meeting there had been distributed to the members of the Committee a report from the Special Manager of the System Open Market Account on foreign exchange market condi tions and on Open Market Account and Treasury operations in foreign currencies for the period May 2 through May 17, 1967, and a supplemental report for May 18 through 22, 1967. Copies of these reports have been placed in the files of the Committee. In comments supplementing the written reports, Mr. MacLaury reported there had been no change in the Treasury gold stock this week nor had there been any change since February. As recently as yesterday it had appeared that no reduction would be required for the next few weeks, but that was no longer certain. Various developments had resulted in a sharp increase in gold market activity. Turnover in the London market, which normally averaged about $5 million a day, had risen to near-record levels in recent days: $20 million on Friday, roughly $20 million again yesterday, and $30 million today. The gold pool had suffered substantial three days, totaling about $65 million. The losses in the last activity reflected a combination of factors. The heightened disturbances in Hong Kong, and more particularly the political increased threat of war in the Middle East, were important. The last Thursday to suspend sales of silver U.S. Treasury's decision for export added a further element of uncertainty, especially

since it followed on the heels of last month's discussion of U.S. gold policy. The European press had played up the possibility that what had been done with silver could also be done with gold, although on any reasoned basis it was clear that the two situations were not parallel. As the Committee knew, Mr. MacLaury continued, only the fact that South Africa had been running down its reserves (by $125 million in gold since the end of 1966) had kept the pool deficit in a manage able range this year. At the moment there was only $40 million available to the pool without further discussion among the members, and an additional $50 million could become available after consulta tion. How quickly that margin could disappear was indicated by the pool's losses in the last few days. In the exchange markets, Mr. MacLaury said, the most troublesome development had been the weakening of sterling. immediately The momentum of recovery that had been so evident during the first year ended rather abruptly this month, and for the few months of the two weeks the Bank of England had had to extend intermittent--and past rate. Again, a combination of times sizable--support to hold the at point reduction in the responsible: first, the one-half factors was per cent, together with the rise British Bank rate on May 4 to 5-1/2 pull of London rates rates, had reduced the relative in Euro-dollar important, the disappointing April trade on foreign funds; more

figures, released May 11, triggered the first sharp sell-off of sterling in many months; and finally, of course de Gaulle's press conference a week ago, in which he painted in starkly negative terms the hurdles Britain would have to surmount to attain member ship in the Common Market, added a further blow. Those develop ments, together with the political disturbances just mentioned in connection with gold, put sterling under substantial pressure. For the month to date, the Bank of England had lost, net, well over $100 million in market support operations. At the beginning of the month the British had repaid the final $150 million of balance credits, as required by the rise in such balances sterling during the preceding month. In addition, the Chancellor announced in Parliament early this month--before the reserve losses--that the U.K. would prepay $485 million to the International Monetary Fund and Switzerland on May 25. It was still too early to forecast as a whole would turn out; the British took in $22 how the month today the sterling market had been quiet. million yesterday and If the line were drawn now, however, British reserves would be the end of last month as a result down nearly $800 million from operations and debt repayments. Clearly, of its market support more than half explained by the any such drop--even though Monetary Fund and Switzerland--would repayments to the International on the market. Thus, the have a seriously damaging impact

possibility of bringing into the reserves the remaining British portfolio was being actively discussed, as was the possible necessity of resorting once again to short-term assistance. On the continent, Mr. MacLaury observed, the dollar had generally remained weak. A number of central banks had been taking in dollars. Early in the period the System utilized some $30 million equivalent of its Belgian franc balances under the fully-drawn portion of its swap arrangement with the Belgian to absorb an equal amount of funds taken in by National Bank More recently, there had been a particularly heavy that Bank. dollars into Switzerland where the relative tightness movement of added to the inflows generated by political of the money market had and more recently by the pressures on sterling. uncertainties Bank had taken in from the market Since May 10, the Swiss National course, it would be receiving some well over $100 million, and, of British prepayment. Thus, the $80 million on Thursday from the ways to absorb close to $200 U.S. faced the prospect of finding sale undoubtedly would be part million from the Swiss. A gold be that the System would have package, and it might well of the them. Certainly, the out its swap arrangement with to reactivate summer months was not reassuring, for the dollar over the look meeting, there was indicated at the last and as Mr. Coombs had network would have to be that the System's swap every likelihood heavily relied upon.

Mr. MacLaury went on to say that Mr. Coombs originally had expected to wait until today to ask for the Committee's formal approval of the addition of the central banks of Denmark, Mexico, and Norway to the swap network. However, the develop 1/ ments mentioned in his message of May 12 transmitted by wire 1/ to Committee members made it seem desirable to request approval at that time. As indicated in that message, Denmark particularly wished to be able to announce its new swap arrangement on May 18 along with Norway, and Mexico preferred that its arrangement be announced at the same time. In Mr. Lang's conversations with the Venezuelans following the Committee's preceding meeting, they had indicated that they appreciated being kept informed on developments, but since there was no present prospect of Venezuela's moving toward Article VIII status in the near future they understood that the System would wish to proceed with the other countries involved With respect to the renewal of the swap arrangement with the Bank of France, the developments following the preceding meeting had been reported to the Committee in a memorandum from 2/ Mr. Coombs dated May 9, 1967. He (Mr. MacLaury) had little to add to the information in the memorandum, except to say that 1/ A copy of this telegram has been placed in the Committee's files. 2/ A copy of this memorandum, entitled "Swap arrangements with Common Market countries; discussions at Basle, May 6-7," has been placed in the Committee's files.

Mr. Coombs felt that the frank discussions with the European central bankers had done a lot to clear the air and to bring home the importance of the swap network to them as well as to the United States. The prospect that the System might be prepared to drop one of its arrangements--that with the Bank of France-- was sobering to the Europeans. In that connection, Mr. Coombs had asked him to say that the firm stand the Committee had taken at its preceding meeting had been of great help to Messrs. Hayes and Coombs in their discussions with the Europeans. Mr. Brimmer asked whether the operation of bringing the remaining British portfolio into their reserves would have any effect on the U.S. balance of payments. In reply, Mr. MacLaury commented that the British portfolio no longer included any equities. They did hold a substantial volume of debt securities with maturities of over one year, particularly U.S. agency issues. If they liquidated those holdings or converted them into shorter-term issues the effect would be to increase the U.S. deficit. However, the British appeared to have adequate cash on hand, so even if they brought the portfolio into reserves they would not necessarily convert it immediately. The effects on the U.S. deficit might thus be spread over time. Mr. Maisel asked whether there was any significance to the fact that the U.S. Treasury recently had redeemed bonds denominated

in Belgian francs held by the Belgians in an amount--$30 millionequal to that involved in the System's current disbursements under the Belgian swap line. Mr. MacLaury responded that the Treasury had accumulated $30 million in Belgian francs last fall, and since the Belgians had asked to have the bonds paid off at maturity the Treasury had used the francs to redeem them. It was simply coincidence that the System's subsequent use of the swap line had involved the same figure. He added that there was no reason at this stage to believe would not consider taking on additional bonds that the Belgians at a later date if that seemed appropriate. said he was disturbed by statements in Mr. Coombs' Mr. Mitchell first, that there had been an memorandum of May 9 to the effect, bank governors of the Common Market that agreement by the central full opportunity to express its the Federal Reserve would have any new binding agreement, those central banks reached views before be worked out under which that an agreement might and secondly, the French would have a except that with all the swap agreements As he understood the at the end of the year. common maturity date in arranging common Europeans had been interested matter, the surveillance. Was it maturity dates to facilitate multilateral up its resistance to the that the System had given valid to infer by the Common Market to put the network under surveillance efforts

countries, and was now willing to accept such surveillance at the end of each year? Or was that still a matter for negotiation? Mr. MacLaury replied that the question of the kind of agreement that would be negotiated between the Common Market central banks and the System remained completely open. Mr. Mitchell's point regarding common year-end maturity dates was well taken, but perhaps equally important was the agreement by the Common Market central banks to abandon their efforts to present the System with a fait accompli. Those central banks, of course, had every right to discuss their swap lines with the System among themselves, but the fact was brought home to them that the System was disturbed by their action in taking a firm decision regarding those arrangements without consulting the Federal Reserve. Secondly, Mr. MacLaury said, while it was probable that there would be a move toward a common maturity date--although the matter was still open--that move would involve not only the with the Common Market central banks but also those arrangements System's other partners in the network. If only the with the Market countries were involved, observers might conclude Common that the System had agreed to surveillance by them. But if the general such an impression was less likely to be shift was more created.

Mr. Mitchell then said he thought the Committee should discuss the matter further before the negotiations proceeded. It was possible that the System might already have traded away much of its potential for resisting surveillance by agreeing to negotiate about a common year-end maturity date. In any case, a discussion would give the Special Manager a full understanding of what the Committee would like to accomplish. Mr. Daane agreed that such a discussion would be highly useful. He added that the Special Manager had been conscious of the problem Mr. Mitchell had noted. It was clear that avoiding a common maturity date would be preferable from the System's point of view, but it was important to recognize that the Common Market countries felt quite keenly on the matter of multilateral surveillance. Chairman Martin proposed that the discussion Mr. Mitchell had suggested be put on the agenda for the next meeting of the Committee. Mr. Wayne noted that he also had been disturbed by the suggestion that there be common maturity dates for the swap not necessarily question such a arrangements, although he would it would be desirable to have a memorandum from move. He thought meeting, commenting on the in advance of the next Mr. Coombs dates and providing a fuller significance of common maturity

explanation of the implications of having the whole network on that basis rather than just the Common Market central banks. Mr. Hickman observed that the Committee's interest in avoiding a common maturity date had been evident in the dis cussion at the preceding meeting. Mr. Robertson noted that the question at issue then had concerned quarterly, rather than annual, common maturity dates. Mr. Brimmer recalled a comment of Chairman Martin's at the preceding meeting, when he had been asked whether it was his feeling that the Committee should run the risk of having its swap arrangements brought under the surveillance of the Common Market. The Chairman had replied that it was not yet clear to him how serious that risk was, since much depended on the attitudes of the Germans and the Italians. In his (Mr. Brimmer's) judgment, it was understood at that time that the Committee would agree to negotiations with the Common Market on not automatically the basis of multilateral surveillance. Chairman Martin concurred. He felt that the System had not tied its hands, and that the Committee should keep the matter under In his judgment Messrs. Hayes and Coombs had con consideration. ducted the recent negotiations in an excellent manner.

By unanimous vote, the System open market transactions in foreign currencies during the period May 2 through 22, 1967, were approved, ratified, and confirmed. Mr. MacLaury then noted that the $50 million supplementary standby swap arrangement with the National Bank of Belgium, origi nally negotiated in September 1966, would mature on June 30, 1967; and the full $150 million swap arrangement with the Netherlands Bank would mature on the same date. Both had terms of three months, and he recommended their renewals for additional terms of the same length. As noted in the preceding discussion, there might be a general move toward one-year terms in the System's swap arrangements but that, of course, had not yet been negotiated. By unanimous vote, renewal for further periods of three months of the $50 million supplementary standby swap arrangement with the National of Belgium, and the $150 million Bank standby swap arrangement with the Bank, both scheduled to Netherlands on June 30, 1967, was approved. mature Mr. MacLaury then noted that, as the Committee would recall, swap arrangement with the under the $100 million, twelve-month in effect before September Belgium that had been National Bank of for both parties to make been the established practice 1966, it had six months. That drawing with a maturity of a $50 million drawing its renewal for a June 22, 1967, and he recommended would mature on

further period of six months. As he had indicated, the System now held in balance $20 million in Belgian francs, having utilized $30 million of the fully-drawn portion of the arrangement earlier this month. Renewal for a further period of months of the $50 million drawing six on the swap arrangement with the National Bank of Belgium, scheduled to mature June 22, 1967, was noted without objection. Chairman Martin then invited Mr. Daane to report on developments at the meeting of the Deputies of the Group of Ten which he had attended last week. Mr. Daane said that the Deputies had met in Paris for a day and a half on May 18 and 19. The sessions were largely devoted to further discussion of the unresolved technical issues relating to reserve asset creation that he had mentioned at the previous meeting of the Committee--namely, whether the new asset should be transferable directly or indirectly, whether it should involve in the Fund or separate resources in the Fund or pooled resources and whether repayment provisions should be in a Fund affiliate, It was fair to say that some further progress attached to the asset. in narrowing the differences of view on those technical had been made His own judgment was that the remaining differences probably issues. could be resolved on the issues of transferability and fund resources.

The issue of repayment provisions was the most difficult of the three because it went to the heart of the question of whether the new asset should be credit-like--which was the French view--or money-like, which the U.S. favored. From what he had gleaned outside the formal sessions, it appeared that the French were prepared to take a fairly hard position on that issue, and might drop out of the whole exercise unless they won agreement with their position. The U.S. delegation had submitted two papers, Mr. Daane continued, of which one updated the illustrative Fund scheme for a new reserve unit. Realistically, however, the U.S. representatives did not see much chance for a new reserve unit to emerge from the The second U.S. paper not only updated the Fund's discussions. scheme for a drawing right but improved on the type illustrative That paper had been submitted during of drawing right envisaged. the course of the meeting and was not discussed. Daane went on to say that on the fourth unresolved Mr. Deputies had made no progress. issue--that of decision-making--the a political issue which, he felt sure, would Quite clearly that was level. The Common Market countries have to be resolved at a higher of 85 per cent of votes calling for a majority wanted requirements and they would majority of creditor countries; in the Fund and a greater weight to their Fund votes adjusted to give like to see

countries. The U.S. proposal involved a two-stage voting plan, which had been labelled the "band" proposal. It called for a scheme to go into effect if it won 90 per cent of the votes, and for a second vote to be held if the proportion favoring the scheme fell in the band between 75 and 90 per cent. In the second vote a majority of at least 75 per cent would be required to carry. The U.S. response to the insistence of the Common Market countries on an 85 per cent requirement was to narrow the band involved in its own proposal. As he had indicated, however, the question of decision-making was not likely to be resolved by the Deputies of the Group of Ten. It would have to go at least to the Ministers and Governors. The technical issues would be considered further at a joint with the Executive Directors of the Fund in meeting of the Deputies Paris on June 19 - 21, Mr. Daane said. That presumably would be a meeting of the Ministers and Governors of the Ten. followed by outlines of a plan would be presentable Hopefully, at least the broad time of the meeting in Rio de Janiero in September. by the asked whether Mr. Daane now felt somewhat less Mr. Galusha confident about the probable outcome of the discussions than he had at the last meeting of the Committee. replied that perhaps he was a little less confi Mr. Daane he had been earlier. The position taken by the French dent than

representatives seemed to be closely related to what their government was likely to be willing to accept, and there was no assurance that the other Common Market countries would be willing to go ahead without France. He supposed the key question concerned the attitude of Germany. But the matter lay in the political realm, where he could not offer an expert judgment. Before this meeting there had been distributed to the members of the Committee a report from the Manager of the System Open Market Account covering open market operations in U.S. Government securities and bankers' acceptances for the period May 2 through 17, 1967, and a supplemental report for May 18 through 22, 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: Even keel considerations were the paramount factors guiding open market operations over much of the period since the Committee last met. While there were substantial movements in interest rates in response to basic market factors and shifting expectations, there was a generally comfortable tone in the money market with reserve avail ability a bit on the generous side. At the time of the last meeting the books were open refunding, and, amid uncertain market on the Treasury's May conditions, the outcome was still in doubt. A small amount for Treasury investment accounts was made and of purchases gradually improved before the books closed the atmosphere was relatively high on the on May 3. Although attrition May and June maturities, the Treasury was able to achieve a significant amount of debt extension. Most importantly, of $1.3 billion of Government securities maturing holders exchange larger than in August elected to prerefund--an

many market participants had expected. In view of the Treasury's heavy cash needs in the second half of the calendar year it was indeed useful to reduce the size of the August refunding to routine proportions. While dealers as a group did not take an exces sively large position in the new issues, a few dealers had acquired sizable blocks of the five-year 4-3/4s. As a result, when prices of Government securities deteriorated again a few days after the books had closed, reflecting continuing pressures in the corporate and municipal markets, a booming stock market, and generally buoyant general business expectations, there were heavy professional offerings of intermediate-term Governments in the market. In this atmosphere Treasury investment accounts purchased about $240 million high coupon issues maturing in 1971 to 1974. These purchases were helpful in reducing an overhang of securities in the market without interfering with basic market forces determining interest rates. System purchases of coupon issues were deferred until two days after payment date for the issues offered in the refunding, when, as the written reports indicate, $101.6 million were purchased on a market go-around. Given the downward pressure on Treasury bill rates and the availability of intermediate- and longer-term Government securities, these operations were generally taken by the market in stride, without creating any exaggerated expectations about System interest rate intentions. Over the next three weeks, as the blue book 1/ indicates, it looks as if the System will have to provide about $0.5 billion in reserves unless the Treasury should have to run its balance at the Reserve Banks down before mid-June. After mid-June the situation will be temporarily reversed. Market conditions at the moment would make it feasible to meet a significant pro portion of these needs--perhaps half--through the purchase of coupon issues. The availability of coupon issues and the widespread demand for Treasury bills, noted earlier, are technical factors that tend to make such a pattern of 1/ The report, "Money Market and Reserve Relationships," prepared for the Committee by the Board's staff.

operations feasible. From a policy point of view, operations in coupon issues would make some marginal contribution to the flow of funds in longer-term markets by relieving the overhang of Government securities now in the market. There are risks, however, that an overly aggressive approach to the purchase of coupon issues would lead the market to believe that the System was attempting to establish a pattern of long-term rates. Creation of such an impression would, in my view, be unfortunate since it could lead to an avalanche of offerings to the System and since our operations to supply reserveson current forecasts--would be, at least temporarily, reversed in mid-June. Thus a cautious approach appears called for. I would agree with the blue book that there might be only limited effects on market trends provided expectations do not get out of hand. Current rate trends have been described in detail in the various written reports to the Committee. While the downgrading of some recent economic statistics has dampened somewhat the exuberant view of the economy that prevailed a few weeks ago, expectations are for a strong second half of the year. The weight of corporate and municipal financing continues apace--the June corpo rate calendar now appears likely to exceed the record March calendar, the demand for funds in the tax-exempt area continues to run high, and an announcement of $880 million FNMA participation certificates is expected momentarily by the market. The corporate calendar has been building for July and August with a growing volume of convertible debentures in the works, and the debt limit hearings have done nothing to allay market apprehension of major Treasury and Government agency needs, including PC's, in the new fiscal year. In fact, the proposals for modification of the 4-1/4 per cent interest rate ceiling had quite a depressing influence, particularly on the market for 5-10 year Treasury issues. Long-term rates have, of course, moved significantly higher but further testing of the market is needed to see whether a trading range can be established. Short rates, in contrast, have generally moved lower with investors tending to hole up in the short maturities while market developments unfold. Banks have found it difficult to place CD's with maturities of a year or more, and rates

in that area have moved close to 5 per cent. In yesterday's bill auction average rates of 3.49 and 3.69 per cent were established respectively on 3- and 6-month Treasury bills, down 28 and 22 basis points respectively from the auction preceding the last meeting. The impact of the massive corporate debt restructuring so far this year on the demand for bank credit is still not clear. Many banks report a continuous business loan demand, but it is hard to determine how much this reflects a precau tionary firming up of commitments and how much an early need for cash on the barrel head. As you know, bank credit in May appears to be expanding only moderately on average, and despite the final round of tax acceleration, the June credit proxy forecast is for only a 5 per cent annual rate of growth. Perhaps the forecast is too conservative, but it appears to be a modest growth rate in light of the over-all demand for credit that is apparent in financial markets. Mr. Hickman asked whether the Manager foresaw a tapering off in corporate and municipal bond offerings over the summer months. Mr. Holmes replied that it was very hard to judge when might taper off. Although some issues had been postponed offerings the corporate calendar appeared likely to be very heavy recently, and August, and municipal offerings would probably through July continue in a steady stream. that he had heard reports of investors Mr. Scanlon noted in disposing of fairly large who were encountering difficulties He asked whether that was a general blocks of Government securities. phenomenon. tax reasons there was a tremendous Mr. Holmes replied that for the long-term market, as well as of swapping going on now in amount

some outright selling. However, it was difficult to move large amounts of securities unless one happened to find a buyer with the right needs, because dealers were not willing to build up their positions. Mr. Daane asked whether his understanding was correct that the Manager saw positive advantages in supplying some reserves through operations in coupon issues--in relieving the market over hang and countering downward pressure on bill rates--even though he might be moving against the trend of long-term rates. Mr. Holmes replied affirmatively. As he had indicated, any coupon operations would have to be handled cautiously. But operations on a fairly sizable scale need not be disturbing to the market, given the availability of coupon issues at present and the demand for bills. And, in themselves, they need not have impact on interest rates. a major Mr, Mitchell remarked that he was a little disturbed by emphasis on the need for caution. It seemed to him the Manager's of market expectations the Desk would that with the present state in coupon issues in order to have any have to operate aggressively significant effect. the volume of coupon operations Mr, Holmes replied that might be feasible in the coming period--on that he had suggested sizable relative to past System the order of $250 million--was

operations, although it was not large relative to the over-all volume of market transactions. By unanimous vote, the open market transactions in Government securities and bankers' acceptances during the period May 2 through 22, 1967, were approved, ratified, and confirmed. Chairman Martin then called for the staff economic and financial reports, supplementing the written reports that had been distributed prior to the meeting, copies of which have been placed in the files of the Committee. Mr. Koch made the following statement on economic conditions: It may be a late spring this year, meteorologically speaking, but it was an early spring, economically-speaking. The news for March and early April was most encouraging, with consumption, production, and housing up; the unemploy ment rate steady at a low level; and the rate of inventory accumulation down sharply. But more recently, we have had a flurry of less favorable news again. First, we learned that the earlier estimated rise in consumption had been exaggerated. Then, that employment and industrial production had been weaker in April. More recently, the news has included the fact that the real GNP actually declined a little in the first quarter. To state my conclusion on the economic outlook before let me say at the outset that I agree with my evidence, the conclusion of the green book,1/ namely, that we had or less anticipated the recent flurry of less favorable more and that our confidence in renewed, more economic news expansion by the third quarter is not normal economic buttressing this conclusion today, I should shaken. In like to focus my remarks on two key areas of activity, namely, inventories and defense spending. The report, "Current Economic and Financial Conditions," 1/ for the Committee by the Board's staff, prepared

There is little doubt that the increase in inventories in 1965-66 was excessive and that an adjustment began in the first quarter. The March data confirm the fact that inventory accumulation declined from the very sharp annual rate of $16.5 billion in the fourth quarter of last year to about $5.5 billion in the first quarter of this year. It also seems reasonably clear that more inventory adjustment remains. It is impossible, of course, to say what an appropriate level of inventories is at any given time. But if one assumes that the inventory-sales ratio of, say, mid-1965 was more or less normal, and if one assumes further that final sales this year will increase at about a 6 per cent annual rate, it would probably take a good part of the year for the inventories that are currently excessive to be absorbed. This conclusion also implies little further accumulation but no significant liquidation after March. This is, of course, a grossly oversimplified way of trying to measure excessive inventories. For one thing, it implies the excess stocks are more or less uniformly distributed among the various industries. In fact, that is not true, for they appear to be heavily concentrated in durable goods lines, although no longer in autos. A significant part is in the form of materials and supplies and work-in-process in defense industries. Another large portion is in the hands of manufacturers of construction and other materials and semifabricated products such as steel, nonferrous metals, and stampings. A third substantial amount is at wholesalers of consumer durables other than autos and various materials. This of the excess inventories may make the adjust composition less difficult, at least as it applies to the ment problem down of the increase in materials and eventual working associated with the defense production work-in-process build-up. assessment of the economic In a sense, one's whole be summarized in one word, Vietnam. We of outlook can definitive to say about the likely course have nothing of defense spending. But certain recent future course suggest that such spending will be signif developments icantly above the January Budget Document projections, current fiscal year and next year. both in the The first-quarter estimate of defense spending in the GNP accounts has been revised upward twice--first, of $2.5 billion in the Budget from an implied increase

to $3.3 billion in Commerce's first published figure, and now to $4.2 billion. Also, two independent sources suggest that spending in fiscal 1968 will exceed the figures given in the Budget Document. First, Senator Stennis has suggested that a supple mental appropriation of from $4 to $6 billion will likely be needed next year. Secondly, a statistical calculation developed by our staff that relates GNP defense spending to current and lagged contract awards comes up with the conclusion that defense spending in fiscal 1968 could well exceed the estimates in the Budget by $5 billion or more. And to top it all off, the military and political news about Vietnam and now about the Middle East is certainly consistent with the judgment that defense spending is much more likely to be higher than earlier estimates. The only news which on its face was contradictory to the assumption of considerably higher defense spending was contained in last week's testimony of Secretary Fowler and Budget Director Schultze before the House Ways and Means Committee. They suggested that the Administrative Budget deficit in fiscal 1968 might be $3 billion more than estimated in January, assuming the 6 per cent tax surcharge with an enactment of effective date of July 1. This estimate apparently implies an increase in defense spending of only about over the January projections. Both a billion dollars though, that this deficit estimate and men admitted, defense spending figure could be underesti its implied mated. This may prove to be the understatement of the year. In conclusion, some of the apparent contradiction between today's economic bears and bulls lies in the periods upon which they concentrate. The different time to be concentrating on the relatively near bears seem term future and see at least a weak second quarter, the doldrums, and possibly a September auto strike summer bulls, on the other hand, are looking ahead of us. The and early fall and see a turnaround in beyond the summer coming at a time when total final the inventory situation sales in and of themselves may be private and Government services than the real resources absorbing more goods and at stable prices--except for a of the economy can provide while the small volume of unutilized relatively few months capacity we now have are being put to work. labor and plant

If this is a correct interpretation of many of the bearish and bullish views one hears today, both may be right. Assuming that the effects of monetary policy on spending spread out over a substantial time period, then the possibility of a relatively sluggish economy for the next few months and a strong one thereafter poses a dif ficult problem for monetary policy. From my own point of view, however, I feel the economic outlook over both the near term and the longer run is still cloudy enough to call for continuation of our current policy of cautious ease. Moreover, and perhaps most importantly, we already have had a signifi cant rise in long-term market rates of interest that may well have some dampening effects on housing and perhaps on other forms of investment in the period ahead. Mr. Mitchell commented that Mr. Koch's remarks reinforced doubts he had had about the appropriateness of the second sentence in the staff's draft of the first paragraph of the directive.1/ The sentence in question read "Output is still being retarded by adjustments of excessive inventories, but growth in aggregate final demands continues strong." To his mind that language implied strong growth in various categories of final demand. But strong growth did not appear to be evident in retail sales, or plant and equipment or housing starts; it was evident mainly in defense expenditures, While a large rise in GNP was projected for the third spending. that was still a projection for the future. quarter, at the moment of the evidence in the green book and Mr. Koch's On the basis that the proposed sentence was justified. statement, he doubted submitted by the staff for 1/ Alternative draft directives to these minutes as consideration are appended Committee Attachment A.

Mr. Hickman said that he had reached the same conclusion on first reviewing the staff's draft directive. Mr. Koch remarked that the sentence in question seemed appropriate to him in light of first-quarter GNP developments, when total final sales rose about $15 billion. It was true that the rise in Government expenditures, at an annual rate of nearly 20 per cent, was unusually rapid, but personal consumption expen ditures also increased at a rate of about 5 per cent. Within consumer expenditures, the evidence of weakness was limited mainly to durable goods; both nondurables and services were advancing at usual rates relative to income. It was not unreasonable to expect expenditures in the latter two categories to rise at their projected rates in coming quarters, and a turnaround in durable goods spending seemed likely. More generally, Mr. Koch said, increases in real GNP at a 4 or 5 per cent annual rate--the most that could be expected--would imply increases of about $10 billion per quarter in the GNP at its current level. With Government expenditures advancing at their current rates, much acceleration in the rates at which other kinds of outlays were advancing would put substantial upward pressure on prices. In response to Mr. Mitchell's question, Mr. Koch said he would agree that the main strength in the first quarter had been in

Government spending. Mr. Mitchell then observed that he thought it would be desirable to indicate that fact in the language of the directive. Chairman Martin commented that Mr. Mitchell's point could be accommodated by revising the second clause of the sentence in question to read, "but growth in final demands, particularly Government, continues strong." Mr. Daane said he was agreeable to pinpointing the Govern ment sector in the manner the Chairman had suggested, without trying to specify the degree of strength in the rest of the economy. He personally was more sympathetic than Mr. Mitchell was to the view that there was evidence of strength elsewhere. Mr. Partee made the following statement concerning financial developments: Expansion in the monetary aggregates has proceeded at very close to the projected rates since the last meeting of the Committee. Bank credit is increasing much less rapidly in May than in earlier months this year, as anticipated, and the outlook for June is for another moderate--though somewhat larger--rise. Business loan growth, in particular, has slowed markedly since mid-April. With continuing heavy capital market financing and some inventory liquidation projected, I would expect little strength in business loan demand over the summer, except for a temporary June tax date surge. Despite the recent slowing in bank credit expansion, average rates of growth over the first half still will be very high, reflecting our efforts to stimulate the economy and the associated resurgence in financial intermediation. But in a longer context this expansion can be viewed as a catching-up phase following the period of severely restricted

credit availability last summer and fall. Assuming that our June projections are about right, the rates of increase in the banking aggregates from mid-1966 to mid-1967 will have amounted to 6 per cent for the credit proxy, 11 per cent for total time deposits, and 2-1/2 per cent for the money supply. All of these increases are a good deal below the average rates of growth experienced in the two preceding years of high prosperity. Similarly, the first-quarter flow of funds estimates show a sharp increase in total credit expansion, featured by a massive shift towards financial intermediation. But the $70 billion annual rate for total credit raised is not much different from the figures for 1965 and 1964 and is well below the increases of late 1965 and the first half of 1966. Moreover, the ratio of private borrowing to net private investment outlays in the first quarter remained somewhat lower than it had been prior to mid-1966. Thus I can see no reason, either in the banking numbers or in total credit flows, for faulting the performance of policy over this period, nor for changing its stance at present. Renewed vigorous economic expansion later on may require increased in time, of course, but I agree with Mr. Koch restraint situation remains rather spotty and that that the current that decision need not be made now. Of immediate significance to the Committee, however, the continuing disparate movements in interest rates. are has continued very strong, with The Treasury bill market rate down 25 basis points further since the the 3-month of the Committee. But the capital markets last meeting have remained under exceptional pressure; yields on long municipals, and new issue corporates have Governments, by fully 40 basis points over the last 6 weeks increased distance of the record highs and are again within hailing reached late last summer. important degree the reflect in Both developments expectations for the in investor continuing deterioration and bond prices. Most if course of interest rates future that there will seem convinced not all market participants later in the year, are concerned be a sharp economic upswing intensification of the war about the possibility of a major very large Federal deficit foresee the need for in Vietnam, half, and anticipate con financing operations in the second at least in long-term private credit demands, tinuing strong Under these circumstances, there is a strong and markets. by investors, and a corres pervasive desire for liquidity long-term fixed-dollar commitments. weak interest in pondingly

There obviously is substance to these apprehensions, but the question is one of degree--has investor sentiment, and therefore the change in yield levels, been overdone for now? In short-term markets, constraints on the supply of instruments do appear to have played an important role in the yield decline. The supply of Treasury bills available to the public has dropped unusually sharply this year, reflecting retirements and official purchases by the System and by the Home Loan Banks, and banks have not seemed especially eager to push up their totals of short CD's. After mid-year this situation is likely to reverse, as the supply of short-term Government securities increases sharply with deficit financing and banks perhaps become more interested in issuing Cd's to finance fall loan expan sion. In long-term markets, supply has also played an important role--in the opposite direction--as buyers have had to absorb record volumes of corporate and municipal bonds, as well as large amounts of participation certifi cates. But here, unfortunately, the prospect of a reversal after mid-year is far less certain. The major congestion in long-term markets has been in the corporate area, where public bond offerings have been truly massive. In the first four months, such offerings amounted to $4.6 billion--nearly double the year-earlier total--and no respite is in store for May and June, when calendars continue very heavy. There are three possible grounds for expecting a decline in new issue volume later on. First is that corporations, having reduced liquid asset holdings much less than seasonally early this year, may soon reach desired liquidity ratios once the very tax payments are out of the way. heavy second-quarter The second is that private placement activity is on the rise, which may serve to shift financing from the more interest-sensitive public market. And the third consid eration is that the spread by which corporate outlays for fixed investment and inventories has exceeded internal is declining sharply as the year progresses. funds be extremely hazardous to Nevertheless, it would predict a decline in future capital market financing, in influence that the decisions of a view of the great relatively few corporations can have on the totals. In months of this year, for example, the surge the first four attributable to the fact that 30 in financing was mainly bond offerings of $50 chose to make public corporations

million or more, as against only 13 in the same period last year. Most of this increase represented the issues of manufacturing corporations that seldom come to market. There is a large number of such potential borrowers, and more could decide to come to market because, for example, they wish to reduce their dependence on bank financing or squirrel up liquidity as a hedge against the future. And most such manufacturing firms would probably not be dis suaded by historically high interest rates, particularly if they think rates may move higher in the year or two ahead. High interest rates can influence other borrowers, however, including smaller business enterprises, State and local governments, and home buyers. And many investors can be influenced in how they commit their funds by the in yields available. It seems clear, for differentials that the recent sharp rise in bond rates presents example, a threat to full recovery in the mortgage market. Institu investment latitude already appear to tions with flexible be diverting important amounts of funds to the bond market, and are likely to become progressively less interested in pushing for mortgage commitments if the yield spread as against bonds narrows further from what already is an all support for the residential mortgage market time low. Major from the savings and loan associations, of course, is coming but the record inflows to these and other intermediaries too if savings rates are reduced at could be jeopardized in market yields spreads into the midyear or if the rise instruments that provide a better intermediate-maturity substitute for deposits. in the recovery to curb It seems altogether too early of mortgage and other non-business credit. More the flow in long rates could prove over, a continuing uptrend dangerous, coming on the eve of heavy Treasury exceedingly markets. There could demands in the short and intermediate whole rate structure that would be be an escalation in the in terms of the least premature, if not unwarranted, at economic outlook. a strong upward trend in If we are in the midst of that the System could rates, there may be little long-term But some of the current do to stem the tide. or should and investor sentiment may borrowing may be anticipatory, near-term economic developments. be too sour for prospective set for a market rally, which so, the stage may be about If and help set in motion by focusing the System could encourage

its operations on coupon issues during the next few weeks, when a net of more than one-half billion dollars in additional bank reserves needs to be provided. The Committee's desire to aid long-term markets, to the extent feasible within the context of the System's normal reserve supplying operations, could be recognized explicitly by adoption of alternative B for the directive, which I would recommend. In reply to a question by Mr. Ellis, Mr. Holmes said that the Treasury probably would have to raise cash in the market shortly after mid-year. Mr. Hickman referred to the proposal that part of the reserve needs in the coming peroid might be met by buying coupon issues rather than bills. He asked whether any thought had been given to the possibility of also selling bills, which were in short supply, and concurrently buying intermediate- and long-term bonds. Mr. Holmes said that for the peroid immediately ahead the Desk had enough room to operate in coupon issues without engaging in the type of operation Mr. Hickman had mentioned. There were coupon operations, although at present the risks in over-doing the market was favorable to them. The Desk's technical position of to let $100 million of its bill yesterday in bidding so as action as a small step in the direction holdings run off might be viewed suggested. that concurrent sales of bills Mr. Hickman then remarked might be kept in mind as a possibility and purchases of coupon issues market situation persisted. future, if the present for the

Mr. Partee observed that such swaps would be an important departure from past practice. In any case, they were not likely to be necessary in the coming period, when the Desk would have the latitude to buy as much as $500 million of coupon issues in the course of meeting reserve needs. After that, of course, the Committee might need to consider the bigger step of engaging in swaps, depending on market conditions at the time. Mr. Mitchell asked what was happening to the proceeds of the current heavy corporate bond offerings. In particular, were they being invested in short-term market instruments? Did corporate buying account for much of the recent demand for bills? Mr. Partee said that the available data indicated that the first-quarter decline in corporate liquidity was much less than seasonal. In that period corporations may have bought CD's and bills, although the supply of bills available to the public had declined sharply this year, and CD's outstanding had not been rising recently. Commercial paper, however, had been expanding rapidly. Bank loan figures suggested heavy business loan repayments in the last few weeks, probably reflecting in part the use of bond financing proceeds. whether there were any indications that Mr. Hickman asked the recent tendency for borrowers to bypass the banking system was

putting pressure on the prime rate. In his judgment the current prime rate was too high by at least 1/2 point. Mr. Partee said he had heard relatively little discussion of the prime rate recently. Mr. Hersey then presented the following statement on the balance of payments and related matters: I want to speak this morning about the long-run problem of the balance of payments. But four points about recent developments are worth recalling first. One is that during the seven months just past, the liquidity deficit before special transactions has been running at a rate near $1 billion a quarter, having been swollen by heavy imports, by increased military expenditures abroad, and perhaps also by unidentified movements of U.S. business funds into sterling. The second point is that within this recent period, the merchandise trade balance has improved: imports have passed their peak and exports still rising. Third, identified flows of seem to be private investment funds largely offset the trade in the first quarter of 1967 and kept the improvement adjusted liquidity balance from improving much. Finally, the deficit on the basis of official reserve large this year because of transactions has been very Euro-dollar market by U.S. banks; the repayments to the outflow of these repayments has but very recently the for the moment to some inflow, stopped and given place the renewed efforts of some banks to get paralleling domestic CD money. economy, like our own, has been The international months. This is still the last few standing almost time for U.S. exports. It may going to be a testing time to take a look at the long-run also be a good problem of the balance of payments. three kinds of paths to There are really only for the United exchange equilibrium international the country might simply States to take. Some day in a desperate gambler's mood, and resign give up,

to other countries the fixing of exchange values for the dollar. The consequences would be unpredictable, but probably chaotic; as Mr. Solomon suggested three weeks ago, we might end up with an undepreciated trade dollar and a depreciated capital dollar. Or, the country might take the path of isolationism, raising tariffs to keep imports out and building up administrative restric tions to keep capital in. Or, thirdly, we can still aim to make headway along the path we think the country prefers and should prefer--that is, the path symbolized by IMF, GATT, and OECD, a path of rational international cooperation. When I use words like those, the first questions you must be asking are what kind of cooperation do we want and how are we to get it. Within the government, questions like these receive attention, but it is a pity that in the public mind the question of cooperation to get balance restored has not taken root; it has been squeezed out by the questions of cooperation to finance and avoid speculative disturbances, as the U.S. deficit the separate question of cooperation to well as by invent a supplementary reserve asset. cooperative solution for restoring equilibrium Any include elements relating to trade, to will have to and aid for the nonindustrialized world, to investment capital movements among the industrial countries, and to The Europeans do not see eye to military expenditures. us on the various elements of a solution, but eye with it is much too soon to give up hope. expect the Europeans to inflate their We cannot price levels deliberately so as to bring about a of prices and costs within the present realignment structure--a realignment that I for one exchange rate think is very much needed to help restore equilibrium. Italian policies in 1964 and British and French and 1965 and 1966 are proof enough that German policies in at one stage or another. they will all resist inflation open to us to outdo them in maintain Nevertheless, it is if we can do that, they can ing price stability--and may not always like U.S. hardly disapprove. They is universal acceptance that competition, but there United States is an essential price stability in the element for a cooperative solution. and aid, the United States, With respect to capital emphasis on the need for development as you know, puts much

of European institutional structures and fiscal policies for a more effective mobilization of savings and for its channeling into foreign lending and aid. The Europeans, for their part, have urged us over the years to let U.S. interest rates rise and to put administrative restraints on U.S. capital outflows. By last year we had gone quite a distance along these lines, and many Europeans are not so sure now of what they want us to do. I must turn to what this Committee is directly concerned with: the relation of U.S. monetary policy to any cooperative cure of the imbalance in international payments. Two principles define the relation adequately, I think. First, because the balance of payments cure is a slow matter, changes in U.S. monetary policy should usually be determined only by domestic needs and objec tives. But, secondly, because an essential ingredient of any cooperative solution for the balance of payments is U.S. price stability, the general slant of U.S. monetary should be biased toward the price stability objec policy tive--more so than if we had no external deficit to get rid of. the past six or seven months the Committee During has deliberately disregarded the second of these the three largest economies of principles. Last autumn those of the United States, Germany, the western world, on the edge of recession or in and Britain, were either of view, the top priority then was it. From every point The Federal Reserve acted to prevent a world recession. in its role of international leadership, by rightly to the balance of payments temporarily giving low weight and future price stability. should now be asking ourselves some hard questions We price inflation. Such about ways and means of preventing the United States maintain as: by what means should allowing industrial capacity growth and stability without as to provoke an inflationary to rise so much utilization is it necessary or desirable boom? And, for example: in the U.S. economy go on that total non-Federal debt rate as high as to year at an average rising from year the decade through 1965? Or, 8 per cent, as it did in interest rates really generally: are low long-term more necessary for growth? such as these are resolved, Long before questions of timing. Even today we shall have to face a question recession is now the danger of world we must ask whether should now again Reserve policy and whether Federal past,

give special weight to price stability for balance of payments reasons. I cannot give an unequivocal answer of "yes" today. In Germany,the key country in Europe in this regard, we do not yet have evidence that an upturn has started. Information just received on British industrial production suggests that the cyclical recovery there around the year-end was tending to peter out in February and March. You have heard what Mr. Koch and Mr. Partee have said about the U.S. economy. Whatever the timing may be, it seems clear that once a new advance does get strongly under way the problem of maintaining price stability will force itself on us. Chairman Martin then called for the go-around of comments and views on economic conditions and monetary policy, beginning with Mr. Treiber, who made the following statement: Recent statistics show the economy in a sideways movement. Reduced inventory spending appears to be offsetting a substantial increase in final demand. The business atmosphere has become less buoyant and perhaps more realistic than it was only a few weeks ago. The economic situation, however, has strengthened in several fundamental respects. The inventory adjustment is apparently proceeding in a rapid but orderly fashion, while the housing indicators have continued to strengthen slowly. These developments are consistent with an out look for renewed and strong economic growth in the latter part of the year. The continued sluggishness of consumer buying remains a major source of uncertainty in the private sector of the economy, but the recent rapid build-up of consumer liquid savings, as well as the continued growth in personal income, suggests that some strengthening in this sector is the most likely prospect. At the same time, the Federal budget is highly stimulative. It is apparent that there will be no in income taxes at midyear. The fiscal stimulus increase half of 1967 is likely to be of record or in the second near-record proportions. The prospect for a simultaneous push later in the year, from both a highly stimulative fiscal policy and renewed strong total private demand,

is reminiscent of the situation that occurred in late 1965 and early 1966 when economic over-heating became all too apparent. The dangers of a reemergence of excessive demand pressure are heightened by the cost pressures that are now being created by generous wage settlements. I get the impression that 6 per cent annual wage increases, combined more often than not with cost-of-living escalator clauses, are now viewed as attainable targets in wage negotiations. With food prices likely to move higher in coming months, new wage demands may be even greater, while the escalator clauses under existing contracts will provide a further push in wage costs. All of this suggests that if excessive demand pressures develop on the scale of late 1965 and early 1966, there are Likely to be even more serious price consequences than at that time. The prospect for a renewal of rapid price increases and tight supply conditions in domestic markets becomes especially disturbing against the backdrop of recent of payments developments. The situation here balance deteriorating despite substantial recent is clearly in the trade surplus. The reported liquidity improvement deficit in the first quarter of the year was at a adjusted annual rate of $2.2 billion, but seasonally of special transactions the under after the elimination over $4 billion. Both of these deficit lying deficit was were about unchanged from their high fourth measures a $1 billion rise in our trade quarter rates despite the deficit on an official surplus rate. Moreover, basis was at a $7.3 billion seasonally settlements the first quarter, up from adjusted annual rate in quarter of 1966. The large $100 million in the fourth reflects a shift of foreign official settlements deficit banks. Some of holdings into central private dollar easier conditions in the these shifts resulted from and were reflected in the United States money markets, in the Euro-dollar market. decline of U.S. bank borrowings balance of payments situation The disturbing over-all moreover, to of the year appears, in the first quarter by the results of the in April, judging have continued for that month. the liquidity deficit flash report on and general financial Turning to the banking rebuilding and it seems clear that liquidity situation,

the corporate tax speedups have been the dominant factors in the large increases this year in bank credit and total credit flows. In May, however, bank credit is apparently rising little if at all, and the June forecast is for growth on a comparatively modest scale despite another surge in corporate tax payments. Such slowdowns are not disturbing in view of the sharp increases earlier this year, although a somewhat higher May-June average than is currently forecast would not be inappropriate. There is a large flow of funds into the savings banks and savings and loan associations. Mortgage credit is readily available. But current corporate issues are attractive to savings banks, and a number of savings banks are acquiring modest amounts of such issues. Interest rates on conventional and insured mortgages have been declining since last winter, but very recently we have seen at least one sign of a reversal in the direction of rates on conventional mortgages and scattered reports of increases in rates in the secondary market for FHA mortgages. The most striking current financial developments are in the long-term securities markets. Here rates have been under increased pressure since immediately after the recent discount rate reduction. Corporate and municipal borrowings have been at record high levels, and the markets are facing the prospect of very heavy borrowing through the remainder of the year by the U.S. Treasury and some of the Federal agencies. Although some long-term borrowing rates are approaching the peak levels of 1966, this seemingly is having little effect on willingness to borrow. The heavy corporate credit demands partly reflect the need to rebuild depleted liquidity positions and the heavy tax payments resulting from corporate tax speedups. Two other factors are probably also at work. First, the credit squeeze of last year may have led to a desire to increase liquidity as a hedge against a possible recurrence of the 1966 experience. Such a change in liquidity preference does not imply any definite planning by corporations to use such funds to finance spending on goods and services; rather it would be a precautionary measure. Second, a part of the heavy demands may reflect a decision to accumulate funds

now that will be needed for spending later this year or early next year. These two factors obviously have differing implications for the prospective strength of private demands for goods and services in the months ahead. But, with respect to interest rates, it seems to me on balance that as the second half of the year progresses, forces will be working toward higher, rather than lower, rates. Presumably the greatest effect will be on short- and intermediate-term rates, but there could also be some further rise in long-term rates. In summary, while the aggregative statistics remain on a plateau, the domestic economic outlook has strengthened. It will probably be at least a few more months before a clear uptrend in the economic indicators is firmly established. At the same time, market forces have resulted in a substantial and sustained rise in long-term interest rates despite continued ease in the short-term areas of the market. The rise in long-term rates carries with it the possibility of slowing the prospective economic upturn, especially in the housing sector, Against this background and the poor international balance of payments situation, it seems to me that monetary policy should remain essentially unchanged over the coming four weeks, and that open market operations should be conducted with a view to maintaining about the prevailing conditions in the money market. During the coming weeks the routine or market factors presumably will be absorbing reserves, and thus the System will need to supply reserves in order to maintain prevailing money market conditions. In such circumstances the purchase of coupon issues would seem in moderate amounts in the desirable. Such purchases should tend to relieve some of the light of availability long-term markets generally. Aggressive pressures on the undesirable and even perverse buying could generate expectations, especially if the markets shifts in market conclude that the System had a specific interest were to Caution toward buying in the rate objective in mind. for the purpose of relieving pressures longer-term markets is also reinforced by the strong economic in those markets outlook for the months ahead. I prefer alternative A. I As for the directive, two-way proviso clause which assume, with respect to the

is included in alternative A, that it is the current expectation that total bank credit will rise at a rate of about 5 per cent. I would expect the Manager to act under the proviso clause if the growth rate of the credit proxy were to fall much below that level or to rise substantially to, say, a 10 per cent level. Mr. Ellis commented that perhaps the best way to highlight what was occurring in New England was to contrast what the statis tics were saying about employment, production, and construction with the attitude of buoyancy and optimistic outlook that prevailed. For example, initial claims for unemployment compensation had been more numerous than a year ago for thirteen consecutive weeks through May 6. And yet the papers were crowded with advertisements of job offerings, labor turnover was extremely high, and there was no evident concern about difficulty in securing jobs. Workweeks of manufacturing production workers had continued to contract slightly and overtime had been reduced at some nondefense plants, were confidently seeking, expecting, and in many and yet workers though their contracts did not cases winning wage increases even for wage negotiations this year. provide formally contrast to the U.S. pattern, Mr. Ellis continued, In contracts had been declining in the last residential construction several months, but the increased availability of mortgages had for new construction and the accelerated the amount of planning that optimistic sense of moving ahead. market reflected

Mr. Ellis regarded the consumer spending pattern as a confusing mixture of gains and losses. The Boston Reserve Bank's seasonally adjusted April index for department store sales was down from its March level but held a few points above its year-ago level. Department store sales in the reporting sample for the four weeks ending May 13 were 8 per cent better than those for the same period of 1966, but that relatively good performance only neutralized the poor performance earlier in the year. Cumulative sales for 1967 were just matching those of last year. He would point out, Mr. Ellis said, that the volume of must be increasing. The number of checks business transactions handled during the month of April exceeded year the Boston Bank On a dollar-value basis, checks ago volume by 12 per cent. 3 ran 16 per cent ahead of in the four weeks ending May cleared flows in the District were comparable period. Credit last year's easing. At District savings by signs of more widespread dominated he had reported for the the rate reductions on mortgages banks meeting had now become widespread. Boston banks at the previous in the District 28 now reported the 70 non-Boston savings banks Of One bank had reported a common rate at 6 per cent. their most the other hand, the rates paid per cent mortgage rate. On 5-3/4 of the 80 banks in the continued to rise; seven on deposits

reporting survey increased their rates in April. Sixty-five per cent of those banks now reported 4-1/2 per cent as the rate they paid. Discussions with District savings bankers revealed some desire on their part for a lower rate on their deposits, but no willingness to start a downward trend. Happiness with the inflow of funds did not incline them to upset the relationships which supported that inflow. At commercial banks, too, liquidity was rebuilding compared to a year ago, Mr. Ellis continued. Investment port folios had been increased by about 25 per cent, with the major source of funds being the time deposit sector. Time deposits had grown 21 per cent in the past year in the First District, 8 per cent for the nation. With loan demand compared with unchanged or only slightly stronger, banks' willingness to supply it had been three months ago. was definitely greater than funds also that the banks were reaching into the There was evidence in signing up CD's. Long-maturity CD's had been fall maturities had ranged upward to boost in rates, which getting the largest Banks appeared to be points in the First District. 25 basis use late in the year when themselves with funds for providing could rise appreciably. District insur business bank loan demand that policy loans seemed to have leveled ance companies reported approximately twice their 1965 level, and that an off at a rate

increase in mortgage payments and in other flows of funds had permitted them to resume commitments at a rate comparing very well with the 1965 level. Mr. Ellis found the staff analysis presented in the green book and the blue book in advance of today's meeting to be espe cially useful because it concentrated more than usually on projecting the probable course of the economy for the remainder of the year. He agreed very much with the tone of that analysis and with Mr. Koch's comments this morning, and was glad to see the emphasis on final demand in the analysis. He found himself wanting to take issue with the projections at only two points, at both of which he thought the analysis was more conservative than was warranted. His first question related to the projec tion for "only a moderate growth in consumer expenditures in the second and third quarters."1/ He had difficulty accepting 1/ The language quoted by Mr. Ellis was employed on page 11-4 of the green book, in the context of the following passage: "In real terms, the rise in disposable income in the first quarter was larger than in any quarter of the past the second quarter flow of income will be year. Although somewhat smaller, the increase in spending power will still be substantial. Gains in total employment--although not in wage rates are continuing, while industrial employment--and tax-take in the first half the small increase in the personal an unusually high proportion of income of this year is leaving gains in consumer's hands. These high levels of real income in an exceptionally high and rising saving have been reflected consumers are therefore in the last six months, and rate over However, total retail sales a position to step up spending. since extended periods of high rates are still sluggish, and before, we are projecting savings have occurred of consumer expenditures in the second moderate growth in consumer only a and third quarters."

the logic of the argument that the occurrence of extended periods of high savings rates in the past was adequate reason to expect only moderate growth in consumer spending. The facts that incomes were growing rapidly and that savings had been high would incline him to expect a step-up in consumer spending of significant proportion--and he said that knowing the retail sales data for March had been revised downward. The second point at which Mr. Ellis' expectation differed from the staff's related to the estimates of Federal expenditures underlying the projections of the high-employment deficit shown in the table on page 111-18 of the green book. As he read the numbers, the staff's estimates were conservative. In particular, the projected third-quarter high-employment Federal deficit of $10.2 billion seemed to him to be an underestimate, and portended an even higher fourth-quarter deficit. Unhappily, Mr. Ellis said, both of those differences in projections served only to intensify concern for the inflationary pressures that would be present in the economy in the third, and especially the fourth, quarters of this year. In that connection Mr. Hersey had done the Committee a service in reminding it of the importance of preserving price stability for the sake of the balance of payments.

In seeking to translate such economic projections into policy prescriptions, Mr. Ellis continued, one obviously arrived first at a conclusion that fiscal policy as presently projected was quite inappropriate for the needs of the economy. Not only would fiscal policy be very stimulative; debt management would be impeding the possibility of utilizing monetary policy smoothly and effectively. The unprecedented borrowing needs, on the order of $18 billion, between July and December of this year obviously translated into frequent and large Treasury issues in the capital market. The obvious desirability of avoiding major shifts in monetary policy during the course of Treasury financing would mean that the opportunities for shifting policy after early July very likely to be limited. were In Mr. Ellis' opinion those reflections added up to a very the Federal Reserve. The projections uncomfortable choice facing intentions of consumers, business, and Government clearly indicated be satisfied by an economy at levels which could not to be spending of utilization of its labor already operating with high rates financing were going to The mechanics of Treasury resources. to schedule between July and December, make policy moves difficult was quite likely that the first of July it and yet between now and and there might rate might move up fractionally the unemployment to slight declines in the public attention given be additional

capacity utilization rate in manufacturing. But because monetary policy worked with a lag, because the projections were firm, and because later changes in policy would be difficult, in his judg ment the trend of policy should be gradually shifted into a posture of lessened ease between now and the first of July. It clear to the market that the Committee was not should become a rapid rate of bank credit expansion as a pressing to maintain of resisting recession. Mr. Koch had used the continued means the Committee's current policy. phrase "cautious ease" to describe rather a little more caution and a little He (Mr. Ellis) would urge less ease. Ellis said, it would be that point of view, Mr. From put major emphasis on coupon operations clearly inappropriate to into a downward path. The volume designed to tip long-term rates suggested--$250 million--was the Manager had of coupon purchases a continued intention to fight quite large, and would signal thought the Committee could not recession with further ease. He and an effort to do so of rising long-term rates, stem the tide would be interpreted as a deliberate policy move, Furthermore, Mr. Ellis remarked, the existence of high rates must be having some marginal effect in restrain long-term investment. In view of the GNP projection, the ing capital conclude that it should be thankful Committee might logically

for whatever restraint such rates will have provided by next fall. Without prejudice to the value of coupon operations on some occa sions, he saw no long-range objective in their intensification at this time and he would reject alternative B of the directive drafts. In keeping with the objective he had expressed of beginning to tip policy toward less ease, Mr. Ellis said, he would urge that the proviso clause of alternative A be amended to provide for off setting only those deviations of bank credit expansion in excess of the projected 4 - 7 per cent growth rate. That could be done quite simply by inserting the word "upward" before the word "deviations" in the proviso clause of alternative A. Mr. Irons reported that economic conditions in the Eleventh District were strong. Although rates of increase had moderated considerably and the District economy was moving sidewise, activity was at a very high level. The employment situation continued to be very tight around such major cities as Dallas and Houston, where rates were running in a 1.9 to 2.2 per cent range and unemployment of employed persons rose each month. The District the numbers unchanged for the past two or index had remained about production with activity in both durable and nondurable goods three months, industries relatively stable. Residential construction was down level, but nonresidential construction was up and from its year-ago construction activity probably was up slightly. Department total

store sales were 7 per cent above a year ago in the week ending May 13, and for the year to date they were up about 4 per cent. Automobile registrations were running about 8 per cent below last year. The picture in agriculture was mixed; moisture conditions had become good recently in large areas of the District, but in the western part there continued to be a serious need for moisture. In the financial area, Mr. Irons said, bank loans, demand deposits, and time and savings deposits were all down less than seasonally during the past three or four weeks. Most of the loan decline was in loans on Government securities; commercial and industrial loans were up by a moderate amount. The decline in time and saving deposits was due largely to a reduction in large CD's, although some bankers also reported that there had been some slowing of growth in consumer-type CD's. District banks, espe cially the larger banks, were more liquid now than at this time a year ago, just prior to the intensification of monetary restraint. However, they were not as liquid as they would like to be, in view of the loan demands they anticipate. They also pointed out that, necessary for the System to shift toward restraint if it became the impact upon bank liquidity might be more again this year, rapid; thus, their concern with the current liquidity position, it is somewhat better than a year ago. even though

Member bank borrowings from the Dallas Reserve Bank had been negligible recently, Mr. Irons continued, but District banks had increased their borrowings through the Federal funds market and in total were sizable net purchasers of Federal funds. Some District banks were maintaining day-to-day balances of funds purchased ranging from $25 - $35 million up to as high as $85 - $95 million. With respect to the national economy, it seemed to Mr. Irons that the situation was one of continuing adjustment of a sort that the Committee had desired and had hoped would occur smoothly. The current inventory adjustment, and the related adjustments in indus trial production and employment, seemed to him to be of that type. There apparently also had been an adjustment, if that is the word for it, between consumer income and expenditures, with the savings rate rising somewhat. Defense expenditures were continuing to rise, with no promise of moderating. He was concerned about the wage might develop and was inclined to agree with pressures that regarding the possibility of settlements involving Mr. Treiber Such wage rises would have a substantial 6 per cent increases. effect on prices. the money markets had performed rea In Mr. Irons' judgment sonably well in the past few weeks, but the capital market certainly Increasing numbers of observers appeared had been under pressure.

to be expecting tighter money market conditions. There was general concern about the Federal budget deficit and the means by which it would be financed; if an expansionary credit policy was to be employed to help finance it, it was expected that the System would be fighting inflation again soon. He found very few people who anticipated much help from fiscal policy. On the contrary, stimulative rather than a restrictive fiscal policy was anticipated. There also was concern about the U.S. balance of payments position. While the trade sector had shown improvement recently, other sectors had deteriorated to the point at which the over-all balance of payments problem continued to be serious. were becoming concerned about recent events and Also, more people with respect to silver and gold. The typical Eleventh speculations businessman did not like the notion of tinkering with District U.S. gold policy. of that general situation, Mr. Irons Against the background Committee to indicate by its was a good time for the felt that this made in credit policy. He liked actions that no change was being ease," and thought that should be the Mr. Koch's phrase, "cautious B for the directive objective. He favored alternative Committee's Committee had been and up the problem that the because it pointed market. He agreed that caution would be facing in the capital issues; it would be in operating in coupon would be necessary

unfortunate if the market came to believe that the Committee was virtually pegging long-term rates or setting a pattern for them. But it might be well to engage in operations in longer-term securities within reasonable limits and at times when the Desk judged such operations to be feasible, simply to give some support to the market and without leaving the impression that the Committee was attempting to peg a rate or a pattern of rates. With that qualification, he favored alternative B. Mr. Swan remarked that developments in the Twelfth District had contributed to the weakness in the national statistics for April. The unemployment rate in the Pacific Coast States rose sharply to over 5 per cent, with reductions in employment most marked in agriculture, construction, and manufacturing. However, rains and cold weather during much of April undoubtedly unusual played a significant role in that situation. The weather probably in construction activity and was a major factor in the weakness explained in good part the drop in lumber production; it probably when such starts were rising starts in the West at a time housing crops also had been District fruit and vegetable elsewhere. the period. Seattle was the affected by weather during adversely indeed, it was the only metropol one booming area in the District; that had a of 60 in the country, the District, out itan area in "B"--or "low unemployment"--rating.

In the three weeks through May 10, Mr. Swan said, total credit at the District weekly reporting banks declined about $350 million, about equally divided between loans and investments, in contrast to an increase of about the same amount in the corresponding period of 1966. The major banks remained net buyers of Federal funds and were maintaining a considerable volume of loans to securities dealers. As elsewhere, interest rates on longer-term CD's had moved up fractionally in the last few weeks, although currently there did not seem to be any great pressure on banks to obtain funds. Scattered replies from the mid-May survey of bank lending practices suggested a difference between the current situation and bank expectations for the longer run. The replies indicated both increased willingness by banks to make most types of loans currently and expectations of moderately stronger loan demands over the next few months. Last week, Mr. Swan continued, one California mortgage company based in Los Angeles announced an increase in rates on That company advised that the action re residential mortgages. by its principal outlet, the Metropolitan Life flected a decision Company, to favor other investments over residential Insurance increases by other lenders There had not been similar mortgages. as he was aware, by correspondents of in California nor, as far mortgage funds were still Metropolitan Life elsewhere. Certainly,

available through savings and loan associations at rates below that announced by this mortgage company. Nevertheless, the action was an indication of some pressure in the mortgage market. Mr. Swan said he had nothing to add with regard to the national economic situation; he was essentially in agreement with the analysis given in the green book and by the staff this morning. As to policy, he also thought that the Committee should maintain prevailing money market conditions and should continue about the present stance of over-all reserve availability, given the bank credit projection for June. He would hope, however, that bank credit growth would be closer to the lower end of the 4 - 7 per cent range projected than to the higher end. The money market blue book seemed rather reasonable to conditions specified in the for bills and other short him, but if the recent heavy demands he would expect the Federal funds rate term instruments persisted cent, even though other money market to be somewhat below 4 per were maintained as at present. conditions in the capital market, it Given prevailing conditions of coupon issues would be to Mr. Swan that some purchases seemed the reserve-supplying opera justified in the coming period within event. He would not want be undertaken in any tions that would as to create an impression issues to go so far purchases of coupon it did seem appropriate objectives. But Committee had rate that the

to attempt to relieve some of the pressures and to maintain orderly conditions in that area. Mr. Swan said he had a few comments on the draft directive. The opening sentence of the first paragraph said that " renewed economic expansion is in prospect" without any indication of timing. He would prefer to have the statement read, " renewed economic expansion later in the year is in prospect." With respect to the alternatives for the second paragraph, it was true that the Committee had engaged in operations in coupon issues in the past without mentioning them specifically in the directive. He believed, however, that under present circumstances a reference in the directive was desirable. Accordingly, he preferred alter native B to A. But he had two questions about the language of B. First, the phrase, "insofar as practicable" in the final clause of the draft seemed to him to raise many questions. He would suggest dropping that phrase, and adding the word "unusual" before the word "pressures." The clause would then read, "while modera ting unusual pressures in the capital market." Secondly, whether the Committee adopted alternative A or B he felt strongly that it should reintroduce the proviso clause, which had been deleted from the directive adopted at the preceding meeting only because even keel considerations were dominant then. He could accept either a two-way clause such as was shown in alternative A or the one-way

version that Mr. Ellis had suggested. If a proviso clause was added to B, however, he thought its opening words should be, "but open market operations shall be modified," rather than "but opera tions shall be modified," to make clear that the reference intended was not to operations in coupon issues. Mr. Galusha commented that the Ninth District economy still seemed to be going along nicely. It was not growing as rapidly as it had been, but through the first quarter it grew more, relatively, than did the national economy. He had never thought of his District as being an arsenal of democracy but obviously defense orders had had a lot to do with maintaining the growth of output. Optimism remained high among nonagricultural producers in the District, Mr. Galusha said. So far, there had been no hint of impending cutbacks in capital spending. One could find differences of opinion about the near-term future of construction, but his judgment was that optimism dominated. He had even heard in mortgage rates. There was a very sharp talk of an increase increase in building permits in April. Expectations in the construction industry were high. Lumber production in Western Montana had increased, but proof of sustainable recovery had yet to come in. remained dark, Mr. Galusha contin The mood of agriculture continued unhappy. Although generally ued. Farmers and cattlemen

there would be increased acreages, distrust of long-run U.S. Department of Agriculture objectives would keep plantings below maximum acreages. There was no credit pressure anticipated from agriculture in the District this year. Mr. Galusha commented that he had little to say this morning about monetary policy. It might be doubtful that further purchases of coupon issues, even if sizable, would produce a sharp decline in long-term rates. Such a decline would come only when financial markets became convinced that taxes were going to be increased. In visits yesterday on Capitol Hill he had found a surprising receptivity to a tax increase and a good deal of the Administration was not openly pushing for unhappiness that its tax program. That attitude was based on many things, but that people wanted to have a sense of mainly on mail indicating and of participation in the war effort. sacrifice Mr. Galusha continued, that long-term It was not clear, than they presently were, given rates should be a good deal lower prospects. Granting that, he the staff's appraisal of economic if long-term markets were less still would be more comfortable appeared to be, or were feeding by uncertainties than they plagued less on what hopefully were false expectations. At the moment, lower long-term rates. no good case for appreciably there might be point in letting those rates there also seemed to be little But come fall, would appear too high. go to levels which,

Translating that view into directive language presented the same problems to him as it had to Mr. Swan, Mr. Galusha said. But if he understood Mr. Swan's proposed language correctly, it would seem to give ample latitude to the Desk to curb its operations in the coupon area if it appeared that they were leading to the sub stitution of a new set of false expectations for the present ones. Mr. Scanlon remarked that the economic picture in the Seventh District was similar to that reported at the last meeting. A rapid, even inflationary, upswing was widely expected for the remainder of the year, but available statistical evidence on employment, output, orders, and retail trade did not yet support that view. The most spectacular development of the past few months, Mr. Scanlon said, was the large increase in new claims for unemployment compensation, which were no longer confined to the auto industry. Reports of Chicago purchasing agents for March and April showed faster deliveries and shorter order lead-times; stable inventories, production, and employment; lower new orders and backlogs; and poorer profits. Farm machinery had now expe rienced a letdown in demand, probably associated with the recent decline of farm income. Tractor sales in the Corn Belt were off more than 15 per cent from last year in the first quarter and by more than 25 per cent in March.

Banking data currently did not offer useful evidence as to the underlying strength of loan demand, Mr. Scanlon continued. The decline in outstanding loans during the first half of May was contrary to the usual pattern, but was not unexpected following the heavy tax borrowing in March and April. District bank expe rience was similar to that for the nation except for a relatively stronger increase in real estate loans. The first District responses to the quarterly survey of bank lending practices indicated "no change to moderate easing" in loan posture compared with three months earlier. Mr. Scanlon went on to say that because of the huge volume of financing in the capital markets and the wide spread between bank loan rates and commercial paper rates, business loans could drop sharply in the months ahead, except for tax periods, unless business activity were to be very strong. A recent Standard and Poor's survey indicated that only 39 per cent of corporate bond offerings this year were intended to finance plant and equipment expenditures, compared with 63 per cent last year. The bulk of those funds apparently was to be used for working capital, refinancing bank loans, and building liquidity. Mr. Scanlon noted that concern for liquidity continued to be reflected in changes both in bank asset portfolios and in liabilities. The reduction in loan-deposit ratios of major District

banks since late 1966 had been quite small, on the average, with the biggest declines at banks with ratios exceeding 75 per cent. Loan ratios of many banks had continued to rise. Holdings of short-term Governments and money market loans in relation to deposits likewise did not indicate much improvement in liquidity. Nevertheless, "borrowed" funds, from whatever source, had declined substantially, and although a large volume of funds had gone into "other" securities, those had been mainly short-term municipal obligations and PC's of Government agencies. Moreover, since March the major time deposit inflows had been in the form of consumer-type CD's, which the banks regarded as much less subject to withdrawals than the negotiable type but less stable than savings deposits. The fact that the biggest banks still appeared somewhat uncomfortable about their liquidity positions and desired to be better prepared for seasonal demands later in the year seemed to militate against any near-term downward adjustments in either loan or deposit rates at those banks. with the Manager that System operations Mr. Scanlon agreed issues had to be undertaken on a cautious basis. He in coupon ample latitude to operate in that area, would give the Manager any feeling on the part of market participants but would discourage Committee was now using a rate objective over the broad that the It seemed to him that that was a very spectrum of maturities.

delicate business, particularly in view of the amounts the Committee was considering, and that it would require extreme skill and care on the part of the Desk in order to avoid giving the wrong signals to the market. As to policy, Mr. Scanlon favored maintaining the prevail ing conditions in the money market--which was called for by both alternatives for the second paragraph of the directive. If, as Mr. Swan suggested, it was desirable to make reference in the directive to operations in coupon issues, he would accept Mr. Swan's proposed language. Mr. Clay said that, taking into account new data and revi sions of earlier data, current evidence on the private economy and its near-term prospects was somewhat more restrained than at the time of the last meeting of the Committee. However, when that recent evidence was put into the larger prospective of economic forces at work and prospects for the balance of the year, and when account was taken of the stimulative actions of the System in the last six months, the monetary policy implications of the in economic information appeared to be small. recent changes pattern of economic activity could not While the future be said to be clear, Mr. Clay continued, there was substantial that the economy would be moving ahead much more reason to believe third and fourth quarters of the year. Recent actively in the

official statements pointed toward a significant increase in the stimulative thrust of the Federal budget. Moreover, the lull in inflationary pressures probably would be short-lived, not only because of demand and wage developments in the nonfarm sector but also because of increasing food and farm commodity prices. All factors considered, it would appear appropriate at this time to conduct a more moderately expansive monetary policy than in the early months of the year. For the period immediately ahead, Mr. Clay thought mainte nance of essentially the current money market conditions probably would be satisfactory. In that connection, it would be desirable if the Treasury bill rate did not fall below the levels of last week. The developments in long-term interest rates and the increas ing spread between short- and long-term rates were matters of concern. That became particularly true as long-term rates once again approached levels that could have adverse effects upon the flow of funds to the credit markets relative to the savings institutions. While the demand for funds in the credit markets continued in its current volume, there was a real question as to how much could be accomplished by conducting open market operations in the longer maturities, at least without flooding the banking system with reserve funds. There probably would be some marginal impact upon both short- and long-term yields in using such

operations in providing desired reserves, however, and under present circumstances that would appear to be in order. Alternative B of the draft economic policy directives, with Mr. Swan's modifications, appeared satisfactory to Mr. Clay. Mr. Wayne reported that business activity in the Fifth District had shown some small signs of improvement in recent weeks. Building permits rose substantially in April to the highest level since March 1966 and reports indicated modest gains in construction activity, while insured unemployment had declined marginally. Two large national companies had announced substan tial reductions in the list prices of a wide variety of their man-made fibers. The optimism index of the Richmond Reserve Bank's survey panel was a shade higher than a month ago and now better than 80 per cent of the respondents expected stability or some improvement. New and unfilled orders remained weak but had perhaps improved a shade, while the pressure of inventories seemed to have moderated somewhat. The substantial cuts embodied in the recent tariff agreement would probably have a significant impact on the important textile and chemical industries in the District, but the fragmentary information presently available did not permit District weekly reporting banks continued any accurate appraisal. sellers of Federal funds although they had been to be substantial more active in expanding loans and total bank credit than city banks throughout the country.

At the national level, Mr. Wayne continued, the economy was operating at a high rate with near-full employment, despite several major adjustments which were the inevitable consequences of de-escalating an inflationary economy. In the somewhat calmer environment of recent weeks, monetary policy had been able to operate more effectively than in earlier periods. Well supplied with reserves from the earlier operations of the System, the banks had been able to meet their loan demand with little or no need to borrow. Short-term rates had been pushed down to or below the discount rate, but bank lending rates remained relatively high and sticky, while long market rates had been moving steadily higher. Those rates were matters of concern and if conditions were different it might be appropriate to return to a policy of aggressive ease. But several factors in the present situation gave him pause: the lack of improvement in the U.S. balance of the possibility of a rapid deterioration in the payments and country's international financial relations; the delayed effects the large amounts of reserves the System had already supplied; of indefinite budget deficits; the uncer the certainty of large but to restrain inflation if any supporting fiscal action tainty of the possibility of a quick return to the need should arise; and should develop it would be overheated economy. If the latter an unemployment. Since the country by the low level of accentuated

was not now facing a liquidity crisis, he did not believe it was necessary to supply reserves on the large scale of the first quarter. Rather, he would favor a policy which would encourage a moderate and sustainable growth in reserves and bank credit and he would hope that could be done without any great change in prevailing money market conditions. Also, he agreed with the suggestion in the blue book that in supplying reserves the Committee should emphasize as much as feasible the purchase of coupon issues, and therefore he preferred alternative B. Like favored a proviso clause. He would accept all the Mr. Swan, he amendments Mr. Swan had suggested, including the change in the first sentence of the directive. said that in his judgment the current heavy Mr. Mitchell financing was probably all to the goodvolume of capital market the degree that corporations were improving their liquidity to working capital, and paying off positions, increasing their though the large volume of financing had forced up debts--even interest rates and provided some measure of financial long-term restraint. He was still quite uneasy about the economic situation, could be traced to the posture of fiscal but he thought his unease year. More and more he had come policy, both last year and this needed, not only for the early fiscal action was to feel that to deal with the problem mentioned but also reason Mr. Galusha had and the problems of the real economy. of expectations

Mr. Mitchell noted that he was unhappy about the staff's reliance on the bank credit proxy as a policy guide. It was evident that banks could increase the degree to which they were intermediating if they wanted to; rate ceilings were not limiting their ability to obtain funds at present. But because corpora tions were repaying bank loans, loan demands were not strong and banks did not have an incentive to increase their intermediation. It was a mistake, he thought, to use as a criterion for policy a measure that was influenced by the extent to which banks chose to intermediate. About all the System should do in that connection was to try to dissuade the Home Loan Bank Board from rolling back the rate ceilings at savings and loan associations. Thus, Mr. Mitchell continued, he thought the Committee's objective should not be formulated in the directive in terms of bank credit. In what terms should the objective be formulated? interest rates were used as a criterion, it would If long-term appear that there had been a great deal of restraint recently. But he did not think that the recent increases in long rates actually were imposing a large measure of restraint; rather, they a kind of structural adjustment. He came back to the reflected policy. In his judgment, growth money supply as the criterion for recent months had been adequate, if not of the money supply in to restrict it at this point. generous, and he would not attempt

That led him to favor about the same posture for policy--not much change--that most other speakers had advocated today. He favored System purchases of coupon issues for two reasons. First, with the large demand for bills at present, it would be desirable to avoid reducing the supply. Secondly, such operations perhaps would result in some moderation in long-term rates. Mr. Daane said he had little to add to the staff materials and the discussion today of the economic situation. In his judg ment, the cross-currents and uncertainties--which were well illustrated by the colloquy between Messrs. Mitchell and Koch following the latter's statement--pointed clearly to the desir ability of an unchanged policy. While he (Mr. Daane) would not change policy today, he was concerned about the current and prospective balance of payments situation, and by the implications of the defense spending picture. The latter suggested an attempt to run a "guns and butter" economy, but he was skeptical as to whether that could be done without regenerating inflationary pressures. As Mr. Ellis had suggested, the Committee might be approaching the point at which it would be desirable to put more emphasis on caution and less on ease--that is, the point at which it might want to think twice about the risk of supplying reserves at a rate that might add to subsequent inflationary pressures. Today, Mr. Daane said, within the framework of an unchanged policy he would favor emphasizing coupon operations in the manner

and to the extent that the Manager had indicated, with full recognition that there was no intention of trying to alter market expectations regarding the level and pattern of interest rates. He thought coupon operations would be desirable not only in helping to relieve the market overhang, but, more importantly, in cushioning downward pressures on bill rates for balance of payments reasons. Mr. Daane said he would go along with the thrust of alternative B of the draft directives. However, he did not favor the language reading "while moderating pressures in the capital market insofar as practicable" because it carried the connotation that the Committee thought it could move against the tide. He personally would prefer language reading, "while emphasizing operations in coupon issues in supplying reserve needs." That make it clear that purchases of coupon issues were language would be made within the framework of reserve-supplying operations, to connotation that the Committee's opera and it did not carry any could move the market or that the Committee tions by themselves was trying to do so. by saying that he would not favor Mr. Daane concluded B, as Mr. Swan had suggested. a proviso clause to alternative adding clause was first from the time the proviso He had been skeptical about the desirability of attempting introduced into the directive

to "fine tune" Desk operations to deviations of the proxy from expectations, and he continued to have that skepticism. Mr. Maisel commented this was an unusual day. Mr. Daane had just made all the points he (Mr. Maisel) had wanted to make. He had intended to recommend a change in the language of alterna tive B along the lines of that Mr. Daane had suggested and he had also planned to speak against the proviso. Mr. Maisel agreed that the present was a confused period with many types of cross-currents. That was a prime reason why he wished to support the policy outlined in alternative B, although he had some misgivings over the way it had been pre sented. It seemed to him the Committee need not adopt a long-term interest rate objective or even state its concern in terms of a problem of over-all pressures in the capital market. First, Mr. Maisel said, he would like to stress the importance of maintaining a steady growth of credit to avoid distortions in the economy. The projections of bank credit growth, for the next six weeks and for the current fiscal year, were neither quite up to normal. There was no reason not to furnish a normal growth of total reserves. Granted that posture of continuing expansion, the System would have to furnish reserves during the coming period. Given the state of expectations in the market and objectives for the economy this year, a question arose the over-all concerning the logical place for those reserves to be injected.

It seemed clear to Mr. Maisel that the System should put the reserves into the long-term area rather than the bill area. In the bill area they would act mainly to force the bill rate down even further. Purchases would be competing in an area where the market, through its purchases, was showing its own strong preferences. On the other hand, if the System put them into longer-term issues, it would be aiding the market by supplying bills to help meet the market's desires for short-term liquidity. At the same time, the System would be decreasing the total of long-term issues, which the market said it was having trouble in digesting. It might be noted, Mr. Maisel continued, that to do other wise meant that the System would be continuing to shorten still further the average maturity of its portfolio, which already was a good deal shorter than in many past periods. The System had a large portfolio. That meant it had to determine its average than to lengthen it would mean the length. To shorten it rather adopting a portfolio policy opposite to its basic Committee was goals. staying in the short end, the Also, Mr. Maisel said, by future problems. He was somewhat Committee might be increasing reduction had not of a discount rate that the question surprised technical relations between concerned with the been raised by those

the bill rate and the discount rate. The gap below the discount rate was wider now than in over five years. Only in periods following two or more discount rate decreases in the past had there been a wider spread between the bill rate and the discount rate. Did technical relations hold in only one direction? It seemed to Mr. Maisel that the proper policy was simply to continue the Committee's current reserve policy, while adopting a portfolio policy related to the market. The reserves necessary to insure a normal growth in bank credit should be furnished through purchases of long-term issues. The Committee would not attempt to set the interest rates in the long-term market but would not stop them from adjusting in accordance with the demand and supply forces which its portfolio adjustments created. frequently supported the inclusion of a While he had proviso clause in past directives, Mr. Maisel said, he thought the to avoid the use of the proviso unless it had a Committee ought goal to which it could be applied. He had no very firm policy feelings at the moment that the Committee had a firm enough fix and the need for bank credit to recognize on liquidity requirements what a specific proviso should entail. that the directive should include the Since he believed Mr. Maisel supported the wording term "coupon issues" in it,

Mr. Daane had proposed for that purpose. Coupon issues should be emphasized in furnishing reserves. Mr. Brimmer said he favored alternative B for the direc tive with the wording regarding coupon issues that Mr. Daane had proposed. He would stress that he did not consider attempts to influence the level of long-term interest rates as "pegging" the market. He assumed that no one would want the Manager to engage in coupon operations in an aggressive way; he personally would favor supplying about half of the $500 million indicated reserve need through purchases of coupon issues, with those purchases spread over a period rather than made in a few days. It was impor tant to keep in mind the likelihood that rising long-term rates would have an adverse effect on flows of funds to savings intermediaries. He noted that the staff's projection anticipated of $2 billion in the third growth in residential construction increase accounted for roughly quarter, and that that expected private GNP projected for that one-fifth of the increase in total the percentage would be about the same quarter. He assumed that in the fourth quarter. If such growth in GNP was to be achieved, that the revival in housing was it was clearly necessary to assure that goal by itself Committee could not accomplish not aborted. The by moderating increases in long-term interest but it could help, System to maintain a firm stand rates. It also was vital for the on savings deposit rates. proposals for reducing ceilings against

Mr. Brimmer said he would also ask the Committee, and particularly the Reserve Bank Presidents, to give further thought to the problem of restructuring reserve requirements of smaller banks. In visiting recently with Ninth District bankers he had learned that the Minnesota Act abolishing nonpar banking also authorized State banks to invest up to 30 per cent of their required reserves in earning assets. That would seem to represent quite a threat to Minnesota bank membership in the System, and the System should give thought to lightening the burden of membership on smaller banks by use of the authority it already had. He hoped that could be accomplished before it was precluded by a need for over-all credit restraint. Mr. Sherrill said he went along with the majority view today favoring the continuation of prevailing money market condi he agreed that an upswing in the economy was tions because, while he was not sure about its timing. He favored alternative likely, but with the two-way proviso clause addedB for the directive, uncertainties. He favored operations again because of the existing would not get into the discussion of in longer-term issues, but with various objectives that had been objectives because he agreed to see the Committee use its Basically, he would like suggested. market as constructively as possible, operations in the longer-term not disturbed by the possibility that those operations but he was interest rates. He agreed on would have some impact on long-term

the need for caution. Perhaps coupon operations should be limited at this time to the $250 million figure that had been suggested, and the results evaluated before a decision was made to go further. Mr. Hickman remarked that it was clear from information published since the last meeting that the business picture deterio rated in March and April, despite the optimistic expectations expressed by some participants at the Committee's meeting three weeks ago. In real terms, GNP for the first quarter was revised downward rather than upward, and private final sales were weaker than originally estimated. In April, a number of major economic series either were level or declined, including industrial produc tion, new orders for durable goods, retail sales, housing starts, and factory payrolls. Thus, the over-all business picture was dominated by reports of declines or downward revisions in major cyclical indicators. For what it was worth, his staff estimated that real GNP, after declining slightly in the first quarter, at annual rates of 1.3 per cent in the second quarter would increase quarter. Those estimates were and 3.5 per cent in the third slightly less vigor in the close--although suggesting reasonably in the green book, and to quarter--to those presented third by Fourth District economists, who preliminary forecasts submitted Reserve Bank in early June. The figures would meet at the Cleveland position, and would be economy was in a fragile indicated that the for several months. below potential operating

Given that outlook, Mr. Hickman thought that monetary policy should be moderately accommodative, to facilitate the inventory adjustment and to provide the funds needed to finance the expected pick-up of residential construction. His own preference was to permit the aggregate reserve measures and the bank credit proxy to expand at an annual rate around 5 to 7 per cent, with free reserves fluctuating in whatever range was consis tent with those objectives. In addition, he would continue to do what was possible to relieve uncertainties and pressures in the long-term bond market. He therefore favored alternative B for the directive, with Mr. Swan's amendment to the first paragraph and Mr. Daane's to the second. As a matter of fact, Mr. Hickman said, a moderately accom modative monetary policy such as he had suggested would probably for an indefinite period, if it were not for the be appropriate that the Committee knew so little about the future magnitude fact had been trying to sort out fact from of defense spending. It escalated two years ago. If rumor ever since the war in Vietnam another major escalation, pressures would develop that there was the mix of monetary and fiscal policy. would require a change in defense spending could cause the In fact, a major escalation of financial stresses and strains that type of overheating and in late 1965 and 1966. At the present developed in the economy

time, however, those were only conjectures; with the information now available, and with major economic indicators level or weaker, the Committee should do the best that it could to restore sustain able stable economic growth. Mr. Bopp commented that it should be no surprise that business did not look quite so good now as three weeks ago. Adjustment of the economy to the tremendous inventory accumulation of the fourth quarter of last year could hardly be expected to proceed smoothly and continuously. Adjustment of statistics from preliminary estimates was also a fact of life that unfortunately had a greater effect on attitudes than it should. However, Mr. Bopp said, after netting out the backing and filling, he came out about where he had been three weeks ago. The economy remained basically strong, as witness the relative stead of employment and unemployment. But, after some favorable iness news for March, weaknesses had been called to attention again by declines in retail sales and production during April. Mr. Bopp observed, signs For the fourth consecutive month, dominate the economy of the Third District. of slack continued to Manufacturing activity was still weakening and final demand Those signs might not adequately reflect the remained sluggish. District indicators were final only current climate since most data were available, the rates of through March. Where April

decline were slowing. That was evidenced particularly in manufac turing employment. In addition, total unemployment had made a favorable about-face by April. Possibly reflecting those hints of an improved outlook, Mr. Bopp said, loan activity at Philadelphia banks in recent weeks had been increasing more than seasonally. Furthermore, expansion was expected to continue through fall. That expansion reflected (1) an expected pickup in economic activity, (2) some anticipatory borrowing by customers, and (3) expanded lines to small businesses under pressure from tax acceleration. Almost all of the bankers expected conditions to tighten as the summer progressed. Part of be seasonal, but part also reflected an expectation that would activity was picking up. As yet, bankers had not that economic to extend larger credit lines or loans to new been reluctant Some, however, expected reluctance to develop. customers. Mr. Bopp remarked that events in recent weeks seemed to clouded rather than clarified the outlook. One basic him to have extent and duration of the inventory adjustmentuncertainty--the degree of escalation of the war effort--had continued. A second--the uncertainties, for the present he become more acute. Given those as policy was concerned. He was inclined to mark time so far was in capital markets. The that conclusion also by developments led to issues and the stubborness of of a large volume of new persistence

longer-term rates reflected a belief that pressures for funds were likely to build up again before long. For those expecta tions to be turned around, it probably would be necessary for the Desk to pump in very large amounts indeed. He would do whatever was possible by operations in coupon issues to keep long-term rates from rising, but would make no major move toward further ease. That position was reinforced by the large current Federal deficit, Mr. Bopp said. If large deficits continued as the economy picked up in the latter part of the year, it might be close attention to the fiscal-monetary mix so as necessary to pay much stimulation. Caution in easing too much now to avoid too would help to achieve that objective. For the directive Mr. Bopp favored alternative B, as by Mr. Daane, and with a proviso clause. modified that economic conditions were spotty Mr. Kimbrel reported manufacturing figures showed in the Sixth District. The latest adjustments continued to affect a further decline, as inventory lumber, and furniture industries. However, adversely the apparel, the Sixth District, too, was beginning to see some ray of sunshine, of those adjustments were indicate that a good many which would that very recently a large manufacturer behind it. He understood calling back employees, and that of railroad equipment had been

two steel mills were doing the same thing. While those reports might be only straws in the wind, they suggested that the visible statistics might not be an entirely accurate barometer of what was going on now. Automobile sales, on the other hand, were down about 10 per cent in April, after improving in March, and remained depressed in early May. A spot check of local bankers also revealed a decline in the demand for automobile and other instalment loans. The biggest complaint of District farmers had been the weather, Mr. Kimbrel said. Drought conditions in Florida and South Georgia forced cattlemen to feed hay and citrus pulp to their cattle. The drought was especially severe in parts of Florida, which was finally blessed with rain late last week. The same spottiness noted in business and agriculture carried over into banking, Mr. Kimbrel continued. Business which showed a revival in the first half of April, lending, more recently, while other forms of lending improved. slackened should probably give as much attention Here again, though, one developments. According to to future prospects as to current early indications gathered from the lending practices survey, expected loan demand over the next three many District bankers Those prospects tied in with a consid months to strengthen. rates on savings certificates and erable reluctance to reduce

with the practice of the large Atlanta banks of offering higher rates on CD's than banks in New York. That anticipation of a stronger loan demand was probably related in part to developments in the bond markets, which in the last two weeks caused an increase in discounts on FHA and VA mortgages in his area to 3-1/2 and 4 points. Mr. Kimbrel said that he was, of course, quite aware that many of those same developments were taking place in other parts of the country as well, and that one could interpret them in different ways. But, to him at least, they suggested that monetary not be as expansive now as it had been earlier in the policy need the spottiness of the statistics should caution year, although In fact, to stay about where the against any sudden tightening. was might be not only good economics but would also get Committee who always favored a steady applause from those academic economists policy posture. if he were expressing a preference Mr. Kimbrel added that general direction of it would be in the for the directive alternative B. the deceleration of said it appeared that Mr. Francis would soon be halted, and that growth activity had been economic of the Federal Government budget deficit resumed. The increasing Monetary actions to the economy. a growing stimulus was providing

had been very expansionary since early this year, and the response in the real sectors of the economy appeared to have been relatively quick. Since monetary and fiscal developments usually had their chief impact after some lag, the basic present problem was not how to achieve adequate total demand but how to avoid excessive demand. A review of recent monetary developments indicated that they had been very expansive, Mr. Francis continued. In the past three months, total member bank reserves and nonborrowed reserves had risen at about three times their 1960-1966 trends. Federal Reserve credit and the money supply had risen at about double their trends, and commercial bank credit and money plus time deposits had risen about 50 per cent faster than their growth trends. Mr. Francis thought an important concern now was that the System might overreact to the recent need for stimulation. It was to keep in mind that actions had most of necessary continually a lag. With total demand at a high level and their effect after rapidly in coming months, with fiscal actions likely to increase recent large increases in supplies of so expansionary, and with that this was the time to avoid over money and credit, he felt in total demand of last fall and winter. reacting to the pause monetary policy for the future, Mr. Francis In formulating remarked, an effort should be made to visualize economic conditions as they would be when the Committee's actions became most effective.

Projections presented in the green book indicated marked increases in demands for goods and services and in real GNP for the balance of the year. The decline in real GNP from the fourth quarter of 1966 to the first quarter of 1967 represented only a slight deviation from the growth path of high employment output. Recent Administration statements regarding the fiscal outlook for the rest of the year indicated, even if the 6 per cent surtax was passed, a growing net stimulative thrust to the economy from the Federal budget. With that prospect, excessive inflation was likely to appear later in the year unless monetary actions were moderated now. Mr. Francis said the Committee should profit from last year's interest rate experience. By limiting interest rate increases in early 1966, the stage was set for the severe restraint required last summer. Forecasts of a growing Gov ernment deficit with large Treasury borrowing and continued heavy private demands for funds portended upward pressures on interest rates. System actions based on a desire to offset those pressures would provide loan funds in excess of planned saving. Such accommodating actions would lead once again to a need for severe restraint later in the year, with possible repetition of the market dislocations of 1966. If the fundamental situation was such that the Federal Government and the rest of the economy

combined were going to demand more funds than planned saving at current rates, only inflation could follow from attempts on the Committee's part to hold down long-term interest rates. Since there was a reasonable prospect of renewed inflation, the Committee should move at this time to reduce its stimulative force on total demand. As to immediate policy, Mr. Francis believed the blue book's projected increase of money at an 8 to 11 per cent annual rate from May to June would be too rapid. He recommended a growth in money over the next three months at a 2 to 4 per cent rate. Or, in terms of total bank credit, a three-month growth rate of 5 to 7 per cent would seem appropriate. To that end, he recommended an acceptance of a firming of capital market yields. In addition, he believed some firming of the money market might be necessary to moderate the expansion of money and bank credit. It was Mr. Francis' belief that the proviso clause in the directive had been useful to the System in reaching its proximate objectives more quickly, while not reducing its effectiveness in day-to-day operations in the money market. In view of the dif ficulties of selecting a money market target that would provide a desired growth in the Committee's proximate measures, a proviso clause seemed to be imperative for the effective implementation of Committee policy.

For the second paragraph of the directive, Mr. Francis favored language reading, ". . . System open market operations until the next meeting of the Committee shall be conducted with a view to achieving some firming in the money market, but opera tions shall be adjusted as necessary to moderate any deviations of bank credit expansion from a 2 to 6 per cent range." Mr. Robertson made the following statement: I think we need to recognize that there is a certain amount of uneasiness in the air these daysfor reasons which, if taken at face value, would have quite different implications for policy. There is uneasiness over the short-fall of recent business statistics below the most optimistic expectations of a few weeks ago. There is uneasiness about the state of the bond markets, with prices falling under the weight of the seemingly endless parade of corporate and municipal demands. Most of all, a deep-rooted exists concerning the course of the war uneasiness in Vietnam, and the chances that it may add still further to an already powerful but somewhat artificial stimulus to business activity. fiscal reasons might seem to argue for an Some of these policy, while others might seem to support easing of of situation, I think the a tightening. In this kind is to do neither. This right posture for the Committee let particular developments cause is not the time to Expectations can swing us to become jumpy or panicky. along behind them with and trying to follow widely, can simply lead to still policy changes counteracting and financial perform fluctuations in economic greater ance. many of the forces at As a matter of fact, a good to partly compensate for one another, work today ought which seems to me most likely to and the expectation a resumption of vigorous economic prove correct is for in the year. Accordingly, I think the advance later right now would be to hold a wisest policy decision the money market reasonably steady course, keeping

comfortable, and allowing the adjustments still in process to proceed in an orderly fashion. Even within such a policy of "no change," how ever, almost everyone who has spoken today believes there is room for added attention to the long-term markets--that we should give more support to the bond market. At the risk of sounding like a broken record, let me say again that I think this is an area of opera tions of which the Federal Reserve should be very wary. The benefits, it seems clear, are not very large or very certain, and the costs in terms of market interference can easily outweigh them. I do not mean to argue that the System should never intervene in the market for coupon issues. I recognize that there can be a turn of events in which a major overhang of securities inventories is virtually choking the market, and in that circumstance a decisive (and adequately explained) official move to buy up the excess supplies in one swift succession of operations wisest course. But stepping in to buy up may be the bonds when the market is in less extreme difficulties, if it is repeated often enough, will tend to reduce self-reliance, its capacity for responsible the market's behavior, and its ability to index and to balance demands and supplies of funds. Granted that changing the Manager might well be able to complete some particular buying action neatly, the hidden cost of any succession operations may be expected to unfold over the of such run in terms of a potentially less effective longer market performance. I, for one, would rather not pay that cost when it can be avoided. I am in favor of alternative A For these reasons, for the directive as drafted by the staff, particularly clause focused on bank credit. with its two-way proviso is likely to be a month of Recognizing that June financial churning, however, I would considerable encourage the Manager to wait for somewhat larger deviations from expectations than he would ordinarily on the upside, before bringing look for, especially the proviso into play. Martin said he sympathized with Mr. Robertson's Chairman in the long-term market; his position views on System operations

on that subject through the years was well known. But the Committee had taken another course for some time, and he thought it should be prepared to play its hand out. Accord ingly, he had no objections to coupon operations at this time. Much depended on how skillfully they were carried out, and he thought the Committee could rely on the Manager in that connection. If such operations were to be undertaken, he would favor referring to them in the directive, as was done in alternative B. The Chairman noted that the Committee was not unanimous on policy today, with Mr. Francis favoring some firming of money market conditions and the remaining eleven members favoring the of prevailing conditions. Also, a number of maintenance revising the language of the draft suggestions had been made for Committee try to arrive at a He suggested that the directive. majority, with Mr. Francis that was acceptable to the directive if he so desired. to be recorded as dissenting the Committee first considered In discussing the directive, made for revising the staff's suggestions that had been the various paragraph. Mr. Mitchell B for the second draft of alternative the proviso clause included he would rather not have indicated that directive at this time. Messrs. Brimmer and Treiber concurred, in the

and Messrs. Daane and Maisel noted that they had expressed a similar view in the course of the go-around. Chairman Martin said that he also would prefer to omit the proviso clause, which he had never liked much in any case. He asked whether there was any disagreement on the proposal to omit it. Mr. Wayne commented that he still had the preference for including the clause that he had expressed earlier, but he was not prepared to vote against the directive if the majority wanted to omit it. Mr. Swan indicated that he also preferred to retain the clause. He noted that the broader question had been raised of whether the directive should include a proviso clause generally. see the clause abandoned, and he He would be highly reluctant to would discuss the broader issue at some point. hoped the Committee Mr. Maisel commented that as a general rule he preferred to have a proviso clause in the directive, but thought that this was not the right time for it since the members were not of one view on how it should be formulated. remarked that the present seemed to be a Mr. Mitchell to include a proviso clause. singularly inappropriate time Chairman Martin commented that he would prefer to eliminate but his position on the issue was not hard the clause in general, and fast.

The discussion then turned to the formulation of the phrase relating to operations in long-term markets, for which Messrs. Swan and Daane had both proposed language different from that in the staff's draft. Mr. Robertson said he could vote for Mr. Swan's suggested language, calling for "moderating unusual pressures in the capital market." He could not vote for a directive which, as Mr. Daane had proposed, called for "emphasizing operations in coupon issues in supplying reserve needs." Mr. Daane said he thought it was the majority view that "while moderating unusual pressures in the capital the phrase suggest that the Committee was seeking to go further market" would The phrase he had suggested struck him than it in fact wanted to. because it indicated that coupon operations as more straightforward of supplying reserve needs, to be conducted in the context were consistent with the majority believed it was more nearly and he view. pride of authorship in Swan said he had no particular Mr, no objection to the general had proposed, and had the phrase he But he thought the word Daane's suggested language. thrust of Mr. a more neutral word could was too strong. Perhaps "emphasizing" be found.

Chairman Martin then suggested using the word "utilizing" rather than "emphasizing." Mr. Daane agreed that that substitution would be appro priate. He added that it might also be desirable to include the words "part of" before "reserve needs." The phrase would then read, "while utilizing operations in coupon issues in supplying part of reserve needs." In response to the Chairman's request for comment, Mr. Holmes said it appeared from the go-around that most members were agreed that coupon operations would have to be conducted cautiously, and comment also had been made to the effect that the Desk should have latitude to curb operations in coupon issues if they appeared to be leading to difficulties. He thought the word "utilizing" was more neutral than "emphasizing," and thus preferable. With respect to the first paragraph, the Committee agreed to adopt Mr. Swan's suggestion to insert the phrase, "later in the sentence, between "renewed economic expansion" year" in the opening and "is in prospect." Mr. Mitchell then proposed that the second sentence be revised to read: "Output is still being retarded by adjustments of excessive inventories, but with no interruption in the sharply in Government outlays now in sight the prospect is rising trend stronger growth in aggregate final demands." for

Mr. Koch commented that the language Mr. Mitchell had proposed did not appear consistent with the staff projections of a declining rate of increase in Federal defense spending. Such spending, which had risen at a rate of $4.2 billion in the first quarter, was projected to increase at rates of $3 billion in the second quarter and $2.5 billion in the third. Mr. Wayne said he would favor the language Chairman Martin had suggested earlier, following Mr. Mitchell's comment on the second sentence in the course of the go-around. Other members concurred in Mr. Wayne's observation. With Mr. Francis dissenting, the Federal Reserve Bank of New York was authorized and directed, until other wise directed by the Committee, to execute transactions in the System Account in accordance with the follow ing current economic policy directive: The economic and financial developments reviewed at this meeting suggest that renewed economic expansion later in the year is in prospect. Output is still being retarded by adjustments of excessive inventories, but growth in final demands, particularly Government, continues strong. Average wholesale prices have declined recently, but unit labor costs in manufacturing have risen further. Bank credit expansion has slowed in recent weeks from its earlier rapid rate. Long-term interest rates have continued to rise under the influence of heavy securities market financing, but short-term yields have declined further. Some further reductions have been made in foreign central bank discount rates. The balance of payments deficit has remained substantial despite some improvement in the foreign trade surplus. In this situation, it is the Federal Open Market Committee's

policy to foster money and credit conditions, including bank credit growth, conducive to renewed economic expansion, while recognizing the need for progress toward reasonable equilib rium in the country's balance of payments. To implement this policy, System open market operations until the next meeting of the Committee shall be conducted with a view to maintaining the prevailing conditions in the money market, while utilizing operations in coupon issues in supplying part of reserve needs. Chairman Martin then observed that the Committee had planned to continue its discussion today of the implications for its procedures of the "Freedom of Information Act." He noted that certain additional materials bearing on the matter had been distributed since the preceding meeting. These included a memorandum to the Committee from Mr. Hackley dated May 16, 1967, entitled "Rules regarding availability of informa tion," and a memorandum to the Committee from the staff dated May 17, 1967, entitled "Proposed availability of records relating to domestic open market operations at the Federal Reserve Bank of New York under the Freedom of Information Act." Also, at his (Chairman Martin's) suggestion, on May 22 the Secretary had with certain attachments that distributed copies of a memorandum had addressed to him on May 8, 1967. That memorandum, Mr. Hackley Market Committee and the Freedom of entitled "The Federal Open was concerned primarily with the question of Information Act," an executive order exempting the Committee's records seeking

from disclosure. / The Chairman then asked Mr. Hackley to open the discussion. Mr. Hackley said he thought the most important question immediately before the Committee was that raised at the preced ing meeting, relating to a possible executive order exempting all of the records of the Committee. Before turning to that question, however, he would touch briefly on certain other matters. First, last Wednesday the Legal Division had received from the Department of Justice, with a request for comments by last Friday, a revised draft of the Manual providing guidelines for Government agencies in implementing the Freedom of Information Act. The revised draft, in his judgment, was an improvement over the earlier draft. For example, it contained a specific statement to the effect that records of deliberations of an agency were completely exempt from disclosure under the Act. In that connec recommend that the Committee approve a division of tion, he would traditionally known as the "minutes" into two the documents taken, to be called "action one, a record of actions documents: to be made available on a deferred basis; and the minutes" and discussions, which would be other, a record of the Committee's Division's comments on the from disclosure. The Legal exempt referred to have been of the various documents 1/ Copies in the files of the Committee. placed

revised draft of the Manual were concerned principally with the desirability of clarifying the point that materials which were not exempt from disclosure might nevertheless be disclosed on a deferred basis, where some time lag was necessary to avoid impairing an agency's operations. In his judgment the law could be construed to permit such time lags, but it would be helpful to have the point clearly stated in the Manual. Mr. Hackley noted that with his memorandum of May 16 he had submitted a draft of proposed new Committee Rules regarding availa bility of information. He recommended that the draft be approved, subject to any necessary technical or editorial changes and subject to the Committee's final determination with respect to the length of the time lag for publication of its directives and authorizations. He would continue to recommend a time lag of 60 rather than 90 days simply because the shorter period seemed to comply more clearly with the requirement of the Act that statements of general policy be published "currently." However, he thought that a lag of 90 days would be defensible, if that turned out to be the Committee's preference. As the draft of the new Rules was formulated, Mr. Hackley continued, it not only provided for specifying the lag with which the Committee's directives and authorizations would be published, but also indicated that certain unpublished records would be made

available to the public with such time lags as the Committee might decide upon. For example, the Committee could approve a schedule indicating particular time lags--1 day, 8 days, 30 days, or what ever--with respect to the availability of particular records, relating to open market operations, that were held at the Federal Reserve Bank of New York. A proposed schedule of that type was attached to the staff's memorandum of May 17. The schedule listed only documents relating to domestic operations, but a similar list could be prepared for documents relating to foreign currency operations. Turning to the question of an executive order, Mr. Hackley recalled that at the previous meeting he had been directed to to the Department of Justice asking for such an prepare a letter the records of the Committee relating to both order exempting operations. A draft of such a domestic and foreign currency and a copy was attached to his memorandum letter had been prepared, had been distributed to the Committee. to Chairman Martin of May 8 that that it would be unwise and However, he continued to feel strongly order such as that contemplated by unnecessary to seek an executive of all records of the providing for exemption the draft letter, preferable for the Committee his judgment it would be Committee. In with the letter and spirit the position that in complying to take make available all records lean over backward to of the law it would

for which that was practicable; and, where absolutely necessary to avoid impairment of its operations, it would rely upon the statutory exemptions. He believed, and he understood that the legal staff of the New York Bank agreed, that practically all of the Committee's records either were exempt from disclosure under the Act or could be made available on a deferred basis. It was his personal judgment that the Committee would not find itself faced with any serious problems if it did not obtain an executive order. As he had mentioned at the preceding meeting, Mr. Hackley said, the Treasury Department had requested an executive order exempting its records relating to foreign currency operations. They had indicated that their first preference was for an amendment to the 1953 executive order regarding classification of defense making it clear that the term "defense information" information, embraced economic, financial, and monetary matters bearing on U.S. relations with foreign governments. Their second choice was for a executive order covering their foreign currency operations. separate If the Committee were to obtain an exemption for its own foreign currency operations, Mr. Hackley observed, in his opinion of amending the defense information executive order the procedure exemption would lead to many problems. The order to grant that and rigid requirements regarding classification contained detailed and declassification of documents, handling of classified documents,

clearances of personnel, and so forth, that would prove burdensome. It also would be necessary for the Committee to request authoriza tion to make original classifications of defense information under that order; while the Treasury had such an authorization at present, neither the Committee nor the Board did. Accordingly, if the Committee were going to ask for an executive order, he believed it should request one that was separate from the defense order. On checking with the Treasury this morning, Mr. Hackley said, he had learned that as yet they had had no reaction from the Department of Justice to their request, which had been made by letter on April 21. At this point, therefore, it was by no means certain that the Treasury would obtain an executive order exempting their foreign currency records. If the Committee wished to have the matter pursued further, it might authorize the staff to talk with the Treasury staff about coordinating the System's and Treasury's approaches to the matter more closely, and to hold discussions with the appropriate people in the Justice Department. Mr. Maisel noted that the next item on the Committee's agenda of information on policy with respect to publication today concerned network and on other System foreign currency drawings under the swap on the relation between asked Mr. Hackley to comment operations. He Rules and decisions on such questions. the proposed new

Mr. Brimmer said he had a similar question. The item Mr. Maisel had mentioned had been placed on the agenda following a discussion by the Board of a draft of the Special Manager's report for 1966, prepared for inclusion in the Board's Annual Report. One of the points discussed, he recalled, was a request by the Bank of Canada that information not be published at that time regarding a drawing they had made during the year under their swap arrangement with the System. How would such situations be handled under the proposed new Rules? Mr. Hackley replied that his recommendation would be that the Committee rely in such cases on a reasonable construction of the statutory exemptions, as the Justice Department's draft Manual suggested. In his opinion one or more of the statutory exemptions could be construed to cover information relating to operations under a swap agreement. Legally, swap drawings were borrower lender transactions, and it was clear from the draft Manual that information on such transactions was exempt. In reply to Mr. Maisel's question about the status of information concerning negotiations of swap agreements and Committee discussions on that subject, Mr. Hackley said he thought it was clear that such information would be exempt. Mr. Treiber said he would suggest that the Federal Reserve seek promptly an exemption from the Freedom of Information Act of

Committee records pertaining to foreign currency transactions. He had hoped that the Treasury would join in a similar request seeking the exemption of Treasury records pertaining to foreign currency transactions. As regards Federal Reserve foreign currency transactions, Mr. Treiber continued, all such transactions, whether initiated by the Federal Reserve or the foreign central bank, involved a confi dential relationship between the System and the foreign central bank. The System should not reveal to the public on an automatic basis information involving such a relationship. Operations on System initiative were undertaken to defend the dollar, a purpose by premature disclosure. Similarly, a that could be frustrated might find its purposes frustrated by premature foreign central bank disclosure. Unless arrangements, such as the swap arrangements, advantageous, the partnership could fall apart. The were mutually to be a partner if the American foreign partner might not care of the transactions on an partner was committed to disclosure of mutual discussion and a automatic basis and not on a basis the interests of the parties. weighing of the Federal Reserve Bank of New York Mr. Treiber noted that for the System and for the Treasury. conducted similar transactions alike and simultaneously executed the transactions were Sometimes would be much entity. Clearly, administration with the same foreign

simpler at the Federal Reserve Bank of New York if the basic dis closure rules were similar. If the Treasury transactions were classified as "confidential" or "secret" under the 1953 executive order relating to defense information, and the Federal Reserve transactions were a quite different affair, the difficulties would be many. If the Federal Reserve transactions were considered "secret" defense information, there would be a whole new array of problems. He trusted, Mr. Treiber continued, that there could be parallel treatment affording an exemption to records regarding foreign currency transactions by the Treasury and such transactions Reserve. He trusted that that treatment could be by the Federal for by an executive order addressed specifically to foreign provided He would consider it unwise to treat such currency transactions. transactions as secret defense material with all the cumbersome tape associated with such a classification. procedures and red that the Treasury thought a separate Mr. Hackley noted difficulties in that it would be executive order might involve of all categories of to include a specific enumeration necessary was required in the interest of information for which secrecy But there was no such enum national defense or foreign policy. order, and he did not in the existing defense information eration order. The latter in would be necessary in a separate believe one

general could parallel the defense order except with respect to the detailed requirements for handling classified materials. The sepa rate order might simply say that information of the Committee relating to foreign currency operations would be exempt from dis closure to the extent that the Committee determined was necessary. Mr. Maisel asked whether Mr. Hackley thought there would be any substantial difference in the Committee's procedures if it did or did not obtain an executive order exempting information on its foreign currency operations. Mr. Hackley replied that in his judgment the Committee's procedures could be substantially the same whether or not it obtained such an order, on the assumption that the Act permitted a time lag in disclosing information in cases where premature disclosure would impair performance of its statutory functions. Mr. Brimmer asked whether Mr. Hackley was saying that in the absence of an executive order the Committee could defer release of to foreign currency operations, but would some information relating such information available at some point. have to make all replied in the negative, noting that most such Mr. Hackley from disclosure in any case. would be completely exempt information In response to the Chairman's request for comment, Mr. MacLaury the next item on today's agenda, the said that, while not prejudging currency operations as respect to information on foreign goal with

seen by the staff concerned at the New York Bank was to avoid being forced to disclose more than was currently being disclosed as a matter of public policy. Although Mr. Hackley had suggested that obtaining an executive order exempting foreign currency information would make little difference, he would urge that such an order be sought. Of the nine specific exemptions listed in the Act the first, relating to information required to be kept secret in the interest of national defense or foreign policy, seemed most closely applicable to the System's foreign currency operations; but under the language of the Act it could not be relied on unless an executive order was obtained. He agreed that if such an order was sought it would be preferable to have it separate from the existing defense information order, and that it would be desirable to have System and Treasury foreign currency operations treated in parallel fashion. Mr. Daane commented that the Treasury's request for an execu tive order suggested that they thought one was necessary. Mr. Hackley agreed that that might be the case. He added that one possible approach would be to seek a single order covering foreign currency operations of both the Treasury and the System. Mr. Brimmer asked whether the Treasury was relying on the "Trading with the Enemy Act" in the present connection, and Mr. Hackley replied that he had no reason to think so.

Mr. Robertson asked whether there was any time limit within which an executive order had to be sought. If not, the Committee might authorize the staff to consult with the Justice Department while waiting to see what disposition was made of the Treasury's request for an order, If the latter was approved, the Committee could seek an equivalent order at a later date. Mr. Treiber said he would be disturbed if an exemption was granted in the manner the Treasury had suggested--by an amendment to the defense information executive order--since the procedures for handling materials under that order were cumbersome. He thought it would be desirable, before action was taken on the Treasury's request, to try to get a separate order, of simpler form, covering both Treasury and System foreign currency operations. Mr. Daane asked whether the question of the probable response to such a request had been explored with the Department of Justice. Mr. Hackley replied in the negative, noting that the Legal Division had felt that it should have definite authorization from the Committee before pursuing the matter with the Justice Department. however, he thought that such explora As he had indicated earlier, tions might be desirable. Chairman Martin said the Committee might authorize Mr. Hackley with the Treasury and Justice to explore all aspects of the matter

Departments and report back at the next meeting, on June 20. It would be necessary to reach decisions by that time since the Act became effective on July 4. The Chairman went on to say that he had discussed the matter with a number of people, including the Attorney General. The more he had thought about it the more he had come to hope that the Committee would not permit itself to appear to be dragging its feet in releasing information that was of legitimate interest to the public. On reviewing the Committee's minutes recently, he had become increasingly convinced that its domestic operations would not be disturbed if the current policy directives were to be published with a 60-day lag--and certainly not if the lag was 90 days. Mr. Daane noted that he would not be able to attend the Committee meeting on June 20 and accordingly would like to pursue the matter further today. While he was not opposed to providing information to the extent feasible, he was concerned about the possible effects on the Committee's operations and he was not convinced that there would not be the risk of considerable loss of effectiveness unless the Committee was able to retain maximum flexibility with respect to the release of information. He agreed that exploratory discussions should be held to the extent possible, but he would be disturbed if decisions were put off until June 20, when there might be fewer options left open.

Mr. Brimmer noted that he had made a similar point in the discussion at the previous meeting. He suggested that the Committee not confine itself to asking Mr. Hackley to explore the question of an executive order exempting information on its foreign currency operations. The Secretary of the Treasury might also be asked to seek postponement of action on the Treasury's request for an exemp tion until there was an opportunity to review the question with the Secretary and to work out a coordinated approach to foreign currency operations. Mr. Brimmer said he had changed his position somewhat since the previous meeting. He was now prepared to drop his earlier suggestion for seeking an executive order exempting information on domestic as well as foreign currency operations, on the assumption that the Committee would agree to a lag of 90 days for releasing He was opposed to a 60-day lag. its directives. there appeared to be general agreement Mr. Wayne noted that an exemption for information on on the desirability of obtaining executive order. He suggested that foreign currency operations by to discuss a coordinated approach Committee authorize Mr. Hackley the that if that did not prove with the Treasury, on the understanding reporting back to the would be authorized, without feasible he executive order covering System Committee, to request a separate foreign currency operations.

Mr. Maisel remarked that in his judgment an executive order indicating that information on foreign currency operations in general--that is, both those of the System and the Treasury--were required to be kept secret in the interest of foreign policy was preferable to an order directed to the System's foreign currency operations alone. Chairman Martin said that he and Mr. Robertson might under take to act for the Committee in connection with foreign currency information. He would much prefer not to have the Committee seek an exemption covering its domestic operations. Mr. Daane observed that if that was the position of the Committee--and he continued to have reservations regarding its appropriateness--he would share Mr. Brimmer's feeling that the lag in releasing the directives should be 90 rather than 60 days. Mr. Maisel commented that if the Committee agreed on a 90-day lag today, it might plan on publishing its policy record entries for the first quarter of 1967 on June 7, 90 days after the March 7 meeting. Chairman Martin remarked that such a publication date would be so close to the July 4 effective date of the Act that he could see little gain in anticipating the effective date. Mr. Brimmer said that whether or not the Committee planned record in June, it was important to to publish its first-quarter

reach a decision on the lag soon so that the staff would be able to move ahead in preparing for publication. He hoped that decision could be taken today. Mr. Daane agreed. He added that he had some questions regarding the list of documents relating to the operations of the Desk, attached to the staff memorandum of May 17, that were proposed for release with various time lags. He personally was not prepared to accept the list at this juncture. He asked whether Mr. Holmes was satisfied with it. Mr. Holmes replied that the list in question omitted a number of types of records at the New York Bank relating to opera System account. While the Bank's legal staff believed tions of the under the Act, it was not certain that those documents were exempt became necessary to disclose them that a court would agree. If it whether the lag permitted was sufficiently the question would be long to prevent damage to operations. then asked whether the members would indicate The Chairman for release of the a 60- or a 90-day lag they would prefer whether the shorter lag. that he personally favored directives, noting a preference for a 60-day Swan and Wayne expressed Messrs. would not object adding that he nevertheless lag, with the latter to 90 days.

Mr. Maisel said he thought a 60-day lag probably would be preferable, but he would be willing to start with a 90-day lag and consider shortening it later since it would be far easier to shorten to 60 days than it would be to extend the delay if the initial choice turned out to be inappropriate. Mr. Mitchell observed that in his judgment a 60-day lag probably would be adequate in the great majority of cases. However, since a 90-day lag might be desirable occasionally, he would prefer that the longer lag be used on a regular basis. Messrs. Brimmer and Daane commented that they felt strongly that the lag should be 90 days. Mr. Brimmer then asked if the Manager would comment on the question. Mr. Holmes said he agreed with Mr. Mitchell that a 60-day lag for releasing the policy directive might ordinarily not be damaging, but that a 90-day lag might be preferable for the reason Mr. Mitchell had mentioned. Chairman Martin then commented that the question of the sufficiently important to warrant more appropriate time lag seemed study. Accordingly, he proposed that the Committee defer a decision next meeting. It was unfortunate that Mr. Daane on it until its would not be present at that meeting, but if he so desired he could distribute a written statement of his views in advance.

Mr. Wayne noted that Mr. Hackley had made certain recommen dations which appeared to be noncontroversial, and on which the Committee might act today. One such was the recommendation that the Committee's minutes be divided into action minutes and records of discussion. Chairman Martin asked whether there was any objection to approving Mr. Hackley's recommendation concerning the minutes, and none was heard. Mr. Hackley asked whether the Committee was prepared to approve the draft of new Rules regarding the availability of information on a tentative basis. Mr. Treiber remarked that any such approval presumably would be in principle, with the language of the Rules subject to any changes of detail that might be found desirable after further study. Chairman Martin said it appeared that the Committee was prepared to approve the draft rules on that basis. The Chairman then remarked that the Committee obviously had some difficult decisions to make in connection with the Freedom of Information would reiterate his hope that it would not get into a Act, but he of seeming to be reluctant to release information to the position had been made in recent years in public. A great deal of progress was not trying to operate in total demonstrating that the Committee

secrecy. In cases where secrecy was important it should be preserved, but those who favored more disclosure had a good deal of support and he thought the System would be better off if it furnished as much information as possible. The Chairman then suggested that in view of the hour the Committee postpone discussion of the final item on the agenda, relating to policy on information regarding swap drawings and other System foreign currency operations. was no disagreement with the Chairman's suggestion. There the next meeting of the Committee would be It was agreed held on Tuesday, June 20, 1967, at 9:30 a.m. Thereupon the meeting adjourned. Secretary

ATTACHMENT A CONFIDENTIAL (FR) May 22, 1967 Drafts of Current Economic Policy Directive for Consideration by the Federal Open Market Committee at its Meeting on May 23, FIRST PARAGRAPH The economic and financial developments reviewed at this meeting suggest that renewed economic expansion is in prospect. Output is still being retarded by adjustments of excessive invento ries, but growth in aggregate final demands continues strong. Average wholesale prices have declined recently, but unit labor costs in manufacturing have risen further. Bank credit expansion has slowed in recent weeks from its earlier rapid rate. Long-term interest rates have continued to rise under the influence of heavy securities market financing, but short-term yields have declined further. Some further reductions have been made in foreign central bank discount rates. The balance of payments deficit has remained substantial despite some improvement in the foreign trade surplus. In this situation, it is the Federal Open Market Committee's policy to foster money and credit conditions, including bank credit growth, conducive to renewed economic expansion, while recognizing the need toward reasonable equilibrium in the country's balance for progress of payments. SECOND PARAGRAPH Alternative A this policy, System open market operations To implement Committee shall be conducted with a until the next meeting of the view to maintaining the prevailing conditions in the money market, as necessary to moderate any but operations shall be modified of bank credit from current ex apparently significant deviations pectations. Alternative B System open market operations To implement this policy, be conducted with a of the Committee shall until the next meeting the prevailing conditions in the money market, view to maintaining market insofar as pressures in the capital while moderating practicable.

Source

Also: Record of Policy Actions